Tuesday, February 19, 2008

Debt Rattle, February 19 2008

Updated 1.50 pm

Ilargi: Wait a minute! Who said this was a boring story? The plot just got better, much, much better: Buffett owns Moody’s.

Moody's Buffett-ed By Allegations
Cries of foul arose yesterday against Warren Buffett after the powerful credit-rating agency Moody's Investors Service - in which he's the largest shareholder - began pulling the rug out from under his rival insurers to force them into "egregious" deals with Buffett. Allegations of conflicts came from insurance industry sources as the credit crisis deepened over fears that insurance guarantees trading widely on Wall Street - basically private IOUs backing trillions of dollars of bonds and junk paper debt - could become almost worthless.

Last week, the Oracle of Omaha rode to the rescue of the bond-insurance crowd, saying he'd shoulder some of the guarantees himself using his own insurance empire, but only for a very high price. He also would cherry-pick the best insurance bets for himself and leave the failed books of business behind in company shells. Most bond insurers rejected Buffett's costly help, with analysts predicting yesterday that splitting the insurers' businesses into "good" and "bad" assets would trigger a legal battle lasting years.

The fees Buffett would charge are a stunning 150 percent of the premium the bond insurers were already charging their own clients. Moody's - in which Buffett owns 19 percent - has put at least four bond insurers on notice that if they want to keep their pristine credit ratings, they'll have to either pile more cash onto their ledgers or use a bailout like that offered by Buffett.

Bond Insurer Split Threatens $580 Billion of Notes
Credit ratings on more than $580 billion of asset-backed securities may be cut, sparking writedowns by banks, under New York regulator Eric Dinallo's plan to break up bond insurers.

New York Insurance Department superintendent Dinallo proposed splitting the companies' municipal insurance units from their unprofitable businesses of guaranteeing debt linked to subprime mortgages. A separation may preserve AAA rankings for securities sold by local governments and agencies, while allowing asset-backed securities to slide.

"This is one of the worst possible outcomes for the market,"Gregory Peters, head of credit strategy at Morgan Stanley in New York, said in a telephone interview. Lower ratings would force banks that own the mortgage-backed debt to write down the value of the securities by as much as $35 billion, he estimated.

FGIC Corp., the third-largest bond insurer, sought permission to split last week. Dinallo said MBIA Inc. and Ambac Financial Group Inc., the market leaders, may do the same if they can't raise capital. The companies and Security Capital Assurance Ltd. insure about $1 trillion of municipal debt and $580 billion of other securities, including collateralized debt obligations that package bonds into new securities.

Loans go bad as British housing bubble pops
When Shirley Hale's husband dumped her for a younger woman and moved to the Czech Republic, Hale didn't get mad. She got a new house. After selling the family home in 2002, she bought a house in the suburbs of this old industrial city [Manchester] in northern England and took out a mortgage to fix it up. By last year, though, Hale had fallen behind on the payments on her "gorgeous little place" and was looking at foreclosure -- until a sales agent for a mortgage "rescue" company stopped in.

Hale signed over her house for $50,000 less than what it was worth. In return, she says, she was told she could live in it as long as she wanted if she paid the company $600 a month. Six months later, Hale learned her home had been sold and the mortgage transferred to one of Britain's major sub-prime lenders. Hale had 28 days to get out. "I don't even know who owns it now," Hale, 72, said wistfully in an interview in the tiny public-housing apartment she lives in now. "It's empty still. . . . The garden shed has been stolen, all my built-in kitchen has been smashed to pieces, the wallpaper's been ripped off. . . . They could have let me stay."

The American sub-prime mortgage crisis has received attention worldwide, and European officials have been quick to blame lax U.S. oversight of lenders for the international credit crunch that has crippled banks and sent shock waves through the financial markets. But Europe has its own burgeoning mortgage meltdown -- in Britain.

After years of watching house prices soar even faster than those in America -- modest three-bedroom tract houses in the London suburbs were going for $2.2 million at one point -- Britons are now weathering a sharp rise in mortgage defaults. Moreover, many debt-laden homeowners have no means to salvage their properties because favorable loans are suddenly harder to get. Desperate consumers are increasingly turning to costly and confusing financial rescue plans that often end, later if not sooner, in the loss of their homes.

New York Bond Costs Rise as Banks Let Auctions Fail
New York state taxpayers' weekly borrowing costs increased $2.3 million after banks failed to attract bidders to auction-rate bonds and stopped buying unwanted securities. Interest rates on Dormitory Authority bonds sold for the City University of New York rose to as high as 6.26 percent last week from 3.42 percent on Feb. 6, according to data compiled by Bloomberg. Buffalo's rate on water system revenue bonds soared to 11 percent from 3.30 percent. Bonds issued by the Museum of Modern Art climbed to 4.47 percent on Feb. 13 from 3 percent at the end of January.

Rates in the $330 billion auction-rate bond market are rising nationwide after banks from Citigroup Inc. to Goldman Sachs Group Inc. stopped bidding for the debt at periodic sales they oversee, according to Bloomberg data. New York, with $4 billion of auction debt, may convert the bonds to a fixed rate or a different type of variable-rate security, state budget director Laura Anglin said in an interview in Albany last week.

"It hurts,"said Anthony Farina, executive assistant in the Buffalo comptroller's office. Interest costs on the $63 million of auction-rate bonds rose $93,000 for the week, he said. "Nobody expected this kind of jump."State officials, who are reviewing the $4 billion of auction bonds sold by six different authorities as well as by the state in 2002-2004, said the debt was the least expensive type of debt in the two years ended Sept. 30, according to a Dec. 12 report. Since then, it has become the most expensive.

Pittsburgh Hospital Redeems 'Loan Shark' Auction Debt
The University of Pittsburgh Medical Center plans to redeem $430 million of its bonds to stem as much as $500,000 a week in losses caused by a crisis roiling the market for so-called auction-rate securities.

