Today, the FOMC cut the Fed Funds rate to 1.00% and the discount rate to 1.25%. The intent is to free up the credit markets. Unfortunately, this is an unlikely proposition. The FOMC's decision is akin to lowering the price of water when water is scarce. The problem is not that credit is too expensive, but that there is little available. To be sure, there is much capital available to banks, thanks in large part to an increasingly encroaching government, but banks are hoarding capital to help absorb losses due to writedowns or to acquire smaller, somewhat troubled, institutions.
There is little upside to lending money to bank counterparties of the public unless the borrower in question is of impeccable quality. Banks do not wish to be exposed to extraordinary counterparty risk (in the case of interbank lending) and investor aversion to mortgage-backed or asset-backed securities mean that securitization is difficult if not impossible. If banks cannot securitize mortgages, they soon run out of capital and essentially become income-oriented investors. A bank engaging in such business practices is not long for this world.
What about GSE mortgages? Why haven't GSE-qualified mortgage rates fallen? According to the Wall Street Journal it is because investors are unsure of the governments long-term treatment of GSE agency and mortgage-backed debt. As I have said many times, Mr. Paulson's and Congress's actions have eroded instead of bolstering investor confidence.
Further eroding investor confidence is the increasingly activist sentiments emanating from Congress. Initially, the government said it was taking a passive interest in banks receiving aid. This is evidenced by the non-voting shares being purchased by the government as part of the recapitalization plan. However, all is not what it appears.
Congress and NY State Attorney General Andrew Cuomo are imposing their will on the banks. The government wants to review Wall Street bonuses and severance packages. No vote is necessary. The government is imposing its will. This is the case for any bank which accepted assistance, including those who were forced by the Treasury to participate two weeks ago. This is not your father's America, but it may be your grandfather's (New Deal).
If cutting the Fed Funds and Discount rates will not help increase lending much, if at all, why bother? The answer is two-fold. First, doing so technically makes short-term capital more affordable although, with the Fed Funds rate already trading in the .25% to .50% area, today's ease will have little effect. Mostly, today's ease was done for psychological reasons. If the public believes the Fed is doing everything it can to fix the system, they may be more willing to invest in banks and provide capital. Maybe some potential home buyers re-enter the market feeling confident that we have bottomed. I believe this to be a mistaken belief and besides, fewer potential buyers can qualify for mortgages.
At some point, weaker borrowers will be foreclosed upon and weaker institutions will fail and then, after much pain, the recovery can begin.
Investors should be wary of investing on the log end of the curve. The printing or money / issuing of debt side is beginning to win the tug of war with the flight to quality. The lowering of short-term rates could hasten the rebalancing away from the dollar and could also help put the brakes on falling commodities prices. Stay short to mid-term and stay in high quality investments. High-yield bond defaults are likely to rise from their relatively mild current pace of approximately 5.00%.
Wednesday, October 29, 2008
Monday, October 27, 2008
No Laffing Matter
In today's Wall Street Journal, noted economist Arthur Laffer published an editorial entitled "The Age of Prosperity Is Over". Mr. Laffer pulls no punches. He compares President Bush and the current Congress to Herbert Hoover and accuses Fed Chairman Bernanke of "bungling" monetary policy.
The following paragraphs, in my opinion, speak volumes:
"When markets are free, asset values are supposed to go up and down, and competition opens up opportunities for profits and losses. Profits and stock appreciation are not rights, but rewards for insight mixed with a willingness to take risk. People who buy homes and the banks who give them mortgages are no different, in principle, than investors in the stock market, commodity speculators or shop owners. Good decisions should be rewarded and bad decisions should be punished. The market does just that with its profits and losses."
"No one likes to see people lose their homes when housing prices fall and they can't afford to pay their mortgages; nor does any one of us enjoy watching banks go belly-up for making subprime loans without enough equity. But the taxpayers had nothing to do with either side of the mortgage transaction. If the house's value had appreciated, believe you me the overleveraged homeowner and the overly aggressive bank would never have shared their gain with taxpayers. Housing price declines and their consequences are signals to the market to stop building so many houses, pure and simple."
"But here's the rub. Now enter the government and the prospects of a kinder and gentler economy. To alleviate the obvious hardships to both homeowners and banks, the government commits to buy mortgages and inject capital into banks, which on the face of it seems like a very nice thing to do. But unfortunately in this world there is no tooth fairy. And the government doesn't create anything; it just redistributes. Whenever the government bails someone out of trouble, they always put someone into trouble, plus of course a toll for the troll. Every $100 billion in bailout requires at least $130 billion in taxes, where the $30 billion extra is the cost of getting government involved."
As I have said in the (very recent) past, companies, investors and home owners who made poor decisions, must suffer the consequences (of some kind. Until banks are cleansed of bad assets, markets cleansed of weak companies and home prices are permitted to reset to prices which attract buyers, we will remain in a long and painful economic recession.
For political reasons, politicians in both parties are trying to avoid cutting the cancer out the economy out of fear that the operation will be too painful. In reality, not purging the economy of this rotting disease will prove fatal for capitalism in the U.S.
I am not convinced that this bank bailout will right the economy. It will result in larger banks swallowing relatively-healthy smaller institutions in an effort to pad deposits. Be concerned with large banks which cannot make a substantial acquisition and of smaller institutions which attract no buyers.
Many financial advisers have asked why break-evens on short-term TIPs are negative. The reason is the market is pricing in much deflation during the next two years. Whether or not this happens remains to be seen. However, keep in mind that no matter how cheap a TIP looks, if the rate of inflation declines significantly, one could lose money, even when receiving par at maturity is considered.
Investing in TIPs should be viewed similarly to investing in foreign currency bonds. If the inflation index falls, one can receive less than their investment at maturity. This is just like a currency decline on a foreign bond. I would be very cautious when investing in short-term TIPs. In spite of the fact that TIPs are government securities, investors are SPECULATING on the change in the rate of inflation.
The following paragraphs, in my opinion, speak volumes:
"When markets are free, asset values are supposed to go up and down, and competition opens up opportunities for profits and losses. Profits and stock appreciation are not rights, but rewards for insight mixed with a willingness to take risk. People who buy homes and the banks who give them mortgages are no different, in principle, than investors in the stock market, commodity speculators or shop owners. Good decisions should be rewarded and bad decisions should be punished. The market does just that with its profits and losses."
"No one likes to see people lose their homes when housing prices fall and they can't afford to pay their mortgages; nor does any one of us enjoy watching banks go belly-up for making subprime loans without enough equity. But the taxpayers had nothing to do with either side of the mortgage transaction. If the house's value had appreciated, believe you me the overleveraged homeowner and the overly aggressive bank would never have shared their gain with taxpayers. Housing price declines and their consequences are signals to the market to stop building so many houses, pure and simple."
"But here's the rub. Now enter the government and the prospects of a kinder and gentler economy. To alleviate the obvious hardships to both homeowners and banks, the government commits to buy mortgages and inject capital into banks, which on the face of it seems like a very nice thing to do. But unfortunately in this world there is no tooth fairy. And the government doesn't create anything; it just redistributes. Whenever the government bails someone out of trouble, they always put someone into trouble, plus of course a toll for the troll. Every $100 billion in bailout requires at least $130 billion in taxes, where the $30 billion extra is the cost of getting government involved."
As I have said in the (very recent) past, companies, investors and home owners who made poor decisions, must suffer the consequences (of some kind. Until banks are cleansed of bad assets, markets cleansed of weak companies and home prices are permitted to reset to prices which attract buyers, we will remain in a long and painful economic recession.
For political reasons, politicians in both parties are trying to avoid cutting the cancer out the economy out of fear that the operation will be too painful. In reality, not purging the economy of this rotting disease will prove fatal for capitalism in the U.S.
I am not convinced that this bank bailout will right the economy. It will result in larger banks swallowing relatively-healthy smaller institutions in an effort to pad deposits. Be concerned with large banks which cannot make a substantial acquisition and of smaller institutions which attract no buyers.
Many financial advisers have asked why break-evens on short-term TIPs are negative. The reason is the market is pricing in much deflation during the next two years. Whether or not this happens remains to be seen. However, keep in mind that no matter how cheap a TIP looks, if the rate of inflation declines significantly, one could lose money, even when receiving par at maturity is considered.
