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| To: Davy Crockett who wrote (8099) | 8/10/2007 1:06:25 AM | | From: John Pitera | 1 Recommendation of 13611 | | my pleasure -- RANDALL W. FORSYTH keeping his astute eye on the situation today in Barron's
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Even After $1 Trillion Goes Poof, It Ain't Over
NO, THAT WASN'T THE BIG ONE. Not even close.
Even though the Dow Jones Industrial Average plunged nearly 400 points Thursday amid a deepening liquidity crisis, the Great Unwind of the global credit pyramid still has further to go.
The European Central Bank took the unprecedented step of injecting nearly €100 billion or $130 billion into the European money markets after BNP Paribas halted withdrawals from three investment funds because their assets -- of which more than one-third are related to subprime mortgages -- were impossible to value in the nonfunctioning secondary market. A week ago, the big French bank's chief executive asserted its exposure to U.S. subprime "is absolutely negligible."
The Federal Reserve also injected $24 billion into the U.S. banking system via repurchase agreements, a hefty but not unprecedented liquidity provision. The actions by the ECB and the Fed came in response to a sharp rise in the cost of overnight money amid a scramble for cash. In the U.S., the federal funds rate rose to close to 5½%, well above the Fed's 5 1/4% target rate. But the amid the crisis, the fed-funds futures market placed 88% probability of a quarter-point Fed rate cut next month, up from 20% odds on Wednesday.
The real story behind this money-market mumbo-jumbo is that there's a 21st century version of a run on the bank, and the central banks have had to step in to do their prime duty of supplying liquidity when the market won't.
The effects of the rolling subprime debacle, which has circled the globe, have come home to roost. Based on the DJ Wilshire index, the U.S. stock market has shed $1 trillion in value since its peak on July 13. So far this year, this broadest measure of the U.S. equity market is up 2.5%, as is the Standard & Poor's 500, far less than the 6.5% year-to-date gain in the Dow cited by the bulls.
But it isn't over.
"A mini Minsky moment" is how UBS senior economic adviser George Magnus describes Thursday's markets. That reference is to the late economist Hyman Minsky, who theorized that financial markets were inherently unstable, swinging from excesses of fear and greed, resulting in the business cycle. Indeed, strong economies will tend to breed overconfidence among lenders and borrowers, leading to excesses and their inevitable correction.
"It's another episode along the path," Magnus describes Thursday's market upheavals. "It's not the episode that has you reaching for tin helmets."
For now, he ticks off three things that are staving off a debacle.
Default rates are relatively low and "the denouement can take a long time," he observes. In housing, while subprime and alt-A borrowers are going bust, the prime sector hasn't seen a significant deterioration in delinquencies.
But, he adds, the full weight of resets on adjustable-rate mortgages have yet to been felt. From the beginning of 2007 through the middle of 2008, over $1 trillion ARMs will reset, many from low "teaser" rates. Then the extent of the declines in home prices and the financial fallout will be apparent, Magnus observes.
For now, he continues, corporate balance sheets in aggregate are in good shape even as highly leveraged companies remain vulnerable. Moreover, the global financial system remains awash in liquidity. And the global economy is humming, Magnus further points out.
Nevertheless, the lack of transparency for the new esoteric instruments, such as collateralized debt obligations and collateralized loan obligations, has exacerbated the current nervousness because nobody knows what they're worth, he also notes.
In that, it appears some of the problem lies with asset-backed commercial paper "conduits" and so-called structured investment vehicles. These ABCP conduits and SIVs are used to fund the purchase of assets such as trade receivables, auto loans, credit cards, whole mortgage loans, as well as securities such as corporate debt, residential mortgage-backed securities and CDOs, according to a Bear Stearns report.
The ABCP conduits and the SIVs then are able to issue high-grade commercial paper to finance these assets, which are less the prime quality. ABCP now comprises over half the $2 trillion-plus commercial paper market, up from 20% in 1998, according to MacroMavens' Stephanie Pomboy. And, money market funds own 27% of all CP outstanding, she also notes.
According to the Bear report, some $38 billion-$43 billion RMBS and CDOs could be liquidated from ABCP conduits. Got that? In other words, a load of these assets is backing ABCP and may have to be sold into a less than receptive market.
Fears of large and wholesale liquidations may be behind the big price drops in triple-A mortgage securities, the firm notes. The worst case may be discounted and these securities may be attractive, the Bear report concludes.
Maybe so, but just last Friday, Bear's CFO called the current fixed-income market the worst he's seen in 22 years, which would imply it's not the best time for these mind-numbingly complex securities. What Bear's fixed-income brain trust is currently thinking can't be reported here because the firm shut journalists out of a conference call on the state of the market Thursday.
More remarkable is that the capital markets have arrived at this "mini-Minsky moment" while central banks have not been pursuing restrictive policies and unemployment is low, observes F. Mark Turner of Babson Capital. And, it might be added, well before the real economy feels much impact from the current financial dislocations.
