Friday, October 31, 2008

The Weight of Money In The Market

Can you feel it, today, in equities?

ISDA sees hope, releases meaningless figure

Apparently, a giant paperwork exercise, courtesy of a Swedish firm, has reduced a self-admitted meaningless figure, "total notional value".

Still, these preliminaries must be important, one hopes, toward generating something like a system-wide open-interest figure, broken down along various lines.

They also passed out some guidance and documentation guidelines. Do Hedge Funds ... take guidance?

Oh, for those of us, not privy to the inner workings of the CDS market, some useful jargon was explained. A "Compression", a.k.a. a "tear-up", which seems roughly analogous to a netting or an unwind (it doesn't make their glossary).

Morning Roundup

  • Hopefully, you didn't lift your hedges too much or for too long. There is still a Republican in the White House.
    • GM will ... not get a lifeline...without a fight. Maybe it makes sense to give one after a bankruptcy declaration (when Cerberus is at bay?). That's the kind of deal that Neel's National Cash-n-Carry could execute, right?
    • Bush Administration is standing tall (like Hoover?), and it appears that the details of a plan to stall foreclosures, on the minds of many, will not be publicly vetted. Why close-to-the-vest is a good instinct is beyond me, assuming proposals meet a minimum level of competence.
    • Foot-dragging has an almost measurable price. Foreclosures look set to hit a new record (MICA) while the Administration debates and "hard looks" a problem that they should have thought through about a year ago or more.

  • Non-financial earnings of S&P500 companies are up a likely 9% or so in the quarter. That's not a depression. (bloomberg)
  • With energy cliff diving, housing prices lose a downdraft and affordability ticks up, but everyone will focus on data from datasets on home equity, despite that no one knows exactly how the estimates or done or has 'backed-out' the impact of record foreclosures depressing selling prices. Somehow the Federal Government (policy makers) didn't get into the data collection process early on in the crisis, so most of the datasets are ... private (so far as I can tell).
  • Wall Street is so top heavy, that it's executive payouts may exceed what is due to the entire workforce of some companies. The Wall Street Journal says its true, so ... curb your bias. Anyway, if it is true, then how can one say "no" to GM but "yes" to banking?

Thursday, October 30, 2008

Fear of the Unkown


Hong Kong has some notoriety for its property booms and busts, just have a look at the chart, to refresh your memory.

While changes in home prices are scary on the way down, you'll notice that Hong Kong lives. Better than that, they thrive (the stock market is up).

Not everything is the same or parallel (HK's market has some unique structural quirks), but ... you cannot help but wonder if 50 years of rising prices in the U.S. has created an unusually soft psyche on the issue of the resilience of economies in the face of price swings and the value of real-estate, in the long run.

These violent price swings are typical of Hong Kong. The property bubble before the handover saw prices rise 70% (54% in real terms) from Oct 1995 to 1997. Then there was a traumatic burst, coinciding with the Asian Crisis, and property prices fell 44% in one year (Oct 1997 to 1998). From the peak to the mid-2003 trough, prices fell 66% in nominal terms (61% in real terms).


February 25, 2005

According to the Hong Kong Monetary Authority (HKMA), the number of residential mortgage loans (RMLs) in negative equity declined from a peak of around 106,000 cases worth about 165 billion Hong Kong dollars (21.15 billion US dollars) in June, 2003, to 19,200 cases last December with an aggregate value of 33 billion Hong Kong dollars (4.23 billion US dollars).

The figure represented a decline of over 80 percent from the peak. Compared with last September, the number fell 24 percent.

The HKMA said the improving employment market strengthened borrowers' repayment ability and improved the quality of banks' consumer lending.

Chief Executive of HKMA Joseph Yam Chi-kwong said the negative equity number should drop further as the property price continued to rise and people kept paying their installments. He said negative equity had ceased to have much impact on the stability of the banking system

Please Pass the Panic

So a number of sources have compiled dramatic charts that show looming rate-resets and the doom of negative home equity.

With all the resources at the disposal of some new organizations, why hasn't anyone published a cross-reference of who were the mortgage brokers and the lenders who were active, in places like Texas and Florida and California and Michigan?

It's not that the debt-load isn't worrisome, it's that the frame of reference is that the whole thing is like an abstract happening, a great exogenous shock, a Case-Shiller index.

It wasn't, altogether. It was fed. There were companies set up and 'top producers' given garlands.

It's amazing how quickly the mortgage companies have disappeared, taking with them almost all public face of who was active in the industry and what they did, where and when.

If you want self-regulating markets, don't you have to make it plain that people cannot disappear, at least?

Securities Lending? Are you serious?


Just when you thought your jaw couldn't drop to the floor, again, this year, you learn something new.

AIG lost $18 billion - billion - in its securities lending business. (h/t Felix Salmon)

Now, I'm out of it, but securities lending used to be one of those super-great, side businesses that turned an "extra" 2-5% a year, at almost no risk required.

So, to have lost $18 billion ... well, one just has to stagger back. 'Securities lending' must have been a euphemism for Casino Royal. Although this bit of information is in no way conclusive, it raises the prospect, not of some bets gone wrong, but of an almost abject loss of internal controls.

Of the two big Fed loans, the smaller one, the $38 billion supplementary lending facility, was extended solely to prevent further losses in the securities-lending business. So far, $18 billion has been drawn down for that purpose.

For securities lending, an institution with a long time horizon makes extra money by lending out securities to shorter-term borrowers. The borrowers are often hedge funds setting up short trades, betting a stock’s price will fall. They typically give A.I.G. cash or cashlike instruments in return. Then, while A.I.G. waits for the borrowers to bring back the securities, it invests the money.

In the last few months, borrowers came back for their money, and A.I.G. did not have enough to repay them because of market losses on its investments. Through the secondary lending facility, the insurer is now sending those investments to the Fed, and getting cash in turn to repay customers.

Chart for the Day: Latin America ETF


SYM: ILF, iShares Latin America Exchange Traded Funds

Notebook to history

Gas crack spreads go negative.

Very rare (I doubt it is a first, though).

Valero, however, is zooming (up 25% in the past 5 days) on relief in the the broader backdrop of their position in the industry, I'd hazard.

The post-mortem on Porsche's VW coup-extraordinaire continues:

According to reports the big trade that caught out the hedge funds was actually shorting ordinary shares versus preferred. As Bloomberg reports, the trade failed when ordinary shares effectively controlled by Porsche sky-rocketted and the differential between the two widened the wrong way - the pref falling some 14 per cent on Tuesday.

Both thanks to FT's Alphaville

DOW Theorists Unite?


As they race ahead today, are transports confirming?

Exxon, BP with Record Profits, Again

That, of course, is neither here nor there (nor unexpected). keeps reading stories that exploration projects, especially big-rig stuff, is likely to be canceled, now that oil is at $60-$70.

So, the question persists.

Why does Exxon continue to pay a dividend? BP? Shouldn't they be saving all the cash they can for "lean times"?

I mean, isn't that an argument that companies, even the strongest and best capitalized, are short-term oriented and there is a role for those "investors" with a longer-term perspective, like the USG, the American populace?

Unless...unless...they are well calibrated and have all the cash they need to fund the entire industry's wildest exploration desires, if they wanted. In which case, ... well, one may want to keep an eye on exploration companies, despite any softening in day rates, yes?

Wall Street's Latest ...

Let's see, Target is going to be worth more because they have become better merchants and have innovations in purchasing and inventory management.


They've lowered their cost of capital?


Oh, they are going to take advantage of tax law, so that their real-estate is suddenly worth more (because it's wrapped into a tax-favored REIT).

Great. Innovation. Great. No really, great. Great.

