Bush this morning ...:
(circa) "...these steps have been carefully planned."
Carefully planned? Sounds like something someone blurted out, after raising their hand ...
WHY DID PAULSON DO IT? 'WE CAN BE HEROES'
Here's the Paulson conundrum.
If The System is really in trouble - I mean seriously in trouble, like avoiding Great Depression II, then giving $20 billion to mega banks and $10 billion to investment banks is ... peanuts.
If the system needs only a little capital or no capital at all, having worked through the problems-to-date already, then Paulson looks like a hero.
Update: Paulson confirms - "we are giving money only to healthy banks". (it's embarrassing for him, without explnation).
Tuesday, October 14, 2008
We Can Be Heros
Why did Paulson do it?
Why would JP Morgan Chase need more capital?
They just raised $10 billion, $2 billion more than they said they would, in the most choppy and difficult markets in decades, a week ago or so.
No wonder their shares were ... down in today's up trading day. They just got "involuntarily injected".
Does he think the market will not eventually see through this cloak-and-dagger routine and wonder why $10 billion more is enough for Morgan Stanley and Goldman, presently, but the $11 billion equity raise that Lehman did months before their downfall was ... not enough.
I'll bet Citigroup is pissed that they didn't try to bid more, now that the taxpayers are subsidizing BOA's purchase of Wachovia (with an "extra" $5 billion "injection").
WE SHOULD HAVE KNOWN
This is what happens when you hire investment bankers. They do deals.
NEXT WEEK'S HEADLINES
What would you do if someone forced you to take capital?
I'd buy back either high-yielding debt or common shares*.
Or, I'd write down the worst of my assets, like my commercial real-estate portfolio, my buyout loans ...
I'd hang onto my sub-prime junk. Why? I might get to sell it to Paulson's Cash-and-Carry guy for an above-market price.
To be charitable, maybe there is something we don't know. Maybe they need the money, so they can comply we conservative accounting principles for assets? ... this is still the Bush Administration. Would you put a high probability on that?
*Update: Under the terms of the deal, this is restricted, unless you pay back the government first.
Monday, October 13, 2008
TARP goes to WARP speed, to avoid scrutiny
YIPPEE! DUE TO UNQUANTIFIED, ASSERTED 'SYSTEMIC RISK', YOU NOW OWN SHARES IN FAILING BANKS
Instead of owning real-estate, by buying up defaulted mortgages, we're going to own banks and ... all the bank managements that we've come do love, over these days.
I love my AIG. Those guys have got it going on!
ORWELLIAN DOUBLE-SPEAK FROM BUSH ADMINISTRATION
It even lands on the front pages of the New York Times.
Savor this. Dividends "don't count", because they are not ... paid out of earnings.
The goal is to inject massive liquidity into the banking system. The government will purchase perpetual preferred shares in all the largest U.S. banking companies. The shares will not be dilutive to current shareholders, a concern to banking chief executives, because perpetual preferred stock holders are paid a dividend, not a portion of earnings.
HUMOR IN UNIFORM
It it too soon to start calling Paulson's go-to guy "Cash-and-Carry"?
15 Men on a Dead Man's Chest - $1 Billion in Legal Fees!
"...ho, ho, ho and a bottle of rum."
AmLaw Daily reports that, according to court documents made public Wednesday, the firm received a $5 million advance in September for work leading up to the bank’s bankruptcy filing. ...
But that $5 mil could be peanuts. AmLaw Daily notes that UCLA law prof Lynn LoPucki, estimates advisory and legal fees could come to $906 million, according to Bloomberg reports.
-law blog
HOLDING NOSE
We are a service economy. Full service economy (@ $950/hr).
Statement 133
It appears that the wizard-accounts have been working quietly, as always, to shine light where it is much needed, at least for investors.
Regulators need their own approach.
Policy makers still need to think of the larger issues and consider how to make changes, without scaring the hell out of this sensitive part of the market.
July 6, 2008
The accounting board proposal would cover sellers of CDSs, the entities that act as insurers. They would have to disclose such details as the nature and term of the credit derivative, the reason it was entered into and the current status of its payment and performance risk.
In addition, the seller would provide the amount of future payments it might be required to make, the fair value of the derivative and whether there are provisions that would allow the seller to recover money or assets from third parties to pay for the insurance coverage it has written.
They are also after clearing up the "mini banks", also know as qualified special purpose entities (QSPEs or "Q's"), that got set-up off balance sheet, even in the post-Enron era.
If you have written a credit derivative to support something such a vehicle, that would seem to lessen the likelihood that the vehicle would "qualify". It does appear that there is too much "recourse", right?
A $100 billion margin collateral call?
