Monday, September 29, 2008

Thumbs Down on Rescue Legislation

Over the weekend congressional leaders and the White House had reported agreement on a plan involving a $700 bailout of Wall Street, proposed as a public need to keep the general economy afloat. I don't buy it, the people I've been speaking to who aren't bloggers don't buy it either, their general mood is one of anger about it, and 228 house members thought similarly enough that they turned down this initial draft of the bill. I feared that a bill where taxpayers reimburse the recent losses of the financial industry would be rubber stamped, which I am pleased has proven untrue. Naturally, this isn't over yet.

Another $630 Billion Injection from the Fed

One day I'm going to have to sit down and add it all up, but by the running tally, I have around $400 billion of cash injections so far by the Fed into the banking system, in the form of TAFs, PL... and TD..Fs...whatever alphabet soup they list it under. Today it looks like $630 can be added to whatever there was before.

There have been news reports of the LIBOR spread (London Inter-Bank Office Rate) rising, with is the market rate banks lend to one another for short term loans. Historically it is better form for banks to borrow from other banks rather than borrow from the Fed. Usually the LIBOR follows closely the Federal Funds Rate, but now it is taking off indicating banks are cash hoarding and distrustful of the creditworthiness of their fellows. Todays action is intended to unfreeze banks and keep credit liquidity flowing. Like previous bailout instruments from the Fed, it is basically releasing $630 billion in short-term cycling bonds where treasuries are exchanged for securitized debt.

This article gives some figures. Starting with this post of mine from July, we have: TAFs in 21-day cycles at $75 billion; TAFs in 84-day cycles of $25 billion; TLSFs in 28-day cycles of $200 billion; and PDCFs in overnight cycles of around $40 billion. Now, today, adding to that is an expansion of TAFs to $75 Billion in 84-day cycles; and $330 billion to foreign central banks (terms were unspecified in the article, but it's a cash swap of dollars for foreign currency). Pulling out the calculator I get $720 Billion; plus there would have been a pre-existing line of credit to foreign central banks of $290 before today, which totals $1010 billion the Fed has in short term bonds to boost liquidity in U.S. ($390 billion) and foreign ($620 billion) markets.

Please excuse any omissions or calculation errors; the exact details matter less than the point that over a trillion dollars exists in the system, backed by U.S. taxpayers, to keep the domestic and world credit economy on life support.

ADDENDUM [10/6/08]: I don't know how the AP article gets $225 billion for 84-day TAFs. It's $75 billion, and numbers were recalculated accordingly. Calculations will continue to be refined as data filters through the press.

The Death Parade of Giants

Wachovia's turn. Citigroup has just announced it will be cherry picking Wachovia's banking division. I doubt anybody is going to touch the rest of it. We see here again the FDIC's new business model: seize a bank, hand the assets over to a more solvent bank practically for free ($2.2 billion; a pitance considering the value of the retail outlets and deposits), and then declare bankruptcy on what is left. Previous regulatory efforts screwed shareholders but protected bond holders. These latest actions give both the shaft. Depositors are protected, even those with more than $100,000 in an account. WaMu held the record of being the largest bank failure in U.S. history for all of four days. Almost certainly Wachovia will dwarf that.

This marks the second collapse of a bank where I had deposits. My thinking was, the bigger they were, the more likely a bailout, and the earlier this happens in the process, the more systemic capacitance there will be to rescue deposits.

ADDENDUM [10/3/08]: It appears bond holders weren't left to rot, not totally, anyway. As part of the deal the FDIC had agreed to absorb up to $42 billion in bad loans. Today it is up in the air as to whether Citigroup will be acquiring Wachovia with is arrangement, or that Wells Fargo will arrange a private buyout, where bad debt would be shifted over instead to the congressional bailout plan that may be passed later today.

CORRECTION [10/15/08]: So, I guess the word is that Wachovia was not technically a bank failure; but rather was bought out by Wells Fargo (and the tax base who will be covering Wachovia's toxic debt). So, Washington Mutual retains the crown as the largest bank failure to date.

Thursday, September 25, 2008

Uh Oh....

This uptick on the base money supply is worrisome and if not a random artifact of the financial turmoil and indicative of a trend it could spell concerns for the value of the dollar. It will be followed here. That said, there are so many deflationary events in play that an expansion of the base money supply was to be expected and will not necessarily mean the dollar is about to tank.

