If you are like me, the frustration is reaching critical mass. On one front, politicos and pundits grouse about what to do to save troubled homeowners and speed the economic turnaround. What they do not realize, or won't admit, is that to not permit home prices to find the bottom and let the free market reward the wise and punish the foolish, the recession could be long and deep. The same could be said about banks and investment banks. Many will be spared because the lesson which should be taught is a costly one.
Short speculators and and muckrakers are also getting my dander up. These "investors" will do anything to see their prophecy fulfilled. Take Lehman Brothers for example. The firm has ample liquidity, can tap the Fed for liquidity and can use non-treasuries as collateral. That still was not good enough for some on Wall Street. Lehman then announces plans to raise $3 billion via a convertible preferred deal. The short speculators denounced it as proof that Lehman is in trouble. This may or may not be true, but these same "experts" would be just as negative if Lehman did not come with a deal, expressing their opinions that Lehman cannot raise capital. This is a Catch-22.
As with politicians, market pundits should be taken with a grain of salt. We (I am also a pundit) have agendas. Mine to to shoot holes in the theories and bloviations of various talking heads and legalized market manipulators.
I will leave all with two words of advice. First, beware of strategies which blindly use cyclical historic precedents. Secondly, beware of regulators bearing new rules.
Monday, March 31, 2008
Wednesday, March 26, 2008
The Dead Parrot Sketch
Housing activists staged a demonstration in the lobby of the Bear Stearns building to protest the "bailout" of Bear Stearns, but are irate that there was no bailout of troubled homeowners. OK, let's set the record straight. Bear Stearns was not bailed out. It is gone, finis, kaput! It has failed and has ceased to be. It is an ex investment bank. Bear Stearns shareholders were wiped out. Two dollars or ten dollars it makes no difference. Shareholders were wiped out.
As I have said previously, I am no fan of bailouts and abhor moral hazards, but to let Bear go bankrupt would not have taught anyone a lesson and the Fed, Treasury or Congress would still be using taxpayer money, in this case to support a failing financial system. It was the bank failures of 1930 / 31 which which caused the Great Depression to be so deep and so long. The crash of 1929 merely started the ball rolling.
More writedowns are coming. More CDOs will be written down (especially if the monoline insurers cannot fulfill their obligations). Leveraged loans will haunt investment banks. If enough investors, lenders and counterparties become concerned enough to back away from another Wall Street Firm, we could see a replay of Bear. Who vould it be? Every investment bank is at least somewhat vulnerable. All it takes is some party panicking.
When will it all stop? When housing prices bottom, but that will not happen until home prices are permitted to seek their own levels. Bear Stearns shareholders lost almost their entire investment. Home owners are not nearly in as bad shape. After all, many troubled home owners never invested any money (no money down).
I write an Internal Use Only piece at my real job. However, a friend of mine, independently, has written about a subject on which I touched today. Please visit the following blog:
http://bondguy1824.blogspot.com/
As I have said previously, I am no fan of bailouts and abhor moral hazards, but to let Bear go bankrupt would not have taught anyone a lesson and the Fed, Treasury or Congress would still be using taxpayer money, in this case to support a failing financial system. It was the bank failures of 1930 / 31 which which caused the Great Depression to be so deep and so long. The crash of 1929 merely started the ball rolling.
More writedowns are coming. More CDOs will be written down (especially if the monoline insurers cannot fulfill their obligations). Leveraged loans will haunt investment banks. If enough investors, lenders and counterparties become concerned enough to back away from another Wall Street Firm, we could see a replay of Bear. Who vould it be? Every investment bank is at least somewhat vulnerable. All it takes is some party panicking.
When will it all stop? When housing prices bottom, but that will not happen until home prices are permitted to seek their own levels. Bear Stearns shareholders lost almost their entire investment. Home owners are not nearly in as bad shape. After all, many troubled home owners never invested any money (no money down).
I write an Internal Use Only piece at my real job. However, a friend of mine, independently, has written about a subject on which I touched today. Please visit the following blog:
http://bondguy1824.blogspot.com/
Tuesday, March 25, 2008
In The Long Run
The decision of JPM to pay up to $10 per share for Bear Stearns is being met with derision from all sides. Populists are claiming that taxpayer dollars are being used to "bailout" Bear Stearns. This is ridiculous. Tell BSC share holders who will receive $10 for stock which was trading at $80+ just weeks ago.
