Based on 2007 10-k and 8-k 2008 financial statements
Bear Stearns (total liability 383.6 bil, asset 395 bil, 143 bil financial instrments)
1.repo financing 102 bil, 26.6% of liabilities
2.long term 68.5 bil, 17.85% of liabilities
3.unencumbered collateral asset: 16.3 bil w a borrowing value of $14 bil (3.6%)
3.a unregulated unencumbered collateral asset: $5.1 bil (1%)
4.mortgage and abs exposure 46 bil + 30 bil(VIE), 11.6% of total, 32% of financial instruements
--> cash + unregulated unencumbered collateral asset = 17 bil + 5 bil = 22 bil (5.7%)
Lehman (liab 668.6 bil, asset 691 bil, financial instrument 393 bil)
1.repo financing 181.7 bil, 27%
2.long term 123 bil,k 18.4%
3.unencumbered collateral asset: 193.6 bil (29%)
3.a unregulated unencumbered collater asset: $98.1 bil (14.7%) (including cash equivalent) no change until Feb 29th 2008
Exposure to Toxic Assets
mortgage exposure 89 bil, out of assets 691 bil 13%, 22% of financial instrmenet
in Q1. US mortgage exposure is $22 bil, CMBS $36.1 bil ($17 bil US)
Appropriate Hedging: FI gross writedown in Q1 $4.7 bil ($3 residential mortgage, 1.1 CMBs, 0.7 bil leveraged loan), net write-down $1.8 bil (0.8 net RMBS, $0.7 bil CMBS, $0.3 leverage loan) (60% hedged)
writedown forecast
Morgage: 3 bil, CMBS 1.7 bil, Leveraged Loan 0.7 : net $2 bil
captial: the company is planning to raise 3.7 bil convertible preferred stock. Together with eligible collater and liqudity pool (98 bil), it is well positioned.
---> cash + unregulated unencumbered collateral asset = 98.1 bil (14.7%)
Comments:
--Bear Stearns has far more liquidity issue than Lehman
--Leh should weather the storm. But it will have further stumbles. The best time to buy Leh credit is the end of Q2.
Monday, March 31, 2008
Banks Regulatory Overhaul
``Our current regulatory regime is almost solely focusedabove ground at the tree level,'' Paulson said in remarks at theTreasury in Washington. ``The real threat to market stability isbelow ground, at the root level where the health of financialfirms is intertwined.''
``We should and can have a structure that is designed for the world we live in, one that is more flexible, one that can better adapt to change, one that will allow us to moreeffectively deal with inevitable market disruptions, one thatwill better protect investors and consumers,'' Paulson said.
``We should and can have a structure that is designed for the world we live in, one that is more flexible, one that can better adapt to change, one that will allow us to moreeffectively deal with inevitable market disruptions, one thatwill better protect investors and consumers,'' Paulson said.
trading view: Icelandic banks
Glitnir Banki HF
--A rating, CDS trading at nearly 1000 bps, stock trading at nearly 17.25, -20% down YTD
--strategy: sell 5y cds or sell 5y CDS + short stocks
--reasoning:
a.even though it has 300 bil ISK bonds and loans due this year, it has enought funding to cushion liquidity: LT bonds increased 300 bill (ISK) in 2007; Customers deposits increased 300 bil (ISK)
b.iceland economy is still holding up fine, unemployment rate 1%, 7 year low
c.iceland authority will serve as the backstop of the bank
--A rating, CDS trading at nearly 1000 bps, stock trading at nearly 17.25, -20% down YTD
--strategy: sell 5y cds or sell 5y CDS + short stocks
--reasoning:
a.even though it has 300 bil ISK bonds and loans due this year, it has enought funding to cushion liquidity: LT bonds increased 300 bill (ISK) in 2007; Customers deposits increased 300 bil (ISK)
b.iceland economy is still holding up fine, unemployment rate 1%, 7 year low
c.iceland authority will serve as the backstop of the bank
Prospects are uncertain for insurers
The Treasury Department's proposal to let insurers choose federal rather than state regulation would fulfill a long-held dream of some of the industry's major players. But many doubt that this piece of the financial-regulation overhaul plan will become reality any time soon.
As part of its broad bid to change how financial firms are overseen, the Treasury Department wants the power to charter insurance companies at the federal level, if they prefer. Now, insurance is regulated by states, and big insurers have griped for years that they must deal with dozens of bureaucracies and sets of rules.
Under Treasury's proposal, insurers would have the option of being regulated by the federal government, though they could also remain under state regulation. (Firms that chose federal regulation would still have to comply with state laws in some cases, under the proposal.)
The proposal says that state regulation makes it "cumbersome and more costly" for insurers to develop products that they can sell nationally, and "creates increasing tensions" for U.S. insurers operating abroad and foreign insurers in the U.S.
But the industry does not unanimously support the concept. "We don't believe you need a massive new bureaucracy," says Robert Rusbuldt, chief executive of the Independent Insurance Agents & Brokers of America, a trade group.
One concern among smaller insurers is that the big firms will gain an advantage. Smaller insurers "would have less opportunity to switch" regulatory regimes because of the time and cost involved,
As part of its broad bid to change how financial firms are overseen, the Treasury Department wants the power to charter insurance companies at the federal level, if they prefer. Now, insurance is regulated by states, and big insurers have griped for years that they must deal with dozens of bureaucracies and sets of rules.
Under Treasury's proposal, insurers would have the option of being regulated by the federal government, though they could also remain under state regulation. (Firms that chose federal regulation would still have to comply with state laws in some cases, under the proposal.)
The proposal says that state regulation makes it "cumbersome and more costly" for insurers to develop products that they can sell nationally, and "creates increasing tensions" for U.S. insurers operating abroad and foreign insurers in the U.S.
But the industry does not unanimously support the concept. "We don't believe you need a massive new bureaucracy," says Robert Rusbuldt, chief executive of the Independent Insurance Agents & Brokers of America, a trade group.
One concern among smaller insurers is that the big firms will gain an advantage. Smaller insurers "would have less opportunity to switch" regulatory regimes because of the time and cost involved,
Sunday, March 30, 2008
Housing Woes Shake Bank in California
The financial crisis threatened to claim its first casualty in the U.S. banking industry, as federal and state regulators gave a rare directive to Fremont General Corp. to shore up its operations immediately.
While the California lender's woes don't pose a threat to the broader financial system, its plight marks a new stage in the turmoil that began last summer. Regulators said the Brea, Calif., company, parent of a once highly active subprime lender called Fremont Investment & Loan, must raise new capital within the next 60 days or sell its banking subsidiary.
Fremont disclosed Friday that the FDIC had issued a "prompt corrective action" order on Wednesday requiring it to raise capital or be sold, according to a filing with the Securities and Exchange Commission. "The financial condition of Fremont General Corporation, the company having ultimate control over the Bank, continues to deteriorate," the FDIC said in the order.
Along with the California Department of Financial Institutions, the FDIC set a May 26 deadline to raise the capital. At the same time, the regulators said the bank can't seek capital by offering depositors higher interest rates than the rates prevailing in the California market. In addition, the bank won't be allowed to make capital payments to its parent or an affiliate, or pay bonuses to bank executives.
Fremont doesn't appear likely to attract a federal rescue such as the one arranged for Bear Stearns Cos. Bear, a major Wall Street investment bank, had huge, complex exposure to other companies and creditors that could have provided a systemic shock to financial markets in the event of its collapse. Fremont's exposure is more isolated and contained.
Fremont was one of the top 10 U.S. originators of subprime loans, thanks to practices that included loose underwriting and aggressive marketing to brokers.
Fremont was hardly a household name. All of its 22 retail branches were in California, and it didn't advertise directly to consumers with TV ads or newspaper pitches. Yet from 2004 to 2006, Fremont made $81 billion in high-interest-rate loans, fourth-highest among U.S. lenders, according to a Wall Street Journal analysis of lending data filed with federal regulators. Nearly all of its home mortgages were subprime loans, which then were bundled into pools, sliced up and sold off to investors.
In March 2007, the federal government forced Fremont to stop making subprime loans and to cease operating with management whose "policies and practices are detrimental." The company agreed to the order and sold its subprime division. Fremont was permitted to keep its commercial real-estate operations, but the FDIC required the bank to shore up this business line and improve risk management.
In October, Massachusetts Attorney General Martha Coakley filed a suit against Fremont General and its banking unit, Fremont Investment & Loan, alleging that they were offering risky products such as 100% financing and "no documentation" loans that were unfair and deceptive.
Fremont denies wrongdoing. In a court filing in November, it said that without access to its loans -- often requiring a lower standard of proof of income, assets and credit history than traditional lenders -- "many Massachusetts residents who are homeowners today would never have been able to purchase homes." Last month, a Massachusetts court issued a preliminary injunction saying Fremont couldn't foreclose on mortgages in the state without checking with the attorney general.
Fremont was also a key player in Florida, one of the markets hardest hit in the real-estate slump. In 2005, at the housing boom's peak, Fremont made nearly 5,000 high-rate mortgages in the Miami/Miami Beach/Kendall metro area, making it the second-biggest subprime lender there.
The company, which hasn't filed financial results since Sept. 30, has been seeking a buyer for months. It installed a new CEO and executive team in November and a new board in January.
The FDIC has given "prompt corrective action" notices to only 13 other banks since it started releasing public data on these directives in 1993. Six of those banks failed, some within weeks of the notice. Such notices typically only come when a bank has very low capital levels or is at risk of failure. (Federal bank regulators often issue less-stringent public and private enforcement actions against banks.)
There have only been five bank failures since July 2004. But federal regulators have warned of more potentially insolvent institutions, particularly banks with high exposures to risky commercial real-estate loans.
After the savings-and-loan crisis of the late 1980s, Congress passed a law that required early intervention in problem banks -- known as "prompt corrective actions" -- to prevent troubled banks from digging themselves into a deeper hole. The 1991 legislation was called the Federal Deposit Insurance Corporation Improvement Act.
The best hope for Fremont might be a federally engineered sale at a fire-sale price, or a deal structured in a way that cushions the buyer from some liabilities. For example, the 1983 purchase of Seafirst Corp. by BankAmerica Corp., a predecessor of Bank of America Corp., included new nonvoting preferred shares that left Seafirst shareholders bearing the financial risk of bad loans for five years. Also, Chemical New York Corp. -- now part of J.P. Morgan Chase & Co. -- was able to spin off problem energy and real-estate loans into a separate bank when it bought Texas Commerce Bancshares Inc. in 1987.
Some larger lenders also are trying to bolster depleted capital levels. Washington Mutual Inc., the nation's largest savings-and-loan, and National City Corp., a Cleveland-based bank, have hired investment bankers to help them raise cash, say people familiar with the matter. National City is also exploring a possible sale of itself. The capital-raising efforts haven't been successful so far.
While the California lender's woes don't pose a threat to the broader financial system, its plight marks a new stage in the turmoil that began last summer. Regulators said the Brea, Calif., company, parent of a once highly active subprime lender called Fremont Investment & Loan, must raise new capital within the next 60 days or sell its banking subsidiary.
Fremont disclosed Friday that the FDIC had issued a "prompt corrective action" order on Wednesday requiring it to raise capital or be sold, according to a filing with the Securities and Exchange Commission. "The financial condition of Fremont General Corporation, the company having ultimate control over the Bank, continues to deteriorate," the FDIC said in the order.
Along with the California Department of Financial Institutions, the FDIC set a May 26 deadline to raise the capital. At the same time, the regulators said the bank can't seek capital by offering depositors higher interest rates than the rates prevailing in the California market. In addition, the bank won't be allowed to make capital payments to its parent or an affiliate, or pay bonuses to bank executives.
Fremont doesn't appear likely to attract a federal rescue such as the one arranged for Bear Stearns Cos. Bear, a major Wall Street investment bank, had huge, complex exposure to other companies and creditors that could have provided a systemic shock to financial markets in the event of its collapse. Fremont's exposure is more isolated and contained.
Fremont was one of the top 10 U.S. originators of subprime loans, thanks to practices that included loose underwriting and aggressive marketing to brokers.
Fremont was hardly a household name. All of its 22 retail branches were in California, and it didn't advertise directly to consumers with TV ads or newspaper pitches. Yet from 2004 to 2006, Fremont made $81 billion in high-interest-rate loans, fourth-highest among U.S. lenders, according to a Wall Street Journal analysis of lending data filed with federal regulators. Nearly all of its home mortgages were subprime loans, which then were bundled into pools, sliced up and sold off to investors.
In March 2007, the federal government forced Fremont to stop making subprime loans and to cease operating with management whose "policies and practices are detrimental." The company agreed to the order and sold its subprime division. Fremont was permitted to keep its commercial real-estate operations, but the FDIC required the bank to shore up this business line and improve risk management.
In October, Massachusetts Attorney General Martha Coakley filed a suit against Fremont General and its banking unit, Fremont Investment & Loan, alleging that they were offering risky products such as 100% financing and "no documentation" loans that were unfair and deceptive.
Fremont denies wrongdoing. In a court filing in November, it said that without access to its loans -- often requiring a lower standard of proof of income, assets and credit history than traditional lenders -- "many Massachusetts residents who are homeowners today would never have been able to purchase homes." Last month, a Massachusetts court issued a preliminary injunction saying Fremont couldn't foreclose on mortgages in the state without checking with the attorney general.
Fremont was also a key player in Florida, one of the markets hardest hit in the real-estate slump. In 2005, at the housing boom's peak, Fremont made nearly 5,000 high-rate mortgages in the Miami/Miami Beach/Kendall metro area, making it the second-biggest subprime lender there.
The company, which hasn't filed financial results since Sept. 30, has been seeking a buyer for months. It installed a new CEO and executive team in November and a new board in January.
The FDIC has given "prompt corrective action" notices to only 13 other banks since it started releasing public data on these directives in 1993. Six of those banks failed, some within weeks of the notice. Such notices typically only come when a bank has very low capital levels or is at risk of failure. (Federal bank regulators often issue less-stringent public and private enforcement actions against banks.)
There have only been five bank failures since July 2004. But federal regulators have warned of more potentially insolvent institutions, particularly banks with high exposures to risky commercial real-estate loans.
After the savings-and-loan crisis of the late 1980s, Congress passed a law that required early intervention in problem banks -- known as "prompt corrective actions" -- to prevent troubled banks from digging themselves into a deeper hole. The 1991 legislation was called the Federal Deposit Insurance Corporation Improvement Act.
The best hope for Fremont might be a federally engineered sale at a fire-sale price, or a deal structured in a way that cushions the buyer from some liabilities. For example, the 1983 purchase of Seafirst Corp. by BankAmerica Corp., a predecessor of Bank of America Corp., included new nonvoting preferred shares that left Seafirst shareholders bearing the financial risk of bad loans for five years. Also, Chemical New York Corp. -- now part of J.P. Morgan Chase & Co. -- was able to spin off problem energy and real-estate loans into a separate bank when it bought Texas Commerce Bancshares Inc. in 1987.
Some larger lenders also are trying to bolster depleted capital levels. Washington Mutual Inc., the nation's largest savings-and-loan, and National City Corp., a Cleveland-based bank, have hired investment bankers to help them raise cash, say people familiar with the matter. National City is also exploring a possible sale of itself. The capital-raising efforts haven't been successful so far.
Saturday, March 29, 2008
Growing Gulf Divides China and Old Foe - NY Times
Across much of the Western world, the Dalai Lama is known as the beatific spiritual leader of a humble community of Buddhists, beloved in Hollywood, Congress and the White House, winner of the Nobel Peace Prize.
Chinese leaders cast him in a different light. They call him a separatist and a terrorist, bent on killing innocent Han Chinese and “splitting the motherland.” That gap in perception, which has grown immeasurably wider in the two weeks since violent unrest rocked Tibet, is breeding pessimism that Chinese leaders are willing — or perhaps even able — to embark on a new approach to Tibet even as it threatens to cast a long shadow over their role as hosts of the Olympic Games this summer.
Already, President Nicolas Sarkozy of France has suggested that he might consider using his presidency of the European Union this summer to organize a boycott of the opening ceremonies of the Olympics. An embarrassing protest at the lighting ceremony of the Olympic torch in Greece, and the cries of monks in Lhasa who disrupted a scripted tour of the Tibetan capital for foreign reporters on Thursday, portend a steady drum roll of criticism of China.
The call for some kind of Chinese-Tibetan talks continues to mount. On Friday, the Dalai Lama, speaking in India, made his most extended comments on the violence, accusing China’s state-run media of trying to “sow the seeds of racial tension” there but calling for “meaningful dialogue” with Beijing about how to defuse tensions.
China says that the riots killed about 20 people and were orchestrated by separatist followers of the Dalai Lama, the exiled Tibetan spiritual leader, and that the government responded with restraint.
Chinese leaders cast him in a different light. They call him a separatist and a terrorist, bent on killing innocent Han Chinese and “splitting the motherland.” That gap in perception, which has grown immeasurably wider in the two weeks since violent unrest rocked Tibet, is breeding pessimism that Chinese leaders are willing — or perhaps even able — to embark on a new approach to Tibet even as it threatens to cast a long shadow over their role as hosts of the Olympic Games this summer.
Already, President Nicolas Sarkozy of France has suggested that he might consider using his presidency of the European Union this summer to organize a boycott of the opening ceremonies of the Olympics. An embarrassing protest at the lighting ceremony of the Olympic torch in Greece, and the cries of monks in Lhasa who disrupted a scripted tour of the Tibetan capital for foreign reporters on Thursday, portend a steady drum roll of criticism of China.
The call for some kind of Chinese-Tibetan talks continues to mount. On Friday, the Dalai Lama, speaking in India, made his most extended comments on the violence, accusing China’s state-run media of trying to “sow the seeds of racial tension” there but calling for “meaningful dialogue” with Beijing about how to defuse tensions.
China says that the riots killed about 20 people and were orchestrated by separatist followers of the Dalai Lama, the exiled Tibetan spiritual leader, and that the government responded with restraint.
Paulson's plan to overhaul regulatory system
Mr. Paulson is also expected to call for the Office of Thrift Supervision, which regulates federal thrifts, to be phased out within two years and merged with the Office of the Comptroller of the Currency, which regulates national banks. One reason is that there is very little difference these days between federal thrifts and national banks.
A key part of the blueprint is aimed at fixing lapses in mortgage oversight. Mr. Paulson plans to call for the creation of a new entity, called the Mortgage Origination Commission, according to an outline of the Treasury Department's plan, which was first reported by the New York Times. This new entity would create licensing standards for state mortgage companies. This commission, which would include representatives from the Fed and other agencies, would scrutinize the way states oversee mortgage origination.
Also related to mortgages, Mr. Paulson is expected to call for federal laws to be "clarified and enhanced," resolving any jurisdictional issues that exist between state or federal supervisors. Many of the problems in the housing market stemmed from loans offered by state-licensed companies. Federal regulators, too, were slow to create safeguards that could have banned some of these practices.
A market stability regulator, which would likely be the Fed, would have broad powers over all three types of companies. A new regulator, called the Prudential Financial Regulatory Agency, would oversee the financial regulation of the insurance and federally insured banks. Another regulator, the Business Regulatory Agency, would oversee business conduct at all the companies.
A key part of the blueprint is aimed at fixing lapses in mortgage oversight. Mr. Paulson plans to call for the creation of a new entity, called the Mortgage Origination Commission, according to an outline of the Treasury Department's plan, which was first reported by the New York Times. This new entity would create licensing standards for state mortgage companies. This commission, which would include representatives from the Fed and other agencies, would scrutinize the way states oversee mortgage origination.
Also related to mortgages, Mr. Paulson is expected to call for federal laws to be "clarified and enhanced," resolving any jurisdictional issues that exist between state or federal supervisors. Many of the problems in the housing market stemmed from loans offered by state-licensed companies. Federal regulators, too, were slow to create safeguards that could have banned some of these practices.
A market stability regulator, which would likely be the Fed, would have broad powers over all three types of companies. A new regulator, called the Prudential Financial Regulatory Agency, would oversee the financial regulation of the insurance and federally insured banks. Another regulator, the Business Regulatory Agency, would oversee business conduct at all the companies.
Executive Summary of Paulson with Regard to Overhaul of Regulatorty System
The mission of the Department of the Treasury (“Treasury”) focuses on promoting economic growth and stability in the United States. Critical to this mission is a sound and competitive financial services industry grounded in robust consumer protection and stable and innovative markets.
Financial institutions play an essential role in the U.S. economy by providing a means for consumers and businesses to save for the future, to protect and hedge against risks, and to access funding for consumption or organize capital for new investment opportunities.
A number of different types of financial institutions provide financial services in the United States: commercial banks and other insured depository institutions, insurers, companies engaged in securities and futures transactions, finance companies, and specialized companies established by the government. Together, these institutions and the markets in which they act underpin economic activity through the intermediation of funds between providers and users of capital.
This intermediation function is accomplished in a number of ways. For example, insured depository institutions provide a vehicle to allocate the savings of individuals. Similarly, securities companies facilitate the transfer of capital among all types of investors and investment opportunities. Insurers assist in the financial intermediation process by providinga means for individuals, companies, and other financial institutions to protect assets fromv arious types of losses. Overall, financial institutions serve a vitally important function in theU.S. economy by allowing capital to seek out its most productive uses in an efficient matter. Given the economic significance of the U.S. financial services sector, Treasury considers the structure of its regulation worthy of examination and reexamination.
http://online.wsj.com/public/resources/documents/WSJ_20080328_Paulson.pdf
Financial institutions play an essential role in the U.S. economy by providing a means for consumers and businesses to save for the future, to protect and hedge against risks, and to access funding for consumption or organize capital for new investment opportunities.
A number of different types of financial institutions provide financial services in the United States: commercial banks and other insured depository institutions, insurers, companies engaged in securities and futures transactions, finance companies, and specialized companies established by the government. Together, these institutions and the markets in which they act underpin economic activity through the intermediation of funds between providers and users of capital.
This intermediation function is accomplished in a number of ways. For example, insured depository institutions provide a vehicle to allocate the savings of individuals. Similarly, securities companies facilitate the transfer of capital among all types of investors and investment opportunities. Insurers assist in the financial intermediation process by providinga means for individuals, companies, and other financial institutions to protect assets fromv arious types of losses. Overall, financial institutions serve a vitally important function in theU.S. economy by allowing capital to seek out its most productive uses in an efficient matter. Given the economic significance of the U.S. financial services sector, Treasury considers the structure of its regulation worthy of examination and reexamination.
http://online.wsj.com/public/resources/documents/WSJ_20080328_Paulson.pdf
Friday, March 28, 2008
It is time to put financial institutions within the purview of the Fed
Treasury Secretary Henry Paulson hinted Wednesday that he wants the country's patchwork financial regulatory system overhauled. It is a good time to do so.
The Federal Reserve is now lending money to investment banks, traditionally supervised by the Securities and Exchange Commission. And the Fed helped rescue Bear Stearns because, in today's interconnected markets, the firm's problems threatened the deposit-taking banks the Fed does regulate. With real levers to deploy, the Fed is well-placed to lead a simpler, more coherent regulatory effort that encompasses all of Wall Street.
It isn't a secret that the current regime is a mess. It puts different financial institutions -- or their different parts -- within the purview of the Fed, the Federal Deposit Insurance Corp., the SEC, the Office of the Comptroller of the Currency and a host of others.
The United Kingdom long ago folded multiple supervisors into one entity, the Financial Services Authority. The FSA is fallible. On Wednesday, it admitted shortcomings in its supervision of mortgage lender Northern Rock. But at least it can take a holistic view across financial markets.
The Fed already trades with the investment banks on its 20-strong list of primary dealers, so it knows them well. That relationship and the Fed's balance sheet give it real muscle. The Fed has traditionally used its power and influence to encourage prudence and pre-empt problems at banks. That is arguably of broader importance than the SEC's more retrospective compliance and enforcement mindset, although that has its place, too.
The Fed's monetary-policy role also meshes comfortably with a financial-stability remit, as the feedback loop between the mortgage meltdown and the economy has shown.
Of course, the Fed isn't perfect. Some argue, for instance, that its moves to save Bear came too late. But the financial experts at the Fed's New York branch look relatively smart so far. While the U.S. system needs more than just an extension of the Fed's oversight to the rest of Wall Street, it could be a good start.
The Federal Reserve is now lending money to investment banks, traditionally supervised by the Securities and Exchange Commission. And the Fed helped rescue Bear Stearns because, in today's interconnected markets, the firm's problems threatened the deposit-taking banks the Fed does regulate. With real levers to deploy, the Fed is well-placed to lead a simpler, more coherent regulatory effort that encompasses all of Wall Street.
It isn't a secret that the current regime is a mess. It puts different financial institutions -- or their different parts -- within the purview of the Fed, the Federal Deposit Insurance Corp., the SEC, the Office of the Comptroller of the Currency and a host of others.
The United Kingdom long ago folded multiple supervisors into one entity, the Financial Services Authority. The FSA is fallible. On Wednesday, it admitted shortcomings in its supervision of mortgage lender Northern Rock. But at least it can take a holistic view across financial markets.
The Fed already trades with the investment banks on its 20-strong list of primary dealers, so it knows them well. That relationship and the Fed's balance sheet give it real muscle. The Fed has traditionally used its power and influence to encourage prudence and pre-empt problems at banks. That is arguably of broader importance than the SEC's more retrospective compliance and enforcement mindset, although that has its place, too.
The Fed's monetary-policy role also meshes comfortably with a financial-stability remit, as the feedback loop between the mortgage meltdown and the economy has shown.
Of course, the Fed isn't perfect. Some argue, for instance, that its moves to save Bear came too late. But the financial experts at the Fed's New York branch look relatively smart so far. While the U.S. system needs more than just an extension of the Fed's oversight to the rest of Wall Street, it could be a good start.
Ten Days That Changed Capitalism
The past 10 days will be remembered as the time the U.S. government discarded a half-century of rules to save American financial capitalism from collapse.
On the Richter scale of government activism, the government's recent actions don't (yet) register at FDR levels. They are shrouded in technicalities and buried in a pile of new acronyms.
But something big just happened. It happened without an explicit vote by Congress. And, though the Treasury hasn't cut any checks for housing or Wall Street rescues, billions of dollars of taxpayer money were put at risk. A Republican administration, not eager to be viewed as the second coming of the Hoover administration, showed it no longer believes the market can sort out the mess.
"The Government of Last Resort is working with the Lender of Last Resort to shore up the housing and credit markets to avoid Great Depression II," economist Ed Yardeni wrote to clients.
First, over St. Patrick's Day weekend, the Fed (aka the Lender of Last Resort) and the Treasury forced the sale of Bear Stearns, the fifth-largest U.S. investment bank, to J.P. Morgan Chase at a price so low that a shareholder rebellion prompted J.P. Morgan to raise the price. To induce J.P. Morgan to do the deal, the Fed agreed to take losses or gains, if any, on up to $29 billion of securities in Bear Stearns's portfolio. The outcome will influence the sum the Fed turns over to the Treasury, so this is taxpayer money; that's why the Fed sought Treasury Secretary Henry Paulson's OK.
1 DISCUSSION
Has the U.S. government done enough to save American financial capitalism, or has it crossed a line? Join a discussion
2.
Then the Fed lent directly to Wall Street securities firms for the first time. Until now, the Fed has lent directly only to Main Street banks, those that take deposits from ordinary folks. That's because banks were viewed as playing a unique economic role and, supposedly, were more closely regulated than other types of lenders. In the first three days of this new era, securities firms borrowed an average of $31.3 billion a day from the Fed. That's not small change, and it's why Mr. Paulson, after the fact, is endorsing changes to give the Fed more access to these firms' books.
Increased Leverage
In the days that followed, the Republican Treasury secretary leaned on two shareholder-owned, though government-chartered, companies -- Fannie Mae and Freddie Mac -- to raise capital that their boards didn't want to raise. In exchange, their government regulator allowed them to increase their leverage so they can buy about $200 billion more in mortgage-backed securities.
So Fannie and Freddie will get bigger, a welcome development when mortgage markets are in trouble. Already, they have regained lost market share. They accounted for 76% of new mortgages in the fourth quarter of last year, up from 46% in the second quarter, Mr. Paulson said Wednesday. But everyone knows that if Fannie or Freddie stumble, taxpayers will get stuck with the tab.
And then, the federal regulator of the low-profile Federal Home Loan Banks, which are even less well capitalized than Fannie and Freddie, said they could buy twice as many Fannie and Freddie-blessed mortgage-backed securities as previously permitted -- more than $100 billion worth.
Was this necessary? It's messy, uncomfortable and undoubtedly flawed in many details. Like firefighters rushing to a five-alarm fire, policy makers are making mistakes that will be apparent only in retrospect.
Too Great to Ignore
But, regardless of how we got here, the clear and present danger that the virus in the housing, mortgage and credit markets is infecting the overall economy is too great to ignore. The Great Depression was worsened because the initial government reaction was wrong-headed. Federal Reserve Chairman Ben Bernanke spent an academic career learning how to avoid repeating those mistakes.
Is it working? It is helping. One key measure is the gap between interest rates on mortgages and safe Treasury securities. A wide gap means high mortgage rates, which hurt an already sickly housing market. A lot of recent activity, including Wednesday's previously planned auction in which the Fed is trading Treasurys for mortgage-backed securities, is aimed at increasing demand for those securities to drive down mortgage rates.
The gap remains enormous by historical standards, but has narrowed. On March 6, according to FTN Financial, 30-year fixed-rate mortgages were trading at 2.92 percentage points above the relevant Treasury rates; Wednesday the gap was down to 2.22. Normal is about 1.5 percentage points. Money markets are still under stress, as banks and others hoard cash and super-safe short-term Treasurys.
Is it enough? Probably not. Although it's hard to know, the downward tug on the overall economy from falling house prices persists. The next step, if one proves necessary, is almost sure to require the explicit use of taxpayer money.
Cushion the Blow
The case for doing more is twofold. One is to cushion the blow to families and communities, even if some are culpable. The other is to disrupt a dangerous downward spiral in which falling prices of houses and mortgage-backed securities lead lenders to pull back, hurting the economy and dragging asset prices down further, and so on.
In ordinary times, a capitalist economy lets prices -- such as those of homes, mortgage-backed securities and stocks -- fall to the point where the big-bucks crowd rushes in, hoping to make a killing. But if the big money remains on the sidelines, unpersuaded that a bottom is near, the wait for bargain hunters to take the plunge could be very long and very painful.
So the next step, no matter how it is dressed up, is likely to involve the government's moving in ways that put a floor under prices, hoping that will limit the downside risks enough so more Americans are willing to buy homes and deeper-pocketed investors are willing, in effect, to lend them the money to do so.
On the Richter scale of government activism, the government's recent actions don't (yet) register at FDR levels. They are shrouded in technicalities and buried in a pile of new acronyms.
But something big just happened. It happened without an explicit vote by Congress. And, though the Treasury hasn't cut any checks for housing or Wall Street rescues, billions of dollars of taxpayer money were put at risk. A Republican administration, not eager to be viewed as the second coming of the Hoover administration, showed it no longer believes the market can sort out the mess.
"The Government of Last Resort is working with the Lender of Last Resort to shore up the housing and credit markets to avoid Great Depression II," economist Ed Yardeni wrote to clients.
First, over St. Patrick's Day weekend, the Fed (aka the Lender of Last Resort) and the Treasury forced the sale of Bear Stearns, the fifth-largest U.S. investment bank, to J.P. Morgan Chase at a price so low that a shareholder rebellion prompted J.P. Morgan to raise the price. To induce J.P. Morgan to do the deal, the Fed agreed to take losses or gains, if any, on up to $29 billion of securities in Bear Stearns's portfolio. The outcome will influence the sum the Fed turns over to the Treasury, so this is taxpayer money; that's why the Fed sought Treasury Secretary Henry Paulson's OK.
1 DISCUSSION
Has the U.S. government done enough to save American financial capitalism, or has it crossed a line? Join a discussion
2.
Then the Fed lent directly to Wall Street securities firms for the first time. Until now, the Fed has lent directly only to Main Street banks, those that take deposits from ordinary folks. That's because banks were viewed as playing a unique economic role and, supposedly, were more closely regulated than other types of lenders. In the first three days of this new era, securities firms borrowed an average of $31.3 billion a day from the Fed. That's not small change, and it's why Mr. Paulson, after the fact, is endorsing changes to give the Fed more access to these firms' books.
Increased Leverage
In the days that followed, the Republican Treasury secretary leaned on two shareholder-owned, though government-chartered, companies -- Fannie Mae and Freddie Mac -- to raise capital that their boards didn't want to raise. In exchange, their government regulator allowed them to increase their leverage so they can buy about $200 billion more in mortgage-backed securities.
So Fannie and Freddie will get bigger, a welcome development when mortgage markets are in trouble. Already, they have regained lost market share. They accounted for 76% of new mortgages in the fourth quarter of last year, up from 46% in the second quarter, Mr. Paulson said Wednesday. But everyone knows that if Fannie or Freddie stumble, taxpayers will get stuck with the tab.
And then, the federal regulator of the low-profile Federal Home Loan Banks, which are even less well capitalized than Fannie and Freddie, said they could buy twice as many Fannie and Freddie-blessed mortgage-backed securities as previously permitted -- more than $100 billion worth.
Was this necessary? It's messy, uncomfortable and undoubtedly flawed in many details. Like firefighters rushing to a five-alarm fire, policy makers are making mistakes that will be apparent only in retrospect.
Too Great to Ignore
But, regardless of how we got here, the clear and present danger that the virus in the housing, mortgage and credit markets is infecting the overall economy is too great to ignore. The Great Depression was worsened because the initial government reaction was wrong-headed. Federal Reserve Chairman Ben Bernanke spent an academic career learning how to avoid repeating those mistakes.
Is it working? It is helping. One key measure is the gap between interest rates on mortgages and safe Treasury securities. A wide gap means high mortgage rates, which hurt an already sickly housing market. A lot of recent activity, including Wednesday's previously planned auction in which the Fed is trading Treasurys for mortgage-backed securities, is aimed at increasing demand for those securities to drive down mortgage rates.
The gap remains enormous by historical standards, but has narrowed. On March 6, according to FTN Financial, 30-year fixed-rate mortgages were trading at 2.92 percentage points above the relevant Treasury rates; Wednesday the gap was down to 2.22. Normal is about 1.5 percentage points. Money markets are still under stress, as banks and others hoard cash and super-safe short-term Treasurys.
Is it enough? Probably not. Although it's hard to know, the downward tug on the overall economy from falling house prices persists. The next step, if one proves necessary, is almost sure to require the explicit use of taxpayer money.
Cushion the Blow
The case for doing more is twofold. One is to cushion the blow to families and communities, even if some are culpable. The other is to disrupt a dangerous downward spiral in which falling prices of houses and mortgage-backed securities lead lenders to pull back, hurting the economy and dragging asset prices down further, and so on.
In ordinary times, a capitalist economy lets prices -- such as those of homes, mortgage-backed securities and stocks -- fall to the point where the big-bucks crowd rushes in, hoping to make a killing. But if the big money remains on the sidelines, unpersuaded that a bottom is near, the wait for bargain hunters to take the plunge could be very long and very painful.
So the next step, no matter how it is dressed up, is likely to involve the government's moving in ways that put a floor under prices, hoping that will limit the downside risks enough so more Americans are willing to buy homes and deeper-pocketed investors are willing, in effect, to lend them the money to do so.
Auction rate Securities hurt Tech Companies
The $330 billion market for the securities -- long-term instruments with rates that reset frequently at auction -- has seized up, making it difficult for holders to convert them to cash.
Dallas telecom company MetroPCS Communications Inc. recently took an $83 million charge related to auction-rate securities, the arcane debt instruments -- once thought to be as safe as cash -- that are now nearly impossible to sell in today's jittery markets.
in MetroPCS 10-k 2007, auction rate securiteis are disclosed under short investments
The Company holds investments of $133.9 million in certain auction rate securities some of which are secured by collateralized debt obligations with a portion of the underlying collateral being mortgage securities or related to mortgage securities. Consistent with the Company’s investment policy guidelines, the auction rate securities investments held by the Company all had AAA credit ratings at the time of purchase. With the liquidity issues experienced in global credit and capital markets, the auction rate securities held by the Company at December 31, 2007 have experienced multiple failed auctions as the amount of securities submitted for sale in the auctions has exceeded the amount of purchase orders. In addition, three auction rate securities held by the Company have been placed on credit watch. However, as of January 31, 2008, all of the auction rate securities held by the Company still retain a AAA/Aaa rating as reported by Standard and Poors and Moody’s Investors Service.
The estimated market value of the Company’s auction rate security holdings at December 31, 2007 was approximately $36.1 million, which reflects a $97.8 million adjustment to the principal value of $133.9 million. Although the auction rate securities continue to pay interest according to their stated terms, based on statements received from the Company’s broker and an analysis of other-than-temporary impairment factors, the Company has recorded an impairment charge of $97.8 million during the year ended December 31, 2007, reflecting the portion of auction rate security holdings that the Company has concluded have an other-than-temporary decline in value.
Dallas telecom company MetroPCS Communications Inc. recently took an $83 million charge related to auction-rate securities, the arcane debt instruments -- once thought to be as safe as cash -- that are now nearly impossible to sell in today's jittery markets.
in MetroPCS 10-k 2007, auction rate securiteis are disclosed under short investments
The Company holds investments of $133.9 million in certain auction rate securities some of which are secured by collateralized debt obligations with a portion of the underlying collateral being mortgage securities or related to mortgage securities. Consistent with the Company’s investment policy guidelines, the auction rate securities investments held by the Company all had AAA credit ratings at the time of purchase. With the liquidity issues experienced in global credit and capital markets, the auction rate securities held by the Company at December 31, 2007 have experienced multiple failed auctions as the amount of securities submitted for sale in the auctions has exceeded the amount of purchase orders. In addition, three auction rate securities held by the Company have been placed on credit watch. However, as of January 31, 2008, all of the auction rate securities held by the Company still retain a AAA/Aaa rating as reported by Standard and Poors and Moody’s Investors Service.
The estimated market value of the Company’s auction rate security holdings at December 31, 2007 was approximately $36.1 million, which reflects a $97.8 million adjustment to the principal value of $133.9 million. Although the auction rate securities continue to pay interest according to their stated terms, based on statements received from the Company’s broker and an analysis of other-than-temporary impairment factors, the Company has recorded an impairment charge of $97.8 million during the year ended December 31, 2007, reflecting the portion of auction rate security holdings that the Company has concluded have an other-than-temporary decline in value.
First Auction of Term Security Lending Facility Shows Less Desperation
Top-notch banks and brokerages on Wall Street appear less desperate than feared for super-safe Treasurys, if the soft demand for the first auction of the Federal Reserve's security lending facility is any guide.
At the same time, cash borrowings at the Fed's primary dealer facility increased modestly from a week earlier, averaging a daily $32.9 billion in the latest week to Wednesday.
In the first Treasurys swap, dealers put in a mere $86.1 billion in bids for the $75 billion in Treasury securities on offer, according to the New York Fed. The Fed accepted a broad range of hard-to-trade mortgage debt as collateral for its loans of super-safe government debt.
Mr. Franzese said people had expected dealers to submit as much as $100 billion for the auction. The lower-than-expected bids suggested dealers "aren't dying for the money."
As a result, the low-risk Treasurys markets saw a knee-jerk sell-off after the auction results were announced. Short-dated Treasurys, such as three-month T-bills and two-year notes, erased early gains, while the five-, 10- and 30-year sectors were down further following the auction results. The benchmark 10-year note ended down 11/32 point, or $3.4375 for every $1,000 invested, to yield 3.534%. That's up from 3.494% Wednesday. Yields rise when prices fall.
Tony Crescenzi, chief bond-market strategist at Miller Tabak & Co. in New York, said dealers did not show signs of "being desperate" to get their hands on Treasurys much beyond what was available, given the 1.15 bid-to-cover ratio. Bid-to-cover is a gauge of demand used in auctions that measures the ratio of the amount on offer and the amount of bids submitted.
At the same time, cash borrowings at the Fed's primary dealer facility increased modestly from a week earlier, averaging a daily $32.9 billion in the latest week to Wednesday.
In the first Treasurys swap, dealers put in a mere $86.1 billion in bids for the $75 billion in Treasury securities on offer, according to the New York Fed. The Fed accepted a broad range of hard-to-trade mortgage debt as collateral for its loans of super-safe government debt.
Mr. Franzese said people had expected dealers to submit as much as $100 billion for the auction. The lower-than-expected bids suggested dealers "aren't dying for the money."
As a result, the low-risk Treasurys markets saw a knee-jerk sell-off after the auction results were announced. Short-dated Treasurys, such as three-month T-bills and two-year notes, erased early gains, while the five-, 10- and 30-year sectors were down further following the auction results. The benchmark 10-year note ended down 11/32 point, or $3.4375 for every $1,000 invested, to yield 3.534%. That's up from 3.494% Wednesday. Yields rise when prices fall.
Tony Crescenzi, chief bond-market strategist at Miller Tabak & Co. in New York, said dealers did not show signs of "being desperate" to get their hands on Treasurys much beyond what was available, given the 1.15 bid-to-cover ratio. Bid-to-cover is a gauge of demand used in auctions that measures the ratio of the amount on offer and the amount of bids submitted.
Streamline Derivative Trading Process
Credit-derivative traders usually agree to the terms of a trade over the phone. After that, a dealer typically records the trade and sends an email or electronic message to the client to confirm the trade. In other instances, a firm on one side of a swap may ask another dealer to take its position, in a process called "novation." That requires the approval of the firm's original trading partner, and such requests are also commonly sent via email.
When such requests surge, dealers have to sort through hundreds of emails. In their letter to the Fed, market participants said one of their goals is to make better use of electronic platforms to handle these novation requests and confirmations.
A few years ago, regulators became aware that some traders were scribbling down details of derivative trades on scraps of paper and leaving the trades unconfirmed for weeks or months on end. Concerned that markets might malfunction if some companies failed and firms didn't have a good grip on their exposures to others, the Fed in 2005 pushed large dealers to clean up their large backlogs of derivatives trades and outstanding confirmations. That effort was largely successful, but recent market events have shown that more needs to be done.
When such requests surge, dealers have to sort through hundreds of emails. In their letter to the Fed, market participants said one of their goals is to make better use of electronic platforms to handle these novation requests and confirmations.
A few years ago, regulators became aware that some traders were scribbling down details of derivative trades on scraps of paper and leaving the trades unconfirmed for weeks or months on end. Concerned that markets might malfunction if some companies failed and firms didn't have a good grip on their exposures to others, the Fed in 2005 pushed large dealers to clean up their large backlogs of derivatives trades and outstanding confirmations. That effort was largely successful, but recent market events have shown that more needs to be done.
Wednesday, March 26, 2008
What is the main dispute of Clear Channel deal
The main dispute centers on the syndicate's demand that the private-equity firms replace a long-term financing package of at least six years in the original agreement with a short-term, three-year bridge-financing agreement. Such a change would constrain the ability of a highly leveraged company to deploy capital and operate its business.
In addition, the financial firms asked that the buyers not use a revolving credit facility or Clear Channel's cash flow to pay down about $3.8 billion in short-term debt securities, according a person familiar with the talks.
In addition, the financial firms asked that the buyers not use a revolving credit facility or Clear Channel's cash flow to pay down about $3.8 billion in short-term debt securities, according a person familiar with the talks.
Clear Channell Deal Collapse
Banks financing the $19.5 billionuyout of Clear Channel Communications Inc. stand to lose about3 billion on the transaction because loan prices have tumbled.
The banks committed to lend as much as $22 billion to fund the deal, $18 billion of it as senior secured loans. They have the most to lose if the deal goes ahead. The continuing crisis in the market for leveraged debt means they would have to mark down the value of their Clear Channel loans as soon as the deal closes and book the losses.
Such debt has typically been marked down 15%, meaning the banks could lose $2.7 billion the moment they close the deal. Still, the commitment letters the banks signed when the deal was cut in May make it almost impossible for them to back out of their commitments.
Banks led by Citigroup Inc. and Deutsche Bank AG agreed inApril to provide $22.1 billion for the purchase by private-equity firms Thomas H. Lee Partners LP and Bain Capital PartnersLLC. Since then, losses on subprime-mortgage securities spreadthroughout credit markets and loan prices for similar LBOs fellto as low as 85 cents on the dollar.
Negotiations are stuck on details of the credit agreement,the Wall Street Journal reported, citing unidentified peoplefamiliar with the matter. The banks asked for more cash upfrontand stricter payment terms, the New York Times reportedyesterday, citing people briefed on the discussions.
Thomas H. Lee and Bain, both based in Boston, agreed to pay$39.20 a share after raising their bid to $37.60 and givinginvestors a 30 percent equity stake in the company. Shareholdersapproved the deal in September.
While lenders typically commit to financing when buyouts are announced, the final terms are worked out just before thedeal closes.
A collapse may force the private-equity firms to pay asmuch as $600 million in breakup fees. Banks may be better off offering to pay the penalty on behalf of the firms rather than completing the deal, said Mark Patterson, chairman and co-founder of MatlinPatterson Global Advisers LLC, which invests inbankrupt and distressed companies.
``It's cheaper for the banks to pay breakup fees and getthe loan off their books than try and syndicate these loans at95 to 85 cents on the dollar,'' Patterson said.
Clear Channel debt rallied in anticipation that thecompany's chance of default would be reduced without the burdenof the LBO debt.
The cost to protect Clear Channel's existing debt fromdefault fell for a second day, indicating investors are lessconcerned about the debt. Credit-default swaps tied to thecompany's bonds narrowed 11 basis points to 637 basis points,according to CMA Datavision in London. That means it would cost$637,000 to protect $10 million in debt for five years.
The banks committed to lend as much as $22 billion to fund the deal, $18 billion of it as senior secured loans. They have the most to lose if the deal goes ahead. The continuing crisis in the market for leveraged debt means they would have to mark down the value of their Clear Channel loans as soon as the deal closes and book the losses.
Such debt has typically been marked down 15%, meaning the banks could lose $2.7 billion the moment they close the deal. Still, the commitment letters the banks signed when the deal was cut in May make it almost impossible for them to back out of their commitments.
Banks led by Citigroup Inc. and Deutsche Bank AG agreed inApril to provide $22.1 billion for the purchase by private-equity firms Thomas H. Lee Partners LP and Bain Capital PartnersLLC. Since then, losses on subprime-mortgage securities spreadthroughout credit markets and loan prices for similar LBOs fellto as low as 85 cents on the dollar.
Negotiations are stuck on details of the credit agreement,the Wall Street Journal reported, citing unidentified peoplefamiliar with the matter. The banks asked for more cash upfrontand stricter payment terms, the New York Times reportedyesterday, citing people briefed on the discussions.
Thomas H. Lee and Bain, both based in Boston, agreed to pay$39.20 a share after raising their bid to $37.60 and givinginvestors a 30 percent equity stake in the company. Shareholdersapproved the deal in September.
While lenders typically commit to financing when buyouts are announced, the final terms are worked out just before thedeal closes.
A collapse may force the private-equity firms to pay asmuch as $600 million in breakup fees. Banks may be better off offering to pay the penalty on behalf of the firms rather than completing the deal, said Mark Patterson, chairman and co-founder of MatlinPatterson Global Advisers LLC, which invests inbankrupt and distressed companies.
``It's cheaper for the banks to pay breakup fees and getthe loan off their books than try and syndicate these loans at95 to 85 cents on the dollar,'' Patterson said.
Clear Channel debt rallied in anticipation that thecompany's chance of default would be reduced without the burdenof the LBO debt.
The cost to protect Clear Channel's existing debt fromdefault fell for a second day, indicating investors are lessconcerned about the debt. Credit-default swaps tied to thecompany's bonds narrowed 11 basis points to 637 basis points,according to CMA Datavision in London. That means it would cost$637,000 to protect $10 million in debt for five years.
Feb Durable Goods Order
--It provides solid clues that consumers, especially corporations, are less willing to invest. It is a red flag, indicating that economy will further weaken.
--New orders droped 1.7%, reflecting less demand for druable goods
--Capital Goods, especially non-defense cap good, an important item reflecting corporations' invesment spending, dropped -4.3%, most since Aug 2007
--New orders droped 1.7%, reflecting less demand for druable goods
--Capital Goods, especially non-defense cap good, an important item reflecting corporations' invesment spending, dropped -4.3%, most since Aug 2007
China Policy Helped Fuel Bubble
The 40% decline since October in the Shanghai Stock Exchange's composite index of Chinese-listed shares has coincided neatly with the global financial-market rout. For a government worried about what would happen when the country's 100 million speculators found their portfolios suddenly plunging, this probably is a relief. Beijing can, after all, point the finger at all those subprime mortgages in Florida.
