Stoneleigh: Central bankers cannot prevent a huge increase in risk premiums, which will send rates for all long term borrowing much higher in nominal terms. Against a backdrop of credit deflation, real interest rates will be even higher. There is no safe level of debt to be carrying when interest rates go through the roof and your income becomes uncertain. This is a recipe for sky-rocketing defaults, and in a highly leveraged world that feeds a vicious circle of positive feedback.
Credit Crack-Up Being Ignored
Now let's pay attention to another area for a minute I've talked about before - the bond market.
When PIMCO goes short the long end of Treasuries, you better pay attention. And they have - negative 18%, from their last disclosure. That means 18% of their position (in total!) is net short treasuries.
This is a bet on a massive crack-up in the bond market, with rates skying higher and prices falling through the floor. I've written about this before, but folks, believe me, if Bill Gross is on this, you better pay attention. If he's wrong he's going to get murdered, but if he's right the entire economy, especially housing, is going to get murdered.
Yes, murdered worse than it already has.
How?
Simple - right now 30 year fixed mortgages are about 6%. If we get a bond market crack-up and the 10 year goes up 200 basis points (2%), for example, Bill's short bet (assuming he's short the 10) is worth 2% x 10 (duration) or an instantaneous 20% profit.
But what happens to your house? Well, mortgage rates will probably rise by the same 200 basis points, or go from 6-8%. That's a 33% increase, which will result in a roughly 28% loss in buying power for home purchasers!
It will also hit other types of debt such as credit cards but the difference 200 basis points makes on a 20% credit card interest rate (10%) is far less than the impact on debt with less "spread", such as mortgages.
So this "crack up", should it occur and be mild, results in your house losing 28% of its value. Should that "crack up" be severe, say, a 500 basis point rise (not out of the realm of possibility; see the late 70s into 1980) the consequences would be catastrophic (a loss of 50% of value, essentially "all at once.")
And that's on top of what your home's value loses from bubble deflation - this change is additive but immediate, as the impact on money available happens now, not through the process of the bubble unwinding.
Stoneleigh: I have a great deal of respect for Doug Noland, but I disagree with him here that the recent actions of central bankers could lead to another year of speculative excess. I think the current rally is nearing its end, which would signal the next phase of the credit crunch. As significant as recent actions by the Fed and the BoE have been, I don't think they can do more than inspire fleeting optimism, and without confidence those actions cannot restore liquidity. Confidence is liquidity.
The Meaning of Stage II
Otherwise intelligent financial commentators argue that today's rising energy and food prices are not a "monetary phenomenon." Instead, these price pressures are said to be due to strong demand from China and India - wealthier consumers choosing to upgrade their diets. But both the Chinese and Indian economies (and many others) are now operating with virtually unlimited Credit - a unique combination of rampant domestic Credit growth coupled with massive foreign financial flows. As I've explained ad nauseam, U.S. Current Account Deficits and dollar impairment are the root cause of scores of runaway domestic Credit systemic that comprise the Global Credit Bubble. This historic Bubble is everywhere and in everyway a monetary (Credit) phenomenon.
It is my argument that Stage II Means another year of massive U.S. Current Account Deficits. This would Mean, for one, a prolonging of the massive flow of liquidity into international central bank reserves (creating domestic Credit in the process), sovereign wealth funds, and (to a lesser extent) the hedge fund community. The consequences from a further ballooning of this Unwieldy Global Pool of Speculative Finance are not at all clear. Secondly, another year of U.S. Deficits would Mean another year of excessive liquidity flows into the already overheated economies throughout Asia, the Middle East and elsewhere. Importantly, these Monetary Processes and Inflationary Dynamics are by now well entrenched and extraordinarily powerful after years of unrelenting excess. Resulting Monetary Disorder should be expected to go to increasingly destabilizing extremes (think NASDAQ 1999 and subprime 2006!) - and indeed we're seeing evidence for as much in near $120 crude, the global food price spike and related hoarding, and wildly unstable and speculative global financial markets.
It is in this context that I believe U.S. policymakers are today unknowingly risking global financial and economic catastrophe. They are, of course, fixated on domestic concerns and are willing to do any and everything in a desperate attempt to sustain the U.S. Bubble Economy. They are oblivious to both the heightened risks associated with today's Current Account Deficits and to the various linkages of their policies to Heightened International Monetary Disorder. Stage II is fraught with great but not easily recognizable risks.