The hospital offered to buy back $91 million of its debt yesterday, and will make similar offers for almost $340 million more, according to Tal Heppenstall, UPMC's treasurer. Holders have until March 19 to sell the bonds back for $100.01 of par value plus accrued interest, according to a notice posted on Bloomberg.

Funding costs soared nationwide in the $330 billion market for auction-rate securities as banks from Citigroup Inc. to Goldman Sachs Group Inc. stopped bidding for the debt at the periodic sales they organize. New York state, with $4 billion of auction debt, may convert the bonds to a fixed rate or a different type of variable-rate security, state budget director Laura Anglin said in an interview in Albany last week.

"It's outrageous,"Heppenstall said. "We're a AA rated credit. We don't need to get financing from loan sharks."

Ilargi: Am I missing something here? First: how does a $55 billion fund manage to run a $14 billion deficit? Second: who is the genius who thinks this can be made up for by playing double or nothing?

If your pension is managed by these bright lights, it’s tme to get nervous.

Equities lure US pension guarantor
The Pension Benefit Guaranty Corporation, the US government-sponsored guarantor for pensions, plans to step up its investments in riskier assets such as equities as it seeks to plug a $14bn deficit. The move, quietly announced on the President's Day public holiday in the US on Monday, will mean the PBGC will double its allocation of equity investments to 45 per cent of its total assets.

The PBGC, which in effect acts as a pensions insurance fund, guarantees the benefits of 44m workers and is currently paying benefits to 700,000 retirees. It holds approximately $55bn (€37.4bn, £28bn) in assets to invest under its new policy.
It has, however, no access to credit from the government. It relies only on insurance premiums paid by the companies whose plans it insures and the investment returns those premiums can earn. If it became insolvent, it would either have to slash benefits paid to retirees or seek a taxpayer bailout.

The PBGC did not have the resources to meet all its future commitments, Charles Millard, director of the corporation, said yesterday. In view of the current deficit, Mr Millard, said: "We do want to make sure we do our best to avoid the need for a taxpayer bailout. The old strategy locks in the deficit." Mr Millard said he believed the long-term nature of its liabilities meant that the PBGC could withstand short-term market volatility. He also announced that the scheme would make investments in private equity and real estate.

The PBGC altered its investment strategy in 2004 to tilt towards increased investments in low-risk bonds, which move with pension liabilities. The deficit rose and subsequent legislative attempts to increase the scheme's funds failed. The PBGC, which also holds pension scheme assets it takes over from insolvent employers, held 28 per cent in equities at the end of last year. Under the new, higher-risk investment plan it will allocate 45 per cent of its total assets to a diversified set of fixed-income investments, down from about 72 per cent at the end of 2007. It will also invest 10 per cent in alternative investment vehicles, including hedge funds.

Un Ballo In Maschera
I have often remarked that I am on the deflation side of the inflation-deflation debate. Here is one more argument in support of this thesis:

So-called "innovative" finance monetized real estate and corporate assets that where hitherto immune from being turned into money equivalents. This was done via an array of asset-backed securities and derivatives which often went all the way to the fourth order. Starting from plain vanilla mortgage, consumer and corporate loans (i.e. funded debt), the investment bank factories synthesized a whole array of artificial goods, ultimately far removed from the income streams of the underlying assets:
  1. CDOs and CLOs, i.e. tranched bonds made up of loan packages.
  2. CDSs on the above bonds, i.e. credit insurance policies.
  3. Hybrid and synthetic CDOs, i.e. bonds made up of the above CDSs.
  4. SIVs that issued their own ABCP in order to buy and hold the above "goods".
  5. CPDOs that were structured to own CDS income streams.

... and more...

The alphabet soup seems thick and opaque, but don't let the jargon confuse you. Here is the crucial point: almost all of these "securities" were unfunded debt, i.e. money equivalents created from thin air. All they did was to generate more and more "buying power" to boost asset prices higher, from houses in the Inland Empire of California to share prices in New York, London and Shanghai. In case it is still unclear: it was margin debt.

If you are familiar with buying stocks or commodities on margin, you can immediately appreciate what went on, and why all current attempts to avert a wider crisis will fail miserably for as long as the focus is on the symptoms, instead of the underlying illness. Margin debt cannot be "restructured" with falling asset prices. Period.

Depending on the leverage used, this debt is now worth anything from zero to a deep discount from face value. And that's where it is trading at, when it trades at all in the secondary market. All those trying to hide the balance sheet reality behind plywood and canvas should be recognized for what they are: Potemkin village builders.

This artificial money is now being removed, destroyed by dropping asset prices. How much of this "margin money" was created, in the first place? In a word, lots. In the end of 2007, financial sector debt amounted to 110% of US GDP, or $15.4 trillion. It was 63% just ten years ago.

Shedlock vs. Schiff: Rumble in the Economic Jungle
While Democrats struggle to line up behind one candidate or the other, there is a lesser known, yet more important fight going on over your wealth. This is the rumble in the economic jungle, and its outcome could determine if you end up being a pauper or a king. We could have massive inflation, and any cash and U.S. treasuries you hold could end up being nearly worthless. Or deflation could set in, and stocks, commodities, and housing could come crashing down.

In one corner is the mighty Mike "Mish" Shedlock of the blog Global Economic Trend Analysis. If you haven't already visited his blog, I highly encourage you to do so. Mish updates his blog almost daily, with running commentary on the latest financial and economic news. He has a great sense of humor, and his intellect cuts right to the point.

Mish's point is deflation is inevitable. There is no escaping a contraction in money and credit supply. The financial tsunami hitting our country will overwhelm the Fed and the federal government. He is firmly on the side of the deflationistas.
In the other corner, representing the inflationistas, is Peter Schiff. Peter Schiff, of Euro Pacific Capital, Inc., is famous.

Schiff argues: "In perhaps one of biggest ironies to ever to come out of Washington, this week Congress simultaneously pilloried major league baseball players for using artificial stimulants to pump up their performance while passing legislation to do just that to the national economy…Those in the deflation camp believe that money supply will collapse as a natural consequence of the implosion of the biggest credit bubble in U.S. history. As loans go bad, assets, which collateralize these loans, will be sold at fire sale prices to satisfy creditors."