That isn't to say the credit crunch hasn't contributed to China's stock-market decline. Its newbie class of equity investors sees many of the same headlines as the rest of the world's punters. And they know the country's sovereign wealth fund, China Investment Corp., has been called upon to bail out ailing financial institutions on Wall Street.
Still, global market sentiment isn't the only force at work. China tightly restricts the flow of foreign capital into the Shanghai and Shenzhen stock markets. To blame the recent slide solely on hedge funds and international investors dumping their holdings of Chinese stocks, as Zhou Xiaochuan, governor of People's Bank of China, did this month, is a stretch.
The government's own policies surely helped inflate the bubble, which saw the Shanghai Composite index rocket more than 400% in two years. In addition to limiting foreign investment, the government caps the flow of domestic money destined for international stocks. Moreover, the lack of capital gains or inheritance taxes, with only a nominal stamp duty imposed on stock investments, arguably helped fuel share-price inflation.
The bubble's deflation has, not surprisingly, damped the erstwhile ebullience of the Chinese market. But rising inflation is a more fundamental threat. Producer prices last month rose 6.6% from a year earlier. Chinese companies will need to pass these higher costs on to their customers if they want to keep profit margins intact. That is a tall order.
The Beijing government is alarmed by the rise in consumer prices -- which hit a near 9% annual pace last month. That may not sound scary with the economy growing at an 11% clip. But because the average Chinese household spends a third or more of its wages on food, the worry is that rising consumer prices will fuel social unrest. The headline-grabbing protests in Tibet might be a harbinger of what could happen elsewhere.
With the Olympic Games coming to Beijing and the world watching, the government may take more extreme measures to combat inflation. Already it has forced banks to put aside more reserves, which it hopes will reduce lending. It has done this repeatedly in recent years, to little effect.
Among other options are further price controls. These might damp food prices, but as the U.S.'s Nixon administration learned in 1971, controls often just make goods disappear from shelves. Either way, companies would bear the brunt of restrictions on their ability to pass on higher costs to consumers.
More radical measures could include allowing the Chinese currency to revalue at a faster pace. That would help curb inflation by making imported goods -- including energy, raw materials, grains and meat -- cheaper. It also would slam the export sector. Higher dollar prices for goods at the very moment big clients like Wal-Mart Stores are seeing customers tightening their belts could lead many manufacturers to close shop.
Of course, there are companies in China whose businesses can withstand inflation. Morgan Stanley points to infrastructure plays like Jiangsu Expressway; airports; telecom operator China Mobile, and coal-miner China Shenhua Energy as potentially safer havens. And a year or two of clipped earnings might seem a small price to pay if it enables the government to prevent upheaval among China's 1.3 billion people. But Chinese investors thinking their portfolios have been hit by nothing more than subprime fallout should prepare for worse to come.
That isn't to say the credit crunch hasn't contributed to China's stock-market decline. Its newbie class of equity investors sees many of the same headlines as the rest of the world's punters. And they know the country's sovereign wealth fund, China Investment Corp., has been called upon to bail out ailing financial institutions on Wall Street.
Still, global market sentiment isn't the only force at work. China tightly restricts the flow of foreign capital into the Shanghai and Shenzhen stock markets. To blame the recent slide solely on hedge funds and international investors dumping their holdings of Chinese stocks, as Zhou Xiaochuan, governor of People's Bank of China, did this month, is a stretch.
The government's own policies surely helped inflate the bubble, which saw the Shanghai Composite index rocket more than 400% in two years. In addition to limiting foreign investment, the government caps the flow of domestic money destined for international stocks. Moreover, the lack of capital gains or inheritance taxes, with only a nominal stamp duty imposed on stock investments, arguably helped fuel share-price inflation.
The bubble's deflation has, not surprisingly, damped the erstwhile ebullience of the Chinese market. But rising inflation is a more fundamental threat. Producer prices last month rose 6.6% from a year earlier. Chinese companies will need to pass these higher costs on to their customers if they want to keep profit margins intact. That is a tall order.
The Beijing government is alarmed by the rise in consumer prices -- which hit a near 9% annual pace last month. That may not sound scary with the economy growing at an 11% clip. But because the average Chinese household spends a third or more of its wages on food, the worry is that rising consumer prices will fuel social unrest. The headline-grabbing protests in Tibet might be a harbinger of what could happen elsewhere.
With the Olympic Games coming to Beijing and the world watching, the government may take more extreme measures to combat inflation. Already it has forced banks to put aside more reserves, which it hopes will reduce lending. It has done this repeatedly in recent years, to little effect.
Among other options are further price controls. These might damp food prices, but as the U.S.'s Nixon administration learned in 1971, controls often just make goods disappear from shelves. Either way, companies would bear the brunt of restrictions on their ability to pass on higher costs to consumers.
More radical measures could include allowing the Chinese currency to revalue at a faster pace. That would help curb inflation by making imported goods -- including energy, raw materials, grains and meat -- cheaper. It also would slam the export sector. Higher dollar prices for goods at the very moment big clients like Wal-Mart Stores are seeing customers tightening their belts could lead many manufacturers to close shop.
Of course, there are companies in China whose businesses can withstand inflation. Morgan Stanley points to infrastructure plays like Jiangsu Expressway; airports; telecom operator China Mobile, and coal-miner China Shenhua Energy as potentially safer havens. And a year or two of clipped earnings might seem a small price to pay if it enables the government to prevent upheaval among China's 1.3 billion people. But Chinese investors thinking their portfolios have been hit by nothing more than subprime fallout should prepare for worse to come.
Bank of China Cuts Subprime Exposure
Bank of China Ltd., which has been the most heavily invested in U.S. subprime securities among Asia's financial institutions, said it halved that exposure by the end of last year and posted better-than-expected profit for 2007.
Separately, Industrial & Commercial Bank of China Ltd., China's biggest lender by assets, said its 2007 net profit rose 65%.
Bank of China started investing in subprime assets in 2002, and by the end of 2006 it had some $10 billion of such assets in its portfolio, it said in a statement Tuesday. The bank has been paring down those investments, either by writing them off or selling them at reduced values.
On Tuesday, it said it had reduced its subprime exposure to $4.99 billion -- half the portfolio's original value when the bank first made such details public in August 2007. The lender also has booked an impairment allowance of $1.3 billion to cover potential losses, it said in its statement.
Analysts are likely to spend the next few days trying to figure out exactly how much the bank has lost on its subprime investments. The lender said in its statement that it "disposed" of a portion of the higher-risk U.S. subprime-asset-backed securities and all of its subprime-mortgage-related collateralized debt obligations in the fourth quarter. CDOs are among the most volatile of subprime investments, and getting rid of all of them has significantly reduced the bank's risks, analysts say.
Yet it still isn't clear exactly how much the bank has lost from its subprime portfolio. Wang Zhaowen, the bank's spokesman, declined to answer any questions. International banks in general have lost between 30% and half of the value of their subprime investments.
Analysts suggest that the subprime losses probably haven't pressured net earnings because of the way the bank has done the accounting. Some of the losses could have been booked to shareholder equity rather than recorded as a profit-and-loss number. If so, the government -- which owns about 70% of the bank -- would have taken the lion's share of the hit, rather than foreign and domestic investors. Such an accounting method is legal, analysts say.
Meanwhile, Industrial & Commercial Bank of China said its 2007 net profit rose to 81.52 billion yuan from 49.26 billion yuan amid higher interest income and growth in its fee-based services, such as bank cards and wealth management.
The bank said it booked a charge of US$400 million for its exposure to U.S. subprime-mortgage-related investments valued at US$1.226 billion. It said the provisions are enough to cover any potential losses from the investments.
Separately, Industrial & Commercial Bank of China Ltd., China's biggest lender by assets, said its 2007 net profit rose 65%.
Bank of China started investing in subprime assets in 2002, and by the end of 2006 it had some $10 billion of such assets in its portfolio, it said in a statement Tuesday. The bank has been paring down those investments, either by writing them off or selling them at reduced values.
On Tuesday, it said it had reduced its subprime exposure to $4.99 billion -- half the portfolio's original value when the bank first made such details public in August 2007. The lender also has booked an impairment allowance of $1.3 billion to cover potential losses, it said in its statement.
Analysts are likely to spend the next few days trying to figure out exactly how much the bank has lost on its subprime investments. The lender said in its statement that it "disposed" of a portion of the higher-risk U.S. subprime-asset-backed securities and all of its subprime-mortgage-related collateralized debt obligations in the fourth quarter. CDOs are among the most volatile of subprime investments, and getting rid of all of them has significantly reduced the bank's risks, analysts say.
Yet it still isn't clear exactly how much the bank has lost from its subprime portfolio. Wang Zhaowen, the bank's spokesman, declined to answer any questions. International banks in general have lost between 30% and half of the value of their subprime investments.
Analysts suggest that the subprime losses probably haven't pressured net earnings because of the way the bank has done the accounting. Some of the losses could have been booked to shareholder equity rather than recorded as a profit-and-loss number. If so, the government -- which owns about 70% of the bank -- would have taken the lion's share of the hit, rather than foreign and domestic investors. Such an accounting method is legal, analysts say.
Meanwhile, Industrial & Commercial Bank of China said its 2007 net profit rose to 81.52 billion yuan from 49.26 billion yuan amid higher interest income and growth in its fee-based services, such as bank cards and wealth management.
The bank said it booked a charge of US$400 million for its exposure to U.S. subprime-mortgage-related investments valued at US$1.226 billion. It said the provisions are enough to cover any potential losses from the investments.
Tuesday, March 25, 2008
JPM Deal will go through
JP nows has 39.5% stake
On March 24, 2008, JPMorgan Chase and Bear Stearns, in connection withentering into the Amendment, entered into a Share Exchange Agreement, underwhich JPMorgan Chase will purchase 95 million newly issued shares of BearStearns common stock, or 39.5% of the outstanding Bear Stearns common stock after giving effect to the issuance, in exchange for the issuance of 20,665,350shares of JPMorgan Chase common stock to Bear Stearns and the entry by JPMorganChase into the Amended and Restated Guaranty Agreement and the Fed GuarantyAgreement (each as described below).
NYSE makes an exception for the stock excange
While the rules of the New York StockExchange (the "NYSE") generally require shareholder approval prior to theissuance of securities constituting 20% or more of the outstanding shares of alisted company, the NYSE's Shareholder Approval Policy provides an exception incases where the delay involved in securing shareholder approval for the issuancewould seriously jeopardize the financial viability of the listed company. Inaccordance with the NYSE's rule providing that exception, the Audit Committee ofBear Stearns's Board of Directors has expressly approved, and the full Board ofDirectors has unanimously concurred with, Bear Stearns's use of the exception.
On March 24, 2008, JPMorgan Chase and Bear Stearns, in connection withentering into the Amendment, entered into a Share Exchange Agreement, underwhich JPMorgan Chase will purchase 95 million newly issued shares of BearStearns common stock, or 39.5% of the outstanding Bear Stearns common stock after giving effect to the issuance, in exchange for the issuance of 20,665,350shares of JPMorgan Chase common stock to Bear Stearns and the entry by JPMorganChase into the Amended and Restated Guaranty Agreement and the Fed GuarantyAgreement (each as described below).
NYSE makes an exception for the stock excange
While the rules of the New York StockExchange (the "NYSE") generally require shareholder approval prior to theissuance of securities constituting 20% or more of the outstanding shares of alisted company, the NYSE's Shareholder Approval Policy provides an exception incases where the delay involved in securing shareholder approval for the issuancewould seriously jeopardize the financial viability of the listed company. Inaccordance with the NYSE's rule providing that exception, the Audit Committee ofBear Stearns's Board of Directors has expressly approved, and the full Board ofDirectors has unanimously concurred with, Bear Stearns's use of the exception.
Home Loand Banks May More Mortgage Securities
The agency that regulates the Federal Home Loan Banks has given them more scope to acquire mortgage-backed securities, marking the latest attempt by the U.S. government to restore confidence in the country's housing market.
Under rules announced Monday by regulators at the Federal Housing Finance Board, the 12 regional banks will be able to increase their holdings of mortgage securities issued by Fannie Mae and Freddie Mac by more than $100 billion.
Though created by Congress and federally regulated, the home-loan banks are owned by more than 8,000 banks, thrifts, credit unions and insurance companies. The home-loan banks' main role is to provide loans, known as "advances," to their owners, which are called "members." Because investors assume that the government would bail out the home-loan banks in a crisis, they can borrow cheaply in the international bond markets. Countrywide Financial Corp. and other ailing mortgage lenders have relied heavily in recent months on advances from the home-loan banks as other sources of credit dried up.
6 times leverage
The home-loan banks previously could have holdings of mortgage securities of no more than three times their capital. Effective immediately, the regulator is raising that to six times capital for the next two years. At the end of 2007, the banks had combined capital of about $54 billion, and they held $136 billion of mortgage-backed securities as of Sept. 30, the latest data available. But the regulator said the banks must submit a plan to manage the risks of additional holdings before they embark on purchases that would take them over the old limit.
In theory, the new rules would allow the banks to increase their holdings of the securities by a maximum of around $160 billion, but they are considered very unlikely to bump up against the limits, a spokesman for the regulator said.
In the past, critics at the regulator and in government sometimes argued that the home-loan banks held too many mortgage securities and that such holdings did little to support the banks' "mission" of providing funds for housing. The critics argued that there were plenty of other investors willing to buy mortgage securities and that the home-loan banks should focus on providing advances to local banks. Today, such criticism has vanished as regulators search for ways to ensure a steady flow of money into mortgage securities.
Under rules announced Monday by regulators at the Federal Housing Finance Board, the 12 regional banks will be able to increase their holdings of mortgage securities issued by Fannie Mae and Freddie Mac by more than $100 billion.
Though created by Congress and federally regulated, the home-loan banks are owned by more than 8,000 banks, thrifts, credit unions and insurance companies. The home-loan banks' main role is to provide loans, known as "advances," to their owners, which are called "members." Because investors assume that the government would bail out the home-loan banks in a crisis, they can borrow cheaply in the international bond markets. Countrywide Financial Corp. and other ailing mortgage lenders have relied heavily in recent months on advances from the home-loan banks as other sources of credit dried up.
6 times leverage
The home-loan banks previously could have holdings of mortgage securities of no more than three times their capital. Effective immediately, the regulator is raising that to six times capital for the next two years. At the end of 2007, the banks had combined capital of about $54 billion, and they held $136 billion of mortgage-backed securities as of Sept. 30, the latest data available. But the regulator said the banks must submit a plan to manage the risks of additional holdings before they embark on purchases that would take them over the old limit.
In theory, the new rules would allow the banks to increase their holdings of the securities by a maximum of around $160 billion, but they are considered very unlikely to bump up against the limits, a spokesman for the regulator said.
In the past, critics at the regulator and in government sometimes argued that the home-loan banks held too many mortgage securities and that such holdings did little to support the banks' "mission" of providing funds for housing. The critics argued that there were plenty of other investors willing to buy mortgage securities and that the home-loan banks should focus on providing advances to local banks. Today, such criticism has vanished as regulators search for ways to ensure a steady flow of money into mortgage securities.
Monday, March 24, 2008
Negative Repo Rates in 2003
Contrary to popular belief, interest rates can drop below zero. From early August to mid-November of 2003, negative rates occurred on certain U.S. Treasury security repurchase agreements. An examination of the market conditions behind this development reveals why market participants are sometimes willing to pay interest on money lent.
Short-term interest rates fell to their lowest level in forty-five years in 2003. The low rates, coupled with a sharp increase in intermediate-term yields during the summer, gave rise to significant settlement problems in the ten-year Treasury note issued in May. To ease those problems, market participants lent money at attractive rates on investment contracts that provided the note as collateral. From early August through mid-November, such repurchase agreements ("repos" or "RPs") were sometimes arranged at negative interest rates.
This episode of negative interest rates is interesting for several reasons. For one, it refutes the popular assumption that interest rates cannot go below zero because a lender would prefer to hold on to its money and receive no return rather than pay someone to borrow the money. This may be true for uncollateralized loans, but a lender may be willing to pay interest if the securities offered as collateral on a loan allow it to meet a delivery obligation. Researchers (D'Avolio 2002; Jones and Lamont 2002) have reported cases of negative interest rates when equity securities are offered as collateral. The events of 2003 show that negative rates can also occur when Treasury securities are offered as collateral.
The 2003 episode is also interesting because of the specific circumstances that led to negative interest rates. The option of Treasury market participants to fail on, or postpone, delivery obligations with no explicit penalty usually puts a floor of zero on repo rates. In 2003, however, ancillary costs of failing increased as settlement problems in the May ten-year note persisted. The increased costs ultimately led some participants to agree to negative interest rates on RPs that provided the May note as collateral.
Finally, the episode of negative interest rates is interesting because it illustrates how market participants adapt old contract forms to satisfy new needs as economic conditions evolve. In particular, market participants devised "guaranteed-delivery" RPs that allowed for negative interest rates without unduly penalizing a lender of money if a borrower failed to deliver collateral as promised.
This edition of Current Issues explores the recent episode of negative interest rates in detail. We begin with a brief review of repurchase agreements. We then describe how market conditions led to an extraordinary volume of settlement fails in the May ten-year note. Finally, we explain how the fails problem became so severe that some market participants chose to lend money at negative rates in order to borrow the note.
Repurchase Agreements
Repurchase agreements play a crucial role in the efficient allocation of capital in financial markets. They are widely used by dealers to finance their market-making and risk management activities, and they provide a safe and low-cost way for institutional investors to lend funds or securities. The importance of the repo market is suggested by its immense size: dealers with a trading relationship with the Federal Reserve Bank of New York—so-called primary dealers—reported financing $2.41 trillion of fixed-income securities with RPs in August 2003.1
An RP is a sale of securities coupled with an agreement to repurchase the same securities on a later date and is broadly similar to a collateralized loan. As shown in Figure 1, a dealer can borrow $10 million overnight from a corporate treasurer at an interest rate of 3 percent per annum by selling Treasury notes valued at $10,000,000 and simultaneously agreeing to repurchase the same notes the following day for $10,000,833. The payment from the initial sale is the principal amount of the loan; the excess of the repurchase price over the sale price ($833) is the interest on the loan. As with a collateralized loan, the corporate treasurer has possession of the dealer's securities and can sell them if the dealer defaults on its repurchase obligation.
General Collateral Repurchase Agreements
A general collateral RP is a repurchase agreement in which the lender of funds is willing to accept any of a variety of Treasury and other related securities as collateral. The class of acceptable collateral commonly includes all Treasury securities, but it might be limited to Treasury securities maturing in less than ten years or it might extend to agency issues as well as Treasury securities. The lender is concerned primarily with earning interest on its money and having possession of assets that can be sold quickly in the event of a default by the borrower. Interest rates on overnight general collateral RPs on Treasury securities are usually quite close to rates on overnight loans in the federal funds market. This reflects the essential character of a general collateral RP as a device for borrowing and lending money.
Special Collateral Repurchase Agreements
A special collateral RP is a repurchase agreement in which the lender of funds designates a particular security as the only acceptable collateral.2 Dealers and others lend money on special collateral RPs in order to borrow specific securities needed to deliver against short sales. A short sale is a sale of securities that the seller does not own and that it has to borrow to make delivery. Dealers sell Treasury securities short in the expectation that prices will be lower in the future, to hedge the risk of other fixed-income securities, and to accommodate customer purchase interests.
The interest rate on a special collateral RP is commonly called a "specials" rate. The owner of a Treasury security that a dealer wants to borrow may not have any particular interest in borrowing money, but can nevertheless be induced to lend the security if it is offered an opportunity to borrow money at a specials rate less than the general collateral rate. For example, if the rate on a special collateral RP is 2 percent and the general collateral rate is 3 percent, then—as shown in Figure 2—an investor can earn a 100 basis point spread by borrowing money on the special collateral RP and relending the money on a general collateral RP.
The difference between the general collateral rate and the specials rate for a security is a measure of the "specialness" of the security. If the demand to borrow the security is modest relative to the supply available for lending, a dealer borrowing the security will usually be able to lend its money at a rate no lower than about 15 to 25 basis points below the general collateral rate. If the demand to borrow is strong, or if the supply is limited, the specials rate for the security may be materially below the general collateral rate and the specialness spread correspondingly large.3
A Lower Bound on Special Collateral Repo Rates?
Interest rates on special collateral RPs nearly always stay above zero because, instead of lending money at a negative interest rate to borrow a particularly scarce issue, a short seller can choose to fail on its delivery obligation. In a "fail," a seller does not deliver the securities it promised to a buyer on the scheduled settlement date and, consequently, does not receive payment for the securities. The convention in the Treasury market is to reschedule delivery for the next day at an unchanged price.4 As detailed in Box 1, the cost of failing is about the same as the cost of borrowing a security on a special collateral RP at an interest rate of zero. It follows that failing is usually preferable to borrowing a security at a negative specials rate.
The zero lower bound on specials rates depends on the absence of any costs or penalties for failing other than a delay in the receipt of the invoice price. However, the events of 2003 show that fails can sometimes have significant ancillary costs and that those costs can lead to negative interest rates on special collateral RPs.5
Short Sales and Settlement Fails in the Summer of 2003
Intermediate-term Treasury yields rose sharply during the summer of 2003. Yields on ten-year notes rose from about 3.15 percent in mid-June to 3.50 percent at the end of June and to 4.50 percent in mid-August. The rise led to an extraordinary volume of short sales of the on-the-run (or most recently issued) ten-year note (the 3 5/8 percent note maturing in May 2013) as holders of fixed-income securities sold the note short to hedge against the possibility of further rate increases.6 Demand to borrow the note (to deliver against short sales) expanded commensurately.
With the general collateral rate at about 1 1/4 percent until late June, and subsequently at about 1 percent, the specials rate for the ten-year note did not have far to fall before it hit zero. Demand to borrow the note drove the specials rate to within a few basis points of zero by June 23 (Chart 1). The rate hit zero on July 10, after which additional borrowing demand spilled over into settlement fails.7
In the absence of any evidence that interest rates had stopped rising, hedgers maintained their short positions through July. Demand to borrow the ten-year note remained strong and the specials rate for the note remained at zero. The persistence of the specials rate at zero left sellers with little economic incentive to borrow the note to cure their settlement fails. In late July, one market participant commented, "the issue . . . has totally stopped clearing."8
Strategic Fails
The fails situation worsened when some market participants realized that they could acquire a free (or nearly free) option to speculate against an increase in the specials rate for the ten-year note by contracting to lend the note against borrowing money at a zero (or near zero) rate of interest for a term of several days or weeks and then intentionally—or strategically—failing to deliver the note. Understanding the nature of this option requires an appreciation of the consequences of failing to settle the starting leg of a repurchase agreement.
Market convention holds that if a collateral lender fails to deliver securities on the scheduled starting date of an RP and thus fails to receive funds from its counterparty, it nevertheless owes the counterparty interest on the principal amount of the borrowing for the full term of the RP. The full amount of interest is owed regardless of whether the collateral lender delivers the securities late or not at all. (The repo contract terminates on the originally scheduled closing date even if the securities are delivered late.) Among other things, this convention provides an incentive for the collateral lender to deliver the securities on the scheduled starting date.
Consider, however, a trader who does not own the ten-year note but who nevertheless agrees to lend the note over the interval from July 15 to July 29, 2003, against borrowing $10 million at a zero rate of interest. Suppose the trader fails to deliver the note on the scheduled starting date. Regardless of whether the trader delivers the note late or not at all, the trader will not owe its counterparty any interest because the interest rate on the repo contract is zero. Suppose also that the specials rate on the ten-year note for RPs ending July 29 rises to 0.50 percent on July 22. The trader can then borrow the note from July 22 to July 29 against lending $10 million—thereby earning $972 interest [$972 = (7/360) x 5 0.50 percent of $10 million]—and deliver the borrowed note against its original repo contract—thereby borrowing $10 million at a zero rate of interest for the seven days remaining on that contract. The $10 million borrowing funds the trader’s loan of $10 million and the trader makes a net profit of $972.
A similar analysis applies if the specials rate is positive but small. For example, if the fourteen-day specials rate for the ten-year note is 0.05 percent, a trader would pay only $194 for the implicit option described in the preceding paragraph [$194 = (14/360) x 5 0.05 percent of $10,000,000].
Ancillary Costs of Fails
By early August, dealers were beginning to incur substantial ancillary costs as a result of their fails. Opportunity costs stemming from regulatory capital requirements are one example. The net capital rule of the Securities and Exchange Commission provides that dealers have to maintain additional capital—that is, assets in excess of liabilities—for fails to deliver more than five business days old and for fails to receive more than thirty calendar days old. Additional capital is required because "aged" fails are a source of credit risk. If two parties agree to a securities transaction and the buyer becomes insolvent prior to settlement, the seller will incur a loss if the price of the security has fallen and it has to find a replacement buyer at a lower price. The buyer will incur a loss if the price of the security increases after the trade is negotiated and the seller subsequently becomes insolvent. Capital charges for aged fails soak up capital that would otherwise be available to support profitable risk-taking activities; in this way, they impose opportunity costs on dealers.9
By early August, dealers were also experiencing increased labor costs and deteriorating customer relations. Labor costs rose because dealers were forced to divert back-office personnel from their usual assignments to efforts aimed at reducing the backlog of unsettled trades.10 Customers became unhappy when they did not receive the securities they had purchased, even after long delays. This left them in the position of involuntarily financing dealer short positions and meant that they themselves had nothing to deliver in the event they decided to sell.
Negative Specials Rates
In the strained environment of early August, some dealers became willing to pay interest on money lent to borrow the ten-year note. They concluded that it would be less expensive to pay interest to borrow the notes needed to remedy their settlement fails than to continue to incur the capital charges, labor costs, and customer dissatisfaction associated with the fails.
Loan Fees in the Federal Reserve's Securities Loan Auctions
The first indication that the specials market for the ten-year note was undergoing a major change came in the Federal Reserve's securities loan auctions. As described in Box 2, the Fed offers to lend securities that it owns on a daily basis. Dealers who borrow securities from the Fed pay a fee, expressed in percent per annum, which is equivalent to the difference between the rate paid for borrowing money in the general collateral market and the rate earned on lending money in the specials market. When transactions are settling normally, the loan fee that dealers are willing to pay the Fed to borrow a security will not rise above the general collateral rate because the specials rate for the security will not go below zero.11
The average auction loan fee for the ten-year note rose materially above the general collateral rate for the first time on August 5 when it hit 1.25 percent (Chart 2). The general collateral rate was 0.95 percent that day so the implied specials rate for the note was -30 basis points (Chart 3). On August 11, 12, and 13, the loan fee exceeded 1.20 percent and the implied specials rate was less than -20 basis points. Thus, the Fed's loan auctions in the first half of August gave a clear indication of unusual stress in the market for borrowing the ten-year note.
That stress eased a bit following issuance of a new ten-year note (the 4 1/4 percent note maturing in August 2013) on August 15. Average auction loan fees for the 3 5/8 percent note moderated to about 1 percent and the implied specials rate rose to about zero. However, at 11 a.m. on September 8, the Treasury Department announced that it would reopen the 4 1/4 percent ten-year note in an auction on September 11. This quashed any hope that it might reopen the 3 5/8 percent note in order to alleviate the fails situation in that note.12 On the same day, the loan fee for the 3 5/8 percent note moved back above the general collateral rate and the implied specials rate fell to -11 basis points. The implied specials rate stayed well below zero through the beginning of October, reaching a low of -146 basis points on September 26.
Specials Rates for the 3 5/8 Percent Note
Comparing Charts 1 and 3 raises the question of why the specials rate for the 3 5/8 percent note remained at zero when the implied specials rate for the same note in the Fed's loan auctions was well below zero. Part of the answer lies in the difference between the certainty that the Fed will deliver securities following an auction and the likelihood that a private collateral lender would deliver on a loan of the notes. Dealers were willing to pay a premium to borrow from the Fed because the Fed never fails to deliver securities. (As noted in Box 2, the Fed only auctions securities that are actually in its account at the time of an auction.) In contrast, a private collateral lender may fail to deliver securities on a special collateral RP just as a private seller may fail to deliver securities on an outright sale. This was a material risk in the case of the 3 5/8 percent note because, as explained earlier, specials rates at or near zero created an incentive for market participants who did not already own the note to agree to lend it and then intentionally fail to deliver. The absence of any widely accepted convention for how interest payments would be treated in the event of a settlement fail also contributed to the difference between the zero specials rate in the private collateral loan market and the negative implied specials rate in the Fed's collateral auctions.
Guaranteed-Delivery Special Collateral RPs with Negative Interest RatesIn mid-September, some dealers began to enter into "guaranteed-delivery" repo contracts for the 3 5/8 percent note at interest rates as low as -3 percent.13 The guarantee of delivery on these contracts was weaker than a contractual commitment that the collateral lender would bear the costs of any damages caused by its failure to make delivery, but it was stronger than the obligation to deliver collateral against a conventional repo contract. Participants in the guaranteed-delivery market had a common understanding that an offering for guaranteed delivery would be made only if the notes were already in the lender's possession and available for settlement. Participants also had a common understanding that a negative rate contract would be canceled if the collateral lender failed to deliver the notes on the scheduled starting date. This precluded the use of guaranteed-delivery contracts as vehicles for speculating against an increase in the specials rate for the notes.
Negative rate RPs did not make financing a short position in the 3 5/8 percent notes more expensive than it had been; they merely converted the implicit ancillary costs of failing—including incremental capital charges, higher labor costs, and customer dissatisfaction—into the explicit cost of lending money at a negative rate of interest in order to cure an outstanding fail. Moreover, the negative rates likely provided some additional incentive for holders of the notes to lend their securities.
After mid-October 2003, market stresses in the 3 5/8 percent ten-year note gradually eased and dealers began to make progress in reducing their outstanding fails through industry efforts to identify and net offsetting fails among multiple counterparties.14 Bids and offers for the note in guaranteed-delivery RPs at negative interest rates disappeared and the frequency with which the Fed's auction loan fee for the note exceeded the general collateral rate declined.
Conclusion
From early August to mid-November of 2003, some market participants lent money at negative interest rates to borrow a particular Treasury note. The episode is instructive because it refutes the popular assumption that interest rates cannot go below zero and demonstrates how the collateral value of a security can lead to negative interest rates. The episode also shows that the ancillary costs of failing on an obligation to deliver Treasury securities can sometimes be significant. Finally, the episode shows that market participants will modify old contract forms to meet new needs—demonstrated in this case by the appearance of guaranteed-delivery repo contracts—as economic conditions evolve.
comments:
--high demand for collateral - Treasury, such as short-sell, can lead to low, even negative, repo rate
Short-term interest rates fell to their lowest level in forty-five years in 2003. The low rates, coupled with a sharp increase in intermediate-term yields during the summer, gave rise to significant settlement problems in the ten-year Treasury note issued in May. To ease those problems, market participants lent money at attractive rates on investment contracts that provided the note as collateral. From early August through mid-November, such repurchase agreements ("repos" or "RPs") were sometimes arranged at negative interest rates.
This episode of negative interest rates is interesting for several reasons. For one, it refutes the popular assumption that interest rates cannot go below zero because a lender would prefer to hold on to its money and receive no return rather than pay someone to borrow the money. This may be true for uncollateralized loans, but a lender may be willing to pay interest if the securities offered as collateral on a loan allow it to meet a delivery obligation. Researchers (D'Avolio 2002; Jones and Lamont 2002) have reported cases of negative interest rates when equity securities are offered as collateral. The events of 2003 show that negative rates can also occur when Treasury securities are offered as collateral.
The 2003 episode is also interesting because of the specific circumstances that led to negative interest rates. The option of Treasury market participants to fail on, or postpone, delivery obligations with no explicit penalty usually puts a floor of zero on repo rates. In 2003, however, ancillary costs of failing increased as settlement problems in the May ten-year note persisted. The increased costs ultimately led some participants to agree to negative interest rates on RPs that provided the May note as collateral.
Finally, the episode of negative interest rates is interesting because it illustrates how market participants adapt old contract forms to satisfy new needs as economic conditions evolve. In particular, market participants devised "guaranteed-delivery" RPs that allowed for negative interest rates without unduly penalizing a lender of money if a borrower failed to deliver collateral as promised.
This edition of Current Issues explores the recent episode of negative interest rates in detail. We begin with a brief review of repurchase agreements. We then describe how market conditions led to an extraordinary volume of settlement fails in the May ten-year note. Finally, we explain how the fails problem became so severe that some market participants chose to lend money at negative rates in order to borrow the note.
Repurchase Agreements
Repurchase agreements play a crucial role in the efficient allocation of capital in financial markets. They are widely used by dealers to finance their market-making and risk management activities, and they provide a safe and low-cost way for institutional investors to lend funds or securities. The importance of the repo market is suggested by its immense size: dealers with a trading relationship with the Federal Reserve Bank of New York—so-called primary dealers—reported financing $2.41 trillion of fixed-income securities with RPs in August 2003.1
An RP is a sale of securities coupled with an agreement to repurchase the same securities on a later date and is broadly similar to a collateralized loan. As shown in Figure 1, a dealer can borrow $10 million overnight from a corporate treasurer at an interest rate of 3 percent per annum by selling Treasury notes valued at $10,000,000 and simultaneously agreeing to repurchase the same notes the following day for $10,000,833. The payment from the initial sale is the principal amount of the loan; the excess of the repurchase price over the sale price ($833) is the interest on the loan. As with a collateralized loan, the corporate treasurer has possession of the dealer's securities and can sell them if the dealer defaults on its repurchase obligation.
General Collateral Repurchase Agreements
A general collateral RP is a repurchase agreement in which the lender of funds is willing to accept any of a variety of Treasury and other related securities as collateral. The class of acceptable collateral commonly includes all Treasury securities, but it might be limited to Treasury securities maturing in less than ten years or it might extend to agency issues as well as Treasury securities. The lender is concerned primarily with earning interest on its money and having possession of assets that can be sold quickly in the event of a default by the borrower. Interest rates on overnight general collateral RPs on Treasury securities are usually quite close to rates on overnight loans in the federal funds market. This reflects the essential character of a general collateral RP as a device for borrowing and lending money.
Special Collateral Repurchase Agreements
A special collateral RP is a repurchase agreement in which the lender of funds designates a particular security as the only acceptable collateral.2 Dealers and others lend money on special collateral RPs in order to borrow specific securities needed to deliver against short sales. A short sale is a sale of securities that the seller does not own and that it has to borrow to make delivery. Dealers sell Treasury securities short in the expectation that prices will be lower in the future, to hedge the risk of other fixed-income securities, and to accommodate customer purchase interests.
The interest rate on a special collateral RP is commonly called a "specials" rate. The owner of a Treasury security that a dealer wants to borrow may not have any particular interest in borrowing money, but can nevertheless be induced to lend the security if it is offered an opportunity to borrow money at a specials rate less than the general collateral rate. For example, if the rate on a special collateral RP is 2 percent and the general collateral rate is 3 percent, then—as shown in Figure 2—an investor can earn a 100 basis point spread by borrowing money on the special collateral RP and relending the money on a general collateral RP.
The difference between the general collateral rate and the specials rate for a security is a measure of the "specialness" of the security. If the demand to borrow the security is modest relative to the supply available for lending, a dealer borrowing the security will usually be able to lend its money at a rate no lower than about 15 to 25 basis points below the general collateral rate. If the demand to borrow is strong, or if the supply is limited, the specials rate for the security may be materially below the general collateral rate and the specialness spread correspondingly large.3
A Lower Bound on Special Collateral Repo Rates?
Interest rates on special collateral RPs nearly always stay above zero because, instead of lending money at a negative interest rate to borrow a particularly scarce issue, a short seller can choose to fail on its delivery obligation. In a "fail," a seller does not deliver the securities it promised to a buyer on the scheduled settlement date and, consequently, does not receive payment for the securities. The convention in the Treasury market is to reschedule delivery for the next day at an unchanged price.4 As detailed in Box 1, the cost of failing is about the same as the cost of borrowing a security on a special collateral RP at an interest rate of zero. It follows that failing is usually preferable to borrowing a security at a negative specials rate.
The zero lower bound on specials rates depends on the absence of any costs or penalties for failing other than a delay in the receipt of the invoice price. However, the events of 2003 show that fails can sometimes have significant ancillary costs and that those costs can lead to negative interest rates on special collateral RPs.5
Short Sales and Settlement Fails in the Summer of 2003
Intermediate-term Treasury yields rose sharply during the summer of 2003. Yields on ten-year notes rose from about 3.15 percent in mid-June to 3.50 percent at the end of June and to 4.50 percent in mid-August. The rise led to an extraordinary volume of short sales of the on-the-run (or most recently issued) ten-year note (the 3 5/8 percent note maturing in May 2013) as holders of fixed-income securities sold the note short to hedge against the possibility of further rate increases.6 Demand to borrow the note (to deliver against short sales) expanded commensurately.
With the general collateral rate at about 1 1/4 percent until late June, and subsequently at about 1 percent, the specials rate for the ten-year note did not have far to fall before it hit zero. Demand to borrow the note drove the specials rate to within a few basis points of zero by June 23 (Chart 1). The rate hit zero on July 10, after which additional borrowing demand spilled over into settlement fails.7
In the absence of any evidence that interest rates had stopped rising, hedgers maintained their short positions through July. Demand to borrow the ten-year note remained strong and the specials rate for the note remained at zero. The persistence of the specials rate at zero left sellers with little economic incentive to borrow the note to cure their settlement fails. In late July, one market participant commented, "the issue . . . has totally stopped clearing."8
Strategic Fails
The fails situation worsened when some market participants realized that they could acquire a free (or nearly free) option to speculate against an increase in the specials rate for the ten-year note by contracting to lend the note against borrowing money at a zero (or near zero) rate of interest for a term of several days or weeks and then intentionally—or strategically—failing to deliver the note. Understanding the nature of this option requires an appreciation of the consequences of failing to settle the starting leg of a repurchase agreement.
Market convention holds that if a collateral lender fails to deliver securities on the scheduled starting date of an RP and thus fails to receive funds from its counterparty, it nevertheless owes the counterparty interest on the principal amount of the borrowing for the full term of the RP. The full amount of interest is owed regardless of whether the collateral lender delivers the securities late or not at all. (The repo contract terminates on the originally scheduled closing date even if the securities are delivered late.) Among other things, this convention provides an incentive for the collateral lender to deliver the securities on the scheduled starting date.
Consider, however, a trader who does not own the ten-year note but who nevertheless agrees to lend the note over the interval from July 15 to July 29, 2003, against borrowing $10 million at a zero rate of interest. Suppose the trader fails to deliver the note on the scheduled starting date. Regardless of whether the trader delivers the note late or not at all, the trader will not owe its counterparty any interest because the interest rate on the repo contract is zero. Suppose also that the specials rate on the ten-year note for RPs ending July 29 rises to 0.50 percent on July 22. The trader can then borrow the note from July 22 to July 29 against lending $10 million—thereby earning $972 interest [$972 = (7/360) x 5 0.50 percent of $10 million]—and deliver the borrowed note against its original repo contract—thereby borrowing $10 million at a zero rate of interest for the seven days remaining on that contract. The $10 million borrowing funds the trader’s loan of $10 million and the trader makes a net profit of $972.
A similar analysis applies if the specials rate is positive but small. For example, if the fourteen-day specials rate for the ten-year note is 0.05 percent, a trader would pay only $194 for the implicit option described in the preceding paragraph [$194 = (14/360) x 5 0.05 percent of $10,000,000].
Ancillary Costs of Fails
By early August, dealers were beginning to incur substantial ancillary costs as a result of their fails. Opportunity costs stemming from regulatory capital requirements are one example. The net capital rule of the Securities and Exchange Commission provides that dealers have to maintain additional capital—that is, assets in excess of liabilities—for fails to deliver more than five business days old and for fails to receive more than thirty calendar days old. Additional capital is required because "aged" fails are a source of credit risk. If two parties agree to a securities transaction and the buyer becomes insolvent prior to settlement, the seller will incur a loss if the price of the security has fallen and it has to find a replacement buyer at a lower price. The buyer will incur a loss if the price of the security increases after the trade is negotiated and the seller subsequently becomes insolvent. Capital charges for aged fails soak up capital that would otherwise be available to support profitable risk-taking activities; in this way, they impose opportunity costs on dealers.9
By early August, dealers were also experiencing increased labor costs and deteriorating customer relations. Labor costs rose because dealers were forced to divert back-office personnel from their usual assignments to efforts aimed at reducing the backlog of unsettled trades.10 Customers became unhappy when they did not receive the securities they had purchased, even after long delays. This left them in the position of involuntarily financing dealer short positions and meant that they themselves had nothing to deliver in the event they decided to sell.
Negative Specials Rates
In the strained environment of early August, some dealers became willing to pay interest on money lent to borrow the ten-year note. They concluded that it would be less expensive to pay interest to borrow the notes needed to remedy their settlement fails than to continue to incur the capital charges, labor costs, and customer dissatisfaction associated with the fails.
Loan Fees in the Federal Reserve's Securities Loan Auctions
The first indication that the specials market for the ten-year note was undergoing a major change came in the Federal Reserve's securities loan auctions. As described in Box 2, the Fed offers to lend securities that it owns on a daily basis. Dealers who borrow securities from the Fed pay a fee, expressed in percent per annum, which is equivalent to the difference between the rate paid for borrowing money in the general collateral market and the rate earned on lending money in the specials market. When transactions are settling normally, the loan fee that dealers are willing to pay the Fed to borrow a security will not rise above the general collateral rate because the specials rate for the security will not go below zero.11
The average auction loan fee for the ten-year note rose materially above the general collateral rate for the first time on August 5 when it hit 1.25 percent (Chart 2). The general collateral rate was 0.95 percent that day so the implied specials rate for the note was -30 basis points (Chart 3). On August 11, 12, and 13, the loan fee exceeded 1.20 percent and the implied specials rate was less than -20 basis points. Thus, the Fed's loan auctions in the first half of August gave a clear indication of unusual stress in the market for borrowing the ten-year note.
That stress eased a bit following issuance of a new ten-year note (the 4 1/4 percent note maturing in August 2013) on August 15. Average auction loan fees for the 3 5/8 percent note moderated to about 1 percent and the implied specials rate rose to about zero. However, at 11 a.m. on September 8, the Treasury Department announced that it would reopen the 4 1/4 percent ten-year note in an auction on September 11. This quashed any hope that it might reopen the 3 5/8 percent note in order to alleviate the fails situation in that note.12 On the same day, the loan fee for the 3 5/8 percent note moved back above the general collateral rate and the implied specials rate fell to -11 basis points. The implied specials rate stayed well below zero through the beginning of October, reaching a low of -146 basis points on September 26.
Specials Rates for the 3 5/8 Percent Note
Comparing Charts 1 and 3 raises the question of why the specials rate for the 3 5/8 percent note remained at zero when the implied specials rate for the same note in the Fed's loan auctions was well below zero. Part of the answer lies in the difference between the certainty that the Fed will deliver securities following an auction and the likelihood that a private collateral lender would deliver on a loan of the notes. Dealers were willing to pay a premium to borrow from the Fed because the Fed never fails to deliver securities. (As noted in Box 2, the Fed only auctions securities that are actually in its account at the time of an auction.) In contrast, a private collateral lender may fail to deliver securities on a special collateral RP just as a private seller may fail to deliver securities on an outright sale. This was a material risk in the case of the 3 5/8 percent note because, as explained earlier, specials rates at or near zero created an incentive for market participants who did not already own the note to agree to lend it and then intentionally fail to deliver. The absence of any widely accepted convention for how interest payments would be treated in the event of a settlement fail also contributed to the difference between the zero specials rate in the private collateral loan market and the negative implied specials rate in the Fed's collateral auctions.
Guaranteed-Delivery Special Collateral RPs with Negative Interest RatesIn mid-September, some dealers began to enter into "guaranteed-delivery" repo contracts for the 3 5/8 percent note at interest rates as low as -3 percent.13 The guarantee of delivery on these contracts was weaker than a contractual commitment that the collateral lender would bear the costs of any damages caused by its failure to make delivery, but it was stronger than the obligation to deliver collateral against a conventional repo contract. Participants in the guaranteed-delivery market had a common understanding that an offering for guaranteed delivery would be made only if the notes were already in the lender's possession and available for settlement. Participants also had a common understanding that a negative rate contract would be canceled if the collateral lender failed to deliver the notes on the scheduled starting date. This precluded the use of guaranteed-delivery contracts as vehicles for speculating against an increase in the specials rate for the notes.
Negative rate RPs did not make financing a short position in the 3 5/8 percent notes more expensive than it had been; they merely converted the implicit ancillary costs of failing—including incremental capital charges, higher labor costs, and customer dissatisfaction—into the explicit cost of lending money at a negative rate of interest in order to cure an outstanding fail. Moreover, the negative rates likely provided some additional incentive for holders of the notes to lend their securities.
After mid-October 2003, market stresses in the 3 5/8 percent ten-year note gradually eased and dealers began to make progress in reducing their outstanding fails through industry efforts to identify and net offsetting fails among multiple counterparties.14 Bids and offers for the note in guaranteed-delivery RPs at negative interest rates disappeared and the frequency with which the Fed's auction loan fee for the note exceeded the general collateral rate declined.
Conclusion
From early August to mid-November of 2003, some market participants lent money at negative interest rates to borrow a particular Treasury note. The episode is instructive because it refutes the popular assumption that interest rates cannot go below zero and demonstrates how the collateral value of a security can lead to negative interest rates. The episode also shows that the ancillary costs of failing on an obligation to deliver Treasury securities can sometimes be significant. Finally, the episode shows that market participants will modify old contract forms to meet new needs—demonstrated in this case by the appearance of guaranteed-delivery repo contracts—as economic conditions evolve.
comments:
--high demand for collateral - Treasury, such as short-sell, can lead to low, even negative, repo rate
Strain in Repo market signal the high demand for Treasury
Rate markets have been so consistently abnormal for so long," said William O'Donnell, rates strategist at UBS Securities in Stamford, Conn., it will take more than liquidity boosters to restore confidence and to put the economy back on track.
Last week, rates to borrow Treasurys in the securities repurchase market -- essential to the smooth functioning of the financial system -- turned negative and Treasury bill yields plunged to levels not seen in more than 50 years, signaling strong demand for government debt. Bond prices rise when yields fall. Fails in the repo markets have also risen as it has become uneconomical for investors to return loaned Treasurys.
At one point on Thursday, the three-month T-bill repo rate was quoted at -0.2%, and bills to December were seeing bids of -0.25%. These rates typically hover around the target fed-funds rate, which is at 2.25%. Fixed-income markets were closed Friday for the Easter holidays.
Given the massive demand for Treasurys, and investors' tight grip on government debt once they've snatched it up, "the Fed adding to the supply mix should help," said Kevin Flanagan, fixed-income strategist at Morgan Stanley Individual Investor Group.
At a minimum, the Fed's lending facility should nudge repo market rates higher this week and slow the frenzied buying of T-bills. The facility complements another effort by the Fed to get more liquidity to dealer banks -- the primary dealer credit facility. That allows securities firms to borrow at the discount window, a privilege normally accorded only to regulated financial institutions that take deposits.
Also this week, the Fed will conduct March's second Term Auction Facility sale, which auctions funds to banks that take deposits. The auction Tuesday will be the Fed's eighth sale under the program, which was created late last year to address liquidity pressures after banks proved reluctant to tap into the discount window for emergency borrowings. The auction sizes have increased steadily, with the Fed this month offering $100 billion in two auctions.
All this liquidity comes as quarter-end -- typically a volatile time for markets -- looms. Investors are normally unwilling to have riskier loans on their books this time of year and hoard the safest possible securities.
Last week, rates to borrow Treasurys in the securities repurchase market -- essential to the smooth functioning of the financial system -- turned negative and Treasury bill yields plunged to levels not seen in more than 50 years, signaling strong demand for government debt. Bond prices rise when yields fall. Fails in the repo markets have also risen as it has become uneconomical for investors to return loaned Treasurys.
At one point on Thursday, the three-month T-bill repo rate was quoted at -0.2%, and bills to December were seeing bids of -0.25%. These rates typically hover around the target fed-funds rate, which is at 2.25%. Fixed-income markets were closed Friday for the Easter holidays.
Given the massive demand for Treasurys, and investors' tight grip on government debt once they've snatched it up, "the Fed adding to the supply mix should help," said Kevin Flanagan, fixed-income strategist at Morgan Stanley Individual Investor Group.
