Sunday, November 30, 2008

Nouriel has a Black Friday

Uh, oh:

CNNMoney reports:

"Under these circumstances, to start off the season in this fashion is truly amazing and is a testament to the resiliency of the American consumer, and undeniably proves a willingness to spend," Martin said in a statement.

Wednesday, November 26, 2008

The Bears Have Come Home

"Where are we in the cycle?"

"Goldilocks has eaten and slept and the bears have just come home."

Meanwhile, real disposable income was up on this morning's dipstick, so ...

Tuesday, November 25, 2008

No Federal Money for Lender Education ...


If you missed it, they are all excited over at HUD about a new form, that has no enforcement mechanism and won't be required until 2010. (It's still a big deal, maybe a break in a multi-decade log-jam, even).

Meanwhile, everyone, Left and Right, is agreed that some form of debt-counseling helps improve mortgage loan performance. We voted federal money for it, in the past year, maybe twice.

Still, no one appears to study the affect of education (or jail?) on ... those doing the lending. It's an abstract we prefer to call 'structural market failure', I guess, related to 'mis-aligned' incentives. No culpability there.

The knee-jerk free-marketeers seem to believe that the appropriate penalty for lender silliness is their own bankruptcy, not discharge of their poorly conceived loans.

Financial Statement Variety

Sampler from some of the recent financial reports for financial institutions. Sometimes, things just jump off the page at you:

(1) The Sub-Prime Group (SPG) exposures became fully integrated into VAR during the first quarter of 2008. As a result, September 30, 2008 and third quarter 2008 average VAR increased by approximately $60 million and $73 million, respectively. June 30, 2008 and second quarter 2008 VAR increased by approximately $95 million and $135 million, respectively.

(1) The FRB granted interim capital relief for the impact of adopting SFAS 158, “Employer’s Accounting for Defined Benefit Pensions and Other Postretirement Benefits” (SFAS 158), at December 31, 2006.

The claims are for breaches of the duty of care, breach of fiduciary duty, waste, insider trading, fraud, gross mismanagement, violations of the Sarbanes-Oxley Act of 2002, and unjust enrichment.

Derivative contracts with a financing element, net

YTD 2008

YTD 2007


This new ABS lending program from the Treasury/Fed is quite a powerful construct, providing 'levered financing' to the market. Woo-hoo!

This term-financing for up to a year for a variety of initial asset types, subject to a (one-year?) price-volatility haircut. The collateral must be "AAA", highest quality. In addition to the price/market-risk haircut, the Treasury then backstops the Fed with an equity pool, for the credit risk.

Two things I don't like, based on a quick first-read.

- 'AAA' may not be the part of the market that needs the most help. I'd like to see a broader range of collateral. All qualities may need help, to the extent the market is shut down, but still.

- The Treasury ought not to be the one managing the collateral, unless it intends to immediately enter into a forward purchase agreement with someone in the marketplace (and take a residual risk to lubricate the deal, maybe).

The Fed using it's balance sheet during crisis is just fine. However, with this latest construct, the Government looks like it is too much both the supply and the demand for funds. Of course, it's just $200 billion, so no need to wring hands over it, either.

"Dual-action" may be fine to address a blip in a market or smooth things over, in a market that isn't huge. It may even be a powerful "can-do" in a near deflationary environment.

But, on face, it doesn't seem a sound recipe for the long-term or for much larger asset classes, like commercial real-estate or private-label RMBS (nor does 1-yr term financing, given the duration of the underlying collateral of those instruments)

Fannie/Freddie Bashing To Continue

...until agency spreads blow out, no doubt. Just another lame attempt by the outgoing administration to hand-tie the nation and the new administration.

There are days that I think the GOP no longer care about the finances of the Republic - even its homeowners - and would just assume see it go through "bankruptcy", just like they want for GM and every other homeowner who gets a foreclosure notice.

It bears reminding, I guess, that we are a nation of people, not merely cash flows and assets:

So, now that the McCain camp which tried to use this same “Fannie/Freddie did it” fairy tale in its anti-Obama campaign—is history, as is most of Fannie and Freddie--what are the Republicans going to dredge up to in an effort to sanitize their regulatory shortcomings and, once again, blame Fannie Mae and Freddie Mac?

Most observers point to the seminal actions by Mudd and Syron, respectively, to purchase large amounts of toxic Alt A and private label subprime securities (PLS) in 2006 and 2007, as the major red ink causes.

But, almost as important, is the fact that virtually every aspect of the two mortgage companies business was presided over and blessed by their former regulator the Office of Housing Enterprise Oversight (OFHEO), following the May, 2006 consent agreements both companies signed with OFHEO. From that point on, the regulatory agency had their own employees in both companies every business day of the week reviewing all transactions and decisions.

If the former GSE managements made bad business calls, what’s that say about the OFHEO staff who shared in their meetings and machinations?

This next Waxman hearing should be fun to watch as the Committee GOP has to perforce blame other Republicans for mortgage misfeasance or malfeasance!

Monday, November 24, 2008

Read Your Mankiw


Robert Barro points out that there may be a current, sizable deflation risk premium, just as there was once an inflation-risk premium incorporated in the observed yields (although some thought that had since passed, with the ability to use products to manage inflation risks...).

Uncertainty about how best to use these expectational variables has kept me from updating the rates chart, for now. They are projecting maybe five years of deflation. [!]. It's possible that the structure of the TIPS offering has some technical impact, not just the liquidity.

Separately, perhaps one of the NIPA pros can explain why the price indexes for Q3 GDP were rising for line items like "Gasoline, fuel oil, and other energy goods" and how the consumption deflator seems... so large.

Citi By The Numbers ...


There is this post over at Brad DeLongs, with a high level view of what happened to Citi.

Here is another stylized view, Citi by the numbers:

At the end of 2006, Citibank had just under $90 billion in tangible, common shareholder equity. That would be about $18/share. The market liked Citi enough to pay up almost 2.7 times tangible book for a common share.

Twenty-one months later, by the end of the third quarter of 2008, Citibank had recognized $32.2 billion in credit losses and provisions for losses, earning 3.6 billion in 2007 and losing about $10 billion in 2008 (so far).

Tangible book value of common was $68.8 billion or about $12.60/shr and the market was paying up as little as $4-$6/shr, implying significant further loses. If those loses were in the range of $33 billion, it would imply a valuation of just 1.0 times tangible book (based on my guesstimates for earnings over the next 18 months).

