Wednesday, July 30, 2008

Outlook of US Economy from JP Morgan Q2 2008 statements

Its Credit Cards services has around 79 bil loans reported in the book in Q2 08, $75 bil loans in Q1 08, $80.5 bil in Q2 07. The nonperforming assets of around $6 mil in Q2 08 and Q1 08, $8 mil in Q2 07. Net charge off is $1064 mil in Q2 08, $989 mil in Q1 08, $741 mil in Q2 07. Net charge off rate is 5.66%, 5.01%, 3.76% in Q2 08, Q1 08, Q2 07 respectively. The pace of increase in Q2 .66%, lower than that in Q1 but higher than Q4 07 and Q3 7, indicating the consumer credit market has yet to bottom out. Similar pattern is also found in consumer item - Consumer (includes RFS and Corporate/Private Equity), whose net charge off rate is 1.81%, 1.5%, 0.57% in Q2 08, Q1 08, Q2 07 respectively. The silver lining is the pace of increase of these credit items in Q2 08 is lower than those in Q1 08. The Q3 08 release and other macoeconomic data in July and August will be critical in concluding whether the credit crisis is bottoming out.

Stimulus Program Is Working To Lift Spending, Study Says

Study indictes that stimulus package are propping up the economy by boosting consumers spending in nondurable big-ticket items. Estimated increase in GDP caused by category will be ~0.8%... The government's economic-stimulus payments are being spent at "significant rates" and should boost consumer spending substantially into the current quarter, a pair of professors found in a preliminary study of the program's effects. The typical family increased its spending on food, drug products and other daily merchandise by 3.5% when the rebates arrived relative to a family that hadn't received its rebate yet, the study found. The government started sending the payments at the end of April; checks totaling more than $90 billion have gone out so far. The study, by professors Jonathan Parker at Northwestern University's Kellogg School of Management and Christian Broda at the University of Chicago's Graduate School of Business, is the first to calculate effects of the 2008 stimulus program. MORE COVERAGE • Read the full study (PDF) A key piece of consumer spending -- nondurable consumption, which excludes big-ticket items such as dishwashers and cars -- will be boosted by 4.1% in the current quarter because of the stimulus, they estimate. The category accounts for about a fifth of gross domestic product. They estimate that demand for nondurable spending rose by 2.4% in the second quarter as a direct result of the stimulus payments. The average family spent about 20% of its rebate in the first month after receipt, a higher spending rate than with the 2001 tax rebate that appears to have helped to end the recession that year, the study found. Low-income households increased their spending at almost double the rate of the average household. The authors used data collected on consumer purchases from ACNielsen, which tracks actual spending behavior, along with surveys of those consumers. The scope of the survey -- comprising more than 30,000 households -- prevented the authors from drawing conclusions on durable-goods spending, because such goods are purchased less regularly. But survey responses found that most consumers reported spending their rebates on those big-ticket items and on services, rather than on clothing and groceries. The $168 billion economic-stimulus program, featuring more than $100 billion in direct payments to taxpayers, cleared Congress in February with strong bipartisan support against worries that the economy would stumble from the housing and financial crises. Even with consumer confidence at very low levels, strong data on retail sales in the second quarter suggested the rebate checks were propping up the economy. The government is expected to report Thursday that the overall economy grew at an annual rate of more than 2% in the second quarter. "The rebates are maintaining retail sales and spending while people are being pinched on other fronts," Mr. Parker said in an interview.

Tuesday, July 29, 2008

Merrill's failure in hedging CDO

Merrill dumped 30 bil face value of CDO for just 22 cents per dollar. At some degree, it reflected company's failure to hedge CDO exposure. At the end of Q2 08, the company has net exposure just 4.5 bil, gross exposure 19.9 bil. Well hedged CDO should be independen of market condition. Hence, Merrill only needs to get rid of 4.5 bil book value of unhedged CDO. Merrill sold 11.1 bil book value (30 bil face value) of CDO for approximately 6 bil. It leads me to believe that at least 6.6 bil of CDO failed to be hedged well, highly probably due to the poor quality of counterparty. Don't forget, Merrill had taken a loss of $4 bil in Q2 concerning credit revaluation due to the downgrades of CDS insurers. The following excerpt from WSJ further reinforces my thoughts ... Merrill also didn't let on that it had struck a deal in principle around early July with bond insurer Security Capital Assurance Ltd. to tear up derivative contracts tied to $3.74 billion in CDOs. That agreement, which hadn't been finalized, resulted in a $500 million payment to Merrill, also announced Monday ... Why would Merr did it now when the market condition still out of woods and it had raised some capital? There are multiple explanations: To precaution against capital inadequecy; Pessimistic view of the prolonged outlook of market downturn. Above these, I would say that Mer sees the failure of hedging and no liquidity of CDO and want to put CDO mess behind forever.

Monday, July 28, 2008

Merrill Lynch 'Lance the Boil'

Firm Dumps Mortgage Assets as Crisis Drags On; Another Big Write-Down Merrill Lynch & Co., trying to purge its balance sheet of some of its worst remaining problems, said it is selling more than $30 billion in mortgage assets at a steep loss. Merrill also said it plans to raise about $8.5 billion in new common stock despite terms of an earlier stock sale in December that required it to make extra payments to investors who bought shares at a much higher price. Common-stock issues are typically unpopular because they dilute current shareholders. A Singapore company that has purchased a big slug of Merrill stock in the past year will put in $3.4 billion of the new capital. The announcement came as a surprise to Wall Street. Merrill Chief Executive John Thain, who just 12 days ago had resisted calls by Wall Street analysts for a fire sale to pare down the firm's holdings of mortgage debt, said the firm expects to take a new $5.7 billion write-down in the third quarter, after racking up $41 billion in write-downs since June 2007. Merrill's announcement came after a tumultuous day in stock and bond markets. The Dow Jones Industrial Average fell 239.61 points, or 2.1%, to 11131.08, bringing it down 16% on the year. All the blue-chip average's financial components traded lower, stung by the collapse late Friday of two small banks, First National Bank of Nevada and First Heritage Bank of Newport Beach, Calif. State and federal officials took new steps to address the market's woes Monday. The Treasury Department said that four of the nation's largest banks -- Bank of America Corp., Citigroup Inc., J.P. Morgan Chase & Co. and Wells Fargo & Co. -- agreed to begin issuing a type of debt called covered bonds, which the Bush administration has been pushing as a way to help reinvigorate the housing market. Meanwhile, New York's top insurance regulator, Eric Dinallo, helped broker a deal between bond insurer Security Capital Assurance Ltd. and Merrill that would allow the troubled insurer to cancel $3.74 billion of bond-insurance policies it has written in return for a payment of $500 million. (See related article.) Merrill's decision to sell the mortgage assets was described by one person close to the company as an attempt to "lance the boil" and put the mortgage debacle behind it once and for all. The decision signals Merrill sees no immediate turnaround in the sharp decline of assets backed by mortgages. Before the latest announcement, Merrill had raised more than $15 billion through various common and preferred share issues. It also sold a number of key assets, including unloading its 20% stake in Bloomberg LP for almost $4.5 billion. Financial shares shot up in mid-July after the federal government offered help for mortgage giants Fannie Mae and Freddie Mac and announced steps to crack down on short-selling, in which investors seek to profit from a decline in shares. But many obstacles remain to a resolution of the credit crisis that has gripped the market since last year. Bank and brokerage shares fell sharply Monday as investors worried anew about losses on mortgage-related assets and the weak economy and housing market. "This is a financial crisis in slow motion," said Nicholas Bohnsack of Strategas Research Partners. Merrill shares fell nearly 12% in regular-hours trading, before its announcement. In after-hours trading, the shares recovered slightly. Merrill Lynch has been hit hard by the mortgage crisis, largely owing to big bets on mortgage-backed securities not long before the market for those securities collapsed. Late last year, Stan O'Neal, the chief executive who oversaw those bets, was forced out. He was replaced in December by Mr. Thain, a former Goldman Sachs Group Inc. mortgage trader who later ran the New York Stock Exchange. Despite installing new risk controls and a new management team, Mr. Thain has been unable to steer Merrill out of trouble. This month it reported its fourth straight quarterly loss. Sitting on CDOs Merrill has been sitting on collateralized debt obligations, securities backed by pools of mortgages or other assets. The biggest single action Merrill took Monday was the sale of mortgage assets to an affiliate of Lone Star Funds. Those assets had a face value of $30.6 billion, and Merrill was carrying them on its books at $11.1 billion as of the end of June. Lone Star paid just $6.7 billion for the assets, or 22 cents for every dollar of face value. The sale reduced Merrill's holding of such assets by more than half, to $8.8 billion from $19.9 billion. Merrill said it would finance about 75% of the value of the deal. Other banks with toxic assets have taken similar action, in their quest to find someone to take the assets off their hands. Despite the steep discount, Merrill's sale may bode well for other firms on Wall Street such as Lehman Brothers Holdings Inc. that are also sitting on hard-to-sell assets. The new stock sale by Merrill is doubly painful because the firm offered price protection to some investors including Temasek Holdings Pte. Ltd., a Singapore state-owned investment company, on earlier sales in December and March of $6.2 billion in stock at $48 a share. Merrill said at the time that if it sold stock at a lower price within 12 months, it would compensate the $48-a-share investors. With Merrill's stock at a closing price of $24.33 a share, that price protection would cost Merrill $2.5 billion, though Temasek agreed to plow that money into its $3.4 billion investment in the new stock. The price of the shares wasn't specified. Also Monday, Merrill announced management plans to buy 750,000 shares of common stock in the coming public offering. Shaky Guarantors Another issue for Merrill has been the shaky standing of financial guarantors such as Security Capital Assurance, the company that was part of Monday's deal announced by New York state regulators. These guarantors wrote insurance against losses on bonds held by Merrill, but with so many bonds going bad, the guarantors were looking less likely to make good on their promises. Merrill had already written down $8.5 billion of its exposure to financial guarantors such as SCA during the past nine months, leaving it with just $2.9 billion in remaining exposure. Last month Merrill won a summary judgment in federal court in New York upholding its right to collect on SCA's insurance. Merrill said Monday the deal involving SCA -- in which it will give up the insurance in exchange for the $500 million payment -- would cause it to write down another $500 million in the third quarter. The agreement is likely to set a precedent for other insurers and financial institutions that are facing steep losses from problematic subprime-mortgage securities created over the past few years. Other bond insurers have also written billions of dollars of guarantees on mortgage bonds and might not have the capital to make payments on those guarantees. This could set the stage for a resolution of their problems. The bond insurers also have hundreds of billions of dollars of guarantees written on municipal bonds, and a resolution of their mortgage troubles could help relieve uncertainty in the municipal arena.