How do the numbers work out if the government wises up and pulls the plug on this clever, new, kinda-tax-"deduction"?

(Don't hate me, Bill. Superb, well articulated ideas on the financial crisis. It can only be helpful if more people had confidence that there is equity-capital financing available. On the other hand, no one at Treasury seems to be listening, too much, so a word to the wise ... falls on deaf ears? :-)

Steady On - Keep Lending

The good folks over at CalcRisk ask, "No Home ATM. No credit cards. What is a debt addicted U.S. consumer to do?"

Oil prices are down considerably from last year. This will help the low-end of the market. A lot. That could keep consumption level, other things being equal, even under mildly restrictive credit conditions.

The high-end of the market will not have their "equity" to spend (maybe $200-300 bn per annum), but that has been cut back slowly for a while now, and is already priced into the home-improvements stocks, like Home Depot, don't you think?

In the Spring, the Obama tax cuts will be on the horizon, further easing the worries about a rapid deleveraging. Q4/Q1 is as much the odds-on bet for a trough consumer retrenchment as any guesstimate.

First, banks need to be pushed to keep lending. With funding rates at less than 1%, they can afford to write loan portfolios that have 7% default rates!

Second, they are going to make "their world" worse, if they panic themselves. The time to have reserved for losses is at the top of the cycle. Trying to write the best vintage of loans at the bottom to "catch up" will only create what they hope to forestall, a worsening environment.

Third, personal finance people should stop lying to people that their FICO score is in their control. It's not. It's a black box. Consumers have a lot of power in the chain, under bogus "Universal Banking". Sooner or later, someone is going to realize that consumers can threaten to take their deposits away from card companies, if they don't behave. You know, find a local bank to do your checking and savings account and cut out the card companies who panic.

Inventory Secured, All Ahead Full

Industry leader Toll Brothers secures their home inventory:

[NEW YORK, Oct 29 (Reuters)]

Toll has mounted rent-to-own programs in New York City; Singer Island, Florida; and Scottsdale, Arizona, under which tenants have time to rent while they consider buying.

Builders tend to deploy rent-to-own during the downside of a housing cycle, said Mollie Carmichael and Lesley Deutch of Irvine, California-based John Burns Real Estate Consulting.

"It's the product of tough times and also the number of homes that are out there competing. Kudos to Toll for taking a creative approach," Carmichael said.

It's Still Hoover Time At The Bush White House

This detail looks good:

To attract financial institutions to the program, the government would then guarantee to repay the lender for a portion of its loss if the borrower defaulted on the reconfigured loan - WaPo

Looks smart. To avoid perverse incentive to push everyone into 'default', some residual risk is left with the lender.

And, of course, it's still Hoover time at the White House:

While Treasury and FDIC officials have reached an agreement on the principles of the program, the White House is resisting, according to the sources, who declined to be identified because the negotiations are ongoing.


It did take team Bush almost all of 2006 to come up with the notion that a "surge" was needed, as the conflagration in Iraq grew and grew and grew. As late as November, Bush said he wouldn't be rushed into a decision ... he even showed "leadership" by waiting for the election result to finally dismiss Rumsfeld.

*Lives* were in the balance, then. What does that say about how important they think this is, now?

My guess? The White Houses's banking and real-estate lobbyists are looking for ... a way to bake in a "killer" loophole that is hard to see in advance.

Wednesday, October 29, 2008

Chart of the Day


(n.b.: it's always a good idea to buy the stocks that get kicked out of the S&P500 ... no kidding.)

Unanimous Fed Board: 'We Will Turn the Solvency Hourglass, Presently'

50-50 Funds and Discount Rate

Fed does the right thing. World rejoices - you know, with what they have left, that is.'s happening!

WASHINGTON (Reuters) - U.S. banking regulators [FDIC led] are working closely with the Bush administration [Treasury] to create a loan guarantee program that would serve as an incentive for servicers to modify home loans, the chairman of the Federal Deposit Insurance Corp said on Thursday.

Oh, please, let's hope they get some bi-partisan help in at Treasury (and some people with markets expertise), before they come up with a ridiculous plan that ends up in a knock-down fight on the Hill. Please!

Buy the banks! Buy everything! Buy America! Buy Latin America! Buy Warren Buffet! Buy Champagne! Those who were once blind, now can see!

A Plea : Not another three years of "Global Healing"


If it isn't, can we please have a different theme than "Global Healing" this time? We heard it so much last time, it's like a hit-single that has soured.

Can I suggest,

  • "Economic Aftercare"?
  • "A New Creditworthiness for Our Time"?
  • "Rightime Releveraging"?
  • "Flipping the Solvency Hourglass"

Back to the future:

The world is in the midst of what could well go down in history as the first recession of this modern era of globalization. It’s a recession whose seeds were sown in the depth of the financial crisis of [{insert date}]. Under the leadership of Treasury Secretary [{insert name}], the United States played a key role in staving off what he called the world’s worst financial crisis since the 1930s. It is an honor to share this platform with him this morning. But just as America moved aggressively to save the world nearly three years ago, it has paid a steep price for those noble efforts. That rescue mission fostered a climate that took the US economy to excess -- resulting in a destabilizing asset bubble, an overhang of excess capacity, and an extraordinary shortfall of consumer saving. It also left the United States with its largest balance-of-payments deficit in modern history. As you probe the implications of America’s unprecedented external imbalance, I urge you to do so in this broader context.

- Steve Roach, before congress, July, 2001

Your Daily Variation

...rather looks like the market is setting up to make the Fed ease an "excuse" to race higher, don't you think?

My Kingdom for a "AAA"

I would like to remember the name of the professor who said that "AAA" was not an optimal rating / structure.

In today's environment, "AAA" means that the world is your oyster, at least in the financial world (apart from what the government is doing ...).

You'll notice that the Corporate Governance Quotient is low for a few of the insurers who have gotten ... pounded, frankly.

Negative Effective Interest Rates for the Poor?

... after fees, maybe yes:

Use foresight when taking out money from your bank's ATM. Taking out $30 or $40 dollars from an out-of-network ATM is the same as paying 9 percent interest on your money.

Stating the Obvious

Gradually, markets appear to be suggesting that they expect the U.S. will lead out of the financial crisis, despite being at the center of ... "weakness", shall we say?

This is because Europe appears in a weaker position to weather their storm; "Asia" is not de-coupled enough to do it on their own, even with oil in the 60s; and the Emerging economies of Latin America and elsewhere have been hit by the commodity bust and the mother of all currency crisis, in which they have an ... er, international handicap.

It's possible that this will reverse, some time down the road. We'll see how much 'domestic demand' China and others can 'stimulate' through the relaxation in global interests rates, which should hit a near cycle-low today, as the Fed is expected to ease the Worldwide pain with a policy rate cut.


Keep a list of the IMF "bailouts". They have been increasingly good long-leading indicators of historical buy opportunities...

There will be long lists as to whether yesterday's rally was more than a rally to be sold. Sadly, so far, it doesn't look like a "... and-didn't-look-back" rally to me.

Still, the market has shown that it is quite vulnerable to good news. Suppose the drop in gas prices forces bears and doomy-economists back to the drawing board on "consumer deleveraging" thesis ... that's worth positioning just for the sake of it.

On the other hand, 2 million "structural defaults" over residential housing will have ruined the credit rating of ... 2 million. Have I said anything about preventable foreclosures, yet today? Preventable foreclosures, Preventable foreclosures, Preventable foreclosures, ...

Quote for the Day

Life in the fast lane:

Analysts say Porsche’s profits from derivatives will be carefully scrutinised in the future, after they made €3.5bn from that business last year – triple the amount made from selling cars.-FT

It's clear that Americans need to deregulate some more. "Free" markets are so much "funner".

