Thursday, January 24, 2008

Debt Rattle, January 24 2008

Here’s two more pieces on the monoliners.

NY regulator: fixing bond insurers will take time

Any plan to fix the bond insurers' difficulties will take "some time," because of the complexity of the issues and the number of parties involved, New York State Insurance Superintendent Eric Dinallo said in a statement on Thursday.

Dinallo also said that clearly it is important to resolve issues related to the bond insurers as soon as possible. Dinallo met with a group of banks on Wednesday to press them to put up capital to bail out the wobbly bond insurers.

Ilargi: I think it was CalculatedRisk who said earlier today that there is no time for the bond insurers. Me, I’m more fantasizing about the level of pressure put on the ratings agencies to NOT downgrade anything in the field. Problem with that is, Moody’s, Fitch and S&P have a huge credibility issue, that seriously threatens their vey survival. If they don’t start telling it like it is on the bond insurers, and very soon too, they may lose the last few torn shreds of confidence that are left.

Next we have the New York Times, seemingly trying to fool their readers into thinking this is a new issue: "the next thing to worry about". Where were they the past few months? Never mind.

Next on the Worry List: Shaky Insurers of Bonds
Even as stocks ended five days of losses with a surprising recovery on Wednesday, officials began moving to defuse another potential time bomb in the markets: the weakened condition of two large insurance companies that have guaranteed buyers against losses on more than $1 trillion of bonds. Regulators fear a possible chain of events in which the troubled bond insurers, MBIA and Ambac, might be unable to keep their promise to pay investors if borrowers default on their debt.

That could leave the buyers of the bonds — including many banks and pension funds — on the hook for untold billions of dollars in losses, shaking confidence in the financial system. To avoid a possible crisis, insurance regulators met with representatives of about a dozen banks on Wednesday to discuss ways to shore up the insurers by injecting fresh capital, much as Wall Street firms have turned to outside investors recently after suffering steep losses related to subprime mortgages. While it is unclear what steps, if any, the banks and regulators may ultimately take, the talks focused on raising as much as $15 billion for the companies, according to several people briefed on the discussion who asked not to be identified because of the sensitive nature of the discussions.

Eric R. Dinallo, the New York insurance superintendent who regulates MBIA, called Wall Street executives on Tuesday to set up the meeting at his office in Lower Manhattan. He led the session on Wednesday and suggested that the group move in as little as 48 hours to get a deal done ahead of any downgrading of the bond guarantors by credit ratings firms. Mr. Dinallo could face resistance from banks that do not have significant exposure to the guarantors and thus have less incentive to put up money. It is also unclear how executives and shareholders of the companies would react to the plan and the prospect of ceding control.

Sean Dilweg, the commissioner of insurance in Wisconsin, which regulates Ambac, sat in on the meeting but said he would be working with Ambac directly. Mr. Dilweg said he met separately on Tuesday with executives at Ambac, which is based in New York but chartered in Wisconsin. “Eric is looking at the overall issue, but I am pretty confident that we will work through Ambac’s specific issues,” Mr. Dilweg said in a telephone interview. “They are a stable and well-capitalized company but they have some choices to make.”

Ilargi: A well-capitalized company? Their market cap is $1.1 billion, with $556 billion in insured bonds, they lost another 17.3% on the Street today, and 90% from the top, and they are what? Methinks the commisioner wouldn’t like to see Ambac fail. Well, too bad.

While $15 billion might seem like a large amount of money for banks to commit to bond guarantors at a time when many investors have lost faith in them, Mr. Haines said it would be smaller than the billions the banks might have to write down if the companies lost their top ratings or incurred major losses.

“It’s a calculated kind of risk,” he said.

Ilargi: That’s what I said earlier today. Looks like a great deal. Like an offer they can’t refuse. But boy oh boy!

Existing Home Sales Fall, First Annual Price Drop Since Great Depression
Sales of existing homes in the U.S. fell more than forecast in December, capping the biggest annual slump in 25 years and the first decline in prices since the Great Depression.

Purchases fell 2.2 percent to an annual rate of 4.89 million, the National Association of Realtors said today in Washington. For all of last year, sales of single-family homes declined 13 percent and prices dropped 1.8 percent, the first decrease since records began in 1968 and probably the first since the 1930's, the group said.

Falling property values and stricter borrowing terms will lead to more foreclosures and depress housing for most of this year, economists said. Investors anticipate the Fed will cut interest rates again next week in an effort to prevent the downturn from exacerbating weakness in the broader economy.