India's Swelling Deficit Has Potential to Set Off Cascading Economic Troubles

NEW DELHI -- India's slowing economy is beginning to show another big crack: A growing government deficit that could hurt much-needed investment in India's ramshackle infrastructure, boost inflation and undermine growth. A hefty list of expenditures is at the root of India's fiscal woes, especially a once-a-decade salary increase that Standard & Poor's estimates could mean pay increases of as much as 40% for 2.9 million central government employees. Were the government to approve the full amount, the ratings agency figures it could cost as much as the equivalent of 2.4% of gross domestic product. State governments are likely to follow suit. Oil prices also are jacking up government costs. New Delhi is issuing bonds equivalent to 3.6% of GDP to oil and fertilizer companies to partially compensate them for selling their products domestically at lower-than-global prices. While some fuel prices were increased in June, India's domestic fuel prices still significantly lag global ones. Then there is politics. The Congress party, which leads India's fragile governing coalition, is expected to loosen the purse strings before a general election that must happen by May. It already won approval of a debt-cancellation package for many of India's impoverished farmers. Overall, Morgan Stanley predicts, India's fiscal deficit -- including central, state and so-called off-budget items -- will rise to 11.4% of GDP in the fiscal year ending March 31, up from an estimated 7.7% in the previous year. The spending increase is likely to play out in a number of ways that will harm the Indian economy, which has been growing robustly in spite of sporadic instability such as recent bomb blasts in Ahmedabad and Bangalore. (Please see related article on page A6.) It may give another boost to inflation, which is already running at an annual rate of more than 11%. And that could prompt the central bank to continue to raise interest rates, or take other measures to try to keep inflation in check. Along with some other negative factors, the result is that India's growth is likely to ease to between 7% and 7.5% this fiscal year, many economists estimate, down from 9.1% the previous year. The higher spending is also bound to hurt India's efforts to deal with some long-term problems, including modernizing its decrepit ports, roads, power systems, airports and telecommunications infrastructure over the next five years. Among the projects that could be delayed is an infrastructure-development program, Bharat Nirman, to improve drinking water, electricity, roads, telephones and irrigation in rural areas. Many economists say that India needs to improve its infrastructure to sustain rapid economic growth. In the 1990s, India also faced a growing fiscal deficit. Then, too, a key factor was the once-every-decade rise in government pay packages. In the subsequent drive to bring down the deficit, infrastructure spending was curtailed, which especially hurt manufacturers. It was easier for the government to cut back on building roads, hospitals and schools than on government-employee pay or interest payments. Infrastructure has been neglected for so long that the Indian government figures it needs as much as $500 billion in spending over the next several years to equip the country properly. The government hopes to provide much of the money, with the rest coming from private funding. But, "government finances are not in good shape, which does not augur well for increasing investment rates dramatically," according to a Goldman Sachs report. 'India's infrastructure is way behind the rest of the world," said Shiksha Bhatia, a 26-year-old human resources executive at Google Inc. in Gurgaon, near New Delhi. "Roads are not well-built and full of potholes, especially the rural areas," and "power cuts make people's lives miserable." Fans or air conditioning are essential in India's sweltering summer heat. Businesses also suffer. Pramod Bhasin, president and chief executive of Genpact Ltd., in Gurgaon, which runs call centers around the country, said his company must provide its own transportation, power, security and education for its employees. As the outsourcing sector expands outside the major cities, he said, India will require "better regional airports [and] better social infrastructure that invites middle and senior management to move and live" there. The worsening fiscal situation could affect the nation's creditworthiness, and the borrowing prospects of some of its most important companies. Ratings agency Fitch recently changed its view on the outlook for a key rating of Indian debt to negative from stable, saying its move was "based on a considerable deterioration in the central government's fiscal position." Lehman Brothers Asian sovereign credit analyst Yang-Myung Hong said that ratings agencies aren't likely to rush to downgrade India's sovereign debt. But if the fiscal situation and inflation worsens appreciably, he said, "we could actually see the ratings get additional negative pressure." A downgrading of India's sovereign-debt rating could hurt commercial banks, including ICICI Bank Ltd., the country's largest private-sector bank, said Mr. Hong, "because they are pretty much linked to the sovereign rating." More broadly, Indian companies could face higher interest rates at home, because government efforts to finance its deficit could swamp the bond market, analysts warn. That could especially affect industrial enterprises looking to finance large capital projects. Some companies are already scaling back expenditure in anticipation of higher interest rates, said Jigar Shah, head of research for securities firm Kim Eng Securities Ltd. based in Mumbai. Among those vulnerable to higher borrowing costs, he said, are state-run oil-marketing company Indian Oil Corp. and cement companies ACC Ltd. and Ambuja Cements Ltd.

Sunday, July 27, 2008

US get the blues - from Economists

NATIONS, like people, occasionally get the blues; and right now the United States, normally the world’s most self-confident place, is glum. Eight out of ten Americans think their country is heading in the wrong direction. The hapless George Bush is partly to blame for this: his approval ratings are now sub-Nixonian. But many are concerned not so much about a failed president as about a flailing nation. One source of angst is the sorry state of American capitalism (see article). The “Washington consensus” told the world that open markets and deregulation would solve its problems. Yet American house prices are falling faster than during the Depression, petrol is more expensive than in the 1970s, banks are collapsing, the euro is kicking sand in the dollar’s face, credit is scarce, recession and inflation both threaten the economy, consumer confidence is an oxymoron and Belgians have just bought Budweiser, “America’s beer”. Now the world seems very multipolar. Europeans no longer worry about American ascendancy. The French, some say, understood the Arab world rather better than the neoconservatives did. Russia, the Gulf Arabs and the rising powers of Asia scoff openly at the Washington consensus. China in particular spooks America—and may do so even more over the next few weeks of Olympic medal-gathering. Americans are discussing the rise of China and their consequent relative decline; measuring when China’s economy will be bigger and counting its missiles and submarines has become a popular pastime in Washington. A few years ago, no politician would have been seen with a book called “The Post-American World”. Mr Obama has been conspicuously reading Fareed Zakaria’s recent volume. America has got into funks before now. In the 1950s it went into a Sputnik-driven spin about Soviet power; in the 1970s there was Watergate, Vietnam and the oil shocks; in the late 1980s Japan seemed to be buying up America. Each time, the United States rebounded, because the country is good at fixing itself. Just as American capitalism allows companies to die, and to be created, quickly, so its political system reacts fast. In Europe, political leaders emerge slowly, through party hierarchies; in America, the primaries permit inspirational unknowns to burst into the public consciousness from nowhere. Everybody goes through bad times. Some learn from the problems they have caused themselves, and come back stronger. Some blame others, lash out and damage themselves further. America has had the wisdom to take the first course many times before. Let’s hope it does so again.

Saturday, July 26, 2008

American Express Q2 2008 - conservative level of provision but no imminent danger

--The company released earning of Q2 2008 this week: rev almost flat but net income decreased ~40% relative to Q2 07 to 0.65 bil due to its high provision. --The change of charge off and delinquency rate is increasing at slowing pace: net charge off increasd from 1 bil to 1.19 bil in Q1 08 and 0.66 bil in Q2 07; delinquency (30 days past due) rate stay at 3.6% --The change in provision level seems overdone relative to the change of charge off and delinquency: provision in Q2 08 is 2.4 bil, almost 100% from 1.2 bil in Q1 08 and threefold increase from Q 07. The company is taking conservative approach to set aside enough reserve to cushion future loss. Opinion: 1.provision level might be lower next quarte and its earning might be higher than Q2 08 due to lower provision 2.moderate overweight the company

Friday, July 25, 2008

Understanding The Housing Bill

The Senate is expected to clear a sweeping housing bill Saturday and send it to the president for his signature. The legislation would address the home-foreclosure crisis and shore up the government-sponsored mortgage giants Fannie Mae and Freddie Mac. The House passed the bill Wednesday by a vote of 272-152. A look at what the bill would do: — Give the Treasury Department the power to extend Fannie Mae and Freddie Mac an unspecified line of credit and to buy their stock, if necessary, to prop up the mortgage companies. The two companies back or own $5 trillion in U.S. mortgages — nearly half the nation's total. — Allow qualified homeowners facing foreclosure to apply for lower fixed-rate, 30-year mortgages backed by loan guarantees from the Federal Housing Administration. The original lenders would have to agree to take a loss on their loans. The housing bill aims to help 400,000 Americans with subprime home loans refinance into 30-year, fixed-rate mortgages backed bythe government. The measure passed the House of Representativesand President George W. Bush has said he would sign it. — Create an independent regulator to oversee Fannie Mae and Freddie Mac. The regulator could establish minimum capital requirements for the two companies and limits on their portfolios. It would also have approval power over the pay packages of Fannie Mae and Freddie Mac executives. — Provide $3.9 billion in grants to communities with the highest foreclosure rates to buy foreclosed and abandoned properties. — Give about $15 billion in housing tax breaks, including a credit of up to $7,500 for first-time homebuyers who bought homes between April 9, 2008, and July 1, 2009. — Put a cap of $625,500 on the loans Fannie Mae and Freddie Mac can buy in certain high-priced areas, and a cap in other areas of up to 15 percent above the median home price. — Count any federal infusion for the mortgage giants under the debt limit, essentially capping how much the government could spend to stabilize the companies without further approval from Congress. As of Tuesday, the national debt that counts toward the limit stood at about $9.5 trillion, roughly $360 billion below the statutory ceiling. Material from The Associated Press was used in this report.