Anyway, Porsche snagging VW has to be one of the most remarkable coups in history. Much bigger than AOL swallowing Time-Warner, don't you think?

And, if it turns out that they were tickling the bellies of the hedge-fund fish by lending them stock (knowingly or otherwise) before reeling them in, it will be a ... triumph, in a Greek kinda way.

Tuesday, October 28, 2008

Required Reading

Q3: Homeownership and Vacancy Rates, via CalculatedRisk


Preventable foreclosures ... center stage, yet again. Anyone else notice this theme, over and over and over again? Yet, our entire Treasury Department appear to have banks' capital on the brain, still.

"Innovation in mortgages", with luck, can be substantially substituted by the HUD program(s) and the already expanded use of Freddie and Fannie.

Should the government "target" a homeownership rate? No. Does throwing a huge number of people into the rental markets (or otherwise) and depressing home prices (and nominal bank debts) somehow "work" better? No.

[btw, I agree with the estimation approach, but the base estimate of the demand for housing looks low at circa 800K, for no-change in the homeownership rate. What about some amount of obsolescence in the housing stock? As best memory serves, the historical series during times when the ownership rate was steady suggests a higher number.]

Wait for no man ...


...I go to the store at 2:00 because it is raining and I figure no one else will be out, so I'll have the aisles to myself.

The market goes up 700 points (8%+).


Anyway, I hope it is not a real bottom, for personal reasons. If it is, I'll have outdone Elaine Garzarelli by half, doing what even my mentors said was impossible: picking an exact bottom.

Maybe it is my fate in life. I picked Singapore within the hour of its crisis bottom back in the 90s. Still, I totally missed the NASDAQ top (Goldman has bragging rights on that one, right?).

Anyway, it's a little, temporary solace (aren't they all?) for an out-of-work guy who has only his own spreadsheets and none of the trappings of a "GMO Van Otterloo", say.

Michael Lewis

Few get the license to parody Wall Street quite the way and as much as Michael Lewis has.

Here (over the weekend), he has at it with Andrew Ladhe's, 'Good-riddance-to-all, I-was-in-it-for-the-money' piece.


"As the trading room filled with smoke, and acquired that only sweet smell I know that is not success [ganja], I realized it was time for me to share more."
Sadly, some of the people who actually like the markets, who are not just in it for the money, get set aside or trampled, somehow, it appears, perhaps as the others find each other ...

The Global Risk Chessboard

The Taiwanese were apparently among the marginal sellers of agencies.

The worst fears about this are all pretty grim, but the risks are still enough to be judged remote...

(hat-tip to David Merkel)

You can't make this sh--, er... stuff up

Depsite "rescue":

  • SAN FRANCISCO (MarketWatch) -- Merrill Lynch & Co. (MER:Merrill Lynch & Co., Inc MER 15.21, -0.65, -4.1%) said Monday its board declared a quarterly dividend of 35 cents, unchanged from the previous quarter. The dividend will be paid Dec. 3 to shareholders of record on Nov. 13.

I always wanted my tax dollars to go to Merrill shareholders, you?

  • Oct. 27 (Bloomberg) -- Five straight quarters of losses and a 70 percent slide in its stock this year haven't stopped Merrill Lynch & Co. from allocating about $6.7 billion to pay bonuses.

Some people clearly weren't involved in creating the troubles, so it's hard to be against all bonus payments, but one guesses that the bulk of the money isn't trickling to ... the rank-and-file.


True or false:

U.S. Housing was overpaid and overleveraged, mostly, but not overbuilt (except in Florida?).

If true, then the "pop" of the bubble is not as severe, because it is easier to adjust, when there hasn't been a dramatic oversupply / inventory build ...

[update: Tishman, on CNBC 7:37 a.m., 10/28: there has not been spec buildout in commercial property as there was in 1991-1992 era. (I do pretty good for a guy with his eyes closed, eh? Now for the residential piece ...)]

Thinking at the margin


The good folks over at Calculate Risk have two scary looking calculations, related to negative home equity.

Since this is a solutions-oriented blog (hopefully), here's an idea to help fear from becoming a policy paralytic.

When you have a problem that appears too large or too complex to solve, try solving a smaller problem first.


One way to dice the problem is to only help at the margin. As long as there are people with jobs and incomes, then LTV is not as important, in the short and mid-term.

Focus, instead, on those loans that are at default because of a loss of income (job) or because of loan terms that could be sensibly restructured.

If you start early and make a point of not putting up perverse incentives by allowing some loans to go into collection, you can "manage" this problem, with far less resources than the worst estimates of the "total problem".

If default rates, at their worst, range up to 18% (guessed twice the projected unemployment rate in a severe slowdown) and maybe 4% are not able to be mitigated, then we are talking about addressing 14% of the entire problem with public money. That might be cut in half, if it can be shared with lenders 50/50. That assistance can be spread out over time, so the huge cash outlays are not needed all at once. The realization of the rest of the losses can get spread out over an even longer period of time, for many loans.

If there is some debt-for-equity swap done as part of the distressed-mortgage deal, then the long-term expectations also get successfully managed, because any stabilization or bottoming of the housing markets will immediately be taken as the upswing of a "virtuous circle", in which "worthless" debt-for-equity bets look like they may pay off, thereby boosting confidence in the lenders that offered those terms.

A slow adjustment is sensible and workable. Belief that "free markets work" or in letting the housing markets going through an unattended, fierce, and rapid adjustment that overshoots, even, is probably not the best option for the general welfare ...

Monday, October 27, 2008

Energy Derivatives?

One Gulf Bank has run awry of "a derivatives" trade to the tune of $742 million.

Can we guess that this was oil futures related? Someone sell massive puts, on the view that oil was going ... sky high (pun intended)?

Currency? A little too much enthusiasm for the Euro?

Who knows .... somehow I doubt it is CDS.

Update: Someone else doesn't know how to hedge their book? (Shaking head)
Equity Deriv Losses At DeutcheBank


S&P500 dipped through my 850 number, today, below which I once called "looney land", without the assumption of a collapse of the U.S. financial system.

Paul Kedrosky finds well paid industry manager Jeremy Grantham using 535 as his overshoot number.

I feel so ... recklessly optimistic.

Should Pigou Club Disband?

I keep hearing conservative commentators insisting that new taxes (translated by them to "Obama") will be the bane of all economic activity, in the current environment.

So, should the Pigou Club disband?

Signs of the times ...

Financial market watchers appear to be getting ... a little shell shocked.

This item's headline caught my notice as evidence of he same:

Progress: Nothing Blows up on a Sunday

Saturday, October 25, 2008

Knowing what you don't know - Where's that data, Mr. Paulson

Two pieces out today, outlining a topic near and dear to this blog's screed: policy response that anticipates knowing what you do not know (as a modus of action, not a paralytic).

The sad part is that at lot of the "unkowns" are "known unkowns", at least to those who have a grasp of financial markets structure and modern financial instruments. That is, 'the collective' is smart enough today, there is enough expertise mucking about, that we know the data that we need, for decision and risk mitigation (even crisis risk mitigation). For some reason, that data is either behind closed doors or no one is (or has been) gathering it, in a systematic fashion. What's more, the people looking at it *may* not know how to interpret it, have events moving so fast they haven't the time to stop and 'think it over', or have actually reached the wrong conclusions, for any number of reasons, some good (poor but reasonable inference), some not (ideological).

Greg Mankiw: But Have We Learned Enough? (NYT) As always, Greg does an excellent job explaining things (in my no-count estimation, that is). He slips when he goes for the NLRB, while mentioning housing, yet skips the Home Loan Board. via Blodget, They Didn't See the Great Depression Coming, Either.