Investing in TIPs should be viewed similarly to investing in foreign currency bonds. If the inflation index falls, one can receive less than their investment at maturity. This is just like a currency decline on a foreign bond. I would be very cautious when investing in short-term TIPs. In spite of the fact that TIPs are government securities, investors are SPECULATING on the change in the rate of inflation.
Saturday, October 25, 2008
Another One Bites The Dust
Another One Bites The Dust
Anyone who knows me or has read my articles and blog posts knows that I have a contentious relationship with the Wall Street Journal. Their editorial pages can be blatantly right-wing and their articles discussing various investment vehicles and their raison d’etre have been less than accurate. However, an editorial discussing the latest bubble to burst is completely accurate.
The editorial page in October 24, 2008 edition of the Wall Street Journal discusses the bursting of the “other” bubble. That bubble is the oil bubble. As I have been ranting about for approximately nine months, the run up on oil was due to a weak dollar caused by short-term rates, and speculators who used oil as a dollar hedge. Now that the dollar is strengthening (in spite of low rates), oil prices have fallen. Now that being long oil is not a viable speculation strategy, speculators have left the market. Even a decision by OPEC to cut production has had little effect on oil prices. The belief that the price in oil prices was completely due to fundamentals was fostered by pundits who were ill-informed, dishonest or both.
From where was this demand supposed to come? It was supposed to come from developing nations which had allegedly decoupled from the U.S. They allegedly decoupled even though they relied on the U.S. as the primary market for their goods. That is some feat not to be affected by the economy which purchases the majority of one’s goods. It was all bogus. The market was being manipulated by participants looking to foster a self-fulfilling prophecy.
The danger now is that, it appears that the government is trying to re-inflate the bubble, but it doesn’t know how to do it. I am fearful that it will be successful, but judging by recent policies, there is little chance of doing so in the near future. However, it could happen again a few years from now.
The Fed is expected to lower the Fed Funds target rate to 1.00% at next week’s FOMC meeting. I believe this is a desperate attempt to sooth nerves. It will have little economic effect. Why? The problem is that it is too expensive to borrow, but rather that banks are unwilling or (more accurately) unable to lend, at least not like before. Banks are hoarding cash because they know they will have billions more in writedowns. One only need look to Wachovia as evidence. Prior to it being acquired by Wells Fargo, Wachovia had written-down just over $20 billion. After Wachovia had to come clean for the merger, that number of writedowns rose to over $96 billion. That is quite a jump. One must wonder how much the larger players have yet to write-down. It is likely well over $100 billion.
Thus far, the government’s rescue plans have focused on banks not having to take large writedowns. This is like trying to live with cancer instead of removing the malignant growth. The balance sheet malignancies before the banking system can once again be healthy and investors come back to the markets to re-capitalize the banks.
The free market does work. Yesterday, existing home sales unexpectedly rise fueled by buyers purchasing foreclosed properties. This is a good thing. Once the market is permitted to seek its own level, the housing markets will stabilize and the recover can truly begin. If this is all that is needed, why doesn’t government permit this to happen?
There are two reasons, one social and one economic. The social reason is that Americans have been taught that they are entitled to own their own homes. The real estate industry used this belief to convince buyers that it is their right to own, not just a home, but “the” home. There is also a belief in this country that a bank is evil of it forecloses on home. Owning a home is a responsibility, not a right.
The economic reason is that if home foreclosures continue, home prices will continue to decline. Although the market dictates that home prices should decline, the result would be much damage to bank balance sheets and more failures (possibly including larger institutions) would occur. Banks unwisely loaned money to those who could not pay. Some of it was greed, but some of it was mandated by the government. Congress conveniently leaves itself off the list of guilty parties.
Congress is directly to blame for the deepening crisis. By permitting and (in the case of Barney Frank and Chris Dodd) encouraging Treasury Secretary Paulson to wipe out the GSE preferred holders (allegedly to protect taxpayers), the preferred market was killed. This has eliminated banks from raising Tier-1 capital (Tier-1 consists of preferred stock, common stock or deposits) from private investors. Banks have been raising CD rates to attract deposits and investment banks Morgan Stanley and Goldman Sachs have become bank holding companies is desperate attempts to stay afloat. Other banks have purchases their smaller and weaker brethren to gather deposits. It isn’t enough. This is why the government is buying preferred shares of large (and soon to be mid-size banks and insurance companies). If the government had simply backstopped Freddie and Fannie and purged management, without wiping out shareholders, investors and not taxpayers would be recapitalizing banks and the GSEs.
Where do we go from here? We probably go into a major global recession (we are probably already there). Without confidence in the banking system, investors will continue to flock to the safety of U.S treasuries. This will keep long-term rates low and the dollar relatively strong. This will help consumers by keeping food and every prices low. Of course, job losses will also result. Not until investors are willing to recapitalize banks and banks are willing to lend, we will remain in an economic fund or worse.
How is investor confidence to be restored? Banks must come clean as to their writedowns. If a bank will fail as the result, it should be auctioned-off to healthy banks. Home prices can then be permitted to correct. Yes, some home owners will lose their homes, but buyers who can better afford to own these homes will step up. How can banks obtain enough capital which to lend?
PNC’s acquisition of National City can be used as a blueprint. TARP funds can be used to facilitate purchases of weaker banks by stronger banks. That should be the extent of government involvement. Healthier banks, without government ownership, will attract investors. This will permit banks to recapitalize and lend. The government should also reinstate GSE dividends (as stated by former Fed Governor Wayne Angell). The government should admit its mistake and vow never to do so again. Investors would also recapitalize the GSEs, lessening the burden on taxpayers.
There is one problem with all of this. It requires an apolitical approach. Looks like we’re in for nasty weather, I see bad times today.
Anyone who knows me or has read my articles and blog posts knows that I have a contentious relationship with the Wall Street Journal. Their editorial pages can be blatantly right-wing and their articles discussing various investment vehicles and their raison d’etre have been less than accurate. However, an editorial discussing the latest bubble to burst is completely accurate.
The editorial page in October 24, 2008 edition of the Wall Street Journal discusses the bursting of the “other” bubble. That bubble is the oil bubble. As I have been ranting about for approximately nine months, the run up on oil was due to a weak dollar caused by short-term rates, and speculators who used oil as a dollar hedge. Now that the dollar is strengthening (in spite of low rates), oil prices have fallen. Now that being long oil is not a viable speculation strategy, speculators have left the market. Even a decision by OPEC to cut production has had little effect on oil prices. The belief that the price in oil prices was completely due to fundamentals was fostered by pundits who were ill-informed, dishonest or both.
From where was this demand supposed to come? It was supposed to come from developing nations which had allegedly decoupled from the U.S. They allegedly decoupled even though they relied on the U.S. as the primary market for their goods. That is some feat not to be affected by the economy which purchases the majority of one’s goods. It was all bogus. The market was being manipulated by participants looking to foster a self-fulfilling prophecy.
The danger now is that, it appears that the government is trying to re-inflate the bubble, but it doesn’t know how to do it. I am fearful that it will be successful, but judging by recent policies, there is little chance of doing so in the near future. However, it could happen again a few years from now.
The Fed is expected to lower the Fed Funds target rate to 1.00% at next week’s FOMC meeting. I believe this is a desperate attempt to sooth nerves. It will have little economic effect. Why? The problem is that it is too expensive to borrow, but rather that banks are unwilling or (more accurately) unable to lend, at least not like before. Banks are hoarding cash because they know they will have billions more in writedowns. One only need look to Wachovia as evidence. Prior to it being acquired by Wells Fargo, Wachovia had written-down just over $20 billion. After Wachovia had to come clean for the merger, that number of writedowns rose to over $96 billion. That is quite a jump. One must wonder how much the larger players have yet to write-down. It is likely well over $100 billion.
Thus far, the government’s rescue plans have focused on banks not having to take large writedowns. This is like trying to live with cancer instead of removing the malignant growth. The balance sheet malignancies before the banking system can once again be healthy and investors come back to the markets to re-capitalize the banks.
The free market does work. Yesterday, existing home sales unexpectedly rise fueled by buyers purchasing foreclosed properties. This is a good thing. Once the market is permitted to seek its own level, the housing markets will stabilize and the recover can truly begin. If this is all that is needed, why doesn’t government permit this to happen?