Housing Market Development

U.S. foreclosure filings more than doubled in the second quarter from a year earlier as falling homeprices left borrowers owing more on mortgages than theirproperties were worth. One in every 171 U.S. homeowners lost their house to foreclosure, received a default notice or was warned of a pending auction, an increase of 121 percent from a year earlier and a 14 percent rise from the first quarter, RealtyTrac Inc. said today ina statement. Almost 740,000 properties were in some stage of theforeclosure process, the most since the Irvine, California-basedreal estate data company began reporting in January 2005. Bank seizures in the first half of the year increased by 154percent to 370,179 from the same period in 2007, RealtyTrac said. Last year's second-quarter data on bank repossessions was notavailable, according to RealtyTrac. Economists estimated 2.5 million homes nationwide will enter the foreclosure process this year, up from about 1.5 million in 2007.

Thursday, July 24, 2008

We interrupt regular programming to announce that the United States of America has defaulted …" Part 2 from NakedCapitalism

US has not experienced sovereign debt crisis because it can finance itself, printing money to repay obligations. The speical status of US derives from the dollar that is the major reserve and trade currency. The aura of stability and stable store of value derives from the strength of US economy and military power. Now the dominance is coming to an end...

High levels of debt are sustainable provided the borrower can continue to service and finance it. The US has had no trouble attracting investors to date. Warren Buffett (in his 2006 annual letter to shareholders) noted that the US can fund its budget and trade deficits as it is still a wealthy country with lots of stock, bonds, real estate and companies to sell.

In recent years, the United States has absorbed around 85% of total global capital flows (about US$500 billion each year) from Asia, Europe, Russia and the Middle East. Risk adverse foreign investors preferred high quality debt – US Treasury and AAA rated bonds (including asset-backed securities ("ABS"), including mortgage-backed securities ("MBS")). A significant portion of the money flowing into the US was used to finance government spending and (sometimes speculative) property rather than more productive investments.

The real reason that the US actually has not experienced a sovereign debt crisis is that it finances itself in it own currency. This means that the US can literally print dollars to service and repay it obligations.

The special status of the US derives, in part, from the fact that the dollar is the world’s major reserve and trade currency. The dollar’s status derives, in part, from the gold standard that once pegged the dollar to the value of gold. The peg and full exchangeability is long gone.

The aura of stability and a safe store of value based on the strength of US economy and military power has continued to support the dollar. In 2003, Saddam Hussein, when captured, had US$750,000 with him – all in US$100 bills. The dollar's favoured position in trade and as a reserve currency is based on complex network effects.

Many global currencies are pegged to the dollar. The link is sometimes at an artificially low rate, like the Chinese renminbi, to maintain export competitiveness. This creates an outflow of dollars (via the trade deficit that in turn is driven by excess US demand for imports based on an overvalued dollar). Foreign central bankers are forced to purchase US debt with dollars to mitigate upward pressure on their domestic currency. The recycled dollars flow back to the US to finance the spending. This merry-go-round is the single most significant source of liquidity creation in financial markets. Large, liquid markets in dollars and dollar investments are both a result and facilitator of the process and assist in maintaining the dollar’s status as a reserve currency.

The dominance may be coming to an end. There is increasing discussion of re-denominating trade flows in currencies other than US$. Exporters are beginning to invoice in Euro or Yen. There are proposals to price commodities, such as oil and agricultural goods, in currencies other dollars. Some countries have abandoned or loosened the linkage of their domestic currency to the dollar. Others are considering such a move.

Foreign investors, including central banks, have reduced investment allocations to the dollar. The dollar’s share of reserves has fallen from a high of 72% to around 61%. Foreign investor demand for US Treasury bonds has weakened in recent times. Low nominal (negative real) rates on interest and dollar weakness are key factors.

Foreign investors may not continue to finance the US. At a minimum, the US will at some stage have to pay higher rates to finance its borrowing requirements. Ultimately, the US may be forced to finance itself in foreign currency. This would expose the US to currency risk but most importantly it would not be able to service its debt by printing money. The US, like all borrowers, would become subject to the discipline of creditors.

For the moment, the US$ is hanging on – just.

Inventory of homes hits another high

Inventories of homes rose 0.2% at the end of June to 4.49 million available for sale, which represented a 11.1-month supply at the current sales pace. There was a 10.8-month supply at the end of May. Sales fell 6.6% in the Northeast, 3.4% in the Midwest, and 3.1% in the South. Sales rose 1.0% in the West.

Wednesday, July 23, 2008

Wachovia (WB) vs Wahsington Mutual (WM)

--WM is in a worse position than WB in terms of its asset quality and credit loss --Nearly 80% of WM's book is exposed to risky assets while WB has much less share of book exposed to risky assets, ~50%. Furthermore, WB loan is more divierersified. --WM has reserve less share for its NPA, ~56%, than WB does, ~90% --WM has a lower Tier 1 capital ratio, 7.8%, than WB, 8% opinion --underweight WM

Basel committee looks to close risk loophole

Global banking supervisors are seeking to close a regulatory loophole that made it easier for banks around the world to own the complex assets that have caused huge losses during the current credit crisis. A proposal on Tuesday by the Basel Committee on Banking Supervision could overhaul the way banks calculate risk on their trading books and make it more costly to hold the kind of structured debt products that brought losses to banks such as UBS, Citigroup and Merrill Lynch. However, the measures may trigger protests from banks, not least because they could further undermine profits and make it harder to distribute complex products to investors. The committee is seeking industry comment on its proposal but plans to issue an interim version of the new requirement – an Incremental Risk Charge (IRC) – later this year and have the final version ready by January 2010. The move is part of the wide-ranging regulatory response to the credit crisis and the instability it has caused to the financial system and the real economy. Christopher Cox, chairman of the US Securities and Exchange Commission, said the proposed IRC would also apply to investment banks. “The market turmoil has had a severe impact on many commercial and investment banks,” he said. “The incremental risk guidelines and related changes to the Basel II framework will contribute to a safer and sounder financial system.” There are two main thrusts to the new capital charge. The first expands the types of risk to be assessed when calculating capital charges beyond those captured in so-called value-at-risk models. For debt products, capital will be charged against default risk, along with risks related to ratings downgrades, price changes and market liquidity. The second thrust expands the time scale over which those risks must be calculated. VaR models typically calculate such risks over 10 days; the IRC will require risks be calculated with 99.9 per cent certainty over a full year. The purpose of this change is to align the standard on banks’ trading books, where they hold securities, with the standards in their traditional loan books. “The committee also believes the proposed IRC framework would be less vulnerable to regulatory arbitrage and would more effectively promote forward looking risk measurement approaches,” the paper said.