The foundations of the current panic are rooted in two great uncertainties: the value of home collateral backing assets and the overall asset quality of major bank's balance sheets.

The first was laid bare last year, as a threat to financial institutions, against the backdrop of rising policy rates.

The impact of the first uncertainty on the second has been greatly misjudged. Policy makers - and others - failed to understand early on the caustic market impact that the unkown scope of the problems would create, the risk-aversion that would result. At the same time, estimates of the impact ranged from the modest ($100-$200 billion, losses on subprime issuance) to the fantastic (Nouriel Roubini, et. al.), with no systematic data or regulatory voice with enough authority to ... adjudicate those figures or their systemic ... implications (i.e. how the distribution of the risk was spread throughout the interlocking system).

The propagation of the panic occured when the small, but meaningful, steps taken to quell the initial faultline ... stopped working. Managements, who had just raised modest amounts of capital, assured investors (and regulators?) that asset quality was 'manageable', and then went bust, bankrupt, with vague explanations, like, "a run on the bank". Regulators were unable (or unwilling) to mitigate these steps in the chain, lacking central authority and a generalized, systematic plan for the both the scope and the individual asset classes at the root of the problem. Although they did prevent AIG's massive book of derivatives from a bankruptcy, the resulting mixed record has only mitigated, but not quelled, the two main uncertainties. Why? Well, it is in part because that record has also raised questions about the Treasury/Reserve's ability to continue to quell The Great Unkowns. The Fed usually wins such Titan clashes, but it's hard to "bring that to the bank", this time (pun intended).

Of course, once you unleash the hounds of war, so to speak, the Pandora's box is open. People are free to let their imaginations wander, to discount every impending crisis, to indulge in "doom" (and profit from it). What's important analytically is not to confuse these imaginings with the two principle uncertainties, at least in the early part of the crisis. (Later on, it is a multi-front war, arguably).


Now, "the system" has already been through one "feedback step" of a loop - the outcome of the first step is now the input to the next, by my reckoning only (there is always Hope that I'm wrong). Authorities have used all their conventional tools, almost to the maximum, but have failed to come up with a plan, yet, to deal decisively with the two uncertainties.

There are many paths to dealing with uncertainty. Standing by - standing by - with a bucket of taxpayer capital to throw around generically when 'the system' migrates to the next phase seems like a poor choice, whether or not it eventually works.

On the other hand, amounts can be tallied and made known, alongside plans to reduce leverage and risk through systemic unwinds, particularly of certain derivatives and leveraged spread risks. One of the key tools of the USG, its guarantee and its long-term holding period, can be used at the margin, to provide a stochastic floor under the value of home collateral, to directly reduce uncertainty. This may prove costly, in the short and mid-term, but it is sure-footed.

I'm sure there are plenty of other proposals to weigh and consider. It's easy enough to figure out whether they will 'work' to address the two large uncertainties.


A general fiscal stimulus is not sufficient to either of the primary uncertainties. Although it may smooth-over the eventual, realized risks, it does almost nothing ex-ante to reduce the uncertainties in any quantifiable way.

The best way to think about the fiscal stimulus, therefore, might be as dealing with the ... er, "choppy outcome" of the first step (unless we are fortunate, yet, that it reverses, even to a large degree).

Given that the scope and size of the problems remain ... unquantified and not decisively mitigated, going into part two, "stimulus" ought to focus on the long-term and on structural advances that raise the expectation, not of reflation (even in the mid-term), but of long-term variables, such as productivity, efficiency, and future capital availability.

Friday, October 24, 2008

New Idea: Shutting Down the Multiplication of Risk, For a Time


The last proposal was for a forced unwind of synthetic CDO contracts.

I've already talked about the need for regulators to forestall, as much as possible, further blows to the system (not just throw rescue lines of capital injections).

In the prior writings, this involved isolating individual credits, that potentially have destabilizing "resonances" throughout the system because of CDS contracts. (Not all will, that is why the regulators need to have enough data to know which ones do...).

We can also propose emergency regulatory authority to overtly manipulate the collateral for the reference indexes that have driven an orgy of spread risk speculation, including credit risk, levered throughout the system, synthetically or otherwise.

  1. Pro bono publico, the government throws a guarantee around the issues/companies in the index, neutralizing prospective default risk. Hopefully, there is not too much residual risk related to any "events" that the government cannot "re-insure", but that's not a 'show stopper'. (Yes, there is a 'free rider' boost for the cash bond holders - who the hell cares, at this point?).

  2. Through a series of moves, the issues are retired, default free, the instruments that rely on them are unwound, fiat, and the system deleverages, until it has the capacity to try again, with "better models" and more capital (probably more than enough, by then, but let's not digress).

n.b. This effort is designed to target the structured products that appear to be looming large, still, for a controlled systemic unwind. I'm unconvinced that the regular trading of credit, by responsible parties (i.e. risk-managed entities that are willing to disclose their net exposures), is something that ought to halt.

For the Record

Friday, October 24, 2008, very likely a day that will be remembered for a long time (at least by insiders), a conservative SONY management cuts profit outlook in half (specified reasons to tbd).

Update: weak demand cited. This is the refrain for this quarter, already. Companies who make their estimates are 'cautious' and those who do not have "blamed" weak demand, in many instances.

Chart of the Day : Almost Instantaneous Destruction of the Carry Trade

Based on press reports, one might have thought that "the carry trade" has been unwinding since Feb/Mar of this year and should be done by now.

I think that Sanford Grossman, for instance, was doing long the dollar, so ... this chart doesn't apply to all / everyone, clearly.

via Alea

What one risks when you run currency-unhedged, pic is Euro-Yen.

Update: To be read alongside this week's notable negative swap spread.

Dumping of assets

One doesn't know, but if Cramer's reports are true (big IF), the rapid and sudden dumping of assets on the market by hedge funds ... is a red flag for regulating their access to leverage, at a minimum.

It appears that the lessons of LTCM have not been ... taken to heart. Maybe, 100 small firms all going bust on the same day has the same market impact as .. LTCM, yes?

"Mr. Paulson, tear down this structure!"


I have to say that this note is worrisome, because I do not understand why these fully synthetic structures have not been "targeted" to be unwound, dismantled. Perhaps no one has the legal right to initiate the process by which the structure is terminated?

Whatever the case, there is no cash asset tied up in these structures, legally (they are built on reference only to other instruments). To me, that means that they can and ought to be unwound. Maybe a lot of them have been ...

The prospect that regulators would let a multi-billion dollar, off balance-sheet, Damocles sword hang over the capital of banks, in a way that is now an obvious, self-fulfilling danger is ludicrous. They should act and act soon. This is a kind of low-hanging deleveraging, right?

If there is more to dismantling the synthetic mountain of cards than just calculating the net NPV required to 'unwind' the "legs" of the trade, please let me know. Otherwise, the right people have to get on the phone and these particular assets ... need to end, for a time, I think. (That's quite a lot different than "nuking" all CDS contracts, etc.).


Greenspan, Krugman - the Dimensions of the Problem

After listening to Greenspan today and to Krugman tonight, on Charlie Rose, I continue to be struck by the amount to which the categories and scope of the problems *may* yet be ... under estimated.

Part of the problem seems to be a lack of understanding, at the highest levels, of the types of products that Wall Street has generated, coupled with a lack of knowledge of who owns what inside 'the system'.

Greenspan was right to point out that the explosion in lowest quality sub-prime lending occurred after 2005 and was coincident with a rise in securitization. He tied it to foreign capital. Yet, in another part of testimony, the key purchasers of SIVs (structured vehicles), on one estimate, is north of 70% done by hedge funds. Is that 'foreign capital'?