At a minimum, the Fed's lending facility should nudge repo market rates higher this week and slow the frenzied buying of T-bills. The facility complements another effort by the Fed to get more liquidity to dealer banks -- the primary dealer credit facility. That allows securities firms to borrow at the discount window, a privilege normally accorded only to regulated financial institutions that take deposits.
Also this week, the Fed will conduct March's second Term Auction Facility sale, which auctions funds to banks that take deposits. The auction Tuesday will be the Fed's eighth sale under the program, which was created late last year to address liquidity pressures after banks proved reluctant to tap into the discount window for emergency borrowings. The auction sizes have increased steadily, with the Fed this month offering $100 billion in two auctions.
All this liquidity comes as quarter-end -- typically a volatile time for markets -- looms. Investors are normally unwilling to have riskier loans on their books this time of year and hoard the safest possible securities.
Mortgage Rescue Options
Pressure is growing in Washington to help ease the housing crisis. Last week's move by regulators to reduce the amount of surplus capital held by mortgage titans Fannie Mae and Freddie Mac could help make home loans easier to find. But more direct efforts to stem foreclosures seem inevitable. The Federal Reserve's bailout of Bear Stearns may add to the political pressure to do something for homeowners, too.
If the government chooses to rescue ailing homeowners, it should aim to keep its costs and legal hassles to a minimum. And any plan should acknowledge that most people want to remain in their homes -- even if their mortgage is worth slightly more than their house. Those who send their keys to the bank -- known as "jingle-mail" -- have serious negative equity in their homes, cash-flow problems or both. If the government can ease pressure on these homeowners' cash flows, there should be fewer foreclosures.
Subsize
There are options. The federal government could intervene directly, perhaps by subsidizing a temporary half-point reduction in interest rates for every percentage point a mortgage servicer cuts the rate. As government intervention goes, that approach would be fast and relatively efficient. It also would minimize moral hazard -- the reckless behavior of those who don't bear the full consequences of their actions.
Refinance into lower-rate loans
Other plans are more problematic. Economist Martin Feldstein, for example, proposed that the government refinance those with negative equity on their first mortgages into lower-rate loans. But that doesn't make much sense. Given the choice between walking away from a loan worth more than the value of a house, or replacing the debt with a nondischargeable government obligation for the same amount at a slightly lower rate, few would chose the latter. It would also be an unfair boon to investors in second-lien mortgages.
Write off
Rep. Barney Frank and Sen. Christopher Dodd take a different approach. The Democrats' closely related proposals would pressure lenders to write off part of the loans held by some two million households. The borrowers would then refinance into as much as $400 billion of new loans, insured by the Federal Housing Administration.
Reducing the debt burden on these households would give underwater borrowers an incentive to stay put along with breathing room to make payments. But it isn't clear whether lenders will play along and reduce their loans by 15% of the current value of the homes, as the plan calls for.
Buy the debt outright
If not, the government might consider another option -- that is, if it wants to go down the route of actually creating equity for homeowners. A lot of the homeowners with 2006- and 2007-vintage adjustable-rate mortgages who are now losing their houses actually have positive equity on their first mortgage. The problem is, they also have second-lien mortgages. If the government were to buy that debt at a steep discount and slash the rates or principal amounts, it would ease borrowers' cash-flow problems and allow them to stay in their homes.
The holders of the second-lien debt would probably jump at the opportunity, because, if the houses go into foreclosure, that debt would be worth less than whatever the government offers. Of course, this approach still creates moral hazard. But limiting the plan to those with positive equity on their first mortgages would minimize its total cost.
However, it wouldn't be easy. The government would have to vet appraisals carefully to ensure it was dealing with borrowers with positive equity. Also, a lot of the loans are wrapped inside mortgage-backed securities. Pulling loans out of those securities could pit one class of investor against another, and could hurt those who have bet the securities will decline in value. The government would have to craft legislation to allow it to purchase the loans without setting off a firestorm of litigation. But if it succeeded, this approach might be a cheap and effective way to stem the rising tide of foreclosures.
If the government chooses to rescue ailing homeowners, it should aim to keep its costs and legal hassles to a minimum. And any plan should acknowledge that most people want to remain in their homes -- even if their mortgage is worth slightly more than their house. Those who send their keys to the bank -- known as "jingle-mail" -- have serious negative equity in their homes, cash-flow problems or both. If the government can ease pressure on these homeowners' cash flows, there should be fewer foreclosures.
Subsize
There are options. The federal government could intervene directly, perhaps by subsidizing a temporary half-point reduction in interest rates for every percentage point a mortgage servicer cuts the rate. As government intervention goes, that approach would be fast and relatively efficient. It also would minimize moral hazard -- the reckless behavior of those who don't bear the full consequences of their actions.
Refinance into lower-rate loans
Other plans are more problematic. Economist Martin Feldstein, for example, proposed that the government refinance those with negative equity on their first mortgages into lower-rate loans. But that doesn't make much sense. Given the choice between walking away from a loan worth more than the value of a house, or replacing the debt with a nondischargeable government obligation for the same amount at a slightly lower rate, few would chose the latter. It would also be an unfair boon to investors in second-lien mortgages.
Write off
Rep. Barney Frank and Sen. Christopher Dodd take a different approach. The Democrats' closely related proposals would pressure lenders to write off part of the loans held by some two million households. The borrowers would then refinance into as much as $400 billion of new loans, insured by the Federal Housing Administration.
Reducing the debt burden on these households would give underwater borrowers an incentive to stay put along with breathing room to make payments. But it isn't clear whether lenders will play along and reduce their loans by 15% of the current value of the homes, as the plan calls for.
Buy the debt outright
If not, the government might consider another option -- that is, if it wants to go down the route of actually creating equity for homeowners. A lot of the homeowners with 2006- and 2007-vintage adjustable-rate mortgages who are now losing their houses actually have positive equity on their first mortgage. The problem is, they also have second-lien mortgages. If the government were to buy that debt at a steep discount and slash the rates or principal amounts, it would ease borrowers' cash-flow problems and allow them to stay in their homes.
The holders of the second-lien debt would probably jump at the opportunity, because, if the houses go into foreclosure, that debt would be worth less than whatever the government offers. Of course, this approach still creates moral hazard. But limiting the plan to those with positive equity on their first mortgages would minimize its total cost.
However, it wouldn't be easy. The government would have to vet appraisals carefully to ensure it was dealing with borrowers with positive equity. Also, a lot of the loans are wrapped inside mortgage-backed securities. Pulling loans out of those securities could pit one class of investor against another, and could hurt those who have bet the securities will decline in value. The government would have to craft legislation to allow it to purchase the loans without setting off a firestorm of litigation. But if it succeeded, this approach might be a cheap and effective way to stem the rising tide of foreclosures.
CIT is reeling due to its venture outside its comfortable helm and reliance on securitization for funding
When Jeffrey M. Peek took the helm of CIT Group Inc. in 2004, the company had a reputation as a sleepy, but reliable, lender to small and midsize businesses. Today, CIT is reeling.
The situation, some say, has its roots in Mr. Peek's attempts to rejuvenate the New York company. A veteran Wall Street investment banker, Mr. Peek steered CIT into investing heavily in subprime mortgages. It bought a student-loan company. And instead of holding many of its loans on its books, CIT sold them to outside parties.
But last week, after ratings firms downgraded its debt, the company lost access to the funding that normally finances its day-to-day operations. CIT had to drain a $7.3 billion backup credit line, igniting fears that the company was headed for bankruptcy court.
By selling more of CIT's loans to outsiders, executives figured the company would free up capital that could be used to make new loans. But when loan and securitization markets ground to a halt last year, the strategy came under mounting pressure.
In addition to selling its loans, CIT also gets its financing from raising short-term and long-term debt via the capital markets. But, with investors worried about the declining values of lenders' assets, those sources have largely evaporated in recent months.
The reliance on securitization "has contributed to the difficulty they are in," says Sean Egan, managing director at Egan-Jones Ratings Co., an independent credit-rating firm. "Because there's very little securitization being done right now, a major issue is whether the company will be successful in raising long-term capital sources."
Meanwhile, in 2005, CIT jumped into student loans by purchasing Educational Lending Group Inc. CIT also started making more mortgages to people with weak credit histories.
After decades of slow growth, CIT "ventured outside of its comfortable realm and aimed into higher-profit markets," Mr. Hofmann says. "They timed that very badly."
The situation, some say, has its roots in Mr. Peek's attempts to rejuvenate the New York company. A veteran Wall Street investment banker, Mr. Peek steered CIT into investing heavily in subprime mortgages. It bought a student-loan company. And instead of holding many of its loans on its books, CIT sold them to outside parties.
But last week, after ratings firms downgraded its debt, the company lost access to the funding that normally finances its day-to-day operations. CIT had to drain a $7.3 billion backup credit line, igniting fears that the company was headed for bankruptcy court.
By selling more of CIT's loans to outsiders, executives figured the company would free up capital that could be used to make new loans. But when loan and securitization markets ground to a halt last year, the strategy came under mounting pressure.
In addition to selling its loans, CIT also gets its financing from raising short-term and long-term debt via the capital markets. But, with investors worried about the declining values of lenders' assets, those sources have largely evaporated in recent months.
The reliance on securitization "has contributed to the difficulty they are in," says Sean Egan, managing director at Egan-Jones Ratings Co., an independent credit-rating firm. "Because there's very little securitization being done right now, a major issue is whether the company will be successful in raising long-term capital sources."
Meanwhile, in 2005, CIT jumped into student loans by purchasing Educational Lending Group Inc. CIT also started making more mortgages to people with weak credit histories.
After decades of slow growth, CIT "ventured outside of its comfortable realm and aimed into higher-profit markets," Mr. Hofmann says. "They timed that very badly."
Sunday, March 23, 2008
Fed's Move to ease the concerns in MBS market
Repo
The Fed has already announced several initiatives to provide additional liquidity to the MBS market, including expanded, longer-term repo operations in which bond dealers pledge MBS to borrow short-term funds from the Fed. Only MBS backed by the federal government or by the federally-sponsored mortgage agencies Fannie Mae and Freddie Mac can be pledged in such operations.
Term Security Lending Facility
The Fed has also unveiled a facility to lend dealers up to $200 billion in Treasury bonds, starting March 27, in return for a like amount of both agency-backed and other ("private label") MBS for up to 28 days.
Discount Window
Finally, on Sunday it announced a new facility under which bond dealers can borrow directly from the Fed's discount window with a wide variety of investment-grade collateral, including agency and private label MBS and corporate bonds.
Outright Purchase
Some on Wall Street have pressed the Fed to go further and purchase MBS outright. The Fed has the legal authority to purchase agency MBS but not private label MBS. It has been reluctant to do so since that could potentially distort the fundamental prices of such securities. Its recent steps were aimed at averting a crippling aversion by investors to holding any MBS irrespective of their fundamental value.
Relex Capital Contraint for Fannie and Freddie
The Fed has, however, lent its moral support to other initiatives to boost demand for MBS. Fed Chairman Ben Bernanke has called on Fannie and Freddie to issue additional capital, which would expand their ability to buy or guarantee MBS. He has also called for an expansion of the Federal Housing Administration's authority to guarantee troubled mortgages.
The Fed has already announced several initiatives to provide additional liquidity to the MBS market, including expanded, longer-term repo operations in which bond dealers pledge MBS to borrow short-term funds from the Fed. Only MBS backed by the federal government or by the federally-sponsored mortgage agencies Fannie Mae and Freddie Mac can be pledged in such operations.
Term Security Lending Facility
The Fed has also unveiled a facility to lend dealers up to $200 billion in Treasury bonds, starting March 27, in return for a like amount of both agency-backed and other ("private label") MBS for up to 28 days.
Discount Window
Finally, on Sunday it announced a new facility under which bond dealers can borrow directly from the Fed's discount window with a wide variety of investment-grade collateral, including agency and private label MBS and corporate bonds.
Outright Purchase
Some on Wall Street have pressed the Fed to go further and purchase MBS outright. The Fed has the legal authority to purchase agency MBS but not private label MBS. It has been reluctant to do so since that could potentially distort the fundamental prices of such securities. Its recent steps were aimed at averting a crippling aversion by investors to holding any MBS irrespective of their fundamental value.
Relex Capital Contraint for Fannie and Freddie
The Fed has, however, lent its moral support to other initiatives to boost demand for MBS. Fed Chairman Ben Bernanke has called on Fannie and Freddie to issue additional capital, which would expand their ability to buy or guarantee MBS. He has also called for an expansion of the Federal Housing Administration's authority to guarantee troubled mortgages.
Saturday, March 22, 2008
'Doomsdays' and Bargains in CMBS
Commercial-real-estate debt has rallied after months of declines, but some fund managers are betting that top-quality securities can still be bought on the cheap.
Their reasoning: Prices of top-quality commercial-real-estate debt are still at levels that are wildly out of line. Securities are priced at levels that imply default rates could reach 80%, or even 100%, of their underlying loans, they say. Historically, though, the worst period in the commercial-real-estate debt market saw defaults on those bonds reach roughly 31%.
While fund managers concede that commercial real estate is entering a slump, they argue that the doomsday scenario reflected in prices of high-quality securities is unwarranted.
"The implied losses are so severe that under any reasonable scenario you can't justify these levels," says Angelo Manioudakis, a portfolio manager at OppenheimerFunds. "There is still huge value."
The culprit behind the apparent disconnect, mutual-fund managers say, is the scramble by banks and brokerage firms in recent months to hedge against commercial-real-estate loans made by those firms. That protection comes in the form of selling CMBX indexes, which are baskets of credit-default swaps on commercial-real-estate debt. Hedge funds, sensing an opportunity for a quick profit, piled on the selling with bets that the index would fall, further driving the index down.
Thanks to this downward pressure on prices, the spread between U.S. Treasurys and the highest rated, triple-A CMBX soared. For the triple-A series 3 index, which tracked debt issued in mid-to-late 2006, the spread jumped as high as 2.70 percentage points from 0.60 percentage point at the start of the year. This in turn has translated into lower prices on actual securities.
This past week, however, there was a steep decline in those spreads. The rally began after players took note that the CMBX indexes barely budged during the Bear Stearns turmoil despite the securities firm's exposure to commercial-real-estate debt.
That was followed by reassurances from Lehman Brothers Holdings Inc. and Goldman Sachs Group Inc. about the relative health of their mortgage portfolios, as well as the Federal Reserve's steps to lower interest rates. These events sparked a rush by speculative players to buy back their short positions. Meanwhile, longer-term investors were encouraged by the bounce and also began to buy, players say.
As a result, the spread on the CMBX Triple-A series 3 index has fallen to around 1.90 percentage points, its lowest level since late February.
Nonetheless, that kind of a reading on the triple-A CMBX indexes implies cumulative default rates on the underlying loans of as high as 100%, players say, depending on the assumptions made for recoveries that would follow defaults.
"If every commercial-real-estate loan is defaulting...I would consider a more appropriate hedge to be canned goods, ammunition, livestock," jokes Derrick Wulf, a portfolio manager at Dwight Asset Management Co. That implied level of default would "far exceed any experience that we've ever seen, even during the savings-and-loan crisis," he says.
That isn't to say that there aren't big potential problems in commercial real estate. "There was a deterioration of [loan] underwriting quality and eventually that has to come to the surface...and we will see some very large loans experiencing a default," says Bryan Whalen, a partner at Metropolitan West Asset Management, which oversees $25 billion.
One challenge for investors is that unlike residential-mortgage-backed securities, which are typically backed by hundreds of loans, it isn't unusual to see a single loan make up 10% of a commercial-real-estate-backed security. That leaves bondholders much more vulnerable to even a small percentage of defaults if they happen to own one that goes bad.
Despite the compelling value that commercial-mortgage-backed securities offer, the lack of price stability is keeping many investors on the sidelines. The volatility of the CMBX is making it difficult to track the pricing of the bonds, says Sam Davis, a senior managing director at Allstate Investments LLC, part of insurer Allstate Corp., who manages a $7 billion commercial-mortgage-bond portfolio.
Still, fund managers say the numbers just don't add up to warrant such low prices. Oppenheimer's Mr. Manioudakis notes that loans underwritten in 2007 -- a year that he says is "commonly believed to be one of the worst underwritten vintages" of loans -- haven't had as many first-year defaults as some prior episodes.
Historic Lowe Default Rate in 2008
Still, fund managers say the numbers just don't add up to warrant such low prices. Oppenheimer's Mr. Manioudakis notes that loans underwritten in 2007 -- a year that he says is "commonly believed to be one of the worst underwritten vintages" of loans -- haven't had as many first-year defaults as some prior episodes.
The first-year default rates on triple-A-rated 2007 debt has been 0.09%, Mr. Manioudakis says. Meanwhile, the default rate on loans underwritten in 1974 was 7.1% in their first year, and in 1975 the first-year default rate was 3.04%.
Even loans underwritten in 1986 -- which would turn out to be the worst vintage of loans in the markets' history with the 31% lifetime default rate -- had a 0.92% default rate its first year, 10 times as high as the 2007 loans, Mr. Manioudakis says.
A layer of protection
There is another reason that some say triple-A commercial-real-estate debt is a safer bet than market prices indicate: The securities typically offer a layer of protection that isn't contained in residential-real-estate-backed debt.
Most triple-A commercial-real-estate securities have a built-in cushion protecting investors from losses of as much as 30% on the underlying loans. Even after defaults, recovery rates on those loans can easily be 65 or 70 cents on the dollar.
Fund managers also argue that there is an important difference between the commercial and residential real-estate markets.
"If the market value of a [commercial] property declines, the owner isn't going to walk away from the investment if it's still producing positive income," says Dwight's Mr. Wulf, who has been buying top-tier, shorter-term commercial-real-estate debt with maturities of one to two years.
Metropolitan West's Mr. Whalen is taking a cautious view of the commercial-real-estate debt market, especially anything outside the high levels of the capital structure. Still, he says, at recent levels "it's very attractive."
Their reasoning: Prices of top-quality commercial-real-estate debt are still at levels that are wildly out of line. Securities are priced at levels that imply default rates could reach 80%, or even 100%, of their underlying loans, they say. Historically, though, the worst period in the commercial-real-estate debt market saw defaults on those bonds reach roughly 31%.
While fund managers concede that commercial real estate is entering a slump, they argue that the doomsday scenario reflected in prices of high-quality securities is unwarranted.
"The implied losses are so severe that under any reasonable scenario you can't justify these levels," says Angelo Manioudakis, a portfolio manager at OppenheimerFunds. "There is still huge value."
The culprit behind the apparent disconnect, mutual-fund managers say, is the scramble by banks and brokerage firms in recent months to hedge against commercial-real-estate loans made by those firms. That protection comes in the form of selling CMBX indexes, which are baskets of credit-default swaps on commercial-real-estate debt. Hedge funds, sensing an opportunity for a quick profit, piled on the selling with bets that the index would fall, further driving the index down.
Thanks to this downward pressure on prices, the spread between U.S. Treasurys and the highest rated, triple-A CMBX soared. For the triple-A series 3 index, which tracked debt issued in mid-to-late 2006, the spread jumped as high as 2.70 percentage points from 0.60 percentage point at the start of the year. This in turn has translated into lower prices on actual securities.
This past week, however, there was a steep decline in those spreads. The rally began after players took note that the CMBX indexes barely budged during the Bear Stearns turmoil despite the securities firm's exposure to commercial-real-estate debt.
That was followed by reassurances from Lehman Brothers Holdings Inc. and Goldman Sachs Group Inc. about the relative health of their mortgage portfolios, as well as the Federal Reserve's steps to lower interest rates. These events sparked a rush by speculative players to buy back their short positions. Meanwhile, longer-term investors were encouraged by the bounce and also began to buy, players say.
As a result, the spread on the CMBX Triple-A series 3 index has fallen to around 1.90 percentage points, its lowest level since late February.
Nonetheless, that kind of a reading on the triple-A CMBX indexes implies cumulative default rates on the underlying loans of as high as 100%, players say, depending on the assumptions made for recoveries that would follow defaults.
"If every commercial-real-estate loan is defaulting...I would consider a more appropriate hedge to be canned goods, ammunition, livestock," jokes Derrick Wulf, a portfolio manager at Dwight Asset Management Co. That implied level of default would "far exceed any experience that we've ever seen, even during the savings-and-loan crisis," he says.
That isn't to say that there aren't big potential problems in commercial real estate. "There was a deterioration of [loan] underwriting quality and eventually that has to come to the surface...and we will see some very large loans experiencing a default," says Bryan Whalen, a partner at Metropolitan West Asset Management, which oversees $25 billion.
One challenge for investors is that unlike residential-mortgage-backed securities, which are typically backed by hundreds of loans, it isn't unusual to see a single loan make up 10% of a commercial-real-estate-backed security. That leaves bondholders much more vulnerable to even a small percentage of defaults if they happen to own one that goes bad.
Despite the compelling value that commercial-mortgage-backed securities offer, the lack of price stability is keeping many investors on the sidelines. The volatility of the CMBX is making it difficult to track the pricing of the bonds, says Sam Davis, a senior managing director at Allstate Investments LLC, part of insurer Allstate Corp., who manages a $7 billion commercial-mortgage-bond portfolio.
Still, fund managers say the numbers just don't add up to warrant such low prices. Oppenheimer's Mr. Manioudakis notes that loans underwritten in 2007 -- a year that he says is "commonly believed to be one of the worst underwritten vintages" of loans -- haven't had as many first-year defaults as some prior episodes.
Historic Lowe Default Rate in 2008
Still, fund managers say the numbers just don't add up to warrant such low prices. Oppenheimer's Mr. Manioudakis notes that loans underwritten in 2007 -- a year that he says is "commonly believed to be one of the worst underwritten vintages" of loans -- haven't had as many first-year defaults as some prior episodes.
The first-year default rates on triple-A-rated 2007 debt has been 0.09%, Mr. Manioudakis says. Meanwhile, the default rate on loans underwritten in 1974 was 7.1% in their first year, and in 1975 the first-year default rate was 3.04%.
Even loans underwritten in 1986 -- which would turn out to be the worst vintage of loans in the markets' history with the 31% lifetime default rate -- had a 0.92% default rate its first year, 10 times as high as the 2007 loans, Mr. Manioudakis says.
A layer of protection
There is another reason that some say triple-A commercial-real-estate debt is a safer bet than market prices indicate: The securities typically offer a layer of protection that isn't contained in residential-real-estate-backed debt.
Most triple-A commercial-real-estate securities have a built-in cushion protecting investors from losses of as much as 30% on the underlying loans. Even after defaults, recovery rates on those loans can easily be 65 or 70 cents on the dollar.
Fund managers also argue that there is an important difference between the commercial and residential real-estate markets.
"If the market value of a [commercial] property declines, the owner isn't going to walk away from the investment if it's still producing positive income," says Dwight's Mr. Wulf, who has been buying top-tier, shorter-term commercial-real-estate debt with maturities of one to two years.
Metropolitan West's Mr. Whalen is taking a cautious view of the commercial-real-estate debt market, especially anything outside the high levels of the capital structure. Still, he says, at recent levels "it's very attractive."
Friday, March 21, 2008
LEH Q1 2008
Overall
--NI $489 million, $0.81 per share, 57% drop from Q1 2007($1.15 billion, or $1.96), 59% drop from Q4 2007 (886 million, $1.54)
--Net Revenue $3.5 billion, 31% drop from Q1 07(5 bil) and 20% drop from Q4 07(4.4 bil)
Segments -- only FI capital market suffered
--Capital Market: 1.7 bil revenue, 52% decrease from from 3.5 Q1 07.
----FI:0.262 mil, 88% from 2.2 bil Q1 07
----Equity:1.4 bil, 6% increase from 1.3 bil (drivers prime borkerage and execution service)
--IBanking: $867 million, an increase of 2% from $850 million Q1 07 (driver: M&A)
--Investment Mg: 968 mil, an increase of 39% from 695 mil.
----Asset Mg: 618 mil, 49% from $416 mil
----Private Wealth Mg: 350 mil from 279 mil, 25%
Costs: -- eff cost control, still has more room to cut
--Non-interest expenses $2.8 billion, $3.3 billion Q1 2007 and $3.2 Q4 2007.
--Compensation and benefits as a percentage of net revenues was 52.5%, 49.3% Q1 and Q4 2007.
Liquidity and Funding -- shfit to long term funding
--liquidity pool of $34 billion Q1 08. other unencumbered assets of $64 billion and our regulated entities had unencumbered assets of $99 billion.
--Our policy is to operate with an excess of long-term funding sources over our long-term funding requirements (“cash capital surplus”). We seek to maintain a cash capital surplus at Holdings of at least $2.0 billion. As of November 30, 2007, our cash capital surplus at Holdings increased to $8.0 billion, up from $6.0 billion at November 30, 2006.
--Long-term borrowings (less current portion) increased to $123.2 billion at November 30, 2007, up from $81.2 billion at November 30..(50% increase)
Asset Quality -- appropriate hedge
--Mortgage: Gross writedown 3 bil, but net bil 0.6 bil, remaining exposure 31.8 bil
----Prime and Alt-A: 14.6 bil
--CMBS: gross writedown 1.1 bil (3%), net 0.7 bil, $36.1 bil
--Leveraged Financing: writeoff 0.7(3%), net 0.7, exp 28.7(70% high yield)
--
--NI $489 million, $0.81 per share, 57% drop from Q1 2007($1.15 billion, or $1.96), 59% drop from Q4 2007 (886 million, $1.54)
--Net Revenue $3.5 billion, 31% drop from Q1 07(5 bil) and 20% drop from Q4 07(4.4 bil)
Segments -- only FI capital market suffered
--Capital Market: 1.7 bil revenue, 52% decrease from from 3.5 Q1 07.
----FI:0.262 mil, 88% from 2.2 bil Q1 07
----Equity:1.4 bil, 6% increase from 1.3 bil (drivers prime borkerage and execution service)
--IBanking: $867 million, an increase of 2% from $850 million Q1 07 (driver: M&A)
--Investment Mg: 968 mil, an increase of 39% from 695 mil.
----Asset Mg: 618 mil, 49% from $416 mil
----Private Wealth Mg: 350 mil from 279 mil, 25%
Costs: -- eff cost control, still has more room to cut
--Non-interest expenses $2.8 billion, $3.3 billion Q1 2007 and $3.2 Q4 2007.
--Compensation and benefits as a percentage of net revenues was 52.5%, 49.3% Q1 and Q4 2007.
Liquidity and Funding -- shfit to long term funding
--liquidity pool of $34 billion Q1 08. other unencumbered assets of $64 billion and our regulated entities had unencumbered assets of $99 billion.
--Our policy is to operate with an excess of long-term funding sources over our long-term funding requirements (“cash capital surplus”). We seek to maintain a cash capital surplus at Holdings of at least $2.0 billion. As of November 30, 2007, our cash capital surplus at Holdings increased to $8.0 billion, up from $6.0 billion at November 30, 2006.
--Long-term borrowings (less current portion) increased to $123.2 billion at November 30, 2007, up from $81.2 billion at November 30..(50% increase)
Asset Quality -- appropriate hedge
--Mortgage: Gross writedown 3 bil, but net bil 0.6 bil, remaining exposure 31.8 bil
----Prime and Alt-A: 14.6 bil
--CMBS: gross writedown 1.1 bil (3%), net 0.7 bil, $36.1 bil
--Leveraged Financing: writeoff 0.7(3%), net 0.7, exp 28.7(70% high yield)
--
One case of Repo deal
4.5 Tril market size: The over-the-counter repo market is now one of the largest and most active sectors in the US money market. Repos are widely used for investing surplus funds short term, or for borrowing short term against collateral. Dealers in securities use repos to manage their liquidity, finance their inventories, and speculate in various ways. The Fed uses repos to manage the aggregate reserves of the banking system.
What are Repos?
Repos, short for repurchase agreements, are contracts for the sale and future repurchase of a financial asset, most often Treasury securities. On the termination date, the seller repurchases the asset at the same price at which he sold it, and pays interest for the use of the funds. Although legally a sequential pair of sales, in effect a repo is a short-term interest-bearing loan against collateral.
The annualized rate of interest paid on the loan is known as the repo rate. Repos can be of any duration but are most commonly overnight loans. Repos for longer than overnight are known as term repos. There are also open repos that can be terminated by either side on a day’s notice. In common parlance, the seller of securities does a repo and the lender of funds does a reverse. Because money is the more liquid asset, the lender normally receives a margin on the collateral, meaning it is priced below market value, usually by 2 to 5 percent depending on maturity.
The overnight repo rate normally runs slightly below the Fed funds rate for two reasons: First a repo transaction is a secured loan, whereas the sale of Fed funds is an unsecured loan. Second, many who can invest in repos cannot sell Fed funds. Even though the return is modest, overnight lending in the repo market offers several advantages to investors. By rolling overnight repos, they can keep surplus funds invested without losing liquidity or incurring price risk. They also incur very little credit risk because the collateral is always high grade paper.
Repos are not for Small Investors
The largest users of repos and reverses are the dealers in government securities. As of August 2006 there were 23 primary dealers recognized by the Fed, which means they were authorized to bid on newly-issued Treasury securities for resale in the market. Primary dealers must be well-capitalized, and often deal in hundred million dollar chunks. In addition there are several hundred dealers who buy and sell Treasury securities in the secondary market and do repos and reverses in at least one million dollar chunks.
The balance sheet of a government securities dealer is highly leveraged, with assets typically 50 to 100 times its own capital. To finance the inventory, there is a need to obtain repo money in large amounts on a continuing basis. Big suppliers of repo money are money funds, large corporations, state and local governments, and foreign central banks. Generally the alternative of investing in securities that mature in a few months is not attractive by comparison. Even 3-month Treasury bills normally yield less than overnight repos.
Clearing Banks and Dealer Loans
A securities dealer must have an account at a clearing bank to settle his trades. For example, suppose ABC company has $20 million to invest short term. After negotiating the terms with the dealer, ABC has its bank wire $20 million to the clearing bank. On receipt, the clearing bank recovers the funds it loaned the dealer to acquire the securities being sold, plus interest due on the loan. It then transfers the sold securities to a special custodial account in the name of ABC. Since government securities exist as book entries on a computer, this is a trivial operation.
The next morning the dealer repurchases the securities from ABC, pays the overnight interest on the repo, and regains possession of the securities. Assuming a 5% repo rate, the interest due on the $20 million overnight loan would be $2,777.78, which is based on a 360-day year. If both parties agree, the repo could be rolled over instead of paid off, thus providing another day of funds for the dealer and another day of interest for ABC.
If the dealer is short on funds needed to repurchase the securities, the clearing bank will advance them with little or no interest if repaid the same day. Otherwise the bank will charge the dealer interest on the loan and hold the securities as collateral until payment is made. Since dealer loans typically run at least 25 basis points above the Fed funds rate, dealers try to finance as much as they can by borrowing through repos. By rolling over repos day by day, the dealer can finance most of his inventory without resorting to dealer loans. It is sometimes advantageous to repo for a longer period, using a term repo to minimize transaction costs.
Clearing banks charge a fee for executing dealer transactions. They prefer not to issue large dealer loans because it ties up the bank’s own reserves at little profit. In truth, there is not enough capacity in all of the clearing banks in New York to provide dealer loans sufficient to cover the financing needs of the large securities dealers
comments:
1.how will repo rate impact a dealer's liquidity
2.what is the dynamics of repo rate
when underlying collateral, like Treasury, is in high demand, dealers will lower repo rate, disencouraging money leader to take awsy collateral. Why? not cash
What are Repos?
Repos, short for repurchase agreements, are contracts for the sale and future repurchase of a financial asset, most often Treasury securities. On the termination date, the seller repurchases the asset at the same price at which he sold it, and pays interest for the use of the funds. Although legally a sequential pair of sales, in effect a repo is a short-term interest-bearing loan against collateral.
The annualized rate of interest paid on the loan is known as the repo rate. Repos can be of any duration but are most commonly overnight loans. Repos for longer than overnight are known as term repos. There are also open repos that can be terminated by either side on a day’s notice. In common parlance, the seller of securities does a repo and the lender of funds does a reverse. Because money is the more liquid asset, the lender normally receives a margin on the collateral, meaning it is priced below market value, usually by 2 to 5 percent depending on maturity.
The overnight repo rate normally runs slightly below the Fed funds rate for two reasons: First a repo transaction is a secured loan, whereas the sale of Fed funds is an unsecured loan. Second, many who can invest in repos cannot sell Fed funds. Even though the return is modest, overnight lending in the repo market offers several advantages to investors. By rolling overnight repos, they can keep surplus funds invested without losing liquidity or incurring price risk. They also incur very little credit risk because the collateral is always high grade paper.
Repos are not for Small Investors
The largest users of repos and reverses are the dealers in government securities. As of August 2006 there were 23 primary dealers recognized by the Fed, which means they were authorized to bid on newly-issued Treasury securities for resale in the market. Primary dealers must be well-capitalized, and often deal in hundred million dollar chunks. In addition there are several hundred dealers who buy and sell Treasury securities in the secondary market and do repos and reverses in at least one million dollar chunks.
The balance sheet of a government securities dealer is highly leveraged, with assets typically 50 to 100 times its own capital. To finance the inventory, there is a need to obtain repo money in large amounts on a continuing basis. Big suppliers of repo money are money funds, large corporations, state and local governments, and foreign central banks. Generally the alternative of investing in securities that mature in a few months is not attractive by comparison. Even 3-month Treasury bills normally yield less than overnight repos.
Clearing Banks and Dealer Loans
A securities dealer must have an account at a clearing bank to settle his trades. For example, suppose ABC company has $20 million to invest short term. After negotiating the terms with the dealer, ABC has its bank wire $20 million to the clearing bank. On receipt, the clearing bank recovers the funds it loaned the dealer to acquire the securities being sold, plus interest due on the loan. It then transfers the sold securities to a special custodial account in the name of ABC. Since government securities exist as book entries on a computer, this is a trivial operation.
The next morning the dealer repurchases the securities from ABC, pays the overnight interest on the repo, and regains possession of the securities. Assuming a 5% repo rate, the interest due on the $20 million overnight loan would be $2,777.78, which is based on a 360-day year. If both parties agree, the repo could be rolled over instead of paid off, thus providing another day of funds for the dealer and another day of interest for ABC.
If the dealer is short on funds needed to repurchase the securities, the clearing bank will advance them with little or no interest if repaid the same day. Otherwise the bank will charge the dealer interest on the loan and hold the securities as collateral until payment is made. Since dealer loans typically run at least 25 basis points above the Fed funds rate, dealers try to finance as much as they can by borrowing through repos. By rolling over repos day by day, the dealer can finance most of his inventory without resorting to dealer loans. It is sometimes advantageous to repo for a longer period, using a term repo to minimize transaction costs.
Clearing banks charge a fee for executing dealer transactions. They prefer not to issue large dealer loans because it ties up the bank’s own reserves at little profit. In truth, there is not enough capacity in all of the clearing banks in New York to provide dealer loans sufficient to cover the financing needs of the large securities dealers
comments:
1.how will repo rate impact a dealer's liquidity
2.what is the dynamics of repo rate
when underlying collateral, like Treasury, is in high demand, dealers will lower repo rate, disencouraging money leader to take awsy collateral. Why? not cash
Europe's Central Banks Inject Additional Cash
European central banks flooded the financial system with extra funds in response to proliferating signs of uneasiness in markets as Germany's early credit-market casualty IKB Deutsche Industriebank AG received yet another shot of capital.
With rumors about banks' creditworthiness proliferating and banks hoarding cash ahead of the long holiday weekend and the coming end of the quarter, the European Central Bank pumped an extra €15 billion ($23.41 billion) in five-day funds into euro-zone money markets to tide financial institutions over until Tuesday. The sum comes atop the extra €25 billion in weekly loans the ECB offered earlier.
The Bank of England, meanwhile, extended the extra £5 billion ($9.91 billion) it lent to United Kingdom financial institutions Monday, saying the extra funds would stay on offer until April 9, the day before the central bank's next interest-rate decision. Also Thursday, German state development bank KfW announced it will grant troubled German lender IKB an additional €450 million in fresh capital to cover more write-downs on its assets.
Outside money markets, there was another sign of slowing growth in the euro-zone economy. The composite Purchasing Managers Index -- a measure of private-sector activity in the euro zone -- reversed February's sharp gain, falling to 51.9 in March from 52.8 a month earlier, research group NTC Economics said. A level above 50 signals an expansion in activity; below 50 signals contraction.
Activity across manufacturing and services sectors eased in France, albeit from high levels, while activity in Germany, the region's largest economy, picked up.
The ECB has been holding rates steady at 4% while the U.S. Federal Reserve has been reducing them. Many analysts argue that factors including a U.S. recession and the surging euro mean growth this year will slow more sharply than the central bank's projection. They anticipate the ECB will start cutting its key rate in June.
With rumors about banks' creditworthiness proliferating and banks hoarding cash ahead of the long holiday weekend and the coming end of the quarter, the European Central Bank pumped an extra €15 billion ($23.41 billion) in five-day funds into euro-zone money markets to tide financial institutions over until Tuesday. The sum comes atop the extra €25 billion in weekly loans the ECB offered earlier.
The Bank of England, meanwhile, extended the extra £5 billion ($9.91 billion) it lent to United Kingdom financial institutions Monday, saying the extra funds would stay on offer until April 9, the day before the central bank's next interest-rate decision. Also Thursday, German state development bank KfW announced it will grant troubled German lender IKB an additional €450 million in fresh capital to cover more write-downs on its assets.
Outside money markets, there was another sign of slowing growth in the euro-zone economy. The composite Purchasing Managers Index -- a measure of private-sector activity in the euro zone -- reversed February's sharp gain, falling to 51.9 in March from 52.8 a month earlier, research group NTC Economics said. A level above 50 signals an expansion in activity; below 50 signals contraction.
Activity across manufacturing and services sectors eased in France, albeit from high levels, while activity in Germany, the region's largest economy, picked up.
The ECB has been holding rates steady at 4% while the U.S. Federal Reserve has been reducing them. Many analysts argue that factors including a U.S. recession and the surging euro mean growth this year will slow more sharply than the central bank's projection. They anticipate the ECB will start cutting its key rate in June.
Capital Replenishment
The Federal Reserve temporarily averted a financial-system meltdown by sponsoring the rescue of Bear Stearns. But the system is still fragile. The best way to shore it up -- without taxpayers providing yet more bailouts -- is to require banks and brokers to raise more capital.
This wouldn't be such a problem if the damage were spread evenly. But relatively few victims have suffered. Two-thirds of the subprime write-downs up to the end of last year were taken by just 10 big banks and brokers. These firms retain more than 60% of the world's exposure to subprime assets, and roughly half its stuck leveraged buyout loans, too.
Shoring up their capital bases is likely to prove painful. Only a few banks are sitting on big profits from stakes in listed companies, which could be sold if times got tough. And while banks often do have stakes in private companies, these aren't simple to liquidate. Fortis's €2.1 billion sale this week of half its asset-management arm to China's Ping An looks like the exception rather than the rule. Royal Bank of Scotland -- which along with Fortis foolishly extended itself with its top-of-the market purchase of ABN Amro -- has been trying to get rid of its Angel Trains leasing business for months.
Hard to sell assets during turburlents market
Raising money by floating a business on the stock market also won't be easy, given market conditions. This week's successful initial public offering of Visa, which gave timely cash injections to banks including Bank of America, Citigroup and J.P. Morgan Chase, looks like something of a one-off.
Hybrid Captial is teoo expensive
Other options for raising capital aren't appealing. Tapping the credit markets for so-called hybrid capital is expensive. British bank HBOS raised £750 million last week at 9.5%, representing a risk premium four times as large as it would have paid a year ago.
Sovereign Wealth Fund is not hesitating
Selling shares to rich foreign investors might seem an attractive option. And, in the early stages of the crisis, that's exactly what the likes of Citigroup, Merrill Lynch and UBS did. They tapped sovereign-wealth funds in Asia and the Middle East for capital.
The snag is that the funds have lost about 40% of the $50 billion they have invested to date -- so they may be reluctant to throw good money after bad.
Tap their own shareholder
This means that to raise significant capital, financial institutions may be forced to tap their own shareholders. Scrapping dividends, as UBS has done, would help a bit. But a better solution would be to launch deeply discounted rights issues -- as Société Générale did successfully last week to fill the hole left by its rogue trader. Two Portuguese banks -- BCP and BPI -- have similarly got the message and announced rights issues to replenish weak capital coffers.
In recent weeks, officials have been ramping up the pressure. Treasury Secretary Henry Paulson has been telling banks to review dividend policies and raise more capital. The mortgage-agency regulator has done a deal with Freddie Mac and Fannie Mae that involves easing some of the constraints under which they operate in return for the companies raising "significant" capital -- although it's not quite clear how much that will be.
This pressure probably isn't yet strong enough to have the desired effect. Many financial bosses are reluctant to ask shareholders for bailout money, perhaps fearing that they could pay with their jobs. The authorities need to remind banks that it is better to sacrifice the boss than the whole franchise.
This wouldn't be such a problem if the damage were spread evenly. But relatively few victims have suffered. Two-thirds of the subprime write-downs up to the end of last year were taken by just 10 big banks and brokers. These firms retain more than 60% of the world's exposure to subprime assets, and roughly half its stuck leveraged buyout loans, too.
Shoring up their capital bases is likely to prove painful. Only a few banks are sitting on big profits from stakes in listed companies, which could be sold if times got tough. And while banks often do have stakes in private companies, these aren't simple to liquidate. Fortis's €2.1 billion sale this week of half its asset-management arm to China's Ping An looks like the exception rather than the rule. Royal Bank of Scotland -- which along with Fortis foolishly extended itself with its top-of-the market purchase of ABN Amro -- has been trying to get rid of its Angel Trains leasing business for months.
Hard to sell assets during turburlents market
Raising money by floating a business on the stock market also won't be easy, given market conditions. This week's successful initial public offering of Visa, which gave timely cash injections to banks including Bank of America, Citigroup and J.P. Morgan Chase, looks like something of a one-off.
Hybrid Captial is teoo expensive
Other options for raising capital aren't appealing. Tapping the credit markets for so-called hybrid capital is expensive. British bank HBOS raised £750 million last week at 9.5%, representing a risk premium four times as large as it would have paid a year ago.
Sovereign Wealth Fund is not hesitating
Selling shares to rich foreign investors might seem an attractive option. And, in the early stages of the crisis, that's exactly what the likes of Citigroup, Merrill Lynch and UBS did. They tapped sovereign-wealth funds in Asia and the Middle East for capital.
The snag is that the funds have lost about 40% of the $50 billion they have invested to date -- so they may be reluctant to throw good money after bad.
Tap their own shareholder
This means that to raise significant capital, financial institutions may be forced to tap their own shareholders. Scrapping dividends, as UBS has done, would help a bit. But a better solution would be to launch deeply discounted rights issues -- as Société Générale did successfully last week to fill the hole left by its rogue trader. Two Portuguese banks -- BCP and BPI -- have similarly got the message and announced rights issues to replenish weak capital coffers.
In recent weeks, officials have been ramping up the pressure. Treasury Secretary Henry Paulson has been telling banks to review dividend policies and raise more capital. The mortgage-agency regulator has done a deal with Freddie Mac and Fannie Mae that involves easing some of the constraints under which they operate in return for the companies raising "significant" capital -- although it's not quite clear how much that will be.
This pressure probably isn't yet strong enough to have the desired effect. Many financial bosses are reluctant to ask shareholders for bailout money, perhaps fearing that they could pay with their jobs. The authorities need to remind banks that it is better to sacrifice the boss than the whole franchise.
Citi are running out of funds
CIT Group Inc. said Thursday that its normal sources of funding have dried up because of the credit crisis, forcing the New York company to draw down its entire $7.3 billion line of backup credit. That could mean trouble for commercial borrowers, since CIT will shrink its lending operations and sell assets in order to conserve cash.
While it isn't a bank, CIT is a major lender that specializes in providing financing to companies of all sizes that often can't get all the capital they want from traditional banks. With customers in more than 30 industries and 50 countries, CIT had managed assets of $83.2 billion as of Dec. 31, about the same size as KeyCorp, a regional bank in Cleveland.
Since CIT can't fund its operations with bank deposits, it typically relies on a combination of financing including short-term borrowing known as commercial paper as well as asset backed markets and the corporate bond market.
But those funding sources have been frozen by the credit crunch. A downgrade by Standard & Poor's on Tuesday made it even harder for CIT, which celebrated its 100th anniversary last month, to find financing.
After CIT said it was forced to tap its emergency credit, its shares plunged as much as 45%. In New York Stock Exchange trading Thursday, CIT shares were down 17%, or $2.01, at $9.63, in a sign that investors think the company has bought itself time in a turbulent environment.
CIT's problems are the latest sign of tightening credit for small and medium-sized businesses. Mounting defaults on mortgages and other consumer loans have made many banks increasingly cautious about all types of lending, a trend that threatens to aggravate the U.S. economy's slowdown. A Federal Reserve survey in January showed that about a third of banks had toughened standards on commercial loans, while about 40% said they were charging higher interest rates on such loans.
CIT must have enough cash to cover $9.7 billion of debt that matures in 2008, in addition to its short-term commercial-paper debt. The largest chunk comes due in May, when the company needs to pay or refinance $3.8 billion of bonds. The company has slightly less than $2.5 billion of cash on hand, and it plans to sell $5 billion to $7 billion in assets.
While it isn't a bank, CIT is a major lender that specializes in providing financing to companies of all sizes that often can't get all the capital they want from traditional banks. With customers in more than 30 industries and 50 countries, CIT had managed assets of $83.2 billion as of Dec. 31, about the same size as KeyCorp, a regional bank in Cleveland.
Since CIT can't fund its operations with bank deposits, it typically relies on a combination of financing including short-term borrowing known as commercial paper as well as asset backed markets and the corporate bond market.
But those funding sources have been frozen by the credit crunch. A downgrade by Standard & Poor's on Tuesday made it even harder for CIT, which celebrated its 100th anniversary last month, to find financing.
After CIT said it was forced to tap its emergency credit, its shares plunged as much as 45%. In New York Stock Exchange trading Thursday, CIT shares were down 17%, or $2.01, at $9.63, in a sign that investors think the company has bought itself time in a turbulent environment.
CIT's problems are the latest sign of tightening credit for small and medium-sized businesses. Mounting defaults on mortgages and other consumer loans have made many banks increasingly cautious about all types of lending, a trend that threatens to aggravate the U.S. economy's slowdown. A Federal Reserve survey in January showed that about a third of banks had toughened standards on commercial loans, while about 40% said they were charging higher interest rates on such loans.
CIT must have enough cash to cover $9.7 billion of debt that matures in 2008, in addition to its short-term commercial-paper debt. The largest chunk comes due in May, when the company needs to pay or refinance $3.8 billion of bonds. The company has slightly less than $2.5 billion of cash on hand, and it plans to sell $5 billion to $7 billion in assets.
$100 Billion Power Deal Reshapre Euro Energy Landscape
French and Spanish companies are in advanced discussions about pursuing a tricky $100 billion deal in the Spanish utility industry that could reshape the European energy landsca
Électricité de France SA, one of Europe's largest utilities, is in talks about forming a bidding duo with Actividades de Construcción y Servicios SA, a Spanish construction company. The team would make simultaneous bids for two of Spain's largest utilities -- Iberdrola SA, the country's largest by market value, and Unión Fenosa, the third-largest, according to people familiar with the matter. Adding debt, the combined value of the transactions would be about $134 billion, not including any premium the buyers might pay.
Europe's power industry has undergone major consolidation in recent years. The European Union has tried to usher competition into an industry once dominated by state-owned monopolies. Over the past decade it has tried to crack open the market, allowing a power producer in France to sell power in Spain, and an Austrian company to sell power in Italy. To create space for new players, it capped the market share of the older incumbents in their home markets.
The re-election of a Socialist government in Spain earlier this month may favor more deal-making there. Prime Minister José Luis Rodríguez Zapatero has hinted he won't oppose cross-border deals.
Électricité de France SA, one of Europe's largest utilities, is in talks about forming a bidding duo with Actividades de Construcción y Servicios SA, a Spanish construction company. The team would make simultaneous bids for two of Spain's largest utilities -- Iberdrola SA, the country's largest by market value, and Unión Fenosa, the third-largest, according to people familiar with the matter. Adding debt, the combined value of the transactions would be about $134 billion, not including any premium the buyers might pay.
Europe's power industry has undergone major consolidation in recent years. The European Union has tried to usher competition into an industry once dominated by state-owned monopolies. Over the past decade it has tried to crack open the market, allowing a power producer in France to sell power in Spain, and an Austrian company to sell power in Italy. To create space for new players, it capped the market share of the older incumbents in their home markets.