Others believe that it was unfair for the Fed to interfere and push JPM to pay up for BSC. Still others are miffed that BSC was not allowed to fail. Truthfully, I am usually in the third camp, but to do so would have caused massive panic over the health of the financial system It could have been the 1930s all over again. In the 1930s, financial institutions were permitted to fail and fail they did.
The Fed had to protect the financial system. It had to protect the financial system from irrational fears of irrational investors and fearful institutions. Irrational investors don't concern me as most individual investors are, shall we say, stupid. They buy tech stocks in spite of no earnings. They buy emerging market debt at lower yields than AA-rated corporate bonds. They buy low-coupon callable bonds and preferreds at discounts thinking they will be called (if I have to explain why this is stupid, you are a lost cause). They buy T-bills with yields around 1.00% and TIPs at negative yields.
When individual investors decline to invest in financial sector bonds I take it with a grain of salt. However, when institutions decline to loan money or trade with a firm, I become alarmed. Not necessarily because I think they have any insight into a potentially troubled firm, but because they may be concerned about the problems of others because they have the very problems they fear others have.
We are not done with the pain. Leveraged loans will be the blowup du jour in the coming weeks. Clear Channel promises to be the first and maybe biggest problem of the latest round. It is getting to the point that I almost want one of these big arrogant firms to blow up, but that would be cutting of my nose to spite my face. The saga continues.
Others believe that it was unfair for the Fed to interfere and push JPM to pay up for BSC. Still others are miffed that BSC was not allowed to fail. Truthfully, I am usually in the third camp, but to do so would have caused massive panic over the health of the financial system It could have been the 1930s all over again. In the 1930s, financial institutions were permitted to fail and fail they did.
The Fed had to protect the financial system. It had to protect the financial system from irrational fears of irrational investors and fearful institutions. Irrational investors don't concern me as most individual investors are, shall we say, stupid. They buy tech stocks in spite of no earnings. They buy emerging market debt at lower yields than AA-rated corporate bonds. They buy low-coupon callable bonds and preferreds at discounts thinking they will be called (if I have to explain why this is stupid, you are a lost cause). They buy T-bills with yields around 1.00% and TIPs at negative yields.
When individual investors decline to invest in financial sector bonds I take it with a grain of salt. However, when institutions decline to loan money or trade with a firm, I become alarmed. Not necessarily because I think they have any insight into a potentially troubled firm, but because they may be concerned about the problems of others because they have the very problems they fear others have.
We are not done with the pain. Leveraged loans will be the blowup du jour in the coming weeks. Clear Channel promises to be the first and maybe biggest problem of the latest round. It is getting to the point that I almost want one of these big arrogant firms to blow up, but that would be cutting of my nose to spite my face. The saga continues.
Thursday, March 20, 2008
Run, Run, Run, Run, Run, Run, Run, Run.
CIT Group is the latest financial firm to be victimized by the liquidity crunch. At work, one broker asked me why I didn't see this coming three or four weeks prior. I explained that, in today's market, it is difficult to see this coming, sort of.
What happened to CIT was akin to a 1930s run on a bank. In the 1930s, depositors, fearing a bank failure would rush to withdraw their money, thereby causing a bank failure. This is similar to what happened to CIT today (and to Bear, Thornburg, Carlyle and a host of other troubled firms). CIT was unable to access the capital markets to obtain liquidity. Why? Because investors would not purchase CIT commercial paper and bonds because they were afraid to own CIT debt out of fear of possible liquidity problems. In doing so, they caused the liquidity crisis they feared.
Fears of counterparty risk and diminishing liquidity are causing much investors and counterparty panic. This panic threatens to cause major disruptions on Wall Street. Possibly the worst disruptions since the Great Depression.
Who is immune? The real question may be; Who isn't immune. Fear, real or imagined, can cause liquidity to evaporate. Counterparties will refuse to do business with brokerage firms who may have liquidity issues. The Fed's liquidity programs may not help as planned.
There is a stigma about borrowing form the Fed. Lehman, Goldman and Morgan Stanley borrowed from the Fed's new primary dealer facility to reduce the stigma of borrowing from the Fed. Time will tell if there gestures will have the desired effect.
Some financial firms do not have access to the Fed. Problems could lie with consumer and commercial finance companies and regional banks. Some finance firms, such as CIT, have bank credit facilities. CIT tapped theirs, but what happens if banks, themselves strapped for cash, cut finance companies off from capital? The possibilities are frightening.