How to restore European resilience - FT

Game over. After braving a barrage of global headwinds for two years without veering off course, the eurozone economy is now finally running aground. The surge in oil prices by $45 per barrel over the first six months of the year and the further 4.5 per cent spike in the effective euro exchange rate at the same time have gone beyond what the region can bear. Unless oil and currency markets turn around soon, the eurozone may grow hardly at all for the next three quarters. Leading indicators now point south. Adjusted for inflation, narrow M1 money supply is already contracting, signalling a recession risk. Unfortunately, real M1 is one of the best and most forward-looking guides to future growth. Standard business confidence indices have also come off sharply. Fundamentally, the eurozone is still in better shape than either the US or the UK. But while the US is being kept afloat by lax monetary and fiscal policy and an undervalued exchange rate, the eurozone has a modestly restrictive monetary policy, a roughly neutral fiscal stance and a wildly overvalued currency. Both the US and the eurozone are likely to scrape by with semi-stagnation, that is with growth so far below trend that we will need a magnifying glass to see it. But the risk that any additional shock could cause a recession is now as high for the eurozone as it has been for the US for more than a year already. The travails of Spain and Ireland, where real-estate driven booms have turned to Anglo-American style busts, have received a lot of attention. The pair matters. Although they jointly account for just 12 per cent of eurozone gross domestic product, they lifted the growth rate by 0.25 per cent on average over the past nine years. If they both succumb to recession, as they probably will, they could subtract 0.2 per cent from eurozone growth for the next two years instead. But for the main drivers of the downturn, we have to look at the giants, not the minnows. France and Germany have both exhausted their cyclical recovery model. France had relied on buoyant consumer demand, helped by various tax cuts. However, the surge in oil prices has eroded the gains in nominal disposable income. French consumers no longer have the means to spend more. In Germany, the strong euro and weaker demand from within Europe are now crimping export growth. Worse, record oil prices are preventing the rebound in long-depressed private consumption which otherwise would have followed last year’s gains in investment and employment. The biggest domestic risk for the eurozone is a full-blown confrontation between monetary policy and wage policy. Ultimately, workers have to accept that they will have to pay their higher energy and grocery bills themselves. Pretending that they can pass the costs on to their employers via offsetting wage increases or their governments via offsetting petrol tax cuts will only boomerang back on to them with a vengeance as companies lay off workers and governments are forced to raise other taxes or cut spending in response. In the eurozone, the partial wage-indexation mechanisms in countries such as France and Spain as well as the 5 per cent wage increase that Germany granted many public servants in April have sent exactly the wrong signal. For the European Central Bank, 4 per cent inflation and less subdued wage pressure present a huge challenge. But almost two thirds of the rise in the price level can be traced back to higher oil and food prices. To keep headline inflation at its de facto target of 1.9 per cent in the face of such imported inflation, the ECB would have had to push the domestic economy into deflation. Fortunately, it has not done so yet and will not have to do it now. Market forces are already gearing up to beat wage inflation back down again to a sustainable level some time next year. Eurozone unemployment started to rise in April. With a near-stagnant economy, the ranks of the unemployed could swell from a trough of 11.1m this winter to almost 12.5m next summer. This should put the lid back on wage inflation in 2009 without a need for the ECB to nudge the economy closer to recession by further rate increases. Fiscal policy is not in a position to steady the economy directly. France and Italy cannot afford a stimulus programme. Spain has already used up much of the latitude which it had earned in years of prudence. Only Germany, which hit its citizens with a higher value added tax while the economy was coasting on a cyclical high 18 months ago, has some room to cushion the blow. A cut in payroll taxes, which are borne by workers and employers alike, would raise disposable incomes and reduce wage costs at the same time, making this stimulus acceptable to the ECB. By and large, eurozone policymakers cannot do much about the oil and food shock, although a root-and-branch reform of the European Union agricultural policies and a market-opening World Trade Organisation deal would certainly not go amiss. But they could at least try to avoid mistakes such as the rise in the healthcare payroll tax that Germany is planning for 2009. Abolishing wage-indexation mechanisms, or relinking them from oil-driven headlines to the much steadier core measures of inflation, would help. Ideally, policymakers could see the growth pause as a sombre reminder that the eurozone needs further labour market reforms to make it even more resilient against future calamities.

Tuesday, July 22, 2008

Wachovia Q2 08

--NI -8.8 bil loss againt revenue 7.5 bil, much worse than expected --Provision has increased a lot, but allowance % NPA, 90%, still low compared to BAC and C, all above 150% --Risky assets (ABS CDO, subprime, commercial, leveage finance loans) has shrank to ~6bil from 12 bil in Q1 08. But its exposure to pick-a-pay is still a concern. --the delinquencies of 2006 and 2007 vintage of pick-a-pay mortgage has not bottomed out yet. but its 2004 and 2005 vintgage has. opinion --neutral

subprime pool performance update -- Credit Sights

--2005 vintage RMBS (subprime) shows signs of improvement: the number of deliquent mortgaes as a proportion of the origianl trust pool has started o fall; a slowdown in defaults. --2006 and 2007 vintage RMBS also shows signs of stablization in delinquencies, but not in defaults. --2007 mortgages are considerably frothier than those extended in 2006 and 2006. --2007 repesents the lowest in subprime RMBS issuance since 2003 at ~200 bil vs 450 bil in both 2005 and 2006. --key driver for further subprime mortgage defaults is less the nuances of the loans themselves, but hte macroeconomic conditions - unemployement and interest rates faced by the borrowers.

Monday, July 21, 2008

Like S&Ls? Paying the Tab For a Cleanup

Get ready, American taxpayer -- you may be called on to solve the credit crisis. So far in this debacle, now more than a year old, the government response has been mainly designed to keep the markets and economy running, with the Federal Reserve slashing interest rates and pumping cash into the financial system. The fiscal response, similarly, has kept consumers spending with tax rebates. The next stage of the crisis won't be solved by easy money. It involves not liquidity but the capital base of financial institutions that have warehouses full of mortgage debt, leveraged loans and other toxic assets fouling up their balance sheets. One approach for regulators could be to force these firms to either raise new capital or get out of the game by liquidating their assets. "Our regulators have been lax in their enforcement of existing capital rules," says Daniel Alpert, managing director at Westwood Capital. "When you have top institutions, such as Merrill Lynch,scrounging around for the family silver to sell each quarter, clearly our financial institutions are not adequately capitalized for long-term viability." At some point banks may run out of funding sources or willing buyers for their misfit loans. A three-letter solution is already on the lips of many investors: RTC. Resolution Trust Corp. was established during the savings-and-loan crisis of the late 1980s and early 1990s. The clearinghouse sold off some $394 billion in assets of 747 failed S&Ls, costing the taxpayer about $76 billion, according to the Federal Deposit Insurance Corp. Potential losses in this crisis are far larger, with estimates of $1 trillion or more being bandied about. Taxpayers won't be on the hook for anything close to that. But their bill could make the $124 billion they paid, in total, for the S&L crisis seem a bargain. The alternative might be worse. If regulators wait too long to clean up the mess, the U.S. starts to resemble Japan in the 1990s, allowing "zombie" banks to shuffle along, unable to raise capital or lend while the economy lingers in purgatory. In a speech earlier this month, Treasury Secretary Henry Paulson hinted at this when he proposed a "resolution process," a morgue of sorts where big banks can go to die without infecting the rest of the system. That's where the RTC idea comes in. "Everybody's waiting for another Resolution Trust solution," says James McGlynn, managing director of equities at Summit Investment Partners. "The perfect part of that is the 'resolution' -- we want a resolution to the financial abyss we're in right now." The RTC wasn't established at the start of the S&L crisis, but when the government's morgue was overwhelmed with dying banks. Election-year politics could delay the cleanup this time; candidates likely don't want to discuss the costs ahead. Any taxpayer solution will only worsen already troubling fiscal problems. But that's the price for a system that -- as New York University economist Nouriel Roubini and others put it -- privatizes profits and socializes losses.

Markets Police Themselves Poorly, But Regulation Has Its Flaws

The lastest epside of credit crunch indicated that neither market discipline and regulation succeeded. Still in the short term, the pendulum between market force and regulation will swing to more oversight... The events of the past few weeks leave U.S. policy makers at a crossroads in a long-running debate about how to police financial markets. For much of the past quarter-century, policy has tilted away from strict regulation and toward relying on market discipline to keep the financial system on an even keel. Market players, the thinking went, had an incentive not to push themselves or their counterparties too far, because they had too much to lose if they did. This approach has failed, but finding a workable alternative won't be easy. Carmen Reinhart, a University of Maryland economist who has studied centuries of financial crises, concludes that blowups happen almost inevitably after financial markets are liberalized or some innovation allows capital to flow more freely. She and fellow researcher Kenneth Rogoff found that during the loosely regulated 1980s and '90s there were 137 banking crises around the globe, compared with a total of nine during the more tightly regulated '50s, '60s and '70s. Deregulation of interest rates on deposits at U.S. thrifts in the early 1990s, for example, led to a wave of risk-taking and the savings-and-loan crisis. "Market discipline exists in theory, but in practice, ahead of each crisis, what we see is quite the opposite," Ms. Reinhart says. Such discipline clearly broke down at places like Citigroup and Merrill Lynch, which in the past nine months have written down more than $80 billion combined on bad investments. They took too many risks on complex mortgage investments that they created but didn't adequately understand. More broadly, Wall Street's version of market discipline produced the worst housing crisis since the Great Depression -- just a few years after a burst bubble in Internet stocks. Yet in recent days, the alternative to market discipline -- regulation -- hasn't stood up very well to scrutiny either. IndyMac Bank, the mortgage specialist that collapsed earlier this month, was a federally regulated bank. The failure of the IndyMac Bancorp unit could cost American taxpayers as much as $8 billion. Ms. Reinhart likens the hodgepodge of state and federal bank supervisors to a "banana republic" of regulation. Fannie Mae and Freddie Mac, the troubled U.S. mortgage giants, are another example of regulation gone awry. They have their own regulator, the Office of Federal Housing Enterprise Oversight, whose main mission is to ensure they have enough capital. Despite the oversight, they might need capital injections from the U.S. Treasury amid mounting mortgage losses. Unlike other areas of the economy, the Bush administration has been trying for years to sharpen oversight of the two companies. Congress is finally near completion of legislation that would create a stronger regulator to watch over Fannie and Freddie. But that comes too late for the current foreclosure crisis, which has shown that their capital requirements were too low. Ironically, hedge funds -- which are largely unregulated, and where market discipline remains the government's main policy tool -- haven't produced a major blowup this cycle. The Federal Reserve has pushed investment banks to ensure that their hedge-fund clients don't borrow too much and get overextended. So far, it seems to be working. With the exception of two funds run by Bear Stearns, no major hedge-fund players have collapsed during the current credit crunch. However, the hedge funds did play an important role in fueling the credit boom that preceded the current crunch -- by funding and trading many of the complex debt instruments that have quickly unwound. Collateralized debt obligations and credit-default swaps, two kinds of debt instruments that played a starring role in Bear Stearns' troubles, were the playground of many hedge funds. John Paulson, the billionaire hedge-fund manager, made his fortune by using these markets to bet against housing. "The enormous losses and write-downs taken at financial institutions around the world since August, as well as the run on Bear Stearns, show that, in this episode, neither market discipline nor regulatory oversight succeeded," Fed Chairman Ben Bernanke said in a major address on regulation earlier this month. The conclusion is humbling. Policy makers need to fix a broken financial system with policy levers they know are damaged, too. The pendulum between market forces and regulation has no reassuring place to swing, though in the short-run, it is surely swinging toward regulation. Unlike his predecessor, Alan Greenspan, a strong advocate of letting the market discipline itself, Mr. Bernanke has been pushed into the role of Mr. Fixit, forced to strike some new balance with more regulation. That will mean tinkering with everything from the way that credit-derivatives trades are settled to the way investment banks manage their short-term funding in "repo" markets, where they use securities as collateral for short-term loans. It will also mean broadening the Fed's powers to oversee investment banks and possibly others. Some economists, while quick to acknowledge the market's failure, also look upon this shift with trepidation. "What we have is obviously very dynamic markets that have the ability to run circles around regulators and they have an incentive to exploit every possible opening there is for regulatory arbitrage," says Raghuram Rajan, a University of Chicago economist who sounded alarms about the excesses building up in the financial system back in 2005. One of the most important, and least talked about, needs for overhaul, he says, is making sure that bankers have the right incentives: for example, in their own compensation, to ensure they don't push their institutions to extremes. "Regulation can work better if you have the governance issues straightened out," he says. There are other risks in this building shift toward more regulation. As Mr. Bernanke pointed out in his July speech on the subject, the act of bailing out financial institutions like Bear Stearns, Fannie Mae and Freddie Mac could undermine market discipline even more. If a bank's managers know their institution won't be allowed to fail, they have an incentive to take bigger chances. "Market participants might incorrectly view the Fed as a source of unconditional support for financial institutions and markets," Mr. Bernanke said. That's one reason why the Fed and the Treasury seem intent on seeing shareholders of firms like Bear Stearns punished when their institutions need help. Somebody needs to pay, and the board has to answer to shareholders. The other risk is that regulators go too far, coming out with new rules that stifle innovation or risk-taking. In the early 1990s, regulators came to bear the brunt of blame for the credit crunch because of the demands they placed on banks and thrifts to tighten their standards and build capital. The regulators are cracking down again now, two or three years too late.