Yes, that's a big drop in the premium paid. The stock is "washing out", as the pros say.

n.b. TARP "infusions" do not make the stock price go up or boost the capital stake for common holders, just for the firm as a whole. I'm guessing this may be creating a great deal of confusion in the punditocracy, because it looks like the TARP isn't "doing anything", because people are looking at the common stock price and asking, "why is it going down, not up, after TARP?"

See also, The Bankless Rally


I don't have these figures in detail. The company did offer up this high-level summary, during it's "Townhall Meeting". "LLR" are loan-loss reserves. "S&B" is 'Securities and Banking', which, for them, includes structured products, trading, private equity, investment banking, hedge funds, and a lot more.

In Finance There Is No East or West


The service companies arise:

Colliers Abood Wood-Fay Launches Distressed Property Services Group
Published: November 20, 2008

Miami--Colliers Abood Wood-Fay recently launched its Distressed Property Services Group. The group brings together an integrated team of resources, disciplines and professionals with over 75 years combined experience in managing distressed assets in inflationary or recessionary markets.

I mean, people are asking, "How do I get a piece of TARP?" Well, now you know...

Is CNBC hopeless?

They are focused on some stupid meme about taxes on the wealthy?

We're bailing out the entire financial system, and this is what is topic number one?

The market is selling off? As if they have never heard about sell the news? (*eyes roll*)

Obama - First Press Conference

Very impressive.

  • -Clean grasp of the multi-faceted problem (even talked about doing more than one thing at a time).
  • -Handled long-term and short-term aspects of economic stimulus with alacrity
  • -Daily briefings - perhaps indicates a markets orientation right at the top
  • -"In charge" - no wandering or pushing off to advisers on basic structure, goals or intent of policy
  • -Stimulus will be almost first act as President and will include changes to various processes of government
  • -Bailouts for Detroit will be as "sound" as practicable

In fact, the only detraction perhaps was the characterization that Americans have pride in their auto industry. I think we are finding out, from the polls, that is about 50/50.

Christina Romer is an impressive grab. Can you imagine an afternoon with Summers, Romer, and, say, Doris Kearns Goodwin in the Oval office? It seems like we can sleep a little easier than during the Bush Administration, at a minimum.

Bailout Sundays


Our Nation's quick-draw team has ... had another bailout weekend. Citigroup is the patient on the table, five-days after they started a free-fall.

The deal is the deal, improvised or not. I don't think you need to take-up 90% of the residual to make a good re-insurance market, but other (more informed) opinions could be had on that. It's a noteworthy point, especially because one may want to repeat this guarantee immediately at the next target (and there will be one, right?). I also think that the government should have left some of the tail probability on the table, taking just a "slice" not the whole enchilada. Last, a back-of-the-envelop, 10% haircut seems ... so yesterday, compared to the valuation technologies available, presently. Also, I guess Wilbur Ross, a lighthouse of the free-marketeers, wasn't available...

The markets will likely cheer the result, in a modest way, but will wonder if we still have moved from weekend-solutions to a comprehensive solution that was sought by "enacting TARP".


Meanwhile, the worst number from last week was the yield on long-term Treasuries.

That was no panic buying (I don't think). The market has clearly started to lose confidence in the direction of the real U.S. economy. Chief culprits are the Bush-Paulson abdicating their leadership and a lack of a plan to address the bad-asset problem, right at the source - foreclosures, real-estate price declines, and, now, weak economic activity.


The diagrams of a "bad-asset cycle" suggest, conventionally, that economic stimulus will "break the cycle", even if I thought that addressing the bad-asset problem (the value of home collateral) directly would have been a good first "stimulus" step.

So far, our reactive policy seems unable to get ahead of the curve. We haven't stopped any market from "breaking", that I can think of. To paraphrase Galbraith, "the key feature of the panic was that it kept getting under-estimated [until the system was so weak that antibiotics wouldn't work]."

Snarking aside, we can (and must) track the shoes in the cycle:

  • Subprime has gone first, along with the bond-insurance markets.
  • Weak corporate credit may have gone second (not just the non-financials, but the financial CP market, including non-bank financials).
  • Regular corporate credit has worsened, arguably, but not yet broken (not sure where the super-senior synthetic CDO risk on corporates is trading, now).
  • Last week, commerical-MBS broke.
  • Last month, the ABS market may have had a seizure.
  • The commodity markets have largely imploded
  • We've had the first round of a currency crisis in the developed economies that has spilled over to the emerging economies.

On deck:
  • The massive insurance market looks like it is ... dire.
  • The municipal bond market is holding on, so far, given the failure of the bond insurers and the interregnum uncertainty in the U.S.
  • The global sovereign market is okay, but cracking at the fringes. A second-round of currency crisis ... waits for a 'trigger'.
  • We are waiting to hear what is going to happen with alt-A "prime" and regular-way prime RMBS.
  • The agency market is under attack by the Treasury Secretary and his rightwing ideological travelers.

Sunday, November 23, 2008

Cycling on Empty

For those who keep asking about a market bottom, Paul Kedrosky wonders aloud about whether the worst is past.

The lack of systematic, government-mandated and collected statistics on the structure of the mortgage loan market appears to be a running theme in how the uncertainty keeps going, and going, and going. (There may be some that I just do not know about).

Among the things I haven't seen systematically outlined:

  • How many sub-primes have been re-financed into primes, and who were the companies that originated those loans
  • How many loans, of all types, have pre-payment penalties, and who were the companies that originated those loans
  • How many ARMs, by class/type, are pay-option arms, and who were the companies that originated those loans
  • How many loans had mortgage insurance paid for by financing and who were the companies that originated those loans
  • How many IO's have terms greater than 30 years, and who were the companies that originated those loans
  • For a variety of cross-sections, what are the summary statistics for the "margin" required? How many have a margin so high, on re-set or otherwise, that the "normal economics" of the loan are "gotcha", i.e. as time passes, the chances are great that indebtedness (total due) will increase, perhaps even if rates fall?
I'm sure the list could go longer, right? Some of these are policy-oriented questions, but still ...