Goodbye WaMu, I Hardly Knew Ye

When JP Morgan acquired Bear Stearns with $44 billion in federal backing, that is what broke the camels back: truth be told that was the spark that started this blog. I hope to squeeze in a retrospective on Bear Stearns one day.

Today, federal regulators seized Washington Mutual and handed operations over to JP Morgan for a firesale $1.9 billion, with an agreement that JP Morgan would raise another $8 billion through stock sales. Reportedly, this marks the biggest bank failure in U.S history (though I don't know about the "stunning twist" remark).

I feel safe now about my little money market fund in WaMu; it's been taken over by a power hitter even among the financial giants.

ADDENDUM [9/27/08]: So... it doesn't look like WaMu was exactly bought out by JP Morgan. It was seized by the FDIC, its assets were handed over to JPM, and now it is filing for bankruptcy such that its debt will be defaulted on.

Tuesday, September 23, 2008

Goldman Sachs, Morgan Stanley Accepting Deposits

Goldman Sachs (GS) and Morgan Stanley (MS) have shifted from pure investment banking, and now seek traditional deposits. In a sense it is news as this marks an end to investment banking on Wall Street. This article suggests they will be buying deposits from banks taken over by the FDIC.

Saturday, September 20, 2008

Mortgage Bailout Bill, Part 2

A more expansive bailout proposal than the last one is making its way through congress, and will no doubt be signed in to law. The key feature is that is authorizes the Treasury to buy up to $700 billion in toxic mortgage securities. Now the prior bailout bill had two major parts to it; one was a mortgage rescue proposal that assisted conversion of adjustable loans to fixed rate at the current price of the house minus 10%; and the other part authorized the conservatorship of Fannie Mae and Freddie Mac such that the Treasury Department could purchase unlimited mortgage securities with T-Bills. If one good thing can be said of this bill it limits such purchases—to $700 billion dollars. At least there is a price on it. But I'm sure that will be expanded as necessary.

This current bill dispenses with any pretense of helping the American citizenry and is squarely a bailout of the banks. The only justification made is to expect really really scary things to happen if it doesn't pass. This is all congruent with my prediction earlier that the shape of the banking bailout would be the Treasury department exchanging T-Bills for problematic mortgage securities. If banks can chuck mortgages so easily one wonders how motivated they will be to participate in the rescue part of the first bill.

Anyway, this bill isn't passed yet so discussion of the details will wait until then.

Friday, September 19, 2008

Thank You For Not Shorting

Okay, it was kind of funny when the SEC put restrictions on "naked" shorting for a few select financial institutions, but now it looks like they are trying to put an end to nearly all shorting of the finance industry to maintain a government mandated artificial elevation of asset prices—and this is just getting annoying. Today, Wall Street has become a fine example of a socialist economy.

ADDENDUM [10/1/08]: The ban on shorting was extended today by the SEC until October 17.

UPDATE [1/4/09]: In a nice validation, Cox, chairman of the SEC, expressed regrets over the shorting policy, and admits that on reviewing the data it had unintented consequences. Faced with similar circumstances he says he would not be inclined to repeat the action again.

UPDATE [3/26/09]: Recently, limits have been placed on shorting on down ticks, but you can still short on up ticks. Oh brother!

I'm Getting a Bailout

For probably similar reasons that people bungee jump and eat puffer fish, through all of this I've been keeping a money market account at Washington Mutual. It's a small fraction of the savings I have, but the amount is not trivial either. The branch is right down the street from me, so I went there asking for an FDIC-insured CD, but they pushed a money market on me instead—showing me CD rates that were close to a half a percent and a money market rate closer to 3%. Suspicious, I querried about the possibility of losing money but they insisted everything was insured and it was no different than a CD, and could pull out my money whenever I wanted. So I bit. It's been working out fine, except one time after making a deposit two or three weeks ago the teller machine refused to let me make a withdrawal.

Without an exhaustive bailout everybody knows Washington Mutual is teetering on a seizure by the FDIC, which doesn't worry me particularly. I figure a bank going down sooner in this mess is better than one going down later. Still, without the sudden and rather unexpected passage today by congress of a $50 billion "backstop" for institutional money market funds, I'm wondering if I might have lost some money in all this.