The re-election of a Socialist government in Spain earlier this month may favor more deal-making there. Prime Minister José Luis Rodríguez Zapatero has hinted he won't oppose cross-border deals.
Thursday, March 20, 2008
HY bonds see rising defaults
17 percent of all high-yield bonds weretrading at distressed levels, up from 11 percent in January andthe highest since June 2003, according to Standard & Poor's.Media and entertainment companies accounted for more than one-third of the $104 billion in such debt. High-yield media bondshave lost about 10 percent this year, more than double thedecline of the average junk issue, Merrill Lynch & Co. indexdata show.
Cary, North Carolina-based R.H. Donnelley and Idearc, ofDallas, performed the worst among the 50 top high-yield issuersin February, Merrill data show.
The last recession was in 2001. Speculative-grade mediadebt gained 9.3 percent in 2000, 12 percent in 2001 and 7.5percent in 2002 while junk bonds on average lost value in 2000and 2002, returning 4.5 percent in 2001. Junk debt is ratedbelow Baa3 by Moody's Investors Service and BBB- by Standard &Poor's, owned by New York-based McGraw-Hill Cos.
Junk-bond default rates may more than quadruple to 4.6percent this year from 1.09 percent in January, Diane Vazza,global head of fixed-income research at S&P in New York,predicted in February.
Cary, North Carolina-based R.H. Donnelley and Idearc, ofDallas, performed the worst among the 50 top high-yield issuersin February, Merrill data show.
The last recession was in 2001. Speculative-grade mediadebt gained 9.3 percent in 2000, 12 percent in 2001 and 7.5percent in 2002 while junk bonds on average lost value in 2000and 2002, returning 4.5 percent in 2001. Junk debt is ratedbelow Baa3 by Moody's Investors Service and BBB- by Standard &Poor's, owned by New York-based McGraw-Hill Cos.
Junk-bond default rates may more than quadruple to 4.6percent this year from 1.09 percent in January, Diane Vazza,global head of fixed-income research at S&P in New York,predicted in February.
Stepping Up to the Fed's Window
How exactly does an investment bank borrow from the Fed? That's what Wall Street is trying to figure out under the Federal Reserve's new lending facility.
A number of Wall Street firms are using the Fed's facility to exchange their securities for cash, a potential relief for officials who had worried that the stigma of borrowing from the Fed could keep firms away.
Morgan Stanley borrowed $2 billion Tuesday from the Fed using "pretty liquid" assets as collateral, said Chief Financial Officer Colm Kelleher. "We didn't need to, but I felt we should to show there was no stigma, and show support for what the Fed had done," he said.
Goldman Sachs Group Inc. tapped it for $100 million Tuesday. Lehman Brothers Holdings Inc. also used it.
My Trip to the Discount Window1: Our correspondent braves stigma in the service of the nation's financial stability.
The facility was among the more dramatic steps that the Fed has taken to ensure that financial institutions, overloaded with hard-to-sell securities, wouldn't face the kind of cash squeeze that crippled Bear Stearns Cos. The facility allows securities dealers, including investment banks, to borrow cash directly from the Fed by exchanging a range of bonds for overnight loans that can be rolled over daily.
Previously, this type of lending had only been available to commercial banks.
The terms on these loans are potentially favorable to Wall Street, subjecting firms to relatively easy requirements on some types of collateral and to a low interest rate.
Liquidity Machine
"The Fed is taking short-term credit risk that it's monitoring very closely, while providing the market with the liquidity it needs," says Art Certosimo, head of broker-dealer services at Bank of New York Mellon, one of the largest clearing banks.
Primary Dealer Credit Facility
The Fed's facility is called the "Primary Dealer Credit Facility." It works much the same way as regular securities repurchase, or repo, agreements that Wall Street firms conduct with each other every day in normal times.
Overnight to 120 days
Financial firms enter into repo transactions to borrow or lend short-term money -- a financial institution swaps securities as collateral in return for cash. It agrees to repurchase the securities a day or so later when the agreement matures in exchange for the cash plus interest on the loan.
4.5 Trillion Repo Market
The repo market is $4.5 trillion in size. In this case, the lender is the Fed, and the interest rate it is charging on the loans is the discount rate, or 2.5%.
Requirements to deal with Fed
In exchange for its loans, the Fed is accepting a grab bag of collateral from investment banks. The securities it is taking include debt such as corporate bonds, muni bonds, mortgage-backed securities and even collateralized debt obligations. The Fed requires the securities to have market prices and to be rated "investment-grade" by at least two credit-rating services. To get the loans, the dealers must deposit the securities with a clearing bank, which handles the transfer of securities and cash.
Lenders in the repo market typically require that borrowers give them more collateral than the value of the loan, to protect themselves from market-price declines in the event the loan can't be paid back and the securities have to be sold.
According to people familiar with the matter, the Fed is lending $95 for every $100 in securities that dealers bring to it, regardless of the type of collateral. In other words, the Fed requires the same amount of additional collateral whether a dealer is borrowing against a Triple A-rated corporate bond or a Triple B-minus subprime-backed bond.
Only Fed is so generous
In regular day-to-day repos, institutions have been lending less than $90 for every $100 of riskier mortgage-backed securities.
The Fed's uniform margin requirements aren't set in stone. So far they have gotten the attention of some bankers. When it makes loans to commercial banks through its discount window, the Fed has varying margin requirements. For example, it lends $98 for every $100 in Treasury securities but $92 for every $100 in foreign-currency corporate bonds that are rated Triple-A.
Insights
Discount Window(Primary Deal Credit Facility): Collateral can be Repo Collateral _ IG Corp _ Muni + MBS + ABS + CMBS
Repot: Collateral only US Govt + Agencies
A number of Wall Street firms are using the Fed's facility to exchange their securities for cash, a potential relief for officials who had worried that the stigma of borrowing from the Fed could keep firms away.
Morgan Stanley borrowed $2 billion Tuesday from the Fed using "pretty liquid" assets as collateral, said Chief Financial Officer Colm Kelleher. "We didn't need to, but I felt we should to show there was no stigma, and show support for what the Fed had done," he said.
Goldman Sachs Group Inc. tapped it for $100 million Tuesday. Lehman Brothers Holdings Inc. also used it.
My Trip to the Discount Window1: Our correspondent braves stigma in the service of the nation's financial stability.
The facility was among the more dramatic steps that the Fed has taken to ensure that financial institutions, overloaded with hard-to-sell securities, wouldn't face the kind of cash squeeze that crippled Bear Stearns Cos. The facility allows securities dealers, including investment banks, to borrow cash directly from the Fed by exchanging a range of bonds for overnight loans that can be rolled over daily.
Previously, this type of lending had only been available to commercial banks.
The terms on these loans are potentially favorable to Wall Street, subjecting firms to relatively easy requirements on some types of collateral and to a low interest rate.
Liquidity Machine
"The Fed is taking short-term credit risk that it's monitoring very closely, while providing the market with the liquidity it needs," says Art Certosimo, head of broker-dealer services at Bank of New York Mellon, one of the largest clearing banks.
Primary Dealer Credit Facility
The Fed's facility is called the "Primary Dealer Credit Facility." It works much the same way as regular securities repurchase, or repo, agreements that Wall Street firms conduct with each other every day in normal times.
Overnight to 120 days
Financial firms enter into repo transactions to borrow or lend short-term money -- a financial institution swaps securities as collateral in return for cash. It agrees to repurchase the securities a day or so later when the agreement matures in exchange for the cash plus interest on the loan.
4.5 Trillion Repo Market
The repo market is $4.5 trillion in size. In this case, the lender is the Fed, and the interest rate it is charging on the loans is the discount rate, or 2.5%.
Requirements to deal with Fed
In exchange for its loans, the Fed is accepting a grab bag of collateral from investment banks. The securities it is taking include debt such as corporate bonds, muni bonds, mortgage-backed securities and even collateralized debt obligations. The Fed requires the securities to have market prices and to be rated "investment-grade" by at least two credit-rating services. To get the loans, the dealers must deposit the securities with a clearing bank, which handles the transfer of securities and cash.
Lenders in the repo market typically require that borrowers give them more collateral than the value of the loan, to protect themselves from market-price declines in the event the loan can't be paid back and the securities have to be sold.
According to people familiar with the matter, the Fed is lending $95 for every $100 in securities that dealers bring to it, regardless of the type of collateral. In other words, the Fed requires the same amount of additional collateral whether a dealer is borrowing against a Triple A-rated corporate bond or a Triple B-minus subprime-backed bond.
Only Fed is so generous
In regular day-to-day repos, institutions have been lending less than $90 for every $100 of riskier mortgage-backed securities.
The Fed's uniform margin requirements aren't set in stone. So far they have gotten the attention of some bankers. When it makes loans to commercial banks through its discount window, the Fed has varying margin requirements. For example, it lends $98 for every $100 in Treasury securities but $92 for every $100 in foreign-currency corporate bonds that are rated Triple-A.
Insights
Discount Window(Primary Deal Credit Facility): Collateral can be Repo Collateral _ IG Corp _ Muni + MBS + ABS + CMBS
Repot: Collateral only US Govt + Agencies
Finanacial Market
--------------------------- Market Size ----------------------------------------
World Security Mkt Size
--$360 tril
Global debt and equity
--$100 tril
Convertible bond
--$400 bil
Equity
US- 13-14 tril
Euro - 13- 14 tril
Govtment debt
--10 tril ( 5 tril held by public , 4 tril intragovertment)
--budget for 2008 $1 tril, usually 400 - 500 bil
Mortgage
--Total Mortgage Mkt 22 trillion (or 5.4 tril? )
--Outstanding Residentail Mortage market 11.5 tril
--Commercial 3.4 tril
-----CMBS 800 bil
--Agency MBS 4.1 trillion
--CMO 19 trillion
--subprime mkt: $900 billion
--Subprime-mortgage bonds : $600 billion
--ABS $2.5 tril
--Outstanding MBS mkt 7.5 tril, Agency MBS 4.5 tril
CDO Market
--US dollar CDO volume currently outstanding is 1.14 trillion
--Cash CDO $1 trillion, Synthetic CDO $1.6 tril/ JPM $757 bil
--ABS CDOs: $1 trillion
CDS Market
--gross 55 tril
--net 1.5 tril
--equal divided by company/individual names bonds, credit indexes like ABX, and structured finance instruments like CDO and CLOs.
Treasury
--4.8 tril
Commercial Paper
--1.7 tril
Repo
--$4.5 trillion
Corporate Bonds
--Size $6 tril
--High Yield: $1 tril
Auction Rate Securities $330 bil
--Muni $200 to $250 bil
--$100 bil Student Loan
--$65 bil issued by Closed-end funds
CDS market
--$62 Trillion
Consumer
--Consumer Credit $2.5 tril
SIV
--$400 bil
Funds size
--Insurance management funds: $16 tril
--pension funds: $15 tril
--Sovereign wealth funds: $3.7 tril by the end of 2007, $9.3 tril by 2012
--Invsetment companies: $21 tril
--Hedge Funds: $1.9 tril
a.credit hedge funds 1/3, 750 bil, leveraged 5-10:1
--Money Market Fund: $3.4 trill (842 retail-class shares $1.2 tril, 1,179 institutional-class shares 2.2 tril)
Money Market - 3.4 tril
Close-end Funds: 200 bil
Oil reserve
--14 or 15 trillion barrels of oil
--consumed 1 tri barrels
2007/8
-- 50 tril US Credit Market debt
-- 14.8 tril mortgage ( 11 tril household vs 3.6 commercial )
---- 4.7 tril Agency and GSE Morgage Pool
---- 3.4 tril Commercial Mortgage ( 2.7 comm vs 0.8 multifamily) hedl by commercial banks and saving loans
---- 3 tril mortgage ABS ( 0.4 tril GSE CMO, 2 tril private label CMO, 0.77 mult family + commerical mortgage)
(http://www.federalreserve.gov/releases/Z1/current/accessible/l126.htm)
---- 3 tril private label mortgage pools held by Savings and Commerical banks (derived)
-- 11 tril corporate and foreign bonds
-- 7.4 tril GSE backed securities
-- 5 tril Treasury
-- 2.6 muni
-- 2 bank loans
-- 2.55 consumer credit
--------------------------------- US Government Stats
--Budget Deficit in 2009 $1.2 bil (10% of GDP)
--Revenue 2.5 bil (20% of GDP)
a.> 17% goes to medical payment
b.>17% goes to national defense
b.17% goes to interest payment
US government indebtness in 2008
--11 tril total debt outstanding
--5.3 tril Fannie and Freddie Mac debt and guarantees
--4.7 tril retirement and healthcare liability to fed employees and veterans
--6.5 tril PV of Social Security shortfalls
--32.3 tril PV of Medicare shortfalls
-- -5.2 net of debt held by SS and Medicare
--total 54 tril
----------------------------------- China Market ---------------------------------
--1.2 bill population vs 300 mil in US
--2-3 tril market cap vs $8 tril in US
--1.6 tril GDP
--$60 tril assuming the same GDP per capital as the US
Corp Bond
--Outstanding corporate debt in China 1.268 trillion yuan at the end of 2008, up 66% from the previous year.
--Corporate bonds account for 8% of China's total outstanding bonds, well below approximately 20% in the U.S in 2007/8.
China A share market
两市总市值为253157亿元 (3 tril)。流通市值为85566，大概是33%左右
开放式股票型基金仓位更是大幅下降4.2个百分点至83%.
三季度末，全部基金手中持有的现金资产为2563.61亿元，环比二季度大幅增加了15.57%。其中，光是华夏、博时、易方达、嘉实和南方这五大基金公司手中持有的现金便达到836.68亿元。
-> mutual funds market size -> 13000亿元 (15% of floating market)
----------------------------------- Historical Crisis --------------------------------
69-71: Wilson President loss in Gold trades
71: Nixon terminate gold exchange window
73: Oil criss, caused by Mid eastern and Arab countries to boycott US's support of Israel
79: Iran Revolution, roiling oil market again
79-81: US fight down inflaiton, which reached 12%
86-96: S&L Crisis
90-99: Japan Banking Crisis
a.1985 - Guang Chuang agreement - yen appreciate from 250 to 200 in 3 months, 1871, 120.
b.1987 - Basel agreement, 8% capital is required for international banks (most Japan banks have lower capial rate)
c.1990, Jan 12 - US use Put options again Japan Stock Index
d.资产价格下跌造成了1 500万亿日元的财富损失 这个数字还相当于日本三年国内生产总值（GDP）
1998-99: Asian Banking Crisis
2000-2005: Germany suffered the worst recession since WII
08-08: Subprime Crisis
World Security Mkt Size
--$360 tril
Global debt and equity
--$100 tril
Convertible bond
--$400 bil
Equity
US- 13-14 tril
Euro - 13- 14 tril
Govtment debt
--10 tril ( 5 tril held by public , 4 tril intragovertment)
--budget for 2008 $1 tril, usually 400 - 500 bil
Mortgage
--Total Mortgage Mkt 22 trillion (or 5.4 tril? )
--Outstanding Residentail Mortage market 11.5 tril
--Commercial 3.4 tril
-----CMBS 800 bil
--Agency MBS 4.1 trillion
--CMO 19 trillion
--subprime mkt: $900 billion
--Subprime-mortgage bonds : $600 billion
--ABS $2.5 tril
--Outstanding MBS mkt 7.5 tril, Agency MBS 4.5 tril
CDO Market
--US dollar CDO volume currently outstanding is 1.14 trillion
--Cash CDO $1 trillion, Synthetic CDO $1.6 tril/ JPM $757 bil
--ABS CDOs: $1 trillion
CDS Market
--gross 55 tril
--net 1.5 tril
--equal divided by company/individual names bonds, credit indexes like ABX, and structured finance instruments like CDO and CLOs.
Treasury
--4.8 tril
Commercial Paper
--1.7 tril
Repo
--$4.5 trillion
Corporate Bonds
--Size $6 tril
--High Yield: $1 tril
Auction Rate Securities $330 bil
--Muni $200 to $250 bil
--$100 bil Student Loan
--$65 bil issued by Closed-end funds
CDS market
--$62 Trillion
Consumer
--Consumer Credit $2.5 tril
SIV
--$400 bil
Funds size
--Insurance management funds: $16 tril
--pension funds: $15 tril
--Sovereign wealth funds: $3.7 tril by the end of 2007, $9.3 tril by 2012
--Invsetment companies: $21 tril
--Hedge Funds: $1.9 tril
a.credit hedge funds 1/3, 750 bil, leveraged 5-10:1
--Money Market Fund: $3.4 trill (842 retail-class shares $1.2 tril, 1,179 institutional-class shares 2.2 tril)
Money Market - 3.4 tril
Close-end Funds: 200 bil
Oil reserve
--14 or 15 trillion barrels of oil
--consumed 1 tri barrels
2007/8
-- 50 tril US Credit Market debt
-- 14.8 tril mortgage ( 11 tril household vs 3.6 commercial )
---- 4.7 tril Agency and GSE Morgage Pool
---- 3.4 tril Commercial Mortgage ( 2.7 comm vs 0.8 multifamily) hedl by commercial banks and saving loans
---- 3 tril mortgage ABS ( 0.4 tril GSE CMO, 2 tril private label CMO, 0.77 mult family + commerical mortgage)
(http://www.federalreserve.gov/releases/Z1/current/accessible/l126.htm)
---- 3 tril private label mortgage pools held by Savings and Commerical banks (derived)
-- 11 tril corporate and foreign bonds
-- 7.4 tril GSE backed securities
-- 5 tril Treasury
-- 2.6 muni
-- 2 bank loans
-- 2.55 consumer credit
--------------------------------- US Government Stats
--Budget Deficit in 2009 $1.2 bil (10% of GDP)
--Revenue 2.5 bil (20% of GDP)
a.> 17% goes to medical payment
b.>17% goes to national defense
b.17% goes to interest payment
US government indebtness in 2008
--11 tril total debt outstanding
--5.3 tril Fannie and Freddie Mac debt and guarantees
--4.7 tril retirement and healthcare liability to fed employees and veterans
--6.5 tril PV of Social Security shortfalls
--32.3 tril PV of Medicare shortfalls
-- -5.2 net of debt held by SS and Medicare
--total 54 tril
----------------------------------- China Market ---------------------------------
--1.2 bill population vs 300 mil in US
--2-3 tril market cap vs $8 tril in US
--1.6 tril GDP
--$60 tril assuming the same GDP per capital as the US
Corp Bond
--Outstanding corporate debt in China 1.268 trillion yuan at the end of 2008, up 66% from the previous year.
--Corporate bonds account for 8% of China's total outstanding bonds, well below approximately 20% in the U.S in 2007/8.
China A share market
两市总市值为253157亿元 (3 tril)。流通市值为85566，大概是33%左右
开放式股票型基金仓位更是大幅下降4.2个百分点至83%.
三季度末，全部基金手中持有的现金资产为2563.61亿元，环比二季度大幅增加了15.57%。其中，光是华夏、博时、易方达、嘉实和南方这五大基金公司手中持有的现金便达到836.68亿元。
-> mutual funds market size -> 13000亿元 (15% of floating market)
----------------------------------- Historical Crisis --------------------------------
69-71: Wilson President loss in Gold trades
71: Nixon terminate gold exchange window
73: Oil criss, caused by Mid eastern and Arab countries to boycott US's support of Israel
79: Iran Revolution, roiling oil market again
79-81: US fight down inflaiton, which reached 12%
86-96: S&L Crisis
90-99: Japan Banking Crisis
a.1985 - Guang Chuang agreement - yen appreciate from 250 to 200 in 3 months, 1871, 120.
b.1987 - Basel agreement, 8% capital is required for international banks (most Japan banks have lower capial rate)
c.1990, Jan 12 - US use Put options again Japan Stock Index
d.资产价格下跌造成了1 500万亿日元的财富损失 这个数字还相当于日本三年国内生产总值（GDP）
1998-99: Asian Banking Crisis
2000-2005: Germany suffered the worst recession since WII
08-08: Subprime Crisis
Costly Fuel, Economic Woes Weigh Down U.S. Airlines
Merrill Lynch now predicts that the eight largest U.S. carriers will post combined losses of $1.5 billion this year, compared with a previous forecast for a collective profit of $1.7 billion. J.P. Morgan analyst Jamie Baker expects wider industry losses of between $4 billion and $9 billion this year, and a slump in travel demand starting in the second quarter.
The airlines have hoarded big piles of cash, estimated at nearly $25 billion at the end of 2007. But while oil prices retreated yesterday, falling $4.94 to $104.48 a barrel on the New York Mercantile Exchange, they remain near all-time highs. And with jet-fuel prices around $132 a barrel, those cash piles could shrink fast, putting carriers in danger of breaching debt covenants with lenders.
Bill Warlick, an airline-debt analyst at Fitch Ratings, said if aviation-fuel prices remain constant for the rest of the year, potentially $10 billion or more of the airlines' cash "could fly out the window."
Mr. Warlick expects cash to get tighter this year if there isn't a pullback in fuel prices or an airline merger. If those stresses continue into 2009, he said some airlines could find themselves cash-strapped enough to file for Chapter 11 bankruptcy protection and some, potentially, could be forced to liquidate.
For now, the situation isn't uniformly grim. Most of the major airlines were profitable in 2007 as a whole, though several slipped into the red in the fourth quarter because of higher fuel costs.
Airlines were successful at pushing through fare increases last year and have negotiated several increases this year. Travel demand also remains strong, with carriers reporting that 75% or more of their domestic seats were filled in January. But Standard & Poor's Corp. recently predicted that "this trend will stall across the industry in the face of softer demand, likely first on domestic routes and then in international markets."
It was a reduction in travel demand in early 2001 that presaged a severe downturn for the airlines. That plunge was exacerbated by the Sept. 11, 2001, terrorist attacks and a spike in fuel costs. Since 2001, four big airlines and many smaller ones have been through bankruptcy court and others reorganized under the threat of a bankruptcy filing. Collectively, the airlines laid off 170,000 workers -- or about 38% of their labor forces -- cut wages and benefits, and pared other expenses.
That's left them with scant room to make further cost reductions, said John Heimlich, chief economist for the Air Transport Association trade group. "Unlike the last cash crunch, it's a lot harder to find things to cut this time." Carriers can either cut costs or increase revenue, he said, "and they're still trying to find the revenue angle."
If oil had stayed at $50 a barrel, the industry would have been highly profitable. But the price of oil has more than doubled since 2004, and the difference between the cost of a barrel of crude and a barrel of jet fuel -- the so-called crack spread -- has widened dramatically as refiners have boosted their profit margins on aviation fuel, capitalizing on a lack of refining capacity by charging airlines more. So when crude-oil prices drop, airlines don't always see immediate relief.
From 2002 to 2007, the jet-fuel crack spread rose to an average $18.59 a barrel from $3.61, and this week the spread topped $30 a barrel before narrowing some yesterday.
Airlines continue to hedge some of their fuel needs, but at current prices hedging is extremely costly, and the carriers don't want to lock in historically high fuel costs in case prices fall.
The airlines have hoarded big piles of cash, estimated at nearly $25 billion at the end of 2007. But while oil prices retreated yesterday, falling $4.94 to $104.48 a barrel on the New York Mercantile Exchange, they remain near all-time highs. And with jet-fuel prices around $132 a barrel, those cash piles could shrink fast, putting carriers in danger of breaching debt covenants with lenders.
Bill Warlick, an airline-debt analyst at Fitch Ratings, said if aviation-fuel prices remain constant for the rest of the year, potentially $10 billion or more of the airlines' cash "could fly out the window."
Mr. Warlick expects cash to get tighter this year if there isn't a pullback in fuel prices or an airline merger. If those stresses continue into 2009, he said some airlines could find themselves cash-strapped enough to file for Chapter 11 bankruptcy protection and some, potentially, could be forced to liquidate.
For now, the situation isn't uniformly grim. Most of the major airlines were profitable in 2007 as a whole, though several slipped into the red in the fourth quarter because of higher fuel costs.
Airlines were successful at pushing through fare increases last year and have negotiated several increases this year. Travel demand also remains strong, with carriers reporting that 75% or more of their domestic seats were filled in January. But Standard & Poor's Corp. recently predicted that "this trend will stall across the industry in the face of softer demand, likely first on domestic routes and then in international markets."
It was a reduction in travel demand in early 2001 that presaged a severe downturn for the airlines. That plunge was exacerbated by the Sept. 11, 2001, terrorist attacks and a spike in fuel costs. Since 2001, four big airlines and many smaller ones have been through bankruptcy court and others reorganized under the threat of a bankruptcy filing. Collectively, the airlines laid off 170,000 workers -- or about 38% of their labor forces -- cut wages and benefits, and pared other expenses.
That's left them with scant room to make further cost reductions, said John Heimlich, chief economist for the Air Transport Association trade group. "Unlike the last cash crunch, it's a lot harder to find things to cut this time." Carriers can either cut costs or increase revenue, he said, "and they're still trying to find the revenue angle."
If oil had stayed at $50 a barrel, the industry would have been highly profitable. But the price of oil has more than doubled since 2004, and the difference between the cost of a barrel of crude and a barrel of jet fuel -- the so-called crack spread -- has widened dramatically as refiners have boosted their profit margins on aviation fuel, capitalizing on a lack of refining capacity by charging airlines more. So when crude-oil prices drop, airlines don't always see immediate relief.
From 2002 to 2007, the jet-fuel crack spread rose to an average $18.59 a barrel from $3.61, and this week the spread topped $30 a barrel before narrowing some yesterday.
Airlines continue to hedge some of their fuel needs, but at current prices hedging is extremely costly, and the carriers don't want to lock in historically high fuel costs in case prices fall.
“民之所忧，我之所思；民之所思，我之所行”
“民之所忧，我之所思；民之所思，我之所行。”一向喜爱引用诗词古赋的国务院总理温家宝，在今天十一届全国人大一次会议闭幕后的中外记者会上，多番引经据典，妙句水流。
据中评社报道，在2003年的两会记者会上，当时新当选总理的温家宝引用林则徐的两句诗向人民立誓：“苟利国家生死以，岂因祸福避趋之。”在5年后的今天，谈及当选总理以来的心路历程时，温家宝说，还想在当年的誓言上加上一句话：“天变不足畏，祖宗不足法，人言不足恤。” 他说，5年已经过去了，行事见于当时，是非公于后世。历史是人民创造的，也是人民书写的。一个领导者应该把眼睛盯住前方，把握现在，思考未来。 有记者提及千万名网民对总理提问题、提建议时，温家宝说，他常常一边看网，脑子里就想一段话，就是“民之所忧，我之所思；民之所思，我之所行”。群众之所以用这么大的精力来上网写问题、提建议，是要政府解决问题的。 文思泉涌的温家宝在谈到两岸问题时说，他是一个爱国主义者，脑子里总是在想，“一心中国梦、万古下泉诗”，“度尽劫波兄弟在，相逢一笑泯恩仇”。将本着平等互利的原则与台湾进行协商。 在回答关于解放思想的问题时，温家宝说，他一直很重视两句话：一句话来自《诗经》，一句话来自《诗品》，就是“周虽旧邦，其命惟新”、“如将不尽，与古为新”。解放思想和改革开放将永不停止，一直到中国现代化的成功，还需要解放思想。
另据台湾联合报报道，中共总理温家宝昨天谈到两岸政治问题，强调「一中」原则；回应台湾大选后两岸经贸关系，则以八个字「加强协作，互利共赢」为根本原则。
每次答台湾问题，温家宝都引用诗句，昨天他说，「我是一个爱国主义者，我脑子里总是想，『一心中国梦，万古下泉诗』，『度尽劫波兄弟在，相逢一笑泯恩仇』」。
温家宝说，进一步发展两岸经贸关系，就是继续推进两岸经贸交流，特别是尽快实现直接「三通」。
对「加强协作、互利共赢」的根本原则，温家宝说，大陆方面要认真地履行诺言，凡是对台湾同胞有利的事，一定努力去做，而且把它做好。大陆方面将继续扩大同台湾经贸交流的范围，包含投资、贸易、旅游、金融，提高协作的层次。在这些问题上，都可以本着平等互利的原则进行协商；这样做，实际上是发挥两岸互补和互利的优势。
温家宝批台湾至今限制大陆产品输台，达两千多种；还限制大陆企业到台湾投资。他说，台湾到大陆的企业达七万多家，投资金额四百八亿美元，如果加上通过第三者到大陆的，超过七百多亿美元。
温家宝念的诗哪里来？
「度尽劫波兄弟在，相逢一笑泯恩仇」，意谓原来像仇人一样，为了国家民族的利益，杯酒释前嫌，把个人恩怨全忘了。
出自鲁迅「题三义塔」，全诗是：「奔霆飞焰歼人子，败井残垣剩饿鸠。偶值大心离火宅，终遗高塔念瀛洲。精篱梦觉仍衔石，斗士诚坚共抗流。度尽劫波兄弟在，相逢一笑泯恩仇。」
「一心中国梦，万古下泉诗」，出自南宋诗人郑思肖的「德佑二年岁旦」，是诗人自述冀求国家统一的心声。
全诗是「力不胜于胆，逢人空泪垂。一心中国梦，万古下泉诗。日近望犹见，天高问岂知。朝朝向南拜，愿睹汉旌旗。」
所谓「下泉诗」，是指「诗经」中的「下泉」篇。郑思肖是南宋诗人，也是元代著名画家。宋亡后，隐居苏州，坐卧必向南，自号「所南」，以示不忘宋室。专工画兰，花叶萧疏，他画兰不画土、根，寓宋沦亡。 （联合报）
据中评社报道，在2003年的两会记者会上，当时新当选总理的温家宝引用林则徐的两句诗向人民立誓：“苟利国家生死以，岂因祸福避趋之。”在5年后的今天，谈及当选总理以来的心路历程时，温家宝说，还想在当年的誓言上加上一句话：“天变不足畏，祖宗不足法，人言不足恤。” 他说，5年已经过去了，行事见于当时，是非公于后世。历史是人民创造的，也是人民书写的。一个领导者应该把眼睛盯住前方，把握现在，思考未来。 有记者提及千万名网民对总理提问题、提建议时，温家宝说，他常常一边看网，脑子里就想一段话，就是“民之所忧，我之所思；民之所思，我之所行”。群众之所以用这么大的精力来上网写问题、提建议，是要政府解决问题的。 文思泉涌的温家宝在谈到两岸问题时说，他是一个爱国主义者，脑子里总是在想，“一心中国梦、万古下泉诗”，“度尽劫波兄弟在，相逢一笑泯恩仇”。将本着平等互利的原则与台湾进行协商。 在回答关于解放思想的问题时，温家宝说，他一直很重视两句话：一句话来自《诗经》，一句话来自《诗品》，就是“周虽旧邦，其命惟新”、“如将不尽，与古为新”。解放思想和改革开放将永不停止，一直到中国现代化的成功，还需要解放思想。
另据台湾联合报报道，中共总理温家宝昨天谈到两岸政治问题，强调「一中」原则；回应台湾大选后两岸经贸关系，则以八个字「加强协作，互利共赢」为根本原则。
每次答台湾问题，温家宝都引用诗句，昨天他说，「我是一个爱国主义者，我脑子里总是想，『一心中国梦，万古下泉诗』，『度尽劫波兄弟在，相逢一笑泯恩仇』」。
温家宝说，进一步发展两岸经贸关系，就是继续推进两岸经贸交流，特别是尽快实现直接「三通」。
对「加强协作、互利共赢」的根本原则，温家宝说，大陆方面要认真地履行诺言，凡是对台湾同胞有利的事，一定努力去做，而且把它做好。大陆方面将继续扩大同台湾经贸交流的范围，包含投资、贸易、旅游、金融，提高协作的层次。在这些问题上，都可以本着平等互利的原则进行协商；这样做，实际上是发挥两岸互补和互利的优势。
温家宝批台湾至今限制大陆产品输台，达两千多种；还限制大陆企业到台湾投资。他说，台湾到大陆的企业达七万多家，投资金额四百八亿美元，如果加上通过第三者到大陆的，超过七百多亿美元。
温家宝念的诗哪里来？
「度尽劫波兄弟在，相逢一笑泯恩仇」，意谓原来像仇人一样，为了国家民族的利益，杯酒释前嫌，把个人恩怨全忘了。
出自鲁迅「题三义塔」，全诗是：「奔霆飞焰歼人子，败井残垣剩饿鸠。偶值大心离火宅，终遗高塔念瀛洲。精篱梦觉仍衔石，斗士诚坚共抗流。度尽劫波兄弟在，相逢一笑泯恩仇。」
「一心中国梦，万古下泉诗」，出自南宋诗人郑思肖的「德佑二年岁旦」，是诗人自述冀求国家统一的心声。
全诗是「力不胜于胆，逢人空泪垂。一心中国梦，万古下泉诗。日近望犹见，天高问岂知。朝朝向南拜，愿睹汉旌旗。」
所谓「下泉诗」，是指「诗经」中的「下泉」篇。郑思肖是南宋诗人，也是元代著名画家。宋亡后，隐居苏州，坐卧必向南，自号「所南」，以示不忘宋室。专工画兰，花叶萧疏，他画兰不画土、根，寓宋沦亡。 （联合报）
Wednesday, March 19, 2008
Fed is becoming more creative
the Fed signaled in its end-of-meeting statement that the prospect of more rate cuts remains on the table. "The outlook...has weakened further," it said. "Consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth." It said "downside risks to growth remain," and the Fed will "act in a timely manner as needed."
Nonetheless, the Fed has increasingly come to the view that lower rates alone won't restore order to the financial markets and prevent a severe recession. It has rolled out ever more creative and aggressive attempts to infuse cash into market corners where it normally doesn't operate, culminating in Sunday's decision to lend to investment banks from its "discount window," a privilege previously reserved for commercial banks. Chairman Ben Bernanke also has publicly backed action to use public money to stem a tide of mortgage defaults and foreclosures.
The Fed's actions are among several aggressive steps throughout the federal government that are coming to a head this week and could prove critical in combating the crisis. Today the regulator of Fannie Mae and Freddie Mac, which provide the bulk of funding for home mortgages, is to announce an easing of their capital requirements and the companies are to pledge to raise more capital, people familiar with the matter said. Those steps should enable them to back more mortgages.
While the Fed still expects inflation to ease as commodity prices plateau and as higher unemployment blunts wage and price gains, it said that "uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully."
The futures markets reduced the expectation they are showing for additional cuts. The futures now see the federal-funds rate, charged on overnight loans between banks, easing to between 1.5% and 1.75% by year's end. Before yesterday's move, futures investors were betting the rate would fall to 1.25% to 1.5%.
The Fed also lowered the rate charged on direct "discount window" loans it makes available to banks and -- since Sunday -- to investment banks. It slashed the rate to 2.5% from 3.25%, keeping it a quarter-point above the federal-funds rate. Commercial banks began lowering their prime interest rates, to which some variable-rate loans are tied, to 5.25% from 6%.
The stresses in the credit markets have kept some of the Fed's rate-cutting efforts from filtering through to borrowers, as reflectecd in 30 mortgage rate and jukp mortgage rate.
Nonetheless, the Fed has increasingly come to the view that lower rates alone won't restore order to the financial markets and prevent a severe recession. It has rolled out ever more creative and aggressive attempts to infuse cash into market corners where it normally doesn't operate, culminating in Sunday's decision to lend to investment banks from its "discount window," a privilege previously reserved for commercial banks. Chairman Ben Bernanke also has publicly backed action to use public money to stem a tide of mortgage defaults and foreclosures.
The Fed's actions are among several aggressive steps throughout the federal government that are coming to a head this week and could prove critical in combating the crisis. Today the regulator of Fannie Mae and Freddie Mac, which provide the bulk of funding for home mortgages, is to announce an easing of their capital requirements and the companies are to pledge to raise more capital, people familiar with the matter said. Those steps should enable them to back more mortgages.
While the Fed still expects inflation to ease as commodity prices plateau and as higher unemployment blunts wage and price gains, it said that "uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully."
The futures markets reduced the expectation they are showing for additional cuts. The futures now see the federal-funds rate, charged on overnight loans between banks, easing to between 1.5% and 1.75% by year's end. Before yesterday's move, futures investors were betting the rate would fall to 1.25% to 1.5%.
The Fed also lowered the rate charged on direct "discount window" loans it makes available to banks and -- since Sunday -- to investment banks. It slashed the rate to 2.5% from 3.25%, keeping it a quarter-point above the federal-funds rate. Commercial banks began lowering their prime interest rates, to which some variable-rate loans are tied, to 5.25% from 6%.
The stresses in the credit markets have kept some of the Fed's rate-cutting efforts from filtering through to borrowers, as reflectecd in 30 mortgage rate and jukp mortgage rate.
China Set up Capital Raising Venue for SME
SHANGHAI -- Stock prices in China are tumbling and companies are delaying initial public offerings of stock. Yet government officials said the timing is right to establish a market that will give small companies more opportunity to sell stock and raise cash.
The listing venue will help channel financing into start-up and other early stage companies. It will be run by the Shenzhen Stock Exchange, whose president has dubbed it "a Nasdaq-like growth enterprise market," or GEM. Officials say details of the market will be released soon, with the first IPOs to follow as early as May.
Premier Wen Jiabao gave the effort a boost this month when he included starting a GEM in his list of the government's economic aims for the year in his address to the National People's Congress, the nation's Legislature.
China's new listing venue will carry symbolic weight: underscoring an embrace by the Communist Party of the five million registered, privately owned businesses in China.
Small businesses in China remain hobbled by a financial system dominated by big banks with deep ties to state-owned business and little appetite for providing start-up capital.
Historically, stock markets dedicated to small companies such as the U.S. "pink sheets," London's Alternative Investment Market, Hong Kong's Growth Enterprise Market and Tokyo Stock Exchange's Mothers market have been prone to abuses, ranging from companies with accounting problems to stock scams and insider trading, as well as thin trading in some stocks.
In China, poor accounting, insider trading and corporate theft plague the country's more established stock markets, namely the Shanghai Stock Exchange and its smaller counterpart in Shenzhen. Shenzhen's GEM seems likely to emerge as the most speculative corner of the Chinese market
Still, letting China's investors gamble is part of the strategy. The GEM is aimed at investors with a stomach for the kind of high-risk and high-reward strategy typical of venture capitalists, who seed multiple enterprises with money in the hope a Microsoft or Google might emerge.
One regulator involved in GEM planning said the market will be considered a success if just one of 200 new listings becomes a blockbuster company.
Foreign investors will have limited ability to trade in the new market. Still, it will offer more scope for early stage investors -- including foreign ones -- to take their Chinese companies public locally. That isn't easy now, as politics tends to favor large companies from among the estimated 20,000 businesses hoping to join the 1,600 companies that already have gone public on the Shanghai and Shenzhen exchanges since 1990.
The GEM idea was proposed eight years ago. Its coming to fruition now reflects a belief among policy makers that their overhauls of the structure and operations of China's stock market since 2005 have gained investor confidence, as seen in China's exchanges recently hosting some of the world's biggest IPOs.
The Shenzhen Stock Exchange has been quietly carving out a role as the venue of choice for lesser-known companies, and they often outperformed. Since 2004, when the Shenzhen market first lowered thresholds to attract small- and medium-size enterprises, more than 200 of such companies have gone public on what is called the SME section. They now boast a combined market value of about $150 billion.
The listing venue will help channel financing into start-up and other early stage companies. It will be run by the Shenzhen Stock Exchange, whose president has dubbed it "a Nasdaq-like growth enterprise market," or GEM. Officials say details of the market will be released soon, with the first IPOs to follow as early as May.
Premier Wen Jiabao gave the effort a boost this month when he included starting a GEM in his list of the government's economic aims for the year in his address to the National People's Congress, the nation's Legislature.
China's new listing venue will carry symbolic weight: underscoring an embrace by the Communist Party of the five million registered, privately owned businesses in China.
Small businesses in China remain hobbled by a financial system dominated by big banks with deep ties to state-owned business and little appetite for providing start-up capital.
Historically, stock markets dedicated to small companies such as the U.S. "pink sheets," London's Alternative Investment Market, Hong Kong's Growth Enterprise Market and Tokyo Stock Exchange's Mothers market have been prone to abuses, ranging from companies with accounting problems to stock scams and insider trading, as well as thin trading in some stocks.
In China, poor accounting, insider trading and corporate theft plague the country's more established stock markets, namely the Shanghai Stock Exchange and its smaller counterpart in Shenzhen. Shenzhen's GEM seems likely to emerge as the most speculative corner of the Chinese market
Still, letting China's investors gamble is part of the strategy. The GEM is aimed at investors with a stomach for the kind of high-risk and high-reward strategy typical of venture capitalists, who seed multiple enterprises with money in the hope a Microsoft or Google might emerge.
One regulator involved in GEM planning said the market will be considered a success if just one of 200 new listings becomes a blockbuster company.
Foreign investors will have limited ability to trade in the new market. Still, it will offer more scope for early stage investors -- including foreign ones -- to take their Chinese companies public locally. That isn't easy now, as politics tends to favor large companies from among the estimated 20,000 businesses hoping to join the 1,600 companies that already have gone public on the Shanghai and Shenzhen exchanges since 1990.
The GEM idea was proposed eight years ago. Its coming to fruition now reflects a belief among policy makers that their overhauls of the structure and operations of China's stock market since 2005 have gained investor confidence, as seen in China's exchanges recently hosting some of the world's biggest IPOs.
The Shenzhen Stock Exchange has been quietly carving out a role as the venue of choice for lesser-known companies, and they often outperformed. Since 2004, when the Shenzhen market first lowered thresholds to attract small- and medium-size enterprises, more than 200 of such companies have gone public on what is called the SME section. They now boast a combined market value of about $150 billion.
Time to Break up Citi
It must be frustrating in some ways for Citigroup's board to watch J.P. Morgan Chase take advantage of the credit crunch to scoop up Bear Stearns. But rather than take it as a sign that bigger is better, Citigroup's new chief executive, Vikram Pandit, should zig while J.P. Morgan zags. Citigroup's recent troubles have highlighted what investors have been telegraphing for years: The scale of the bank makes it unmanageable.
Many investors believe Citigroup will have to visit the trough for a third time to raise fresh capital. If so, Mr. Pandit will need to offer something in return. As a quid pro quo, investors should demand that he separate the company's retail and consumer bank from its corporate and investment-banking arm.
The arguments for keeping them together have always been wobbly. For most of his tenure, Chuck Prince, Mr. Pandit's immediate predecessor, fought against suggestions the bank should be broken up. But the company's sprawl almost certainly contributed to executives' inability to manage exposure on so many toxic fronts. Citigroup's board appeared equally stumped. From leveraged-buyout loans to credit-card receivables and subprime-mortgage securities to structured credit, no financial institution has taken punches in as many places as has Citigroup.
Citigroup's managers and directors used to argue that sheer size gave it an advantage in absorbing hits in one market without torpedoing the overall bottom line. This hasn't been borne out. Last year, write-downs and allocations to reserves totaled an eye-popping $32.5 billion -- reducing profit by $18 billion from 2006. These woes have shaken confidence in the U.S. megabank; more than $165 billion has been wiped off Citigroup's market capitalization from the high of January 2007. The market now places a higher value on both Bank of America and J.P. Morgan, and Wells Fargo is nipping at Citigroup's heels.
Dividing in half won't raise new money. Citigroup has only two options for that: sell assets or ask investors to pitch in. The problem is that divesting businesses in today's horrific market risks destroying even more shareholder value. No one wants the bad assets. And the good ones, such as Mexico's Banamex, which could perhaps fetch $20 billion on a good day, or Citi's retail banks in Korea and Poland, might fetch less-than-stellar prices. That leaves going back to shareholders, who should demand a promise of partition from Mr. Pandit in exchange for their support.
Many investors believe Citigroup will have to visit the trough for a third time to raise fresh capital. If so, Mr. Pandit will need to offer something in return. As a quid pro quo, investors should demand that he separate the company's retail and consumer bank from its corporate and investment-banking arm.
The arguments for keeping them together have always been wobbly. For most of his tenure, Chuck Prince, Mr. Pandit's immediate predecessor, fought against suggestions the bank should be broken up. But the company's sprawl almost certainly contributed to executives' inability to manage exposure on so many toxic fronts. Citigroup's board appeared equally stumped. From leveraged-buyout loans to credit-card receivables and subprime-mortgage securities to structured credit, no financial institution has taken punches in as many places as has Citigroup.
Citigroup's managers and directors used to argue that sheer size gave it an advantage in absorbing hits in one market without torpedoing the overall bottom line. This hasn't been borne out. Last year, write-downs and allocations to reserves totaled an eye-popping $32.5 billion -- reducing profit by $18 billion from 2006. These woes have shaken confidence in the U.S. megabank; more than $165 billion has been wiped off Citigroup's market capitalization from the high of January 2007. The market now places a higher value on both Bank of America and J.P. Morgan, and Wells Fargo is nipping at Citigroup's heels.
Dividing in half won't raise new money. Citigroup has only two options for that: sell assets or ask investors to pitch in. The problem is that divesting businesses in today's horrific market risks destroying even more shareholder value. No one wants the bad assets. And the good ones, such as Mexico's Banamex, which could perhaps fetch $20 billion on a good day, or Citi's retail banks in Korea and Poland, might fetch less-than-stellar prices. That leaves going back to shareholders, who should demand a promise of partition from Mr. Pandit in exchange for their support.
Tuesday, March 18, 2008
Paterson Discusses Past Extramarital Affairs
The day after he was sworn in to replace a governor who left office in disgrace because of a prostitution scandal, Gov. David A. Paterson admitted that he had had relationships with women other than his wife, including one who is on the state payroll
It was yet another surreal scene in Albany, a city still reeling from revelations last week that Gov. Eliot Spitzer had become ensnared in a federal investigation into a high-priced prostitution ring and his resignation. That another governor could have questions raised about his sex life, so soon after being sworn in, seemed agonizing to many here.
In the earlier news conference, Mr. Paterson said he was speaking out because he did not want the state to become embroiled in another sordid distraction.
“I wanted to come forward because I didn't want it hanging over my head,” Mr. Paterson said. “I didn't want to be compromised, perhaps, by innuendo or some sort of message that you better not do something or we're going to out you about the infidelity in your marriage.”
Sheldon Silver, the speaker of the State Assembly, said he admired Mr. Paterson’s courage in admitting the infidelity and suggested that the couple’s past problems, which he called “a nice story,” could serve as an inspiration to other couples who find their marriages imperiled.
It was yet another surreal scene in Albany, a city still reeling from revelations last week that Gov. Eliot Spitzer had become ensnared in a federal investigation into a high-priced prostitution ring and his resignation. That another governor could have questions raised about his sex life, so soon after being sworn in, seemed agonizing to many here.
In the earlier news conference, Mr. Paterson said he was speaking out because he did not want the state to become embroiled in another sordid distraction.
“I wanted to come forward because I didn't want it hanging over my head,” Mr. Paterson said. “I didn't want to be compromised, perhaps, by innuendo or some sort of message that you better not do something or we're going to out you about the infidelity in your marriage.”
Sheldon Silver, the speaker of the State Assembly, said he admired Mr. Paterson’s courage in admitting the infidelity and suggested that the couple’s past problems, which he called “a nice story,” could serve as an inspiration to other couples who find their marriages imperiled.
75 bps cut, downside risk remains
--Fed Reserve cut its mai lending rate by 75 bps to 2.25 to prop up the faltering economy and restore confidence in the financial systems
--75 bps us justified by tightening credit condition, softening labor market, slowing retail sales and industry production, and deepening housing slump. These factors will continue to weight on economic growth.
--Fed has already put its $900 bil portfolio in the front line of market turmoil to starve off a collpase of brokerage firms.
--The policy action will foter market liquidity, promote moderate growth and mitigate risks to economic activity.
--Still downside risk remains. The downward housing prices and increasing home forecloures have not bottomed out yet.
--Inflation has been elevated, but will moderate in the coming quarters, reflecting projected leveling-out of energy and other commodity proces and an easing of pressures on resources utilization.
--75 bps us justified by tightening credit condition, softening labor market, slowing retail sales and industry production, and deepening housing slump. These factors will continue to weight on economic growth.
--Fed has already put its $900 bil portfolio in the front line of market turmoil to starve off a collpase of brokerage firms.
--The policy action will foter market liquidity, promote moderate growth and mitigate risks to economic activity.
--Still downside risk remains. The downward housing prices and increasing home forecloures have not bottomed out yet.
--Inflation has been elevated, but will moderate in the coming quarters, reflecting projected leveling-out of energy and other commodity proces and an easing of pressures on resources utilization.