He continues to say that "the Fed's ability to pump liquidity into the market in the 1930's was limited by the gold backing requirements on U.S. currency. No such limitations exist today. This distinction is critical. When credit was destroyed after the Crash of 1929, the Fed was not able to simply replace it out of thin air. Today however, the Fed will likely print as much money as necessary to prevent nominal prices from collapsing." In other words, every time the stock market threatens to go down, the Fed will create more money, sending it into the financial system either via the banks or working with the Treasury Department to send it to whatever special interest is now deemed to be deserving of new money by Paulson, Pelosi, and Reid.

Mish retorts that "Schiff makes a false assumption that the Fed can replace credit out of thin air. The Fed is simply not in control of credit at all. The Fed can encourage borrowing but it cannot force it. The second failure by Schiff pertains to monetary printing. There are constraints on the Fed that he ignores. For example the Fed cannot simultaneously target both money supply and interest rates. Should the Fed pursue a massive printing campaign, interest rates will rise. Think of the consequences for housing and commercial real estate. Schiff ignores the consequences of interest rates on existing debt, much of which is variable rate. Furthermore, think about what rising rates would do to future expansion plans of businesses."

Readers, I promise you this. Unlike politicians, I will not wrap my self-interest in a deceitful web of hope, belief, and inspiration. There is no inspiration here. Just pure and utter self-interest in trying to find out how to protect my wealth from the government. I'm writing in the hopes that some of you will share your thoughts with me, so that I can better understand these issues.

So will Schiff be correct? Will gold and oil go through the roof? With food prices continue to skyrocket? Or is Mish correct? Will housing continue to fall and drag down commodities and stocks (interestingly, although Mish is a deflationista, he recommends gold as well)? While I have been a bull on oil and gold for many years, I have recently begun to question whether the commodity run might be coming to an end. To be honest, I'm not sure. It has been many years since I have been so confused.

Straight Talk on the Monoline Mess
Let me be clear on how my common sense, outside the box mentality views this mortgage insurer mess as of now. I haven't revisited this in a while. A few facts:
  1. Bad debt is bad debt. It really doesn't matter if Moody's or Fitch downgrades or upgrades XYZ corp to AAA or CCC. If the market knows its junk (ex. paying 14% in a 7% interest environment like MBIA) then its junk. The companies trying to struggle to keep their AAA rating should be stuggling to prove they are not junk to the market. They are praying to the wrong gods.

  2. If any of the major mono cum multi-lines do split up and separate structured product from muni risk, the banks will be swamped with devaluations, and we will be taught the true definition of "writedown". Of course, this could just be a threat to the banks to have them pony up. Blackstone is a part owner of FGIC (the company that applied to be split) and they know their way around money. This is a quote from Dinallo (the NYS insurance commissioner) "We will look at the business plan and we will see where it goes," New York Insurance Superintendent Eric Dinallo said in a Bloomberg Television interview today. "Maybe just the filing of the application will invite capital in," he said." Of course, having insureds invest money into the insurers to save the insured portfolio defeats the purpose of buyign insurance in the first place. In addition, it doesn't technically qualify as insurance, since economic risk was not truly transferred in exchange for compensation. All you are doing is moving money from the right pocket to the left pocket. You are no safer or more insured for doing so. I went through this in my first post on the monoline industry.

  3. Everyone is focused on the muni industry and how safe it is, but I warned last year that the drop in revenue from housing related fees, income taxes, and the like will combine with the rapidly inflated budgets of the boom times to shock and surprise many who believe that muni debt is bullet proof.

  4. For those who remained focus on the muni side of this debacle, let me remind you that if Buffet buys the choice muni debt or the monolines are bifurcated, the CDS market will collapse faster and more violently than the subprime market. Hedge funds, investment/mortgage/commercial banks, and reinsurers will get slammed, and some of them may be gone for good. I have carefully positioned myself for such an occurence for it is inevitable in some form or fashion. The structured product insurance business in its current form is done for.

  5. I am amazed at just how many people ensconced in this industry still do not realize how much trouble it is in. A friend of mine who actually provides the legal support and structure for the industry seriously believes that Buffet's offer will help the industry. Huhhh??? I see it as the hari kari sword that Buffet has so generously offered. Buffet's plan is worse than the bifucation plan, because his would drive the whole company out of business for Buffet's gain. Not that there is anything wrong with that. I am all for capitalism, unless I was a monoline shareholder that is. At least the bifurcation plan would save some of the company. They both are the only ways to go for the municipal insureds though. The NYS Port Authority is now paying 20% on their monoline insured debt because of a downgrade, up from around 4%.

  6. No matter what happens, if the capital strained banks (who are severely hard up for capital, which is why they are accepting onerous terms from foriegn investors) provide capital, or the mono cum multilines bifurcate, or if Buffet buys out the muni risk for that "free profit": the structured product defaults will overcome the relatively anemic capital reserves that have been put in place against them.

Ilargi: We’ll have quite a bit on the Northern Rock story today, how could we not. And Americans, Canadians and everyone else should sit up and pay attention. For anyone who wonders how the US -or their own- government, will handle the inevitable upcoming bank failures, just follow the Northern Rock saga in the days and weeks to come. You ain’t seen nothing yet. Taking a government to court is not an easy thing to do, but we may see this come to pass, unless Brown and buddies cough up dozens of billions. And if the UK courts don’t slam this one down, there’s always Brussels.

Welcome to Tweedledum Darling’s new type of bank
Who needs National Savings when you’ve got Northern Rock? Britain’s dodgiest bank has now become Britain’s safest bank, thanks to Alistair Darling’s decision to nationalise the Rock.

Fancy the 5.8pc tax free available in a direct ISA from Darling’s existing savings bank, National Savings & Investments (NS&I)? Don’t be silly. Get down to one of his new branches and enjoy the Northern Rock brand of Government savings, all with new, improved interest. The NS&I’s 5.8pc can’t compete with Northern Rock’s 6.2pc ISA, now part of the Treasury’s suite of super savings rates.