What worse, we also know that there was an explosion in the creation of synthetic CDOs, perhaps because physical issuance couldn't keep pace with the 'demand creation' done by Wall Street in search of riskless yield pickups.

As for Krugman, it would be a logical, conceptual extension for him to go past "capital" as a way to rescue banks, and actually think in detail about the various types of instruments that are threatening the capital base and what to do about it, directly (bottom up). Put plainly, "more capital" and a broad-spray fiscal stimulus *may* not be targeted enough, given the unknown size of the problems and the limited budgetary resources. There may be solutions that actually target assets and instruments, in ways that change the risk-characteristics of assets, making the need for capital injections less urgent and all of it less of a caustic "unkown".

Thursday, October 23, 2008

Greenspan - the rest

11:04 a.m. Greenspan obliquely supports the divorce of CDS trading from physical settlement, suggesting that settlement issues relating to the "discretionary" request for the exchange for physical collateral "be resolved". [update/note: I mention this only because I have yet to hear any official say anything with this degree of particularity, indicating that they are thinking at all about the risk-characteristics of newer instruments. In other words, this is not a view on whether the development of a cash-settled market, as has happened, is good or bad.]

Using the Arrow framework, we went through a period in which risk was hidden, more than spread, via silly model assumptions and an issuance gravy train with scant capital backing.


We also went through a period in which derivatives and structured-products magnified so-called spread risks, those related to credit quality and to different maturities on the yield curve; and, somewhat counterintuitively, the spreading around of risk that occurred enabled that multiplication, without reducing the systemic risk, either by isolating loss or putting risk(s) in the hands of those most capable of pricing it or bearing it without systemic implications (e.g. the hands of seasoned experts, "natural hedgers", or well-capitalized speculators or investors).

To analogize, the first is like a bad loan that gets syndicated, but to affiliates.

The second, to summarize at even a higher level of abstraction, was like writing financial insurance to protect people from ... the business cycle, basically.

It's the housing markets, stupid!

Greenspan confirms the assessment given here weeks ago, but stops shy of the proposals advanced here for a Brady-like plan for home-mortgage defaults, in which the temporarily lost collateral value of home equity is shared by the deep pockets and long-term holder status of the U.S. Government. (Even a small amount of insurance will go a long way to stabilizing the market's assessment of the collateral's prospective worth - it can put a floor under value, without removing all uncertainty, a sound outcome of "intervention").

Anyway, here is the operative quote, from the maestro, Greenspan:

Indeed, a necessary condition for this crisis to end is a stabilization of home prices in the U.S. They will stabilize and clarify the level of equity in U.S. homes, the ultimate collateral support for the value of much of the world’s mortgage-backed securities.

"Preventable foreclosures" has centerstage..

The rest is noise, backward looking and important for understanding how free markets can fail to regulate themselves -- as if that would come as a "shock" to anyone but Milton-Friedman-fed ideologues, raising questions about settlement and securitization.

What's missing? A fair amount.

For one, there are other storm clouds to diffuse. (I've forgotten to include synthetics in my frequent lists, sadly). There continues to be a need to be broadly anticipatory, to forestall unmitigated blows to confidence. One has to imagine that the markets as a whole would be served by taking an upper hand on events and "force" an unwind, at current prices, of synthetic CDOs, to the extent that something like that could be coordinated.

That's exceptionally tough medicine. However, waiting on events, as Paulson has suggested, only presents another opportunity for the markets to lose confidence in 'The System'.

Wednesday, October 22, 2008

Fancy Juxtaposition of the Day

Item: Moody's and S&P basically trashed on the Hill today (Fitch escapes).

Item: Cable news turns to Moody's Chief Economist for expert commentary.

Now, Mark Zandi has been as good a commentator on events as any, perhaps even better than average, and certainly a moderating influence on those economists with radical views ... but you just have to savor life's little "ironical moments".


These firms put people in charge who didn't know enough or who were willing to risk the whole franchise to be CDO Queens.

THAT, sdaly, starts to call into question the judgment and ability of those who select and promote talent within the organization.
The hearings on the Hill that revealed some of the most naughty of messages and e-mails were as bad as those from tech underwriters of the 1990s, who penned that their securities offerings were known to them to be p.o.s.

One expects that from brokers. One doesn't typically expect that from ratings agencies, who often limit their market power to subtle and episodic abuse(s), not flagrant joke's-on-you.

Fitch emerged as one of the three who had a CEO that knew enough to refuse the "game", even at the cost of market share and soaring stock price.

As for the others, the blackspot will widen. It takes years - decades - to build up a reputation as a "rating agency", no matter what field or industry you are in. These firms put people in charge who didn't know enough or who were willing to risk the whole franchise to be CDO Queens.

THAT, sadly, starts to call into question the judgment and ability of those who select and promote talent within the organization.

Gloomy Economists: Preliminary Assessment

History shows that economists are no better at prediction than ... many others (maybe a little better than weathermen, but I don't have any references from the Journal of Economic Forecasting to share, presently).


It's not necessary that all deleveraging is rapid and fierce. The U.S. consumer will benefit from lower commodity and energy prices globally. That's a source for deleveraging that doesn't involve cuts in top-line consumption. Because the U.S. consumer will benefit, perhaps disproportionally to consumers in the emerging economies, who may have more serious economic imbalances to work through, that's a positive for the U.S. dollar and long-term Treasury dollar financing, if it weren't complicated by the structural trade deficit.

As for financial leverage, especially at financial companies, rapid adjustments precipitated by declines in asset quality don't necessarily translate into "long term outlooks". At some point, the financial system will "catch it's breath".


It's not clear that the credit needs of a growing U.S. Economy rely on 30:1 leverage at Lehman Brothers, right? Those high-profile adjustments are seriously removed from Main Street, who can probably get by even with slightly higher credit-spreads for a while.

Many company balance sheets are in good shape, right? The corporate sector isn't screaming out of balance or "excess risk taking", is it?

Monday, October 20, 2008

Home Prices Set to Overshoot?

The lack of attention on the foreclosures and the unwillingness to deal with anything more than banks is driven home by this chart (see below).

If we just take what we know from the Case-Shiller indexes (not the most comprehensive, but sitll good enough), and use those with a simple consumption-based model, it looks like the forecasts for another 15% decline in the overall index suggest that real-estate, if it bottoms there, will have overshot the downside.

From 1987-2007, PCE grew by about 6%. The value of housing stock arguably should be related to both PCE and to the share of consumption in the economy.

The black line, below, is the trend since 1987. It's affected by the last run-up in housing. Grabbing, instead, a "low point", say 2000, which pre-dates the distortion of the run-up and is obviously a "conservative" point on the line, one can draw two lines that estimate "normal" supply-demand trends, one at a "low" growth rate of 4% and the other at the historical rate of 6%.

Another 15% down from the July C-Shiller implies that the 'historical rate' line would be crossed in July of 2009, just eight months from now. Basing things at 2000 is already conservative, so points below that start to look like clear overshoot. Already, we are seeing signs of pent-up demand creation, with super-low new housing permits well below reasonable estimates of long-term demand for single-family housing.

The C-Shiller index futures are looking for just about a 10% decline, until next August (from the July index levels, the latest reading available).

Las Vegas-5%-10%-16%-13%-16%-16%-9%
Los Angeles-3%-11%-16%-12%-20%-18%-20%
New York-2%-5%-9%-10%-10%-12%-16%
San Diego-3%-11%-14%-13%-16%-16%-14%
San Francisco-5%-11%-14%-13%-16%-16%-14%

These futures have not been great predictors. More on that later.