U.S. Mulls Next Steps in Crisis
Bipartisan Goal
The swiftness and virulence of the financial problems have been stunning. The problems are rooted in a bipartisan goal to figure out ways for lower-income Americans to buy homes, so that they could build financial wealth and plant deep stakes in their neighborhoods. But the instruments that mortgage companies devised included provisions -- interest resets after five years, no down payments -- that buyers didn't fully appreciate could backfire. When those subprime mortgages were bundled into packages of debt and sold to a daisy chain of interlocked financial institutions, the risks of those provisions eluded investors considered far more sophisticated than first-time home buyers.
Essentially, the risks were hidden from view -- "a lack of transparency," financial types call it. The irony is that the U.S. and the International Monetary Fund have been lecturing developing countries since at least the 1980s of that very danger. If economic risks aren't transparent to investors, they're likely to blow up, and can drag down an economy. That's happened repeatedly in Latin America and in the late 1990s in Asia and Russia.
Now the U.S. is wrestling with questions that have long dogged other nations. Who should be bailed out? Who bears the cost? What is the role for the central bank? How should markets be regulated to avoid a repeat of the problems?
Bigger Role of Government
Chairman Ben Bernanke has also been faster than the Bush administration to embrace a bigger role for the federal government in resolving the crisis. A few weeks ago, he argued that the FHA should be allowed to guarantee more delinquent mortgages as a carrot to private lenders to write down the value of those mortgages without foreclosing on the homeowners.
Mr. Bernanke, a Republican, isn't ideological. From his long studies of the Great Depression he concluded that event could have been prevented had the Fed shown more leadership. And he credits the Depression's end to the creativity of President Franklin D. Roosevelt. In 2000, he advised Japanese policy makers struggling with that country's long malaise to emulate FDR.
"Many of his policies did not work as intended but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done," he wrote.
Indeed, the goal of U.S. policy makers is to avoid the malaise that gripped Japan for a decade after its banks accumulated vast sums of bad debt following the burst of a late-1980s bubble in real estate. When land prices collapsed, so did the value of the real-estate collateral that backed most loans, leaving many borrowers unable to repay and saddling Japanese lenders with trillions of yen in bad loans.
Financial authorities waited years for the bad loans to fade away without government action. But the problem only started to lift after the government, starting around 1998, began injecting huge amounts of public funds in the hobbled banks. It took until around 2005 for the banks to clear up the worst of their bad loans and for the first time in nearly a decade report rises in their loans outstanding.
The U.S. turmoil so far doesn't look nearly as intractable as Japan's, and so far President Bush and Treasury Secretary Henry Paulson have emphasized voluntary industry efforts to renegotiate troubled loans, along with a limited expansion of federal housing finance programs. Although Messrs. Bush and Paulson say they're open to other ideas, they have also made clear that they haven't yet heard a plan that they think would work to address the wave of home foreclosures now sweeping the nation, and the financial turmoil that the housing problems have spawned.
The Same Issues
The U.S. will face the same issues that Asian nations faced in the crisis of 1997-98. Is it better to nationalize financial firms outright, or inject bonds that provide the funding to carry on, so long as the recipients agree to repay the bonds with future profits?
Glenn Hubbard, a former Bush White House chief economist who is now dean of the Columbia University's business school, says regulators should pay more attention to financial sector liquidity than they have in the past. But he's fearful that detailed regulation of specific financial instruments could backfire. The system is so complicated, he says, that it's hard to know what the consequences will be. Inadvertently, regulators could "diminish risk-taking among prudent investors and increase risk-taking by the clever."
Other Possibilities
Other possibilities include increasing tax-exempt bond authority, changing bankruptcy laws, reducing principal balances for underwater loans or issuing so-called "negative equity certificates." Under the latter, Treasury's Office of Thrift Supervision proposed that banks reduce mortgage balances to help homeowners hang onto their houses, but receive in exchange certificates that would give them rights to any windfall profits should the house value rise again. Mr. Paulson hasn't indicated that he would support the plan.
The swiftness and virulence of the financial problems have been stunning. The problems are rooted in a bipartisan goal to figure out ways for lower-income Americans to buy homes, so that they could build financial wealth and plant deep stakes in their neighborhoods. But the instruments that mortgage companies devised included provisions -- interest resets after five years, no down payments -- that buyers didn't fully appreciate could backfire. When those subprime mortgages were bundled into packages of debt and sold to a daisy chain of interlocked financial institutions, the risks of those provisions eluded investors considered far more sophisticated than first-time home buyers.
Essentially, the risks were hidden from view -- "a lack of transparency," financial types call it. The irony is that the U.S. and the International Monetary Fund have been lecturing developing countries since at least the 1980s of that very danger. If economic risks aren't transparent to investors, they're likely to blow up, and can drag down an economy. That's happened repeatedly in Latin America and in the late 1990s in Asia and Russia.
Now the U.S. is wrestling with questions that have long dogged other nations. Who should be bailed out? Who bears the cost? What is the role for the central bank? How should markets be regulated to avoid a repeat of the problems?
Bigger Role of Government
Chairman Ben Bernanke has also been faster than the Bush administration to embrace a bigger role for the federal government in resolving the crisis. A few weeks ago, he argued that the FHA should be allowed to guarantee more delinquent mortgages as a carrot to private lenders to write down the value of those mortgages without foreclosing on the homeowners.
Mr. Bernanke, a Republican, isn't ideological. From his long studies of the Great Depression he concluded that event could have been prevented had the Fed shown more leadership. And he credits the Depression's end to the creativity of President Franklin D. Roosevelt. In 2000, he advised Japanese policy makers struggling with that country's long malaise to emulate FDR.
"Many of his policies did not work as intended but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done," he wrote.
Indeed, the goal of U.S. policy makers is to avoid the malaise that gripped Japan for a decade after its banks accumulated vast sums of bad debt following the burst of a late-1980s bubble in real estate. When land prices collapsed, so did the value of the real-estate collateral that backed most loans, leaving many borrowers unable to repay and saddling Japanese lenders with trillions of yen in bad loans.
Financial authorities waited years for the bad loans to fade away without government action. But the problem only started to lift after the government, starting around 1998, began injecting huge amounts of public funds in the hobbled banks. It took until around 2005 for the banks to clear up the worst of their bad loans and for the first time in nearly a decade report rises in their loans outstanding.
The U.S. turmoil so far doesn't look nearly as intractable as Japan's, and so far President Bush and Treasury Secretary Henry Paulson have emphasized voluntary industry efforts to renegotiate troubled loans, along with a limited expansion of federal housing finance programs. Although Messrs. Bush and Paulson say they're open to other ideas, they have also made clear that they haven't yet heard a plan that they think would work to address the wave of home foreclosures now sweeping the nation, and the financial turmoil that the housing problems have spawned.
The Same Issues
The U.S. will face the same issues that Asian nations faced in the crisis of 1997-98. Is it better to nationalize financial firms outright, or inject bonds that provide the funding to carry on, so long as the recipients agree to repay the bonds with future profits?
Glenn Hubbard, a former Bush White House chief economist who is now dean of the Columbia University's business school, says regulators should pay more attention to financial sector liquidity than they have in the past. But he's fearful that detailed regulation of specific financial instruments could backfire. The system is so complicated, he says, that it's hard to know what the consequences will be. Inadvertently, regulators could "diminish risk-taking among prudent investors and increase risk-taking by the clever."
Other Possibilities
Other possibilities include increasing tax-exempt bond authority, changing bankruptcy laws, reducing principal balances for underwater loans or issuing so-called "negative equity certificates." Under the latter, Treasury's Office of Thrift Supervision proposed that banks reduce mortgage balances to help homeowners hang onto their houses, but receive in exchange certificates that would give them rights to any windfall profits should the house value rise again. Mr. Paulson hasn't indicated that he would support the plan.
Bear Stearns shrinking cash positions
On Thursday evening, after customers had continued to pull their money out of Bear Stearns, the bank reached out to J. P. Morgan, looking to discuss ways the Wall Street giant could help ease Bear's cash crunch.
By then, Bear Stearns's cash position had dwindled to just $2 billion from $17 bil. In a conference call at 7:30 p.m., officials at Bear Stearns and the Securities and Exchange Commission told Fed and Treasury officials that the firm saw little option other than to file for bankruptcy protection the next morning.
Bear Stearns's hope was that the Fed would make a loan from its discount window to provide several weeks of breathing room. That, the firm hoped, would perhaps halt a run on the bank by allowing it to swap bonds for the cash necessary to return to customers.
The Fed's standard preference in dealing with a troubled institution is to first seek a private-sector solution, such as a sale or financing agreement. But the possibility of a bankruptcy filing Friday morning created a hard deadline.
A trigger point was looming for Bear Stearns in the so-called repo market, where banks and securities firms extend and receive short-term loans, typically made overnight and backed by securities. At 7:30 a.m., Bear Stearns would have to begin paying back some of its billions of dollars in repo borrowings. If the firm didn't repay the money on time, its creditors could start selling the collateral Bear had pledged to them. The implications went well beyond Bear Stearns: If other investors questioned the safety of loans they made in the repo market, they could start to withhold funds from other investment banks and companies.
The $4.5 trillion repo market isn't a newfangled innovation like subprime-backed collateralized debt obligations. It is a decades-old, plain-vanilla market critical to the smooth functioning of capital markets. A default by a major counterparty would have been unprecedented, and could have had unpredictable consequences for the entire market.
The pace and complexity of events left Bear's board of directors groping for answers. "It was a traumatic experience," says one person who participated. Sleep deprivation set in, with some of the hundreds of attorneys and bankers sleeping only a few hours during a 72-hour sprint. Dress was casual, with neckties quickly shorn.
By then, Bear Stearns's cash position had dwindled to just $2 billion from $17 bil. In a conference call at 7:30 p.m., officials at Bear Stearns and the Securities and Exchange Commission told Fed and Treasury officials that the firm saw little option other than to file for bankruptcy protection the next morning.
Bear Stearns's hope was that the Fed would make a loan from its discount window to provide several weeks of breathing room. That, the firm hoped, would perhaps halt a run on the bank by allowing it to swap bonds for the cash necessary to return to customers.
The Fed's standard preference in dealing with a troubled institution is to first seek a private-sector solution, such as a sale or financing agreement. But the possibility of a bankruptcy filing Friday morning created a hard deadline.
A trigger point was looming for Bear Stearns in the so-called repo market, where banks and securities firms extend and receive short-term loans, typically made overnight and backed by securities. At 7:30 a.m., Bear Stearns would have to begin paying back some of its billions of dollars in repo borrowings. If the firm didn't repay the money on time, its creditors could start selling the collateral Bear had pledged to them. The implications went well beyond Bear Stearns: If other investors questioned the safety of loans they made in the repo market, they could start to withhold funds from other investment banks and companies.
The $4.5 trillion repo market isn't a newfangled innovation like subprime-backed collateralized debt obligations. It is a decades-old, plain-vanilla market critical to the smooth functioning of capital markets. A default by a major counterparty would have been unprecedented, and could have had unpredictable consequences for the entire market.
The pace and complexity of events left Bear's board of directors groping for answers. "It was a traumatic experience," says one person who participated. Sleep deprivation set in, with some of the hundreds of attorneys and bankers sleeping only a few hours during a 72-hour sprint. Dress was casual, with neckties quickly shorn.
Monday, March 17, 2008
Fed Balance Sheet and Monetary Base
Assets
1. Securities. These are the Fed’s holdings of securities, which consist primarilyof Treasury securities but in the past have also included banker’s acceptances.The total amount of securities is controlled by open market operations (theFed’s purchase and sale of these securities). As shown in Table 1, “Securities”is by far the largest category of assets in the Fed’s balance sheet.
2. Discount loans. These are loans the Fed makes to banks. The amount isaffected by the Fed’s setting the discount rate, the interest rate that theFed charges banks for these loans.
These first two Fed assets are important because they earn interest.Because the liabilities of the Fed do not pay interest, the Fed makes billionsof dollars every year—its assets earn income, and its liabilities cost nothing
Liabilities
1.Federal Reserve notes (currency) outstanding. The Fed issues currency(those green-and-gray pieces of paper in your wallet that say “FederalReserve note” at the top). The Federal Reserve notes outstanding are theamount of this currency that is in the hands of the public. (Currency heldby depository institutions is also a liability of the Fed but is counted as partof the reserves liability.)Federal Reserve notes are IOUs from the Fed to the bearer and are alsoliabilities, but unlike most liabilities, they promise to pay back the bearersolely with Federal Reserve notes; that is, they pay off IOUs with otherIOUs. Accordingly, if you bring a $100 bill to the Federal Reserve anddemand payment, you will receive two $50s, five $20s, ten $10s, or onehundred $1 bills.People are more willing to accept IOUs from the Fed than from youor me because Federal Reserve notes are a recognized medium ofexchange; that is, they are accepted as a means of payment and so functionas money. Unfortunately, neither you nor I can convince people thatour IOUs are worth anything more than the paper they are written on.1THE FED’S BALANCE SHEET AND THE MONETARY BASE W-412.
2.Reserves. All banks have an account at the Fed in which they holddeposits. Reserves consist of deposits at the Fed plus currency that is physicallyheld by banks (called vault cash because it is stored in bank vaults).Reserves are assets for the banks but liabilities for the Fed, because thebanks can demand payment on them at any time and the Fed is requiredto satisfy its obligation by paying Federal Reserve notes. As shown in thechapter, an increase in reserves leads to an increase in the level of depositsand hence in the money supply.Total reserves can be divided into two categories: reserves that the Fedrequires banks to hold (required reserves) and any additional reserves thebanks choose to hold (excess reserves). For example, the Fed mightrequire that for every dollar of deposits at a depository institution, a certainfraction (say, 10 cents) must be held as reserves. This fraction (10%)is called the required reserve ratio. Currently, the Fed pays no intereston reserves.3. U.S. Treasury deposits. The Treasury keeps deposits at the Fed, againstwhich it writes all its checks.
Monetary Base
The first two liabilities on the balance sheet, Federal Reserve notes (currency)outstanding and reserves, are often referred to as the monetary liabilities ofthe Fed. When we add to these liabilities the U.S. Treasury’s monetary liabilities(Treasury currency in circulation, primarily coins), we get a construct called themonetary base. The monetary base is an important part of the money supply,because increases in it will lead to a multiple increase in the money supply (everythingelse being constant). This is why the monetary base is also called high-powered money. Recognizing that Treasury currency and Federal Reservecurrency can be lumped together into the category currency in circulation,denoted by C, the monetary base equals the sum of currency in circulation plusreserves R. The monetary base MB is expressed as follows:
MB = (Federal Reserve notes + Treasury currency coin) + reserves= C + R
1. Securities. These are the Fed’s holdings of securities, which consist primarilyof Treasury securities but in the past have also included banker’s acceptances.The total amount of securities is controlled by open market operations (theFed’s purchase and sale of these securities). As shown in Table 1, “Securities”is by far the largest category of assets in the Fed’s balance sheet.
2. Discount loans. These are loans the Fed makes to banks. The amount isaffected by the Fed’s setting the discount rate, the interest rate that theFed charges banks for these loans.
These first two Fed assets are important because they earn interest.Because the liabilities of the Fed do not pay interest, the Fed makes billionsof dollars every year—its assets earn income, and its liabilities cost nothing
Liabilities
1.Federal Reserve notes (currency) outstanding. The Fed issues currency(those green-and-gray pieces of paper in your wallet that say “FederalReserve note” at the top). The Federal Reserve notes outstanding are theamount of this currency that is in the hands of the public. (Currency heldby depository institutions is also a liability of the Fed but is counted as partof the reserves liability.)Federal Reserve notes are IOUs from the Fed to the bearer and are alsoliabilities, but unlike most liabilities, they promise to pay back the bearersolely with Federal Reserve notes; that is, they pay off IOUs with otherIOUs. Accordingly, if you bring a $100 bill to the Federal Reserve anddemand payment, you will receive two $50s, five $20s, ten $10s, or onehundred $1 bills.People are more willing to accept IOUs from the Fed than from youor me because Federal Reserve notes are a recognized medium ofexchange; that is, they are accepted as a means of payment and so functionas money. Unfortunately, neither you nor I can convince people thatour IOUs are worth anything more than the paper they are written on.1THE FED’S BALANCE SHEET AND THE MONETARY BASE W-412.
2.Reserves. All banks have an account at the Fed in which they holddeposits. Reserves consist of deposits at the Fed plus currency that is physicallyheld by banks (called vault cash because it is stored in bank vaults).Reserves are assets for the banks but liabilities for the Fed, because thebanks can demand payment on them at any time and the Fed is requiredto satisfy its obligation by paying Federal Reserve notes. As shown in thechapter, an increase in reserves leads to an increase in the level of depositsand hence in the money supply.Total reserves can be divided into two categories: reserves that the Fedrequires banks to hold (required reserves) and any additional reserves thebanks choose to hold (excess reserves). For example, the Fed mightrequire that for every dollar of deposits at a depository institution, a certainfraction (say, 10 cents) must be held as reserves. This fraction (10%)is called the required reserve ratio. Currently, the Fed pays no intereston reserves.3. U.S. Treasury deposits. The Treasury keeps deposits at the Fed, againstwhich it writes all its checks.
Monetary Base
The first two liabilities on the balance sheet, Federal Reserve notes (currency)outstanding and reserves, are often referred to as the monetary liabilities ofthe Fed. When we add to these liabilities the U.S. Treasury’s monetary liabilities(Treasury currency in circulation, primarily coins), we get a construct called themonetary base. The monetary base is an important part of the money supply,because increases in it will lead to a multiple increase in the money supply (everythingelse being constant). This is why the monetary base is also called high-powered money. Recognizing that Treasury currency and Federal Reservecurrency can be lumped together into the category currency in circulation,denoted by C, the monetary base equals the sum of currency in circulation plusreserves R. The monetary base MB is expressed as follows:
MB = (Federal Reserve notes + Treasury currency coin) + reserves= C + R
Hedge Funds, Once a Windfall, Contribute to Bear's Downfall
For years, Bear Stearns Cos. reaped a windfall lending money to hedge funds and conducting trades for them. As these funds multiplied, the firm was among the leaders courting them, providing everything from advice on how to launch a fund to helping them find office space.
The hedge-fund business came back to haunt Bear Stearns last week, however, as a wave of nervous funds pulled their accounts, helping to put the brokerage firm in a precarious position. The moves, which came even though the hedge funds' accounts often are separate from Bear Stearns's own accounts, serve as a reminder of the growing importance of the uncertain business of catering to hedge funds. Indeed, one of Bear Stearns's most valuable remaining assets, and one that was certainly attractive to announced acquirer J.P. Morgan Chase & Co., is this lucrative business called prime-brokerage, some argue.
Through all the tumult, however, one huge hedge fund, Paulson & Co., has stuck with Bear Stearns, despite a rocky history between the two, adding some support to the embattled brokerage firm.
Some see a delicious irony: Paulson pocketed a whopping $15 billion last year on bets that the housing market would crumble and that the value of subprime mortgages would shrink. Bear, meanwhile, was brought to its knees by poor mortgage-bond trades in its own hedge funds and by the growing credit crunch, which began with the mortgage turmoil.
Behind Paulson's confidence: The hedge fund, like most others, is a client of Bear Stearns Securities Corp., a separate, regulated entity that is supposed to have excess capital to survive any problems. At the same time, the Paulson funds have borrowed little money to make trades, so they haven't handed securities over to Bear Stearns to serve as collateral for any borrowing.
Funds pulling their accounts from the firm say they would rather be safe than sorry, and are concerned that the protection of the entity won't hold up, or that Bear Stearns Securities might have lent money to its parent company.
When a hedge fund borrows money from a broker like Bear Stearns or uses it to conduct a trade, the fund usually places securities in an account at the brokerage firm. Hedge funds fear that their account could be frozen in some way if their prime broker runs into trouble, especially if the broker files for bankruptcy protection.
Some hedge funds also fret that if they pay back the money they have borrowed from Bear, the prime broker may not quickly return the collateral the hedge fund gave it to secure loans in the first place, possibly because they have used the securities elsewhere. Another concern is that a wounded broker like Bear Stearns could abruptly cut off financing to hedge funds, which would force them to liquidate investments, possibly sustaining losses, to repay loans.
The unknown is what Bear's prime-brokerage clients have been reacting to," said John Broadhurst, a partner in the hedge-fund practice of San Francisco law firm Shartsis Friese LLP. "Some hedge-fund managers are just yanking their business. Others are weighing the perceived risks with the hassle of changing prime brokers."
The business of dealing with hedge funds has been an increasingly important business for Bear Stearns, representing 10% or more of revenue, and a higher percentage of earnings in recent years, according to estimates from David Hendler, a senior analyst at CreditSights, Inc., a research firm.
"They are one of the original players in this market, as hedge funds grew as an investor base, they grew with it. It's a double-edged sword though; guys who were helping Bear to grow now are taking money out."
The hedge-fund business came back to haunt Bear Stearns last week, however, as a wave of nervous funds pulled their accounts, helping to put the brokerage firm in a precarious position. The moves, which came even though the hedge funds' accounts often are separate from Bear Stearns's own accounts, serve as a reminder of the growing importance of the uncertain business of catering to hedge funds. Indeed, one of Bear Stearns's most valuable remaining assets, and one that was certainly attractive to announced acquirer J.P. Morgan Chase & Co., is this lucrative business called prime-brokerage, some argue.
Through all the tumult, however, one huge hedge fund, Paulson & Co., has stuck with Bear Stearns, despite a rocky history between the two, adding some support to the embattled brokerage firm.
Some see a delicious irony: Paulson pocketed a whopping $15 billion last year on bets that the housing market would crumble and that the value of subprime mortgages would shrink. Bear, meanwhile, was brought to its knees by poor mortgage-bond trades in its own hedge funds and by the growing credit crunch, which began with the mortgage turmoil.
Behind Paulson's confidence: The hedge fund, like most others, is a client of Bear Stearns Securities Corp., a separate, regulated entity that is supposed to have excess capital to survive any problems. At the same time, the Paulson funds have borrowed little money to make trades, so they haven't handed securities over to Bear Stearns to serve as collateral for any borrowing.
Funds pulling their accounts from the firm say they would rather be safe than sorry, and are concerned that the protection of the entity won't hold up, or that Bear Stearns Securities might have lent money to its parent company.
When a hedge fund borrows money from a broker like Bear Stearns or uses it to conduct a trade, the fund usually places securities in an account at the brokerage firm. Hedge funds fear that their account could be frozen in some way if their prime broker runs into trouble, especially if the broker files for bankruptcy protection.
Some hedge funds also fret that if they pay back the money they have borrowed from Bear, the prime broker may not quickly return the collateral the hedge fund gave it to secure loans in the first place, possibly because they have used the securities elsewhere. Another concern is that a wounded broker like Bear Stearns could abruptly cut off financing to hedge funds, which would force them to liquidate investments, possibly sustaining losses, to repay loans.
The unknown is what Bear's prime-brokerage clients have been reacting to," said John Broadhurst, a partner in the hedge-fund practice of San Francisco law firm Shartsis Friese LLP. "Some hedge-fund managers are just yanking their business. Others are weighing the perceived risks with the hassle of changing prime brokers."
The business of dealing with hedge funds has been an increasingly important business for Bear Stearns, representing 10% or more of revenue, and a higher percentage of earnings in recent years, according to estimates from David Hendler, a senior analyst at CreditSights, Inc., a research firm.
"They are one of the original players in this market, as hedge funds grew as an investor base, they grew with it. It's a double-edged sword though; guys who were helping Bear to grow now are taking money out."
Fed's Taboo broken
The Federal Reserve announced one of the broadest expansions of its lending authority since the 1930s in an effort to stem a credit crisis that is engulfing the financial system and threatening a deep recession.
For the first time securities dealers, effective today and for at least the next six months, may borrow from the Fed on much the same terms as banks. The Fed also lowered the rate charged on such borrowings from what's known as its discount window by a quarter of a percentage point, to 3.25%, and extended the maximum term to 90 days from 30.
In some ways, the initiatives better equip the Fed to help a financial system that has changed drastically from one based on banks for most of its 95-year existence. It took a unanimous vote by the Fed's five governors yesterday to invoke a Depression-era clause in the Federal Reserve Act to waive the usual prohibition on Fed loans to nonbanks. A Fed official told reporters today's circumstances couldn't have been envisioned when the Fed was created, and noted newer central banks like Europe's have many of these powers. But these steps also take the central bank into uncharted territory with new and potentially troublesome risks.
Those risks include the possibility that with the credit crunch showing no sign of lifting, the Fed will be called on to lend to other troubled firms and end up a major creditor of Wall Street, even if at present the risk of any substantial loss appears small. Another risk is that while the Fed used a loophole yesterday in the Federal Reserve Act to expand its lending to nonbanks in "unusual and exigent" circumstances, it has in effect expanded the federal safety net with no political debate. However, the Fed sought and received agreement over the $30 billion loan from Treasury Secretary Henry Paulson, who informed President Bush.
Officials appear to hope the initiatives will restore enough confidence to markets to allow a smaller rather than larger rate cut tomorrow, but they acknowledge it will depend partly on how markets evolve over coming days
On Wall Street, there is likely to be some relief that the Fed has finally opened the discount window to securities dealers, something they have long clamored for. The Fed has been reluctant because the move was outside its explicit mandate. "This is a five-vodka event," said a senior executive at one big brokerage firm that previously didn't have access to this funding source. "Liquidity is no longer an issue."
For all their creativity, the Fed moves are also an acknowledgment that its previous steps have failed to stem the collapse in investor confidence, forcing it to abandon many of its original principles, such as not favoring particular firms or market sectors and sticking within its explicit statutory authority.
Last Tuesday, it announced what Wall Street called its most creative initiative yet: It lent up to $200 billion of its much-sought Treasurys to investment banks starting March 27 in return for a like amount of now-shunned mortgage backed securities for up to 28 days. The announcement led to a huge rally in stocks. But within days dealers were telling the Fed it didn't go far enough. They wanted longer term, more immediate funding against a broader range of collateral.
For the first time securities dealers, effective today and for at least the next six months, may borrow from the Fed on much the same terms as banks. The Fed also lowered the rate charged on such borrowings from what's known as its discount window by a quarter of a percentage point, to 3.25%, and extended the maximum term to 90 days from 30.
In some ways, the initiatives better equip the Fed to help a financial system that has changed drastically from one based on banks for most of its 95-year existence. It took a unanimous vote by the Fed's five governors yesterday to invoke a Depression-era clause in the Federal Reserve Act to waive the usual prohibition on Fed loans to nonbanks. A Fed official told reporters today's circumstances couldn't have been envisioned when the Fed was created, and noted newer central banks like Europe's have many of these powers. But these steps also take the central bank into uncharted territory with new and potentially troublesome risks.
Those risks include the possibility that with the credit crunch showing no sign of lifting, the Fed will be called on to lend to other troubled firms and end up a major creditor of Wall Street, even if at present the risk of any substantial loss appears small. Another risk is that while the Fed used a loophole yesterday in the Federal Reserve Act to expand its lending to nonbanks in "unusual and exigent" circumstances, it has in effect expanded the federal safety net with no political debate. However, the Fed sought and received agreement over the $30 billion loan from Treasury Secretary Henry Paulson, who informed President Bush.
Officials appear to hope the initiatives will restore enough confidence to markets to allow a smaller rather than larger rate cut tomorrow, but they acknowledge it will depend partly on how markets evolve over coming days
On Wall Street, there is likely to be some relief that the Fed has finally opened the discount window to securities dealers, something they have long clamored for. The Fed has been reluctant because the move was outside its explicit mandate. "This is a five-vodka event," said a senior executive at one big brokerage firm that previously didn't have access to this funding source. "Liquidity is no longer an issue."
For all their creativity, the Fed moves are also an acknowledgment that its previous steps have failed to stem the collapse in investor confidence, forcing it to abandon many of its original principles, such as not favoring particular firms or market sectors and sticking within its explicit statutory authority.
Last Tuesday, it announced what Wall Street called its most creative initiative yet: It lent up to $200 billion of its much-sought Treasurys to investment banks starting March 27 in return for a like amount of now-shunned mortgage backed securities for up to 28 days. The announcement led to a huge rally in stocks. But within days dealers were telling the Fed it didn't go far enough. They wanted longer term, more immediate funding against a broader range of collateral.
Sunday, March 16, 2008
liquidity analysis of Bearn Stearns and Lehman
Based on 2007 10-k financial statements
Bear Stearns (total liability 383.6 bil, asset 395 bil, 143 bil financial instrments)
1.repo financing 102 bil, 26.6% of liabilities
2.long term 68.5 bil, 17.85% of liabilities
3.unencumbered collateral asset: 16.3 bil w a borrowing value of $14 bil (3.6%)
3.a unregulated unencumbered collateral asset: $5.1 bil (1%)
4.mortgage and abs exposure 46 bil + 30 bil(VIE), 11.6% of total, 32% of financial instruements
--> cash + unregulated unencumbered collateral asset = 17 bil + 5 bil = 22 bil (5.7%)
Lehman (liab 668.6 bil, asset 691 bil, financial instrument 393 bil)
1.repo financing 181.7 bil, 27%
2.long term 123 bil,k 18.4%
3.unencumbered collateral asset: 193.6 bil (29%)
3.a unregulated unencumbered collater asset: $98.1 bil (14.7%) (including cash equivalent)
4.mortgage exposure 89 bil, out of assets 691 bil 13%, 22% of financial instrmenet
---> cash + unregulated unencumbered collateral asset = 98.1 bil (14.7%)
Comments:
--Bear Stearns has far more liquidity issue than Lehman
Bear Stearns (total liability 383.6 bil, asset 395 bil, 143 bil financial instrments)
1.repo financing 102 bil, 26.6% of liabilities
2.long term 68.5 bil, 17.85% of liabilities
3.unencumbered collateral asset: 16.3 bil w a borrowing value of $14 bil (3.6%)
3.a unregulated unencumbered collateral asset: $5.1 bil (1%)
4.mortgage and abs exposure 46 bil + 30 bil(VIE), 11.6% of total, 32% of financial instruements
--> cash + unregulated unencumbered collateral asset = 17 bil + 5 bil = 22 bil (5.7%)
Lehman (liab 668.6 bil, asset 691 bil, financial instrument 393 bil)
1.repo financing 181.7 bil, 27%
2.long term 123 bil,k 18.4%
3.unencumbered collateral asset: 193.6 bil (29%)
3.a unregulated unencumbered collater asset: $98.1 bil (14.7%) (including cash equivalent)
4.mortgage exposure 89 bil, out of assets 691 bil 13%, 22% of financial instrmenet
---> cash + unregulated unencumbered collateral asset = 98.1 bil (14.7%)
Comments:
--Bear Stearns has far more liquidity issue than Lehman
Repo market dries up
Bear Stearns Cos.' financing crisis is shining the spotlight on an important market Wall Street banks, hedge funds and others rely on heavily for day-to-day cash needs.
The $4.5 trillion securities repurchase, or "repo" market, enables financial institutions to obtain short-term, often overnight, funds by selling securities and agreeing to repurchase them a day or so later when the agreement matures. They get cash in return for the securities they temporarily exchange.
In normal times, these loans are inexpensive and roll over easily. That's made them an increasingly important source of funding for many Wall Street firms, who sit on giant securities portfolios.
As with other kinds of short-term financing recently, the money is drying up. Investors and financial institutions who lend in this market have become worried about losing money on securities used as collateral. Determined to protect themselves, they're pulling back from offering repo financing to each other. That has the potential to leave Wall Street in a chaotic scramble for cash -- a likely reason the Federal Reserve stepped in so quickly to aid Bear.
In recent years, repo financing has accounted for a fifth to roughly a quarter of the total assets of the five top Wall Street dealers taken as a group, said analyst Brad Hintz of Sanford C. Bernstein & Co. He calls this market "the Achilles heel of the securities firms."
Some firms have been trying to reduce their reliance on repo financing. Last year, for example Morgan Stanley reduced its repo financing to $162.8 billion, or 16% of total assets, at its Nov. 30 fiscal year end, from $267.6 billion, or 24% of total assets from a year earlier.
Since mid-February, conditions in the repo market have tightened dramatically. That's made it harder not only for securities firms, but also for hedge funds and others to obtain or roll over such loans to finance their investments and trades. The development coincided with sharp price declines in some securities used as collateral for repo loans.
"It was the market failure to roll repo -- securitized lending agreements -- that appears to have been Bear's problem," Jeffrey Rosenberg, Bank of America's head of credit strategy research, said in a report analyzing Bear's problem.
In a conference call Friday, Bear Stearns chief financial officer Sam Molinaro said a liquidity crunch hit Bear because "we experienced pretty broad cash outflows from a number of different sources," including "the repo area" as well as outflows from the firm's prime brokerage clients and margin calls on derivative contracts.
Bear may have been vulnerable to a repo a pullback because of worries about the value of this collateral. Mortgages represented a greater percentage of its total assets, Mr. Rosenberg said, at one-third, compared to 12% at Merrill Lynch & Co. and Goldman Sachs Group Inc., 13% at Morgan Stanley, and 29% at Lehman Brothers Holdings Inc.
Some banks and lenders are choosing to make repo loans only in exchange for the safest debt securities, such as U.S. Treasury bonds, which have surged in value in recent weeks. Wall Street dealers and hedge funds that want to borrow against their holdings of mortgage securities have had to fork over significantly more collateral in order to get loans.
Some banks and lenders are choosing to make repo loans only in exchange for the safest debt securities, such as U.S. Treasury bonds, which have surged in value in recent weeks. Wall Street dealers and hedge funds that want to borrow against their holdings of mortgage securities have had to fork over significantly more collateral in order to get loans.
For relatively safe bonds backed by Fannie Mae and Freddie Mac, for instance, lenders a few weeks ago were requiring $102 in securities as collateral for every $100 in loans. The demand hit $105 last week. For bonds backed by 'Alt-A' loans, which some consider to be between subprime and prime in terms of credit quality, repo lenders are demanding as much as $130 of collateral for every $100 in loans.
Repo disruptions helped doom a $21.7 billion mortgage fund, Carlyle Capital Corp., last week. Carlyle financed most of the fund's operations with low-interest repo credit to boost returns.
Carlyle said one bank moved to reduce the size of the repo loans it made to Carlyle to 95% of the underlying value of the assets used as collateral, from 97%. Another dealer had reduced the value of the loans' collateral to "markedly lower levels than other banks." Data from the Federal Reserve last week showed that Wall Street dealers had accumulated around $66 billion in net holdings of mortgage-backed securities in their inventories, a historic high.
Those levels have been unusually elevated for the last few weeks, and "mean that there has been a significant decline in liquidity in the mortgage market, which is resulting in dealers holding large amounts of assets," says Mustafa Chowdhury, head of U.S. rates research at Deutsche Bank in New York. In calmer times, those balances are typically below $30 billion.
The $4.5 trillion securities repurchase, or "repo" market, enables financial institutions to obtain short-term, often overnight, funds by selling securities and agreeing to repurchase them a day or so later when the agreement matures. They get cash in return for the securities they temporarily exchange.
In normal times, these loans are inexpensive and roll over easily. That's made them an increasingly important source of funding for many Wall Street firms, who sit on giant securities portfolios.
As with other kinds of short-term financing recently, the money is drying up. Investors and financial institutions who lend in this market have become worried about losing money on securities used as collateral. Determined to protect themselves, they're pulling back from offering repo financing to each other. That has the potential to leave Wall Street in a chaotic scramble for cash -- a likely reason the Federal Reserve stepped in so quickly to aid Bear.
In recent years, repo financing has accounted for a fifth to roughly a quarter of the total assets of the five top Wall Street dealers taken as a group, said analyst Brad Hintz of Sanford C. Bernstein & Co. He calls this market "the Achilles heel of the securities firms."
Some firms have been trying to reduce their reliance on repo financing. Last year, for example Morgan Stanley reduced its repo financing to $162.8 billion, or 16% of total assets, at its Nov. 30 fiscal year end, from $267.6 billion, or 24% of total assets from a year earlier.
Since mid-February, conditions in the repo market have tightened dramatically. That's made it harder not only for securities firms, but also for hedge funds and others to obtain or roll over such loans to finance their investments and trades. The development coincided with sharp price declines in some securities used as collateral for repo loans.
"It was the market failure to roll repo -- securitized lending agreements -- that appears to have been Bear's problem," Jeffrey Rosenberg, Bank of America's head of credit strategy research, said in a report analyzing Bear's problem.
In a conference call Friday, Bear Stearns chief financial officer Sam Molinaro said a liquidity crunch hit Bear because "we experienced pretty broad cash outflows from a number of different sources," including "the repo area" as well as outflows from the firm's prime brokerage clients and margin calls on derivative contracts.
Bear may have been vulnerable to a repo a pullback because of worries about the value of this collateral. Mortgages represented a greater percentage of its total assets, Mr. Rosenberg said, at one-third, compared to 12% at Merrill Lynch & Co. and Goldman Sachs Group Inc., 13% at Morgan Stanley, and 29% at Lehman Brothers Holdings Inc.
Some banks and lenders are choosing to make repo loans only in exchange for the safest debt securities, such as U.S. Treasury bonds, which have surged in value in recent weeks. Wall Street dealers and hedge funds that want to borrow against their holdings of mortgage securities have had to fork over significantly more collateral in order to get loans.
Some banks and lenders are choosing to make repo loans only in exchange for the safest debt securities, such as U.S. Treasury bonds, which have surged in value in recent weeks. Wall Street dealers and hedge funds that want to borrow against their holdings of mortgage securities have had to fork over significantly more collateral in order to get loans.
For relatively safe bonds backed by Fannie Mae and Freddie Mac, for instance, lenders a few weeks ago were requiring $102 in securities as collateral for every $100 in loans. The demand hit $105 last week. For bonds backed by 'Alt-A' loans, which some consider to be between subprime and prime in terms of credit quality, repo lenders are demanding as much as $130 of collateral for every $100 in loans.
Repo disruptions helped doom a $21.7 billion mortgage fund, Carlyle Capital Corp., last week. Carlyle financed most of the fund's operations with low-interest repo credit to boost returns.
Carlyle said one bank moved to reduce the size of the repo loans it made to Carlyle to 95% of the underlying value of the assets used as collateral, from 97%. Another dealer had reduced the value of the loans' collateral to "markedly lower levels than other banks." Data from the Federal Reserve last week showed that Wall Street dealers had accumulated around $66 billion in net holdings of mortgage-backed securities in their inventories, a historic high.
Those levels have been unusually elevated for the last few weeks, and "mean that there has been a significant decline in liquidity in the mortgage market, which is resulting in dealers holding large amounts of assets," says Mustafa Chowdhury, head of U.S. rates research at Deutsche Bank in New York. In calmer times, those balances are typically below $30 billion.
Dude Fed, stop the morale hazards
In an extraordinary weekend intervention, the Fed announced the most dramatic expansion yet of its lending, promising to lend for up to six months to securities dealers under terms normally reserved only for tightly regulated banks.
The central bank also cut the rate on such direct loans by a quarter of a percentage point, just two days before it is likely to slash interest rates more broadly. It also made a rare weekend cut in the discount rate -- ordinarily charged on direct loans to banks, and now also to securities dealers -- to 3.25% from 3.5%, while helping bring Bear Stearns into the arms of J.P. Morgan Chase.
That narrows the spread with the more economically important federal-funds rate, now 3%, to a quarter of a point. The Fed is also expected to cut the fed-funds rate target by at least half a point at its meeting Tuesday.
The moves were the latest and most aggressive yet in a series of steps that demonstrate how the Fed's traditional tools aren't suited to dealing with a crisis now sweeping the modern financial system. But, by also agreeing to lend up to $30 billion to J.P. Morgan Chase to finance illiquid assets inherited from its purchase of Bear Stearns Cos., the Fed is taking on new risks.
The Fed was created in 1913 in part to be "lender of last resort" during crises such as the one now sweeping through the financial system. But it was equipped for an economy in which banks provided most credit. Now banks share that role with institutional investors, finance companies, asset-backed pools and securities dealers such as Bear Stearns.
Even as it innovated in the current crisis, the Fed had avoided favoring a particular firm or class of securities. On Friday it crossed that line, stepping in to provide emergency funding to keep Bear Stearns afloat amid a severe cash crunch at the Wall Street firm. That funding will now be replaced by $30 billion lent to J.P. Morgan but secured solely by hard-to-value assets inherited from that firm's purchase of Bear, meaning if the assets decline sufficiently in value, the Fed will bear a loss.
set a precedent for future troubled firms.
Adam Posen, a central-banking expert at the Peterson Institute for International Economics in Washington, said other troubled firms claiming an equally critical position at the nexus of the financial system now "have political and legal precedent to ask for" help. He said the expectation of such help could also harden the negotiating position of a troubled firm, potentially complicating private-sector solutions.
The Fed has intervened from time to time in specific situations, from Treasury loans to Mexico in 1994 to brokering the rescue of the hedge-fund Long Term Capital Management in 1998. But it has been rare for the Fed to put its own money at risk. The most important example of this was in 1984 when it and the Federal Deposit Insurance Corp. lent billions to Continental Illinois. Efforts to find a buyer were fruitless and the federal government ultimately ended up owning most of the failed bank.
The financial system is much more interconnected and opaque than in 1984.
Since the 1980s, Congress has limited the ability of regulators to prop up weak banks. At the same time, the financial system has moved away from insured deposits to other sources of funding. Securities dealers' "repo" borrowings -- short-term collateralized loans that grease the market for a wide variety of securities -- have more than doubled to $4.5 trillion and now exceed banks' federally insured deposits.
Fed officials believe that multiple sources of credit have made the economy more resilient and less exposed to problems in banks. Less than a year ago, Fed Vice Chairman Donald Kohn predicted that with a more market-based and less bank-based system, the Fed would rely more on interest rates to stem crises than direct loans to market participants.
But the Fed has already learned that interest-rate cuts alone aren't enough to stem the current crisis, and has not only had to use the discount window, but in ways it never thought likely.
The central bank also cut the rate on such direct loans by a quarter of a percentage point, just two days before it is likely to slash interest rates more broadly. It also made a rare weekend cut in the discount rate -- ordinarily charged on direct loans to banks, and now also to securities dealers -- to 3.25% from 3.5%, while helping bring Bear Stearns into the arms of J.P. Morgan Chase.
That narrows the spread with the more economically important federal-funds rate, now 3%, to a quarter of a point. The Fed is also expected to cut the fed-funds rate target by at least half a point at its meeting Tuesday.
The moves were the latest and most aggressive yet in a series of steps that demonstrate how the Fed's traditional tools aren't suited to dealing with a crisis now sweeping the modern financial system. But, by also agreeing to lend up to $30 billion to J.P. Morgan Chase to finance illiquid assets inherited from its purchase of Bear Stearns Cos., the Fed is taking on new risks.
The Fed was created in 1913 in part to be "lender of last resort" during crises such as the one now sweeping through the financial system. But it was equipped for an economy in which banks provided most credit. Now banks share that role with institutional investors, finance companies, asset-backed pools and securities dealers such as Bear Stearns.
Even as it innovated in the current crisis, the Fed had avoided favoring a particular firm or class of securities. On Friday it crossed that line, stepping in to provide emergency funding to keep Bear Stearns afloat amid a severe cash crunch at the Wall Street firm. That funding will now be replaced by $30 billion lent to J.P. Morgan but secured solely by hard-to-value assets inherited from that firm's purchase of Bear, meaning if the assets decline sufficiently in value, the Fed will bear a loss.
set a precedent for future troubled firms.
Adam Posen, a central-banking expert at the Peterson Institute for International Economics in Washington, said other troubled firms claiming an equally critical position at the nexus of the financial system now "have political and legal precedent to ask for" help. He said the expectation of such help could also harden the negotiating position of a troubled firm, potentially complicating private-sector solutions.
The Fed has intervened from time to time in specific situations, from Treasury loans to Mexico in 1994 to brokering the rescue of the hedge-fund Long Term Capital Management in 1998. But it has been rare for the Fed to put its own money at risk. The most important example of this was in 1984 when it and the Federal Deposit Insurance Corp. lent billions to Continental Illinois. Efforts to find a buyer were fruitless and the federal government ultimately ended up owning most of the failed bank.
The financial system is much more interconnected and opaque than in 1984.
Since the 1980s, Congress has limited the ability of regulators to prop up weak banks. At the same time, the financial system has moved away from insured deposits to other sources of funding. Securities dealers' "repo" borrowings -- short-term collateralized loans that grease the market for a wide variety of securities -- have more than doubled to $4.5 trillion and now exceed banks' federally insured deposits.
Fed officials believe that multiple sources of credit have made the economy more resilient and less exposed to problems in banks. Less than a year ago, Fed Vice Chairman Donald Kohn predicted that with a more market-based and less bank-based system, the Fed would rely more on interest rates to stem crises than direct loans to market participants.
But the Fed has already learned that interest-rate cuts alone aren't enough to stem the current crisis, and has not only had to use the discount window, but in ways it never thought likely.
eurolibor surges to year high
Interest rates in sterling money markets jumped on Friday with three-month interbank lending at its highest rate since the start of the year and the highest one-day move since rates began rising again in mid-February.
Huw Van Steenis, head of banking analysis at Morgan Stanley, said the pressures in money market rates reflects the fact that a significant supplier of bank liquidity - Structured Investment Vehicles (SIVs) have simply disappeared from the market in the past year.
“Half of the buyers of senior bank debt are on buyers’ strike,” Mr Van Steenis said.
SIV had been heavy buyers of commercial paper and medium-term notes, often issued by banks to finance their own holdings of mortgage and other asset-backed securities.
Because this source of funding has dried up, banks are now having to look to each other for cash, he said.
Moreover, as credit markets seized up, corporate borrowers who might once have turned to the credit markets for capital are now also looking to their bankers for cash.
This amounts to “an involuntary expansion of balance sheets for banks” Mr Van Steenis said.
The easiest way for banks to shrink balance sheets is simply to cut the amount of lending each instution provides to the others. “What is good for each bank individually is not good for the market as a whole,” he said.
Huw Van Steenis, head of banking analysis at Morgan Stanley, said the pressures in money market rates reflects the fact that a significant supplier of bank liquidity - Structured Investment Vehicles (SIVs) have simply disappeared from the market in the past year.
“Half of the buyers of senior bank debt are on buyers’ strike,” Mr Van Steenis said.
SIV had been heavy buyers of commercial paper and medium-term notes, often issued by banks to finance their own holdings of mortgage and other asset-backed securities.
Because this source of funding has dried up, banks are now having to look to each other for cash, he said.
Moreover, as credit markets seized up, corporate borrowers who might once have turned to the credit markets for capital are now also looking to their bankers for cash.
This amounts to “an involuntary expansion of balance sheets for banks” Mr Van Steenis said.
The easiest way for banks to shrink balance sheets is simply to cut the amount of lending each instution provides to the others. “What is good for each bank individually is not good for the market as a whole,” he said.
Fed's emergency finance in 4 decades to an non-FIDC bank
Friday’s action by the Federal Reserve marks the first time since the 1960s that the US central bank has authorised the provision of emergency finance to any financial institution other than a regulated deposit-taking bank.
Analysts speculated that the Fed could be forced to provide emergency finance to other investment banks and possibly even some hedge funds in the weeks ahead. In a statement, the Fed said its move was intended to “promote the orderly functioning of the financial system”.
the market is too fragile to withstand another systematic risk.
A second Fed official said that providing emergency funds to an unregulated financial institution would create serious moral hazard.
The Fed said it was acting under section 13.3 of the Federal Reserve Act, which gives it authority to lend to any individual, partnership or corporation “in unusual and exigent circumstances”.
As a primary dealer in the bond market, Bear is eligible to take part in the new $200bn securities lending facility that will allow dealers to swap hard-to-finance mortgage securities for Treasuries with the Fed.
But the SLF, like the Fed’s new one month term repo operation, operates through twice-monthly auctions. The first auction does not take place until March 27. Bear evidently could not wait.
Analysts speculated that the Fed could be forced to provide emergency finance to other investment banks and possibly even some hedge funds in the weeks ahead. In a statement, the Fed said its move was intended to “promote the orderly functioning of the financial system”.
the market is too fragile to withstand another systematic risk.
A second Fed official said that providing emergency funds to an unregulated financial institution would create serious moral hazard.
The Fed said it was acting under section 13.3 of the Federal Reserve Act, which gives it authority to lend to any individual, partnership or corporation “in unusual and exigent circumstances”.
As a primary dealer in the bond market, Bear is eligible to take part in the new $200bn securities lending facility that will allow dealers to swap hard-to-finance mortgage securities for Treasuries with the Fed.