Fear has similar effects as greed, only in the opposite direction. The main difference is that bubbles caused by greed are corrected by price declines, investors are unhappy, but life goes on. Turmoil caused by fears, real or imagined, can have devastating results.
What happened to CIT was akin to a 1930s run on a bank. In the 1930s, depositors, fearing a bank failure would rush to withdraw their money, thereby causing a bank failure. This is similar to what happened to CIT today (and to Bear, Thornburg, Carlyle and a host of other troubled firms). CIT was unable to access the capital markets to obtain liquidity. Why? Because investors would not purchase CIT commercial paper and bonds because they were afraid to own CIT debt out of fear of possible liquidity problems. In doing so, they caused the liquidity crisis they feared.
Fears of counterparty risk and diminishing liquidity are causing much investors and counterparty panic. This panic threatens to cause major disruptions on Wall Street. Possibly the worst disruptions since the Great Depression.
Who is immune? The real question may be; Who isn't immune. Fear, real or imagined, can cause liquidity to evaporate. Counterparties will refuse to do business with brokerage firms who may have liquidity issues. The Fed's liquidity programs may not help as planned.
There is a stigma about borrowing form the Fed. Lehman, Goldman and Morgan Stanley borrowed from the Fed's new primary dealer facility to reduce the stigma of borrowing from the Fed. Time will tell if there gestures will have the desired effect.
Some financial firms do not have access to the Fed. Problems could lie with consumer and commercial finance companies and regional banks. Some finance firms, such as CIT, have bank credit facilities. CIT tapped theirs, but what happens if banks, themselves strapped for cash, cut finance companies off from capital? The possibilities are frightening.
Fear has similar effects as greed, only in the opposite direction. The main difference is that bubbles caused by greed are corrected by price declines, investors are unhappy, but life goes on. Turmoil caused by fears, real or imagined, can have devastating results.
Tuesday, March 18, 2008
You Never Give Me Your Money
The Fed eased by 75 basis points today, much to the chagrin of major Wall Street firms. However, the Fed's decision not to give into the Street tells us two things.
1) The Fed is concerned about inflation (as indicated by the Fed's text and two dissenting presidents.
2) It believes that cuts to the Fed Funds and Discount rates will be only marginally effective in easing the credit crunch.
Most outside observers are puzzled about why low short-term borrowing rates have not resulted in an improved housing market and economy. The answer is that banks need all the capital they can get for themselves. They need more capital to offset billions of dollars of writedowns, fund operations and to build reserves should the crunch deepen. The do not have the excess capital to lend to home buyers.
This is evidenced by the fact that 30-year mortgage rates are higher than before the credit crunch began last August. Banks are only using capital to write high-quality loans which can be securitized. Even then, investors what to be compensated with high yields. This is why we see 30-year fixed rate mortgages above 6.00%
What is going to free the financial sectors from its current death spiral? When Wall Street firms and banks announce that the writedowns are over and can ensure investors and counterparties that worst is over and the danger has passed the crunch will end.
Will a bailout of troubled mortgages be required to facilitate this? Maybe, but the morale hazard it creates is almost too much to bear. Why in the world should we bail out home buyers who bought too much home? Are people really dumb enough not to realize that adjustable-rate mortgages have rates that can rise? If so, these people deserve to lose their homes.
Alas, many will not lose their homes. The bail out is underway. The taxpayer will once again ride to the rescue and bailout poorly managed banks and stupid home buyers. Of course, only "rich" people (those making more than $70,000) will really be affected. Gotta love class warfare.
1) The Fed is concerned about inflation (as indicated by the Fed's text and two dissenting presidents.
2) It believes that cuts to the Fed Funds and Discount rates will be only marginally effective in easing the credit crunch.
Most outside observers are puzzled about why low short-term borrowing rates have not resulted in an improved housing market and economy. The answer is that banks need all the capital they can get for themselves. They need more capital to offset billions of dollars of writedowns, fund operations and to build reserves should the crunch deepen. The do not have the excess capital to lend to home buyers.
This is evidenced by the fact that 30-year mortgage rates are higher than before the credit crunch began last August. Banks are only using capital to write high-quality loans which can be securitized. Even then, investors what to be compensated with high yields. This is why we see 30-year fixed rate mortgages above 6.00%
What is going to free the financial sectors from its current death spiral? When Wall Street firms and banks announce that the writedowns are over and can ensure investors and counterparties that worst is over and the danger has passed the crunch will end.