China's "Troubles"

A growth recession, in which the economy expands at only 7.3%.

Will the GITICs ... withstand such a horrific shock?

Well, for comparison:

US national debt is about 20 times China's on a nominal basis, five times on a purchasing-power-parity basis, almost four times on a debt-to-GDP basis, and 100 times on a per capita basis. US per capita income is about 35 times that of China in 2005, which means each US citizen is carrying almost three times the national debt-to-income ratio as his or her Chinese counterpart.

Sunday, October 19, 2008

The Worst is Behind

One of the measures of the primary problem, the number of ARM re-sets (adjustable rate mortgage), is already falling, with greater than two-thirds of the "nightmare" behind, according to figures compiled by the Federal Reserve.

Of course, for the 1/3 left and the 2/3 who 'bought some time', that is no comfort whatsoever.

Ridiculous ARMs are one of the structural excesses of the sub-prime grab-and-run, done by so-called 'mortgage brokers'. (Another were heart stopping pre-payment penalties.)

Of the secondary problems, the knock-on impacts and economic stress, both self-fulfilling and otherwise, ... still bite.

Mortgage Maps

By the way, have you noticed how little information about the dimensions of the problems actually makes it into the press and most commentary?

It does suggest that deliberate or passive inscrutability remains near to the core of this mess, the distribution of these loans, the impossible resets, the woefully inadequate "Hope Now Alliance", the amount of loans refinanced to-date at conventional rates, real-world data on LTV by zip code - all these figures, ... private data only. Gulp!

Saturday, October 18, 2008

Why Policy Response May Be ... Too Late

An unforgiving mistress, the markets are notorious for not giving people a second-chance, double-tops and double-bottoms notwithstanding.

Whatever life-blood liquidity that a reverse-auction or a 'fixed price government bid' might give to the frozen solid assets clogging balance sheets of "intermediaries" (*cough*), it's always possible that relief will come too late.


One could surmise that a bottom will come when both house prices and defaults have rounded the corner. An arguably better guess might be when defaults have peaked - it's possible that defaults will peak before home price declines bottom.

Here's one chart of the default rates on sub-prime loans, by vintage.

I don't know how this dataset is calculated, but if one did have a handle on that, you could make informed guesses with a fair amount of confidence. In any case, it could happen in Q4, perhaps before the first voluntary TARP ... event (we don't even know what it is going to be).

As an aside, Greenspan believes that home prices may bottom in 1H09. That looks like a w.a.g. to me, but he might have some analysis to support that conclusion ...

Friday, October 17, 2008

The Rise and Fall of a TARP


Price is everything. The price that the Treasury ends up paying for TARP assets could get ... politicized.

Assume they decide to actually take action on defaults, rather than just ... bail out lenders.

They have authority to modify loan terms, once they own them. Assume they know what terms they want to offer. That suggests the price that they should bid for assets, for pools of sub-prime securities and alt-a loans (or perhaps even structured assets built up on those pools).

That price could get "political", because they will be under pressure to offer better terms to lenders, from ... the lender-lobby, let's say.

If they think they are going to pay a lot more to get ownership, and then write-them down to some set of modified terms at taxpayer expense, then someone is going to see through that, fast, and raise a stink.

Of course, the TARP is constrained to buy asset pools, not individual loans, which is inefficient for targeting loans that you would want to restructure immediately. Put another way, if there are 20% default rates, say, you end up buying 8 mortgages that you have to buy up for every 2 that you want to address immediately.

To me, this is a serious inefficiency, if your target is to actually want to do something about smoothing the adjustment in the real-asset markets that need to clear, i.e. the residential housing markets that are 'underwater' on price and debt.

To be fair, "working retail" (as I've suggested in my own musing / approach) is a hurdle too, as there are millions of defaults and near defaults that the government would have to offer terms on.

Nevertheless, I think that creative ways to address that might be uncovered, like working with the servicing agents to get the work done that the government needs. It has to be at least as easy to contract that help and it's a LOT less risky, politically and otherwise, because the whole thing is simple and easy for the public to understand.

More on the Fed's Balance Sheet

The Fed appears determined not be outdone by either the market or its balance sheet. (see comment from early today).

The new authority to pay interest on reserves provides one additional method by which they can can control the money supply, by managing 'excess reserves', beyond the usual methods, to date.

It doesn't appear to me as robust as the other methods, like a matched sale or a coupon pass operation, but it could still keep them with a strong hand, whatever else yet happens with their balance sheet.

At the Asset Class

This, of course, is my specialty, if I can be accused of having one.


Warren Buffet, sage investor, is making headlines, today, with his oddly public discussion in the NYT of why he likes American equities.

On the other hand, Paul Krugman, recently anointed Nobel winner and weighty dismal scientist, says today, "I confidently predict that this slump will be nasty, brutish, and long." (most likely based on his long-held fear that the great American consumer is tapped-out and that economic weakness, especially bank weakness, will surely unravel that weave, now out of reach of ordinary policy wonkers).


If things get a lot worse, bonds are the asset class of choice. I don't care how much panic there is in the market, evnetually non-bond money will rush there, based on fundamentals, if it senses ... dare we say it, deflation. We are already at zero CPI...

If things are mild or we enter into a long period of "headwinds", not downward spiral for profits, then the "panic" in the bond markets will unwind. Again, bonds are the thing to own, both because relaxing credit-risk worries are beneficial (even if not fully determinative) and because many corporates have good balance sheets and the ability to pay, even when refinanced at somewhat higher rates.

So, only in the case that the corporate profit expectations firm in the next six months or so, after having weakened, might we expect the equities market to radically do better than the market for credit bonds.

1,000 Point Trading Range for the S&P500?

The VIX at 70 suggests a daily volatility (standard deviation of returns) of 4.4% ..

If the S&P500 "settles down" into a range between 1000 and 900 (currently at 950), by entering into a joint economic and 'banking' "show-me mode", that suggests, believe it or not, that the VIX is a little ... low.


At least, so far, we've seen no indications whatsoever of any specialist firms on the brink of failure, etc.

Asset Management via the Fed is ... Popular This Week

The Fed's balance sheet has been motivating a few dramatic graphs.

First, it's a good thing that the Fed is extending its balance-sheet, during a time of crisis.

It's reasonable, however, to worry about too much of a good thing.

As it is, the Fed's new "discount window", called the TAF (or TSLF), is popular in the current week, to the tune of $114 billion.

By Fed district, the use of the get-a-treasury bond by pledging 'illiquid' collateral:

1. Table 1. TAF Lending Increase/(decrease) in week
(in $billions, w/w 08-Oct-18)

The FED's Pawn Shop: these are securities that the FED has accepted in its special program, on a collateralized, temporary basis, to help banks through hard times.

Total 114092
Boston 4500
New York 44585
Philadelphia 500
Cleveland 4535
Richmond 28638
Atlanta 8120
Chicago 2324
St. Louis -50
Minneapolis 5005
Kansas City -2100
Dallas 2000
San Francisco 16035

No doubt some will take this as proof of further asset deterioration among banks or as some kind of indicator of how unhealthy bank assets are. Begging more at the 'special window' may not be a short-term indication that asset quality is getting worse. It may just indicate that the work-out is speeding up. It may also be a true indicator of liquidity - these assets may be throwing off the expected cash flows, but the banks in question simply need to be able to get reasonable, non-market-price liquidity, in order to address what is happening on the liability side of their balance sheets.

In any case, the markets will naturally be sizing up the situation, through the tea leaves, and asking how sustainable the current situation is (so far, it looks like the Fed could hang in there as long as they want, even at these expanded levels, I'd *guess*).