Sunday, July 20, 2008

debt to income (debt-to-income) ratio - Greenspan

A rising debt-to-income ratio for households, or of total nonfinancial debt to GDP, is not , in itself, a measure of stress. It is largely a reflection of dispersion of a growing financial imbalance of economic entities that in turn reflects the irreversible up-drift in division of labor and specialiation.

Saturday, July 19, 2008

A brief family history Toxic fudge

ADAM SMITH thought that private companies chartered to fulfil government tasks had “in the long run proved, universally, either burdensome or useless”. That has not stopped them thriving. America has five government-sponsored enterprises (GSEs), set up to subsidise loans to homeowners or farmers. (Sallie Mae, which deals with students, gave up GSE status in 2004.) Because they count as privately owned, GSEs are kept off the government’s books. For politicians that has made them irresistible ever since the Farm Credit System’s creation in 1916. Fannie Mae and Freddie Mac dominate the GSE system, accounting for four-fifths of its total credit portfolio. Fannie was created in 1938 as a government corporation. In 1968 the Johnson administration decided to list its shares to reduce the budgetary pressures created by the Vietnam war, according to Thomas Stanton, of Johns Hopkins University. Freddie was born in 1970 and listed in 1989. Both companies aim to support the secondary mortgage market. They have succeeded all too well: they own or guarantee about half of all mortgages.

Friday, July 18, 2008

Fannie Mae and Freddie Mac End of illusions

A series of articles on the crisis gripping the world economy and global markets starts where it all began—with America’s deeply flawed system of housing finance Illustration by Bob Venables THERE is a story about a science professor giving a public lecture on the solar system. An elderly lady interrupts to claim that, contrary to his assertions about gravity, the world travels through the universe on the back of a giant turtle. “But what supports the turtle?” retorts the professor. “You can’t trick me,” says the woman. “It’s turtles all the way down.” The American financial system has started to look as logical as “turtles all the way down” this week. Only six months ago, politicians were counting on Fannie Mae and Freddie Mac, the country’s mortgage giants, to bolster the housing market by buying more mortgages. Now the rescuers themselves have needed rescuing. After a headlong plunge in the two firms’ share prices (see chart 1), Hank Paulson, the treasury secretary, felt obliged to make an emergency announcement on July 13th. He will seek Congress’s approval for extending the Treasury’s credit lines to the pair and even buying their shares if necessary. Separately, the Federal Reserve said Fannie and Freddie could get financing at its discount window, a privilege previously available only to banks. The absurdity of this situation was highlighted by the way the discount window works. The Fed does not just accept any old assets as collateral; it wants assets that are “safe”. As well as Treasury bonds, it is willing to accept paper issued by “government-sponsored enterprises” (GSEs). But the two most prominent GSEs are Fannie Mae and Freddie Mac. In theory, therefore, the two companies could issue their own debt and exchange it for loans from the government—the equivalent of having access to the printing press. Absurd or not, the rescue package notched up one immediate success. Freddie Mac was able to raise $3 billion in short-term finance on July 14th. But the deal did little to help the share price of either company or indeed of banks, where sentiment was dented by the collapse of IndyMac, a mortgage lender (see article). The next day Moody’s, a rating agency, downgraded both the financial strength and the preferred stock of Fannie and Freddie, making a capital-raising exercise look even more difficult. As a sign of its concern, the Securities and Exchange Commission, America’s leading financial regulator, weighed in with rules restricting the short-selling of shares in Fannie and Freddie. The whole affair has raised questions about the giant twins. They were set up (see article) to provide liquidity for the housing market by buying mortgages from the banks. They repackaged these loans and used them as collateral for bonds called mortgage-backed securities; they guaranteed buyers of those securities against default. This model was based on the ability of investors to see through one illusion and boosted by their willingness to believe in another. The illusion that investors saw through was the official line that debt issued by Fannie and Freddie was not backed by the government. No one believed this. Investors felt that the government would not let Fannie and Freddie fail; they have just been proved right. The belief in the implicit government guarantee allowed the pair to borrow cheaply. This made their model work. They could earn more on the mortgages they bought than they paid to raise money in the markets. Had Fannie and Freddie been hedge funds, this strategy would have been known as a “carry trade”. It also allowed Fannie and Freddie to operate with tiny amounts of capital. The two groups had core capital (as defined by their regulator) of $83.2 billion at the end of 2007 (see chart 2); this supported around $5.2 trillion of debt and guarantees, a gearing ratio of 65 to one. According to CreditSights, a research group, Fannie and Freddie were counterparties in $2.3 trillion-worth of derivative transactions, related to their hedging activities. There is no way a private bank would be allowed to have such a highly geared balance sheet, nor would it qualify for the highest AAA credit rating. In a speech to Congress in 2004, Alan Greenspan, then the chairman of the Fed, said: “Without the expectation of government support in a crisis, such leverage would not be possible without a significantly higher cost of debt.” The likelihood of “extraordinary support” from the government is cited by Standard & Poor’s (S&P), a rating agency, in explaining its rating of the firms’ debt. The illusion investors fell for was the idea that American house prices would not fall across the country. This bolstered the twins’ creditworthiness. Although the two organisations have suffered from regional busts in the past, house prices have not fallen nationally on an annual basis since Fannie was founded in 1938. Investors have got quite a bit of protection against a housing bust because of the type of deals that Fannie and Freddie guaranteed. The duo focused on mortgages to borrowers with good credit scores and the wherewithal to put down a deposit. This was not subprime lending. Howard Shapiro, an analyst at Fox-Pitt, an investment bank, says the pair’s average loan-to-value ratio at the end of 2007 was 68%; in other words, they could survive a 30% fall in house prices. So far, declared losses on their core portfolios have indeed been small by the standards of many others; in 2008, they are likely to be between 0.1% and 0.2% of assets, according to S&P. Of course, this strategy only raises another question. Why does America need government-sponsored bodies to back the type of mortgages that were most likely to be repaid? It looks as if their core business is a solution to a non-existent problem. However, Fannie and Freddie did not stick to their knitting. In the late 1990s they moved heavily into another area: buying mortgage-backed securities issued by others (see chart 3). Again, this was a version of the carry trade: they used their cheap financing to buy higher-yielding assets. In 1998 Freddie owned $25 billion of other securities, according to a report by its regulator, the Office of Federal Housing Enterprise Oversight (OFHEO); by the end of 2007 it had $267 billion. Fannie’s outside portfolio grew from $18.5 billion in 1997 to $127.8 billion at the end of 2007. Although they tended to buy AAA-rated paper, that designation is not as reliable as it used to be, as the credit crunch has shown. Sometimes the mortgage companies were buying each other’s debt: turtles propping each other up. Although this boosted short-term profits, it did not seem to be part of the duo’s original mission. As Mr Greenspan remarked, these purchases “do not appear needed to supply mortgage market liquidity or to enhance capital markets in the United States”. Joshua Rosner, an analyst at Graham Fisher, a research firm, who was one of the first to identify the problems in the mortgage market in early 2007, reckons Fannie and Freddie were buying 50% of all “private-label” mortgage-backed securities in some years—that is, those issued by conventional mortgage lenders. This left them exposed to the very subprime assets they were meant to avoid. Although that exposure was small compared with their portfolios, it could have a big impact because they have so little equity as a cushion. Both companies make a distinction between losses on trading assets (which they take as a hit against profits) and on “available-for-sale” securities which they hold for the longer term and disregard, if they think the losses are temporary. At the end of 2007, according to OFHEO, Fannie had pre-tax losses of this type of $4.8 billion; Freddie’s amounted to $15 billion. The companies have also been unwilling to accept the pain of market prices in acknowledging delinquent loans. When borrowers fail to keep up payments on mortgages in the pool that supports asset-backed loans, Fannie and Freddie must buy back the loan. But that requires an immediate write-off at a time when the market prices of asset-backed loans are depressed. Instead, the twins sometimes pay the interest into the pool to keep the loans afloat. In Mr Rosner’s view, this merely pushes the losses into the future. Adding to the complexity is the need for both Fannie and Freddie to insure their portfolios against interest-rate risk—in particular, the danger that borrowers may pay back their loans early, if interest rates fall, leaving the companies with money to reinvest at a lower rate. This risk caused the duo to take huge positions in the derivatives market, and was at the centre of an accounting scandal earlier this decade. In addition, Fannie and Freddie have bought insurance against borrower defaults when the homebuyer lacks a 20% deposit. But the finances of the mortgage insurers do not look that healthy, which may mean the risk ends up back with the siblings. Just as the rescuers need rescuing, so the insurers may need insuring. None of these practices seemed to dent the confidence of OFHEO in its charges. The regulator said as recently as July 10th that both Fannie and Freddie had enough capital. Indeed, their capital-adequacy requirement was reduced earlier this year so that they could make more of an effort to bolster the housing market. Capital offence By its own measure, OFHEO was right. At the end of the first quarter, the two companies exceeded their minimum capital requirements by $11 billion apiece, according to CreditSights. To fall to the “critical level”, which would require OFHEO to take the agencies into “conservatorship” (a fancy word for nationalisation), CreditSights says Fannie would have to lose $16 billion of capital and Freddie $14 billion. And because neither Fannie nor Freddie has depositors, there is no danger of their suffering a run, as Northern Rock, a British bank, did last year. So why the crisis? Given the gearing in the businesses, things only need to go slightly wrong for there to be a big problem. Freddie lost $3.5 billion in 2007; Fannie reported a $2.2 billion loss in the first quarter, having lost $2.05 billion last year. Each had credit-related write-downs of between $5 billion and $6 billion last year. On a fair-value basis, which assumes that all assets and liabilities are realised immediately, Freddie had negative net worth of $5.2 billion at the end of the first quarter. Clearly, if the pair continue to lose money for much longer, their capital base will be eroded. And, of course, Congress wanted their businesses to expand—meaning that more, not less, capital would be needed. That would require shareholders to stump up more money. But investors tend to anticipate a big equity-raising by selling the shares, and a falling share price makes an equity issue less likely. The fall was sufficiently speedy in mid-July to prompt Mr Paulson to step in. The stockmarket had called the government’s bluff. The rescue package may have reassured the creditors but it did not stop the share price of either Fannie or Freddie from falling. After all, the government is likely to extract a heavy penalty from shareholders in return for its support (creditors are another matter, especially as a lot of GSE paper is held by foreign central banks). Nevertheless the hope is that, if confidence can be restored, Fannie and Freddie can survive without raising capital until market conditions improve. In the short term, as the success of the debt issue on July 14th showed, they should be able to go about their business. The authorities are keen to avoid nationalisation, which would bring the whole of Fannie’s and Freddie’s debt onto the federal government’s balance sheet. In terms of book-keeping this would almost double the public debt, but that is rather misleading. It would hardly be like issuing $5.2 trillion of new Treasury bonds, because Fannie’s and Freddie’s debt is backed by real assets. Nevertheless, the fear that the taxpayer may have to absorb the GSEs’ debt pushed Treasury bond yields higher. That suggests yet another irony; the debt of the GSEs has been trading as if it were guaranteed by the American government, but the debt of the government was not trading as if Uncle Sam had guaranteed that of the GSEs. If Congress approves this package, the Fed will have more authority over the agencies. But that will give the central bank another headache. If an institution is struggling, the normal answer is to shrink its activities and wind it down slowly. But that is the last thing that the housing market needs right now. With the credit crunch, Fannie and Freddie have become more important than ever, financing some 80% of mortgages in January. So they will need to keep lending. Nor is there scope to offload their portfolios of mortgage-backed securities, given that there are scarcely any buyers of such debt. And if the Fed has to worry about safeguarding Fannie and Freddie, can it afford to raise interest rates to combat inflation? American monetary policy may be constrained. The GSEs are not the only liability for the government. IndyMac’s recent collapse is the latest call on the Federal Deposit Insurance Corporation (FDIC). The FDIC has some $53 billion of assets, so it is better funded than most deposit-insurance schemes. But if enough banks got into trouble, the government would be on the hook for any shortfall. The same is true of the Pension Benefit Guaranty Corporation, which insures private sector benefits, but is already $14 billion in deficit. In the end, the turtle at the bottom of the pile is the American taxpayer. But that suggests that, if Americans are losing money on their houses, pensions or bank accounts, the right answer is to tax them to pay for it. Perhaps it is no surprise that traders in the credit-default swaps market have recently made bets on the unthinkable: that America may default on its debt.