But then, nor can most banks compete with this sort of state-backed generosity. The first thing nationalisation does is put Ron Sandler, the new executive chairman of Northern Rock, on a collision course with the entire UK banking system who will be crying foul over unfair competition. And what about the Rock’s 125pc mortgages? Back in September, sitting having coffee in Number 11, Darling told me it was time that banks got back to “good old fashioned banking”.

The very next day he was engulfed by the Rock crises. Good old fashioned banking was never the Rock’s strong point as epitomised by the offer of loans worth 25pc more than the total value of your property – guaranteeing negative equity. The only chance of these loans turning positive would be in times of rampant house price inflation which, the last time I looked, seem to have faded. Now Darling finds himself the proud owner of that bank, despite his call for a return to more traditional ways of running a bank.

The Alice in Wonderland world that Darling has made for himself involves policies made up as he goes along. If he’s not the Mad Hatter then his performance with Gordon Brown at their joint press conference yesterday was pure Tweedledum and Tweedledee. Back at Northern Rock, its website is currently offering another savings bond paying 6.35pc – the Fixed Rate Access Bond which exhorts savers to “Catch it while you can”.

I suspect this one will disappear faster than a white rabbit down a hole once Sandler is forced to run the bank and stay within Europe’s state aid rules, although Darling could give us no detail yesterday about how the Rock will be governed and regulated in this regard. Whether it’s been the thrust-then-retreat on capital gains tax reform, the same forwards-then-backwards motion on non-domiciles or the even more dramatic vacillation on Northern Rock, the Treasury has been making policy on the hoof for at least five months.

The Tories have dubbed Darling a “dead man walking”. The Queen of Hearts would have chosen a different phrase. Both anticipate the inevitable.

Anger mounts after nationalisation
Shareholders in Northern Rock were spitting blood yesterday even as they consulted lawyers about their options following the government's nationalisation of the stricken bank.

The government's move was comparable to the worst practices of developing markets and "immoral", hedge funds said, while the valuation method chosen by the government for compensation was flawed. "I work on the front line in places like Kazakhstan and even there I haven't experienced expropriation of shares by the government," said Angelo Moskov, London chief executive of QVT Financial, the $11bn (£5.6bn) hedge fund which holds just under 1 per cent of Northern Rock.

"The importance of legal action is enormous, to remove the ability of the government ever to do this ever again."
Other shareholders said the government had done serious damage to its reputation, with Alistair Darling's future seen as short-lived. "All the dithering reinforces the view that Brown cannot make a decision," one major institutional investor said. "This is not how you run a company, let alone a country."

SRM Global, the Monaco hedge fund which is Northern Rock's biggest shareholder with an 11.5 per cent stake, is widely seen to be the most advanced in preparing its legal case. RAB Capital, the second-biggest investor with 8.1 per cent, also met lawyers yesterday to examine possible action, while representatives of small shareholders are discussing legal manoeuvres.

Philip Richards, chief executive of RAB, said the nationalisation was "extraordinary and immoral".
"It is extraordinary that the government, presented with a very credible package led by new management and backed by shareholders to the tune of £700m, has chosen to try to expropriate the bank for next to nothing."

No Lull in Mortgage Pitches
The mortgage market may be in a historic upheaval, but mortgage companies continue to pump out upbeat advertisements. Countrywide Financial brags in its ads that “No one can do what Countrywide can” and that “Countrywide can show you the way home.” Wachovia ads feature an “Approved” stamp prominently at the top, and Bank of America says, “Homeownership is the best medicine.”

Also, the National Association of Realtors is running national television ads saying there has never been a better time to buy a home. Home values nearly double every 10 years, the commercial claims, showing a young couple walk up to their white colonial-style home. Despite rising foreclosures, defaults, lawsuits and investigations by state and federal regulators, the mortgage industry has not reduced its ad spending. Mortgage experts say spending will be strong into the spring, a prime buying time for the housing market. But consumer advocates say the ads continue to be misleading.

“There’s been huge scrutiny on these companies, but they are continuing to advertise,” said Sally Greenberg, executive director of the National Consumers League, a nonprofit organization in Washington. “Many of these companies are bleeding, and these ads are a way to get more money into the door.”
Indeed, the Mortgage Bankers Association is predicting this will be a down year for the industry, and on Friday it said that the total value of mortgages produced would be down 16 percent from its level last year.

America's problem isn't liquidity, it's insolvency
We continue to read articles in the financial press and elsewhere by widely-respected mainstream economists who have a tendency to quote mindlessly from Keynes’ masterpiece “The General Theory of Employment, Interest and Money”.

They couldn’t be further from the truth, however, when they claim that the current credit cycle liquidity problems can be corrected with a little fiscal stimulus and cheap money to jumpstart the ailing economy. It is not liquidity that is preventing the money from flowing; it’s insolvency! The banks won’t lend to deadbeats anymore! HELLO! Sure, cheaper money helps high credit score borrowers refinance and pay less in interest charges, but cheaper money does nothing for the existing bad loans backed by No Income, No Collateral, and No Character. 

When we were first introduced to credit back in the late 1960's, bankers learned about the 3 C's of credit: Collateral, Character, and Cash Flow.  There was no such thing as a NINA (No Income, No Assets) loan. Indeed, back then it was virtually unheard of to lend money to an unqualified borrower. It wasn't until I arrived on Wall Street some 15 to 20 years later and was involved in the securitization industry (particularly the sub-prime industry) that I realized hundreds of institutions, employing thousands of employees, were willingly making millions of loans to borrowers with, yep, you guessed it, No collateral, No income, No character! Some of these were white shoe institutions with blue-chip stocks.

Of course mortgage borrowers are walking away and feeling no shame as they fling the front door keys to the wind! I have been writing about this and speaking about it at conferences for years, and wondered why nobody listened. As a result of many years of predatory lending, the United States is facing an insolvency problem that is unprecedented. Leverage must be reduced to restore faith in the solvency of institutions before anyone will trust them again with their hard-earned cash. Lending has begun to go back on balance sheet but it’s already too late to save the ailing SIV’s and if the monoline insurers fail, say goodbye to the asset-backed CP market.   