That seems way too high, but I'll post this as a marker of the steps in the AIG collapse.
From David Paul:
In simple terms, AIG's collapse came as a result of the following sequence of events:
- 1. In the wake of the decline in real estate prices, the market value of mortgage-backed securities declined.
- 2. Under accounting rules that were established after the downfall of Enron -- implemented to require rapid disclosure of investment losses -- AIG marked down the value of its mortgage-backed securities portfolio.
- 3. These investment losses resulted in a reduction of AIG's capital reserves -- the core measure of its financial strength.
- 4. As a result of the decline in AIG's capital reserves, Standard & Poor's and Moody's Investors Service downgraded AIG from triple-A to the single-A level.
- 5. These rating downgrades to the single-A level triggered collateralization requirements under AIG's CDS contracts.
- 6. The amount of the collateral that AIG had to produce under its estimated $450 billion of CDS contracts approximated $100 billion.
And AIG did not have $100 billion in available funds.
Other accounts suggest that "the mortgage portfolio" really was a collection of CDS written on mortgage-related securities.
Exchanges, Settlement Systems Functioned Amazingly
We should take a minute to appreciate just how far market structure has come.
All of the exchanges and settlement systems have coped with volatility and price "crashes", without any reported disasters.
Even ISDA handled its biggest...um... credit-event, default, price-fixing auction, ever. It was a little messy, but it wasn't an unmitigated disaster or anything.
Long time ago, the market used to have to "close" in order for the back office to catch up.
Look around the world, things are pretty good, too. Only a few markets had to shut down.
Paging ISDA, New Estimate Please
Now seems as good a time as any for ISDA to show how much progress has been made in the past nine months.
One major dealer down and a zillion little initiatives to help quantify and manage the outstanding risks means it's ... update time.
We have some justification to expect a revised estimate, please.
FWIW, I think the ISDA estimate is ... a far better one than simply applying a default rate to a notional. If they have good data, then one could go so far as to say that their estimate is also ... trustworthy.
Please Pass the Panic - Elephants Holding Tails
OUR GLOBAL RISK AVERSION ROUNDTABLE
If the musings on this page are correct, then the progression of panic has gone as follows:
1, THE END OF "CREDIT PROTECTION", AS YOU KNEW IT
- -Credit protection holders "panic" as Fuld's Lehman zips its fly, for the last time, closing shop because of a lot of reasons, but mainly because of worries about mortgage-backed asset quality (possibly), commercial real-estate loans (notably), and collateral calls that could not be met (reportedly), but not margin calls (reportedly).
There is a market-wide rush to unwind credit protection and to sell some underlying bond holdings, pushing up credit spreads (to be confirmed). Other market participants must engage in significant balance-sheet repositioning/selling, to continue to meet policy requirements (including pending accounting rule changes), causing the cash markets for bills, notes, and bonds to gyrate, too, further spooking the derivatives holders as volatility rises.
Fearing the optics of looking like they were "too risky" and the redemptions it can cause, some bond mutual funds and some money market funds ... dash for "quality", further pushing up credit spreads (size to be confirmed). Anyone with credit inventory not accounted for as held-to-maturity ... has to take a mark-to-market "hit" to income. Those who only look at "hits" as indicators, get spooked. Amplified short-sellers (a.k.a. hedge funds) ... get motivated.
2. I'M JUST A COUNTRY DOCTOR EQUITY GUY
- -Interpreting this rush to liquidity as a "credit crunch", leading economists wing flap, appropriately. A few ominous economic numbers come in, and suddenly the equity market needs to discount a profits recession that is not mild. Some economists, equity investors, and reporters focus on "confirming evidence", rather than "dis-confirming evidence", in the form of "hits", "rumors", and other temporarily adverse ... happenings.
A few big banks need to get sopped up - that becomes a negative, in the worry environment, instead of a positive. Equity investors rush for the door. Some economists use that to project further declines in spending. Worries mount that money-center banks and others have lost their balance sheet capacity to lend.
Last, the Pandora's box opens. People write openly about long-term problems coming home to roost, like a precipitous fall in the dollar and an end of the Treasury's issuance capacity. "Solutions" get more stridently declared and ... wildly conceived.
3. REGULATORS PANIC - THE GOLDEN HINDE
- -Regulators start to throw more money than Xerxes ever had at the problem:
Central banks in another coordinated effort have agreed to provide unlimited amounts of dollars (against the appropriate collateral) to the markets. This is via the Swiss National Bank, the Bank of England and the ECB. Thank you to reader Milton Arbogast who mentioned that in a comment on a previous post.