But the SLF, like the Fed’s new one month term repo operation, operates through twice-monthly auctions. The first auction does not take place until March 27. Bear evidently could not wait.
Fed unfair treatment to Wall Street firms
While numerous Wall Street firms have gotten in trouble over the years, the response from Fed has varied widely. For most of the 20th century, "it wasn't thought to be part of public policy" for the government to step in and support or rescue ailing financial firms, says Roy Smith, a finance professor at New York University business school and himself a former Goldman partner. Indeed, after the stock market crash of 1929 and the ensuing depression, "the Wall Street firms didn't have many friends when they got into trouble."
In 1970, Goodbody & Co., then the fourth largest U.S. brokerage, got into trouble from a market downturn and trade-processing delays. The New York Stock Exchange stepped in to sponsor an acquisition by Merrill Lynch & Co., indemnifying Merrill for some of its costs.
The most prominent casualty of the 1987 stock-market crash was E.F. Hutton & Co., which suffered crippling losses on top of a damaging check-kiting scandal two years earlier. Hutton was able to arrange a rescue acquisition on its own with the Shearson Lehman Brothers unit of American Express Co. that December.
The biggest precedent for a government-sponsored rescue occurred in 1998. That's when the Federal Reserve gathered Wall Street chief executives in its august meeting rooms to pony up enough capital to prop up giant hedge fund Long Term Capital. The move prevented a fire sale of roughly $100 billion in assets. Bear made some enemies on Wall Street by refusing to participate in this $3.6 billion rescue.
But some firms are left to fail without aid. In 2005, commodities powerhouse Refco Inc. sought bankruptcy-law protection after questions emerged about its accounting only months after its initial public offering.
Bear's own recent need for government support is ironic, says Wall Street money manager Michael Holland, because "they were a firm that was always known for doing the smart, risk-averse thing, take advantage of the opportunity and don't ever get blown up."
In 1970, Goodbody & Co., then the fourth largest U.S. brokerage, got into trouble from a market downturn and trade-processing delays. The New York Stock Exchange stepped in to sponsor an acquisition by Merrill Lynch & Co., indemnifying Merrill for some of its costs.
The most prominent casualty of the 1987 stock-market crash was E.F. Hutton & Co., which suffered crippling losses on top of a damaging check-kiting scandal two years earlier. Hutton was able to arrange a rescue acquisition on its own with the Shearson Lehman Brothers unit of American Express Co. that December.
The biggest precedent for a government-sponsored rescue occurred in 1998. That's when the Federal Reserve gathered Wall Street chief executives in its august meeting rooms to pony up enough capital to prop up giant hedge fund Long Term Capital. The move prevented a fire sale of roughly $100 billion in assets. Bear made some enemies on Wall Street by refusing to participate in this $3.6 billion rescue.
But some firms are left to fail without aid. In 2005, commodities powerhouse Refco Inc. sought bankruptcy-law protection after questions emerged about its accounting only months after its initial public offering.
Bear's own recent need for government support is ironic, says Wall Street money manager Michael Holland, because "they were a firm that was always known for doing the smart, risk-averse thing, take advantage of the opportunity and don't ever get blown up."
Bear isn't too big to fail, too important to fail
The Federal Reserve is bailing out Bear Stearns. But it isn't because the firm is too big to fail. It is a fraction the size of its competitors. And regulators usually leave stumbling brokers to fend for themselves -- as they did when Drexel Burnham and First Boston stood on the brink. But the financial system has become more tightly bound in recent years by webs of counterparty exposure. If one important player failed, the fallout would be keenly felt by all.
Giving Bear access, with the help of J.P. Morgan Chase, to loans from its discount window, represents a huge increase in the Fed's willingness to support a broker -- an institution it doesn't directly regulate.
Of course, the Fed has sponsored bailouts of entities outside its purview before, as when it herded banks to unwind Long-Term Capital Management a decade ago. Then, too, it was concerned about banks' counterparty exposure to the hedge fund.
That kind of exposure has increased a lot since then through the ballooning derivatives markets. Credit derivatives, which barely existed when LTCM ran aground, now constitute a $50 trillion market, though much of that consists of offsetting contracts. Other derivatives markets have also grown.
These have seen only one episode where a big counterparty defaulted -- when Enron went toes up in 2001. Its trading partners worked out their net exposures and negotiated settlements through the bankruptcy process. But that took time.
If a big counterparty like Bear went bust today, it is unclear whether the result would be so orderly. Banks are racing to grab as much liquidity as possible, whether via margin calls from borrowers or at Fed loan auctions. And prices of many illiquid instruments are difficult to come by. It would be hard to quickly define each institution's net exposure to Bear.
Until they knew where they stood, banks would be even less likely to lend, and more likely to try to grab collateral from counterparties -- accelerating the crisis. Bear may not be too big to fail, but its market role -- like that of its rivals -- may be too complicated. The Fed is right to try to keep it afloat.
Sparkling History
For much of its history, Bear thrived on its ability to handle risk. Founded in 1923 as a stock-trading partnership, Bear was transformed a decade later by the arrival of Salim "Cy" Lewis, a former Salomon Brothers trader, into a bond-trading powerhouse. In 1940, he jumped into takeover speculation, buying New York subway stocks and city bonds after correctly anticipating that the city would take over the subway lines.
Under Mr. Lewis's successor Alan "Ace" Greenberg and then James Cayne, Bear expanded into other areas of fixed income, most notably the booming market for mortgage securities. It was one of the first on Wall Street to go public in 1985, and three years later also became one of the first to depart the Wall Street area and move to midtown Manhattan.
---
Like Drexel Burnham Lambert Inc., which collapsed in 1990 after its main market, junk bonds, suffered a steep downturn, Bear's main market of mortgages has been the center of bond-market woes that hit Wall Street starting in June.
But the Federal Reserve didn't intervene to stop Drexel's collapse, partly because the firm had been the subject of a bruising series of regulatory investigations that took hold in 1986.
Giving Bear access, with the help of J.P. Morgan Chase, to loans from its discount window, represents a huge increase in the Fed's willingness to support a broker -- an institution it doesn't directly regulate.
Of course, the Fed has sponsored bailouts of entities outside its purview before, as when it herded banks to unwind Long-Term Capital Management a decade ago. Then, too, it was concerned about banks' counterparty exposure to the hedge fund.
That kind of exposure has increased a lot since then through the ballooning derivatives markets. Credit derivatives, which barely existed when LTCM ran aground, now constitute a $50 trillion market, though much of that consists of offsetting contracts. Other derivatives markets have also grown.
These have seen only one episode where a big counterparty defaulted -- when Enron went toes up in 2001. Its trading partners worked out their net exposures and negotiated settlements through the bankruptcy process. But that took time.
If a big counterparty like Bear went bust today, it is unclear whether the result would be so orderly. Banks are racing to grab as much liquidity as possible, whether via margin calls from borrowers or at Fed loan auctions. And prices of many illiquid instruments are difficult to come by. It would be hard to quickly define each institution's net exposure to Bear.
Until they knew where they stood, banks would be even less likely to lend, and more likely to try to grab collateral from counterparties -- accelerating the crisis. Bear may not be too big to fail, but its market role -- like that of its rivals -- may be too complicated. The Fed is right to try to keep it afloat.
Sparkling History
For much of its history, Bear thrived on its ability to handle risk. Founded in 1923 as a stock-trading partnership, Bear was transformed a decade later by the arrival of Salim "Cy" Lewis, a former Salomon Brothers trader, into a bond-trading powerhouse. In 1940, he jumped into takeover speculation, buying New York subway stocks and city bonds after correctly anticipating that the city would take over the subway lines.
Under Mr. Lewis's successor Alan "Ace" Greenberg and then James Cayne, Bear expanded into other areas of fixed income, most notably the booming market for mortgage securities. It was one of the first on Wall Street to go public in 1985, and three years later also became one of the first to depart the Wall Street area and move to midtown Manhattan.
---
Like Drexel Burnham Lambert Inc., which collapsed in 1990 after its main market, junk bonds, suffered a steep downturn, Bear's main market of mortgages has been the center of bond-market woes that hit Wall Street starting in June.
But the Federal Reserve didn't intervene to stop Drexel's collapse, partly because the firm had been the subject of a bruising series of regulatory investigations that took hold in 1986.
Saturday, March 15, 2008
Potential cascading effect of BSC's collapse
The fate of Bear Stearns could matter greatly to the many governments, hedge funds, pension funds and other investors who entered into derivatives contracts with the brokerage firm.
Some of the investors engaged in these swaps with Bear are better positioned than others. Bear created two subsidiary companies, known as special-purpose vehicles, with a separate legal status intended to make their obligations secure even if the parent company goes bankrupt. These SPVs are triple-A-rated, and their management would be assumed by another brokerage firm if Bear collapsed.
But many other investors entered into swaps with a direct subsidiary of Bear that would be more acutely exposed to the firm's future.
Some of the investors engaged in these swaps with Bear are better positioned than others. Bear created two subsidiary companies, known as special-purpose vehicles, with a separate legal status intended to make their obligations secure even if the parent company goes bankrupt. These SPVs are triple-A-rated, and their management would be assumed by another brokerage firm if Bear collapsed.
But many other investors entered into swaps with a direct subsidiary of Bear that would be more acutely exposed to the firm's future.
split of Bear Stearns
In the event of a split, Bear has four businesses that could interest buyers: the investment-banking business, which underwrites stocks, bonds and advises on mergers; the fixed-income and capital-markets businesses, which trade stocks, bonds and other securities; the clearing unit, which settles trades and also services and lends to hedge funds via a prime brokerage; and the high-net-worth group, which advises the rich on investments. The first two would have trouble attracting buyers, because of their exposure to volatile markets.
The clearing business, with the prime brokerage, would probably attract the most attention, and several bankers said it might be attractive to rivals including Morgan Stanley, Goldman Sachs Group Inc., UBS AG, J.P. Morgan Chase or Bank of New York Mellon Corp. However, the prime-brokerage business has its risks, and on a conference call today, Bear Stearns executives acknowledged that some of the business hits they have taken were because of prime brokerage.
The clearing unit in which it resides is the only Bear business to turn a profit last year -- about $566 million on revenue of $1.2 billion.London-based HSBC Group is perennially described as a good fit because of the lack of overlap between the two businesses: HSBC's European strength would balance Bear's strength in the U.S., where it draws more than 70% of its revenues. In addition, HSBC doesn't have a large advisory business in the U.S. to compete with Bear Stearns, and it could use Bear Stearns's valuable "high net worth," or wealth-investor, business. HSBC declined to comment. Chapter 11 remains so unappetizing that "to threaten it is almost laughable; it would be like a person holding a gun to their own head and yelling, 'Stop or I will shoot,'" said one person involved in the matter.
Bear Stearns may have trouble if it wants to sell its headquarters building quickly. The sales market for all commercial property has seized up as a result of the credit crunch. There have been few deals since SL Green Realty Corp. closed on its $1.6 billion sale-leaseback acquisition of two downtown Manhattan buildings late last year from Citigroup.
liquidity plagues Bear Stearns
Brokerages break out the size of this emergency cash in their financial filings with the Securities and Exchange Commission. To gauge its sufficiency, the reserve can be compared to the main type of debt that brokerages rely on to finance their operations. This debt is called collateralized borrowing, because to get the loans the brokerages have to pledge assets as security to the creditor. If these creditors pull back sharply, a brokerage is in deep trouble.
From public comments by Bear executives Friday, it appears much of the liquidity squeeze was caused by a pulling back by creditors that had extended loans based on collateral provided by Bear. These types of creditors "were no longer willing to provide financing," Samuel Molinaro, Bear's chief financial officer, said on the Friday call.
Bear would have been particularly exposed to this withdrawal, because its emergency cash pile was small compared to this debt. On Nov. 30, that cash reserve of $17 billion was only about 17% of the $102 billion owed through secured financings.
If the prices of assets Bear had pledged fell, the brokerage would have had to post a payment to the creditor called margin. One big purpose for the emergency funds is to have the cash to make margin payments during a credit-markets crisis. "My guess is that Bear did not adequately stress-test and didn't have enough liquidity to meet those margin payments," said Michael Peterson, director of research at Pzena Investment Management.
Like Bear, Lehman is a big bond player and also one of the smaller Wall Street firms. But it is on sturdier ground than Bear, many investors said. "I'm pretty comfortable with Lehman's liquidity," said Mr. Peterson, whose firm owns Lehman shares. "The lessons of 1998 were not at all lost on Lehman."
Aiming to make its balance sheet sturdier after 1998, Lehman became less reliant on short-term borrowing, which can dry up quickly. At the end of November, it had $28 billion in debt coming due in the following 12 months, well below the $34.9 billion in its liquidity reserve. "What gives me comfort right now is that Lehman has very little short-term debt," Mr. Peterson said.
The firm's emergency-cash pile was 19% of its $182 billion in secured financings, putting it below the numbers for Goldman Sachs, Morgan Stanley and Merrill Lynch. At those firms the emergency cash was 38%, 39% and 34%, respectively, of collateralized financings.
In a crunch, Lehman may be able to raise cash by selling another big pool of liquid assets, which is valued at more than $60 billion. Adding that to the liquidity cash reserve gives Lehman a potential $100 billion cash pile, equal to 54% of collateralized financing. That is ahead of some other brokers and far stronger than Bear's 31%.
In addition, the debt that comes from the collateralized financing typically is matched by a similar loan to another customer, which creates an asset. When offset against each other, the collateralized financing liability becomes much smaller. In Lehman's case, it is about $20 billion, which is only about 60% of its emergency cash.
From public comments by Bear executives Friday, it appears much of the liquidity squeeze was caused by a pulling back by creditors that had extended loans based on collateral provided by Bear. These types of creditors "were no longer willing to provide financing," Samuel Molinaro, Bear's chief financial officer, said on the Friday call.
Bear would have been particularly exposed to this withdrawal, because its emergency cash pile was small compared to this debt. On Nov. 30, that cash reserve of $17 billion was only about 17% of the $102 billion owed through secured financings.
If the prices of assets Bear had pledged fell, the brokerage would have had to post a payment to the creditor called margin. One big purpose for the emergency funds is to have the cash to make margin payments during a credit-markets crisis. "My guess is that Bear did not adequately stress-test and didn't have enough liquidity to meet those margin payments," said Michael Peterson, director of research at Pzena Investment Management.
Like Bear, Lehman is a big bond player and also one of the smaller Wall Street firms. But it is on sturdier ground than Bear, many investors said. "I'm pretty comfortable with Lehman's liquidity," said Mr. Peterson, whose firm owns Lehman shares. "The lessons of 1998 were not at all lost on Lehman."
Aiming to make its balance sheet sturdier after 1998, Lehman became less reliant on short-term borrowing, which can dry up quickly. At the end of November, it had $28 billion in debt coming due in the following 12 months, well below the $34.9 billion in its liquidity reserve. "What gives me comfort right now is that Lehman has very little short-term debt," Mr. Peterson said.
The firm's emergency-cash pile was 19% of its $182 billion in secured financings, putting it below the numbers for Goldman Sachs, Morgan Stanley and Merrill Lynch. At those firms the emergency cash was 38%, 39% and 34%, respectively, of collateralized financings.
In a crunch, Lehman may be able to raise cash by selling another big pool of liquid assets, which is valued at more than $60 billion. Adding that to the liquidity cash reserve gives Lehman a potential $100 billion cash pile, equal to 54% of collateralized financing. That is ahead of some other brokers and far stronger than Bear's 31%.
In addition, the debt that comes from the collateralized financing typically is matched by a similar loan to another customer, which creates an asset. When offset against each other, the collateralized financing liability becomes much smaller. In Lehman's case, it is about $20 billion, which is only about 60% of its emergency cash.
America in Recession
--Government policy," he said, "is like a person trying to drive a car on a rough patch. If you ever get stuck in a situation like that, you know full well it's important not to overcorrect -- because when you overcorrect you end up in the ditch."
--American household debt has more than doubled in a decade to $13.8 trillion at the end of 2007 from $6.4 trillion in 1999, the vast majority of it in mortgages and home equity lines, according to Fed data. But the value of U.S. householders' biggest asset -- their homes -- is now falling.
--The Fed has moved to buy $400 billion worth of mortgage-backed securities for its $800 billion total securities portfolio in an effort to jolt that crucial market back to life and prevent rising mortgage rates from further depressing the U.S. housing market.
--While there is continued debate about how to treat the current disease, there is a consensus emerging on the causes. "Soaring delinquencies on U.S. subprime mortgages were the primary trigger," that initial shock both uncovered and exacerbated other weaknesses in the global financial system."
--For years, Mr. Rogoff and like-minded economists harped that the U.S. current account deficit was unsustainable. But despite the belief that it would necessarily reverse, it kept growing through the first part of this decade, going from 3.6% of gross domestic product at the end of 1999 to a record 6.8% at the end of 2005. Lately, the deficit has seen a slight narrowing, but the combination of credit crisis and the economic downturn may have proved the catalyst for a faster, and potentially more dangerous, adjustment.
carry trade leads to the fall of dollar
--The dollar and subprime -- they're two sides of the same coin," says Princeton University economist Hyun Song Shin. Many U.S. hedge funds and financial institutions were speculating in mortgage-related securities with money that was ultimately borrowed in Japan, where interest rates have been low for years. He notes foreign banks' net liabilities in the yen interbank market surged between April 2006 and April 2007. As investments bought with money borrowed in Japan get sold and converted back into yen, he says, "we see both a fall in asset prices and a fall in the dollar."
--One worry is that we'll cross some line and there'll be a systemic wave of fund failures. It's a reason why the market is so nervous,
--Mohamed El-Erian, co-chief executive officer of Allianz SE's Pacific Investment Management Co., says the hedge-fund community is unwinding its leverage. "This will push more of them into 'survival mode,' further accentuating distressed sales and nervousness among the prime brokers," he wrote to his colleagues Thursday morning. "In such a world, the quality of the assets matters less than whether you can finance them [or] how liquid they are."
--American household debt has more than doubled in a decade to $13.8 trillion at the end of 2007 from $6.4 trillion in 1999, the vast majority of it in mortgages and home equity lines, according to Fed data. But the value of U.S. householders' biggest asset -- their homes -- is now falling.
--The Fed has moved to buy $400 billion worth of mortgage-backed securities for its $800 billion total securities portfolio in an effort to jolt that crucial market back to life and prevent rising mortgage rates from further depressing the U.S. housing market.
--While there is continued debate about how to treat the current disease, there is a consensus emerging on the causes. "Soaring delinquencies on U.S. subprime mortgages were the primary trigger," that initial shock both uncovered and exacerbated other weaknesses in the global financial system."
--For years, Mr. Rogoff and like-minded economists harped that the U.S. current account deficit was unsustainable. But despite the belief that it would necessarily reverse, it kept growing through the first part of this decade, going from 3.6% of gross domestic product at the end of 1999 to a record 6.8% at the end of 2005. Lately, the deficit has seen a slight narrowing, but the combination of credit crisis and the economic downturn may have proved the catalyst for a faster, and potentially more dangerous, adjustment.
carry trade leads to the fall of dollar
--The dollar and subprime -- they're two sides of the same coin," says Princeton University economist Hyun Song Shin. Many U.S. hedge funds and financial institutions were speculating in mortgage-related securities with money that was ultimately borrowed in Japan, where interest rates have been low for years. He notes foreign banks' net liabilities in the yen interbank market surged between April 2006 and April 2007. As investments bought with money borrowed in Japan get sold and converted back into yen, he says, "we see both a fall in asset prices and a fall in the dollar."
--One worry is that we'll cross some line and there'll be a systemic wave of fund failures. It's a reason why the market is so nervous,
--Mohamed El-Erian, co-chief executive officer of Allianz SE's Pacific Investment Management Co., says the hedge-fund community is unwinding its leverage. "This will push more of them into 'survival mode,' further accentuating distressed sales and nervousness among the prime brokers," he wrote to his colleagues Thursday morning. "In such a world, the quality of the assets matters less than whether you can finance them [or] how liquid they are."
Tibetan Challenge to China
--The Tibetian uprising marked the challenge to Beijing and could have repercussions for the Olympics.
--This level of global publicity and scrutiny could heighten the fallout for China if it acts too forcefully in Lhasa. Beijing has been under fire for human rights, treatment of Northe Korean refugees...
--Beijing also essentially withdrew from negotiations aimed at political rapprochement with the Dalai Lama, a recipient of the Nobel Peace Prize, and restarted a campaign of public attacks on him.
--The government also has stepped up efforts to punish expressions of dissent and curtail religious freedoms.
--While trying to stifle dissent, Beijing also has been trying to cast itself in the role of economic savior for Tibet. Communist officials describe "pre-liberation" Tibet as a feudal state governed by powerful monks and one of the most backward places in the world. Beijing has spent heavily in Tibet, especially to develop the tourism, meatpacking, dairy and mining industries.
--This level of global publicity and scrutiny could heighten the fallout for China if it acts too forcefully in Lhasa. Beijing has been under fire for human rights, treatment of Northe Korean refugees...
--Beijing also essentially withdrew from negotiations aimed at political rapprochement with the Dalai Lama, a recipient of the Nobel Peace Prize, and restarted a campaign of public attacks on him.
--The government also has stepped up efforts to punish expressions of dissent and curtail religious freedoms.
--While trying to stifle dissent, Beijing also has been trying to cast itself in the role of economic savior for Tibet. Communist officials describe "pre-liberation" Tibet as a feudal state governed by powerful monks and one of the most backward places in the world. Beijing has spent heavily in Tibet, especially to develop the tourism, meatpacking, dairy and mining industries.
Friday, March 14, 2008
Credit Analysis of Financial Institutes
Bear Stearns
1.Securities sold under agreements to repurchase increased 42 bil from 70 to 102 bil in 2007. The company seemed deperately borrowed money using collateral. JPM
2.Level 3, 28 bil out of 144 bil, almost 20%. GS only 7%
3.cash and cash equivalent, 20 bil, less than level 3 or mortgage exposure, $46 bil vs $39 in 2006.
4.facts asssts $395 bil, cap $3-4 bil
5.liquidity pool (excess liquidity 17 bil and net cash captal 8.2 bil) ~ $26 bil
-->large level 3 and mortgage exposure, little capital cushion, market undweight
Lehman Brothers
1.Securities sold under agreements to repurchase increased 24 bil from $126 bil to $150 bil.
2.level 3 5.4 bil out of 29 bil. 18%
3.cash and equivalent, $7.3 bil, larger than level 3, but less than mortgage and ABS exposure $89 bil (residentail 37 vs 27 in 2006, CMBS 39 vs 24.7 bil in 2006) vs $57 in 2006
4.facts assets $691 bil
5.liquidity pool $35 bil.
--> large exposure to mortgage, market underweight
1.Securities sold under agreements to repurchase increased 42 bil from 70 to 102 bil in 2007. The company seemed deperately borrowed money using collateral. JPM
2.Level 3, 28 bil out of 144 bil, almost 20%. GS only 7%
3.cash and cash equivalent, 20 bil, less than level 3 or mortgage exposure, $46 bil vs $39 in 2006.
4.facts asssts $395 bil, cap $3-4 bil
5.liquidity pool (excess liquidity 17 bil and net cash captal 8.2 bil) ~ $26 bil
-->large level 3 and mortgage exposure, little capital cushion, market undweight
Lehman Brothers
1.Securities sold under agreements to repurchase increased 24 bil from $126 bil to $150 bil.
2.level 3 5.4 bil out of 29 bil. 18%
3.cash and equivalent, $7.3 bil, larger than level 3, but less than mortgage and ABS exposure $89 bil (residentail 37 vs 27 in 2006, CMBS 39 vs 24.7 bil in 2006) vs $57 in 2006
4.facts assets $691 bil
5.liquidity pool $35 bil.
--> large exposure to mortgage, market underweight
A run on the Bearn Stearns
--The lifeline gives Bear access to cash for an initial period of 28 days. J.P. Morgan will borrow the money from the Fed and relend it to Bear. Exact terms weren't disclosed, but the amount is limited only by how much collateral Bear can provide, Fed officials said.
--At Northern Rock, it was depositors running. At Bear Stearns, it was counterparties
--But by Thursday afternoon, it was becoming clear within Bear that the firm couldn't withstand an accelerating retreat by worried customers -- in effect, a run on the bank. Securities firms that had been willing to accept collateral from Bear Stearns were insisting on cash instead. And the hedge funds that use Bear to borrow money and clear trades were withdrawing cash from their accounts.
-- J.P. Morgan's risk officers were familiar with Bear's collateral because J.P. Morgan was the clearing agent for its trades; thus, J.P. Morgan seemed to be in good position to lend Bear money, say people familiar with Mr. Schwartz's thinking.
--The Fed each day lends money to its 20 "primary dealers," including Bear, through its money-market "repo" operations, which provide funding for one to 28 days to influence the level of interest rates. But those operations don't permit the Fed to advance much money to Bear by itself, and the loans must be secured by the highest-quality collateral, which is now in short supply. (Term Security Lending Facility)
--The Fed can lend directly through its "discount window," but ordinarily only to commercial banks. A 1932 provision of the Federal Reserve Act allows the Fed to lend to non-banks if at least five of its seven governors approve. That provision was last regularly used during the Great Depression. It is meant to underscore that the central bank should lend to nonbanks only in extreme circumstances.
--For Fed officials it was a difficult choice. They did not want to single Bear out for help and they realized their actions aggravated "moral hazard" -- the tendency of bailouts to encourage future risky behavior. But the alternative was potentially far worse. Bear risked defaulting on extensive "repo" loans, in which it pledges securities as collateral for overnight loans from money-market funds. If that happened, other securities dealers would see access to repo loans become more restrictive. The pledged securities behind those loans could be dumped in a fire sale, deepening the plunge in securities prices.
--By 7 a.m. Friday, the New York Federal Reserve Bank had agreed that it would provide financing to Bear Stearns via J.P. Morgan Chase. J.P. Morgan Chase was used as a conduit because, as a commercial bank, it already has access to the Fed's discount window, is under the Fed's supervisory authority, is Bear's clearing bank and knows Bear well from a previous discussion of a possible strategic tie-up.
--Thus, technically the Fed still hasn't lent directly to investment banks. But the central bank has explicitly assumed the risk of the loan. If Bear fails and the collateral it posts is insufficient to cover the loan, the Fed will sustain a loss. Officials say there is no preset maximum amount of the loan, other than how much collateral Bear is able to provide to meet the Fed's requirements.
--The role of J.P. Morgan as Bear's savior is somewhat paradoxical, considering the recent tense relationship between the two firms. J.P. Morgan was one of several lenders that played a role in Bear's troubles last summer when J.P. Morgan demanded more collateral from one of Bear's struggling hedge funds. There was a heated conversation between Mr. Black, co-head of J.P. Morgan's investment bank, and Mr. Spector, then Bear's co-president, over Bear's reluctance to bail out the hedge fund. J.P. Morgan ultimately served Bear with a default notice on a loan to Bear.
--The role of rescuer has long been part of J.P. Morgan's history. In what's known as the Panic of 1907, a semi-retired J. Pierpont Morgan helped stave off a national financial crisis when he helped to shore up a number of banks that had seen a run on their deposits.
--Some 80 years later, the bank played a similar role when it helped organize a government-backed bailout of Chicago's Continental Illinois, a bank sagging under a mountain of bad loans.
--J.P. Morgan has been on the prowl for acquisitions. Although it is thought to be most interested in a large regional bank, Bear's assets could be too good, and too cheap, to turn down.
--J.P. Morgan might also be interested in buying just Bear's prime brokerage business, a key Wall Street business -- used by hedge funds to borrow money and clear trades -- that J.P. Morgan doesn't now have. The Bear unit has a good reputation but has suffered from a loss of cash balances in recent months.
--The immediate capital infusion isn't likely to restore enough confidence in Bear to stop the exodus.
--
--At Northern Rock, it was depositors running. At Bear Stearns, it was counterparties
--But by Thursday afternoon, it was becoming clear within Bear that the firm couldn't withstand an accelerating retreat by worried customers -- in effect, a run on the bank. Securities firms that had been willing to accept collateral from Bear Stearns were insisting on cash instead. And the hedge funds that use Bear to borrow money and clear trades were withdrawing cash from their accounts.
-- J.P. Morgan's risk officers were familiar with Bear's collateral because J.P. Morgan was the clearing agent for its trades; thus, J.P. Morgan seemed to be in good position to lend Bear money, say people familiar with Mr. Schwartz's thinking.
--The Fed each day lends money to its 20 "primary dealers," including Bear, through its money-market "repo" operations, which provide funding for one to 28 days to influence the level of interest rates. But those operations don't permit the Fed to advance much money to Bear by itself, and the loans must be secured by the highest-quality collateral, which is now in short supply. (Term Security Lending Facility)
--The Fed can lend directly through its "discount window," but ordinarily only to commercial banks. A 1932 provision of the Federal Reserve Act allows the Fed to lend to non-banks if at least five of its seven governors approve. That provision was last regularly used during the Great Depression. It is meant to underscore that the central bank should lend to nonbanks only in extreme circumstances.
--For Fed officials it was a difficult choice. They did not want to single Bear out for help and they realized their actions aggravated "moral hazard" -- the tendency of bailouts to encourage future risky behavior. But the alternative was potentially far worse. Bear risked defaulting on extensive "repo" loans, in which it pledges securities as collateral for overnight loans from money-market funds. If that happened, other securities dealers would see access to repo loans become more restrictive. The pledged securities behind those loans could be dumped in a fire sale, deepening the plunge in securities prices.
--By 7 a.m. Friday, the New York Federal Reserve Bank had agreed that it would provide financing to Bear Stearns via J.P. Morgan Chase. J.P. Morgan Chase was used as a conduit because, as a commercial bank, it already has access to the Fed's discount window, is under the Fed's supervisory authority, is Bear's clearing bank and knows Bear well from a previous discussion of a possible strategic tie-up.
--Thus, technically the Fed still hasn't lent directly to investment banks. But the central bank has explicitly assumed the risk of the loan. If Bear fails and the collateral it posts is insufficient to cover the loan, the Fed will sustain a loss. Officials say there is no preset maximum amount of the loan, other than how much collateral Bear is able to provide to meet the Fed's requirements.
--The role of J.P. Morgan as Bear's savior is somewhat paradoxical, considering the recent tense relationship between the two firms. J.P. Morgan was one of several lenders that played a role in Bear's troubles last summer when J.P. Morgan demanded more collateral from one of Bear's struggling hedge funds. There was a heated conversation between Mr. Black, co-head of J.P. Morgan's investment bank, and Mr. Spector, then Bear's co-president, over Bear's reluctance to bail out the hedge fund. J.P. Morgan ultimately served Bear with a default notice on a loan to Bear.
--The role of rescuer has long been part of J.P. Morgan's history. In what's known as the Panic of 1907, a semi-retired J. Pierpont Morgan helped stave off a national financial crisis when he helped to shore up a number of banks that had seen a run on their deposits.
--Some 80 years later, the bank played a similar role when it helped organize a government-backed bailout of Chicago's Continental Illinois, a bank sagging under a mountain of bad loans.
--J.P. Morgan has been on the prowl for acquisitions. Although it is thought to be most interested in a large regional bank, Bear's assets could be too good, and too cheap, to turn down.
--J.P. Morgan might also be interested in buying just Bear's prime brokerage business, a key Wall Street business -- used by hedge funds to borrow money and clear trades -- that J.P. Morgan doesn't now have. The Bear unit has a good reputation but has suffered from a loss of cash balances in recent months.
--The immediate capital infusion isn't likely to restore enough confidence in Bear to stop the exodus.
--
MBS TBA
Mortgage pass-through securities are created when mortgages are pooled together and sold as undivided interests to investors. Usually, the mortgages in the pool have the same loan type and similar maturities and loan interest rates. The originator (for instance, a bank) may continue to service the mortgage and will "pass through" the principal and interest, less a servicing fee, to an agency or private issuer of mortgage-backed securities. Mortgages are then packaged by the agency or private issuer and sold to investors. The principal and interest, less guaranty and other fees are then "passed through" to the investor, who receives a pro rata share of the resulting cash flows.
Most agency pass-through securities, however, trade on a generic or to-be-announced (TBA) basis. In a TBA trade, the seller and buyer agree to the type of security, coupon, face value, price, and settlement date at the time of the trade, but do not specify the actual pools to be traded. Two days before settlement, the seller identifies the specific pools to be delivered to satisfy the commitment.
Trading in agency pass-throughs may take place on any business day, but TBA securities usually settle on one specific date each month. The Public Securities Association releases a monthly schedule that divides all agency pass-throughs into six groups, each settling on a different day. Agency pass-throughs generally clear through electronic book-entry systems.
Nonagency pass-throughs are composed of specific pools and do not trade on a TBA basis. New issues settle on the date provided in the prospectus. In the secondary market, these securities trade on an issue-specific basis and generally settle on a corporate basis (three business days after the trade).
Most agency pass-through securities, however, trade on a generic or to-be-announced (TBA) basis. In a TBA trade, the seller and buyer agree to the type of security, coupon, face value, price, and settlement date at the time of the trade, but do not specify the actual pools to be traded. Two days before settlement, the seller identifies the specific pools to be delivered to satisfy the commitment.
Trading in agency pass-throughs may take place on any business day, but TBA securities usually settle on one specific date each month. The Public Securities Association releases a monthly schedule that divides all agency pass-throughs into six groups, each settling on a different day. Agency pass-throughs generally clear through electronic book-entry systems.
Nonagency pass-throughs are composed of specific pools and do not trade on a TBA basis. New issues settle on the date provided in the prospectus. In the secondary market, these securities trade on an issue-specific basis and generally settle on a corporate basis (three business days after the trade).
Accounting Rules will rattle banks
Accounting rules may add another complication. Under purchase-accounting guidelines that take effect at the end of this year and will apply to deals closing in 2009, an acquirer effectively will have to mark a bank's loan portfolio to market prices, even though those loans currently are carried at their cost, or par value.
Since many bank loans are under pressure and at risk of default, that process would require the buyer to pony up additional equity, essentially inflating the deal's price tag. Bankers say that purchase-accounting rules could become an impediment to financial-services deals.
Instead, an increasing number of small and midsize banks are trying to raise cash by selling shares to the public. While that boosts capital levels, it also erodes the value of existing shareholders' positions.
Some banks are expected to line up outside investors to "backstop" such offerings by agreeing to buy a certain amount of the new stock. Those arrangements are meant to reassure investors who are wary of putting their money in financial stocks.
Since many bank loans are under pressure and at risk of default, that process would require the buyer to pony up additional equity, essentially inflating the deal's price tag. Bankers say that purchase-accounting rules could become an impediment to financial-services deals.
Instead, an increasing number of small and midsize banks are trying to raise cash by selling shares to the public. While that boosts capital levels, it also erodes the value of existing shareholders' positions.
Some banks are expected to line up outside investors to "backstop" such offerings by agreeing to buy a certain amount of the new stock. Those arrangements are meant to reassure investors who are wary of putting their money in financial stocks.
Japan economy quakes anew as yen soars against dollar
--Yen drops below 100, making Japan's economy a slowdown or recession more likely
--Japan is again suffering from a broad sense of drift, after momentum built up under charismatic Prime Minister Junichiro Koizumi, in power from 2001 to 2006. Parliament, split between the two big parties since last year, is in gridlock, leaving the country without a central-bank governor less than a week before the incumbent steps down. The benchmark Nikkei Stock Average is down 19% for the year.
--For Japan, the reverberations from a weak dollar come at a particularly vulnerable time. Despite six years of modest growth(avg 1% since 2002), consumers still haven't opened up their purse strings. The Bank of Japan's benchmark interest rate remains at 0.5%.
--The Bank of Japan hoped to raise interest rates to a more normal level, to give itself more flexibility. Instead, it is stuck: It can't raise rates when the economy's outlook is weak, nor can it lower them much. More creative steps by the BOJ are off the table until it gets a permanent new governor.
--Japan is particularly vulnerable to currency fluctuations because its economy depends so heavily on exports for growth. Japan's economy grew by 2.1% last year, and more than half of that growth came from exports.
--Toyota Motor Corp. sees annual operating profit cut by 35 billion yen, or about $350 million, every time the dollar's value slips by one yen. With the dollar having lost more than 10 yen since the end of last year, that suggests Toyota's profits could take a several-billion-dollar hit. The car maker's president, Katsuaki Watanabe, told reporters yesterday it isn't clear if the company could maintain profit growth if the dollar continues to slide, despite cost cuts and other possible measures.
--The last time Japan faced a seriously weak dollar was in 1994 and 1995, when the dollar stayed below the 100-yen level for a year and a half, and reached a historic low of 79.75 yen. Japan fought back by intervening heavily in the currency markets to depress the value of the yen and boosted government spending to help weaker companies.
--Savings from the strong yen in no way offset the damage from the rise in commodity prices. Over the past year, wheat prices have more than doubled. Nissin expects higher ingredient costs to shave at least three billion yen off its earnings for the year ending March 31. It anticipates "far greater losses" going forward, the spokesman says.
--The good news is that currency markets remain highly traded, with none of the freezing-up that has characterized large swaths of the credit markets.
--Japan is again suffering from a broad sense of drift, after momentum built up under charismatic Prime Minister Junichiro Koizumi, in power from 2001 to 2006. Parliament, split between the two big parties since last year, is in gridlock, leaving the country without a central-bank governor less than a week before the incumbent steps down. The benchmark Nikkei Stock Average is down 19% for the year.
--For Japan, the reverberations from a weak dollar come at a particularly vulnerable time. Despite six years of modest growth(avg 1% since 2002), consumers still haven't opened up their purse strings. The Bank of Japan's benchmark interest rate remains at 0.5%.
--The Bank of Japan hoped to raise interest rates to a more normal level, to give itself more flexibility. Instead, it is stuck: It can't raise rates when the economy's outlook is weak, nor can it lower them much. More creative steps by the BOJ are off the table until it gets a permanent new governor.
--Japan is particularly vulnerable to currency fluctuations because its economy depends so heavily on exports for growth. Japan's economy grew by 2.1% last year, and more than half of that growth came from exports.
--Toyota Motor Corp. sees annual operating profit cut by 35 billion yen, or about $350 million, every time the dollar's value slips by one yen. With the dollar having lost more than 10 yen since the end of last year, that suggests Toyota's profits could take a several-billion-dollar hit. The car maker's president, Katsuaki Watanabe, told reporters yesterday it isn't clear if the company could maintain profit growth if the dollar continues to slide, despite cost cuts and other possible measures.
--The last time Japan faced a seriously weak dollar was in 1994 and 1995, when the dollar stayed below the 100-yen level for a year and a half, and reached a historic low of 79.75 yen. Japan fought back by intervening heavily in the currency markets to depress the value of the yen and boosted government spending to help weaker companies.
--Savings from the strong yen in no way offset the damage from the rise in commodity prices. Over the past year, wheat prices have more than doubled. Nissin expects higher ingredient costs to shave at least three billion yen off its earnings for the year ending March 31. It anticipates "far greater losses" going forward, the spokesman says.
--The good news is that currency markets remain highly traded, with none of the freezing-up that has characterized large swaths of the credit markets.
Thursday, March 13, 2008
Subprime Writedowns: Is the Worst Over?
Standard & Poor's Ratings Services believes that the bulk of the writedowns of subprime securities may be behind the banks and brokers that have already announced their results for full-year 2007. There may be some additional marks to market as market indicators have shown deterioration in the first quarter. However, when we dissect the percentage of write-downs taken against various types of exposures, in our opinion the magnitude of some write-downs is greater than any reasonable estimate of ultimate losses.
To this amount we add approximately $40 billion in writedowns of insurers (financial guarantors and other insurers) and banks in the Gulf States and Asia to arrive at a rough estimate of $150 billion in global disclosed writedowns to-date.
Most of the writedowns have been on the so-called supersenior tranches of CDOs of subprime ABS. To date, banks have written down their unhedged supersenior CDOs of ABS by more than $65 billion. On an original exposure of about $160 billion, this represents about a 40% discount. However, that discount percentage varies tremendously from institution to institution.
In our view, some of the variation may be based on differences in the specific securities the institution owns, as the securities vary widely in their ultimate loss characteristics. Some of the variables that affect the valuation are whether the exposure was to so-called CDO-squared securities (CDOs that purchased tranches of CDOs) or to the supersenior tranches of high-grade CDOs or mezzanine CDOs; the proportion of the underlying loans that were of 2005 or earlier vintages; how many of the CDOs' investments were in other CDOs and in subprime residential
mortgage-backed securities (RMBS); and the levels of subordination in each structure.
Based on available information, we believe that the largest players can be seen as having undertaken a rigorous valuation methodology to come up with conservative valuations. Citigroup Inc. and Merrill Lynch & Co. Inc., for example, value their high-grade supersenior tranches at 52% and 68% discounts to original exposure, respectively. The broader range of banks values them at only a 30% discount. Similarly, Citi and Merrill value the supersenior tranches of the mezzanine CDOs at 63% and 73% discounts, respectively, whereas the broader range of banks values them at a 48% discount.
To this amount we add approximately $40 billion in writedowns of insurers (financial guarantors and other insurers) and banks in the Gulf States and Asia to arrive at a rough estimate of $150 billion in global disclosed writedowns to-date.
Most of the writedowns have been on the so-called supersenior tranches of CDOs of subprime ABS. To date, banks have written down their unhedged supersenior CDOs of ABS by more than $65 billion. On an original exposure of about $160 billion, this represents about a 40% discount. However, that discount percentage varies tremendously from institution to institution.
In our view, some of the variation may be based on differences in the specific securities the institution owns, as the securities vary widely in their ultimate loss characteristics. Some of the variables that affect the valuation are whether the exposure was to so-called CDO-squared securities (CDOs that purchased tranches of CDOs) or to the supersenior tranches of high-grade CDOs or mezzanine CDOs; the proportion of the underlying loans that were of 2005 or earlier vintages; how many of the CDOs' investments were in other CDOs and in subprime residential
mortgage-backed securities (RMBS); and the levels of subordination in each structure.
Based on available information, we believe that the largest players can be seen as having undertaken a rigorous valuation methodology to come up with conservative valuations. Citigroup Inc. and Merrill Lynch & Co. Inc., for example, value their high-grade supersenior tranches at 52% and 68% discounts to original exposure, respectively. The broader range of banks values them at only a 30% discount. Similarly, Citi and Merrill value the supersenior tranches of the mezzanine CDOs at 63% and 73% discounts, respectively, whereas the broader range of banks values them at a 48% discount.
Business Inventory Feb 2008
--Inventories at U.S. businesses roseat a slower pace than sales in January, reflecting efforts by companies to draw down stockpiles as they brace for weaker demand.
--The 0.8 percent gain was larger than forecast and thebiggest since June 2006, the Commerce Department said today inWashington. Sales rose 1.5 percent, the most since March 2007.
--A separate Commerce report today showed retail sales unexpected fell in February, signaling efforts to pare inventories will lead to cutbacks in orders to wholesalers and factories. A manufacturing slowdown will likely contribute to the onset of a recession this year as the housing slump deepens.
--The other report from Commerce today showed sales at U.S.retailers dropped 0.6 percent in February, led by a decline atauto dealers. The decrease indicates falling payrolls and homevalues and surging energy costs have tipped the economy into arecession.
--One bright spot in the report on business inventories was that the jump in January sales left the amount of stockpiles on hand at a 1.25 months' supply, matching a record low.
--Retail stockpiles, the only part of today's inventoriesreport that was not previously released, increased 0.4 percent.
--A drop in stockpiles at automakers led to an unexpected decline in total inventories in the fourth quarter and was one ofthe major reasons the economy grew at a less than forecast 0.6 percent annual rate. Stockpiles fell at a $10.1 billion annualpace, the biggest decline in almost six years, and subtracted 1.5percentage points from growth.
--Retail inventories account for about a third of all businessinventories. Factory stockpiles, which account for about 35 percent, gained 1.3 percent in January after a 0.9 percentincrease the prior month, Commerce said.
--Wholesalers' stockpiles, which account for the rest, rose 0.8 percent after a 1.1 percent increase the prior month, theCommerce Department said. Wholesale sales rose 2.7 percent, the most since March 2004.
--Wholesale stockpiles were pushed up by gains in oil prices.Crude oil futures traded on the New York Mercantile Exchangeaveraged $92.91 a barrel in January, up from $91.74 a barrel inDecember. Prices have since continued to rise above $100 abarrel.
--Consumer spending in the current quarter may slow to a 0.5percent pace, the slowest since 1991, according to a Bloombergsurvey taken last week, as record fuel costs and falling homevalues weigh on household spending.
--The 0.8 percent gain was larger than forecast and thebiggest since June 2006, the Commerce Department said today inWashington. Sales rose 1.5 percent, the most since March 2007.
--A separate Commerce report today showed retail sales unexpected fell in February, signaling efforts to pare inventories will lead to cutbacks in orders to wholesalers and factories. A manufacturing slowdown will likely contribute to the onset of a recession this year as the housing slump deepens.
--The other report from Commerce today showed sales at U.S.retailers dropped 0.6 percent in February, led by a decline atauto dealers. The decrease indicates falling payrolls and homevalues and surging energy costs have tipped the economy into arecession.
--One bright spot in the report on business inventories was that the jump in January sales left the amount of stockpiles on hand at a 1.25 months' supply, matching a record low.
--Retail stockpiles, the only part of today's inventoriesreport that was not previously released, increased 0.4 percent.
--A drop in stockpiles at automakers led to an unexpected decline in total inventories in the fourth quarter and was one ofthe major reasons the economy grew at a less than forecast 0.6 percent annual rate. Stockpiles fell at a $10.1 billion annualpace, the biggest decline in almost six years, and subtracted 1.5percentage points from growth.
--Retail inventories account for about a third of all businessinventories. Factory stockpiles, which account for about 35 percent, gained 1.3 percent in January after a 0.9 percentincrease the prior month, Commerce said.
--Wholesalers' stockpiles, which account for the rest, rose 0.8 percent after a 1.1 percent increase the prior month, theCommerce Department said. Wholesale sales rose 2.7 percent, the most since March 2004.
--Wholesale stockpiles were pushed up by gains in oil prices.Crude oil futures traded on the New York Mercantile Exchangeaveraged $92.91 a barrel in January, up from $91.74 a barrel inDecember. Prices have since continued to rise above $100 abarrel.
--Consumer spending in the current quarter may slow to a 0.5percent pace, the slowest since 1991, according to a Bloombergsurvey taken last week, as record fuel costs and falling homevalues weigh on household spending.
Novations increase as risk of Bear Stearns increases
Increasingly, these traders also are charging hedge-fund clients a fee for novations, or situations in which the fund asks Deutsche Bank to take its position as a counterparty to Bear on a particular transaction. One group of traders worked late Tuesday to review thousands of individual transactions in which Bear was the counterparty, said one person familiar with the situation.
Novations occur frequently and for a variety of reasons, according to traders. During calmer times in the credit markets, approval for novations usually is handled by back offices or operations departments, said Mark Beeston, president of T-Zero, an electronic platform that helps dealers and money managers confirm derivative trades. Given the market's current volatility, it would be natural for higher-ranking risk managers to be much more involved in the consent process, he added.
Novations occur frequently and for a variety of reasons, according to traders. During calmer times in the credit markets, approval for novations usually is handled by back offices or operations departments, said Mark Beeston, president of T-Zero, an electronic platform that helps dealers and money managers confirm derivative trades. Given the market's current volatility, it would be natural for higher-ranking risk managers to be much more involved in the consent process, he added.
Leverage Collapsed Calyle Capital Fund
The fund's collapse shows how Wall Street's biggest players have begun playing hardball with some of their best clients. And they reveal how jittery banks have become about their own loan exposures. In the case of Carlyle, 12 banks had lent the fund about $21 billion, or $20 for every dollar of initial capital.
It also illustrates how the credit crunch has moved far beyond subprime mortgages. Carlyle Capital's portfolio consisted exclusively of AAA-rated mortgage backed securities issued by Fannie Mae and Freddie Mac. They are considered to have the implied guarantee of the U.S. government and pay par at maturity.
Carlyle Capital's investment strategy looked like easy money at first. The fund would exploit the difference between the interest earned on its investments in mortgage securities and the costs of financing those investments.
Like so many other hedge-fund blowups, Carlyle's troubles came from borrowing too much money. The secret to making money was borrowing massive sums. Carlyle Capital managed only $670 million in client money, but used borrowings to boost its portfolio of bonds to $21.7 billion. Until last week, when the dealers started selling the fund's collateral, it was about 32 times leveraged, a level one mortgage-company analyst called "astronomical."