Why is America looking so insolvent? Well, for one reason, the easy money policies of the past have resulted in at least three trillion of really dodgy loans issued for mortgages, automobiles, home equity lines of credit (HELOC), and credit cards. And, to top it off, last Friday the Bureau of Labor Statistics finally started to come clean as benchmark revisions showed that jobs created by the Birth Death Model were just a happy fiction; another 360,000 of jobs just vanished in the employment release. 

Over the next few years, the character of many millions of Americans will be tested as they are forced to make very tough decisions on how they will live and spend money. Will they do the honorable thing and pay down their credit card or mortgage from Countrywide (after reading that the head of Countrywide left the firm with a gazillion bucks), or will they buy groceries for the kids?

What about the baddies in a bond insurer split?
Can it ever be so simple as the goodies and the baddies? On the one hand, the latest Dinallo-inspired plan to save the bond insurers (or at least part of them) seems to be gathering steam. First FGIC was considering the much-heralded “good bank/bad bank” plan that would see the relatively safe business of guaranteeing municipal bonds hived off from a toxic debt insurance rump.

Now it’s one of the two largest that has embraced the good/bad creed. Ambac, reports the WSJ, is in discussions to split itself up so that the municipal bonds backed by the monoline retain their high credit ratings. Beware this supposed panacea. The “good bank/bad bank” split is designed to save municipal bonds - and their many and various uses across the US. But why should those who’ll end up in the “bad bank” stand by and let this roll on?

David Merkel at Aleph is unsympathetic. Most of the municipalities with the failed auctions are creditworthy entities that don’t need bond insurance, he argues. Auction rate structures deliver low long-term financing rates when things are calm. The more sophisticated investors should have known that this wouldn’t hold when short term liquidity dried up, or in times of even moderate stress. The smaller borrowers should have been so advised by their banks. You can’t have long term financing and low rates with certainty.

Merkel has also wondered how the state insurance commissioners intend to get away with favouring one class of claimant over the other - namely the municipalities over those in hock to the “bad bank”, ie the banks with CDO hedging arrangements in place. The appeal of a split is that it would sever the municipal bond business from the structured credit business, as it is the monolines which act as the channel between the two. But, as Bank of America on Monday commented, “the fact that one group of policy holders’ exposures has imperiled the policies of the other does not mean they should foreit the value of their claims altogether.”

The banks in talks to prop up FGIC were, reportedly, taken by surprise by its plans to split itself. And a split would potentially leave billions of dollars of credit default swaps in doubt, as their underlying credit gets sliced into two, very different, portions. Merkel writes:
If I were one of the banks, I would sue the State of New York, and quickly, because NY is moving more quickly than they ought to. There is no NY crisis here, and the politicians and bureaucrats of New York should behave as gentlemen, and not thugs.

US banks borrow $50bn via new Fed facility
US banks have been quietly borrowing massive amounts of money from the Federal Reserve in recent weeks by using a new measure the Fed introduced two months ago to help ease the credit crunch. The use of the Fed’s Term Auction Facility, which allows banks to borrow at relatively attractive rates against a wider range of their assets than previously permitted, saw borrowing of nearly $50bn of one-month funds from the Fed by mid-February.

US officials say the trend shows that financial authorities have become far more adept at channelling liquidity into the banking system to alleviate financial stress, after failing to calm money markets last year.
However, the move has sparked unease among some analysts about the stress developing in opaque corners of the US banking system and the banks’ growing reliance on indirect forms of government support.

“The TAF...allows the banks to borrow money against all sort of dodgy collateral,” says Christopher Wood, analyst at CLSA. “The banks are increasingly giving the Fed the garbage collateral nobody else wants to take...[this] suggests a perilous condition for America’s banking system.” The Fed announced the TAF tool on December 12 as part of a co-ordinated package of measures unveiled by leading western central banks to calm money markets.

The measure marks a distinct break from past US policy. Before its introduction, banks either had to raise money in the open market or use the so-called “discount window” for emergencies. However, last year many banks refused to use the discount window, even though they found it hard to raise funds in the market, because it was associated with the stigma of bank failure.

Merchants of Misery: Debt collection is one of the UK's fastest-growing industries
Agencies pursue 20 million cases a year and resort to underhand (yet often legal) tactics. Now, a change to the law will make their business even easier
Debt collection agencies and bailiffs are raking in unprecedented sums from Britain's growing mountain of personal finance misery, an Independent on Sunday investigation has found. Last year the agencies and bailiffs pursued no fewer than 20 million cases and the methods they used to squeeze money from people are so aggressive that experts ranging from the Citizens' Advice Bureau (CAB) to members of the House of Lords are now calling for legislation to curb these excesses.

A growing army of thousands of "debt chasers" is making millions from the misery of Britons who have spent years spending above their means, in what campaigners have slammed as "legalised profiteering". Personal debt is at a record high of £1.4 trillion, averaging £29,684 for every adult in the country. And people now face the possibility of bailiffs being able to break into their homes and take possessions by force.

The sweeping new powers will be outlined by the Government in May, when it publishes details of how a new Tribunals, Courts and Enforcement Act will work in practice. In a statement to the IoS, a Ministry of Justice (MoJ) spokesperson claimed that the new powers for forcing entry will be used only "as a last resort... in strictly controlled circumstances", and only "once full independent regulation of all private-sector bailiffs has been implemented".

But it emerged last night that, despite bailiffs remaining unregulated, MoJ officials are proposing that they be allowed "to use reasonable force, restraint or violence against debtors thwarting the bailiff's seizure of their goods". Although the Government pledged to regulate bailiffs a year ago, nothing has happened; the findings of a consultation on the issue that should have been published last July have yet to see the light of day. The CAB will meet policy advisers at the MoJ this week to discuss these new powers.