Will a bailout of troubled mortgages be required to facilitate this? Maybe, but the morale hazard it creates is almost too much to bear. Why in the world should we bail out home buyers who bought too much home? Are people really dumb enough not to realize that adjustable-rate mortgages have rates that can rise? If so, these people deserve to lose their homes.
Alas, many will not lose their homes. The bail out is underway. The taxpayer will once again ride to the rescue and bailout poorly managed banks and stupid home buyers. Of course, only "rich" people (those making more than $70,000) will really be affected. Gotta love class warfare.
Monday, March 17, 2008
Blame It On The Banks
Bondholders of Bears Stearns have likely dodge a bullet, thanks to the Fed and JPM. We are hearing that Bear is the latest victim of the credit crisis. My ass it is. Wall Street firms knew many of their MBS securities were crap. They thought their quant models offered away to package garbage debt into stink-proof packages.
Lenders are also guilty. They gave mortgages to whomever could fog a mirror. They believed that they could securitize them and move them off the balance sheets by selling them to some poor sap who readily believed that AAA-rated securities could yield 6.00% in a 4.50% envirnoment.
It is the banks' fault that the Fed must ease in the face of inflation. It is their fault that the economy is tanking into the worst dislocation since the 1930s. This is a damn mess and it will take YEARS to sort out.
I do feel sorry for borrowers who were lied to. For buyers of investment property, those who did not do the math, investment banks and Wall Street firms, I say let them burn.
Lenders are also guilty. They gave mortgages to whomever could fog a mirror. They believed that they could securitize them and move them off the balance sheets by selling them to some poor sap who readily believed that AAA-rated securities could yield 6.00% in a 4.50% envirnoment.
It is the banks' fault that the Fed must ease in the face of inflation. It is their fault that the economy is tanking into the worst dislocation since the 1930s. This is a damn mess and it will take YEARS to sort out.
I do feel sorry for borrowers who were lied to. For buyers of investment property, those who did not do the math, investment banks and Wall Street firms, I say let them burn.
Friday, March 14, 2008
When I woke up this morning, She was gone, solid gone
The title from the Younblood's song "Grizzly Bear" sums up Bear Stearns' liquidity situation this morning. Bear Stearns, a well respected and storied Wall Street firm was brought to the brink of collapse after its liquidity dried up.
Bear Stearns is a major player in the mortgage securities market. The firm is smaller than the other major Wall Street firms and does not have as diverse a business model as its larger and thus was more severely impacted by the down turn in the mortgage market.
Writedowns and reduced profits from its core business have negatively impacted Bear's earnings. Counterparty fears caused other market participants reluctant to trade with Bear. To make matters worse, Bear's creditors cut them off from further capital.
If Bear failed the repercussions around the street could be catastrophic. Bear, as with all other dealers and banks, finances trading positions in the repo market. If Bear failed, it could be some time before such repos were unwound. Money deposited with Bear could be locked up for some time until the situation could be sorted out. Trades would not have settled, leaving counteparties without their promised securities of cashed and other firms could have been pushed to the edge of disaster.
Since no private sources wished to loan Bear money, Bear would need to go to the Fed. The problem is that, except via the repo market, the Fed only lends directly to banks. Bear's clearing agent JP Morgan was called in by Bear for help. Bear CEO Jamie Dimon contacted NY Fed President Geithner and arranged financing. JPM will give Bear 28 day financing which is ultimately backed by the. With liquidity tight and other firms likely to have further writedowns and liquidity problems of their own. The Fed needed to prevent Bear from failing. Bear is now scrambling to find a partner to avoid an implosion.
This underscores the true problems in the financial markets. It is bad. This is why the Fed will risk a prolonged recession. If it let the banking / financial system fail, instead of a recession, we could have a depression.
As recently as last week, there were some strategists who said that the liquidity crisis was overblown and this is just like 1990. This weeks liquidity problems only emphasize just how foolish that analysis was.
Look for more poor earnings , writedowns, Fed easing and inflation for the balance of 2008.
Bear Stearns is a major player in the mortgage securities market. The firm is smaller than the other major Wall Street firms and does not have as diverse a business model as its larger and thus was more severely impacted by the down turn in the mortgage market.