The leverage, combined with severe dislocation in the credit markets, has proved to be Carlyle Capital's undoing. With their balance sheets under extreme pressure, banks have tightened their purse strings and are now requiring more collateral for loans. And in Carlyle Capital's case, the prices of the collateral -- the residential mortgage backed securities, or RMBSs -- have dropped to levels not seen in more than 20 years. The fund said in its statement late Wednesday that the value of the RMBS collateral continues to drop.
It also illustrates how the credit crunch has moved far beyond subprime mortgages. Carlyle Capital's portfolio consisted exclusively of AAA-rated mortgage backed securities issued by Fannie Mae and Freddie Mac. They are considered to have the implied guarantee of the U.S. government and pay par at maturity.
Carlyle Capital's investment strategy looked like easy money at first. The fund would exploit the difference between the interest earned on its investments in mortgage securities and the costs of financing those investments.
Like so many other hedge-fund blowups, Carlyle's troubles came from borrowing too much money. The secret to making money was borrowing massive sums. Carlyle Capital managed only $670 million in client money, but used borrowings to boost its portfolio of bonds to $21.7 billion. Until last week, when the dealers started selling the fund's collateral, it was about 32 times leveraged, a level one mortgage-company analyst called "astronomical."
The leverage, combined with severe dislocation in the credit markets, has proved to be Carlyle Capital's undoing. With their balance sheets under extreme pressure, banks have tightened their purse strings and are now requiring more collateral for loans. And in Carlyle Capital's case, the prices of the collateral -- the residential mortgage backed securities, or RMBSs -- have dropped to levels not seen in more than 20 years. The fund said in its statement late Wednesday that the value of the RMBS collateral continues to drop.
U.S. to Revamp Credit Rules, Drawing From Crisis Lessons
The nation's top economic policy makers plan to release today their broadest blueprint yet for avoiding a recurrence of the credit crunch now threatening the economy
Mr. Paulson told The Wall Street Journal that the recommendations of the President's Working Group on Financial Markets, which he leads, include strengthening state and federal oversight of mortgage lenders and brokers. The group will also recommend implementing what he termed "strong nationwide licensing standards" for mortgage brokers, a move that will probably require legislation.
The group also will propose directing credit-rating firms and regulators to differentiate between ratings on complex structured products and conventional bonds. In addition, it wants rating firms to disclose conflicts of interest and details of their reviews and to heighten scrutiny of outfits that originate loans that are enveloped by various securities.
Another recommendation from the panel is to push issuers of mortgage-backed securities to disclose more about "the level and scope of due diligence" and about the underlying assets of the securities. The panel is also seeking disclosure of whether "issuers have shopped for ratings" -- that is, have had to go to more than one credit-rating firm before getting the triple-A stamp of approval.
And the panel will urge global bank regulators to revisit the latest version of bank capital requirements, known as Basel II for the Swiss city where they were negotiated, so that banks that take on risks hold sufficient capital. The panel also wants regulators to complete updated standards for how banks manage liquidity.
Many of the recommendations parallel those made by others, but the endorsement by top officials carries significant weight. They reflect a consensus of the Working Group, which includes the heads of the Federal Reserve Board, the Federal Reserve Bank of New York, the Securities and Exchange Commission and the Commodity Futures Trading Commission. Each agency has considerable sway over banks, investment houses and investors.
Mr. Paulson told The Wall Street Journal that the recommendations of the President's Working Group on Financial Markets, which he leads, include strengthening state and federal oversight of mortgage lenders and brokers. The group will also recommend implementing what he termed "strong nationwide licensing standards" for mortgage brokers, a move that will probably require legislation.
The group also will propose directing credit-rating firms and regulators to differentiate between ratings on complex structured products and conventional bonds. In addition, it wants rating firms to disclose conflicts of interest and details of their reviews and to heighten scrutiny of outfits that originate loans that are enveloped by various securities.
Another recommendation from the panel is to push issuers of mortgage-backed securities to disclose more about "the level and scope of due diligence" and about the underlying assets of the securities. The panel is also seeking disclosure of whether "issuers have shopped for ratings" -- that is, have had to go to more than one credit-rating firm before getting the triple-A stamp of approval.
And the panel will urge global bank regulators to revisit the latest version of bank capital requirements, known as Basel II for the Swiss city where they were negotiated, so that banks that take on risks hold sufficient capital. The panel also wants regulators to complete updated standards for how banks manage liquidity.
Many of the recommendations parallel those made by others, but the endorsement by top officials carries significant weight. They reflect a consensus of the Working Group, which includes the heads of the Federal Reserve Board, the Federal Reserve Bank of New York, the Securities and Exchange Commission and the Commodity Futures Trading Commission. Each agency has considerable sway over banks, investment houses and investors.
Wednesday, March 12, 2008
Elliot Spitzer's apology
In the past few days I have begun to atone for my private failings with my wife, Silda, my children, and my entire family. The remorse I feel will always be with me. Words cannot describe how grateful I am for the love and compassion they have shown me. From those to whom much is given, much is expected. I have been given much: the love of my family, the faith and trust of the people of New York, and the chance to lead this state. I am deeply sorry that I did not live up to what was expected of me. To every New Yorker, and to all those who believed in what I tried to stand for, I sincerely apologize.
I look at my time as governor with a sense of what might have been, but I also know that as a public servant I, and the remarkable people with whom I worked, have accomplished a great deal. There is much more to be done, and I cannot allow my private failings to disrupt the people’s work. Over the course of my public life, I have insisted, I believe correctly, that people, regardless of their position or power, take responsibility for their conduct. I can and will ask no less of myself. For this reason, I am resigning from the office of governor. At Lt. Gov. Paterson’s request, the resignation will be effective Monday, March 17, a date that he believes will permit an orderly transition.
I go forward with the belief, as others have said, that as human beings, our greatest glory consists not in never falling, but in rising every time we fall. As I leave public life, I will first do what I need to do to help and heal myself and my family. Then I will try once again, outside of politics, to serve the common good and to move toward the ideals and solutions which I believe can build a future of hope and opportunity for us and for our children. I hope all of New York will join my prayers for my friend, David Paterson, as he embarks on his new mission, and I thank the public once again for the privilege of service.
I look at my time as governor with a sense of what might have been, but I also know that as a public servant I, and the remarkable people with whom I worked, have accomplished a great deal. There is much more to be done, and I cannot allow my private failings to disrupt the people’s work. Over the course of my public life, I have insisted, I believe correctly, that people, regardless of their position or power, take responsibility for their conduct. I can and will ask no less of myself. For this reason, I am resigning from the office of governor. At Lt. Gov. Paterson’s request, the resignation will be effective Monday, March 17, a date that he believes will permit an orderly transition.
I go forward with the belief, as others have said, that as human beings, our greatest glory consists not in never falling, but in rising every time we fall. As I leave public life, I will first do what I need to do to help and heal myself and my family. Then I will try once again, outside of politics, to serve the common good and to move toward the ideals and solutions which I believe can build a future of hope and opportunity for us and for our children. I hope all of New York will join my prayers for my friend, David Paterson, as he embarks on his new mission, and I thank the public once again for the privilege of service.
recession comparison
--a major distinction between the aerly 1980s and subsequent decades.
--2001 recession impact to GDP are extremely mild. In the 2001 recession, US economy did not experience a contraction in consumer spending, a rather singular occurrence that stands at odds with the vast majroity of eocnomic slowdowns.
--2001 recession impact to GDP are extremely mild. In the 2001 recession, US economy did not experience a contraction in consumer spending, a rather singular occurrence that stands at odds with the vast majroity of eocnomic slowdowns.
$200 billion Term Security Lending Facility is Different from 28 Repo
The move promises to boost liquidity in the MBS market, but at the price of exposing the Fed to credit risk on these securities.
It takes the US central bank a step closer to the nuclear option of buying mortgage securities in its own right.
“That is the next step,” says Vincent Reinhart, a fellow at the American Enterprise Institute and former chief monetary economist at the Fed.
For now, however, the Fed is stopping clearly short of crossing the line into outright purchases.
It hopes that by allowing the primary dealers to swap MBS for Treasuries they will ease funding pressures in markets in general and the MBS market in particular.
In effect, dealers will be able to park their MBS with the Fed and obtain Treasuries that can in turn be lent out for cash. Senior Fed staffers say this should shore up liquidity in the MBS markets, allowing for better price discovery. That in turn should ease risk spreads on these securities.
The new $200bn Term Securities Lending Facility will augment the increased swap lines announced yesterday that will provide $36bn in offshore dollar loans in Europe, and the $200bn in expanded Term Auction Facility (TAF) loans and 28 day repurchase operations announced on Friday.
The new securities lending facility will target the primary dealers – providing liquidity to investment banks and other securities houses that cannot access the TAF cash loans.
Unlike the 28 day repo, the new facility will accept top-rated private label MBS as well as securities guaranteed by Fannie Mae and Freddie Mac.
The new securities lending operation will be the same term as all the other liquidity operations – 28 days. The staffers said they did not extend the term beyond one month because they did not want to displace the private market for longer-term loans, or take on further credit risk.
The new operations are still focused on tackling liquidity risk rather than credit risk in the markets. However, the staffers admitted that the central bank was taking on additional credit risk by offering to lend Treasuries in return for triple-A rated MBS for a month at a time.
The margin requirements, though not yet fixed, will be more generous than those presently available in the markets. Dealers will be able to roll over their positions with the Fed, which will hold its $200bn portfolio of MBS-backed advances for an indefinite period.
The Fed has several layers of protections in place. It will accept only triple-A rated MBS that are not on review for downgrade and will apply a haircut – lending less face value of these securities). Moreover, it will only deal with those primary dealers that it believes represent a low risk.
Nonetheless, the fact remains that - taking all the liquidity operations together - the Fed is now taking some credit risk on $436bn in one month advances of cash and securities, about half the total value of its $884bn investment portfolio.
Spreads on agency-backed MBS narrowed on Tuesday by about 18 basis points against Treasuries, while the one month Libor/Overnight Index Swap spread was down to 43bp from 56bp the day before. The cost of credit insurance also fell significantly. However, spreads remained far above normal levels, leaving analysts to debate whether the latest efforts would be enough.
Dan Alpert, chief executive of Westwood Capital, an investment bank, said: “The move by the Fed today treats the symptoms but not the infection...It does not treat the underlying cause of the symptoms – the unknown magnitude of residential mortgage loan losses.”
Experts said the significance of the move could lie in what it signals about the Fed’s willingness to consider still more radical steps if required in the future.
Mohammed El Erian, co-chief executive of Pimco, the bond fund manager, said that by deploying its balance sheet more aggressively, the Fed was getting closer to a “regime shift” that could involve the central bank buying MBS directly.
This would substitute the unimpaired public sector balance sheet for a contracting private sector balance sheet.
The Fed has legal authority to buy agency-backed MBS, though not private label MBS.
The US central bank is not there yet. Outright purchases of mortgage securities would expose the Fed to much greater credit risk. The staffers emphasise that it wants to help the market; it does not want to become the market for allocating credit.
Before it took such an extreme step, the US central bank could probably expand the size and term of its new lending operations further.
But with policymakers appearing increasingly willing to consider all options to try to stop the US falling into a 1990s Japan-style recession – and painfully aware of the limits on the effectiveness of interest rate cuts given higher inflation and expanded risk spreads – direct purchases no longer look unthinkable.
It takes the US central bank a step closer to the nuclear option of buying mortgage securities in its own right.
“That is the next step,” says Vincent Reinhart, a fellow at the American Enterprise Institute and former chief monetary economist at the Fed.
For now, however, the Fed is stopping clearly short of crossing the line into outright purchases.
It hopes that by allowing the primary dealers to swap MBS for Treasuries they will ease funding pressures in markets in general and the MBS market in particular.
In effect, dealers will be able to park their MBS with the Fed and obtain Treasuries that can in turn be lent out for cash. Senior Fed staffers say this should shore up liquidity in the MBS markets, allowing for better price discovery. That in turn should ease risk spreads on these securities.
The new $200bn Term Securities Lending Facility will augment the increased swap lines announced yesterday that will provide $36bn in offshore dollar loans in Europe, and the $200bn in expanded Term Auction Facility (TAF) loans and 28 day repurchase operations announced on Friday.
The new securities lending facility will target the primary dealers – providing liquidity to investment banks and other securities houses that cannot access the TAF cash loans.
Unlike the 28 day repo, the new facility will accept top-rated private label MBS as well as securities guaranteed by Fannie Mae and Freddie Mac.
The new securities lending operation will be the same term as all the other liquidity operations – 28 days. The staffers said they did not extend the term beyond one month because they did not want to displace the private market for longer-term loans, or take on further credit risk.
The new operations are still focused on tackling liquidity risk rather than credit risk in the markets. However, the staffers admitted that the central bank was taking on additional credit risk by offering to lend Treasuries in return for triple-A rated MBS for a month at a time.
The margin requirements, though not yet fixed, will be more generous than those presently available in the markets. Dealers will be able to roll over their positions with the Fed, which will hold its $200bn portfolio of MBS-backed advances for an indefinite period.
The Fed has several layers of protections in place. It will accept only triple-A rated MBS that are not on review for downgrade and will apply a haircut – lending less face value of these securities). Moreover, it will only deal with those primary dealers that it believes represent a low risk.
Nonetheless, the fact remains that - taking all the liquidity operations together - the Fed is now taking some credit risk on $436bn in one month advances of cash and securities, about half the total value of its $884bn investment portfolio.
Spreads on agency-backed MBS narrowed on Tuesday by about 18 basis points against Treasuries, while the one month Libor/Overnight Index Swap spread was down to 43bp from 56bp the day before. The cost of credit insurance also fell significantly. However, spreads remained far above normal levels, leaving analysts to debate whether the latest efforts would be enough.
Dan Alpert, chief executive of Westwood Capital, an investment bank, said: “The move by the Fed today treats the symptoms but not the infection...It does not treat the underlying cause of the symptoms – the unknown magnitude of residential mortgage loan losses.”
Experts said the significance of the move could lie in what it signals about the Fed’s willingness to consider still more radical steps if required in the future.
Mohammed El Erian, co-chief executive of Pimco, the bond fund manager, said that by deploying its balance sheet more aggressively, the Fed was getting closer to a “regime shift” that could involve the central bank buying MBS directly.
This would substitute the unimpaired public sector balance sheet for a contracting private sector balance sheet.
The Fed has legal authority to buy agency-backed MBS, though not private label MBS.
The US central bank is not there yet. Outright purchases of mortgage securities would expose the Fed to much greater credit risk. The staffers emphasise that it wants to help the market; it does not want to become the market for allocating credit.
Before it took such an extreme step, the US central bank could probably expand the size and term of its new lending operations further.
But with policymakers appearing increasingly willing to consider all options to try to stop the US falling into a 1990s Japan-style recession – and painfully aware of the limits on the effectiveness of interest rate cuts given higher inflation and expanded risk spreads – direct purchases no longer look unthinkable.
Banks Regulatory Capital Ratios
Tier 1 Capital Ratio
The Board has established a minimum ratio of Tier 1 capital to total assets of 3.0 percent for strong bank holding companies (rated composite "1" under the BOPEC rating system of bank holding companies), and for bank holding companies that have implemented the Board's risk-based capital measure for market risk as set forth in appendices A and E of this part. For all other bank holding companies, the minimum ratio of Tier 1 capital to total assets is 4.0 percent.
Tier 1 Leverage Ratio
A banking organization's tier 1 leverage ratio is calculated by dividing its tier 1 capital (the numerator of the ratio) by its average total consolidated assets (the denominator of the ratio).
The Board has established a minimum ratio of Tier 1 capital to total assets of 3.0 percent for strong bank holding companies (rated composite "1" under the BOPEC rating system of bank holding companies), and for bank holding companies that have implemented the Board's risk-based capital measure for market risk as set forth in appendices A and E of this part. For all other bank holding companies, the minimum ratio of Tier 1 capital to total assets is 4.0 percent.
Tier 1 Leverage Ratio
A banking organization's tier 1 leverage ratio is calculated by dividing its tier 1 capital (the numerator of the ratio) by its average total consolidated assets (the denominator of the ratio).
China money supply decline in Feb
--China's money-supply growth slowed in February.
--M2, the broadest measure, rose 17.5 percent to 42.1trillion yuan ($5.9 trillion) from a year earlier, the People'sBank of China said today on its Web site. That compared with January's 18.9 percent gain and the 17.8 percent median estimateof 14 economists surveyed by Bloomberg News.
--Trade surpluses and foreign direct investment pump cashinto China's economy, adding to the risk that inflation will keep accelerating. Consumer prices jumped 8.7 percent last month,the fastest pace in 11 years, on soaring food costs.
--10 average growth of M2 supply is 16.28%
--M2, the broadest measure, rose 17.5 percent to 42.1trillion yuan ($5.9 trillion) from a year earlier, the People'sBank of China said today on its Web site. That compared with January's 18.9 percent gain and the 17.8 percent median estimateof 14 economists surveyed by Bloomberg News.
--Trade surpluses and foreign direct investment pump cashinto China's economy, adding to the risk that inflation will keep accelerating. Consumer prices jumped 8.7 percent last month,the fastest pace in 11 years, on soaring food costs.
--10 average growth of M2 supply is 16.28%
Retail Sales Rose 20% in China in Feb
-- China's retail sales climbed 20.2percent, matching the fastest pace in at least nine years, a sign that consumer spending may sustain the world's fastest-growing major economy as export demand weakens.
--The increase for January and February was the same as December's and more than the 19 percent median forecast of 18 economists in a Bloomberg News survey. The figure was boosted bythe fastest inflation in 11 years.
--Spending fueled by a 17 percent increase in urban incomes last year helps the expansions in China of Wal-Mart Stores Inc.and Carrefour SA, the world's biggest retailers, and may curb the economy's dependence on exports and investment for growth.Overseas shipments rose 6.5 percent in February, the least inalmost six years.
--China's per capita gross national income of $2,010 in 2006compared with $44,970 in the U.S. and $250 in Rwanda, accordingto a World Bank report.
--The increase for January and February was the same as December's and more than the 19 percent median forecast of 18 economists in a Bloomberg News survey. The figure was boosted bythe fastest inflation in 11 years.
--Spending fueled by a 17 percent increase in urban incomes last year helps the expansions in China of Wal-Mart Stores Inc.and Carrefour SA, the world's biggest retailers, and may curb the economy's dependence on exports and investment for growth.Overseas shipments rose 6.5 percent in February, the least inalmost six years.
--China's per capita gross national income of $2,010 in 2006compared with $44,970 in the U.S. and $250 in Rwanda, accordingto a World Bank report.
TIP has negative real yield
--first time negative since 1997
--Inflation expectations are rising
--other factors are buffeting TIPS. The credit marke seizure has driven investors to safest assets and TIPs has eliminate any risk investor can imagine, besides the government going broke.
--Inflation expectations are rising
--other factors are buffeting TIPS. The credit marke seizure has driven investors to safest assets and TIPs has eliminate any risk investor can imagine, besides the government going broke.
COF monthly charge-off and delinquency statistics
--Feb 2008, reported
NCC: 2.97% reported, 3.79 - managed
30 days + delinquency rate : 3.23% - reported, 3.56% - managed
--Jan
NCC: 3% reported, 3.99% - managed
30 days + D : 3.63% - r, 3.87% - managed
--Dec 2007
NCC: 2.83 % - R, 3.61% - M
30 days + D: 3.66% - r, 3.87% - M
--Nov 2007
NCC: 2.65% - R, 3.52% - M
30 days + D: 3.44% - R, 3.68% -M
--Oct 2007
Net Charge-Off Rate, 2.37% - R, 3.28% - M
30 Days + Delinquency Rate: 3.39% - R, 3.64% - M
--Nov 2006
NCC: 3.23% - R, 3.5% - M
30 days +D : 3.96% - R, 3.69% - M
conclusions
--consumer credit from COF shows no deterioration
NCC: 2.97% reported, 3.79 - managed
30 days + delinquency rate : 3.23% - reported, 3.56% - managed
--Jan
NCC: 3% reported, 3.99% - managed
30 days + D : 3.63% - r, 3.87% - managed
--Dec 2007
NCC: 2.83 % - R, 3.61% - M
30 days + D: 3.66% - r, 3.87% - M
--Nov 2007
NCC: 2.65% - R, 3.52% - M
30 days + D: 3.44% - R, 3.68% -M
--Oct 2007
Net Charge-Off Rate, 2.37% - R, 3.28% - M
30 Days + Delinquency Rate: 3.39% - R, 3.64% - M
--Nov 2006
NCC: 3.23% - R, 3.5% - M
30 days +D : 3.96% - R, 3.69% - M
conclusions
--consumer credit from COF shows no deterioration
$200 billion credit exchange for MBS
The Fed said it would lend Wall Street as much as $200 billion from the central bank's own trove of sought-after Treasury bonds and bills for 28 days in exchange for a roughly equivalent amount of mortgage-backed securities, including some that can't ordinarily be used in transactions with the Fed. Uncertainties about the value of the underlying mortgages, plus forced selling by some investors to repay broker loans, have led many investors to spurn these securities, making them especially difficult to trade.
By taking some of these securities on its own books, the Fed is seeking to make its primary dealers -- the network of 20 Wall Street firms with which it typically does securities business -- more comfortable buying them from their own clients. It hopes this could lead to higher prices and thus lower yields on the mortgage-linked debt. A decline in those yields could help banks offer lower interest rates to prospective homebuyers.
Still, the Fed's efforts won't eliminate the root cause of the economy's problems: falling home prices and a mounting wave of mortgage defaults.
Four foreign central banks, including three in Europe, joined in coordinated action with the Fed yesterday, announcing related measures. The Fed aided those efforts by offering the central banks lines of credit, enabling them to make dollar-denominated loans to European banks
The centerpiece of the Fed's latest initiative is the Term Securities Lending Facility, under which the Fed will lend its primary dealers as much as $200 billion of Treasury securities from its own $713 billion portfolio of those securities.
The Fed initiative is similar in intent to its term-auction facility, launched in December to offer credit to banks. Both focus on specific trouble areas -- the term-auction facility on interbank lending and the new initiative on mortgages. That probably is more effective than blunderbuss interest-rate cuts.
As collateral, the Fed will accept debt or mortgage-backed securities issued or guaranteed by Fannie and Freddie, also known as "agency" securities. It will also accept other residential-mortgage-backed securities, provided they are rated triple-A and not on watch for downgrade, though it didn't specify what type. Such "private label" securities have been especially difficult to trade, in part because the Fed doesn't accept them as collateral for ordinary money-market operations.
The Fed is requiring the collateral to exceed the amount of the loan to protect against losses, so dealers could be surrendering more than $200 billion of mortgage-backed securities to the central bank. That figure still equals less than 5% of all agency mortgage-backed securities. But it provides a strong incentive to dealers to play their role of holding such securities on their balance sheets temporarily as they try to match would-be buyers and sellers.
Indeed, the sum roughly equals all holdings of agency bonds and agency mortgage-backed securities by the primary dealers, said Anthony Crescenzi, bond strategist at Miller Tabak & Co.
However, the step falls short of Wall Street hopes that the Fed would buy agency mortgage-backed securities or agency bonds. Senior Fed staffers told reporters that while the central bank has that authority, such purchases could distort the prices of the securities.
Spreads between yields on agency mortgage-backed securities and Treasurys soared to 3.5 percentage points last week, their widest since 1986, from 2.5 points a month ago, according to Bear Stearns Cos. They had slipped to 3.36 points by Monday and narrowed further to 3.22 points yesterday.
It is the first time the Fed has accepted as collateral MBSs that aren't guaranteed by Fannie Mae or Freddie Mac. Swapping MBSs that are falling in price for iron-clad government bonds will reduce the amount of mortgage securities outstanding in the market, helping to stabilize prices.
Still, the Fed shouldn't become a long-term holder of mortgage credit risk. If the government decides to bail out the sector, it should come clean about it and not engineer a surreptitious risk transfer through the central bank.
There also is the risk that financial institutions may rely on these injections from the Fed rather than stepping up efforts to bolster their capital and sort out their assets. The Fed should make clear under what circumstances it will begin withdrawing its relief programs. For example, it could use price improvements in MBS instruments as a guide. Or it could say it will tighten collateral requirements gradually. Such measures would give its Wall Street charges both the time and incentive to wean themselves from the central-bank faucet.
By taking some of these securities on its own books, the Fed is seeking to make its primary dealers -- the network of 20 Wall Street firms with which it typically does securities business -- more comfortable buying them from their own clients. It hopes this could lead to higher prices and thus lower yields on the mortgage-linked debt. A decline in those yields could help banks offer lower interest rates to prospective homebuyers.
Still, the Fed's efforts won't eliminate the root cause of the economy's problems: falling home prices and a mounting wave of mortgage defaults.
Four foreign central banks, including three in Europe, joined in coordinated action with the Fed yesterday, announcing related measures. The Fed aided those efforts by offering the central banks lines of credit, enabling them to make dollar-denominated loans to European banks
The centerpiece of the Fed's latest initiative is the Term Securities Lending Facility, under which the Fed will lend its primary dealers as much as $200 billion of Treasury securities from its own $713 billion portfolio of those securities.
The Fed initiative is similar in intent to its term-auction facility, launched in December to offer credit to banks. Both focus on specific trouble areas -- the term-auction facility on interbank lending and the new initiative on mortgages. That probably is more effective than blunderbuss interest-rate cuts.
As collateral, the Fed will accept debt or mortgage-backed securities issued or guaranteed by Fannie and Freddie, also known as "agency" securities. It will also accept other residential-mortgage-backed securities, provided they are rated triple-A and not on watch for downgrade, though it didn't specify what type. Such "private label" securities have been especially difficult to trade, in part because the Fed doesn't accept them as collateral for ordinary money-market operations.
The Fed is requiring the collateral to exceed the amount of the loan to protect against losses, so dealers could be surrendering more than $200 billion of mortgage-backed securities to the central bank. That figure still equals less than 5% of all agency mortgage-backed securities. But it provides a strong incentive to dealers to play their role of holding such securities on their balance sheets temporarily as they try to match would-be buyers and sellers.
Indeed, the sum roughly equals all holdings of agency bonds and agency mortgage-backed securities by the primary dealers, said Anthony Crescenzi, bond strategist at Miller Tabak & Co.
However, the step falls short of Wall Street hopes that the Fed would buy agency mortgage-backed securities or agency bonds. Senior Fed staffers told reporters that while the central bank has that authority, such purchases could distort the prices of the securities.
Spreads between yields on agency mortgage-backed securities and Treasurys soared to 3.5 percentage points last week, their widest since 1986, from 2.5 points a month ago, according to Bear Stearns Cos. They had slipped to 3.36 points by Monday and narrowed further to 3.22 points yesterday.
It is the first time the Fed has accepted as collateral MBSs that aren't guaranteed by Fannie Mae or Freddie Mac. Swapping MBSs that are falling in price for iron-clad government bonds will reduce the amount of mortgage securities outstanding in the market, helping to stabilize prices.
Still, the Fed shouldn't become a long-term holder of mortgage credit risk. If the government decides to bail out the sector, it should come clean about it and not engineer a surreptitious risk transfer through the central bank.
There also is the risk that financial institutions may rely on these injections from the Fed rather than stepping up efforts to bolster their capital and sort out their assets. The Fed should make clear under what circumstances it will begin withdrawing its relief programs. For example, it could use price improvements in MBS instruments as a guide. Or it could say it will tighten collateral requirements gradually. Such measures would give its Wall Street charges both the time and incentive to wean themselves from the central-bank faucet.
HEL exposure
JPM - 90 bilion, $450 mil expected loss
Wells Fargo
--banks will ratchet up provision for HEL loss
--While banks can foreclose on a first-lien mortgage, lenders often have little recourse when trying to collect a delinquent home-equity loan, especially if another bank holds the primary mortgage. Banks holding home-equity loans generally can only seize the collateral -- a house -- after the mortgage is paid off.
--Now, the steep decline in housing prices and weak economy are turning the home-equity business upside down. About 4.65% of fixed-rate home-equity loans were delinquent in the fourth quarter of 2007, up from 3.11% a year earlier, according to Equifax Inc. and Moody's Economy.com.
--Other types of consumer loans also are souring, including credit cards and auto loans. But delinquent home-equity loans are rising faster, representing 12.5% of all delinquent loans in the fourth quarter at Bank of America Corp., the largest U.S. bank in stock-market value. That was up from 9.4% in last year's first quarter, according to research firm SNL Financial.
Wells Fargo
--banks will ratchet up provision for HEL loss
--While banks can foreclose on a first-lien mortgage, lenders often have little recourse when trying to collect a delinquent home-equity loan, especially if another bank holds the primary mortgage. Banks holding home-equity loans generally can only seize the collateral -- a house -- after the mortgage is paid off.
--Now, the steep decline in housing prices and weak economy are turning the home-equity business upside down. About 4.65% of fixed-rate home-equity loans were delinquent in the fourth quarter of 2007, up from 3.11% a year earlier, according to Equifax Inc. and Moody's Economy.com.
--Other types of consumer loans also are souring, including credit cards and auto loans. But delinquent home-equity loans are rising faster, representing 12.5% of all delinquent loans in the fourth quarter at Bank of America Corp., the largest U.S. bank in stock-market value. That was up from 9.4% in last year's first quarter, according to research firm SNL Financial.
Tuesday, March 11, 2008
call summary
Macro call
1.buy 10y short 2y - it worked since Oct 2007, spread has widened from 50 bps to 150 bps..
2.buy Muni bonds - out of whack, yielding 5.5% over the Teasury
1.buy 10y short 2y - it worked since Oct 2007, spread has widened from 50 bps to 150 bps..
2.buy Muni bonds - out of whack, yielding 5.5% over the Teasury
why Muni needs insurance
--average size of the muni bond is 32 mil, low liquidity
--it needs insurance to make the bond fungible, exchangle
--it needs insurance to make the bond fungible, exchangle
Fed pump in $200 bil
The Fed announced Tuesday it would ramp up loans of cash and securities to banks and dealers. The new program will let firms borrow up to $200 billion of Treasurys and pledge various flavors of mortgage-backed securities, including both agency and private-label instruments, as collateral
Markets for mortgage securities had been rapidly deteriorating recently as investors facing margin calls and others anxious about the overall financial health of government-sponsored enterprises Fannie Mae and Freddie Mac sold their holdings. The developments alarmed investors and policy makers and led to selling of financial stocks in recent days.
Markets for mortgage securities had been rapidly deteriorating recently as investors facing margin calls and others anxious about the overall financial health of government-sponsored enterprises Fannie Mae and Freddie Mac sold their holdings. The developments alarmed investors and policy makers and led to selling of financial stocks in recent days.
Healthy Compensation Structure
Healthier compensation structures should normally have three elements. First, a large chunk of any bonus above a modest size should be paid in equity, so that bankers have an interest in their colleagues' behavior. Second, equity should vest over several years to ensure that bankers worry about the longer term. Third, part of the bonuses earned each year should be put in escrow -- with the understanding that it will be clawed back if the recipients post losses in subsequent years.
Easy Credit Nourish Banking Jobs
Easy credit via bank loans, high-yield bonds and asset-backed securities nourished the investment-banking ecosystem. A $10 billion private-equity deal might beget $40 million of advisory revenue, plus $70 million in bank lending fees, and $50 million in fees for loans against real estate. That might create an IPO two years down the line, generating $60 million more.
Monday, March 10, 2008
Bear Stearns is Down because of Alt-A
Moody's on Monday downgraded 163 tranches from 15 transactions issued by Bear Stearns Alt-A Trust. The downgrades affected securities issued from 2005 through 2007, with ratings falling to various levels according to the degree of riskiness of the tranche. Seventy-eight of the downgraded tranches remain on review for possible further downgrade, while another 155 tranches were put on review for a first possible downgrade.
Bear Stearns, which with Lehman Brothers Holdings, has been one of Wall Street's biggest originators of residential mortgages and packagers of the mortgages into securities, has about $6 billion of exposure to Alt-A mortgages that it hasn't sold, according to a recent estimate from analyst David Trone of Fox-Pitt Kelton Cochran Caronia Waller.
Lehman, which on Monday began laying off 5% of its work force, is believed to have exposure to about $15 billion of Alt-A mortgages.
Bear Stearns, which with Lehman Brothers Holdings, has been one of Wall Street's biggest originators of residential mortgages and packagers of the mortgages into securities, has about $6 billion of exposure to Alt-A mortgages that it hasn't sold, according to a recent estimate from analyst David Trone of Fox-Pitt Kelton Cochran Caronia Waller.
Lehman, which on Monday began laying off 5% of its work force, is believed to have exposure to about $15 billion of Alt-A mortgages.
Stagflation Equation May Not Add Up
The combination of apparent recession and skyrocketing commodity prices has a lot of people worried that a 1970s nightmare, stagflation, is making a comeback.
But the deep unwind happening in credit markets suggests that the inflation part of stagflation will ultimately remain consigned to the attic, along with bell-bottom pants and disco balls.
Recessions almost always throw cold water on inflation, making stagflation -- a combination of a weak economy and rising prices -- unlikely. That is what Federal Reserve officials will be betting when they slash interest rates again, as they are widely expected to do this month.
"You get stagflation false signals in most recessions," says independent economist Robert Brusca, who points out that inflation has accelerated before or during every recession since 1961. In every case, inflation retreated as economic weakness hurt demand.
Inflation kept reaccelerating in the 1970s because the Fed kept pumped money into the system too aggressively, a mistake officials say is burned into their memories.
There is a strong argument that recession will weigh on inflation this time around. Homeowners, hedge funds and all manner of investors are suddenly being starved of the easy credit they long used to drive asset prices higher. A credit unwind is deflationary, not inflationary. Home prices have tumbled as banks have tightened lending standards. Hedge funds are holding fire sales on assets because banks are calling in loans. Stock prices are wobbling, too.
The process has the potential to become self-feeding. Falling prices make debt burdens greater and reduce the value of collateral behind the debt. Borrowers thus try to shed their debt by selling more assets, driving prices lower still, making debt more painful, in a grim square dance that economist Irving Fisher called the debt-deflation spiral.
An important wild card in all this is the weakening dollar. While a debt unwind is deflationary, a weakening currency is inflationary. It drives up the prices of imported goods. What happens when these two events happen simultaneously?
Several Asian economies went through a similar process a decade ago. Mountains of debt in South Korea, Indonesia, Thailand and other economies crumbled in 1997, leading to waves of public- and private-sector defaults that punished their currencies. Inflation spiked temporarily. Indonesia's consumer prices rose 58% in 1998; economic output shrank 13%. Now that's stagflation.
Yet within two years, Indonesia's currency had stabilized and consumer-price inflation slowed to 3.8%. Korea, Thailand and other Asian economies went through similar fluctuations. Korea's inflation rate spiked to 7.5% in 1998 and settled to 0.8% the next year.
Could the U.S. repeat a version of this today? Well, the dollar has been weakening, and consumer prices are on the rise, with the CPI rising 4.3% in January.
Still, if history is any guide, the Fed is making the right choice by focusing on recession -- and preventing a deflationary spiral that would make a recession seem like a day at the park -- rather than on a bout of inflation that might prove transitory.
But the deep unwind happening in credit markets suggests that the inflation part of stagflation will ultimately remain consigned to the attic, along with bell-bottom pants and disco balls.
Recessions almost always throw cold water on inflation, making stagflation -- a combination of a weak economy and rising prices -- unlikely. That is what Federal Reserve officials will be betting when they slash interest rates again, as they are widely expected to do this month.
"You get stagflation false signals in most recessions," says independent economist Robert Brusca, who points out that inflation has accelerated before or during every recession since 1961. In every case, inflation retreated as economic weakness hurt demand.
Inflation kept reaccelerating in the 1970s because the Fed kept pumped money into the system too aggressively, a mistake officials say is burned into their memories.
There is a strong argument that recession will weigh on inflation this time around. Homeowners, hedge funds and all manner of investors are suddenly being starved of the easy credit they long used to drive asset prices higher. A credit unwind is deflationary, not inflationary. Home prices have tumbled as banks have tightened lending standards. Hedge funds are holding fire sales on assets because banks are calling in loans. Stock prices are wobbling, too.
The process has the potential to become self-feeding. Falling prices make debt burdens greater and reduce the value of collateral behind the debt. Borrowers thus try to shed their debt by selling more assets, driving prices lower still, making debt more painful, in a grim square dance that economist Irving Fisher called the debt-deflation spiral.
An important wild card in all this is the weakening dollar. While a debt unwind is deflationary, a weakening currency is inflationary. It drives up the prices of imported goods. What happens when these two events happen simultaneously?
Several Asian economies went through a similar process a decade ago. Mountains of debt in South Korea, Indonesia, Thailand and other economies crumbled in 1997, leading to waves of public- and private-sector defaults that punished their currencies. Inflation spiked temporarily. Indonesia's consumer prices rose 58% in 1998; economic output shrank 13%. Now that's stagflation.
Yet within two years, Indonesia's currency had stabilized and consumer-price inflation slowed to 3.8%. Korea, Thailand and other Asian economies went through similar fluctuations. Korea's inflation rate spiked to 7.5% in 1998 and settled to 0.8% the next year.
Could the U.S. repeat a version of this today? Well, the dollar has been weakening, and consumer prices are on the rise, with the CPI rising 4.3% in January.
Still, if history is any guide, the Fed is making the right choice by focusing on recession -- and preventing a deflationary spiral that would make a recession seem like a day at the park -- rather than on a bout of inflation that might prove transitory.
Fear Cycle Ensnares Structured Products
The IG9 index reflects the cost of insuring against default by 125 U.S. and Canadian investment-grade companies. It widens when investors buy protection in anticipation of further troubles in corporate credit. Structured products also used the index, primarily selling protection, as part of elaborate money-making strategies.
The widening index is putting extraordinary pressure on complex products such as constant proportion debt obligations and collateralized debt obligations, and is threatening to trigger the unwinding of investment positions.
CPDOs emerged in late 2006. In world where yield was king, CPDOs offered not just generous returns but top-notch ratings. To generate those returns, they used substantial leverage -- about 15 times the principal.
CPDOs sell credit protection against a possible default in the underlying bonds of the CDX. In exchange for the index protection, CPDOs receive premiums, a portion of which are used to pay off their investors.
"What were perfectly viable financing strategies are being pulled apart as lenders steadily increase margin calls in the midst of declining collateral values," said Fran Mustaro, managing director at J. & W. Seligman & Co in New York.
The next unwind trigger for CPDOs is around 2.00 percentage points on the benchmark CDX, according to analysts at Banc of America Securities, not far from Friday's close at 1.77 percentage points. This means the annual cost of five years of insurance against a default on $10 million of bonds in the I9 index is $177,000, a rise of $44,000 since its close on Feb. 26, according to Barclays Capital.
The widening index is putting extraordinary pressure on complex products such as constant proportion debt obligations and collateralized debt obligations, and is threatening to trigger the unwinding of investment positions.
CPDOs emerged in late 2006. In world where yield was king, CPDOs offered not just generous returns but top-notch ratings. To generate those returns, they used substantial leverage -- about 15 times the principal.
CPDOs sell credit protection against a possible default in the underlying bonds of the CDX. In exchange for the index protection, CPDOs receive premiums, a portion of which are used to pay off their investors.
"What were perfectly viable financing strategies are being pulled apart as lenders steadily increase margin calls in the midst of declining collateral values," said Fran Mustaro, managing director at J. & W. Seligman & Co in New York.
The next unwind trigger for CPDOs is around 2.00 percentage points on the benchmark CDX, according to analysts at Banc of America Securities, not far from Friday's close at 1.77 percentage points. This means the annual cost of five years of insurance against a default on $10 million of bonds in the I9 index is $177,000, a rise of $44,000 since its close on Feb. 26, according to Barclays Capital.
Commerical Mortgage market will slump less deeply as Residentail Market
J.P. Morgan Securities, which says the economy has entered a recession, projected last week that commercial-property losses over the next five to eight years will be about $120 billion, or roughly 4% of the sector's $3.2 trillion in debt outstanding. But that's far short of the $200 billion in losses that J.P. Morgan is projecting from the subprime debacle, a 15% loss rate.
William Tanona, a Goldman Sachs Group analyst, expects Bear Stearns Cos., Citigroup Inc., J.P. Morgan Chase & Co., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Morgan Stanley to take combined commercial-property-related write-downs of $7.2 billion in the first quarter, following $1.8 billion of them in the fourth quarter.
Policy makers have become increasingly concerned about the stresses commercial property are putting on small and midsize banks. But many of their problem commercial-real-estate loans are actually housing-related: The banks typically classify construction loans made to condominium and single-family home builders as "commercial."
In the fourth quarter of 2007, 7.5% of the loans from federally insured banks and thrifts to builders of single-family homes were 30 days or more past due, up from 2.1% a year earlier, according to Foresight Analytics, a research company in Oakland, Calif.
For banks lending to condo developers, the pain was even worse. Delinquencies for condo-construction loans rose to 10.1% in the fourth quarter, up from 2.6% a year earlier. By comparison, delinquencies on nonresidential commercial mortgages, secured by properties like office buildings and shopping malls, were 1.6% in the same quarter, up slightly from 1.1% according to Foresight Analytics.
The delinquency rate on the $840 billion of U.S. commercial mortgage-backed securities outstanding is less than 0.5%, near its historic low, according to Trepp LLC, which tracks the market. While the rate is rising, Moody's doesn't expect it to exceed its average of closer to 2% over the next 12 months. Compare that with the roughly 20% of commercial loans made by life-insurance companies in 1986 that defaulted in the subsequent 10 years.
Why is the current bad-loan rate so low? For most of this decade, developers have been showing unusual discipline in delivering new product, with the exception primarily of hotels. Office-property developers in the top 50 markets this year are expected to complete 53.9 million square feet of office space, according to Reis Inc., a real-estate data company. While that's close to double the 2004 pace, it is less than 40% of the average 144 million square feet that was delivered annually in the five years leading up to the collapse of commercial real-estate prices in the early 1990s.
Sam Chandan, Reis's chief economist, says that commercial developers haven't overbuilt due to high construction costs and because the commercial real-estate market didn't start recovering from the last recession until 2004. Usually it takes a few years after a recovery before developers start building speculative projects that have little or no pre-leasing. "We weren't far along enough in the cycle for the market to start chugging," he says. "And then demand began softening because of [the] residential" market.
William Tanona, a Goldman Sachs Group analyst, expects Bear Stearns Cos., Citigroup Inc., J.P. Morgan Chase & Co., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Morgan Stanley to take combined commercial-property-related write-downs of $7.2 billion in the first quarter, following $1.8 billion of them in the fourth quarter.
Policy makers have become increasingly concerned about the stresses commercial property are putting on small and midsize banks. But many of their problem commercial-real-estate loans are actually housing-related: The banks typically classify construction loans made to condominium and single-family home builders as "commercial."
In the fourth quarter of 2007, 7.5% of the loans from federally insured banks and thrifts to builders of single-family homes were 30 days or more past due, up from 2.1% a year earlier, according to Foresight Analytics, a research company in Oakland, Calif.
For banks lending to condo developers, the pain was even worse. Delinquencies for condo-construction loans rose to 10.1% in the fourth quarter, up from 2.6% a year earlier. By comparison, delinquencies on nonresidential commercial mortgages, secured by properties like office buildings and shopping malls, were 1.6% in the same quarter, up slightly from 1.1% according to Foresight Analytics.
The delinquency rate on the $840 billion of U.S. commercial mortgage-backed securities outstanding is less than 0.5%, near its historic low, according to Trepp LLC, which tracks the market. While the rate is rising, Moody's doesn't expect it to exceed its average of closer to 2% over the next 12 months. Compare that with the roughly 20% of commercial loans made by life-insurance companies in 1986 that defaulted in the subsequent 10 years.
Why is the current bad-loan rate so low? For most of this decade, developers have been showing unusual discipline in delivering new product, with the exception primarily of hotels. Office-property developers in the top 50 markets this year are expected to complete 53.9 million square feet of office space, according to Reis Inc., a real-estate data company. While that's close to double the 2004 pace, it is less than 40% of the average 144 million square feet that was delivered annually in the five years leading up to the collapse of commercial real-estate prices in the early 1990s.
Sam Chandan, Reis's chief economist, says that commercial developers haven't overbuilt due to high construction costs and because the commercial real-estate market didn't start recovering from the last recession until 2004. Usually it takes a few years after a recovery before developers start building speculative projects that have little or no pre-leasing. "We weren't far along enough in the cycle for the market to start chugging," he says. "And then demand began softening because of [the] residential" market.
Saturday, March 8, 2008
Even Thornburg, 'Strong' Lender, Is On the Brink
The survival of Thornburg, of Santa Fe, N.M., is of particular concern, because the company specialized in mortgages to relatively wealthy clients with strong credit -- not the subprime borrowers who led to the dissolution of many mortgage lenders last year. Thornburg could become one of the first lenders that focused on financially sound borrowers to fail in this housing crisis, even as delinquencies among its loans remain well below the industry average.
Thornburg disclosed Friday that its independent auditor, KPMG LLC, questioned its ability to survive. Thornburg specializes in making and investing in adjustable-rate, or Alt-A mortgages -- whose credit quality falls between prime and subprime -- as well as "jumbo" loans, above the amount that until recently qualified to be bought by the government-sponsored Fannie Mae and Freddie Mac.
William Gross, chief investment officer of U.S. bond titan Pacific Investment Management Co., said on CNBC on Friday that the firm bought about $100 million of Thornburg's debt in the last few days. He expected the return on the investment to be close to double-digits.
Thornburg is also one of the few remaining real-estate investment trusts that originated home loans, raising questions as to whether this business model will disappear now that its inherent weakness to a liquidity crisis has been exposed. Several residential-mortgage REITs were wiped out last summer by the first wave of the subprime collapse.
The demise of mortgage REITs eliminates an important source of housing finance, and renews the question about whether the REIT structure makes sense for residential-mortgage lenders who need cash cushions to meet margin calls. REITs are real-estate companies that pay no corporate income taxes as long as they pay 90% of their taxable income to investors as dividends.
While many residential mortgage lenders are struggling with the credit crunch, the REIT structure "creates an additional headwind for you, because nearly every dollar you make you have to pay out in dividends," says Omotayo Okusanya, an analyst at UBS AG. A bank or thrift, meantime, can hold on to profits as storm clouds approach. Thornburg paid common stockholders $40 million in dividends on Jan 30.
Moreover, mortgage lenders like Thornburg, because of their limited capital, rely on short-term credit lines more than other big financial institutions. To secure the funding, they use the loans they originate or securities they own as collateral. A sharp drop in the value of the collateral can lead banks to issue margin calls.
Thornburg disclosed Friday that its independent auditor, KPMG LLC, questioned its ability to survive. Thornburg specializes in making and investing in adjustable-rate, or Alt-A mortgages -- whose credit quality falls between prime and subprime -- as well as "jumbo" loans, above the amount that until recently qualified to be bought by the government-sponsored Fannie Mae and Freddie Mac.
William Gross, chief investment officer of U.S. bond titan Pacific Investment Management Co., said on CNBC on Friday that the firm bought about $100 million of Thornburg's debt in the last few days. He expected the return on the investment to be close to double-digits.
Thornburg is also one of the few remaining real-estate investment trusts that originated home loans, raising questions as to whether this business model will disappear now that its inherent weakness to a liquidity crisis has been exposed. Several residential-mortgage REITs were wiped out last summer by the first wave of the subprime collapse.
The demise of mortgage REITs eliminates an important source of housing finance, and renews the question about whether the REIT structure makes sense for residential-mortgage lenders who need cash cushions to meet margin calls. REITs are real-estate companies that pay no corporate income taxes as long as they pay 90% of their taxable income to investors as dividends.
While many residential mortgage lenders are struggling with the credit crunch, the REIT structure "creates an additional headwind for you, because nearly every dollar you make you have to pay out in dividends," says Omotayo Okusanya, an analyst at UBS AG. A bank or thrift, meantime, can hold on to profits as storm clouds approach. Thornburg paid common stockholders $40 million in dividends on Jan 30.
Moreover, mortgage lenders like Thornburg, because of their limited capital, rely on short-term credit lines more than other big financial institutions. To secure the funding, they use the loans they originate or securities they own as collateral. A sharp drop in the value of the collateral can lead banks to issue margin calls.
Mortgage Pool Factor
The percentage of the original principle that is left to be distributed in a mortgage-backed security, as represented by a numerical factor that will be attached on periodic market quotes (such as in Bloomberg) and other presentations of the MBS’s price.
For example, if the face amount of a pooled MBS is $100,000, and the stated pool factor is 0.4587, the remaining balance in the security, yet to be paid to the investor, would be $45,870.