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| To: John Pitera who wrote (8101) | 8/10/2007 1:14:46 AM | | From: John Pitera | of 13611 | | Examination of Conduits ----Money Funds May Hold Subprime, Too
By KAREN RICHARDSON and DAVID REILLY
August 9, 2007; Page C1
Few parts of the capital markets, it seems, are immune from the problems posed by mortgages extended to risky borrowers -- even the usually staid world of money-market funds.
Often viewed as an alternative to bank accounts, money-market funds post fairly mundane yields while offering investors a haven and easy access to their money. The funds tend to invest in certificates of deposit and commercial paper, which are short-term notes either issued by companies or backed by assets such as inventories or loans.
But some commercial paper may be fairly racy, containing mortgage-backed securities that could include chancy subprime loans. That isn't likely to cause big losses at these funds or endanger them. Still, it is prompting money-market managers to pay closer attention to what is backing the commercial paper they buy, demand additional compensation for investing in a particular type of vehicle that issues some asset-backed commercial paper and call for greater transparency in this market.
That, in turn, is bringing a greater focus to bear on so-called conduits. These vehicles issue asset-backed commercial paper and potentially allow banks and other financial institutions to push risky loans off their books. Asset-backed commercial paper accounts for about half the $2.2 trillion commercial-paper market.
The fact that mortgage loans could be causing grief in the commercial-paper market underscores how widely Wall Street packaged and then sold this kind of debt among investors. It also helps explain why problems in the subprime market have caused so much worry among investors.
The problems for the asset-backed commercial paper market began earlier this week when three conduit vehicles said they wouldn't be able to redeem paper coming due and instead would have to extend the maturity of the notes.
One of these vehicles, Broadhollow Funding LLC, encountered problems due to the bankruptcy-court filing of American Home Mortgage Investment Corp., one of the country's biggest lenders. Broadhollow purchased its mortgage products from AHM, which had created the vehicle, to finance the notes it sold to investors.
Broadhollow in Your Portfolio
Broadhollow's notes had been held earlier this year by staid funds such as the Putnam Premier Income Trust and the Evergreen Institutional Money Market Fund, according to Securities and Exchange Commission filings. The holdings were relatively small compared with the funds' overall assets. Officials at the fund groups weren't available to comment.
The problems with Broadhollow and other funds spooked the markets.
"This is supposed to be the most highly liquid portion of the market," says Jon Thompson, investment officer of structured finance at Advantus Capital Management, which has $18 billion in assets, including money-market funds. "The fact that some residential mortgage-related conduits have stopped issuing paper and some are extending past their maturity dates signals you're in the first part of some trouble."
Money-market managers could start switching into more short-term Treasury paper and agency discount notes, which yield less than asset-backed commercial paper but would likely present less risk, Mr. Thompson adds.
"You'll see investors reassessing the programs that are out in the market and how they're structured," says Linda Klingman, a senior portfolio manager for taxable money-market funds at Charles Schwab Investment Management. She added that investors will likely demand higher interest payments from conduits whose paper can be extended, or shy away from it altogether.
Investors are also likely to want more information out of the conduit vehicles that package asset-backed commercial paper. There is a worry that some of these vehicles are being used as dumping grounds for banks looking to move unwanted assets off their balance sheets.
The banks are allowed to keep conduits off their books if they sell off to a third party the obligation to shoulder potential losses stemming from the way the vehicle is structured. This is known as an "expected first loss" and is typically sold for a token amount. This ostensibly puts the risk associated with the vehicle onto another party, although the bank has often agreed to pony up funds to keep the conduit running in the event of trouble.
Asset-backed commercial paper "programs may be used to move assets off a sponsor's balance sheet," says Aoto Kenmochi, a senior director at Fitch Ratings.
What's Inside?
Gauging just what is in these conduits is no easy matter, either because they are able to frequently change their holdings or can contain slices of collateralized debt obligations, which are themselves pools of loans or mortgages. "Investors in conduits are always pushing for more clarity," says Jim Kaplan, who manages about $1.3 billion in money-market funds for William Blair & Co. in Chicago.
Conduit investors typically receive monthly "pool reports" from the program administrators. But since the majority of the conduits are privately placed, they aren't required to make standardized regulatory filings, nor do they need to be timely.
Now, jitters in this market may give investors new clout to change this.
"This is the perfect opportunity for investors to demand more disclosure on these conduits," says Michael Dean, managing director at Fitch's asset-backed securities group.
Write to Karen Richardson at karen.richardson@wsj.com1 and David Reilly at david.reilly@wsj.com2 | | Recommend | Keep | Reply | Mark as Last Read |
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| To: Poet who wrote (8100) | 8/10/2007 1:19:18 AM | | From: John Pitera | of 13611 | | Hello Poet, great to see you and thanks for the kind words.