It is my view that there are significant risks associated with postponing the inevitable adjustment to the U.S. Bubble Economy. As I've attempted to explain previously, the amount of Credit necessary to sustain our uniquely maladjusted Economic Structure is unmanageable. It is unmanageable for our troubled banking system, for our troubled GSEs, and for the expansive money-fund complex - for risk intermediation generally. Stage II Means great risk to the heart of contemporary "money." The problem rests on the reality that "pre-adjustment" Credit (borrowings associated with many businesses and enterprises that will be uneconomic come the arrival of the post-Bubble backdrop) is inherently vulnerable. And as discussed above, today's U.S. Credit is extraordinarily destabilizing in its effects upon the Global Credit Bubble and Resulting Monetary Disorder.
I am at this point more convinced than ever that only a severe crisis will instigate the necessary adjustment to the distorted and imbalanced U.S. and global economies. One is then left with the disconcerting view that Stage II will lead our authorities to exhaust all policy measures in a futile attempt to sustain the unsustainable. The obvious question: how long does the lead up Crisis Stage II last? I would today guess a number of months, although I wouldn't at all be surprised if it was rather short. What will be the impetus for Crisis Stage II? A spike in interest rates, a run from U.S. Treasury and agency debt, a disorderly drop in the dollar, another bout of derivative and Credit market implosion, or acute global financial tumult should be considered leading candidates based on Stage II ramifications. Or it could easily be something completely unexpected, perhaps even war.
One Guy Who Has Seen It All Doesn't Like What He Sees Now
Peter Bernstein has witnessed just about every financial crisis of the past century.
As a boy, he watched his father, a money manager, navigate the Depression. As a financial manager, consultant and financial historian, he personally dealt with the recession of 1958, the bear markets of the 1970s, the 1987 crash, the savings-and-loan crisis of the late 1980s and the 2000-2002 bear market that followed the tech-stock bubble.
Today's trouble, the 89-year-old Mr. Bernstein says, is worse than he has seen since the Depression and threatens to roil markets into 2009 and beyond -- longer than many people expect.
Mr. Bernstein, whose books include "Against the Gods: The Remarkable Story of Risk," sees two culprits. One is the abuse of securitization -- the trend for banks to hold fewer loans on their books and instead turn them into securities that were sold to other investors. The other is simply years of overborrowing by financial institutions and consumers alike.
Mr. Bernstein is hopeful that Federal Reserve intervention will prevent deflation and depression, but he says there is no guarantee.
Triple-A Failure
In 1996, Thomas Friedman, the New York Times columnist, remarked on “The NewsHour With Jim Lehrer” that there were two superpowers in the world — the United States and Moody’s bond-rating service — and it was sometimes unclear which was more powerful. Moody’s was then a private company that rated corporate bonds, but it was, already, spreading its wings into the exotic business of rating securities backed by pools of residential mortgages.
Obscure and dry-seeming as it was, this business offered a certain magic. The magic consisted of turning risky mortgages into investments that would be suitable for investors who would know nothing about the underlying loans. To get why this is impressive, you have to think about all that determines whether a mortgage is safe. Who owns the property? What is his or her income? Bundle hundreds of mortgages into a single security and the questions multiply; no investor could begin to answer them. But suppose the security had a rating. If it were rated triple-A by a firm like Moody’s, then the investor could forget about the underlying mortgages. He wouldn’t need to know what properties were in the pool, only that the pool was triple-A — it was just as safe, in theory, as other triple-A securities.
Over the last decade, Moody’s and its two principal competitors, Standard & Poor’s and Fitch, played this game to perfection — putting what amounted to gold seals on mortgage securities that investors swept up with increasing élan. For the rating agencies, this business was extremely lucrative. Their profits surged, Moody’s in particular: it went public, saw its stock increase sixfold and its earnings grow by 900 percent.
By providing the mortgage industry with an entree to Wall Street, the agencies also transformed what had been among the sleepiest corners of finance. No longer did mortgage banks have to wait 10 or 20 or 30 years to get their money back from homeowners. Now they sold their loans into securitized pools and — their capital thus replenished — wrote new loans at a much quicker pace.