Writedowns and reduced profits from its core business have negatively impacted Bear's earnings. Counterparty fears caused other market participants reluctant to trade with Bear. To make matters worse, Bear's creditors cut them off from further capital.
If Bear failed the repercussions around the street could be catastrophic. Bear, as with all other dealers and banks, finances trading positions in the repo market. If Bear failed, it could be some time before such repos were unwound. Money deposited with Bear could be locked up for some time until the situation could be sorted out. Trades would not have settled, leaving counteparties without their promised securities of cashed and other firms could have been pushed to the edge of disaster.
Since no private sources wished to loan Bear money, Bear would need to go to the Fed. The problem is that, except via the repo market, the Fed only lends directly to banks. Bear's clearing agent JP Morgan was called in by Bear for help. Bear CEO Jamie Dimon contacted NY Fed President Geithner and arranged financing. JPM will give Bear 28 day financing which is ultimately backed by the. With liquidity tight and other firms likely to have further writedowns and liquidity problems of their own. The Fed needed to prevent Bear from failing. Bear is now scrambling to find a partner to avoid an implosion.
This underscores the true problems in the financial markets. It is bad. This is why the Fed will risk a prolonged recession. If it let the banking / financial system fail, instead of a recession, we could have a depression.
As recently as last week, there were some strategists who said that the liquidity crisis was overblown and this is just like 1990. This weeks liquidity problems only emphasize just how foolish that analysis was.
Look for more poor earnings , writedowns, Fed easing and inflation for the balance of 2008.
Thursday, March 13, 2008
Going Off The Rails In My Crazy Train
Watching the markets and keeping up with the financial media is enough to drive a person insane. Before you fly over the cuckoo's nest let's clear a few things up.
1) We are in a recession. There is now way to sugar coat it. Sugar coating does no one any good (no matter heads of retail brokerages are telling brokers and clients). Recessions, like rain, can be depressing, but are an unavoidable part of life. As with rain, things are rosier when it is over. The economy was riding a bubble and now the correction has to occur.
2) The Fed is causing the dollar to weaken and Fed easing is helping to slow the economy. What? Lower rates are slowing the economy? Yup, lower rates are inflationary. A good portion of record-high energy prices are the result of accommodative Fed policy. If this is the case, why doesn't the Fed pause or reverse course? The answer is because the banking system is so screwed up. In spite of eternal optimists blowing sunshine up investor's butts, many banks are bad shape. The Fed is risking a deeper, lengthier recession than what we have become accustomed to avoid a bank failure-driven depression.
3) Buying opportunities abound, if investors manage expectations. The problems are two-fold. Investors expect too much. They want high returns, low risk and no volatility. Yeah, I want that too. Why not just ask for eternal life.
Brokers are no better. Many brokers new to the business (entering in the past five or ten years) have little or no product knowledge. These incompetent buffoons are no better than appliance salesmen. The will read a script, tout past performances and point fingers when something blows up
Well this will the clueless advisers out there: The government agencies are not in danger. If one understood why they were formed and their functions, one realizes that their more needed now than any time in the past. MBS backed by agencies are buying opportunities.
I could go on, but I am pressed for time. Maybe next time I will explain why the issuing bank does not matter one bit when considering the purchase of MBS.
1) We are in a recession. There is now way to sugar coat it. Sugar coating does no one any good (no matter heads of retail brokerages are telling brokers and clients). Recessions, like rain, can be depressing, but are an unavoidable part of life. As with rain, things are rosier when it is over. The economy was riding a bubble and now the correction has to occur.
2) The Fed is causing the dollar to weaken and Fed easing is helping to slow the economy. What? Lower rates are slowing the economy? Yup, lower rates are inflationary. A good portion of record-high energy prices are the result of accommodative Fed policy. If this is the case, why doesn't the Fed pause or reverse course? The answer is because the banking system is so screwed up. In spite of eternal optimists blowing sunshine up investor's butts, many banks are bad shape. The Fed is risking a deeper, lengthier recession than what we have become accustomed to avoid a bank failure-driven depression.
3) Buying opportunities abound, if investors manage expectations. The problems are two-fold. Investors expect too much. They want high returns, low risk and no volatility. Yeah, I want that too. Why not just ask for eternal life.