The next few weeks and few months are going to be a very critical and stressful time for the Global Capital Markets. And it will impact all markets.
Look for more talk about the unwinding of the Carry trade from currencies such as the JPY and the CHF (Swiss Franc).
We should also be expecting to see more regarding credit default swaps; including Counterparty risk. CounterParty Risk will also increasingly become important in the CDO instruments.
Interestingly this Global Turmoil may witness a rally in the USD, especially against the EUR, the GBP, and the higher yield currencies.
JOhn | | Recommend | Keep | Reply | Mark as Last Read | Read Replies (1) |
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| To: John Pitera who wrote (8103) | 8/10/2007 8:09:59 AM | | From: Poet | of 13611 | | A possible rally in the USD vis a vis the EUR?
Hmmm, perhaps a late fall or spring trip to Italy might finally become reasonable. -gg
I'll be reading you, John...and wishing you all good things through what will likely be a stressful time for you.
smooch. | | Recommend | Keep | Reply | Mark as Last Read |
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| To: John Pitera who wrote (8101) | 8/10/2007 8:36:38 AM | | From: Elroy | 1 Recommendation of 13611 | | BNP Paribas halted withdrawals from three investment funds because their assets -- of which more than one-third are related to subprime mortgages -- were impossible to value in the nonfunctioning secondary market. A week ago, the big French bank's chief executive asserted its exposure to U.S. subprime "is absolutely negligible."
These two statements are entirely compatible, right? The funds may be impossible to value because the underlying assets are not being traded, and since Paribas itself is probably a manager of, not an investor in, the funds, Paribas sub-prime exposure might be zero. In other words, if the fund investors lose all their investment capital, Paribas may not lose anything other than the management fees that were coming from those (heading toward zero value) funds. Right? | | Recommend | Keep | Reply | Mark as Last Read | Read Replies (1) |
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| From: Louis V. Lambrecht | 8/10/2007 12:18:20 PM | | | 2 Recommendations of 13611 | | Remembering old posts:
- it takes an average of 4 weeks for derivatives trading companies to assess a (then 4 weeks old) portfolio position.
This is an average, my position is checked online, quasi real-time.
- infamous netting law the derivatives industry is eager to see installed. In case of a deficit in an account, the derivatives netting law would allow the professionals to net their accounts between each-other before assessing losses or even foreclosures.
Small accounts not invited.
How many weeks bookkeeping to add to the first 4 weeks average. ROFL.
See you in 4 to 6 weeks to assess the sub-prime problem, later if the netting law is passed in urgency. | | Recommend | Keep | Reply | Mark as Last Read | Read Replies (2) |
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| To: John Pitera who wrote (8090) | 8/10/2007 2:30:07 PM | | From: Hawkmoon | of 13611 | | I think this paragraph is worth reiterating:
We are of the opinion that the distancing of the borrower from the lender has contributed to the development of lax underwriting standards. Each participant, in the securitization/origination process, takes their ounce of payment, but no one truly worries about the underlying credit quality since the loan will be sold. Furthermore, most participants are compensated on volume and not quality of loan originated. In our opinion, “a rolling loan gathers no loss.” Possibly, with so many sub-prime originators failing because of loan put-backs to them, some degree of underwriting discipline will return to the market; however, with so many types of loan originators operating outside of the regulatory system with minimal capital, it is far better to originate a loan, capture the fee, and then get out of Dodge, should the business go bad. One can always return another day.
But, on the other hand, overeactions in these markets also represent opportunity for those with the guts, and the bucks, to step in an buy something that no one else wants. Also, it represents diversication of risk, much of it to the unregulated Hedge funds. And from I've seen and heard we know how much many of the traditional, and regulated, money funds loath the "Hedgies" and can't wait to see them lose their luster.
Now maybe the Fed is holding off in rescuing the banks from the financial environment they've helped to create, but I can't see them permitting the system to become unwound. And I think it's why we're seeing congressional action, recently so critical of Fannie Mae, ginning up support for increasing the quantity of mortgages they can hold.
But will the Fed act too late, with too little?
One more edit: Don't the banks that initiated those loans (prime and Alt-A) hold some responsibility for breaking that "connection" between the borrower and lender? Say I buy a house under certain terms, my circumstances have no changed and I'm paying the mortagage with no difficulties, and then my lender sells my mortgage.. Now my situation is suddenly pooled into the mass hysteria of the rest of the asset-backed securities markets..
But I don't look at my new mortgage holder. I look at the bank where I took out my loan.. And I see them as having screwed me by selling my loan into the land of "animal spirits" (and diversifying their risk). And I take my business elsewhere...
But on the other hand, these banks WHO KNOW THE BORROWER stand to make money, if they work hand in hand with them to preserve the long-term relationship so important to a bank.
Hawk@gladIdidn'tbuyahousewhenIreturnedfromoverseas.com |
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