Thursday, September 18, 2008

Bush Saves the Day

After feeling a stone's throw—a long one—from almost being mainstream this morning, President Bush comes out and says he will use my tax dollars to keep asset prices excessively high and, in the case of home ownership, out of reach of new buyers, unless I want to take out a toxic loan where the banking industry benefits from the high interest payment I would be forced to endure, not to mention high taxes for state coffers, and the banks will expect a bailout if I run out of money in all this. Put briefly, I feel entirely disconnected from the societal consensus and contrarian harmony has been restored.

I'd be distressed if I weren't convinced he is just speaking irrelevant gibberish that is neither here nor there in terms of the inevitable price corrections and return to economic equlibrium. The Feds injections of liquidity is just a temporary bandaid which, like all credit, will have no effect on money supply if viewed over the full course of the loan. If they really want to keep prices elevated they are going to have to print.

But the market seemed reassured by Bush's speech and abruptly shot up by 400 points, erasing yesterdays losses.

The Contrarian's Fear

From the Fed: "The Federal Open Market Committee has authorized a $180 billion expansion of its temporary reciprocal currency arrangements (swap lines). This increased capacity will be available to provide dollar funding for both term and overnight liquidity operations by the other central banks." By my math, the amount of dollars that was available by the Fed for short term loans to banks and investment banks was around $300 billion through TAFs, TSLFs, and PDCFs. Now, with this, it sounds like close to half a trillion is available to the financial industry through cycling short term bonds originated by the Fed.

This is a response to the turmoil in the wake of Lehman's Bankruptcy and AIGs de facto conservatorship by the Fed, with the DJIA dropping 500 points on Monday and 400 Wednesday, with a modest gain on Tuesday—plunging it well into 10,000 territory for the first time in years. Treasury bonds and gold rallied, such that investors are now taking three-month treasuries with interest payments approaching 0%. This is a highly defensive position. Dollars are in high demand. Institutions are running to treasuries, gold, and cash. The TAF expansion is a response to a scarcity of dollars. Banks worldwide are holding on to dollars and reluctant to lend to one another.

Which raises that uneasy tingle in the back of any contrarians mind when the sheeple start to agree with him, and the position he holds shows signs of becoming mainstream. Lately, the U.S. dollar has been strong against all investment classes: assets, securities, and commodities, and even the Euro. Dollars are a hot item.

Wednesday, September 17, 2008

Another One Bites the Dust!

Okay, here's the deal: your house is burning down. While that is happening, your fire insurance company is teetering on the edge of bankruptcy. If that were to happen, you might be tempted to call your congressman to get a little government assistance to the insurance company—you know, for the "public good"—at least until your business with them is settled.

The same thing is happening with AIG, except that the banks are you, the house burning down is widespread defaulting on mortgage securities, and AIG is the bond insurer of the securities the banks are holding. As the bonds fold (issued through Lehman for example), the banks want their reimbursement.

So the Fed puts $85 billion of taxpayer-funded treasury bills on the line to underwrite AIG, to make sure these swaps are covered. AIG cedes its control to the Fed, who now has a 79.9% stake in the company, and will sell off its performing assets... pretty much the rest of its insurance business, to cover this "bridge" loan. So the plan goes. Almost certainly, stock in the company as of the opening bell is worthless.

Some perfunctory motions were made to have private industry cover the AIG bailout, but there were no serious takers. The Treasury Department briefly pondered another conservatorship, but Fannie Mae and Freddie Mac required Congress to enact, which was easily piggy-backed on the mortgage rescue bill. For AIG this would take time, which it doesn't sound like it had. So the Fed was left holding the bag—or more specifically, taxpayers were.

My earlier prediction that the conservatorship of Fannie Mae and Freddie Mac was sufficient to cover the bailout fell squarely on its rear end less than a week later. You win some, you lose some. Time was when $85 billion was a lot of money. Now it's just pocket change casually thrown around at bankers whimsies.

ADDENDUM [10/8/08]: AIG takes that bailout money... and parties! Days after the bailout, AIG execs celebrated with a $443,343.71 "conference" at the St. Regis Resort in Dana Point, CA. They are planning another little gathering for their brokers in Half Moon Bay this weekend. [10/15/08]: Oh my goodness gracious they just won't stop!