"There is likely to be little or no increase" in gross domestic product this quarter, Harvard University economist Martin Feldstein told the Senate Finance Committee in Washington today. "The probability of a recession in 2008 now exceeds 50 percent. If it occurs, it could be deeper and longer than the recessions of the recent past."

Ilargi says:

Hats off to the (wo)man who came up with the idea of announcing the BoA takeover of CountryLied. It’s absolutely brilliant. No need to sign anything, or have any serious intention of closing the deal. Just the announcement was enough to stave off CFC’s certain bankruptcy, which would have been executed by now, and prop up its stock, as well as lift up the entire industry a few notches with the -false- hope of more deals to come. Will it ever be signed? Want to bet? Really, brilliant sleight of hand.

And take a long hard look at the numbers BoA has put on its CDO's and subprime loans: 30 cents on the dollar. Let's see the entire industry do that, now, today! And then let someone calculate the total losses. It's high time. Oh, and when they're done with that, let's see what they think their Pay-Option ARM's are worth. Come clean boys and girls, let's see what the emperor wears.

Bank of America sees Countrywide deal done in second half
Bank of America CEO Ken Lewis said Tuesday that the company expects to close its previously announced acquisition of mortgage giant Countrywide Financial in the second half of 2008.

CFO Joe Price also told listeners on a conference call Tuesday morning that the company marked down its value for CDOs and subprime loans to less than half their original value. "The combined subprime CDO sales and trading positions at 12/31 are carried at 600 million or about 30 cents on the dollar," Price said.

The executives said they expect the U.S. economy to slow, but they do not expect it to enter a recession.

Housing prices to free fall in 2008 - Merrill
The worst housing financial crisis in decades is only going to get worse, a Merrill Lynch report said Wednesday.
The investment bank forecasted a 15 percent drop in housing prices in 2008 and a further 10 percent drop in 2009, with even more depreciation likely in 2010.

By contrast, the National Association of Realtors (NAR) expects housing prices to remain flat in 2008. NAR did cut its home price estimate for the current quarter, however, to a 5.3 percent year-over-year decline, which represents the steepest drop in that price measure on record. But NAR sees an uptick in home prices in the last two quarters of 2008.
"Merrill Lynch's figures are way too pessimistic, and they are unprecedented," Lawrence Yun, the National Association of Realtors chief economist told "There is so much variation in local housing markets, and we see stable price conditions for 2008."

The current housing crisis and the depreciation in home prices have pummeled the economy, with businesses and consumers cutting back on spending, raising the specter of a recession. "Lower sales and higher inventory for sales are lowering the velocity of transactions," said Fritz Siebel, Director of US Property Derivatives for Tradition Financial Services. "That cannot be a sign of good health for the economy."

But for those who think that the worst is over, Merrill Lynch said that housing prices still remain comparatively high. The brokerage believes that home prices are still far above historical norms when compared to other measures such as rent or GDP. "By our calculations, it will take about a 20 to 30 percent decline in home prices to correct this imbalance," said the report.

Merrill Lynch believes that housing starts will most likely slide another 30 percent by the end of 2008 - a historic low.

Equities rebound on insurance bailout hopes
Investors poured back into equities on Thursday, hoping a rescue plan for ailing bond issuers would stem credit losses, while allegations of a massive trade fraud at Societe Generale added to financial sector woes.

Demand for bonds fell as equities rebounded but currency traders remained cautious.

European and Asian stocks markets took their cue from overnight gains on Wall Street to rise sharply. The pan-European FTSEurofirst 300 was up 3.6 percent and Japan's benchmark Nikkei .N225 closed 2.1 percent higher.

The key driver was news that New York's insurance regulator had pressed major banks on Wednesday to put up billions of dollars to support wobbly bond insurers.

Faith In The Fed: The Last Bubble To Pop
A mad rush by Congress, Bush, the Treasury department and even foreign central banks to "Do Something" is now underway.

If the Fed, Congress, and Central Banks would just stop and think, they would realize they already "did" something. They created the biggest credit bubble in history and we are on the backside of the credit bubble bust right now. It's too late to do anything about that now.

Market action now suggests leveraged hedge funds are selling what they can (oil stocks like Exxon Mobil (XOM) and tech stocks), not what they want (junk mortgage backed securities). The latter simply has no bid. Recent action smacks of margin call selling or a derivative blowup somewhere.