For those reading comments to PK's post, without knowing the array of mortgage market products (I certainly do not), here are some jargon qualifiers:

5/1 ARM, 7/1 ARM, 10/1 ARM - these refer to mortgages that are fixed at an initial rate, for a period of 5, 7, or 10 years, and then reset every year after that. These are sometimes called "hybrid arms". They are to be compared with ARMs that do not have the initial fixed rate, but just re-set periodically from the outset. [I believe, but i'm not certain at all, that there were also ARM mortgages, at one time, in which there was a low initial rate, either floating or fixed, and then you moved into a fixed rate for the remainder of the term.]

ARM 5/2/5 - refers to the limits on how the interest payment reset is done. "First, subsequent, life" is the memory aid: how much the first re-set is limited to, how much each subsequent re-set is limited to, and how much all cumulative re-sets (up or down) are limited to.

IO - loans can be "fully amortizing" or "interest only" (IO)

CMT - is constant maturity treasury (most popular is 1- year maturity for ARMs).
MTA - is not anything related to a transit authority. It is "monthly treasury average" rate. It's just a month average of the CMT values, not a new maturity/duration. As an average, it smooths out the month-to-month volatility.

The last/current 1-yr MTA is 2.256% (although most mortgage contracts round to the nearest 1/8th or something at re-set).

The current 1-yr CMT is 0.96% [!!!].

On the other hand, the 1-yr ARMs rates for new mortgages are surveyed at over 5% and 5/1 ARMs higher still. It looks like 1-yrs bottomed out at 4% when Greenspan took policy rates as low as they are today.

Friday, November 21, 2008

Chart of the Day

So, Tim, how are you at insurance? (Do we dare to ask Paulson & Co.?)

I mean, you can "TARP" Citi if you need to, but, in the words of MetLife, "Who's gonna pay for this mess?" (and it *must* be attended to, maybe even this weekend):

The Hartford Group and Lincoln Life, 5-days of gruesome giddy-up

Chart of yester-jour was AMBAC, up 86%:

Ambac Assurance Corp, Ambac's main unit, paid $1 billion to get out of four contracts it had written to guarantee collateralized debt obligations, reducing the bond insurer's liabilities. It said the terminations would allow it to reduce reserves set aside for market losses on these guarantees. - Reuters

...but today, the "ratings agencies", where everyday is a new day, slammed 'em:

S&P downgraded the senior debt of Ambac Financial (ABK) to BBB from A. It also cut Ambac Assurance Corp., the bond insurance subsidiary, to A from AA. The outlook is negative.-SmartMoney

Real Rates and Future Growth

Using the Fed series for corporate rates, less y/y CPI (not necessarily the best, but the easiest), I have a somewhat different picture than PK has for real rates.

In fact, it is sufficiently different that one can question the read that these levels are due to a factoring in of a collapse of the system. Rather, they look a lot more like the "Greenspan conundrum" has been canceled, and the US is, back to where it used to be, in terms of having to price up for capital? On the other hand, the spread has never been wider, from BAA to AAA, which suggests a high degree of risk aversion and that the rates we are seeing are a consistent with a view of who will survive a collapse or a gross estimate / mis-estimate of what the price of credit should look like in advance of the sharpest downturn, possibly, since the data series was collected.

Chart1. Estimated real rates thru 11/19/08., US Corporate Sector (spread shown on RHS axis)

Here is a look at what has happened this year, so one can judge the timing of the rate rise and how much might be attributable to changes in measured inflation not reflected in a fall in nominal rates... (n.b. measured inflation, not inflation expectations, as PK calculated)

Chart 2. Corporate real rates in 2008, with CPI. Spread of BAA to AAA graphed on right axis.
I'll update with the expectational variables, if I have the time...

Citibank Redux - A Speculative Attack?

Is Citigroup under "speculative attack"?

"Discuss amongst yourselves."

There is a fairly strong prima facie case.

  • -I don't have an in-depth balance sheet comparison, but their own b/s doesn't seem much worse than others, including JPM.
  • -Plugging another "market-driven" 20% haircut to their portfolio, or parts of their portfolio, seems pretty radical.
  • -An "instantaneous" haircut seems panicy, a little ahead of the facts. Defaults on CRE are running in the low single digits (last a looked, which was a while now). Do we believe that operators are so weak financially that two quarters of negative growth are going to drive a fifth of them to bankruptcy, or will that stress build up over a longer time, maybe a year or more.

Thursday, November 20, 2008

Whoring the FHA?

A must read on the next victim of the mortgage-broker wolfpack (via Atrios).

Tranche 'em!

It looks like Citibank is ready for its next TARP infusion.

Meanwhile, Hank "Menace to the Markets" Paulson is hop-scotching in Simi Valley, giving a lecture that, in places, seems to border on a psychotic episode (I have to agree with Cramer about that).

He said, once, he was looking to invest alongside private capital.

Well, he could have seized the day to suggest that Prince Al-Waleed bin Talal's investment was "encouraging" and
"might suggest a way that TARP money can be allocated in the future". The mere suggestion could boost the immediate impact of that investment.

Instead, he misses the opportunity of the day, so that he can what? Lecture to the Reagan faithful about regulation?

Hold to Maturity - Okay for CMBS

It's hard to see why a CMBS portfolio, held for maturity, couldn't be off of mark-to-market.

I'm not sure it will matter, much, for the stock prices, but it will take pressure off the urgency/immediacy surrounding "bank failure", by redefining that term to include an, er... longer-term perspective, right?

Markets flirt with worst-case probabilities

Credit spreads currently present a new "conundrum", the word Greenspan once used for an interest rate poser in another context.

Paul Krugman illustrates the latest market conundrum
People may misinterpret these rates as a 'credit crunch'. That might be a mistake, in the sense that these rates may not be best interpreted in terms of ordinary supply/demand of funds.

What may be driving rates, rather than volumes, is the ongoing assessment of the worst-case economic probabilities.

To me, these markets look like they are pricing in what we might call "event risk". Credit risk doesn't seem to be trading off fundamentals, like historical default probabilities for highly rated debt, even peak probabilities for an economic downturn. Instead, these prices appear to be discounting the likelihood of financial system collapse leading to an economic collapse OR a business failure in the real economy (like GM?) that may induce cascades or feedback into the financial system in ways not easily observed ex ante.

The additional premium for that risk may be wrongly interpreted as a "credit crunch" - even if a persistent and prevailing uncertainty may end up causing a genuine one, paradoxically.

It may seem like a trivial point, but it helps in getting a tight analytical framework. We aren't fighting an "ordinary" credit crunch. It looks like we are still principally fighting the risks of the bottom falling out, right? Of course, the truth is some complex combination of the two.