Mortgage volume surged; in 2006, it topped $2.5 trillion. Also, many more mortgages were issued to risky subprime borrowers. Almost all of those subprime loans ended up in securitized pools; indeed, the reason banks were willing to issue so many risky loans is that they could fob them off on Wall Street.
But who was evaluating these securities? Who was passing judgment on the quality of the mortgages, on the equity behind them and on myriad other investment considerations? Certainly not the investors. They relied on a credit rating.
Thus the agencies became the de facto watchdog over the mortgage industry. In a practical sense, it was Moody’s and Standard & Poor’s that set the credit standards that determined which loans Wall Street could repackage and, ultimately, which borrowers would qualify. Effectively, they did the job that was expected of banks and government regulators. And today, they are a central culprit in the mortgage bust, in which the total loss has been projected at $250 billion and possibly much more.
Nothing Left To Lose At Ambac
Does Ambac have any credibility? I think not. Nonetheless, lets assume the top side of Ambac's estimate that they can generate $1.5 billion as policies mature. To be fair, let's also assume that Goldman Sachs analyst James Fotheringham is correct that Ambac needs to raise $3.4 billion each to fill capital shortfalls.
That is $1.9 Billion that Ambac needs to raise to which Robert Haines, an analyst at CreditSights Inc. says "We question its ability to access the capital markets anytime soon."
But once again, let's give Ambac the benefit of the doubt. Let's assume that Ambac can raise $1.9 billion.
At Thursday's close Ambac had a market cap of $1 billion and a closing price of $3.76. To raise $2 billion at these prices would cause a massive shareholder dilution making each share worth about 1/3 what it is worth today. That would make each share worth about $1.25. There are delisting rules at those prices.
By the way, Bloomberg is reporting "Ambac's new business slumped 87 percent last quarter after ratings companies threatened to strip the insurer of its AAA status".
Amazingly Moody's, Fitch, and the S&P did not downgrade Ambac after this fiacso. I guess the intent is to hold on to those ratings all the way to zero. The excuses at S&P were pathetic....
....exactly how much new business is Ambac going to bring in now? Business is down 87%. With that, I wish to repeat what I said the other day in Ambac expects losses of 81.8% of underlying collateral: "Ambac is not going to get much if any guarantee business. And a guarantee business that does not get guarantee business is guaranteed to go bankrupt. It's as simple as that."
Ambac could have raised money at $40, $30, or $20 far easier than it can raise money at $3.76. Ambac is down a mere 96% in less than a year. What does it have to lose now by saying it will not raise capital? There is quite literally nothing left for Ambac to lose.
That begs the question: Is there is any credibility left to lose with Dick Smith, Managing Director, at the S&P either?
Stoneleigh: It has been my view for some time that the euro was close to topping on instability in the euro zone, and that the dollar would rise as the euro fell - on short covering and a flight to safety. I think we're in the early stages of this process now, although the flight to safety component has yet to materialize. I would expect that to begin building once the recent market rally is over and the decline begins again. My guess is that a dollar rally, once underway, could last for several months at least.
Euro dives as wheels fly off eurozone economy
The euro has suffered its sharpest drop in four years as a blizzard of weak data from Germany, Belgium, France, and Spain spark fears that economic contagion may be spreading from the Anglo-Saxon world to Europe....
....David Owen, an economist at Dresdner Kleinwort, said Europe would soon be engulfed by the twin effects of a "collapse in export volumes" and a slow motion credit squeeze. "The wheels are coming off the eurozone economy," he said.
BNP Paribas warned clients yesterday that the "decoupling story" was no longer credible. "We see Europe in the early stage of a credit crunch, and if we are right credit supply will shut down," it said. Key governors of the European Central Bank began to back away from their hawkish stance of recent weeks, clearly disturbed by the market perception that they are mulling a rate rise to choke.... off price rises. Inflation has reached a post-EMU high of 3.6pc on surging oil and food costs.
Jean-Claude Trichet, ECB president, went out of his way yesterday to brief journalists that "sharp" currency moves had "possible implications for financial and economic stability", a coded threat of co-ordinated intervention by world central banks.
The comments caused a second scramble for dollars in mid-day trading as speculators rushed to cover "short" positions against the greenback....