- No one seems to have a handle on the "root causes" of the panic, or even worry about quantifying them or tasking expert testimony to fully understand them. Everything gets swepted up into varagies like "tsunami", "sub-prime", and various symptoms, like, "run-on-the-bank". The solution? A catch-all, a tarp.
Risky backstops get thrown up in the interbank market, on the presupposition, without much evidence, that banks are worried about settlement risks (?) or counterparty credit risks (?), that have hobbled inter-bank dealing.
The Fed dis-intermediates the banks, to some degree, during their time of peril, and agrees to buy Commerical Paper (i.e. make unsecured loans to the non-financial sector), keeping another leg of the crisis from developing, centered on large consumer-finance firms like GECC and GMAC and their adjunct manufacturers.
Not to be outdone, lawmakers pass out more insurance, even as the storm comes in, providing deposit insurance for millionaires (up to $250,000 per institution per depositor).
As a crowning achievement, the Treasury Secretary gets authority to buy anything at any price, as a "plan" to "stabilize" markets. His go-to guy rushes, with Goldman speed, to hire money managers, lawyers, and set-up clearing arrangements for the U.S. Treasury to become a heavy hitter in the financial markets, at the behest of the Treasury Secretary, drowning out the experts who think that is ... "rubbish-squared".
IF ONLY ... OCCAM'S RAZOR
If only they had done a Brady plan for RMBS (residential mortgage-backed securities), none of the above events would have had to occur.
Ideology ... led everyone to rely on the "HOPE NOW ALLIANCE" instead.
The lessons from this crisis *may* turn out to be all political, rather than economic: to the extent that a set of crisis events is unique, it is not possible, inside a democracy, to take preventive medicine. A crisis needs the catastrophe, before ideologies are cast aside enough to get a fix done. Unfortunately, by then, the cost of the fix is almost invariably magnitudes larger than the preventive once of cure.
Put another way, things do not multiply, without necessity. Organisms adapt, they don't anticipation.
Correctly Valuing the Paulson Put
WE ALL WEAR SHORT-SHORTS
Suppose you have credit default protection supplied by Morgan Stanley. That means that you are exposed to Morgan Stanley, as issuer, in addition to the target of the protection (say a GM bond that you've own).
You might want to buy protection on Morgan Stanley, but no one is selling it, except at ridiculous prices. So, you ... short the stock, instead, if you are really worried, and the price to borrow stock hasn't already gone through the roof. (I guess you'd have to be "really" worried, because there may be some collateral involved for your CDS already, to reassure).
Clearly, if there are a lot of people closing-out / selling their protection back to their dealers and selling the bonds they are worried the most about, would you think that swap spreads and high yield spreads would rise to unheard of levels? Uh, yeah.
...if this kind of a credit-swap, worry-induced run-for-liquidity is occurring, it will peter out presto, when every seller is satisfied, and, in the meantime, the dealers could make a *huge* sum in trading profits.
Either that, or your worry may induce you to seek an immediate 'unwind' of the MS's swap, and possibly to sell out of your bond, if you are still worried about having it insured (your recession expectations rising faster than others, etc.). Clearly, if there are a lot of people closing-out / selling their protection back to their dealers and selling the bonds they are worried the most about, would you think that swap spreads and high yield spreads would rise to unheard of levels? Uh, yeah. One step further: if this kind of a credit-swap induced run-for-liquidity is occurring, it will peter out, when everyone is satisfied and dealers are no longer worried about getting slammed. In the meantime, the dealers could make a *huge* sum in trading profits....if this kind of a credit-swap, worry-induced run-for-liquidity is occurring, it will peter out presto, when every seller is satisfied, and, in the meantime, the dealers could make a *huge* sum in trading profits.
EQUITY GOES BI-NARY
Of course, the Paulson put means that Morgan will not fail, but he might let common shareholders get massively diluted (like AIG?).
Suddenly, your investment is either worth a lot, lot more or worth zero, i.e. either it is worth $20, say, or it is worth $0.
Of course, if the government is willing to make injections without penalizing common holders, the the stock looks like a screaming buy, if you find evidence that there are a lot of nervous default protection buyers with a short interest.
More on what happens when your CP becomes TP
Earlier.
Now I spy this, from Lew Rockwell (of all sources):
One possible answer is that there were a number of overextended industrial or retail companies that could not issue paper. The market for low-rated paper has always been very thin. A downgrade on commercial paper essentially puts the company out of the market. The Fed may have wanted to save some weak big-name companies, being fearful that a bankruptcy at this time of GM or GE or Ford would be a bad thing. - Rockwell
A GM Bankruptcy - NO WAY
DURING SOME CRISIS, WEAKNESS IS A STRENGTH
As you may recall, poor Citibank had to keep lending to Donald Trump, when he ... got "overextended" in the early 1990s. There are plenty of other stories, too. Citibank had to keep lending to Brazil (and other parts of Latin America) in the 1980s, or face creating even worse troubles itself.