Mighty Mouse Bernanke Fails To Save The Day
Unfortunately, there is no "fix" temporary or permanent on either side of the Atlantic. The harder the Fed and ECB fight this mess the longer it will last. Housing prices, asset prices, and leverage all have a lot of unwinding to do. The problem is not liquidity, the problem is solvency. Anyone expecting another miracle save is going to be disappointed.

Mortgage Rates And The Red Queen Race
All things considered, the odds of a huge number of people in 15 year fixed rate mortgages benefiting by this drop in the Fed Funds Rate is pretty slim, especially since the pool of possible beneficiaries is primarily for the last 18 months or so.

Thus, the only people really benefiting from this drop so far are those currently in interest only mortgages, pay option ARMs, or other ARMs specifically tied to short term LIBOR. For those in Pay Option ARMs, this benefit may do nothing but postpone the day of reckoning. This is especially true for Option ARM holders who are only able to afford the minimum payments and are going deeper in debt every passing month due to negative amortization. For the rest, the benefit is real. However, this just puts people back to where rates were a couple years ago.

Conclusion: 175 basis points of rate cuts at best amounts to nothing but treading water when it comes to helping the mortgage crisis.

California Foreclosure Activity Still Rising
"Foreclosure activity is closely tied to a decline in home values. With today's depreciation, an increasing number of homeowners find themselves owing more on a property than it's market value, setting the stage for default if there is mortgage payment shock, a job loss or the owner needs to move," said Marshall Prentice, DataQuick's president.
The median price paid for a California home peaked at $484,000 last March and declined to $402,000 by the end of 2007, although much of that decline was caused by significant shifts in the types of homes that were sold.
Most of the loans that went into default last quarter were originated between August 2005 and October 2006. The median age was 22 months, up from 15 a year earlier, indicating that the pool of at-risk home loans is getting larger.

Dodd Seeks U.S. Program to Buy `Distressed' Mortgages
Senate Banking Committee Chairman Christopher Dodd proposed creating a federal program to buy ``very distressed'' mortgages at steep discounts as part of economic stimulus legislation being developed in Congress….
….Dodd's proposal, modeled on the Depression-era Home Owners' Loan Corp., came as Democrats unveiled several proposals reminiscent of 1930s-style economic-stimulus programs. Senate Majority Leader Harry Reid of Nevada said today Congress should work on a long-term plan that would pay to build roads, utilities, schools and housing.
Dodd outlined his proposal in a letter to Reid yesterday. The program would ensure lenders and investors ``take a haircut'' and are not being bailed out, Dodd said in the letter.
The proposed corporation would buy outstanding mortgages at ``steep discounts'' and convert them into loans insured by the Federal Housing Administration or backed by government-sponsored enterprises, he wrote to Reid. Dodd proposed $10 billion to $20 billion to fund the program.

Refinancing Drives Increase In Mortgage Applications In Latest MBA Weekly Survey
"Refinance applications are up 92% since the beginning of November and purchase applications are up 7%. With tighter credit conditions we do not know how many of these applications will become loans, but it is clear that borrowers are responding to the 40-80 basis point drop in rates we have seen since November 2 across products," said Jay Brinkmann, Vice President of Research and Economics at the Mortgage Bankers Association.

Builders, Banks Could Get Tax Break
U.S. homebuilders, lenders and other struggling companies could receive hefty one-time tax refunds this year and next under a provision of the economic stimulus plan percolating in Washington.

President Bush and lawmakers from both parties aim to quickly inject capital into the economy, which has been hit hard by turmoil in the housing and credit markets, by extending the timeframe under which companies are allowed to retroactively deduct net operating losses against earlier profits.
It would be the second time in recent history that the government has amended this accounting tool, known as a "tax loss carryback," to stimulate the economy in the face of a recession.
Under the proposal, one of several emergency tax breaks being considered for corporate America, companies would for two years be allowed to carry back losses incurred in 2007 and 2008 against profits accrued over the previous five years, instead of the usual two year timeframe.
Some of the biggest beneficiaries would be Wall Street banks such as Citigroup Inc., Merrill Lynch & Co., Morgan Stanley and Bear Stearns Cos. Homebuilders, which have been punched by the housing slump after years of go-go profits, also stand to benefit. In fact, any company that is now struggling following years of healthy profits (that pumped up their tax bills) could in theory benefit.