Tuesday, September 16, 2008

Fed 2% Pause Continues

The FOMC kept overnight rates at 2% today. The Fed has previously suggested its anticipation that they would hold at 2% throughout this year and slowly increase starting next year. Given recent market turmoil, general expectations shifted toward the possibility of a cut. I wouldn't have been surprised if they had cut, and if current deflationary trends continue I anticipate they will cut, but for once we see a hint of backbone against the interests of Wall Street. Here's my thinking: those who are going to be saved—i.e. the major banks—are already in the lifeboat. Those not part of the old boys network will be left to drown, starting with Lehman. AIG remains to be seen.

AIG Woes

The latest Wall Street firm to be headlining the financial news is American International Group (AIG), the largest insurance firm in America that is involved with life insurance and credit default swaps, as well as car insurance that I've been hearing about on the radio (they will come out and change a flat tire for me), and generally a broad range of insurance products. Their stock value (AIG) has followed almost exactly the pattern of Fannie Mae and Freddie Mac, plateauing at just over $60 a share until late 2007, then a steady decline since to around $3 today. As usual, they have given us the song and dance about being "well capitalized" while scrambling for cash—to the tune of asking the Federal Reserve for a $75 billion loan.

Personally I cannot get excited about the downfall of an insurance company; they are the embodiment of the risk aversion seemingly inherent to American culture, if not human nature, that ultimately leads to the expectation that higher powers will fix everything that goes wrong. However, if AIG goes down, their involvement in credit default swap market will likely have diffuse implications in the ongoing financial turmoil.

Monday, September 15, 2008

DJIA Reaction to Lehman Bankruptcy

Today the Dow Jones fell 504 points, and this time it has a clear precipitant—the bankruptcy of Lehman Brothers, the 4th largest investment broker, one that heavily bought in to mortgage securities, and has become the largest bankruptcy in history. The issue is broader than that. For the first time credit default swaps are being triggered, and soon the whole patency of the default swap market (in other words, bond insurance) will be tested. Also, for the first time, some magic wand hasn't been waved to get the bond holders in a financial corporation out of hot water, so swap counterparties are finally on the hook. Apparently Lehman wasn't quite well-connected enough, and a giant has been allowed to die.

A Brief Thought on Oil

A year ago, it seemed like any drop of a hat near any oil refinery was enough to cause oil prices to soar—rumors of the possibility of a workers strike, maintenance necessary for one of the plants—any excuse seemed good enough to drive prices skyward. Today, a hurricane slams in to the Galveston coast, and prices are still falling. At this point I'm convinced that refinery circumstances are unrelated to the oil spike, and hardly need to be considered an actual factor in oil pricing. It was probably a commodity run that has exhausted its course. Not that I'm expecting $1.50 gasoline prices again—growing worldwide demand and decreasing expandability of production are contributing. Where this all equilibrates remains to be seen.

Sunday, September 14, 2008

Lehman & Merrill Weekend Roundup

The news over the weekend is there was no government bailout for Lehman Brothers, nor was there any private buyout either, after Bank of America and Barclays walked away from the table. So they will be filling for bankruptcy and liquidated.

Since Lehman’s debt does not equal its assets, credit default swaps will be triggered, which I do not recall happening so far in this credit unwind, since failed financial firms have been bailed out or bought out with government backing up to this point. Credit default swaps (of which CDOs are included in the class, discussed in this post) are debt insurance funded by private investors—in this case on Lehman’s bonds. So if Lehman goes bankrupt, their bond holders can be reimbursed for losses by private counterparties, according to prior arrangement.

Merrill Lynch fared better. The brokerage will be bought out by Bank of America for $44 billion.

Friday, September 12, 2008

Distress at Lehman

One firm that may be closer to collapse than even Washington Mutual is Lehman Brothers. For the past few days there has been news of imminent collapse without a bailout or takeover due to capitalization problems from mortgage-related loses. Now, if the Treasury Department via Fannie Mae or Freddie Mac is willing to exchange their mortgage securities for T-Bills, then cries of desperation around Lehman Brothers may be overstated, and they might be a good buy at the right price.

Thursday, September 11, 2008

The Shape of the Bailout

Through smoke and fumes, this week we see the outline of the monster that is the mortgage bailout. While measures that exist as of now are not enough to keep housing prices stable or rescue the economy from the deflationary spiral it is in, there is enough at the point to accomplish the fundamental goal of the regulatory effort: that is, saving the banks.