From FT Alphaville, pricing "Armageddon":

European credit spreads were lurching back towards “Armageddon levels” on Wednesday, flirting with their all time highs as speculation mounted over a bail-out for US carmakers. The Markit iTraxx Europe index of investment grade corporate debt widened 12.9 basis points to 175bp, up from a Tuesday closing price of 162bp. The iTraxx Crossover widened by 27.8bp to 899.46, teetering on the brink of the symbolically important 900bp mark last crossed in the fallout after Lehman Brothers collapsed.

Jobs Slipping


Labor shedding, widespread. The South is participating, noticeably.

CA's large number looks (to me) like a fluke in this week's read (these big numbers often get reversed in subsequent release).

Wednesday, November 19, 2008

Quote for the Day

From the WSJ MarketBeaters blog, on the strangeness of just what 75% VIXy means/implies(!):

...some people have been taking positions in the likes of put options on the S&P at 750. These are expiring at the end of the week and they’re trading at about $3, says William Lefkowitz, chief options strategist at vFinance Investments. A goofy bet like this would normally cost the buyer a nickel, because it’s so preposterous. Not anymore.

Among the culprits in today's selloff:
  • -Paulson's walk-away
  • -A couple of defaults (waiting for confirmation) inside CMBS, spreading a new round of panic over of asset quality among the banks
  • -A political uncertainty-tsunami coming from Washington, who are heckling over ... the kinds of details that will be rounding errors if the big picture is ... "lost".
  • -A weak CPI

Diagnosing Freddie and Fannie


We know that Freddie and Fannie dropped their market share (h/t Krugman) at the time when the worst vintage loans were being originated. Because of Fannie's fancy-accounting penalties and because they did not participate in a lot of the "affordability products" dreamt up, they were not the drivers of the worst excesses of the markets.

Well, despite consistently applied loan standards, it looks like their economic model for underwriting was not designed with the notion that a housing price bubble could develop. Their formula appears to have been tied to house prices, rather than to "economic fundamentals".
If they certainly didn't create "the bubble", they did get pushed around by it, based on my first look at the figures.

Why did they, if it wasn't some exceptionally bad credit underwriting standards (the bulk of their credit losses appear to be in one part of the portfolio)? Well, despite consistently applied loan standards, it looks like their economic model for underwriting was not designed with the notion that a housing price bubble could develop and that could be a factor. Their formula appears to have been tied to house prices, rather than to "economic fundamentals".


FHFA/OFHEO, their regulator, sets a "conforming loan limit", among a number of other conforming characteristics. This is key to segmenting the market, for policy purposes, I'd suppose. Now, this limit periodically gets adjusted. How? It looks like it is roughly tied to the OFHEO house price index, with various degrees of lags and discretion.

Of course, all lending does not take place at the limit, so to speak. However, the average loan amount, the new business for a given year, tracks that year's loan limit pretty closely. The two are in a ratio of near 2, for the priod over which I can get data.

Chart 1. The progression of Fannie's conforming loan limit and the average loan size, shown as a ratio (green line). In 2006, the limit was raised to $417,000.

How closely did the limit progression track home price rises, during the go-go days? It lags. They were not being super aggressive. Had they followed the price index lock-step, the conforming limit would have risen faster. In fact, before the big step-up in 2006, to $417K, the limit was over $45,804 below where it might have been, if it had been raised lock-step since 1991 with home price increase. $45K is a material 'undershoot'. Today, with a fall in home prices and the emergency measures to raise the cap even more, the difference between the actual and implied has been wiped out and the limit is actually above where it would be under a lock-step price-formula only.

Chart 2: Green line tracks how much home prices are rising faster than the conforming loan limit is rising. Red line tracks cumulative dollar impact implied by the difference.
What if they had used an "economic underwriting formula", one that was based on economy-wide fundamentals, like median or average household income? makes a case that it is not to difficult to "fix it", so that today's problems are less likely to recur, and the mission of the two GSE's is not cast aside, unthinkingly.
Well, for one thing, they would have cut themselves out of the marketplace, even more. That may seem trivial, but it's an important consideration, when you think of organization re-deisgn. In a bubble regime, one is intentionally, slowly withdrawing "liquidity", which is something that may be counter-intuitive to an organization whose mandate has always been to provide liquidity.

The two charts below show that there was stability in the ratios of the conforming loan limit to either mean or average income, until the mid 2000s, when it rose sharply.

These charts are, of course, bad news, now that we know the outcome of the rise in home prices and how badly this Administration has been in dealing with the aftermath, especially foreclosure mitigation efforts. Between 2001 and 2007, the average Fannie loan size rose 45%, but average household income rose only 16% (by Census Bureau estimates).

it makes a case that it is not to difficult to "fix it", so that today's problems are less likely to recur, and the mission of the two GSE's is not cast aside, unthinkingly.

Charts 3 & 4: Census data on average and median household income related to OFHEO's conforming loan limit (the conforming loan limit tracks average loan size, i.e. the actual values done by the GSEs, fairly closely). No adjustments are made for changes in such financial variables as inflation or general real-estate affordability factors.

Fanning the Flames - GOP's Scorched Earth Ideology


They are all out in the past week, bashing the implied government guarantee on trillions of dollars of outstanding agency debt.

George "Little Hoover" Bush at Federal Hall. Paulson yesterday at CEO summit. Elizabeth Dole, lame duck, at today's hearing.

I ... it's so ... astoundingly irresponsible, in the current environment.

They must hate America.

Brad Setser spells out just one of many risk layouts. At a minimum, they hate America's homeowners.

Tuesday, November 18, 2008

Paulson's Failures, Vol I, Chapter 11

He had time to direct his people to run around and hire money managers and so forth, but according to today's testimony, he's still studying the issue of preventing foreclosures, more than a year after it became consensus that maybe 2 million families were at risk this year alone...

It's not just families at risk. Check it out:

The performance of private label mortgage backed securities that were sliced and diced and sold to investors is just the opposite of Fannie Mae’s and Freddie Mac’s. Private label securities represent less than 20% of the mortgages but 60% of the serious delinquencies. As the regulator of the housing GSEs that own over a quarter of a trillion dollars of private label securities, I ask the private label MBS servicers and investors to rapidly adopt this program as the industry standard. Not only will this streamlined program assist borrowers, but broad acceptance and effective implementation could stabilize communities and property values.