More than eight million Britons are in serious debt – a quarter of whom are struggling to make their repayments. Major lenders are taking legal action against people's assets, according to evidence from the Credit Management Research Centre at the University of Leeds, which warns that people's homes are also at risk.

Until now, Britain's credit boom has been sustained by rocketing house prices and a stable economy, but it has left many vulnerable to even a slight downturn in their fortunes. The Financial Services Authority (FSA) is warning of "a growing number of consumers experiencing debt-repayment problems in 2008", with mortgage repossessions and bankruptcies set to rise.

Treasury cannot be allowed to rob Rock investors
For all its travails, Northern Rock in public ownership will, like a public limited company, have to publish audited accounts. Alistair Darling, chancellor of the exchequer, has said the UK mortgage lender will return to the private sector in due course. Suppose that, when the last set of accounts before its reprivatisation appears, these show that the loan from the state (originally from the Bank of England but now presumably to be assumed by the Treasury) is repaid in full at a market interest rate or above.

Suppose, in other words, that Northern Rock repays the loan on the same terms as billions of transactions on the sterling interbank market. The economic substance of the loan to Northern Rock would be difficult to distinguish from such loans, except that – at least in the early stages when it took the form of a lender-of-last-resort loan from the Bank of England – it was at a penalty rate (ie above market rates).

Should the proceeds from the reprivatisation of Northern Rock belong to the government or the original shareholders? That is the key question. Mr Darling has made clear he does not intend to compensate shareholders at anywhere near the book value of the bank’s capital, which was about £2bn (or £4 a share) in mid-2007 and must still be above £1.5bn. The plan – if the government’s behaviour can be dignified with the word – seems to be that the shareholders are to get nothing.

The proceeds from the reprivatisation (presumably a few years from now) may be deemed to belong to the government. If so, would the government have robbed the shareholders of £1.5bn-£2bn? Mr Darling has no doubt been told by advisers that the government’s approach is legally valid. But the shareholders can also recruit advisers to demonstrate that it is legally invalid and morally outrageous. Their central point will be that, in a nation proud of its respect for the rule of law, the government would have violated principles of private property.

Mr Darling and his advisers would no doubt say this is preposterous. They must think again. They ought, for example, to listen to the senior executives in the British banking industry who nine months ago took it for granted that the Bank of England was their bank, from which they could obtain cash in much the same way as commercial banks in other countries. Those executives have been dismayed that in recent weeks Spanish banks have been able to obtain finance easily from the European Central Bank (but actually from the Bank of Spain) on collateral that the Bank of England has questioned.

These Spanish banks have in many respects the same business model as Northern Rock; in autumn 2007 they faced the same difficulty in financing their assets. But they have not been punished by the Spanish authorities as Northern Rock has been punished by the UK authorities and the government. The Spanish government has not threatened to nationalise them, in spite of the huge advances they have received from the ECB.

Bruising battle ahead over value of shares
The decision to nationalise Northern Rock sets the stage for a bruising legal battle between the government and the mortgage lender’s shareholders that could drag on after the next election. The government is on Monday expected to spell out how much compensation it will pay to shareholders as part of nationalisation.

The exact figure will be worked out by an independent third party. However, the calculation will try to assess what Northern Rock’s shares would be worth if the bank had no government support. This suggests any figure is expected to be very low – much lower than the 90p at which shares were trading on Friday afternoon.
SRM Global and RAB Capital, the two hedge funds that are Northern Rock’s largest shareholders, have made it clear that they are ready to challenge any decision to nationalise the bank in the courts.

Jon Wood of SRM on Sunday said the fund believed there was “significant value” in Northern Rock, and would ”pursue all avenues to protect that value for shareholders”. RAB said it would not comment until it had seen the details of the government’s proposals. Robin Ashby, founder of the Northern Rock Small Shareholders’ Group, said he was “shocked and appalled” at the government’s decision: “This will be hanging around the government for years to come, right up until the next general election.”

The prospect of a nationalisation has sent bankers, lawyers and civil servants scurrying to the history books to study precedents. Shareholders point to the nationalisation of the aircraft and shipbuilding industries in 1977, which contained provisions for compensating shareholders. More recently, the government fought with shareholders of Railtrack, the privatised owner of Britain’s railways, which was put into administration in 2001.

Shareholders have also raised the prospect of taking the case to the European Court of Human Rights, arguing that nationalisation is the equivalent of expropriation of property. SRM believes the bank has a book value of £4.25 a share.
Both the UK Shareholders Association and the Northern Rock Small Shareholders Group are also suggesting the government should be looking to pay about £4 a share. But unless the government suddenly decides to pay significant amounts of compensation to shareholders, it will be up to the courts to decide who is right.

Billions taken out of top UK mutual funds
Private investors have pulled billions of pounds out of some of the UK's best-known mutual funds in recent months, in a sign of jitters about the downturn in markets and the economy. Confidential fund sales data obtained by the Financial Times show the last three months of 2007 were among the worst on record for UK asset managers. Fidelity suffered a net outflow of £977m from its UK funds in the fourth quarter, ceding its top ranking to Invesco Perpetual.

Standard Life reported net outflow of £492m and Norwich Union of £468m, according to data compiled by a UK fund research group. Outflows for Credit Suisse (NYSE:CS) and Axa Framlington were £575m and £347m respectively. Lipper Feri compiled the data from figures provided by asset managers. Analysts say heavy outflows continue this year and fund managers expect investors to take more money out if markets remain volatile.

"You'll probably see record amounts of money going to building societies until the stock market stabilises," said Mark Dampier, head of research at Hargreaves Lansdown, the financial advisory firm. Investment managers of retail funds are being forced to sell top-performing assets to make sure they have cash to pay investors who redeem their units, or holdings, in the funds.

France: Natixis writedown triggers shockwave
A shudder went through the French banking sector on Friday after Natixis, the country’s fourth-largest bank, announced a €1.2bn ($1.8bn) writedown, prompting fears of more losses from the US subprime market. Natixis shares fell 10.7 per cent to close at €9.84 after the bank revealed writedowns of €817m related to the subprime mortgage market and another €380m due to exposure to US monolines, or bond insurers.