It's not easy to decode the Fed's balance sheet in forty words or less.

In theory, the Fed's balance sheet is unbounded. In practice, it is constrained, in various ways. For one, by policy that guards untoward growth or contraction in the money supply. Second, there are preferred methods to do what they want to do, market methods that make it easier for them to operate (e.g. the open markets desk).

It's these method preferences / limits that keep the Fed and the U.S. Treasury linked (as well as the OCC, for that matter), and bring into play factors like the statutory debt limit and so forth. (I believe that is correct. There aren't too many people who know these inner workings without question. It makes intuitive sense, however, for there to be a link, because the traditional 'hyperinflation' is when the Central Bank starts to buy up the debt that the Government has issued, wholesale).

As I look at the sheet, there appear to be some signs that they are ... doing some of everything, including both sterilizing and expanding. There is little to suggest caution is to the wind. The MZM monetary aggregates ... are not "going vertical" (although they do not yet include this weeks robust activities). In the current environment, an exceptionally expansive money supply wouldn't matter anyway, even in the long run, as consumer inflation has flattened to zero in the recent month-to-month; virtually all willingness-to-lend surveys indicate that money velocity is at or near all time lows; and the traditional multipliers of money, banks, are expected to be failing / consolidating over the next twelve months.


What's more, the Fed still looks like it has enough "ordinary capacity" to handle even another $200b in its term lending, before it might be suggested that it could not fully, sometime down the road, undue all that it has done, if the "term" facilities had to be extended "forever" or even well into the economic recovery, when it comes. That's my read, but others who know these accounts better should offer an opinion. (Update: by putting into their quiver a new method, 'interest on reserves', the Fed appears set not to get 'constrained' by what I've called its heretofore 'ordinary' methods).

Unexplained, the drop is agencies held for foreign governments is worth inquiring about. Is it a permanent shift in investor preference or just a temporary blip.

Thursday, October 16, 2008

Note to Self: Don't Bet against the Hacienda

Oct. 16 (Bloomberg) -- Mexico will seek penalties of 10 years' imprisonment for executives of companies who bet against the currency last week [and failed to notify the authorities of the trades], El Universal reported.

Let's Get Physical

Can we talk about it now ... the "bubble" in oil? Are we still sure there is no room for a risk-premium? It's all tied to physical supply and demand?

I ask because I'm actually very interested, having done a little bit of work once on oil market stuff.

I understand the 'physical arguments' and they are surely "a lock", so to speak. Yet, we have this chart in front of us, suggesting a re-thinking or a re-affirmation is in order. Could it be that it is because the amount traded, as a mater of "price discovery" via the pits, is so much less than the amount that actually exchanges hands, via OTC contracts that simply reference those prices?

Ticker USO, the OIL ETF. Is this last, steep leg down all "explained" by the falloff in BRIC demand and ... forced selling?

US Equity Markets - Astound


The U.S. equity market continues to trade, despite the implied volatility at a staggering 80% for the entire basket of U.S. Stocks, a new record.

Wow. When Martin Wolf said an emerging markets crisis in the developed market, it was a clever turn of phrase; but this is a little too "real"...

(The implied volatility is also known as the price of risk or the cost of insurance against price moves).

The Master Speaks

Ken Arrow, with the long view (h/t tyler cowen)

Two things to "add", if that is possible, not presumptuous.

1. Is there information asymmetry when the "less informed" (a.k.a. the trusting) and the "less less informed" (a.k.a. the self-deceived) compete for price? Or, is there another name for that?

2. How high can uncertainty rise, theoretically, yet there still be a 'meaningful' equilibrium or even willingness to risk-share?

Update / More Thoughts: It's fairly clear to most that the issues in securitization and derivatives are not related to the concepts/instruments themselves, but to how the sales processes and risk management processes get abused.

Was $1 for Bear the "right price", afterall

The value of the prime-brokerage business may have just been cut half...:

The chief executive of a leading alternative investment manager said he expected the hedge fund industry to shrink by 50 per cent in coming months - with half the decline coming from withdrawals and half coming from investment losses. -FT

Buy Obama?

If you speculate, then intrade's Obama contract still offers 10-14% upside, even after trading up 3 points after last night's boring "debate".

Got you in a headlock ...

141,000 nights

... London-style bankruptcy for hedge fund clients of Lehman is worse than a headlock, it seems; or else, it is one that goes on ... for years.

``Throwing more bodies at this doesn't solve the problem,'' said Pearson, who said he has a team of ``some dozens,'' including Lehman staff, sorting through the prime-brokerage assets, and 141,000 failed trades.


Meanwhile, CNBC reports that various blocks of collateral from busted hedge funds may be up for sale, depressing this or that set of prices.

I'll add this stage of the liquidation and deleveraging to the chronology.

Also, this: "Investors pulled at least $43bn from US hedge funds in September as market turmoil led to unprecedented withdrawals, an analysis by" ... Trimtabs." Still, that is not even 10% of estimated industry assets ... but that's still a lot to dump on some markets.


Last: "... former Neuberger CEO Jeffrey Lane filed an objection in bankruptcy court Tuesday"

Hurricane Ike

At one point the diameter of Ike's tropical storm and hurricane force winds were 550 and 240 miles (885 and 390 km), respectively, making Ike the most massive Atlantic hurricane recorded.[5]
Massive storm ... I haven't seen any economists adjusting or tempering the "read" on September figures for the impact of a storm that was so huge. In the press, the headline is "Worse since 1974".

Is it so important, from a career perspective, to be the first to forecast the deepest recession imaginable? Does it sell newspapers?

Update: Bloomberg has it. Focuses on strike, storms.

Old-fashioned footdragging at work?

A year ago, Congress was warned in no uncertain terms that regulators lacked and needed the valuable data required to make apt policy decisions, during market crisis. See Bookstaber, here.

Now that we have prices at full blown panic levels, perhaps the political will in Congress to push, not just "encourage the industry to develop ...", will exist.

Having people working day and night on that has to be at least as timely and important in the long term, as anything that Kashkari is working on ...


These words suggest just how much regulators lack a framework, for these decisions that are so critical. It's not offered up to point fingers or to lampoon or degrade. It's offered up as a matter of rigor, as a physician might dispassionately look at the symptoms of a patient in order to make a diagnosis.

Donald Kohn, June, 2008:

"Clearly, capital is a critical defense against unexpected losses. Even with the recent turmoil, the U.S. banking system remains well capitalized."

Either those estimates are correct, and we have just added superfluous capital to the banking system, as a step to instill confidence. Or, something is wrong with the way we measure and think about adequacy.

The Origins of TARP

Could it be in the proposals for discussion from Richard Bookstaber?

Wednesday, October 15, 2008

New Policy Initiative


Can Northeast Governors secure a 20% rebate, for those who bought in advance, if it allowed the oil companies to hedge their future needs?

No one could have foreseen the financial crisis that slammed Wall Street in September and the more than $50 per barrel drop in crude oil prices that are now closer to $80 per barrel. Now with average home heating oil prices at $3.67 per gallon in the state, some home heating oil customers are wondering if they made the right decision.

Update: News reports that oil delivery companies are squeezed between tighter lending standards from banks and customer delinquencies.

Bank Loan Officers ... Panic

Nothing like a rising default rates to cause Bank managers to panic. The Beige Book suggests that the clamp down on credit cards, etc., (raising rates, cutting limits, snapping to 'penalty rates', and pulling lines altogether) was causing consumers to retrench, even as they were paying greatly higher costs for gasoline and their tax-rebate money was ending.