Brokers are no better. Many brokers new to the business (entering in the past five or ten years) have little or no product knowledge. These incompetent buffoons are no better than appliance salesmen. The will read a script, tout past performances and point fingers when something blows up
Well this will the clueless advisers out there: The government agencies are not in danger. If one understood why they were formed and their functions, one realizes that their more needed now than any time in the past. MBS backed by agencies are buying opportunities.
I could go on, but I am pressed for time. Maybe next time I will explain why the issuing bank does not matter one bit when considering the purchase of MBS.
Monday, March 10, 2008
You Are My Sunshine
Richard Bove of Punk Ziegel authored a report stating that today's mortgage / financial debacle is just as overblown as it was in 1990. The problem is that his data is incorrect.
First, he says that the banks have plenty of capital. Challenge! Not when they are borrowing money at egregious rates.
Secondly, he states that 30-year mortgage rates are around 4.88%. Challenge! rates are in the mid 6.00% area.
Thirdly, he says that there is no liquidity crisis as evidenced by three-month LIBOR at 3.00% (actually lower). Challenge! LIBOR is in the 2,90% area because the Fed has pumped massive amounts of liquidity via lower discount and Fed Fund rates and Term Auction Facilities (which the Fed just increased to $50 billion). Think three-month LIBOR would be below 3,00% if the Fed was not pumping this much liquidity into the system? I don't think so. If the Fed would tighten today, three-month LIBOR would probably be 5.00% - 6.00%.
Mr. Bove's poor assessment of the current situation is bad enough, but I am informed that the head of major brokerage house has given this piece to branch managers and has told them to distribute it to brokers.
When I confronted brokers as to why she would do this, I was told that they were told that clients need to be told something positive. This is classic sales B.S. Tell retail investors something comforting even if it is false so they don't move their assets. What great disservice to clients.
How about tell clients the truth. Tell them that the situation is bad, but not hopeless. Tell them that opportunities exist in municipal bonds, agency bonds and bank, high-quality MBS, foreign bonds and bank and finance bonds and preferreds, if one is willing to ride out continued volatility.
Failure to tell the truth is what caused much of the subprime and ARS pain among investors. In the coming weeks, those who are blowing sunshine up the asses of investors will look stupid and those victimized investors will be very angry and will in fact leave.
First, he says that the banks have plenty of capital. Challenge! Not when they are borrowing money at egregious rates.
Secondly, he states that 30-year mortgage rates are around 4.88%. Challenge! rates are in the mid 6.00% area.
Thirdly, he says that there is no liquidity crisis as evidenced by three-month LIBOR at 3.00% (actually lower). Challenge! LIBOR is in the 2,90% area because the Fed has pumped massive amounts of liquidity via lower discount and Fed Fund rates and Term Auction Facilities (which the Fed just increased to $50 billion). Think three-month LIBOR would be below 3,00% if the Fed was not pumping this much liquidity into the system? I don't think so. If the Fed would tighten today, three-month LIBOR would probably be 5.00% - 6.00%.
Mr. Bove's poor assessment of the current situation is bad enough, but I am informed that the head of major brokerage house has given this piece to branch managers and has told them to distribute it to brokers.
When I confronted brokers as to why she would do this, I was told that they were told that clients need to be told something positive. This is classic sales B.S. Tell retail investors something comforting even if it is false so they don't move their assets. What great disservice to clients.
How about tell clients the truth. Tell them that the situation is bad, but not hopeless. Tell them that opportunities exist in municipal bonds, agency bonds and bank, high-quality MBS, foreign bonds and bank and finance bonds and preferreds, if one is willing to ride out continued volatility.
Failure to tell the truth is what caused much of the subprime and ARS pain among investors. In the coming weeks, those who are blowing sunshine up the asses of investors will look stupid and those victimized investors will be very angry and will in fact leave.
Friday, March 7, 2008
Tell Me Why
The plights of hedgefunds such as Carlyle Capital and firms such as Thornburg Mortgage are rattling the market. News that hedge funds are closing and Thornburg is teetering on the precipice of insolvency, in spite of the fact that the mortgage securities they hold are legitimately of high quality. The problems are two fold, leverage and volatility.
First, volatility in the MBS market has caused prices to decline of even high-quality MBS as buyers have vacated the market. Some investors remain unsure if they are truly buying high-quality securities. No one wants to catch a falling knife. Opportunists are exploiting the situation. Funds, such as PIMCO are buying the seized assets at fire sale prices as hedge funds' brokers (major Wall Street Firms) force sales to meet margin calls.