HBOS to debate cash call as property investments struggle
Board directors at HBOS, Britain's biggest mortgage lender, will tomorrow discuss potential plans to tap shareholders for billions of pounds of fresh capital.
The bank, which will accompany its annual meeting on Tuesday with a trading update, was last night undecided about such a move, which will be formally debated at a board meeting tomorrow.
HBOS's core tier-one equity of 5.7 per cent is well above regulatory requirements, although some directors are understood to believe a rights issue would be sensible owing to the perilous state of Britain's mortgage industry.
HBOS is considering raising as much as £4bn; it is also expected to reveal a writedown of up to £3bn at its AGM....
....British banks have come under pressure to raise capital because of the sharply declining value of many of their assets.
HBOS, for example, is facing credit-crunch related problems at two of its biggest property investments, Crest Nicholson and McCarthy & Stone, both of which it co-owns with the Scottish businessman and philanthropist Sir Tom Hunter.
Where was the wise man?
Nodding toward Mr. Rubin’s acute sense of the volatility of the markets, he adds that the only thing Mr. Rubin “is dismissive of is people who are certain of things that are inherently uncertain.”
Mr. Rubin encouraged Goldman to move into more treacherous markets like proprietary trading and commodities trading. Even so, he now says he was always concerned about the dangers posed by risky futures and derivatives trades, having seen how the pell-mell use of futures contracts exacerbated the 1987 stock market crash.
Shortly before leaving Goldman to head up President Clinton’s National Economic Council, Mr. Rubin says, he met with Richard B. Fisher, the chairman of Morgan Stanley, to discuss the idea of imposing stricter margin requirements on futures trading. Mr. Rubin says the idea died after the Chicago Board of Trade told him “we will make sure Goldman Sachs never trades another future on the C.B.O.T. if this went ahead.”
Did Robert Rubin Jeopardize Financial Stability to Protect Goldman Sachs?
That is what he claims, according to the NYT. The NYT reports that Rubin claims that he was considering imposing stricter margin requirements on futures trading when he was leaving Goldman Sachs to take a top position in the Clinton administration. According to the article, Rubin claims he abandoned the plans when the Chicago Board of Trade told him “we will make sure Goldman Sachs never trades another future on the C.B.O.T. if this went ahead.”
A spokesperson for the company that now owns the C.B.O.T. denies that any such threat was ever made, but this is an incredibly important news story. The implication is that a top official in the Clinton administration, who subsequently became Treasury Secretary, altered regulatory policy based on a threat made against his former firm.
If such a threat was actually made, then it should have been reported to the F.B.I. and some people connected with the C.B.O.T. should be sitting in jail right now. If Mr. Rubin was actually prepared to alter regulatory policy to serve his former firm, then he clearly had conflicts of interest that made him unqualified to hold a top government position.
Freddie Mac takes lead in GSE mortgage purchases
Freddie Mac, the second-biggest funder of U.S. home loans, on Friday took the lead in the government-sponsored enterprises' efforts to stabilize the market with mortgage purchases last month.
Agreements by Freddie Mac to buy mortgages soared to the highest level in nearly five years in March after the company's regulator eased capital constraints. The larger publicly traded GSE, Fannie Mae, also boosted its commitments but fell short of analysts' expectations.
Freddie Mac entered contracts to buy $43.5 billion in loans last month, sharply up from $14.8 billion in February and the most since July 2003 as refinancings hit record heights. The contracts portend future growth in the McLean, Virginia-based company's investment portfolio, which increased to $712.5 billion in March from $709.5 billion in February.
Washington-based Fannie Mae said its mortgage purchase commitments rose about $5.9 billion to $31 billion in March, the most since September.
The boosts were expected after the Office of Housing Enterprise Oversight last month reduced the mandatory capital levels that Freddie Mac and the larger Fannie Mae must hold. The move by OFHEO was considered a way to provide stability to the ailing U.S. mortgage and housing markets by increasing the purchasing power of the GSEs by $200 billion.
While Fannie Mae fell short in March, it was probably due more to investment timing rather than policy, analysts said. The GSEs must answer to increased pressure to shore up mortgage funding from key lawmakers, and from the Bush administration that until recently viewed the size of the GSE investments as more harmful than helpful to the U.S. financial system.