There are two reasons, one social and one economic. The social reason is that Americans have been taught that they are entitled to own their own homes. The real estate industry used this belief to convince buyers that it is their right to own, not just a home, but “the” home. There is also a belief in this country that a bank is evil of it forecloses on home. Owning a home is a responsibility, not a right.
The economic reason is that if home foreclosures continue, home prices will continue to decline. Although the market dictates that home prices should decline, the result would be much damage to bank balance sheets and more failures (possibly including larger institutions) would occur. Banks unwisely loaned money to those who could not pay. Some of it was greed, but some of it was mandated by the government. Congress conveniently leaves itself off the list of guilty parties.
Congress is directly to blame for the deepening crisis. By permitting and (in the case of Barney Frank and Chris Dodd) encouraging Treasury Secretary Paulson to wipe out the GSE preferred holders (allegedly to protect taxpayers), the preferred market was killed. This has eliminated banks from raising Tier-1 capital (Tier-1 consists of preferred stock, common stock or deposits) from private investors. Banks have been raising CD rates to attract deposits and investment banks Morgan Stanley and Goldman Sachs have become bank holding companies is desperate attempts to stay afloat. Other banks have purchases their smaller and weaker brethren to gather deposits. It isn’t enough. This is why the government is buying preferred shares of large (and soon to be mid-size banks and insurance companies). If the government had simply backstopped Freddie and Fannie and purged management, without wiping out shareholders, investors and not taxpayers would be recapitalizing banks and the GSEs.
Where do we go from here? We probably go into a major global recession (we are probably already there). Without confidence in the banking system, investors will continue to flock to the safety of U.S treasuries. This will keep long-term rates low and the dollar relatively strong. This will help consumers by keeping food and every prices low. Of course, job losses will also result. Not until investors are willing to recapitalize banks and banks are willing to lend, we will remain in an economic fund or worse.
How is investor confidence to be restored? Banks must come clean as to their writedowns. If a bank will fail as the result, it should be auctioned-off to healthy banks. Home prices can then be permitted to correct. Yes, some home owners will lose their homes, but buyers who can better afford to own these homes will step up. How can banks obtain enough capital which to lend?
PNC’s acquisition of National City can be used as a blueprint. TARP funds can be used to facilitate purchases of weaker banks by stronger banks. That should be the extent of government involvement. Healthier banks, without government ownership, will attract investors. This will permit banks to recapitalize and lend. The government should also reinstate GSE dividends (as stated by former Fed Governor Wayne Angell). The government should admit its mistake and vow never to do so again. Investors would also recapitalize the GSEs, lessening the burden on taxpayers.
There is one problem with all of this. It requires an apolitical approach. Looks like we’re in for nasty weather, I see bad times today.
Thursday, October 23, 2008
Say What You Mean. Mean What You Say
I have long been critical of government interference during this financial crisis. Although some kind of government intervention is necessary (as little as is practical), it seems as though Federal officials cannot go a week without a market roiling gaff.
Today, FHFA (GSE regulator) chief James Lockhart said in a statement that GSE bonds are "explicitly guaranteed" by the government. This sent GSE bonds prices higher. His statement was consistent with various news stories, including one earlier this month in Barrons. I called foul on that story as the GSEs' charters have not been altered to make their debt explicitly guaranteed by the government. Lo and behold, Mr, Lockhart had to retract his statement and admitted that there is no explicit government guarantee of GSE debt. Silence is truly golden.
There is a quandary among fixed income market participants. Being debated is whether long-term rates will remain low due to the flight to safety (which I believe have a way to go yet) or will the new supply of government debt and dollars cause lobg-term rates to rise?
Currently, the flight to safety is winning the tug-of-war versus new treasury supply and the printing of more dollars. As foreign economies follow the U.S. economy into what could be a deep recession, the flight to safety could prevail over increased supply. When the economy stabilizes and signs of recovery materialize, then the results of increased debt issuance should begin to push long-term rates higher. However, for now, safety is the strategy du jour.
Today, FHFA (GSE regulator) chief James Lockhart said in a statement that GSE bonds are "explicitly guaranteed" by the government. This sent GSE bonds prices higher. His statement was consistent with various news stories, including one earlier this month in Barrons. I called foul on that story as the GSEs' charters have not been altered to make their debt explicitly guaranteed by the government. Lo and behold, Mr, Lockhart had to retract his statement and admitted that there is no explicit government guarantee of GSE debt. Silence is truly golden.
There is a quandary among fixed income market participants. Being debated is whether long-term rates will remain low due to the flight to safety (which I believe have a way to go yet) or will the new supply of government debt and dollars cause lobg-term rates to rise?
Currently, the flight to safety is winning the tug-of-war versus new treasury supply and the printing of more dollars. As foreign economies follow the U.S. economy into what could be a deep recession, the flight to safety could prevail over increased supply. When the economy stabilizes and signs of recovery materialize, then the results of increased debt issuance should begin to push long-term rates higher. However, for now, safety is the strategy du jour.
Wednesday, October 22, 2008
Money Get Away
The myth of the so-called "decoupling" continues to be exposed as just that, a myth. Investors, seeking shelter from the strengthening financial storm. Reports of the dollars' demise have been greatly exaggerated. Notice how oil prices have fallen correlative to the dollars' rise. Some credit demand destruction for the fall of oil prices, but demand destruction does not explain the more than halving of the price of oil since its peak of $147.50 per barrel on July 11, 2008.
The reason for falling oil prices are the strengthening dollar and SPECULATION that demand for oil will wane during the coming recessions. I believe that the price of oil will continue to moderate, in spite of OPEC measures to stem its slide (the cartel meets tomorrow). Oil rose too far too fast when fundamentals are considered. Some critics point to the fact that it is not that the dollar is stronger, but foreign currencies which are weakening. I say it does not matter. All currency exchange rates are relative.
Currently, the U.S. economy is perceived to be less weak and better able to weather the financial storm than its foreign counterparts. However, that may not be the case if we continue to move away from free market ideals and toward European-like market socialism. Failure to maintain free market ideals would make the dollar less desirable as a reserve currency.
The reason for falling oil prices are the strengthening dollar and SPECULATION that demand for oil will wane during the coming recessions. I believe that the price of oil will continue to moderate, in spite of OPEC measures to stem its slide (the cartel meets tomorrow). Oil rose too far too fast when fundamentals are considered. Some critics point to the fact that it is not that the dollar is stronger, but foreign currencies which are weakening. I say it does not matter. All currency exchange rates are relative.
Currently, the U.S. economy is perceived to be less weak and better able to weather the financial storm than its foreign counterparts. However, that may not be the case if we continue to move away from free market ideals and toward European-like market socialism. Failure to maintain free market ideals would make the dollar less desirable as a reserve currency.
Tuesday, October 21, 2008
Tell Me What You See
I have had many calls (and have conducted conference calls) regarding what preferreds we like and with which preferreds we have concerns. First off, we like trust preferreds. A line has been drawn by the Treasury with the GSE preferreds. Trust preferreds have a debt component and have been treated as debt. They are actually senior to the bank preferreds purchased by the government. Yes, Paulson said banks will be permitted to pay preferred and equity dividends as long as they pay the government's dividends. I do not trust Paulson. If deemed necessary, the government can force the banks to do nearly anything as per the Treasury' emergency powers.
As for foreign preferreds, they are in the hands of the respective foreign governments and what they require of institutions receiving government support. Governments have been conspicuously silent on the matter. Our feeling is that they will not comment until they have to (when dividends have to be declared).
I have also received renewed interest in investigating collateral performance of their MBS. This is heartening for us. Rather than throwing the baby out with the bath water, advisers and clients are inquiring about the collateral backing their bonds. In most cases, the collateral is fine, in spite of the trading levels. The best MBS were issued prior to mid-2006.
I have been critical of PIMCO's Bill Gross talking his book. However, PIMCO is one of the best bond fund managers on the planet. The Wall Street Journal reports that PIMCO has been selling treasuries and buying GSE MBS. I agree with this strategy. Unlike private label MBS (which are only backed by the collateral), GSE MBS principal is backed by the GSEs. As government backing of GSE bonds is almost explicit, this is where we would look in the MBS market.
Also, this is not Bill Gross talking his book now, but Wall Street Journal reporting regarding what PIMCO has already done. The new supply of treasury securities should begin to push long-term rates higher. We would not be buyers of long-term treasuries. However, I would be a buyer of TIPs. TIPs breakevens are compelling. They should be. After all, deflation may be the norm for the next year. The time to buy tips is when inflation is tame, not after it begins to roar.