The news dragged other banking stocks down. BNP Paribas, France’s biggest bank, dropped 3.3 per cent and Crédit Agricole fell by 5 per cent. Société Générale, which this week launched a €5.5bn rights issue, fell 2.3 per cent.

Natixis, formed in 2006 and controlled by Caisses d’Epargne and Banques Populaires, was scheduled to report annual results next month. But it decided to announce estimated results for 2007 through a statement issued after market close on Thursday due to “the sharpening of the crisis”.

In France, the Heads No Longer Roll
Of all the clubs in the world, the Club of 100 in France may be the most exclusive. Its ranks include leaders in business, politics and law, but it’s the admission policy that really makes the Club des Cent, as it is known here, truly remarkable: only when an existing member dies is space made for a new one.

Officially, the club, now 96 years old, is devoted strictly to gastronomy, and when the group gathers Thursdays for lunch at legendary Paris restaurants like Maxim’s, politics and business are not on the menu. Claude Bébéar, the chairman of AXA, the French insurance giant, and a club member for more than two decades, says that there is “an atmosphere of real friendship; we are very close.”

The same is true of the French business establishment. A close-knit brotherhood — it’s nearly all male — that shares school ties, board memberships and rituals like hunting and wine-tasting, the French business elite is a surprisingly small coterie in a nation of more than 60 million people. But in the wake of a $7 billion loss attributed to a rogue trader at one of the nation’s leading banks, Société Générale, France’s modern-day aristocracy finds itself in the one place it never wants to be: the spotlight.

At least half of France’s 40 largest companies are run by graduates of just two schools, the École Polytechnique, which trains the country’s top engineers, and ENA, the national school of administration. That’s especially remarkable given that the two schools together produce only about 600 graduates a year, compared with a graduating class of 1,700 at Harvard.

“They behave like blood relations,” says Ghislaine Ottenheimer, a journalist and author who has written extensively about the French elite. “There is a sense of impunity because there is no sanction in the family.”
Nevertheless, l’affaire Kerviel and especially the fate of Mr. Bouton — even President Nicolas Sarkozy has suggested that Mr. Bouton should step down — have shaken the French establishment to its core and encouraged those, like Ms. Ottenheimer, who favor change.

“The old system is dying; this is its last gasp,” she says. “Bouton is part of a generation that will soon have to hand control of French capitalism to a more diverse elite.” Perhaps. But it doesn’t appear that Mr. Bouton is facing an imminent slice of the guillotine — unlike American executives at Citigroup and Merrill Lynch, who were forced to step down last fall after their banks suffered huge losses from the subprime mortgage crisis.

Rock debacle will reverberate for years
By nationalising Northern Rock, the Government hopes to achieve closure on one of the most embarrassing and traumatic episodes of its eleven-year rule, yet I fear its problems with the Rock are only just beginning.

At a stroke, the Government has blown its rules for governing the public finances to smithereens, driven a coach and horses through any remaining pretence of fair competition in the mortgage and savings market, subjected its rules and systems for dealing with troubled banks to international ridicule, and profoundly damaged the City's reputation for "can-do" financial innovation.

In the end, the combined brainpower of the City's finest failed to find a private-sector solution to the travails of this relatively unimportant regional mortgage bank, or at least that's the message that the Government has sent to the rest of the world by rejecting two perfectly viable private bids and nationalising the Rock instead. Financial services is meant to be one of the few industries in which Britain excels. That's not the way it looks after the Northern Rock debacle, with the Government incapable of properly regulating its showpiece industry and the industry itself equally incapable of solving its own problems in a market-driven manner.

The Government's depiction of itself as a hapless victim of events beyond its control, with no ultimate option but to nationalise as the least worst solution, is simply not credible. The bottom line is that this is an almighty mess which nationalisation in the manner proposed, with an "incentivised" Ron Sandler determined to run the Rock as a going concern for ultimate resale to the private sector, will more than likely make worse.

China's inflation hits 11-year peak, headed higher
Chinese consumer inflation surged in January to an 11-year high of 7.1 percent and looks set to rise further, cementing expectations that Beijing will stick to a tight monetary policy despite softening economic growth. Many economists said inflation was likely to intensify, even as the impact of recent fierce weather fades, because of rapid money growth and rising raw material costs that have not yet been passed on to the consumer.

Mounting popular concern over inflation poses a stiff policy challenge for China's leaders, who want to use the Olympic Games in August to showcase Beijing's economic stability. "The acceleration in money and credit growth in January suggests that inflation is likely to have further legs to run," Hong Liang and Yu Song, economists with Goldman Sachs in Hong Kong, said in a note to clients.

They said February's consumer price index (CPI) was likely to rise by much more than 7 percent and may approach double digits. "Therefore, we believe it is far too early to expect any policy loosening in China. To the contrary, policy makers in China will likely try to tighten monetary policy further, with more reserve requirement ratio hikes, faster yuan appreciation, and more heavy-handed controls over bank lending," they said.


Anonymous said...

Re: China's inflation hits 11-year peak, headed higher

on Debt Rattle Feb 16:
China Exports Grow 26.7% Despite Weaker Demand, Storm

in an article last year, Henry CK Liu pointed out:

The US has been putting heavy pressure on China to fully open its markets, particularly financial markets as a way to rebalance China’s trade surplus with the US. Writing in the May 22, 2006 issue of Business Week, Stephen Green, Shanghai-based senior economist at Standard Chartered Bank suggests that much of China’s trade surplus in 2005 did not come from trade at all, but rather from capital inflows (perhaps as much as $67 billion) disguised as trade. As a percentage of GDP, China’s trade surplus was actually declining through 1999 to 2004. The Chinese yuan is widely expected by currency speculators to appreciate in the years ahead, and thus has become an attractive investment for foreign and domestic companies engaging in export trade. China’s capital account restrictions make it difficult to bring US dollars into China, except for Chinese exporters and trading companies due to the nature of their business. Exporters, by exaggerating invoices handed over to local authorities, could bring more hard currency into the country over the real value of goods sold outside. This “mis-invoicing” of trade was commonplace in the last decade, but back then it was a way of getting money out of China to repatriate profit. Now it is being used to bring funds into China for more investment in anticipation of future yuan appreciation. This inflates the value of Chinese exports which also gets an additional boost from transfer pricing between units within multinationals to book the profit inside China. This trend, multiplied over millions of price transfers, inflate China’s trade surplus numbers.