"They've got a gun to their head to start to get into this market," said Paul Miller, an analyst at Friedman, Billings Ramsey Inc in Arlington, Virginia.
Bush Urges Expanded Government Role in Buying Student Loans
President George W. Bush urged Congress to pass legislation that would give the federal government more authority to buy student loans from banks and other private companies, saying the credit crunch has put pressure on college students.
``A slowdown in the economy shouldn't mean a downturn in educational opportunities,'' Bush said in his weekly radio address.
As of April 24, more than 50 lenders, accounting for 14 percent of the private student loan volume, had withdrawn from the guaranteed student loan program. About 7 million borrowers will need more than $68 billion in federal loans this academic year, according to Education Department estimates.
More U.S. Households Seek Help With Utilities
More U.S. households are falling behind on their utility bills and seeking public assistance, according to groups that arrange for help. They fear a record number of families will face utility shutoffs in coming months, reflecting fallout from a distressed housing market and rising prices for food and energy.
"The underlying problem is many families are becoming poorer and have to pick which bills to pay," said Mark Wolfe, executive director of the National Energy Assistance Directors' Association, a group that represents state directors of energy-assistance programs. Some states are attempting to buy some time by delaying the date at which utilities are allowed to begin disconnections. That is often prohibited during the winter because it could be life-threatening. Connecticut extended a moratorium on shutoffs to May 1 from April 15 this year....
....Some states have seen double-digit increases in the number of families receiving public assistance to pay their utility and fuel bills. The increases go as high as 80% in Nevada and 44% in Oklahoma. States control how they dole out their share of the $2.5 billion in federal funds distributed under the Low Income Home Energy Assistance Program. Many states are asking Congress to provide more funds for energy assistance.
Trader at center of $73B French bank scandal lands a new job
He was tied this year to one of the largest securities scandals in history and faces charges ranging from forgery to unauthorized computer use, yet the former trader at French bank Societe Generale is gainfully employed, again.
Jerome Kerviel, who shook global financial markets when the bank revealed $7.14 billion in losses tied what it says were unauthorized trades, has landed a new job as a computer consultant.
Stoneleigh: I disagree with this, as I disagree that the current sky-high food prices will last. I think the commodity complex is close to topping and should show sharp declines in the not too distant future, which is not to say that supply is not currently tight or that population is not a problem. Clearly both those things as true, but that is not the whole story. Commodity tops, like equity bottoms, are typically sharp spikes driven by fear and exaggerated by speculation. They are typically followed by equally sharp reversals once it becomes clear that the trend has gone too far.
Over the long term, energy and food will inevitably become more expensive in real terms due to both scarcity and the extreme level of economic disruption that deflation will herald. However, that does not mean that prices must stay high in nominal terms for years to come. My view is that we'll see substantial falls in nominal terms (not adjusted for underlying changes in the money supply), but likely a rise in real terms as purchasing power should fall faster than price during credit deflation. Lower nominal prices do not necessarily imply greater affordability.
Deflation will greatly reduce demand, even for essentials, because demand is not what one wants, but what one is ready, willing and able to pay for. In a world where the collapse of the credit component drastically reduces the available money supply, purchasing power will be scarce indeed.
Population explosion means oil at $100 a barrel is here for years
'A whole load of stuff could come apart here," warned Art Cashin last week on CNBC - the US business channel. "This oil thing - it's gettin' crazy".
Cashin was talking from the floor of a nervous New York Stock Exchange.
After 46 years "in the pit", the gnarled trader is rightly seen as the man with the clearest idea of what "the market" is really thinking.
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And he's right. The oil price is now "kinda' crazy". On Tuesday, crude hit $119.90 a barrel - 87 per cent up on a year ago. The spike was widely attributed to rebel attacks on Shell's Nigerian oil facilities, which threaten to undermine global supplies.
On Friday, prices climbed again, skimming $120 once more. The given reason this time was problems at Exxon's Nigerian plant - along with the threatened strike at the UK's Grangemouth refinery, potentially affecting 70 North Sea drilling platforms.
But while events in Scotland, and the Niger Delta are unfortunate, they don't explain why the crude price is so high.
These localised issues may have added a few dollars to oil in recent days, but for several years now, the fundamentals have been pushing fuel costs relentlessly up. And my view, however frightening, is that oil prices will now average more than $100 a barrel for many years to come.
