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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: Wyätt Gwyön who wrote (84394)	8/3/2007 10:59:58 PM
From: orkrious	Read Replies (2) \| Respond to of 110194

I've probably posted Fleck's missive twice in five years. Tonight's is interesting enough that it's worth making it three times in five years. fleckensteincapital.com Dark Matter Conduits The Credit Chronicles, Continued Today's big news was not the employment report -- which turned out to be a little weaker than expected -- but the escalating (read: not contained) problems in credit land. The papers are full of stories about how mortgage lenders are either canceling certain products or tightening their standards. I'll leave it to readers to stay on top of the individual details. But the important thing to note is that standards are changing rapidly and credit is being restricted. Also, the ratings agencies are starting to realize that the problems affect not just structured credit but some of the folks who traffic in it. As an example, S&P today revised its outlook on Bear Stearns to negative. Earlier in the week, we saw credit-default swaps widen on the brokers, and they widened again today. Those problems snuffed out an early attempt at a rally, leavboxscoreing the indices down better than 1% within a couple hours, led by everything related to housing and the housing-finance food chain. And, as has been the case, what was somewhat strong against the undertow was technology, as the Jell-O movers refused to realize that everything is in trouble. Tough Talk from a CFO Delivers a Glancing Blow After the lows of the first hour, there was a bounce into midday. From there, the market sagged again, tried to rally, and then fell out of bed with about 90 minutes to go. It was almost as though the entire tape was trading on the motion in Bear Stearns' stock. The market's midday highs were associated with it turning slightly positive (after being drubbed earlier on the S&P downgrade). The afternoon swoon followed on the heels of what Bear's CFO said: The fixed-income market is the worst he's seen in 22 years and that the company wasn't going to buy back any stock. Which I take to mean that Mr. Market wasn't buying management's protestations about the situation essentially being business as usual. In any case, about an hour before the close, we were at the day's lows, though there were still some pockets of strength in tech. Then the countdown began: Would there be a miracle stick-save in the last half hour, or we would see a whoosh lower? The former didn't arrive and we saw the latter, with the market going out on the lows of the day and week. Today was as ugly a day as we have seen in ages, as all the indices were mauled. Monday could be nasty. Away from stocks, the dollar was weaker. Oil was down 1%. Treasurys were higher in a flight to quantity. Precious metals were up 1.5%. On the Back of a Bank That Barfed in Düsseldorf Now to touch on an important data point that I learned about today from the lord of the dark matter. (If there are some details here that turn out to be not exactly correct, it's not because he doesn't understand it. It will be because I misinterpreted what he said.) When the German bank IKB imploded earlier this week, it was revealed that they had about $17 billion in subprime exposure and had lost $3 billion. The important point to note: IKB held these structured-credit assets in a conduit, which appears to be some version of a special-purpose entity that banks use to own structured credit. More importantly, conduits are funded in the commercial-paper market. So, in addition to credit risk, it sounds to me like they are borrowing short and lending long, which is always dangerous when your assets are illiquid. There are a couple of important takeaways from this: (1) Next Monday and Tuesday, the conduits will apparently be updating their net asset values (NAVs); and (2) About the middle of August, they will be rolling their commercial paper all at once, as tends to be the case with these conduits. Watch this space. In addition to those two potential data points, it's important to understand that in all likelihood, IKB won't be the last entity in trouble. As my friend notes, most of these European banks all pursued similar strategies. And, I would say that if European banks were involved, U.S. banks probably were, too. He also feels that there will be further catalysts for negative surprises when hedge funds and others get their NAVs sorted out for July month end. However, some dealers in credit-default swaps are having problems coming up with valuations. So, there may be a timeline of as much as a week before that all gets sorted out. The Painful Education of a 70-Cents-on-the-Dollar Scholar Bottom line: The next several weeks should be pregnant with indications of more trouble throughout the whole financial-engineering world. More than a few outfits may discover that the triple-A pieces of paper they thought were worth 100 cents on the dollar are only worth something in the 70s. That will make for a lot of heartache. Positions in stocks mentioned: None.