Secondly, leverage comes into play. To enhance returns, hedge funds borrow money (lever) to purchase more securities. As bids dry up for MBS and ABS, mark-to-market prices fall. Banks and brokers, which are experiencing liquidity problems themselves, cannot or will not extend more credit to hedge funds and other leveraged investors.
Many hedge fund and closed end funds do not realized they are leveraged. The average small investors does know what leverage is. As I asked with enhanced money funds: How did you think these funds earned such stellar returns when bond yields were so low, through creative bond trading?
Although, it is true that these leveraged funds have some brilliant traders and strategists, the main reason they were able to earn, in some cases, double digit returns and very low yield bond environments was due the increased market participation afforded by leverage. In fact, cheap borrowing fostered by the Fed induced easy money days of a few years ago made leveraged strategies that much more profitable. Now that liquidity is expensive or non-existent, these funds are imploding.
I would like to end with this thought. Bond funds can be very lucrative, but they are not bonds. Investors looking for reliable income and return of principal at maturity should purchase a portfolio of appropriate, actual bonds instead of leveraged bond funds.
First, volatility in the MBS market has caused prices to decline of even high-quality MBS as buyers have vacated the market. Some investors remain unsure if they are truly buying high-quality securities. No one wants to catch a falling knife. Opportunists are exploiting the situation. Funds, such as PIMCO are buying the seized assets at fire sale prices as hedge funds' brokers (major Wall Street Firms) force sales to meet margin calls.
Secondly, leverage comes into play. To enhance returns, hedge funds borrow money (lever) to purchase more securities. As bids dry up for MBS and ABS, mark-to-market prices fall. Banks and brokers, which are experiencing liquidity problems themselves, cannot or will not extend more credit to hedge funds and other leveraged investors.
Many hedge fund and closed end funds do not realized they are leveraged. The average small investors does know what leverage is. As I asked with enhanced money funds: How did you think these funds earned such stellar returns when bond yields were so low, through creative bond trading?
Although, it is true that these leveraged funds have some brilliant traders and strategists, the main reason they were able to earn, in some cases, double digit returns and very low yield bond environments was due the increased market participation afforded by leverage. In fact, cheap borrowing fostered by the Fed induced easy money days of a few years ago made leveraged strategies that much more profitable. Now that liquidity is expensive or non-existent, these funds are imploding.
I would like to end with this thought. Bond funds can be very lucrative, but they are not bonds. Investors looking for reliable income and return of principal at maturity should purchase a portfolio of appropriate, actual bonds instead of leveraged bond funds.
Tuesday, March 4, 2008
Rage Against The Machine
A pair of letters in today's Wall Street Journal question the validity of CPI and the Fed's wisdom only focusing on core inflation. One respondent states that higher food and energy prices are not a tax on growth and are being passed through to consumers. Let's discuss.
First, companies truly do not have much pricing power. Outside of fairly inelastic sectors of the economy, what prices have risen? Do televisions cost more? How about computers? Clothing? Nope, most prices are only modestly higher. Raise your prices and 100 producers are waiting in line to take your place.
What about the disconnect between PPI and CPI. PPI was 7.4% (YoY) as per the last report, but CPI was 4.3% (YoY). Sure doesn't look like producers can pass inflation through to me. Think there is a conspiracy in the numbers? If so, you should ask the people in the black helicopters buzzing your home.
Think that higher fuel and energy prices don't act as taxes on growth? If you are a family of four making about $75,000 total and your food an fuel bill is rising through the roof, where is the money coming from to feed your family and drive to work? It is coming from discretionary spending.
Think the Fed ignores headline inflation? Not at all, bit it knows that at best, food and energy prices sap funds from discretionary spending and, at worst, the Fed has no effect on food and energy prices. Dallas Fed President Fisher said as much today.
The truth is that the Fed could raise the Fed Funds rate to 10.00% and wit would have little effect on food and energy prices. People will eat, heat their homes and fuel their vehicles to get to work at the expense of discretionary spending.
All these are truths. However, although the Fed has trouble halting inflation, it can easily cause inflation. By lowering rates, it makes U.S. denominated securities less attractive and causes the dollar to weaken. If the dollar is worth less versus foreign currencies, foreign-made goods can cost more (China has enough margin to keep prices in check, but China is not the largest U.S. trading partner). Conversely, U.S. made goods cost less overseas.