As for foreign preferreds, they are in the hands of the respective foreign governments and what they require of institutions receiving government support. Governments have been conspicuously silent on the matter. Our feeling is that they will not comment until they have to (when dividends have to be declared).
I have also received renewed interest in investigating collateral performance of their MBS. This is heartening for us. Rather than throwing the baby out with the bath water, advisers and clients are inquiring about the collateral backing their bonds. In most cases, the collateral is fine, in spite of the trading levels. The best MBS were issued prior to mid-2006.
I have been critical of PIMCO's Bill Gross talking his book. However, PIMCO is one of the best bond fund managers on the planet. The Wall Street Journal reports that PIMCO has been selling treasuries and buying GSE MBS. I agree with this strategy. Unlike private label MBS (which are only backed by the collateral), GSE MBS principal is backed by the GSEs. As government backing of GSE bonds is almost explicit, this is where we would look in the MBS market.
Also, this is not Bill Gross talking his book now, but Wall Street Journal reporting regarding what PIMCO has already done. The new supply of treasury securities should begin to push long-term rates higher. We would not be buyers of long-term treasuries. However, I would be a buyer of TIPs. TIPs breakevens are compelling. They should be. After all, deflation may be the norm for the next year. The time to buy tips is when inflation is tame, not after it begins to roar.
Sunday, October 19, 2008
Had Enough
Any one who knows me can attest that I no fan of George W. Bush. Yes, I did vote for him twice because his opponents were even more clueless than he. However, it is unfair that his economic policies caused the current financial crisis. What did W. do to precipitate this? The only major economic legislation he has put forth was his tax cuts. That did create an economic boom, but it did not cause the mis-packaging of toxic assets into AAA-rated securities. Freddie and Fannie encouraging home ownership for those who cannot afford it, low interest rates and the unintended consequences of market transparency (which pushed Wall Street firms to trade in derivatives with opaque markets (which began during the Clinton years) are the true culprits.
If Mr. Bush can be blamed for anything it is the performance of his Treasury Secretary, Hammerin' Hank Paulson. Hank talks out of both sides of his mouth and, apparently, is clueless on who to save, who to punish and how to go about either. He has done the most damage since the crisis began.
However, the push or home ownership for all has caused this. Lay the problem squarely at the feet of Chris Dodd and Barney Frank.
The Media and Democratic pundits have done a good job of lumping in John McCain with W. ANYONE who has followed the career of John McCain or has the intelligence to read about the candidates instead of listening to sound-bites and looking to see who looks more "presidential" can attest, John McCain is nothing like George Bush.
This is not so say that Mr. McCain instills me with confidence regarding the economy. He does not. However, he is not George Bush. Barak Obama actually frightens me. Class warfare and socialism are failed beliefs. They do not work to run an efficient economy. His suggestion that companies who move jobs offshore be punished with taxes is grandstanding. U.S. corporations pay the highest corporate tax rates in the developed world. How about cutting corporate taxes for companies who move jobs back to the U.S. to solve their cost differential problem. That won't happen because that is anti-socialist.
Unions will not agree to such a policy unless their Democratic handlers tell them it is alright to do so, even though it would bring jobs back to the U.S. Certain Unions, such as government workers, municipal workers and teachers want do see a less robust corporate sector as its for-profit tenets run counter to their ideology and lifestyles. What they do not realize is that, if there is no strong private sector, tax revenue falls (even if tax rates rise) and layoffs of municipal workers government workers and teachers result.
I encourage everyone to read "The Wealth of Nations" by Adam Smith or, at least, discussions on Adam Smith and Capitalism. Karl Marx and Trotsky are not the sages the left claim them to be.
If Mr. Bush can be blamed for anything it is the performance of his Treasury Secretary, Hammerin' Hank Paulson. Hank talks out of both sides of his mouth and, apparently, is clueless on who to save, who to punish and how to go about either. He has done the most damage since the crisis began.
However, the push or home ownership for all has caused this. Lay the problem squarely at the feet of Chris Dodd and Barney Frank.
The Media and Democratic pundits have done a good job of lumping in John McCain with W. ANYONE who has followed the career of John McCain or has the intelligence to read about the candidates instead of listening to sound-bites and looking to see who looks more "presidential" can attest, John McCain is nothing like George Bush.
This is not so say that Mr. McCain instills me with confidence regarding the economy. He does not. However, he is not George Bush. Barak Obama actually frightens me. Class warfare and socialism are failed beliefs. They do not work to run an efficient economy. His suggestion that companies who move jobs offshore be punished with taxes is grandstanding. U.S. corporations pay the highest corporate tax rates in the developed world. How about cutting corporate taxes for companies who move jobs back to the U.S. to solve their cost differential problem. That won't happen because that is anti-socialist.
Unions will not agree to such a policy unless their Democratic handlers tell them it is alright to do so, even though it would bring jobs back to the U.S. Certain Unions, such as government workers, municipal workers and teachers want do see a less robust corporate sector as its for-profit tenets run counter to their ideology and lifestyles. What they do not realize is that, if there is no strong private sector, tax revenue falls (even if tax rates rise) and layoffs of municipal workers government workers and teachers result.
I encourage everyone to read "The Wealth of Nations" by Adam Smith or, at least, discussions on Adam Smith and Capitalism. Karl Marx and Trotsky are not the sages the left claim them to be.
Saturday, October 18, 2008
Fool Me Twice, Shame On Me
My argument against Treasury wiping out GSE preferred holders was that it would destroy investor confidence in the preferred market and any area in which the government intervened. As we have since experienced, this is exactly what has happened. Cheerleaders on the markets' sidelines have been shouting their support of government intervention, but investors have been much less sanguine. Some may argue that having a dog in the fight (I do work on a fixed income desk and own FREprZ) that I am just voicing by bias. However, I am not the only (and definitely not the most influential) critic.
The markets' aversion for anything Paulson-related should be enough proof that the government is sapping, rather than instilling, confidence in financial preferreds and common equity. However, other fixed income experts have voiced opinions similar to my own and those of many fixed income market participants. James Grant, publisher of Grant's Interest Rate Observer, has published an article in the Wall Street Journal. The following paragraphs from the article speak volumes:
"Perhaps the world has gone so far down the path of socialized finance that there's no turning back. However, the doughty remnant of capitalists should be under no illusion about the risks and opportunities they confront. They can't miss the risks. Mr. Paulson pledges that the government's bank investments will be passive and apolitical, but the record of the Depression-era Reconstruction Finance Corp. suggests that the federal government is a shareholder that can throw its weight around. Besides, would Mr. Paulson's apolitical intentions bind his successor?"
Until The government backs away from its ownership interest in the private sector, I will be fearful of a GSE-like outcome.
The markets' aversion for anything Paulson-related should be enough proof that the government is sapping, rather than instilling, confidence in financial preferreds and common equity. However, other fixed income experts have voiced opinions similar to my own and those of many fixed income market participants. James Grant, publisher of Grant's Interest Rate Observer, has published an article in the Wall Street Journal. The following paragraphs from the article speak volumes:
"Perhaps the world has gone so far down the path of socialized finance that there's no turning back. However, the doughty remnant of capitalists should be under no illusion about the risks and opportunities they confront. They can't miss the risks. Mr. Paulson pledges that the government's bank investments will be passive and apolitical, but the record of the Depression-era Reconstruction Finance Corp. suggests that the federal government is a shareholder that can throw its weight around. Besides, would Mr. Paulson's apolitical intentions bind his successor?"
Until The government backs away from its ownership interest in the private sector, I will be fearful of a GSE-like outcome.
Wednesday, October 15, 2008
He Talks To Angell
Former Fed governor Wayne Angell tells CNBC that the government should instill confidence in preferred shares to get investors to recapitalize troubled institutions. He went on to blame the Treasury for blowing up GSE preferreds for starting this panic and believes that the government should reverse its GSE preferred decision and invite investors to recapitalize FRE and FNM.
If li'l ole me could figure out that suspending GSE dividends was a very bad idea and Wayne Angell agrees, why didn't Paulson realize that last month? Because he and Congress are detached from the retail side of the markets.
If li'l ole me could figure out that suspending GSE dividends was a very bad idea and Wayne Angell agrees, why didn't Paulson realize that last month? Because he and Congress are detached from the retail side of the markets.