James B. Lockhart, III, Bush Appointee, OFEHO, introducing a new "voluntary program", November 11th

Facing Congressional Flame Throwing, Bernanke a Little Too Quiet?


He has yet to say that a bail-in or bail-out or a "bridge" for GM (or "autos") may be a step in buying time for his monetary policy to work, to 'work through the system'.

To the extent that real economic activity and credit creation (default on a credit report) is being affected by foreclosures, some of which may be "prevented" at the margin (maybe up to 75%, based on IndyMac figures), he hasn't offered an opinion of how that relates to his view of monetary policy, in the short term. (He could use the words "urgent" and "necessary", without stepping outside his lane, right? Greenspan used to cajole and remind legislators of their responsibilities, using all kinds of suasion.)

The conscious step to give the Treasury key responsibility for tough decisions, like who fails and who succeeds, is obvious and understandable. But ... there is more to the big picture than just the necessary liquidity programs, yes?

No Deflation at Producer Level


It's an amazing economy, right?

Be careful betting against the U.S. economy, eh?


Maybe we'll see the end of this meme, today, too. Hewlett Packard appears to have done a good job balancing things ...


There will be no 'liquidity trap' with a whopping yield curve like this, perhaps even steeper by today's end:

[yc via bloomberg]

Monday, November 17, 2008

See a Penny, Pick it Up and Other Fallacies


If you see a free dollar in a competitive market, do you pick it up or do you say to yourself, "This is too good to be true, there must be a catch"?

Have a look at Mankiw's chart-grab du jour.

According to this chart, unexplained as it is, you'd expect that the UAW would have no trouble organizing workers in foreign manufacturer's plants (God knows, they've tried). What employee wouldn't want very nearly to double their income, their hourly wage?

Since we know that unionization is not spreading quite like that, do you swallow this chart, or ask, "Hey, this can't be true" or "there must be more to the story"?

If you dig into the data, you find out that the author of this chart is intentionally comparing a fully loaded cost with one that isn't (and based on an estimate by Daimler). The comparable wage rate appears to be $47.50 for 2006...

Can I pick on Greg Mankiw for this? He is a well established and deservedly respected economist, who is known for his acumen and thoroughness (that I admire), both of which will endure a pundit on this mini-blog, right?

So here is a query, that I've had in the back of my mind:

When he wrote his letter to POTUS, he advised the new President to keep his economic advisers close, that no one party has "a monopoly" on the truth.

What does that mean, more precisely? Does that mean that Dr. Mankiw believes that he is wrong, 'doesn't have the truth', half the time? I doubt it.

Does it mean that economists use statistics to make "lies of omission", like this chart above, sans explanation? I don't know.

I hope he just means that economists are sometimes prone to offering one side of the story, for the best of motives, so that there is a positive value to having economists with alternative viewpoints "work a problem". But, then, there is this chart above ... hummm.

Town Haul With Citibank

How did their loan loss reserves get so low? This chart looks like the definition of "FICO madness". Was it all current loss experience, or did somebody decide that the appropriate level of reserves was not much more than what was allowed to count toward Tier 2 capital?

Note to self: credit cards, even at 15% average rate, are not sunflowers that grow to the sky.

Just-in-time loss reservering:

What ever is inside "other loans" and "investments"? Leveraged private equity stuff", commercial real-estate? Synthetic CDOs? (Most of the "Goodwill" is disallowed when calculating capital adequacy).

They have about $100Billion in Tier1 capital and $25 billion in loan reserves, against these assets and all their off balance-sheet exposures. Is it enough? Off hand, it looks too hard to say. It does look unlikely that, on their own, credit cards and RMBS, marked down, would be sufficient to 'break the bank', right?

Something about their jobs cuts and the amount of targeted savings doesn't seem to square, but others know the company better than I do...

I'm so glad that, during a downturn, they can achieve 8% core capital, on the backs of job cuts, with a full guarantee of their debt, and a giant spinnaker-like TARP-sail running with the winds. What is wrong with this picture? More:

We distributed $2.1 billion in dividends to shareholders during the quarter. On October 20, 2008, as previously announced, the Company [the Board of Directors] decreased the quarterly dividend on its common stock to $0.16 per share [about $3.4 billion at an annual rate...]

For the die-hards who are targeting certain people on Citi's board, it's not clear which business lines actually "deserve" job cuts. Are they going to close retail branch offices? Cut dealmakers? The knee-jerk demand to make cuts seems ... reckless. You need some kind of model of what the core business requires. Without it, one would look on knee-jerk job cuts unfavorably, as a costly prescription without a diagnosis...

Thursday, November 13, 2008

Soros: Commerial Paper was proximate cause / transition mechanism

... of inter-bank freeze. In his testimony, he doesn't address other linkages (derivatives, etc.), sweeping them into 'uncertainty' and parts not central to his basic thesis or description of the contagion.

A large money market fund that had invested in commercial paper issued by Lehman Brothers "broke the buck," i.e., its asset value fell below the dollar amount deposited, breaking an implicit promise that deposits in such funds are totally safe and liquid. This started a run on money market funds and the funds stopped buying commercial paper. Since they were the largest buyers, the commercial paper market ceased to function. The issuers of commercial paper were forced to draw down their credit lines, bringing interbank lending to a standstill. Credit spreads-i.e., the risk premium over and above the riskless rate of interest-widened to unprecedented levels and eventually the stock market was also overwhelmed by panic. All this happened in the space of a week.

Lo pegs 'uncertainty' to transparency, indicating that lack of understanding of why Lehman (and others) failed may have contributed to paralyzing uncertainty.'s a lot of reading to do. More later.

Bashing Fannie As a Diversion

Everyone is guilty of it, Left and Right, but when you hear the cause of a problem long before you hear the data, you can bet that something is being shoveled your way.

This happened when we heard how much the Community Reinvestment Act (CRA) was 'the cause', right? Turned out that data was crap. Same for how dangerous it would be if the FDIC limit were not raised to $250,000. Turned out that was crap, too.

Now we hear how bad Freddie and Fannie were, even from the mouth of the President. *sigh*

These two did not participate in the "affordability" products that were dreamt up by the private sector in the first half of the 2000s:

Washington Post
Staff Writer
Thursday, May 12, 2005; Page E04

Mortgage financing giant Fannie Mae said yesterday that its share of the mortgage-related securities market dropped from 45 percent in 2003 to 29 percent in 2004 because of the growing popularity of adjustable-rate mortgages, according to a filing with the Securities and Exchange Commission.