Thursday, July 17, 2008

Merrill Lynch Q2 08

The company shocked the investors by posting much worse than expected earnings reports. Earnings in Q2 08 was -4.6 bil and revenue was 2.1 bil. The loss is mainly from ABS CDO. ABS CDO net loss is 3.5 bil and credit adjustment is 2.8 bil due the deterioration of creditworthness of financial garantors. The gross exposure of ABS CDO declined form 26.3 bil to 19.9 bil. The company probably sold 6.4 bil of ABS CDO with a haircut of ~50%(3.5/6.4). The company has strengthened its liquidity pool from 82 to 92 bil. Also, Merrill could continue to sell its stakes in Blackrock and Financial Data Service to buffet its capital position. This might spook equity market tomorrow. Given existing gross exposure of ABS CDO and uncertainty of financial garantors. I suggest for underweight of company equity and neutral position ot debt.

Wednesday, July 16, 2008

SEC Moves to Curb Naked Short-Selling

This rule might hurt State Street's security lending business, instead of strengthening... Under current rules, a short seller must first locate shares to borrow, but does not have to enter into a contract with the share lender. Often, more than one trader is able to borrow the same shares, creating a multiplier effect in the size of the total short position. Under the emergency order, a short seller would be required to have an actual agreement to borrow the shares. The new move would effectively take shares out of the market for borrowing, which could reduce the amount of stock available for selling short. It's far from clear whether the move, which sparked a barrage of criticism, will curb the activity of short sellers. While its aim is to curb abuses, it also would add an additional layer of bureaucracy to legitimate transactions.

Tuesday, July 15, 2008

State Street Q2 2008

Under the rosy picture the company painted there loomed risk. The comany reported strong earnings above expectation: 1.37 eps vs 1.07 Q2 in 07. Revenue rose to 2.67 bil. The main contriutor is from net interest revenue where the company earn spread between customers' deposits and high yield assets. Thanks to lower interest rate, the company were able to reap high spread during the downturn environment. Accounting Shangnian But one major piece is missing in the NIR discloure: provision. Nearly $70 bil investment portfolio contributed the interest bearing revenue, but its provision is only disclosed in comprenhensive income, not income statement, because it is classified as available-for-sale, not trading, securities. This is somewhat against the major methods wall street banks used. At the end of Q2 08, the unrealized loss is approximately $2 bil. FASB is expected to issue a revision of FIN-46, which might impact the accounting treatment of conduits. STT may have to consolidate the conduits by then. Menial loss It has 27.2 bil exposure to agency MBS, unrealized loss is 445 mil, ~2% haircut; 4.3 bil exposure to CMBS, unrealized loss is 75 mil, ~2% haircut. The 'writeoff' seem lower than those disclosed by competitors. Potential loss It has a large exposure to UK and European RMBS, $6.6 bil. Until now, only unrealized loss together is just 0.3 bil. As Euro and UK housing slump and recession come along, we expect another 0.7 bil loss ahead. Thoughts Try to shy away from the company stocks, but its credit should be relatively ok given its strengthened capital position.