Power and Responsibility
In the Spiderman story, young Peter Parker is told this by his Uncle Ben. Uncle Ben explained that just because one can do something doesn’t mean they should. This is a lesson the banking industry (and the world) is currently learning.
Beginning with President Reagan’s push for deregulation and free markets and continuing through President Clinton’s signing off on the abolishment of the Glass-Steagall act in 1999, the U.S. economy enjoyed a degree of freedom not seen since before the great depression. Financial institutions took advantage of their newly-found power. However, we now know they fell short in the responsibility department. Thanks to the banks, we have moved from an era of free-market capitalism, to an era of government control and intervention. Goodbye Adam Smith. Hello John Maynard Keynes.
What does this mean for banks, the economy and the markets? First, the days of 20 or 30 times leverage is dead. Since common sense did not prevent this kind of levering, the government will. The government will likely try to head off crises such as we have now by constantly overseeing bank operations. This means earnings will be lower than in the recent past and equity dividends will remain somewhat low for the foreseeable future.
Secondly, the days of easy lending are over as well. Although it is true that banks are now better-capitalized, their abilities to lend hinge on investor appetite for asset-backed, mortgage-related securities. No longer will investors merely trust the credit rating services. They will want to know the specific details of the underlying collateral. Vehicles backed by lower-quality assets will be shunned by many investors, regardless of the level of seniority of the tranche in question.
Lastly, reduced leverage and the resulting reduced lending (albeit better than today’s lending environment) will keep economic growth below levels seen during the housing bubble. It will also prevent the purchasing of big ticket items, such as homes and automobiles, from reaching bubble levels. Big ticket items will now be purchased by those who can truly afford them (for the most part).
This will mean that home prices will rise, but at a pace dictated by the gradual movement of the supply glut of homes. Until home inventories fall (and they are sizeable) home prices will fall and then stagnate. Automakers which are already in precarious situations could find themselves in bankruptcy, unless they are the beneficiaries of government assistance.
Is this the end of the pain for the banks? No, they still have toxic assets on their balance sheets. They will have to take losses, unless the government buys the toxic assets at prices above what they are truly worth. Make no mistake, many (if not most) of the toxic assets on bank balance sheets have essentially failed. While the assets are not worth zero, they are not worth par and never will be. Want a hint of how bad things could be? Wachovia had to come clean as a result of it being purchased by Wells Fargo. According to Bloomberg News, Wachovia has now written down $96.7 billion. This is almost twice what Citi has written down ($54.7B). Citi is believed to have the largest collection of toxic assets. Only government over-payment via TARP or creative accounting can prevent further large writedowns at the major banks.
Preferred holders can breathe a sigh of relief now that it is clear that the government will not require banks to suspend preferred or even common dividends, so long as the banks pay dividends on government owned preferreds. There is one fact of which investors and financial advisers should be aware. Trust preferreds are SENIOR to government preferreds. In theory, banks could not pay the government and still pay the dividends on trust preferreds. Also, since trust preferreds are cumulative, investors are entitled to missed dividends as long as the issuer does not fail. Bank failures have just become much less likely thanks to the Peoples Republic of America
What does this mean for interest rates and corporate bond yields? Long-term interest rates should rise due to the new supply of government debt and the dilution of the value of the dollar. However, that may be moderated some by a continued flight to the dollar as the U.S. is still the safest place to park one’s money.
Corporate bond spreads on non-financials should not change much, narrowing somewhat, as they have not widened out in the same fashion as financials. Financial sector senior notes could experience significant spread narrowing now that the government is temporarily guaranteeing senior bonds. Although rising long-term rates could erode any capital gains benefits from spread narrowing, I believe that the spread narrowing may be enough to keep corporate bond prices stable.
For the next year or two we will be playing defense. Investors should stay with the higher quality names as the near-term economic weakness could be a death-knell for troubled companies.
Beginning with President Reagan’s push for deregulation and free markets and continuing through President Clinton’s signing off on the abolishment of the Glass-Steagall act in 1999, the U.S. economy enjoyed a degree of freedom not seen since before the great depression. Financial institutions took advantage of their newly-found power. However, we now know they fell short in the responsibility department. Thanks to the banks, we have moved from an era of free-market capitalism, to an era of government control and intervention. Goodbye Adam Smith. Hello John Maynard Keynes.
What does this mean for banks, the economy and the markets? First, the days of 20 or 30 times leverage is dead. Since common sense did not prevent this kind of levering, the government will. The government will likely try to head off crises such as we have now by constantly overseeing bank operations. This means earnings will be lower than in the recent past and equity dividends will remain somewhat low for the foreseeable future.
Secondly, the days of easy lending are over as well. Although it is true that banks are now better-capitalized, their abilities to lend hinge on investor appetite for asset-backed, mortgage-related securities. No longer will investors merely trust the credit rating services. They will want to know the specific details of the underlying collateral. Vehicles backed by lower-quality assets will be shunned by many investors, regardless of the level of seniority of the tranche in question.
Lastly, reduced leverage and the resulting reduced lending (albeit better than today’s lending environment) will keep economic growth below levels seen during the housing bubble. It will also prevent the purchasing of big ticket items, such as homes and automobiles, from reaching bubble levels. Big ticket items will now be purchased by those who can truly afford them (for the most part).
This will mean that home prices will rise, but at a pace dictated by the gradual movement of the supply glut of homes. Until home inventories fall (and they are sizeable) home prices will fall and then stagnate. Automakers which are already in precarious situations could find themselves in bankruptcy, unless they are the beneficiaries of government assistance.
Is this the end of the pain for the banks? No, they still have toxic assets on their balance sheets. They will have to take losses, unless the government buys the toxic assets at prices above what they are truly worth. Make no mistake, many (if not most) of the toxic assets on bank balance sheets have essentially failed. While the assets are not worth zero, they are not worth par and never will be. Want a hint of how bad things could be? Wachovia had to come clean as a result of it being purchased by Wells Fargo. According to Bloomberg News, Wachovia has now written down $96.7 billion. This is almost twice what Citi has written down ($54.7B). Citi is believed to have the largest collection of toxic assets. Only government over-payment via TARP or creative accounting can prevent further large writedowns at the major banks.
Preferred holders can breathe a sigh of relief now that it is clear that the government will not require banks to suspend preferred or even common dividends, so long as the banks pay dividends on government owned preferreds. There is one fact of which investors and financial advisers should be aware. Trust preferreds are SENIOR to government preferreds. In theory, banks could not pay the government and still pay the dividends on trust preferreds. Also, since trust preferreds are cumulative, investors are entitled to missed dividends as long as the issuer does not fail. Bank failures have just become much less likely thanks to the Peoples Republic of America
What does this mean for interest rates and corporate bond yields? Long-term interest rates should rise due to the new supply of government debt and the dilution of the value of the dollar. However, that may be moderated some by a continued flight to the dollar as the U.S. is still the safest place to park one’s money.
Corporate bond spreads on non-financials should not change much, narrowing somewhat, as they have not widened out in the same fashion as financials. Financial sector senior notes could experience significant spread narrowing now that the government is temporarily guaranteeing senior bonds. Although rising long-term rates could erode any capital gains benefits from spread narrowing, I believe that the spread narrowing may be enough to keep corporate bond prices stable.
For the next year or two we will be playing defense. Investors should stay with the higher quality names as the near-term economic weakness could be a death-knell for troubled companies.
Monday, October 13, 2008
No Value
No Value
There is an excellent editorial in today’s Wall Street Journal discussing the Value at Risk model and how it failed the markets during the current economic crisis. It is nice to see someone else besides myself criticize the blind reliance on models.
For years I have written of the dangers of the fire and forget method of investing. Value at Risk models are only as good as their input data. One can plug in historical data and a formula (being based on logic) can spit out a result. What a formula can never account for is the human element which is the basis of markets and the economy as a whole. The economy is not like the orbiting of the Space Shuttle or a communications satellite. Engineers can use mathematical formulas to make a satellite remain in a specified orbit. Since there is no human interaction with the direction or speed of the satellite, once in orbit, it will perform as planned by a formula. We can predict the arrival of Halley’s Comet. However, markets and economies are all about human interaction. It is why they exist. The reducing of markets and economies into mathematical formulas will always be problematic because formulas cannot predict the human mind. This is, apparently, surprising to some. It is mainly surprising to the scientists who created the formulas. My advise is to learn the markets and human nature before creating a formula.