Homeowners just walking away
As I've noted before, one of the greatest fears for lenders (and investors in mortgage backed securities) is that it will become socially acceptable for upside down middle class Americans to walk away from their homes. These are homeowners with the "capacity to pay, but have basically just decided not to".

Wachovia is seeing that happen now. Imagine what will happen as house prices fall this year and next.


Greyzone said...

The Dodd proposal, coupled with the recent Fed changes and the calls for the government to back the monoline insurers place us pretty close to the government becoming the lender of last resort. Since that has not happened before ever that I can see, I am wondering what impact that might have here. Specifically, I am wondering if that might be the key that lets the irrational views dominate yet a while longer rather than the cold facts of the situation.

Ultimately reality wins but the human capacity to lie, especially to ourselves, is astonishing. This may be the ultimate lie starting to form.

Anonymous said...

Anonymous said...

The current bailout is supposedly going to be from the banks and brokerages. However, it already has signs of the difficulties that the SIV Superfund bailout had, only much sooner.
My understanding of this problem is that they cannot allow these insurers to fail. So they will get bailed out. The bill for it will likely be between 130 billion and 200 billion when all is said and done. I suppose the only source of that kind of money is the American government borrowing it from the Chinese.
'Oh Sir, would you mind paying off these little mistakes. Just put it on my tab'.
So much for moral hazard and all that. Next round should be even more impressive.


Stoneleigh said...

I have no doubt that the government would like us to think it's prepared to act as lender of last resort in order to calm the market's nerves. Unfortunately, when governments try to paper over wide cracks with trifling sums and rhetoric, the markets tends to call their bluff.

This plan is good for a rally (that is to generate another group of empty bag holders), but IMO it won't work once the market starts testing the depths of the government's pockets. There's no way the government could actually afford to bailout the bond insurers.

peakto said...

Stoneleigh -

Isn't any bailout package by the government just another FED printing and tons more inflation.

The US government is broke, and doesn't have any money to give, so it 'borrows' more from the FED.

Ilargi said...


Funny notion that, the US government as lender of last resort. There's two little details that stand in the way. The banknotes state it rather clearly: we trust in G-d to make taxpayers pay enough to keep the boat sailing. That's all the collateral we have. Plus, those notes are not government, but Fed notes, which makes the Fed the always and default lender of last resort.

About Dodd:
He has been Chairman of the Senate Banking Committee for years, and watched from the sidelines as the whip was coming down, instead of doing his regulatory job.

His plan is straight out of a proposal from the Amercan Enterprise Institute, a right wing bunch that thinks there's too much government. That they come with this plan is so absurd, you don't make that up.

Estimates are that 1-2 million foreclosures will be "filed" from subprime loans alone. Dodd's $10-20 billion plan, assuming those 'steep' discounts he flaunts bring prices down fropm $200.000 to $150.000, allows for 100.000 mortgages to be bought. What about the other 90-95%? What to do when the Pay-Option ARM dominoes start falling?

Dood talks about the most distressed loans, those most likely to default. Now how does that help the borrower? Will the payments go down? And if so, by how much, seeing that these are all teaser loans about to reset payments by 50-200%? I doubt more than 25% of the loans bought would allow people to stay in their homes. And that's before the inevitable surge in unemployment numbers.

You know who this really helps? The lenders, who will be real grateful to get the worst loans off their books at those prices.

Dodd tries to bail out the industry that he actively helped to create the distressed loans. And in G-d he trusts that enough burgers will be flipped to pay for it all. Not really, of course, Dodd knows better, but at least another few dozen billion dollars will be transferred to the pockets of the people who donate the cash to keep him and his friends in power.

Stoneleigh said...

Hi PeakTO,

The Fed doesn't print money - it acts as midwife for credit creation, but that requires willing borrowers and lenders. Money and credit are not the same thing, although they've functioned interchangeably for a long time. The difference is that credit can evaporate at inconvenient times - when loans are repaid or defaulted upon or when a debt-based asset class ceases to be trusted and loses 'moneyness' (the ability to act as a store of value or medium of exchange).

Whereas currency inflation is a form of forced loss-sharing akin to dividing the pie of real-wealth into smaller and smaller pieces, a credit expansion instead creates competing claims to each slice of real-wealth pie. When the expansion ends, the fight over ownership begins and much value is destroyed in the process (deflation).

Global credit deflation is likely IMO to destroy much of global trade and undo financial globalization (meaning the reimposition of capital controls). At the moment, the bond market prevents actual currency printing by any country that wants to borrow internationally without having to pay skyhigh rates for the priviledge. As a debt junkie , the US is hardly going to inflict that on itself.