Monday, July 14, 2008

china hot money

Hot money is a major contributor to China fed reserve accumulation. It is procyclicality will only worsen China' situation.... For many years China’s reserve accumulation was largely powered by its high and rising trade surplus and its status as the favourite destination for foreign direct investment. These are relatively stable sources of inflow and are even likely to be neutral or slightly countercyclical. But in recent months it has been no longer the trade surplus, in combination with FDI, that is powering the increase. The trade surplus is slightly down in 2008 compared with last year, as is the use of foreign-sourced funds for investment, even as the rate of Chinese reserve accumulation has doubled. During the first halves of 2005 and 2006, the trade surplus, FDI and estimated interest on China’s reserves accounted for 80-90 per cent of the country’s reserve accumulation. In the first half of 2007, these components accounted for about 70 per cent. This year, however, their share has declined dramatically to 39 per cent from January to May (after we adjust China’s headline growth in reserves to account for a number of transactions that have in effect “outsourced” the job of reserve accumulation to other entities within China). Because there are likely to be speculative inflows buried in the trade and FDI accounts, their true share is probably even lower. So what is powering China’s accelerating reserve accumulation? Probably hot money. As it becomes increasingly clear that China must revalue its currency sharply or else face surging inflation and the threat of financial instability, more and more investors, business people and ordinary households are bringing money into China to take advantage of profits associated with the expected appreciation or to protect themselves from the losses they will incur with the rising renminbi. Consequently a flood of speculative money, amounting possibly to tens of billions of dollars every month, is pouring into China. There is no technical definition of hot money and of course, with much of it entering the country illegally, it is tough to measure, but it is possible to obtain rough proxies for speculative inflows and to track their change over time. In every case the proxy, however it has been derived, shows a startling increase over the past 12 months. The fact that in recent months the authorities have taken increasingly desperate measures to staunch the inflows confirms this interpretation of soaring hot money proxies.If hot money is indeed increasing as quickly as the various proxies suggest, it indicates that not only is Chinese reserve accumulation going through a large quantitative change as it doubles yet again, it is going through an even more important qualitative change. Hot money is notoriously unstable and even more notoriously procyclical. When the economy is growing, or even overheating, inflows are likely to increase net investment and add even more fuel to the economic engine. But when conditions change and the economy begins to slow or the country face financial risks, hot money is likely to flee the country, exacerbating the very conditions it is fleeing. The Asian financial crisis steeled Chinese policymakers to create safeguards against capital flight, and China’s massive reserves and capital controls are likely to prevent a rapid speculative assault on the renminbi. However, just because China may be less vulnerable to an external financing crisis does not mean that authorities are out of the woods. The increasing procyclicality of Chinese capital inflows could place the gradualist, consensus-driven Chinese leadership significantly behind the curve when the inflows reverse, when the government should be providing liquidity to the real economy rather than mopping it up. Under these conditions, the risks to the domestic banking system, rather than the currency, are likely to be more significant.

Sunday, July 13, 2008

Bank consolidation Under the hammer

M&A in financial industry will follow as banks find it's increasingly hard to raise funds. Big deals will be scare because few banks have strong hand to play and most banks sit tight in their capital. But disposal of assets will be the obvisou escape route... LIKE plane-crash survivors forced to eat their fellow passengers, investment bankers have found some sources of nourishment amid the wreckage of the banking industry. Helping weakened institutions to raise capital has produced a useful stream of fees. Goldman Sachs, a tediously successful investment bank, notched up a 72% increase in equity-underwriting revenues in the second quarter, much of it from other banks. But many have their eyes on an even bigger prize: the wave of M&A deals that is expected, eventually, to result from the credit crisis. That a big shake-out is coming is in little doubt. Weaknesses in funding and business models have been laid horribly bare. Some franchises were too focused on the wrong markets. Wachovia, America’s fourth-largest bank, has suffered from outsize exposure to California’s imploding housing market and is a potential takeover target. Others face regulations that threaten their profits. The Wall Street banks are bracing for tougher capital and liquidity requirements as the price for access to the balance sheet of the Federal Reserve. Others still are questioning whether they have the right mix of businesses. The integration of volatile investment banking and staid wealth management at UBS and Credit Suisse, two Swiss banks, is the subject of much alpine soul-searching. Allianz, a German insurer, has apparently lost patience with its foray into investment banking, and is restructuring its Dresdner Bank subsidiary. Rumours fly about the blockbuster deals that may soon be done. Lehman Brothers, a Wall Street bank that is desperately fighting to restore confidence in its prospects, is at the centre of many of them. Barclays, Deutsche Bank, HSBC and Royal Bank of Canada are among the names to have been bandied about as predators in recent weeks. UBS, which has been hit by massive write-downs on mortgage-backed securities, is also the subject of whispers—with Barclays, Deutsche and HSBC again to the fore. Bright-eyed bankers peddle ideas for other combinations. How about Lehman’s Wall Street clout and Standard Chartered’s emerging-markets network? Or HSBC and Merrill Lynch? Short of an implosion to rival that of Bear Stearns in March, however, the rumours are unlikely to become real deals for the time being. For sellers, shares have fallen so steeply that deals are only for the truly desperate. Lehman, where the employees own lots of the equity, has a strong reason not to sell out while prices are so low. UBS is badly bloodied, but has raised lots of capital and said on July 4th that it will come close to breaking even in the second quarter. In Germany the long-awaited sale of Postbank, a retail bank, is reportedly sticking on the optimistic price expectations of Deutsche Post, its parent. More importantly, buyers are scarce. “There are so few people with strong hands to play,” says Huw van Steenis, an analyst at Morgan Stanley. Those banks that do have the firepower to make purchases have plenty of reasons to sit tight. In an environment this febrile, banks are anxious to husband their own capital rather than deplete it. Deutsche Bank is under pressure to bring down its leverage ratio, a measure of gross assets to capital. Barclays raised £4.5 billion ($9 billion) in June, but is still more thinly capitalised than many of its peers. HSBC has been burnt by its disastrous acquisition of Household, an American lender, and is in any case committed to expanding in emerging markets rather than developed ones. Remember too that those banks able to contemplate acquisitions just now are the very ones that tended to manage their balance-sheets most conservatively in the run-up to the crisis. Taking a bet on a big deal today would be a huge and uncharacteristic gamble. Due diligence on banks’ structured-credit exposures remains a nightmarish prospect for would-be acquirers (“a toxic tool-chest of joy” is one observer’s pithy description of Lehman). Liquidity is also now a big part of buyers’ calculations. Few want to bump up the amount of debt that needs to get rolled over while credit markets are still dislocated. Inevitably, accounting standards add to the complexity, by requiring acquirers to account for the assets and liabilities they buy at fair value. In addition, paying out today makes little sense, because targets are still getting cheaper. On July 7th the KBW Bank index of American commercial-bank shares fell to its lowest level since 1997, as investors fretted about rising credit losses. Buyers would doubtless also welcome greater certainty about the regulatory reforms before forking out, particularly over the higher capital requirements the investment banks may have to bear. Regulators themselves may set up roadblocks to deals, either because they take a generally dim view of capital-sapping acquisitions or because of the rules. The restriction that no bank can own more than 10% of American deposits is one reason to doubt reports linking JPMorgan Chase and Wachovia. For UBS, the Swiss would also doubtless want a foreign buyer to decamp to Switzerland, a big barrier to a deal. “Consolidation will come in two years’ time, not now,” says Alessandro Profumo, the boss of UniCredit, an Italian bank. “For now, people are conserving capital.” The less that big pieces of the jigsaw move, the more smaller ones will instead. Banks’ need for capital is not yet satisfied and there is mounting concern that investors are less willing to inject cash into sinking assets (see article). Disposals are the obvious escape route. Some smaller deals are already being done. Bidding is under way for the insurance arm of Royal Bank of Scotland; Banco Sabadell and Banco Pastor, two Spanish banks, have put bits of their insurance divisions on the block too. Citigroup is in talks to offload its German retail operations; predators will doubtless hope that it decides to sell some of its emerging-markets operations too. Deutsche snapped up the Dutch corporate-banking arm of ABN AMRO from Fortis, a Benelux bank, for a song on July 2nd. It paid £709m ($1.1 billion) in cash. Expectations grow that Merrill Lynch, which is due to report its second-quarter earnings on July 17th, will sell some or all of its stakes in Bloomberg, an information provider, and (more damaging to future earnings) BlackRock, a thriving fund manager. A phoney war has broken out down under in anticipation that HBOS, Britain’s biggest mortgage lender, will offload its Australian unit. According to one of Europe’s most senior bankers, there will be “an unending fire-sale of non-core assets” over the next 18 months. The big question, of course, is whether that will keep bank finances shored up long enough for markets to stabilise. If losses continue to spiral, capital dries up, and disposable assets cannot find purchasers, banks will have little choice but to cut back even harder on lending, or to take whatever price they can get.

Roubini's proposal to Fannie and Freddie

Scarstic Roubini proposed a 5% haircut of debtholder for Fanni and Freddie, which in his judegemente is supeior than regulator's conservatorship bailout: 5% haircut wont's destroy their business and the price of their debts have already priced in the insovlvency. He also crticized the govenment's subsidy to housing owners, which generate zippo growth for really economy....