We have to try to keep bank managers from panicking, as much as possible:

To some extent, I suspect that loan officers, even credit-card companies, are fighting the last battle, so to speak. It's human nature, right?

Unfortunately, making this year's vintage of loans the super best ever, may, paradoxically, raise the probability that the existing vintages get ... worse.


Last, we should pressure small banks, as a group, to stop paying dividends, as a matter of prudence, for a year. Publicly doing so can only help the system and help them with ... unruly shareholders, who ... are short-term oriented.

Keeping Ahead of Events: Reducing Credit Risk Multipliers


Someone should prevail on Paulson to do a Brady Plan for sub-prime and alt-a RMBS, already.

But, the market is already moving ahead.

At bat: a recession, one that will lead to corporate defaults, some of which Wall Street has insured using CDS, credit default swaps.

As you can see, the Swap market, such as it is now, has never ... been through a significant economic downturn. n.b. the growth in notional size is only generally indicative of the growth in net risk exposure.

Growth of Credit Default Market, 2001-2008


The first responsibility lies with banks to quantify their risks for regulators. For most, this is probably probably a combination of the basis risk of their hedges and, of course, their unhedged risk.

If the government doesn't like those figures, they should start to do something clever to reduce them.

I have things in mind that don't simply involve 'injecting capital' to paper over the risks.

Whatever solutions you have, the point is clear as is the responsibility: an appropriate regulatory response is to reassure, as best as possible, that the risks of loss are not asymptotically large or freakishly unmanageable, even if the economy tips into a recession.

There are things to do ... it's not wait-and-see, whatsoever!

Keeping Ahead of Events


Readers following the musings about the supposed chain of events of what is "really" happening (only history will show, fully), we can add this data point.

The prime brokers may be having some trouble reining in their ... er, off-the-floor trading operations, know as fast-money hedge-funds (not all such funds are fast-money, levered, or even 'hedged', so one has to be thoroughly discriminating).

Collateral calls, which are like asking leveraged hedged funds to ... produce liquidity, *may* only be working so well.

The reason I'm thinking this is because of a comment on CNBC that there may not be enough high-quality collateral in the system. Which is just another way of saying that the hedge fund industry, at least the risky, trading parts of it, are ... undercapitalized. At least, let's hope it is not the clearing banks themselves.


Let us hope that the NY Fed people are hot on this topic, if it is true. We all remember LTCM.

There are no indications of a repeat of that, apart from general worry indicators. However, there could be 100 "little LTCMs", that could add up to something meaningfully large.

What's somewhat reassuring is that there appears to be no obvious trigger point for those funds who have been caught ... er, "slim", to suddenly collapse. Some folks are keyed on the Lehman event/settlement, but that may not be the straw that breaks the camel's back (from what we know about the net settlement, it appears it could be Still, "significant fails" would be a blow to confidence in an environment that feeds on them.

As it stands, we can only speculate on what is "really" going on.

Policy makers have little to call on, except monetizing assets in a hurry (the hurry part is what will be the worst, if so much occurs in that way).

Whatever the case, if there are risks out there, like the ones outlined, the regulators obviously don't want to be responding to events, but to be seen driving them, as much as possible.

Fear and Loathing of Derivatives: A Note about CDS


There are a lot of people super-freaked by the multi-trillion dollar figures that are compiled on credit derivative swaps (CDS), the instruments that allow people to ... manage credit risk.

Here is an important fact about derivatives.

For a given set of bonds, in the event of default, the economic loss is limited to the par value of the bonds at the time of default. If the bonds are worth, in total, $328 billion, that's the maximum amount that investors will lose*.

Conceptually, derivatives are risk transfer vehicles. In the world of derivatives, my loss is always someone else's gain, contractually. Systemwide, the gains and losses on contracts are always zero, so that any loss is limited to the value of the underlying.

You may find that hard to swallow. Many people have their passions all worked up over it, so there will be a lot of heat. However, that is the case, unequivocally.


Once you understand that, but not before, you gain insights into how to think about the risks that an individual firm can run, without posing a risk to the whole system. It also helps Ben, as he works to help legislators work out laws that will allow firms with large derivatives operations to ... fail without consequence, in the future.

As I understand it, the people who are paid to do so, the BIS (Bank for International Settlements), imposed capital requirements for credit derivatives and other derivatives, that are not too chumpish. This seems to dispell the notion that these things were ... wholly unregulated.

We have no real data of net exposures by firm, so we see through the tea leaves, only. What we might guess, so far, is that those who were regulated, have done more or less okay. Those who were ... er, "beyond regulation", appear to have multiplied their individual risks.

Note to self and others: the unwatched risks are the ones that always multiply!

*technically, it's still a wealth transfer from lender to borrower

see also: Paging ISDA, New Estimate Please

Picking Up Markers: Reform and Re-regulation Watch

Some bloggers have been peeked by this article from the WSJ, The 1% Panic. Without 100 words, that write-up goes in the wrong direction, I think.

I'm more interested in something I heard to day, about how people learned to game models, namely the models Moody's uses. (Apologies to readers, if I'm the last one in the room to get this "news").


Here's how it goes.

A long while back (up to ten years ago?), Moody's started to use market-based metrics, as inputs to their decisions about upgrading and downgrading, because their studies showed that their ratings changes were anticipated by the markets, that they were consistently "late", and that the market, frankly, was pretty good at judging changes in the financial condition of companies, even without non-public information.

Apart from the name of the firm that pioneered that effort, I have no inside info on their process - just to be clear.

What appears may have happened is that speculators in the credit markets pushed vulnerable credits to the brink, nudged the ratings agencies to "confirm", and then pocketed the results of their "push" on the far-side. Translate "speculators" to fast-money hedge-funds.

In other words, it *may* have become possible, for a time, to manipulate the "new" credit markets.

This is quite different than the kind of 'model risk' that everyone knows exists on Wall Street. It's very different than having guessed wrong about the default rates on sub-prime mortgages. This is (old fahsioned) market manipulation - you know, the jailing kind of abuse.

Banks, Banks, Banks on the Brain!

Of course, the Federal Reserve is the chief bank regulator and their source of information is the banks themselves, mostly, but is that creating a bank-bias in decision making? Is it ideology?


If the mortgage market is the "central element" in the current set of problems, then why choose to address it through the banking system, where the default-problem gets magnified by leverage and investor worry?

Why not go right to the housing market? Why not go right after the default problem, directly and surely? The rest will follow that, not the other way around.

Is it less costly to try to do it all by shoring up the banking system? No, no, no. And No!


Listen to Ben on "too big to fail". Boy, he's got that down. He just needs a little more understanding of the derivatives markets and he'll be picture perfect, IMHO.

He could have been a LOT more positive on long-term fundamentals and used the Greenspan term, "resiliency" at least three times or more.

Please Pass the Panic, Part II



ONE negative credit growth number - one - and ONE weak retail sales figure and everyone wants to get out in front and predict that the great American consumer is dead in the water, all the worst fears realized.

A few key economists predict "gloom and doom" and all those with asymmetrical information about what is going on ... panic the business outlook.

Don't believe me? Here's one, long-term Venture Capitalist, showing what "not sure" translates to in the planning framework(s) for many asymmetrical decision makers:

My partner, David Aronoff, wrote a good blog outlining what CEOs should be doing to ensure survival. TechCrunch reports a similar note that angel investor Ron Conway has sent out to his portfolio companies. GigaOm reports that Sequoia Capital called an all-hands, emergency meeting with its portfolio CEOs to walk through a recommended plan of action. I have received copies of emails from a few other funds alerting their CEOs with similar messages. Take action now. Don't dither. Cut costs, cut projects, raise incremental capital, be proactive and plan for the worst.