Although business at Fannie appears to have been robust, it would be a stretch characterize their numbers as "go-go growth" or "unfettered". In fact, before Greenspan couldn't have been bothered to regulate using federal authority, Fannie had laid down underwriting guidelines that just said "no" to a lot of the most ridiculous provisions that brokers were dreaming up to help them sell, sell, sell.

Today, the two could be 80% of the market. Yes, the truth is, if it weren't for them keeping lending, we'd have a far, far worse problem on our hands.

Academics "shine": The Lessons of LTCM, revisited

An "act of God"?

Financial crises may be an unavoidable aspect of modern capitalism, a consequence of the interactions between hardwired human behavior and the unfettered ability to innovate, compete, and evolve.

-MIT Professor, Andrew Lo. (rest is worth the read)
The quote is a little unfair, he went on to talk about limiting those risks in important ways. Still there are other gems, like government should subsidize geekiness/greekiness (we need to subsidize people who rush out to make, maybe, $220K on Wall Street in their first year?):

"In the same way that government grants currently support the majority of Ph.D. programs in science and engineering, new funding should be allocated to major universities to greatly expand degree programs in financial technology."
The good guys in the zero-sum game of trading:

Based upon my research on the activities of hedge funds, there are three important findings I would like to share with the Committee. First, hedge funds did not cause the financial crisis and are in fact helping to mitigate its damage and save taxpayers money. This may seem surprising, but in fact hedge funds have historically made markets more stable [!!!] and helped their investors conserve wealth in times of economic stress. Second, hedge funds’ short-selling activities have helped draw attention to the poor management and investment decisions of financial companies in recent years. Indeed, when hedge funds short-sell the stocks of unhealthy companies, they help to divert capital from companies that are fundamentally unstable. This not only prevents stock market bubbles from becoming much worse, but it helps to ensure that companies that make sound decisions are rewarded and are able to provide stable jobs for their employees. Finally, existing laws and regulations should be strictly enforced against hedge funds and their managers, but changing how hedge funds are regulated could actually undermine the interests of investors and increase economic instability.

-Houman Shadab
, Senior Research Fellow, Mercatus Center, George Mason University

Of course there were those reported strategies of gaming the (partly) market-driven models that the ratings agencies had adopted...

Synthetic CDOs ... Again

Moody’s raising its expectations (again) that corporate default rates will rise, i.e. higher corporate defaults and even further pressures on CDSs and synthetic CDOs - FT Alphaville

Why, oh, why, oh, why-o, doesn't someone - anyone - get out, stand-up, and force an unwind of the synthetic CDOs? Is it really impossible? Can it not be done, for some reason?

Otherwise, how can we just sit around and ... and wait? For a sword to fall.

Seriously. Can you think of anything more ... intentionally self-destructive?

Joblessness In America

The weekly claims are out.

Scanning the reports for the past four or five weeks, there are signs that California and Florida may be bottoming a tad, just as the "rust belt" is ramping up big time. Michigan and Ohio (and Pennsylvania) have been hit hard, at the margin, in the past weeks. Autos and manufacturing.

A Taxpayer Friendly GM "Solution"

This is rather mercenary, but ...

Notice that the non-pension post-retirement benefits of $33 billion equate to $55/share?

If the UAW and "The Government" can come to an understanding, that's a whole LOT of bargaining power.

So much that you could buy out the existing stock holders (just $2 billion), pay off the debholders at market prices, whip this puppy through bankruptcy, maybe, to get out from dealer contracts and the onerous aspects of Cerberus agreement, and still turn a very significant cash profit, in the short-term.

GM, In Their Own Words

So many have stopped listening, long ago, perhaps, but that doesn't mean it isn't still important.

I've pulled some stuff from their 2007 Annual Report, to outline what the company thinks is going on. The details on the VEBA cash funding ... well, it appears that is down the road, truly (as of this writing). At least, it's doesn't look as though it was pre-funded in 2007 or that they are doing more than accrual for it, presently. At least in the current period, the UAW has agreed to them deferring $1.7B of interim cash payments to the VEBA.

Still, you get the general direction, and maybe some inklings on how to assess their own assessment.

Among noteworthy items:

  • They are formally committed, via settlement with the UAW, to helping with health care reform ideas.
  • At the end of the year (2007), the pension obligation was over-funded. Not sure how that stands, currently.
  • They finally suspended dividends to common in July, 2008...[no comment]

The Bush Administration was ... AWOL in 2005 on issues of national health care.

Long - very long - snippet after the jump.

p. 73

Accelerate Cost Reductions and Quality Improvements.

Since the November 2005 announcement of our strategy to reduce structural costs in the manufacturing area, we have introduced a variety of initiatives to accomplish that strategy. In 2007, we achieved our announced target of reducing certain annual structural costs primarily related to labor, pension and other post retirement costs in GMNA and Corporate and other by $9 billion, on average, less than those costs in 2005. This improvement is due largely to the success of attrition programs which reduced the number of our hourly employees by 34,400, the effect of the resulting pension remeasurement, as well as a number of other items including the 2005 Health Care Settlement Agreement with the UAW, reductions in pensions for salaried employees and caps on healthcare costs for salaried retirees. In 2008, we have implemented an additional voluntary special attrition program, for which all 74,000 UAW-represented employees are eligible to participate, including 46,000 employees who are currently eligible for retirement. We continue to focus on our long-term goal of reducing our global automotive structural costs of revenues as a percentage of 2005 revenues to less than 25% by 2010. For 2007, global automotive structural costs were less than 30% of revenue. We believe that the new collective bargaining agreement entered into in October 2007 (2007 National Agreement) provides additional cost reduction opportunities, particularly in the areas of healthcare costs and savings from the implementation of the Tier II wage structure and, accordingly, have revised our previously announced target for further reductions in structural costs as a percent of revenues from 25% in 2010 to 23% by 2012.

...Looking forward, we expect that commodity pricing pressures will remain flat or improve modestly. We also expect to reduce a substantial portion of the cost premiums we have historically paid to Delphi for systems and components over the next three to five years....
... We have seen significant improvements in both warranty and other quality related costs over the past several years, which have enabled the implementation of the extended powertrain warranty. ...