Where did the formulas fail us? As the Journal article stated, they did not take into account the politically-motivated decisions regarding Freddie and Fannie and their social lending to people who could not afford a home or the home which they wished to purchase. The so-called Value at Risk models did not (could not) take into account that many mortgages this time around were issued with little or no documentation. Models cannot factor in home flippers who purchased multiple homes with no money down and, because they never paid down payments, have no impetus to try to make mortgage payments. Remember, these were not the roofs over their heads, but investment speculations. Even primary homeowners who put little or no money down have little incentive to pay their mortgages. Buying a home with no money down is similar to renting in that the only capital expended was to make monthly payments. If one cannot afford the monthly payments, one can simply move to a rental property with nothing lost, except for the monthly payment which would have been made anyway be it rent or mortgage payments.
Formulas should be used as guides and re-engineered to account for new market and economic developments. However, this defeats the purpose of formulas. Investment banks and hedge funds use formulas to manage large pools of money most efficiently. Constant human attention makes it less efficient to do so. Some also believe that adding more human interaction creates more volatility and unpredictability. Too bad, the markets are complex and, often, dangerous places. I would rather have a sharp and savvy trader than a reborn physicist creating formulas based on old data and having little if any market experience. This is akin to the age-old criticism of the military. Military strategies are often criticized for planning to fight the last war. History has demonstrated that the strategy which recognizes and reacts to new realities prevails.
There is an excellent editorial in today’s Wall Street Journal discussing the Value at Risk model and how it failed the markets during the current economic crisis. It is nice to see someone else besides myself criticize the blind reliance on models.
For years I have written of the dangers of the fire and forget method of investing. Value at Risk models are only as good as their input data. One can plug in historical data and a formula (being based on logic) can spit out a result. What a formula can never account for is the human element which is the basis of markets and the economy as a whole. The economy is not like the orbiting of the Space Shuttle or a communications satellite. Engineers can use mathematical formulas to make a satellite remain in a specified orbit. Since there is no human interaction with the direction or speed of the satellite, once in orbit, it will perform as planned by a formula. We can predict the arrival of Halley’s Comet. However, markets and economies are all about human interaction. It is why they exist. The reducing of markets and economies into mathematical formulas will always be problematic because formulas cannot predict the human mind. This is, apparently, surprising to some. It is mainly surprising to the scientists who created the formulas. My advise is to learn the markets and human nature before creating a formula.
Where did the formulas fail us? As the Journal article stated, they did not take into account the politically-motivated decisions regarding Freddie and Fannie and their social lending to people who could not afford a home or the home which they wished to purchase. The so-called Value at Risk models did not (could not) take into account that many mortgages this time around were issued with little or no documentation. Models cannot factor in home flippers who purchased multiple homes with no money down and, because they never paid down payments, have no impetus to try to make mortgage payments. Remember, these were not the roofs over their heads, but investment speculations. Even primary homeowners who put little or no money down have little incentive to pay their mortgages. Buying a home with no money down is similar to renting in that the only capital expended was to make monthly payments. If one cannot afford the monthly payments, one can simply move to a rental property with nothing lost, except for the monthly payment which would have been made anyway be it rent or mortgage payments.
Formulas should be used as guides and re-engineered to account for new market and economic developments. However, this defeats the purpose of formulas. Investment banks and hedge funds use formulas to manage large pools of money most efficiently. Constant human attention makes it less efficient to do so. Some also believe that adding more human interaction creates more volatility and unpredictability. Too bad, the markets are complex and, often, dangerous places. I would rather have a sharp and savvy trader than a reborn physicist creating formulas based on old data and having little if any market experience. This is akin to the age-old criticism of the military. Military strategies are often criticized for planning to fight the last war. History has demonstrated that the strategy which recognizes and reacts to new realities prevails.
Saturday, October 11, 2008
Not Short of Mistakes
This week the Dow suffered its biggest one week loss ever and the S&P suffered its worst week since 1933. Some people are lambasting the shorts as the reason for the tanking markets and while we have no love lost for short positions taken by market manipulators, negative opinions are not without some justification, Besides, the short sale suspension came off last Thursday. It was not responsible for the first three days of the sell off. The real problem is our treasury secretary Hank Paulson.
Hank's missteps began with his handling of the GSEs. Short sellers, for a variety of reasons, were beating up share prices of financial institutions and the GSEs. This was making it very costly for them to raise capital in the open market. However, they were still able to do so. Mr. Paulson in an attempt to calm market fears over the GSEs asked for and received almost unlimited power to backstop the GSEs. The market was not convinced this was a good, thing. If Mr. Paulson used his powers and seized the GSEs, preferred holders could be wiped out and that would have locked up the capital markets.
Mr. Paulson dismissed this as an overreaction. However, this is exactly what has happened. Mom and Pop investors and banks (the biggest buyers of preferred - which give much-needed Tier-1 capital) have been scared away. Bond and commercial paper buyers were scared away as Lehman and Wamu were permitted to fail. In fact it is the inconsistency of government actions which has locked up the markets.
Why has poor government decision making locked up the markets? Because, in spite of what the government and CNBC guests tell us, banks and other institutions are LOADED with bad assets. Assests which will NEVER fully recover. Since banks know what toxic assets they have and have a good idea what their counterparties have, interbank lending has basically ceased. The markets want either a cleansing of balance sheets with institutions taking their medicine or a complete government bailout, explicitly guaranteeing banks. Anything else will leave the markets locked and make a deep recession or depression possible.
Hank's missteps began with his handling of the GSEs. Short sellers, for a variety of reasons, were beating up share prices of financial institutions and the GSEs. This was making it very costly for them to raise capital in the open market. However, they were still able to do so. Mr. Paulson in an attempt to calm market fears over the GSEs asked for and received almost unlimited power to backstop the GSEs. The market was not convinced this was a good, thing. If Mr. Paulson used his powers and seized the GSEs, preferred holders could be wiped out and that would have locked up the capital markets.
Mr. Paulson dismissed this as an overreaction. However, this is exactly what has happened. Mom and Pop investors and banks (the biggest buyers of preferred - which give much-needed Tier-1 capital) have been scared away. Bond and commercial paper buyers were scared away as Lehman and Wamu were permitted to fail. In fact it is the inconsistency of government actions which has locked up the markets.
Why has poor government decision making locked up the markets? Because, in spite of what the government and CNBC guests tell us, banks and other institutions are LOADED with bad assets. Assests which will NEVER fully recover. Since banks know what toxic assets they have and have a good idea what their counterparties have, interbank lending has basically ceased. The markets want either a cleansing of balance sheets with institutions taking their medicine or a complete government bailout, explicitly guaranteeing banks. Anything else will leave the markets locked and make a deep recession or depression possible.
Thursday, October 9, 2008
Some Day You'll Pay The Price
I was concerned that the TARP plan would do little to free up credit. It does little to cleanse banks of their most toxic assets. Banks will not lend to other banks for (rightfully) fear that they may not be repaid. Investors will not buy non-GSE MBS due to the same fear. Now Treasury Secretary Paulson is revisiting an idea he had earlier discounted.
Mr. Paulson is considering making equity investments into troubled banks. This would have the immediate benefit of providing sorely needed Tier-1 capital. However, if it is similar to the treasury's handling of the GSEs, shareholders, common and preferred (non-cum preferred equity)may have cause for concern.
Many banks, including some of considerable size, are in trouble. Something must be done do head of massive failures. European governments have taken steps to make investments in banks or have seized them outright.
I do not see any positive developments for the equity or credit markets. Losses will need to be accounted for and the cleansing of balance sheets must occur to re-instill bank and investor confidence. This probably will not head off a recession.
The next casualties after banks may be the automakers. The Detroit Three (especially GM) may be too far gone to save. Do not be surprised if GM files for CH. XI protection soon.
Mr. Paulson is considering making equity investments into troubled banks. This would have the immediate benefit of providing sorely needed Tier-1 capital. However, if it is similar to the treasury's handling of the GSEs, shareholders, common and preferred (non-cum preferred equity)may have cause for concern.
Many banks, including some of considerable size, are in trouble. Something must be done do head of massive failures. European governments have taken steps to make investments in banks or have seized them outright.