The Fed IS helping to fuel inflation. It may even be contributing to higher oil prices. Why doesn't Mr. Bernanke take a page out of Paul Volcker's book? Because the banking system is in deep trouble and Mr. Bernanke knows it. Just wait until banks and brokers report earnings this month and next.
First, companies truly do not have much pricing power. Outside of fairly inelastic sectors of the economy, what prices have risen? Do televisions cost more? How about computers? Clothing? Nope, most prices are only modestly higher. Raise your prices and 100 producers are waiting in line to take your place.
What about the disconnect between PPI and CPI. PPI was 7.4% (YoY) as per the last report, but CPI was 4.3% (YoY). Sure doesn't look like producers can pass inflation through to me. Think there is a conspiracy in the numbers? If so, you should ask the people in the black helicopters buzzing your home.
Think that higher fuel and energy prices don't act as taxes on growth? If you are a family of four making about $75,000 total and your food an fuel bill is rising through the roof, where is the money coming from to feed your family and drive to work? It is coming from discretionary spending.
Think the Fed ignores headline inflation? Not at all, bit it knows that at best, food and energy prices sap funds from discretionary spending and, at worst, the Fed has no effect on food and energy prices. Dallas Fed President Fisher said as much today.
The truth is that the Fed could raise the Fed Funds rate to 10.00% and wit would have little effect on food and energy prices. People will eat, heat their homes and fuel their vehicles to get to work at the expense of discretionary spending.
All these are truths. However, although the Fed has trouble halting inflation, it can easily cause inflation. By lowering rates, it makes U.S. denominated securities less attractive and causes the dollar to weaken. If the dollar is worth less versus foreign currencies, foreign-made goods can cost more (China has enough margin to keep prices in check, but China is not the largest U.S. trading partner). Conversely, U.S. made goods cost less overseas.
The Fed IS helping to fuel inflation. It may even be contributing to higher oil prices. Why doesn't Mr. Bernanke take a page out of Paul Volcker's book? Because the banking system is in deep trouble and Mr. Bernanke knows it. Just wait until banks and brokers report earnings this month and next.
Monday, March 3, 2008
I Said Over and Over and Over Again
There are times when one has to shout, stop!!!!! Today is one of those days. I compose an internal use only fixed income report for a major investment bank. The report is sent to several thousand brokers at the firm. Each day I lay out market conditions, what it all means and where it may be heading. Every now and then I will repeat a topic, usually when there are signs that my prior concerns may prove true or may be unfounded.
Today I wrote that Bank of America may not guarantee Countrywide debt should the deal close in the third quarter of this year. My partner and I were flooded with e-mail asking if BAC is legally required to guarantee CFC debt if they merge? The answer is no.
Let's break things down. The ability of a parent to guarantee the debt of a subsidiary or vice versa (or one sub to guarantee another) is called cress default protection. You know what. Most corporations to do not have it. Ford does not guarantee Ford Motor Credit debt (or vice versa). Verizon does not guarantee its subsidiaries' debt or vice versa (nor do subs guarantee each other). To assume that BAC will back stop CFC debt is a dangerous assumption. Just as dangerous as assuming that large investment firms would always violate SEC rules and back stop ARS auctions.
I have the opportunity to work as a retail financial advisor. If I have to deal with, not only a lack of knowledge, but also a stubbornness to ignore the truth if it is not what one wants to hear, then maybe I will stick to bloviating.
Today I wrote that Bank of America may not guarantee Countrywide debt should the deal close in the third quarter of this year. My partner and I were flooded with e-mail asking if BAC is legally required to guarantee CFC debt if they merge? The answer is no.
Let's break things down. The ability of a parent to guarantee the debt of a subsidiary or vice versa (or one sub to guarantee another) is called cress default protection. You know what. Most corporations to do not have it. Ford does not guarantee Ford Motor Credit debt (or vice versa). Verizon does not guarantee its subsidiaries' debt or vice versa (nor do subs guarantee each other). To assume that BAC will back stop CFC debt is a dangerous assumption. Just as dangerous as assuming that large investment firms would always violate SEC rules and back stop ARS auctions.
I have the opportunity to work as a retail financial advisor. If I have to deal with, not only a lack of knowledge, but also a stubbornness to ignore the truth if it is not what one wants to hear, then maybe I will stick to bloviating.
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