The issue now is: what happens next to Fannie and Freddie?....The conventional answer is that their shareholders get fully wiped out but that their creditors (those holding the $5 trillion of these agencies' debt and their other liabilities) are made whole... First notice that..... investors always expected that the liabilities of the two GSEs would be eventually backed by the U.S. government. And in spite of the decade long rhetoric....that Fannie and Freddie were private firms.... the reality was different: these were effectively public institutions – not private ones - used by the government (especially this administration) to pursue public policy goals. The hawkish rhetoric about the “moral hazard”....was thrown out of the window the moment the housing and mortgage bust started. Instead, for the last few months the GSEs – that were already bleeding and becoming insolvent on their own portfolio – have been used by the government to back stop the mortgage markets.... To minimize the financial cost of this farce the administration should stop pretending that these are private institutions and go ahead and take them over and nationalize them .... The financial costs of this farce include the $50 billion of subsidy that the GSEs bondholders/creditors are receiving every year as the spread of the agency debt over Treasury is now close to 100bps (100bps on $5 trillion of liabilities is equal to $50 billion)..... But if the government is going to bail them out - because the consequences of a capital levy on their bondholder will destroy the mortgage and housing markets - the government should at least make this implicit liability (the guarantee of the $5 trillion debt of the GSEs) explicit and thus save the U.S. taxpayer that $50 billion subsidy....... let us consider ...what should be done in an ideal world? The simple answer is that we need to limit as much as possible the moral hazard of a bailout of Fannie and Freddie.... And such a bailout is neither necessary, appropriate nor desirable. Of course most of Wall Street, domestic and foreign investors and Congress are already screaming and begging “Bail us out, bail us out!” .... But these screams of “the sky will fall” if we don’t rescue Fannie and Freddie are vastly exaggerated and incorrect for a number of reasons. First, notice that the hit that bondholders will take will be limited in the absence of their bailout. With a debt/liabilities of about $5 trillion and expected insolvency – as of now and in the worst scenario of $200 to $300 billion – the necessary haircut is relatively modest: either a reduction in the face value of the claims of the order of 5% (if the mid-point hole is $250 billion) or – for unchanged face value – a very modest reduction in the interest rate on their debt after it has been forcibly restructured. Second, a 5% haircut is much smaller than the 75% haircut that the holders of Argentine sovereign bonds suffered in 2001-2005, much smaller than the haircuts that holders or Russian and Ecuadorean debt suffered after those sovereign defaults, and much smaller than the 30% haircut that holders of corporate bonds suffer on average when a corporation goes into Chapter 11 and its debt is restructured. So why should Uncle Sam – i.e. eventually the U.S. taxpayer – pay that $250 billion bill when investors in the U.S. and around the world can afford it? The same investors are getting a fat subsidy of $50 billion a year (whose NPV is much bigger than $250 billion) for holding claims that now provide a 100bps spread above Treasuries and are under the implicit guarantee of a full bailout. Third, of the two options we need to pick one: either we formally guarantee those claims and start paying the Treasury yield on that debt saving the tax payer that $50 billion subsidy; or if we maintain the subsidy a credit event in the form of a small haircut because of insolvency would be the fair cost that such investors pay for earning the extra spread over Treasuries. Fourth, while the haircut would reduce the market value of such agency debt and inflict mark to market losses to investors such losses are already priced by the fact that the widening of the agency debt spread relative to Treasuries – from 10bps to about 100bps – has reduced the mark to market value of such agency debt. So, in the current legal limbo of insolvent GSEs whose debt is however not formally guaranteed the persistence of the spread would lead to those $250 billion mark-to-market losses regardless of a formal default, restructuring and haircut on that debt. We may as well resolve that insolvency and restore the positive net worth of the GSEs by doing the haircut. Fifth, a haircut on the debt of the GSEs does not need to destroy their business, the mortgage market or the housing market. The best debtor is a solvent debtor that has restructured and reduced its unsustainable debt burden: that is why firms coming out of a Chapter 11 process that reduces their debt burdens are viable businesses ready again to produce goods and services in a viable and profitable way. The worst thing that can happen to the GSEs is to remain as zombie comatose insolvent institutions whose debt burden is not restructured and who are barely propped by an implicit government lifeline. Do we really believe that GSEs with unrestructured debt kept alive in a zombie government “conservatorship” (the solution now most likely preferred by the U.S. administration) could function properly and continue their service of supporting the mortgage and housing market? Lets instead clean them up first and make them financially viable – after an out-of-court Chapter 11 style debt reduction – so as to ensure that they keep on providing the public goods that they are alleged to give. Sixth, the existence of a major part of the overall U.S. subsidization of housing capital that will eventually lead to the bankruptcy of the U.S. economy. For the last 70 years investment in housing – the most unproductive form of accumulation of capital – has been heavily subsidized in 100 different ways in the U.S.: tax benefits, tax-deductibility of interest on mortgages, use of the FHA, massive role of Fannie and Freddie, role of the Federal Home Loan Bank system, and a host of other legislative and regulatory measures. The reality is that the U.S. has invested too much – especially in the last eight years – in building its stock of wasteful housing capital (whose effect on the productivity of labor is zero) and has not invested enough in the accumulation of productive physical capital (equipment, machinery, etc.) that leads to an increase in the productivity of labor and increases long run economic growth. This financial crisis is a crisis of accumulation of too much debt – by the household sector, the government and the country – to finance the accumulation of the most useless and unproductive form of capital, housing, that provides only housing services to consumers and has zippo effect on the productivity of labor. So enough of subsidizing the accumulation of even bigger MacMansions through the tax system and the GSEs.And these MacMansions and the broader sprawl of suburbian/exurban housing are now worth much less – in NPV terms – not only because of the housing bust and the fall in home prices but also because: a) the high oil and energy prices makes it outrageously expensive to heat those excessively big homes; b) households living in suburbian and exurban homes that are far from centers of work, business and production that are not served by public transportation are burdened with transportation costs that are becoming unsustainable given the high price of gasoline. So on top of the housing bust that will reduce home values by an average of 30% relative to peak high oil/energy prices make the same large homes in the far boonies of suburbia/exurbia worth even less – probably another 10% down – because of the cost of heating palatial MacMansions and because of the cost of traveling dozens of miles to get to work in gas guzzling SUVs. Thus, it is time to stop this destruction of national income and wealth that a cockamamie decades long policy of subsidizing the accumulation of wasteful and unproductive housing capital has caused.... Will this optimal policy solution - an haircut for bondholders - be undertaken? Most likely not as the political economy of housing, mortgages and of “privatizing profits and socializing” losses may dominate the policy outcome. Financial institutions love a system where they gamble recklessly, pocket the profits in good times and let the fisc (taxpayer) pay the bill when their reckless behavior triggers a financial crisis; this is socialism for the rich. That is why you already hear the whole Wall Street Greek chorus moaning for a bailout of the GSEs. But the financial costs of this financial crisis – the worst since the Great Depression – are mounting so fast that any bailout will become fiscally extremely expensive. Indeed, my initial estimates of $1 to $2 trillion dollars of losses from this financial crisis did not include the bailout of Bear Stearns' creditors, the bailout of the GSEs bondholders, the fiscal costs of the Frank-Dodd bill, the fiscal costs a severe U.S. recession that is mushrooming an already large fiscal deficit, the fiscal cost of bailing out – a' la Bear Stearns - the last four remaining major independent broker dealers (as the time for such independent broker dealers is now gone as – given their wholesale overnite funding - they are subject to bank-like runs much more severe than for banks), the cost of bailing out the Federal Home Loan Bank system (another GSE system that pretends to be private and that has been happily propping up or bailing out – to the tune of hundreds of billions of liquidity support – illiquid and insolvent mortgage lenders). Switching the informal guarantee of GSEs debt to a formal government guarantee would by itself increase the US gross public debt by $5 trillion and effectively double it. Thus, soon enough, if we fiscalize all of these losses the U.S. may fast lose its AAA sovereign debt rating and eventually end up like an insolvent banana republic. It is thus time to put a stop to the coming “mother of all bailouts” starting with a firm stop to the fiscal rescue of Fannie and Freddie, institutions that have behaved for the last few years like the “mother of all leveraged hedge funds” with their reckless leverage and reckless financial activities.

Saturday, July 12, 2008

Capital Measures of Fannie and Freddie

Investors, debtholders, companies use different capital measures to guage the riskness and get different pictures. GAAP capital measure include just equity, regulator look at core capital, such as Tier 1, which omits the loss the of asset. The collapse of shares in Fannie Mae and Freddie Mac came down to investors' fear that the mortgage companies don't have enough capital to weather the housing crisis. Yet the companies, and their regulator, say this isn't so. And even as the stock market panicked, investors were more sanguine when it came to Fannie and Freddie's debt. Sound crazy? Actually, it makes perfect sense. Investors, regulators and the government are looking at different numbers when it comes to capital at Fannie and Freddie. The drubbing of their stock highlights a growing loss of confidence among investors in many measures that regulators use to argue the companies' strength. Until Fannie, Freddie and their regulator acknowledge this, the stocks will rightly keep getting killed. So far, though, that isn't happening. In statements Friday, Fannie and Freddie each said they are adequately capitalized, but in arguing their cases pointed to measures of regulatory capital investors no longer trust. Debt investors, meanwhile, haven't been as worried by the capital conundrum because they remain confident the government will, if necessary, back the companies' liabilities. They are probably right to think that a worst-case scenario would run along the lines of the Bear Stearns bailout: The stock gets creamed, but debtholders are all right. At the heart of the questions over capital are three key measures. The most basic is shareholder equity based on generally accepted accounting principles. Next comes core capital, the regulatory measure. Finally, the companies provide a capital figure using market values for all their assets and liabilities. Regulators and the companies look to core capital, which is similar to gauges used for banks, such as Tier I capital. But Fannie and Freddie's regulatory capital figures omit some potential losses, while giving credit for assets that banks wouldn't be able to count toward Tier 1 capital. When times were good, investors didn't worry too much about this. That changed as investors grew more anxious about potential losses from the more than $5 trillion in mortgages the companies hold or guarantee. Investors began paying closer attention to the GAAP balance sheet and fair-value figures. On that score, Fannie looked decidedly weak; Freddie was a basket case. At the end of the first quarter, Freddie's regulatory capital was about $38 billion. Yet GAAP total shareholders equity was $16 billion and common equity, or book value, was just $2 billion. On a fair-value basis, the company had negative net worth of nearly $17 billion. How could there be such a big difference? Core capital excludes losses on securities that Fannie and Freddie hold but that don't immediately show up in profit. Freddie had about $10 billion in such losses in the first quarter. The company believes such losses are temporary, but many investors aren't so sure. The differing views on capital become especially important because they can influence debt investors' willingness to lend short-term money. Fannie and Freddie each had more than $200 billion in short-term debt outstanding at the end of the first quarter. So far, investors haven't backed away from this debt, although they are demanding slightly higher interest rates. That is in part because of the belief that the U.S. government will ultimately make good on the companies' debts. The companies also can fund themselves for short periods without rolling over short-term debts. But that doesn't solve the capital issue. Investors are in show-me mode. Smoke, mirrors and regulatory capital measures will no longer suffice.