Vehicle quality demonstrates continued improvements in 2007. Our recent vehicle launches are performing at record warranty levels, and our Buick and Cadillac brands were first and third, respectively, in the most recent JD Power Vehicle Dependability Study. We have also experienced an 89% decrease in the number of vehicles included in safety and non-compliance recall campaigns since 2005. In 2008, we will maintain our focus on improving our vehicle quality.

Address Health Care/Legacy Cost Burden.

Addressing the legacy cost burden of health care for employees and retirees in the United States is one of the critical challenges we face. For the past three years we have worked with the UAW and our other U.S. labor unions to find solutions to this challenge. In October 2005, we announced the 2005 UAW Health Care Settlement Agreement, which modified postretirement healthcare benefits for UAW active employees, retirees and their eligible dependents to require monthly contributions, deductibles and co-pay obligations for the first time. In October 2007, we signed a Memorandum of Understanding — Post-Retirement Medical Care (Retiree MOU) with the UAW, now superseded by the Settlement Agreement currently pending for court approval (Settlement Agreement). The Settlement Agreement executed in connection with the 2007 National Agreement will incorporate and supersede the 2005 UAW Health Care Settlement Agreement when it is implemented on the later of January 1, 2010 or the date when all appeals or challenges to court approval of the Settlement Agreement have been exhausted (Implementation Date).

We began recognizing benefits from the 2005 UAW Health Care Settlement Agreement during the three months ended September 30, 2006. The remeasurement of the U.S. hourly OPEB plans as of March 31, 2006 generated a $1.3 billion in OPEB expense and $14.5 billion reduction in the OPEB obligation, including the Mitigation Plan as described in Note 15 to our consolidated financial statements. In April 2006, we reached a tentative agreement with the International Union of Electrical Workers Communications Workers of America (IUE-CWA) to reduce healthcare costs that is similar to the 2005 UAW Health Care Settlement Agreement. This agreement was ratified by the IUE-CWA membership in April 2006 and received court approval in November 2006. The IUE-CWA healthcare agreement reduced our 2007 OPEB expense by $.1 billion and OPEB obligation by $.5 billion. The IUE-CWA collective bargaining agreement expired in the fourth quarter of 2007, and we anticipate that our new collective bargaining agreement with the IUE-CWA will include arrangements similar to those contemplated by the Settlement Agreement.

We also increased our U.S. salaried workforce’s participation in the cost of healthcare. In January 2007 we established a cap on our contributions to salaried retiree healthcare at the level of our 2006 expenditures. In the future, when average costs exceed established limits, we will make additional plan changes that affect cost-sharing features of program coverage, effective with the start of the following calendar year. Program changes may include, but are not limited to, higher monthly contributions, deductibles, coinsurance, out-of-pocket maximums and prescription drug payments. We have also reduced the levels of coverage for corporate-paid life insurance for salaried retirees.

The 2007 National Agreement provides for a permanent shift in responsibility for retiree healthcare liabilities of $47 billion to a new benefit plan to be established and funded by the New VEBA, promptly after the Implementation Date. We believe that our initiatives in this area will reduce our U.S. healthcare related cash payments to $2 billion per year, beginning in 2010, reduced from $4.6 billion in 2007.

We will continue to work with our employees, healthcare providers and the U.S. government to find solutions to the critical issues posed by the rising cost of healthcare. The Settlement Agreement provides that we will publicly support federal policies to improve the quality and affordability of healthcare and work cooperatively with the UAW toward that goal. We have agreed with the UAW to form a National Institute for Health Care Reform, which will conduct research and analyze the current medical delivery system in the United States, develop targeted and broad-based reform proposals to improve the quality, affordability and accountability of the system and educate the public, policymakers and others about how these reforms could address the deficiencies of the current system. Our initiatives to reduce healthcare costs during 2007 also included using the global purchasing process to identify more cost-effective suppliers and auditing the eligibility of plan participants as well as working with the UAW and other vehicle manufacturers to support a variety of federal legislation that would reduce employer healthcare costs.

From the 10-Q

In our 2007 10-K, we reported minimum commitments under contractual obligations, which included obligations under our then current contractual labor agreements in North America. Before the Settlement Agreement could become effective, the Settlement Agreement was subject to the exhaustion of any appeals of the July 31, 2008 approval by the United States District Court for the Eastern District of Michigan and the completion of discussions between us and the staff of the SEC regarding the accounting treatment for the transactions contemplated by the Settlement Agreement on a basis we believed to be reasonably satisfactory. The Settlement Agreement became effective in September 2008.

The following table summarizes the decreases, by period, in our contractual obligations as a result of the Settlement Agreement:




2013 and after


(Dollars in millions)

Postretirement benefits (a)(b)

$ 3,338

$ 6,802

$ 4,814


$ 14,954
Less: VEBA assets (a)

(3,338 )

(6,802 )

(4,814 )

(14,954 )

Net postretirement benefits

Net increases due to finalization of the Settlement Agreement







$ 7,590

$ 12,015

$ 19,605

Remaining balance postretirement benefits (a)

$ 728

$ 1,772

$ 5,248

$ 41,311

$ 49,059
Less: VEBA assets (a)

(728 )

(621 )

(1,349 )





Net increases (decreases) due to finalization of the Settlement Agreement


(246 )

(3,636 )

(29,286 )

(33,003 )


$ 165

$ 905

$ 1,612

$ 12,025

$ 14,707

As reported in our 2007 10-K prior to the finalization of the Settlement Agreement.
Amounts include postretirement benefits under the current contractual labor agreements in North America. The remainder of the estimated liability for benefits beyond the current labor agreement and for essentially all salaried employees, is classified under remaining balance of postretirement benefits. These obligations are not contractual.


On July 15, 2008, we announced new planning assumptions based on a U.S. total vehicle market of 14.3 million units in 2008 and 2009, which was at or below industry analysts’ consensus, and a U.S. market share of 21% in those years. Accordingly, we undertook a number of initiatives aimed at conserving or generating approximately $15.0 billion of cash on an incremental basis through the end of 2009. These initiatives included approximately $10 billion of operating actions that are substantially within our control, including structural cost reductions, reducing capital spending, improving working capital, reaching agreement to defer approximately $1.7 billion of scheduled payments to the UAW VEBA, and eliminating the dividend paid on our common stock. Further information about these actions follows:

Salaried employment savings (estimated $1.5 billion effect) — We are executing salaried headcount reductions in the U.S. and Canada through normal attrition, early retirements, mutual separation programs and other tools. In September 2008, we extended voluntary early retirement offers under our Salaried Retirement Window Program (Salaried Window Program) to certain of our U.S. salaried employees. Employees accepting the Salaried Retirement Window Program were required to do so no later than October 24, 2008, with the majority of retirements taking place on November 1, 2008. As of October 31, 2008, 3,460 employees had irrevocably accepted the Salaried Retirement Window Program, which was in excess of the 3,000 needed to achieve our financial target. In addition, health care coverage for U.S. salaried retirees over 65 has been eliminated, effective January 1, 2009. Furthermore, there will be no new base compensation increases for U.S. and Canadian salaried employees for the remainder of 2008 and 2009. We are also eliminating discretionary cash bonuses for the executive group in 2008.