For now, we have to keep lending to GM, I would *guess*.
For one, the market would not take kindly to a massive unwinding of all the financial paper out there, I would *guess* (a lot depends on how that paper is set-up).
WALKING THE TALK
What's acute is that Paulson had backstopped money-market "deposits". That means a GM failure during the period could mean a draw on the Treasury. Maybe it is not that big, but it could be several billions, maybe tens of billions (but not hundreds) of dollars.
Is it known widely how many credit default swaps GMAC has written, if any. It's not disclosed in any financial statements (that I know), even if they have otherwise. (Ditto for GE capital).
Knowing what you don't know - Lehman CDS
WHO PROTECTS THE PROTECTORS?
"We" now know a lot about those settling Credit Default Swap protection on Lehman brothers.
We also know that the buyer of default protection assumes exposure to *both* the (a) issuer of the protection and (b) the target of the protection.
What we do not know, and what I have not seen published, is what the impact of the Lehman failure was on those who owned derivative "protection" that Lehman sold.
I'm not sure if those swap contracts show up in a bankruptcy filing, or, if they do, whether it is at a sufficient level of detail to develop an analytical perspective.
WHAT SHOULD ISDA DO?
Now, for the people who had default contract on (not by) Lehman, ISDA provides a fancy auction process, complete with superior netting of trades and determination of net open interest, so that settlement is ... highly manageable.
But what about those others, those who had protection from Lehman, who suddenly find themselves scrambling, in one way or another, because they are "unprotected"?
I'll leave that as an open question, pending further research.
Depending on the amount of the protection relied on, losing your hedge or your rating-enhancement can be a significant dislocation.
Update, from the Lehman filing, 19 September:
Derivative Contracts
The Registrant and its affiliates are parties to a large number of swaps, options, forwards and other derivative contracts with a variety of counterparties. These derivatives are governed by approximately 7,000 master agreements. The filing of the Voluntary Petition constituted an event of default and automatic early termination under certain of these master agreements and, in other instances, constituted an event of default allowing the applicable counterparties to terminate the agreements. The accelerated obligations under these agreements are expected to be material, but the Registrant is unable to specify their amount at this time.
The Face of TARP
"I'M FROM THE GOVERNMENT AND I'M HERE TO HELP YOU" - Cue 'em Up, October 13, 2008
What's that old saying that there is no problem too complex that it cannot be made worse?
Now we have to listen to Paulson's go-to-guy trumpeting how the government is quickly contracting with law firms, asset managers, and ... otherwise setting itself up as a mega financial manager.
Were your eye's rolling back in your head?
Truly, we are very near the point at which the Bush Treasury should ... stop talking.
A BRADY-PLAN FOR RMBS
I have just one, two sentences that would accomplish more, more quickly:
"I can announce today that the government will begin to offer terms to lenders on defaulted mortgages, of the sub-prime and alt-a category, and those terms will share, probably 50/50, in home price declines, where negative equity exists. All of this activity will exist within the framework of existing law."
Two, three more, and I've got just about the whole thing:
"For now, we are encouraging the Fed to continue to expand its use of special facilities, on a temporary basis, so that firms can manage their liquidity across a spectrum of asset classes and, thereby, meet short-term calls for collateral and the like.
While the banking system, including the finance-arms of companies that drive consumer credit availability, adjusts until it is fully repaired, we will engage in a certain amount of making sure that financing is available to the business sector, by providing capital relief, in a variety of forms*, that allow asset qualities to be conservatively accounted for, until investor confidence is restored.
G7 finance ministers are working with central banks to reduce and neutralize many off balance-sheet exposures, efficiently and quickly, so that the system is no longer burdened by these uncertainties and systemic risk factors are not magnified, in the current environment, by instruments outside the control of regulators."
While the banking system, including the finance-arms of companies that drive consumer credit availability, adjusts until it is fully repaired, we will engage in a certain amount of making sure that financing is available to the business sector, by providing capital relief, in a variety of forms*, that allow asset qualities to be conservatively accounted for, until investor confidence is restored.
G7 finance ministers are working with central banks to reduce and neutralize many off balance-sheet exposures, efficiently and quickly, so that the system is no longer burdened by these uncertainties and systemic risk factors are not magnified, in the current environment, by instruments outside the control of regulators."
*there are various forms of capital requirement relief. off hand, there is the obvious capital-injection. There is also the possibility of lower regulatory capital requirements (cf Japan, 1990s). Last, there is consolidation, in which some investors lose their capital so that others can offer a 'stronger hand' behind risky assets management.
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