Mis-invoicing and transfer pricing numbers show that the China’s trade surplus could have been as small as $35 billion in 2005. Trade could have disguised some $67 billion of non-trade capital inflows.

The implication for China’s policymakers is that China’s booming trade surplus is not caused by an undervalued yuan, but by US pressure to revalue it. As soon as such pressure eases to eliminate expectations of appreciation, China’s trade surplus could suddenly be sharply reduced, not from trade but from capital inflow disguised as trade. Yet this new capital, denominated in dollars, can only enter the Chinese economy by the Chinese central bank buying the dollars with more yuan while reinvesting the dollars in more US treasuries to fuel a further rising US trade deficit. In the mean time, incessant increases in the yuan money supply overheat the Chinese economy, while the Chinese government tries desperately to cool down with ineffective macro measures.

madhatter said...

My understanding of all that is going on is limited at best, and I think it is hard for anyone to know the long term consequences of any action that may be taken in situations like Northern Rock - or the monoline fiasco in the U.S.

If there is a theme running through what is occurring, it is that governments are attempting to protect pubic interests (the munis in the states and depositors in NR) in situations where the private sector has jeopardized them through actions which many of us would consider at best, irresponsible, and at worst, down right fraudulent. If the government has to step in and "save" NR, why should the taxpayer not reap any benefit rather than the private investor who was convinced, wrongly as it turns out, that investing in NR was going to make him/her a profit?

It does appear that not all of NR's competitors are feeling that a nationalized bank is going to take advantage of the situation.

Barkleys confident of level playing field

I suspect that every country and government that finds itself in this quagmire is going attempt to come up with its own solution - and there will be negative externalities to all of them (as was pointed out in yesterday's Debt Rattle) It would be nice if those of us who have lived within our means (financially if not environmentally) could avoid the costs - but it is hard to see that happening.

Anonymous said...


As we see market up, commodity up even more and dollar sink, is there any chance in your view the TAF could keep the major banks out of insolvency for this round?

Stoneleigh said...


IMO there's no chance that the TAF will keep US banks out of insolvency. We're moving closer and closer to a point where there will be a firesale of assets, where many things will be marked-to-market in short order. There really isn't anything that anyone can do to prevent it.

Every credit bubble in history has deflated, and there's no reason to think that this one will be different. Bubbles are grounded in human nature (greed) and that hasn't changed. The only difference this time is the scale of the excesses that have brought us to where we are now (the party), which should translate into the largest credit deflation on record (the hangover).

Anonymous said...

As a newbie, I'm slowly trying to get my mind around the right questions to ask. I was fascinated by the LA Times article, A sinking feeling for the dollar in China

"Nobody here wants the lowly American dollar anymore. Not businessmen, not bankers, not even the "yellow bulls" like this man, who has been a black-market trader for years and whose presence in the lobby of a large state-owned bank is tolerated, oddly, by its managers."

Where would I go to find a good analysis of global currency strengths/weaknesses, given 1) a deflationary environment produced by the bursting of the global credit bubble, and 2) increasing energy costs? The question is too big, but that's how the gist of it seems to me now.

Here's another way to phrase it:

largi, writes here:

"I find it a hard call; I don't see much future strength in the dollar that could increase demand, but then again, i see no other currencies either with much strength. Nobody will trust much of anything anymore, sort of a deflation of faith."

The question is this: Stoneleigh, given a "deflation of faith," what considerations allow you to say: (in the same link)

"As for the dollar, I think it has bottomed for now and is in the initial stages of a significant rebound. I think we'll see it surge on a flight to safety, probably in conjunction with a deflationary crash (which is not too far off IMO)."

Do you see flight to the USD as knee-jerk in such a deflationary crisis, or are there reasons for it? I'm not looking for an "answer." I'm just curious how you (or anyone who thinks about such things!) think about such things....

Perhaps a better quetion is: How will money work when there is a "deflation of faith?" Again, I'm not asking for an "answer," but wondering how one approaches such a questions. :-)

Anonymous said...

FWIW, NFORBRES has been revised at St. Louis Fed.

Note the difference between how it appears here and here.

Market Ticker Forums say this is the result of TAF being removed.

If you go here, though, you see that Feb 13's non-borrowed reserves are negative 18009 (I believe in 1000's).

Don't know what it means, but find it interesting.

Stoneleigh said...

Yes, I do see a flight to safety as largely a knee jerk reaction, especially as it's likely to occur (IMO) in conjunction with a high degree of fear in the market. People who act out of fear act quickly and without a great deal of rational thinking. In other words, fear inspires human herding behaviour more than anything else does.

Greed inspires it too, especially at manic peaks, but fear is a much sharper emotion than greed, hence greed-inspired upward moves in stocks and credit markets tend to be longer term things than fear-inspired declines. Those tend to unfold very quickly. As a flight to safety in the dollar would be a fear-inspired move reflecting what will be going on in stocks and credit markets, I would expect that to be rapid as well.

For years theorists have laboured under the misapprehension (IMO) that markets participants always act rationally, but I would say that's clearly not the case. Very few have any real information, and so they are only able to react to what others do through herding behaviour. As mammals we are hardwired for emotional states - especially fear - to be 'catching'. Like deer who see a flash of white tail or beavers who react to a tail slapped on to the water surface, we react to our species danger signals with a 'run first and ask questions later' approach. Clearly this has been a survival mechanism for humans in the past, but then it was onyl able to affect small numbers of people at once. Now through the global financial system, and the global communications system, it has the potential to affect the behaviour of millions of people almost simultaneously.