I do not see any positive developments for the equity or credit markets. Losses will need to be accounted for and the cleansing of balance sheets must occur to re-instill bank and investor confidence. This probably will not head off a recession.
The next casualties after banks may be the automakers. The Detroit Three (especially GM) may be too far gone to save. Do not be surprised if GM files for CH. XI protection soon.
Wednesday, October 8, 2008
I'm Sorry For The Things I've Done
While reviewing my posts one fact keeps resurfacing. Although I was correct on the oil bubble and the damage to the financial system (it was far worse than even I thought), I poorly assessed the preferred securities situation. This is especially true of the preferred market.
My problem is that I was thinking logically. It appeared illogical that the government would do anything to make it more difficult for compamies to raise Tier-1 capital. Yet, this is exactly what it did when it blew up FRE and FNM preferred holders. It then blundered by acting inconsistently when dealing with troubled firms.
The markets abhor the illogical. Research analysts and strategists do a good job of taking data and formulating opinions. Government actions now require psychics instead of analysts to forecast the markets. Blowing up Lehman after engineering a shotgun wedding for Bear, but before taking over AIG has done that.
I can do a good job looking at the data and telling readers how certain investments shoudl react. However, I can not read the minds of Paulson and Bernanke. It would be helpful if they visited trading desks and financial advisers befoe further policy actions.
My problem is that I was thinking logically. It appeared illogical that the government would do anything to make it more difficult for compamies to raise Tier-1 capital. Yet, this is exactly what it did when it blew up FRE and FNM preferred holders. It then blundered by acting inconsistently when dealing with troubled firms.
The markets abhor the illogical. Research analysts and strategists do a good job of taking data and formulating opinions. Government actions now require psychics instead of analysts to forecast the markets. Blowing up Lehman after engineering a shotgun wedding for Bear, but before taking over AIG has done that.
I can do a good job looking at the data and telling readers how certain investments shoudl react. However, I can not read the minds of Paulson and Bernanke. It would be helpful if they visited trading desks and financial advisers befoe further policy actions.
Missed It By That Much
My recent perusing of posts from earlier this year showed that even a knowledgeable, yet negative, pundit such as myself misjudged just how serious the bank situation was. I never thought that we would get to the point where preferred dividends suspensions and FDIC seizures would be commonplace. Alas, we have fell into the depths of despair. It will be difficult for me to ever suggest preferreds again. Stay far away, especially non-cumulative preferreds.
I Knew Then What We Know Now
Here is a repost of my March 10, 2008 blog:
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.
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.
Listen. Do You Want To Know A Secret
A major investment bank conducted a conference call for brokers and clients to discuss the credit crisis and bank exposure to toxic assets. The speaker on the call expressed his opinion is that banks really do have bad paper on their books.
Much of the toxic assets held on bank balance sheets will never be worth anything near par. The collateral has failed or is failing. Not marking their values lower only puts off the pain to a later date. The bottom line is that many banks are in trouble and need to be just plain bailed out or to be seized and have their assets sold to whatever banks survive.
Want to know how bad it is? Just look at the interbank lending market. It has stalled. Bank CEOs know that their balance sheet is full of glow-in-the-dark assets and need to hoard cash. The last thing they want to do is lend money to a bank which may be more troubled than their own. Folks, there are what I call "disaster banks". Some of them are large, same are more modest in size. These cancers must be cut out of the system before it kills our economy.
Much of the toxic assets held on bank balance sheets will never be worth anything near par. The collateral has failed or is failing. Not marking their values lower only puts off the pain to a later date. The bottom line is that many banks are in trouble and need to be just plain bailed out or to be seized and have their assets sold to whatever banks survive.
Want to know how bad it is? Just look at the interbank lending market. It has stalled. Bank CEOs know that their balance sheet is full of glow-in-the-dark assets and need to hoard cash. The last thing they want to do is lend money to a bank which may be more troubled than their own. Folks, there are what I call "disaster banks". Some of them are large, same are more modest in size. These cancers must be cut out of the system before it kills our economy.
Tuesday, October 7, 2008
Here We Come Again
Today's Wall Street Journal stated the following:
"Another myth is that exports to the rest of the world would somehow rescue the U.S. economy. This was the idea behind the devaluationists -- in Washington and at Harvard -- who pushed a weak dollar to promote exports to counter the U.S. housing slump. So much for that one. Yesterday's selloff was worse in Europe and Latin America than it was on the U.S. Trying to steal "demand" from the rest of the world was short-sighted in the way that beggar-thy-neighbor tactics always are. And with Europe and Japan already in recession, and China slowing down, the export contribution to U.S. GDP is likely to fall sharply."
"A third mistaken idea is that Federal Reserve rate-cutting would save the day. This is the poor sister of the weak-dollar lobby, popular on Wall Street and at Chairman Ben Bernanke's Fed. Despite a year of falling rates, the financial panic is worse than ever and now the real economy is getting hit. The Fed's rate cutting led to dollar flight that produced a commodity spike and oil as high as $147 a barrel. That only made a recession more likely as it sapped consumer discretionary income around the U.S. and worried families and business alike."
"The good news is that some in the Fed now seem to realize this, and the Open Market Committee has stopped its pell-mell flight to a 0% fed funds rate. Instead, the Fed is using its discount window to provide liquidity to banks seeking safety, including yesterday's addition of $600 billion to its Term Auction Facility, growing to $900 billion by November. That's a striking amount of money, but it is the right way for a central bank to manage a panic."
If these comments sound familiar, they should. I have been addressing the weak dollar and the folly of excessive rate cuts since the beginning of this blog. Lowering the Fed Funds rate did not help the situation one iota. The problem as not that money was too expensive, but that it was being hoarded. Banks do not want to lend. Banks need all the capital they can get to recapitalize damaged balance sheets. The only loans it will make are those which are GSE-eligible. The allows banks to recoup the borrowed funds by selling the loans to the GSEs. Banks will not loan to other banks. If you are a bank CEO you know the garbage you have on your balance sheet therefore, you have a pretty good idea what garbage other banks have on their balance sheet. Knowing that, you are reluctant to lend your precious capital to banks who may or may not be able to repay their debt.
Compounding the problem are the inconsistencies of how various corporate crises were handled by the Treasury, the Fed and the FDIC. There is no coincidence in the market and understandably so.
I recall speaking with a colleague in 2004 about what will happen when the non-conforming, subprime, adjustable-rated mortgages adjust higher. We were concerned back in 2004, before the excesses and price spikes seen in the period from 2005 to 2007. The situation became worse than we feared. It is amazing that Wall Street fell into the trap of the unsinkable ship.
The Titanic was once considered unsinkable. Man thought it had found away to account for any and every eventuality. Engineers and others did not, could not, account for the unknown, unknowns. During the past several years, Wall Street put BLIND FAITH in quantitative formulas in the belief that they could account for every eventuality. They forgot about the unknown unknowns. The rocket scientists hubristically believed they were infallible. Their fall to earth was most shocking.
"Another myth is that exports to the rest of the world would somehow rescue the U.S. economy. This was the idea behind the devaluationists -- in Washington and at Harvard -- who pushed a weak dollar to promote exports to counter the U.S. housing slump. So much for that one. Yesterday's selloff was worse in Europe and Latin America than it was on the U.S. Trying to steal "demand" from the rest of the world was short-sighted in the way that beggar-thy-neighbor tactics always are. And with Europe and Japan already in recession, and China slowing down, the export contribution to U.S. GDP is likely to fall sharply."
"A third mistaken idea is that Federal Reserve rate-cutting would save the day. This is the poor sister of the weak-dollar lobby, popular on Wall Street and at Chairman Ben Bernanke's Fed. Despite a year of falling rates, the financial panic is worse than ever and now the real economy is getting hit. The Fed's rate cutting led to dollar flight that produced a commodity spike and oil as high as $147 a barrel. That only made a recession more likely as it sapped consumer discretionary income around the U.S. and worried families and business alike."
"The good news is that some in the Fed now seem to realize this, and the Open Market Committee has stopped its pell-mell flight to a 0% fed funds rate. Instead, the Fed is using its discount window to provide liquidity to banks seeking safety, including yesterday's addition of $600 billion to its Term Auction Facility, growing to $900 billion by November. That's a striking amount of money, but it is the right way for a central bank to manage a panic."