GMNA structural cost reductions (estimated $2.5 billion effect) — Significant progress has been made towards achieving GMNA’s structural cost reduction target. We have accelerated cessation of production at two assembly facilities in addition to shift and line-rate reductions at other facilities. Truck capacity is expected to be reduced by 300,000 vehicles by the end of 2009. Promotional and advertising spending is being reduced by 25% and 20%, respectively, and engineering spending is being curtailed as well. In addition, we are implementing significant reductions in discretionary spending (e.g., travel, non-core information technology projects and consulting services).

Capital expenditure reductions (estimated $1.5 billion effect) — The major components of this reduction are related to a delay in the next generation large pick-up truck and sport utility vehicle programs, as well as V-8 engine development. There will also be reductions in non-product capital spending. These reductions will be partially offset by increases in powertrain spending related to alternative propulsion, small displacement engines and fuel economy technologies.

Working capital improvements (estimated $2.0 billion effect) — Actions are being taken to improve working capital by approximately $1.5 billion in North America and $0.5 billion in Europe by December 31, 2009, primarily by reducing raw material, work-in-progress and finished goods inventory levels as well as implementing lean inventory practices at parts warehouses. All these initiatives are on track for completion prior to December 31, 2009.

UAW VEBA payment deferrals (estimated $1.7 billion effect) — Approximately $1.7 billion of payments that had been scheduled to be made to a temporary asset account in 2008 and 2009 for the establishment of the New VEBA has been deferred until 2010. The outstanding payable resulting from this deferral will accrue interest at 9% per annum. The UAW and Class Counsel have agreed that this deferral will not constitute a change in or breach of the Settlement Agreement. Within 20 business days of the Implementation Date, approximately $7.0 billion of deferred payments, plus interest plus additional contractual amounts will be due to the New VEBA.

The remaining $5 billion of our July liquidity plan included $2 billion to $4 billion of planned asset sales and $2 billion to $3 billion of fundraising in capital markets. We believed that these actions, together with the availability of $4.5 billion under our secured credit line, would provide sufficient liquidity for the balance of 2008 and 2009 as well. The status of these previously-announced activities as of November 7, 2008, is as follows:

Asset sales — We are exploring the sale of the HUMMER business, Strasbourg transmission plant and the AC Delco business. We expect to shortly commence providing offering materials to potential buyers for the HUMMER and AC Delco businesses pursuant to appropriate confidentiality agreements and have already commenced providing confidential offering materials for the Strasbourg transmission plant to interested parties. We are also in the process of monetizing idle or excess real estate and several individual transactions are in various stages of execution.

Capital market activities — Our plan targeted at least $2.0 billion to $3.0 billion of financing during 2008 and 2009. However, due to the prevailing global economic conditions and our current financial condition and near-term outlook, we currently do not have access to the capital markets on acceptable terms. In the three months ended September 30, 2008, we executed $0.5 billion of debt-for-equity exchanges of our Series D convertible bonds due in June 2009. In addition, we have gross unencumbered assets of over $20 billion, which could support a secured debt offering, or multiple offerings, in excess of the initially targeted $2.0 billion to $3.0 billion, if market conditions recover. These assets include stock of foreign subsidiaries, brands, our investment in GMAC and real estate.


which combined with previous initiatives announced on July 15, 2008, would conserve or generate cash of up to $20.0 billion. These additional actions include:

Salaried employment savings (estimated $0.5 billion effect) — Additional salaried employment savings will be achieved through incremental workforce reductions in U.S. and Canada, including involuntary separation initiatives. In addition, we have announced the suspension of our matching contribution to certain defined contribution plans starting November 1, 2008 as well as suspension of other reimbursement programs for U.S. and Canadian salaried employees. We also expect to realize salaried employment savings in Western Europe in 2009 through a wage/salary freeze and other cost reduction initiatives.

Additional GMNA structural cost reductions (estimated $1.5 billion effect) — We expect to reduce GMNA structural cost by an additional $1.5 billion in 2009. These additional reductions would result from the recently announced acceleration of previously planned capacity actions and other plant operating plan changes, additional efficiencies in engineering resources aligned with further product plan changes, continued marketing spending reductions aligned with expected automotive industry conditions and intensified focus on discretionary spending reductions.

Additional working capital reductions (estimated $0.5 billion effect) — GMNA is targeting approximately $0.5 billion of additional working capital reductions beyond the original 2008 target reduction level of $1.5 billion. This additional target reduction is expected to be achieved by continuing to focus on inventory reductions and initiatives related to accounts payable.

Additional capital expenditure reductions (estimated $2.5 billion effect) — In the absence of federal funding support, 2009 capital spending will be reduced from the revised target of $7.2 billion announced on July 15 to $4.8 billion. This reduction will be achieved primarily through deferrals of selected programs (e.g., the Cadillac CTS coupe and the next generation Chevy Aveo for the global market) and related capacity reduction projects. However, we are still planning to increase global spending for fuel economy improvements, and spending related to the Chevy Volt will continue. Beyond 2009, capital expenditures will stabilize in the $6.5 billion to $7.0 billion range (excluding China, which is self funded with our joint venture partner).
These actions are intended to conserve or generate cash of up to $20.0 billion in response to deterioration in the global economy, particularly the automotive industry, so that we can preserve adequate liquidity throughout the period from September 30, 2008 to December 31, 2009. However, the full effect of many of these actions will not be realized until later in 2009, even if they are successfully implemented. We are committed to exploring all of the initiatives discussed above because there is no assurance that industry or capital markets conditions will improve within that time frame. Our ability to continue as a going concern is substantially dependent on the successful execution of many of the actions referred to above, on the timeline contemplated by our plans.