With the conservatorship of Fannie May and Freddie Mac, the Treasury Department will continue to underwrite their traditional economic functions. The federal government will buy troubled mortgages from banks, I imagine at near face value, floating Treasury Bonds as needed to pay for them—such that the Treasury Department holds the mortgage stinkers, bought for with bonds that will be paid off by the taxpayer over time. Banks now have the opportunity to become re-capitalized from recent losses and dump toxic mortgage securities all at once. There is no limit on securities the Treasury Department can buy. I wonder if there are any restrictions at all as to the quality of the loans.

An interesting test of the bailout will be Washington Mutual. All evidence is that they are about to fold. Their bond rating has been cut to junk today. But if in the next week WaMu can dump toxic mortgages on to the treasury department in exchange for T-bills, and survive, then if they can turn around, most likely any bank can. It may still be too late for them. The coming days will tell.

So, does this rescue the economy? It only helps banks that I can see. Congress has given distressed mortgage holders a break, that the Treasury Department will honor, but they will still owe a premium on the properties they bought, that will still consume much of the American consumers' disposable income with high interest and principle payments—that even after the rescue will still be disproportionate to comparable rents.

The only way to stave of the deflationary recession that comes from a credit unwind is to make up for the monetary deficit by printing cash. If the Treasury Department wants to actually stabilize prices, printing is what it will have to do. Hyperinflation would be the consequence. For reasons stated before, that is not what I think they will do. But I would not fully rule out the possibility, and you shouldn’t either if a lot of your money is sitting in the bank. Further bailout policies and any expansion of the base money supply will be reported here as they occur.

Monday, September 8, 2008

Fannie and Freddie Shares Under $1

So, as predicted, this is pretty much it for private ownership of the two mortgage GSEs. Last I looked, both Fannie Mae (FNM) and Freddie Mac (FRE) were trading around a dollar per share each. This is bad news if you bought at Fannies peak at a little over $60 before fall of 2007, or even last Friday at $7/share; or at Freddies Peak of over $60 throughout most of 2007, and $5 as of last Friday. Though the decline from $60 to under $10 per share was due to market activity, and ironically was even slowed down when interventionist measures were passed by congress—this final drop was due to conservatorship of the GSEs by the Treasury Department on Sunday.

This continues a pattern of government intervention first seen with Bear Stearns of rescuing bondholders with desregard to shareholders. I suppose it could be argued that shares were about to bottom out anyway so Treasury actions simply expedited the inevitable, however there was still market play to be had even in the sub-$10 range.

ADDENDUM [9/9/08]: As of tomorrow, Fannie and Freddie will be removed from the S&P 500 index.

Sunday, September 7, 2008

Fannie and Freddie Under Federal Conservatorship

In a move anticipated over the last few days, but made official this Sunday morning, in the next major advance in the bailout saga of the financial industry, the Treasury Department has taken over Fannie Mae and Freddie Mac. Basically, the GSEs have lost their capital base through purchasing bad mortgages from banks, and are unable to acquire new capital through the sales of stock. They will continue to repay bonds with income acquired by repayments of the mortgages they service. When that income fails, which essentially it has, any deficit of bonds repayments will be backed through taxpayer money. Worse, Fannie Mae and Freddie Mac will continue to take on Mortgage Backed Securities from struggling banks through 2009. This move appears to allow banks to hand bad mortgages over to the treasury department for at least the next year.

In essence, the banks are being protected from their exhaustive malinvestments over the past 6 years that will cripple the general economy for many more years to come. Clearly, banks have no reason to fear making unwise loans because they can anticipate a taxpayer bailout every time.

Fannie and Freddie are the sacrificial lambs. They are going down such that the rest of the banking industry can live. They are taking it for the team. I think it is fair to say they will not be able to operate with any sort of private underwriting for a long, long time. As always there is political speak about this action preserving the “American Dream” and keeping the American economy strong, but this is unrelated to either of those two goals. It is squarely intended to keep the banking industry afloat.

In the end, this action merely delays a deflationary recession where prices of assets and commodities fall to affordable levels; that outcome is still going to happen, only a little more slowly now. Taxpayer bailouts only slow down the present economic correction in exchange for putting debt that our children will have to pay in to the pockets of the banking industry today.

More will be posted as details unfold.