If these comments sound familiar, they should. I have been addressing the weak dollar and the folly of excessive rate cuts since the beginning of this blog. Lowering the Fed Funds rate did not help the situation one iota. The problem as not that money was too expensive, but that it was being hoarded. Banks do not want to lend. Banks need all the capital they can get to recapitalize damaged balance sheets. The only loans it will make are those which are GSE-eligible. The allows banks to recoup the borrowed funds by selling the loans to the GSEs. Banks will not loan to other banks. If you are a bank CEO you know the garbage you have on your balance sheet therefore, you have a pretty good idea what garbage other banks have on their balance sheet. Knowing that, you are reluctant to lend your precious capital to banks who may or may not be able to repay their debt.
Compounding the problem are the inconsistencies of how various corporate crises were handled by the Treasury, the Fed and the FDIC. There is no coincidence in the market and understandably so.
I recall speaking with a colleague in 2004 about what will happen when the non-conforming, subprime, adjustable-rated mortgages adjust higher. We were concerned back in 2004, before the excesses and price spikes seen in the period from 2005 to 2007. The situation became worse than we feared. It is amazing that Wall Street fell into the trap of the unsinkable ship.
The Titanic was once considered unsinkable. Man thought it had found away to account for any and every eventuality. Engineers and others did not, could not, account for the unknown, unknowns. During the past several years, Wall Street put BLIND FAITH in quantitative formulas in the belief that they could account for every eventuality. They forgot about the unknown unknowns. The rocket scientists hubristically believed they were infallible. Their fall to earth was most shocking.
Monday, October 6, 2008
I've Seen Fire and I've Seen Rain
In my 20+ years I seen (counting the current debacle) nearly everything. There are some things I have seen several times. This includes "new economies" and the rise of foreign economies which will supplant the U.S. was the world's dominant economic player. It was Japan, then the EU and then China. Tomorrow it could be India, Brazil or whomever. What these new-age financial pundits repeatedly forget is that ALL global economies are linked to the U.S. economy.
The current stories are that Europe is suffering along with the U.S. as its financial institutions also invested in suspect mortgage-related vehicles. Making the European recovery job more difficult is that, rather than being a unified economic block, the EU is a loose confederation of states each with its own finance minister and bank oversight. Each nation will have to decide for itself how to deal with troubled financial institutions. Some much for a united Europe supplanting the U.S. as the world's leading economic power.
The same could be said for China. Now that the Olympic infrastructure boom is behind it and its main market for goods (the U.S.) is slumping, China is starting to slow down. The global economic slowdown is causing commodities prices to fall. This evidenced by the fall in oil prices.
Oil prices dropped below $90 per barrel today as a strengthening dollar and softening demand have a deflationary effect. My argument earlier this year was that a weaker dollar and speculators using oil as a dollar hedge helped to push oil prices higher. I also stated that higher oil prices would cause consumers to conserve and reduce demand (to some extent). Now we can see that as the dollar strengthens, oil prices fall. All of a sudden, spiraling demand forces are no longer mentioned.
Although fundamental factors started the bubble in oil prices, as with all bubbles, speculation inflated it to Zeppelin-like proportions. Look for gasoline to flirt with $3.00 in the near future. I would not get too giddy yet as a cold winter could increase the demand for home heating oil.
Have fun, drive carefully and stay warm.
The current stories are that Europe is suffering along with the U.S. as its financial institutions also invested in suspect mortgage-related vehicles. Making the European recovery job more difficult is that, rather than being a unified economic block, the EU is a loose confederation of states each with its own finance minister and bank oversight. Each nation will have to decide for itself how to deal with troubled financial institutions. Some much for a united Europe supplanting the U.S. as the world's leading economic power.
The same could be said for China. Now that the Olympic infrastructure boom is behind it and its main market for goods (the U.S.) is slumping, China is starting to slow down. The global economic slowdown is causing commodities prices to fall. This evidenced by the fall in oil prices.
Oil prices dropped below $90 per barrel today as a strengthening dollar and softening demand have a deflationary effect. My argument earlier this year was that a weaker dollar and speculators using oil as a dollar hedge helped to push oil prices higher. I also stated that higher oil prices would cause consumers to conserve and reduce demand (to some extent). Now we can see that as the dollar strengthens, oil prices fall. All of a sudden, spiraling demand forces are no longer mentioned.
Although fundamental factors started the bubble in oil prices, as with all bubbles, speculation inflated it to Zeppelin-like proportions. Look for gasoline to flirt with $3.00 in the near future. I would not get too giddy yet as a cold winter could increase the demand for home heating oil.
Have fun, drive carefully and stay warm.
Thursday, October 2, 2008
You Can't Always Get What You Want
In the years following World War II, as the result of the pre-war New Deal programs. This led to a culture of protectionism, less personal responsibility and, thanks to the the add-on Great Society programs of the 1960s, a society built on regulation and entitlement. During the 1970s, the U.S. economy and socialized economies around the world (see Great Britain) failed under the weight of heavy regulations and union power. It wasn't until Ronald Reagan freed the U.S. economy from the chains of government and labor unions in the 1980s. The future looked bright for America and business and financial innovators. This was the case for almost 25 years, until hubris and greed ended the golden age of the American economy.
Everyone who knows me can attest to my free market ideology. Low taxes, less government and free decision making gives people and businesses the incentive to reach for the stars. It creates an environment in which new products, services and efficient business practices improves the quality of life and prosperity for all, except those who wish to show up at work and collect a paycheck.
However, those who benefited from an era of deregulation and innovation took advantage to the situation to line their pockets and abuse the system. Now their misdeeds threatens to send us back to the stone age of 1946 - 1981. There have been cheers from the left that, finally, the worker will triumph again. Think again Trotskyites. In the era of a global economy (and there is no turning back), jobs will go where business can be done most efficiently, bit in terms of cost and efficiency.
What needs to be done is for those responsible for creating this financial mess should be held accountable. This is not done by letting banks fail, but by removing those executives responsible for this crisis from power. Don't stop there. Those who created these vehicles, traded them, marketed them and rated these vehicles (hear that Moody's and S&P analysts) should be banned from the business (Wall Street), permanently. Their bending the models to make them give the desired solution and the mismarketing of these pools of glow-in-the-dark collateral brought us where we are today.
Mortgage brokers and loan officers should also be pursued for potential fraud. Knowledge-based licensing should be required and a fiduciary responsibility should imposed on EVERYONE who sells, explains or recommends mortgage products.
If these reforms are not imposed, look for heavy regulation, high taxes, slow growth and housing projects in our future.
Everyone who knows me can attest to my free market ideology. Low taxes, less government and free decision making gives people and businesses the incentive to reach for the stars. It creates an environment in which new products, services and efficient business practices improves the quality of life and prosperity for all, except those who wish to show up at work and collect a paycheck.
However, those who benefited from an era of deregulation and innovation took advantage to the situation to line their pockets and abuse the system. Now their misdeeds threatens to send us back to the stone age of 1946 - 1981. There have been cheers from the left that, finally, the worker will triumph again. Think again Trotskyites. In the era of a global economy (and there is no turning back), jobs will go where business can be done most efficiently, bit in terms of cost and efficiency.
What needs to be done is for those responsible for creating this financial mess should be held accountable. This is not done by letting banks fail, but by removing those executives responsible for this crisis from power. Don't stop there. Those who created these vehicles, traded them, marketed them and rated these vehicles (hear that Moody's and S&P analysts) should be banned from the business (Wall Street), permanently. Their bending the models to make them give the desired solution and the mismarketing of these pools of glow-in-the-dark collateral brought us where we are today.
Mortgage brokers and loan officers should also be pursued for potential fraud. Knowledge-based licensing should be required and a fiduciary responsibility should imposed on EVERYONE who sells, explains or recommends mortgage products.
If these reforms are not imposed, look for heavy regulation, high taxes, slow growth and housing projects in our future.
Wednesday, October 1, 2008
Do You Smell Bacon
The financial system urgently needs help and the Senate passes a bill with more pork than a Denny's breakfast. This bill includes such helpful features such as a tax on toy arrows, mental health insurance coverage, AMT reform, R&D tax credits and some feature dealing with NASCAR. Even if one supports one of the non-related line items, one must question why a rescue bill which shores up the economy and holds banks and Congress (for its role with Freddie and Fannie) responsible. I say, fewer lawyers and more business people in government. Especially small business people as they need to be the most efficient.
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