However, once international borrowing is no longer possible in any case, then I would certainly expect the printing presses to roll. My best guess on the timing would be 10 years of deflation and depression (which reinforce each other in a positive feedback spiral), followed by a build up to currency hyperinflation.

godraz said...

The US government and its citizens can not actually afford a lot of things they have been doing, but none of this has stopped them from doing it anyway -- largely due to the fact that we've passed along these $ IOU's to other countries for their real goods which their governments in turn have used to buy up our US Treasury notes, which only lends itself to greater indebtedness.

Of course this ponzi scheme of $ IOU debt is insane, especially now that the housing bubble and securitization scams are revealed as unsustainable. But, among the biggest holders of all these outstanding IOU's -- China, Japan, & the Middle East --, who among them is going to be the first to pull their hand out of this monkey trap?!

As far as I can see none of them is prepared to do so as it risks decapitating the very system which sustains their own economic well being (and much else too geo-politically), and so long as they play along by not calling our bluff outright we will continue passing along our debased promise to repay that they will support in kind -- with both Treasury purchases and, of late, their Sovereign Wealth fund investments made directly buying into our credit stressed assets.

Not only do they keep us afloat, even as this scheme tends to lead to currency debasement -- ours by indebtedness that can't be fully repaid and theirs by government devaluation, which evens the score -- who else is there in the world to consume like there is no tomorrow all the goods they must sell to float their own economies but US!

Furthermore, there isn't any other global currency in a position to overthrow the $ and the rest of the world isn't in this position to abandon it -- yet. I think they hope to get there one day and that's the day our indebtedness comes crashing down on us but that's not where we are now.

For a number of reasons, China, Japan & the ME isn't go to pull the plug on the dollar or our government's willingness to take on all manner of back stopping where it is deemed economically and politically necessary. It just isn't in the cards this year.

While I agree with Stoneleigh that "There's no way the government could actually afford to bailout the bond insurers", this does not in any way preclude them from trying to do so!

Hence I think there is a lot of things we think they can not afford to do but that will be done anyways -- full speed ahead and damn the torpedoes!

I also think that anyone who thinks the "markets" are the top dog that wags how this tail spin we are in gets played out are in for a surprise. All one need consider is the short squeeze rally that occured on Tuesday.

And despite the Bond market's supposed ability to force interest rates higher for borrowing, that isn't what it is doing at the present time that I can discern. Yields are running at 4.35% and less! The US $ still has a corner on this market as there isn't a similar one for the Euro!

As it is the Fed can and does sop up all the US treasury debt that isn't wanted by the Bond market, in effect monetizing government debt that no one else wants to pay for, while also managing the yields.

Ultimately, yes, reality both market wise and every other way will rule and we'll likely have our next great GREAT depression. But until then, which I think is still a ways off, everyone of the big powers in this high stakes drama will keeping pushing around their paper chits and using whatverer other means of leverage they have to keep the ponzi game going far longer than a lot of us expect.

IMO, all the usual markers of determing what in the hell is going on and how it determines what should happen next are virtually FUBAR precisely because these usual markers have become so distorted, distended and fallen under micro-management by non-transparent entities, both private and govermental interests of very deep pockets.

To the best of my knowledge greater volatility will be the near-term norm this year, certainly for the next six/eight months, but no definite market crash, and the battle between inflation and deflation remains undetermined -- aka stagflation.

As to our government and the fed's doings, they'll keep on doing what they always do -- and get away doing -- run up more debt; or at least until either our creditors say "Not anymore on our surpluses" or some other agency/event (climate/ecological, geo-political, or PO) says otherwise. Until then, I fully expect a slow motion crash & burn scenario of which the American citizen foots the bill in debt ridden impoverishment.

In any event these are my thoughts on the matter and I could well be proven wrong in whole or part of them, but as my wife said one day to me: "All my facts are based on opinion." ;-)

Gail the Actuary said...

Once it becomes socially acceptable to walk away from an upside down mortgage on a house, it also become socially acceptable to use the mortgage market to protect against the possibility of not being able to sell your home at an adequate price.

To do this, all a person has to do is increase his mortgage to the maximum amount available, before putting the house up for sale. Then, if it doesn't get a high enough price, the seller can just walk away.

It seems to me, once lenders figure this out, they will be forced to limit loans to 80% of less of market value (figured out correctly).