The pool factor is only used to describe a specific class of security, which can be issued by Freddie Mac (FHLMC), Fannie Mae (FNMA), and Ginnie Mae (GNMA).
A pooled MBS is one whose component mortgage payments, instead of being re-bundled or collated, are simply passed through to the investors, month to month, until the mortgage pool has been completely paid off.
For example, if the face amount of a pooled MBS is $100,000, and the stated pool factor is 0.4587, the remaining balance in the security, yet to be paid to the investor, would be $45,870.
The pool factor is only used to describe a specific class of security, which can be issued by Freddie Mac (FHLMC), Fannie Mae (FNMA), and Ginnie Mae (GNMA).
A pooled MBS is one whose component mortgage payments, instead of being re-bundled or collated, are simply passed through to the investors, month to month, until the mortgage pool has been completely paid off.
muni bonds how-to
Not all municipal bonds are created equal. "General-obligation" munis are backed by full faith and credit, and taxation powers, of the issuing state or town. "Revenue" bonds are often riskier: They may be financed by the cash flows of a single car park, or golf course, or toll road.
On the whole, cities and towns are considered riskier than states. Many muni bonds also carry insurance, though it is of questionable value. But the bottom line is that defaults among municipals of all stripes are rare.
Some munis are callable. That means the issuing municipality can pay them off early. And that can make a big difference to the actual interest rate you'll earn.
Munis offer lots of theoretical interest rates, but with a callable bond the one to focus on is "the yield to worst."
Not all munis are tax-free, either. Some, for technical reasons, are subject to Alternative Minimum Tax. Check the fine print. And if you buy a muni below "par" or face value, some annual gain may be subject to tax as well.
On the other hand, munis issued by your state are probably exempt from state as well as federal income tax.
On the whole, cities and towns are considered riskier than states. Many muni bonds also carry insurance, though it is of questionable value. But the bottom line is that defaults among municipals of all stripes are rare.
Some munis are callable. That means the issuing municipality can pay them off early. And that can make a big difference to the actual interest rate you'll earn.
Munis offer lots of theoretical interest rates, but with a callable bond the one to focus on is "the yield to worst."
Not all munis are tax-free, either. Some, for technical reasons, are subject to Alternative Minimum Tax. Check the fine print. And if you buy a muni below "par" or face value, some annual gain may be subject to tax as well.
On the other hand, munis issued by your state are probably exempt from state as well as federal income tax.
Friday, March 7, 2008
On Wall St: Time will eventually prove bankers right
Fast forward to present-day Wall Street and the tables have been turned.
Bankers, private equity executives and many investors are fervent believers in a brighter, richer future
For all the pain experienced by borrowers, investors and banks, the more durable repercussions of this turmoil may not be financial.
The real legacy of this credit squeeze could be a deep-seated public mistrust for the business world accompanied by a wave of regulation.
This week, the FT reported that an association of leading banks was discussing radical measures like not paying bankers’ bonuses until the full effect of their deals had become apparent (i.e. for years).
And just a few days ago, senior private equity figures vowed to bypass banks and fund deals directly from sovereign investors and hedge funds.
Whatever the merits of these last two ideas (I, for one, found them misguided and impractical), they do signal growing unease at the “moneymen” (and women) of downtown New York.
Such negative feelings could, of course, melt away when market conditions improve.
Politicians and public opinion have been shown to have goldfish-like memories.
But past experience also suggests that they have cheetah-like reflexes.
The post-Enron era has shown that high-profile crises can lead to knee-jerk, all-encompassing regulation.
Bankers, private equity executives and many investors are fervent believers in a brighter, richer future
For all the pain experienced by borrowers, investors and banks, the more durable repercussions of this turmoil may not be financial.
The real legacy of this credit squeeze could be a deep-seated public mistrust for the business world accompanied by a wave of regulation.
This week, the FT reported that an association of leading banks was discussing radical measures like not paying bankers’ bonuses until the full effect of their deals had become apparent (i.e. for years).
And just a few days ago, senior private equity figures vowed to bypass banks and fund deals directly from sovereign investors and hedge funds.
Whatever the merits of these last two ideas (I, for one, found them misguided and impractical), they do signal growing unease at the “moneymen” (and women) of downtown New York.
Such negative feelings could, of course, melt away when market conditions improve.
Politicians and public opinion have been shown to have goldfish-like memories.
But past experience also suggests that they have cheetah-like reflexes.
The post-Enron era has shown that high-profile crises can lead to knee-jerk, all-encompassing regulation.
Fed will pump in $200 bil
--The Federal Reserve moved to add asmuch as $200 billion to the banking system over the next monthto offset a deepening credit crisis that may have already pushedthe U.S. economy into a recession.
--The central bank raised to $50 billion each from $30billion the amount intended for auctions of funds on March 10and March 24. The Fed also said in a statement in Washingtontoday that it will make $100 billion available through weekly28-day repurchase agreements, where the central bank will lendcash in return for assets including mortgage-backed bonds.
--The decision is the central bank's latest attempt to reduce the threat to the economy from banks curtailing loans tocompanies and households. Banks and securities firms have postedlosses exceeding $188 billion since the start of last year asthe impact of surging defaults on subprime mortgages rippledthrough world financial markets.
--The Federal Reserve on Friday announced two initiatives to address heightened liquidity pressures in term funding markets.
--First, the amounts outstanding in the Term Auction Facility(TAF) will be increased to $100 billion. The auctions on March
--Second, beginning today, the Federal Reserve will initiatea series of term repurchase transactions that are expected to cumulate to $100 billion. These transactions will be conducted
--The central bank raised to $50 billion each from $30billion the amount intended for auctions of funds on March 10and March 24. The Fed also said in a statement in Washingtontoday that it will make $100 billion available through weekly28-day repurchase agreements, where the central bank will lendcash in return for assets including mortgage-backed bonds.
--The decision is the central bank's latest attempt to reduce the threat to the economy from banks curtailing loans tocompanies and households. Banks and securities firms have postedlosses exceeding $188 billion since the start of last year asthe impact of surging defaults on subprime mortgages rippledthrough world financial markets.
--The Federal Reserve on Friday announced two initiatives to address heightened liquidity pressures in term funding markets.
--First, the amounts outstanding in the Term Auction Facility(TAF) will be increased to $100 billion. The auctions on March
--Second, beginning today, the Federal Reserve will initiatea series of term repurchase transactions that are expected to cumulate to $100 billion. These transactions will be conducted
Feb Nonfarm Payrolls
--Feb Nonfarm Payrolls dropepd 63k, Jan payroll numbers revised downward to -22k from -16k
--The loss of 63k was highest since 2003
--Manufactuering sector lead the pack, losing 52k aft4r falling 31k in Jan
--Retail sector shed around 40k jobs, reflecting the bleaky condition in consumer spending
--Few sectors' payroll numbers are in the postive territory except Government
--Avg. hourly earnings increased from 17.75 to 17.8, a reflection of increasing inflation
--The only silver lining is that unemployment rate, 4.8%, which is lower than expected 5% and lower than last Monday, 4.9%.
--Nonfarm payroll gives us the latest eveidence that economy is contracting. This will further weigh on the faltering capital market, which has been hammered recently by margin calls of hedge funds such as Carlyle Capital Groups, increasing default risk of municipality such as Jefferson country, Ala and consequent dislocations of muni market.
--The market will tanker further today because of this piece of news. Technically we are not in recession. But in practice, we are, as evidenced in downward trending labor numbers, shrinking consumer spending.
--The loss of 63k was highest since 2003
--Manufactuering sector lead the pack, losing 52k aft4r falling 31k in Jan
--Retail sector shed around 40k jobs, reflecting the bleaky condition in consumer spending
--Few sectors' payroll numbers are in the postive territory except Government
--Avg. hourly earnings increased from 17.75 to 17.8, a reflection of increasing inflation
--The only silver lining is that unemployment rate, 4.8%, which is lower than expected 5% and lower than last Monday, 4.9%.
--Nonfarm payroll gives us the latest eveidence that economy is contracting. This will further weigh on the faltering capital market, which has been hammered recently by margin calls of hedge funds such as Carlyle Capital Groups, increasing default risk of municipality such as Jefferson country, Ala and consequent dislocations of muni market.
--The market will tanker further today because of this piece of news. Technically we are not in recession. But in practice, we are, as evidenced in downward trending labor numbers, shrinking consumer spending.
municipalities Default Risk Increases
Jefferson County, Ala., which is struggling with the turmoil in the municipal-bond market, rebuffed demands by four banks yesterday to come up with $200 million to back a derivatives trade gone bad.
The banks have demanded that the county post additional collateral because of losses on derivatives contracts it entered into over the past several years. The contracts, known as interest-rate swaps, were meant to lower the county's borrowing costs and protect it from spikes in interest rates. But critics say the county was speculating.
Jefferson County's financial troubles show how borrowers that took on additional risk in the normally staid tax-exempt municipal bond market are suffering as these corners of the debt markets are tainted by fallout of subprime losses
Moody's Investors Service recently downgraded the county to B3 from A3. Rating firms yesterday also downgraded the county's general debt, its school warrants and various other municipal issues.
Many other municipalities have entered into similar swaps, but Jefferson County was particularly aggressive. Typically, however, a municipality looking to hedge risk holds no more in swaps than its total amount of debt. But Jefferson County holds 13 interest-rate swaps with a value of $5.4 billion, compared with its $3.2 billion in debt.
Durham County, N.C., has also used these derivatives.
The banks have demanded that the county post additional collateral because of losses on derivatives contracts it entered into over the past several years. The contracts, known as interest-rate swaps, were meant to lower the county's borrowing costs and protect it from spikes in interest rates. But critics say the county was speculating.
Jefferson County's financial troubles show how borrowers that took on additional risk in the normally staid tax-exempt municipal bond market are suffering as these corners of the debt markets are tainted by fallout of subprime losses
Moody's Investors Service recently downgraded the county to B3 from A3. Rating firms yesterday also downgraded the county's general debt, its school warrants and various other municipal issues.
Many other municipalities have entered into similar swaps, but Jefferson County was particularly aggressive. Typically, however, a municipality looking to hedge risk holds no more in swaps than its total amount of debt. But Jefferson County holds 13 interest-rate swaps with a value of $5.4 billion, compared with its $3.2 billion in debt.
Durham County, N.C., has also used these derivatives.
Hedge Funds Squeezed As Lenders Get Tougher
The financial turmoil is taking on a new dimension: Banks that lent money to hedge funds and other big risk-takers are asking for some of it back.
Banks demand hedge funds to put up more cash and assets. Margin call produces a negative cycle.
The issue came to the forefront as Calyle Capital Corp said it failed to meet margin calls on loans backing part of its $21.7 billion portfolio. Thornburg Mortgage Inc. said this week it failed to meet a demand from its lenders for $28 million, triggering defaults across its other financing agreements. Thornburg had met over $300 million in margin calls by late February, but was asked at the end of the month to pony up $270 million more.
Typically banks and brokers provide financing to hedge funds through so-called repo transactions, in which a fund turns over securities as temporary collateral for a loan. The fund later buys back the securities at a higher price that includes interest on the loan.
A bank might lend 97 cents against the collateral of a high-quality mortgage security with a market value of $1 -- a difference known as a "haircut" that insures the lender against losses. If the value of the collateral drops to 95 cents, the borrower faces a margin call.
The funds facing the greatest pressure are those that are highly leveraged, meaning they have large borrowings relative to the money entrusted to them. Carlyle Capital managed only $670 million in client money, but used borrowing to boost its portfolio of bonds to $21.7 billion, meaning it was about 32 times leveraged.
Banks demand hedge funds to put up more cash and assets. Margin call produces a negative cycle.
The issue came to the forefront as Calyle Capital Corp said it failed to meet margin calls on loans backing part of its $21.7 billion portfolio. Thornburg Mortgage Inc. said this week it failed to meet a demand from its lenders for $28 million, triggering defaults across its other financing agreements. Thornburg had met over $300 million in margin calls by late February, but was asked at the end of the month to pony up $270 million more.
Typically banks and brokers provide financing to hedge funds through so-called repo transactions, in which a fund turns over securities as temporary collateral for a loan. The fund later buys back the securities at a higher price that includes interest on the loan.
A bank might lend 97 cents against the collateral of a high-quality mortgage security with a market value of $1 -- a difference known as a "haircut" that insures the lender against losses. If the value of the collateral drops to 95 cents, the borrower faces a margin call.
The funds facing the greatest pressure are those that are highly leveraged, meaning they have large borrowings relative to the money entrusted to them. Carlyle Capital managed only $670 million in client money, but used borrowing to boost its portfolio of bonds to $21.7 billion, meaning it was about 32 times leveraged.
Housing Market Slumps Furthur
Among the latest trouble signals, the number of American homes entering foreclosure rose to the highest level on record in the fourth quarter of 2007. Meanwhile, homeowners' share of the equity in their homes fell to a post-World War II low.
The unwelcome contrast provides stark evidence of how falling home prices are weighing on consumers. And it could add urgency to efforts by Federal Reserve officials to avert a larger wave of foreclosures by prodding lenders to reducing the principal -- or total amount owed -- on troubled mortgages
Their share of home equity -- the market value of a home minus the size of its mortgage -- dropped to 47.9% in the final three months of 2007, down one percentage point from the third quarter, the Fed said in a quarterly report. Equity as a percentage of home values has been falling from a high of more than 80% since 1945, when the data started being recorded, but that decline generally has been a result of mortgage debt rising faster than home prices.
The total wealth of American households slipped about $533 billion to $57.7 trillion in the fourth quarter, the first drop since 2002, the Fed said. Central to the decline: The value of housing-related assets -- including those that are mortgaged -- fell by $170 billion to $20.2 trillion while the value of other financial assets, such as stocks, dropped by $254 billion to $45.3 trillion.
According to the Mortgage Bankers Association, more than 2% of the nation's about 46 million mortgage loans were in the foreclosure process in the fourth quarter, and 0.83% of loans entered the process. Both figures are the highest since the industry group started keeping track in 1972.
The delinquency rate for home loans hit 5.82%, up almost a quarter percentage point from the previous quarter and the highest since 1985, when the rate topped 6%, as many regions of the country were hurt by slumping oil and farm-product prices.
The unwelcome contrast provides stark evidence of how falling home prices are weighing on consumers. And it could add urgency to efforts by Federal Reserve officials to avert a larger wave of foreclosures by prodding lenders to reducing the principal -- or total amount owed -- on troubled mortgages
Their share of home equity -- the market value of a home minus the size of its mortgage -- dropped to 47.9% in the final three months of 2007, down one percentage point from the third quarter, the Fed said in a quarterly report. Equity as a percentage of home values has been falling from a high of more than 80% since 1945, when the data started being recorded, but that decline generally has been a result of mortgage debt rising faster than home prices.
The total wealth of American households slipped about $533 billion to $57.7 trillion in the fourth quarter, the first drop since 2002, the Fed said. Central to the decline: The value of housing-related assets -- including those that are mortgaged -- fell by $170 billion to $20.2 trillion while the value of other financial assets, such as stocks, dropped by $254 billion to $45.3 trillion.
According to the Mortgage Bankers Association, more than 2% of the nation's about 46 million mortgage loans were in the foreclosure process in the fourth quarter, and 0.83% of loans entered the process. Both figures are the highest since the industry group started keeping track in 1972.
The delinquency rate for home loans hit 5.82%, up almost a quarter percentage point from the previous quarter and the highest since 1985, when the rate topped 6%, as many regions of the country were hurt by slumping oil and farm-product prices.
Thursday, March 6, 2008
COF as of 03/05/2008
valuation
--BBB+
--10y cash bond trading around 350 bp, used to trade at 400 bps in January 2008, 5y bonds 350 bps
--5y CDS 467 bps, 3y 523 CDS
pros
--high core deposite around 10%
cons
--loan provision increase to 1.29 bill from 0.5 bil in Q3
WB
--AA
trading
--short WB cds, long COF bonds
--BBB+
--10y cash bond trading around 350 bp, used to trade at 400 bps in January 2008, 5y bonds 350 bps
--5y CDS 467 bps, 3y 523 CDS
pros
--high core deposite around 10%
cons
--loan provision increase to 1.29 bill from 0.5 bil in Q3
WB
--AA
trading
--short WB cds, long COF bonds
Ambac Financial Equity Cap Deal
--the 1.5 bill new equity capital falls short of the $2 to $3 billion investors expect.
--the offering is not even backstopped (guarantee) by the consortium of banks that has have supposedly furiously hammer out a bailout of the company.
--losse execeed stress cases of S&P
--the deal paints the company in a a weak position
--the offering is not even backstopped (guarantee) by the consortium of banks that has have supposedly furiously hammer out a bailout of the company.
--losse execeed stress cases of S&P
--the deal paints the company in a a weak position
white knight of Acution-Rate Market
Money-market funds are emerging as a potential white knight for some troubled auction-rate securities.
Auction-rate securities are debt investments that reset their interest rates as regularly as every seven to 35 days. In recent weeks, the $330 billion market for such securities has seized up, leaving many investors unable to cash out.
That's where tax-exempt municipal money-market funds come in. They hold conservative short-term debt offerings and are subject to strict rules that typically prevent them from owning auction-rate securities.
Now there is an effort under way to convert auction-rate securities into more-liquid investments that would be acceptable to municipal money-market funds. The effort would benefit the money-market funds, which have been struggling in recent weeks to find attractive securities amid problems with the bond insurers backing many of their normal holdings.
Converting auction-rate securities into money-fund eligible investments is often done under the original bond documents. The biggest sticking point could be that the borrower of the auction-rate securities or another financial institution must agree to buy the securities in the event no other buyers emerge. That backstop is what essentially differentiates auction-rate securities from investments called variable-rate demand notes that can be held by municipal money-market funds. But with financial institutions suffering losses, few may want to step up and take on that risk.
In some of the first deals, the borrowers using the auction-rate securities are providing the backing, rather than an outside financial institution. Restructurings are happening on a "deal-by-deal" basis says Federated's Ms. Cunningham.
The Georgia Power unit of Southern Co., for instance, recently had $700 million in tax-exempt auction-rate securities, and is now in the process of converting about $500 million of that into variable-rate demand notes, says David Brooks, managing director of capital markets at Southern. As the auction-rate market "got really ugly," in recent weeks, "we started putting out conversion notes," he says. Georgia Power priced about $33 million of the converted securities yesterday, and was planning to price another $100 million today and tomorrow that would be money-fund eligible. Rather than use an outside bank guarantee, it issued the new securities with the backing of its own credit. The benefit of such a move is lower borrowing costs than have recently been available in the auction-rate market. The pricing yesterday, for instance, was approximately 2.70%, while the borrower had recently seen auction rates from 5% to 7%.
Auction-rate securities are debt investments that reset their interest rates as regularly as every seven to 35 days. In recent weeks, the $330 billion market for such securities has seized up, leaving many investors unable to cash out.
That's where tax-exempt municipal money-market funds come in. They hold conservative short-term debt offerings and are subject to strict rules that typically prevent them from owning auction-rate securities.
Now there is an effort under way to convert auction-rate securities into more-liquid investments that would be acceptable to municipal money-market funds. The effort would benefit the money-market funds, which have been struggling in recent weeks to find attractive securities amid problems with the bond insurers backing many of their normal holdings.
Converting auction-rate securities into money-fund eligible investments is often done under the original bond documents. The biggest sticking point could be that the borrower of the auction-rate securities or another financial institution must agree to buy the securities in the event no other buyers emerge. That backstop is what essentially differentiates auction-rate securities from investments called variable-rate demand notes that can be held by municipal money-market funds. But with financial institutions suffering losses, few may want to step up and take on that risk.
In some of the first deals, the borrowers using the auction-rate securities are providing the backing, rather than an outside financial institution. Restructurings are happening on a "deal-by-deal" basis says Federated's Ms. Cunningham.
The Georgia Power unit of Southern Co., for instance, recently had $700 million in tax-exempt auction-rate securities, and is now in the process of converting about $500 million of that into variable-rate demand notes, says David Brooks, managing director of capital markets at Southern. As the auction-rate market "got really ugly," in recent weeks, "we started putting out conversion notes," he says. Georgia Power priced about $33 million of the converted securities yesterday, and was planning to price another $100 million today and tomorrow that would be money-fund eligible. Rather than use an outside bank guarantee, it issued the new securities with the backing of its own credit. The benefit of such a move is lower borrowing costs than have recently been available in the auction-rate market. The pricing yesterday, for instance, was approximately 2.70%, while the borrower had recently seen auction rates from 5% to 7%.
New Spasm Jolts Short Tem Markets
Despite repeated doses of medicine from central banks, short-term lending markets around the world are struggling again.
Libor rate is up across Euorpe and US. The unease is alao filtering into other credit marekts, municipals, corporates and mortgages
the renewed turmoil marks the latest fallout from the deflation of U.S. housing values and the crisis in the subprime-mortgage market. Banks are at the center of the storm. Though having taken billions of dollars of write-offs on trbouled debt, many banks still do not seem finished with that reckoning process. This has left them constrained for capital, and reluctant to lend out money. The downgrade odd of bond insurerer weigh on the credit market.
Short-term money markets are the grease that makes the wheels of financial markets spin smooth.
Issuance of short-term IOUs -- asset-backed commercial paper used by banks and other financial companies to raise money -- struggles to find solid footing. Asset-backed paper outstanding rose by $7.6 billion for the week ending Feb. 27, according to the Federal Reserve. But that hopeful sign followed four prior weeks when debt outstanding shrunk.
The premium companies must pay to issue high-yield bonds has risen to an average of 7.76 percentage points over comparable Treasury bonds, according to Merrill Lynch, up from a gap of 5.92 percentage points at the end of 2007 and just 4.19 percentage points last June.
Meantime, the average yield on a high-quality, tax-free 30-year municipal bond rose to 5.14% last Friday. That was up from 4.25% at the beginning of the year, and well above comparable taxable Treasury bonds -- a historic dislocation.
In addition to lowering interest rates, the Fed has tried to make short-term cash readily available to banks through a mechanism called the Term Auction Facility, in which financial institutions can tap the Fed for cash loans and use a broad array of financial assets as collateral.
Fed officials have indicated that the facility has been a successful tool, and that it is likely to remain in place. It is also possible that the Fed could expand its use of the facility if money market conditions worsen.
Libor rate is up across Euorpe and US. The unease is alao filtering into other credit marekts, municipals, corporates and mortgages
the renewed turmoil marks the latest fallout from the deflation of U.S. housing values and the crisis in the subprime-mortgage market. Banks are at the center of the storm. Though having taken billions of dollars of write-offs on trbouled debt, many banks still do not seem finished with that reckoning process. This has left them constrained for capital, and reluctant to lend out money. The downgrade odd of bond insurerer weigh on the credit market.
Short-term money markets are the grease that makes the wheels of financial markets spin smooth.
Issuance of short-term IOUs -- asset-backed commercial paper used by banks and other financial companies to raise money -- struggles to find solid footing. Asset-backed paper outstanding rose by $7.6 billion for the week ending Feb. 27, according to the Federal Reserve. But that hopeful sign followed four prior weeks when debt outstanding shrunk.
The premium companies must pay to issue high-yield bonds has risen to an average of 7.76 percentage points over comparable Treasury bonds, according to Merrill Lynch, up from a gap of 5.92 percentage points at the end of 2007 and just 4.19 percentage points last June.
Meantime, the average yield on a high-quality, tax-free 30-year municipal bond rose to 5.14% last Friday. That was up from 4.25% at the beginning of the year, and well above comparable taxable Treasury bonds -- a historic dislocation.
In addition to lowering interest rates, the Fed has tried to make short-term cash readily available to banks through a mechanism called the Term Auction Facility, in which financial institutions can tap the Fed for cash loans and use a broad array of financial assets as collateral.
Fed officials have indicated that the facility has been a successful tool, and that it is likely to remain in place. It is also possible that the Fed could expand its use of the facility if money market conditions worsen.
Wednesday, March 5, 2008
Financial System faces commodity-led crisis - re-anchor global inflation
The global economy is facing twin shocks. Natural resource markets are delivering a supply shock of 1970s dimensions, while the financial system is delivering a shock comparable to the bank and thrift crises of the 1988-1993 period. The magnitude of each shock is very different. The financial markets require a recapitalisation of the banking system, with estimates ranging from $300bn to $1,000bn.
By contrast, prospective capital requirements in the resource markets dwarf the current needs of the banking system. According to the International Energy Agency, the global energy sector alone needs a real $22,000bn over the next two decades to meet the anticipated rise in primary energy demand. There is also the unavoidable necessity to reduce the CO2 intensity of energy production, a good 80 per cent of which is derived from the dirtiest of fossil fuels. While an accurate quantification of the size of the required green energy investment is not possible, it is likely to be of a similar scale to the expansion of energy supply.
The energy sector is just one example of the more generalised supply problems afflicting the natural resources markets. Scarcity is endemic across most commodity markets, as existing capacity has struggled to meet a demand shock from the rapidly developing middle income economies. Historically low stock-to-consumption ratios show how severely the supply-demand imbalance has eaten into the margins of comfort in many – if not most – commodity markets. Global grain inventories, for example, are at 40-year lows, equivalent to just 15-20 per cent of annual demand. Most industrial metal inventories are at a 30-year trough relative to consumption.
The broad story is of depletion. Most of the easily obtainable resource deposits have already been exploited and most usable agricultural land is already in production. Natural resource discoveries, where they continue to occur, tend to be of a lower quality and are more costly to extract. Meanwhile, the dwindling supply of unutilised land faces competing demands from biodiversity, biofuels and food production.
Predictably, the scale of response to each of these crises is in inverse proportion to their respective magnitude. In the US, the credit crunch has elicited an instantaneous fiscal package to the tune of $168bn, or 1.2 per cent of nominal GDP. In contrast, the latest annual budget appropriation for renewable energy spending is just $1.72bn – 0.01 per cent of GDP.
The US monetary policy response has also focused exclusively on the credit crisis. The more subdued response in Europe shows the European Central Bank and other central banks are opportunistically using the credit crunch to tame incipient inflation. In contrast, the US has chosen to reflate aggressively. The risk that inflation expectations might drag their anchor has been broadly ignored.
The US policy response has reduced the chance of global growth slowing enough to ease the inflation in natural resource prices. A phase of commodity disinflation is what is needed to prevent economic participants from concluding that rising prices are a one way bet. Since the appropriate size of the stimulus cannot be calibrated with any precision, the aggressive reflation runs the risk of providing a monetary accommodation to the inflationary supply shock. Longer term, a more severe contraction in demand is likely to become necessary to re-anchor inflation expectations.
Indeed, in a global economy, where individual central banks’ control over inflation is limited, the costs of re-anchoring straying inflation expectations are likely to be punitive. Even if the stimulus proves insufficient, policymakers will still have sent a strong signal in support of existing price levels. This explicit statement of policy priorities is unlikely to be lost on consumers and businesses.
On cue, since Washington started to ease policy, investor flows into commodities and other real assets have soared. Meanwhile, in spite of the slide into near-recession, forward inflation expectations in the bond market have risen to match the highest levels seen this century. The message is clear enough, but it is unlikely that anyone will pay much attention in an election year.
By contrast, prospective capital requirements in the resource markets dwarf the current needs of the banking system. According to the International Energy Agency, the global energy sector alone needs a real $22,000bn over the next two decades to meet the anticipated rise in primary energy demand. There is also the unavoidable necessity to reduce the CO2 intensity of energy production, a good 80 per cent of which is derived from the dirtiest of fossil fuels. While an accurate quantification of the size of the required green energy investment is not possible, it is likely to be of a similar scale to the expansion of energy supply.
The energy sector is just one example of the more generalised supply problems afflicting the natural resources markets. Scarcity is endemic across most commodity markets, as existing capacity has struggled to meet a demand shock from the rapidly developing middle income economies. Historically low stock-to-consumption ratios show how severely the supply-demand imbalance has eaten into the margins of comfort in many – if not most – commodity markets. Global grain inventories, for example, are at 40-year lows, equivalent to just 15-20 per cent of annual demand. Most industrial metal inventories are at a 30-year trough relative to consumption.
The broad story is of depletion. Most of the easily obtainable resource deposits have already been exploited and most usable agricultural land is already in production. Natural resource discoveries, where they continue to occur, tend to be of a lower quality and are more costly to extract. Meanwhile, the dwindling supply of unutilised land faces competing demands from biodiversity, biofuels and food production.
Predictably, the scale of response to each of these crises is in inverse proportion to their respective magnitude. In the US, the credit crunch has elicited an instantaneous fiscal package to the tune of $168bn, or 1.2 per cent of nominal GDP. In contrast, the latest annual budget appropriation for renewable energy spending is just $1.72bn – 0.01 per cent of GDP.
The US monetary policy response has also focused exclusively on the credit crisis. The more subdued response in Europe shows the European Central Bank and other central banks are opportunistically using the credit crunch to tame incipient inflation. In contrast, the US has chosen to reflate aggressively. The risk that inflation expectations might drag their anchor has been broadly ignored.
The US policy response has reduced the chance of global growth slowing enough to ease the inflation in natural resource prices. A phase of commodity disinflation is what is needed to prevent economic participants from concluding that rising prices are a one way bet. Since the appropriate size of the stimulus cannot be calibrated with any precision, the aggressive reflation runs the risk of providing a monetary accommodation to the inflationary supply shock. Longer term, a more severe contraction in demand is likely to become necessary to re-anchor inflation expectations.
Indeed, in a global economy, where individual central banks’ control over inflation is limited, the costs of re-anchoring straying inflation expectations are likely to be punitive. Even if the stimulus proves insufficient, policymakers will still have sent a strong signal in support of existing price levels. This explicit statement of policy priorities is unlikely to be lost on consumers and businesses.
On cue, since Washington started to ease policy, investor flows into commodities and other real assets have soared. Meanwhile, in spite of the slide into near-recession, forward inflation expectations in the bond market have risen to match the highest levels seen this century. The message is clear enough, but it is unlikely that anyone will pay much attention in an election year.
what did McCain Say in his rally
“We’re the world’s leader, and leaders don’t pine for the past and dread the future,” he told supporters. “We make the future better than the past. We don’t hide from history. We make history.”
Staples Feels Pinch, Cuts oulook
Staples Inc.'s fiscal fourth-quarter profit fell 1%, and the office-products retailer cut its full-year outlook, citing the challenging economic climate.
The Framingham, Mass., office-products retailer expects negative same-store sales to continue well into 2008, with the second half of the year expected to be a little better than the first half, executives said.
The impact of a slowing economy seemed to accelerate in the fourth quarter, when customer traffic in stores fell 6% and was "particularly bad" in December, the CEO said. "January was better, but traffic remains choppy," he said.
Sales of computers and supplies for printers and copiers were among the strongest product categories, while sales of furniture and business machines were weak.
Same-store sales, or sales at stores open more than a year, declined 6% in North America and 1% in Europe. The company had expected flat to slightly negative same-store sales.
The company now expects full-year earnings per share to grow in the high-single percentage digits on sales growth in the midsingle digits. The company had expected earnings growth in the low teens and sales growth in the high-single digits. The mean forecast by analysts surveyed by Thomson Financial was for per-share earnings growth of 11% to $1.42, on a 7% sales increase to $19.41 billion.
The Framingham, Mass., office-products retailer expects negative same-store sales to continue well into 2008, with the second half of the year expected to be a little better than the first half, executives said.
The impact of a slowing economy seemed to accelerate in the fourth quarter, when customer traffic in stores fell 6% and was "particularly bad" in December, the CEO said. "January was better, but traffic remains choppy," he said.
Sales of computers and supplies for printers and copiers were among the strongest product categories, while sales of furniture and business machines were weak.
Same-store sales, or sales at stores open more than a year, declined 6% in North America and 1% in Europe. The company had expected flat to slightly negative same-store sales.
The company now expects full-year earnings per share to grow in the high-single percentage digits on sales growth in the midsingle digits. The company had expected earnings growth in the low teens and sales growth in the high-single digits. The mean forecast by analysts surveyed by Thomson Financial was for per-share earnings growth of 11% to $1.42, on a 7% sales increase to $19.41 billion.
municipalities face double whammy
Still reeling from soaring funding costs and a shrinking revenue base, some municipal governments are facing loss in their swap deals.
Over the past month, public-sector issuers in the U.S., from health care to utilities, have endured a painful spike in their borrowing costs in the $500 billion market for variable-rate demand obligations, or VRDOs. The market allows long-dated tax-free municipal debt to behave like short-term paper with slightly more attractive yields, making it more attractive for investors.
Now, some issuers are finding that the very contracts they entered to offset these costs, in the derivatives markets and with bond insurers, aren't only failing them but will be near-impossible to exit without taking crushing losses.
Jefferson County, Ala., is the first to show the strain, as Standard and Poor's last week cut ratings on its sewer-revenue debt by six notches into junk territory, owing to "significant increased interest rate costs."
The county is now underwater in its swaps transactions to the tune of around $360 million, according to S&P.
"Those guys are getting royally smoked," said Doug Dachille, chief executive of bond asset manager First Principles.
Many municipal borrowers used the interest-rate-swaps market to lower their financial costs even more. They would cover their floating-rate fees on VRDOs cheaply by paying a counterparty a fixed rate in return for a stream of payments, often set around 67% of the benchmark one-month lending rate for banks, known as the London Interbank Offered Rate. This rate hasn't come close to keeping up with the recent spike in VRDO rates. In fact, it has dropped, in line with aggressive Federal Reserve rate cuts. That means these public-sector issuers must pay bondholders much more than they are getting out of the fixed-rate swap.
To make matters worse for Jefferson County, its ratings downgrade means it must post more collateral to the banks on the other side of its swaps agreement.
According to documents published by Jefferson County detailing its financial straits, the local government entered into 13 swap agreements with Bank of America, Bear Stearns, J.P.Morgan and Lehman Brothers for a notional amount of $5.4 billion.
The rapid-fire downgrades by S&P and Moody's Investors Service triggered protective provisions for the banks. Under the agreements, the county's shakier credit rating obliges it to post $184 million in additional collateral by Friday.
This is money the county doesn't have. According to Moody's, Jefferson has roughly $193 million in available cash, but it faces higher financing costs on another type of debt instrument, auction-rate securities, which have fallen on hard times.
This could be the start of a nasty cycle for state finances already strained by the ailing housing market and threat of recession. It looks like even their funding sources could take chunks out of their budget.
And the solution isn't as simple as canceling the swaps contracts.
"Your VRDO's bleeding you slowly, but terminating that swap will bleed you quickly," said Jeff Previdi, ratings analyst at Standard & Poor's.
Cancellation would mean an immediate upfront loss that would go straight onto the issuers' books and would look particularly ugly next to the shortfalls already being taken into account; among those are possible shrinking revenues as the subprime-mortgage fallout spreads.
Exiting the VRDO is no easier and would come with write-downs of its own. Municipal issuers widely use bond insurers as guarantors to further lighten their funding loads. Canceling their contracts with the insurers would force issuers to surrender those upfront fees, too.
Over the past month, public-sector issuers in the U.S., from health care to utilities, have endured a painful spike in their borrowing costs in the $500 billion market for variable-rate demand obligations, or VRDOs. The market allows long-dated tax-free municipal debt to behave like short-term paper with slightly more attractive yields, making it more attractive for investors.
Now, some issuers are finding that the very contracts they entered to offset these costs, in the derivatives markets and with bond insurers, aren't only failing them but will be near-impossible to exit without taking crushing losses.
Jefferson County, Ala., is the first to show the strain, as Standard and Poor's last week cut ratings on its sewer-revenue debt by six notches into junk territory, owing to "significant increased interest rate costs."
The county is now underwater in its swaps transactions to the tune of around $360 million, according to S&P.
"Those guys are getting royally smoked," said Doug Dachille, chief executive of bond asset manager First Principles.
Many municipal borrowers used the interest-rate-swaps market to lower their financial costs even more. They would cover their floating-rate fees on VRDOs cheaply by paying a counterparty a fixed rate in return for a stream of payments, often set around 67% of the benchmark one-month lending rate for banks, known as the London Interbank Offered Rate. This rate hasn't come close to keeping up with the recent spike in VRDO rates. In fact, it has dropped, in line with aggressive Federal Reserve rate cuts. That means these public-sector issuers must pay bondholders much more than they are getting out of the fixed-rate swap.
To make matters worse for Jefferson County, its ratings downgrade means it must post more collateral to the banks on the other side of its swaps agreement.
According to documents published by Jefferson County detailing its financial straits, the local government entered into 13 swap agreements with Bank of America, Bear Stearns, J.P.Morgan and Lehman Brothers for a notional amount of $5.4 billion.
The rapid-fire downgrades by S&P and Moody's Investors Service triggered protective provisions for the banks. Under the agreements, the county's shakier credit rating obliges it to post $184 million in additional collateral by Friday.
This is money the county doesn't have. According to Moody's, Jefferson has roughly $193 million in available cash, but it faces higher financing costs on another type of debt instrument, auction-rate securities, which have fallen on hard times.
This could be the start of a nasty cycle for state finances already strained by the ailing housing market and threat of recession. It looks like even their funding sources could take chunks out of their budget.
And the solution isn't as simple as canceling the swaps contracts.
"Your VRDO's bleeding you slowly, but terminating that swap will bleed you quickly," said Jeff Previdi, ratings analyst at Standard & Poor's.
Cancellation would mean an immediate upfront loss that would go straight onto the issuers' books and would look particularly ugly next to the shortfalls already being taken into account; among those are possible shrinking revenues as the subprime-mortgage fallout spreads.
Exiting the VRDO is no easier and would come with write-downs of its own. Municipal issuers widely use bond insurers as guarantors to further lighten their funding loads. Canceling their contracts with the insurers would force issuers to surrender those upfront fees, too.
World Feds policy may converge
Among the world's major central banks, the Federal Reserve looks as out-of-place as a person showing up to a black-tie affair in a Halloween costume.
Since September, the Fed has slashed its federal-funds-rate target by 2½ percentage points to 3%, as aggressive as its cuts going into the 2001 recession.
Other central bankers have been loath to follow the Fed's lead. The Bank of England has cut its target rate just twice since December, by just a half percentage point in total. The European Central Bank and the Bank of Japan haven't touched rates since credit problems emerged last year. The Reserve Bank of Australia has been raising rates, with the most recent increase coming yesterday.
Canada's central bank cut its official interest rate by a half percentage point yesterday, to 3.5%, and indicated further rate cuts could be necessary to deal with the fallout from a deteriorating U.S. economy. Canada's major banks were expected to lower their prime rates in response to the Bank of Canada's action, but it wasn't clear when they would act. Canadian banks typically follow the central bank's rate cuts within an hour or so, but they didn't move yesterday.
ECB and Bank of England policy makers meet this week and are expected to keep rates unchanged. Despite signs of economic weakness, inflation in Europe and the United Kingdom has been high, making them reluctant to pursue stimulative rate cuts.
Why the disconnect? The Fed might be on the wrong course. Many complain its easy-money policy is fueling global commodity inflation, making it harder for other central banks to do their jobs.
Another possibility is that other nations are insulated from America's woes and are correctly staying out of the U.S. turmoil. If the global economy was really slowing, this argument goes, commodity prices would be falling, not soaring.
A third possibility, and probably the most likely, is that the rest of the world will eventually have to catch up to the Fed. The Australian central bank, even as it raised interest rates, noted tighter credit conditions and softer business and consumer sentiment in commodity-rich Australia and warned that "global growth will be below trend in 2008." Canada's central bank has also gotten into the rate-cutting act, saying the U.S. slump would have "significant spillover effects on the global economy."
Central bank easing policies will eventually converge, says Lena Komileva, Group-of-Seven economist at Tullett Prebon. The slow response of others means their economies might keep slowing even after a U.S. recovery sets in.
Since September, the Fed has slashed its federal-funds-rate target by 2½ percentage points to 3%, as aggressive as its cuts going into the 2001 recession.
Other central bankers have been loath to follow the Fed's lead. The Bank of England has cut its target rate just twice since December, by just a half percentage point in total. The European Central Bank and the Bank of Japan haven't touched rates since credit problems emerged last year. The Reserve Bank of Australia has been raising rates, with the most recent increase coming yesterday.
Canada's central bank cut its official interest rate by a half percentage point yesterday, to 3.5%, and indicated further rate cuts could be necessary to deal with the fallout from a deteriorating U.S. economy. Canada's major banks were expected to lower their prime rates in response to the Bank of Canada's action, but it wasn't clear when they would act. Canadian banks typically follow the central bank's rate cuts within an hour or so, but they didn't move yesterday.
ECB and Bank of England policy makers meet this week and are expected to keep rates unchanged. Despite signs of economic weakness, inflation in Europe and the United Kingdom has been high, making them reluctant to pursue stimulative rate cuts.
Why the disconnect? The Fed might be on the wrong course. Many complain its easy-money policy is fueling global commodity inflation, making it harder for other central banks to do their jobs.
Another possibility is that other nations are insulated from America's woes and are correctly staying out of the U.S. turmoil. If the global economy was really slowing, this argument goes, commodity prices would be falling, not soaring.
A third possibility, and probably the most likely, is that the rest of the world will eventually have to catch up to the Fed. The Australian central bank, even as it raised interest rates, noted tighter credit conditions and softer business and consumer sentiment in commodity-rich Australia and warned that "global growth will be below trend in 2008." Canada's central bank has also gotten into the rate-cutting act, saying the U.S. slump would have "significant spillover effects on the global economy."
Central bank easing policies will eventually converge, says Lena Komileva, Group-of-Seven economist at Tullett Prebon. The slow response of others means their economies might keep slowing even after a U.S. recovery sets in.
Tuesday, March 4, 2008
top hedge fund list - JPM Chase remains the biggest
--J.P. Morgan Chase & Co. remains the biggest U.S. hedge-fund manager as total assets of the biggest hedge fund firms topped $1.6 trillion as of Jan. 1.
--Assets of the biggest hedge funds increased 34% in 2007 although three of the 10 largest hedge fund firms lost $24 billion in assets during the second half of the year, according to a new biannual survey published by Absolute Return magazine, a unit of HedgeFund Intelligence.
--Since July, Goldman Sachs Group, J.P. Morgan and D.E. Shaw all lost hedge fund assets.
Paulson & Co. and Avenue Capital Group joined the top 10 firms, replacing Tudor and ESL Investments Inc., run by Sears Holdings Corp. Chairman Edward S. Lampert.
Assets of the 262 hedge fund firms that manage $1 billion or more increased by $407 billion, or 34%. That's $60 billion more than their gain in 2006 and greater than any one-year increase since Absolute Return began tracking industry assets in 2003.
During the second half of the year, fund assets increased by 10%, the smallest half-year increase since the survey began.
J,P. Morgan hedge funds had $44.7 billion in assets, down 20% from $56.2 billion in July but up 24% from the total in January 2007.
J.P. Morgan's assets are $8.7 billion higher than the second- and third-place firms: Bridgewater Associates and Farallon Capital Management -- both of which manage $36 billion.
Renaissance Technologies rose to fourth place with $34 billion, a 42% jump, while Och-Ziff
Capital Management rose one spot to fifth place, with $33.2 billion, up 58%.
Paulson joined the top 10 for the first time after its assets quadrupled in 2007 to end the year at $29 billion.
The biggest loser of 2007 was Goldman Sachs Asset Management, which fell to seventh place from second as assets dropped 27% in the second half to end the year at $29.20 billion. D.E. Shaw fell to sixth place, from third.
--Assets of the biggest hedge funds increased 34% in 2007 although three of the 10 largest hedge fund firms lost $24 billion in assets during the second half of the year, according to a new biannual survey published by Absolute Return magazine, a unit of HedgeFund Intelligence.
--Since July, Goldman Sachs Group, J.P. Morgan and D.E. Shaw all lost hedge fund assets.
Paulson & Co. and Avenue Capital Group joined the top 10 firms, replacing Tudor and ESL Investments Inc., run by Sears Holdings Corp. Chairman Edward S. Lampert.
Assets of the 262 hedge fund firms that manage $1 billion or more increased by $407 billion, or 34%. That's $60 billion more than their gain in 2006 and greater than any one-year increase since Absolute Return began tracking industry assets in 2003.
During the second half of the year, fund assets increased by 10%, the smallest half-year increase since the survey began.
J,P. Morgan hedge funds had $44.7 billion in assets, down 20% from $56.2 billion in July but up 24% from the total in January 2007.
J.P. Morgan's assets are $8.7 billion higher than the second- and third-place firms: Bridgewater Associates and Farallon Capital Management -- both of which manage $36 billion.
Renaissance Technologies rose to fourth place with $34 billion, a 42% jump, while Och-Ziff
Capital Management rose one spot to fifth place, with $33.2 billion, up 58%.
Paulson joined the top 10 for the first time after its assets quadrupled in 2007 to end the year at $29 billion.
The biggest loser of 2007 was Goldman Sachs Asset Management, which fell to seventh place from second as assets dropped 27% in the second half to end the year at $29.20 billion. D.E. Shaw fell to sixth place, from third.
Swap Skirmish: Risks Hidden, Says Hedge Fund
As financial markets boomed in recent years, some Wall Street players began selling insurance against things going wrong, in what looked like prudence.
It wasn't.
In separate lawsuits filed in a New York federal court, a $58-million-asset hedge fund alleges that Citigroup Inc. and Wachovia Corp., respectively, improperly required the fund to pay out more money from insurance derivatives contracts known as "credit default swaps" amid a steep decline in the value of mortgage-backed bonds.
The hedge-fund manager says he didn't view the insurance-related trades as particularly risky and now says he feels "suckered." Citigroup and Wachovia each say the fund's claims are "without merit."
Meantime, other financial players say they have been stiff-armed by trading partners when they've tried to cash out on profits from such insurance-related transactions. In one instance, a hedge-fund manager says he was blocked from selling out of a swap position, unless he made another credit-default swap trade.
The skirmishes signal cracks in the vast and unregulated market for such credit default swaps, where banks, hedge funds and others trade insurance against debt defaults. In these swaps, one party pays another to assume the risk that a bond or loan will go bad. The market for such swaps has soared to nearly $45 trillion, a number comparable to all the bank deposits world-wide, according to the International Swaps and Derivatives Association, or ISDA, a trade group.
Hedge funds have played both sides of this market -- in some cases buying this insurance and cashing in when mortgage bonds faltered, and in other cases, selling insurance to other players.
Not everyone who buys these contracts has bonds to insure; because the value of an insurance contract rises or falls with perceptions of risk, they are also bought as a speculation. If the value of the debt changes, parties in a swap may be required to make large payments to each other. Now it looks like reckoning day for some of the speculators.
Deep problems already have emerged in the role of traditional bond-insurance companies such as MBIA Inc. and Ambac Financial Group Inc. involving these contracts. They wrote guarantees on billions of dollars in complex mortgage securities. Such bond insurers in recent years represented a small but psychologically important part of the credit-derivative market, comprising 8% of the sellers of credit protection, according to estimates from the British Bankers Association.
But hedge funds are an even bigger player in this arena. Hedge funds provided roughly one-third of trading volume in all credit derivatives in 2006 -- up tenfold from 2000, the BBA says. And hedge funds accounted for 60% in credit-default-swap trading in high-grade debt and 80% in low-grade debt in the 12 months ending April 2007, Greenwich Associates estimates.
During the credit bubble, even small hedge funds made speculative bets by selling big banks insurance protection on mortgage-backed bonds. Banks bought the protection, reckoning it wouldn't be needed.
"The problem with banks and brokers buying credit protection from hedge funds is that you just don't know when they are going to go dark, turn out the lights and say this is now the brokers' problem," says David Lippman, a managing director of Metropolitan West Asset Management, a bond manager in Los Angeles.
Unlike most other big players in the swaps market, hedge funds aren't subject to heavy oversight by regulators or capital requirements. Financial firms usually guard against the risk of their hedge-fund trading partners being unable to pay by requiring they put up cash or collateral for their swap trades.
The legal cases underline the gridlock that can emerge when such insurance agreements break down. One suit, filed Feb. 14, outlines a credit-default-swap agreement in which Citigroup bought $10 million of protection against a security backed by subprime-mortgage assets from a small Florida hedge fund with just $58 million in capital. The security was a "collateralized debt obligation," known as a CDO, or a thinly traded investment that packages pools of loans.
The fund -- VCG Special Opportunities Master Fund Ltd., which is owned by an investment firm that also owns a Puerto Rican investment bank -- alleges that Citigroup breached its contract after the bank demanded the fund post additional collateral. By this January, the hedge fund says, the collateral Citi sought from it nearly equaled the $10 million "notional," or underlying, amount of the swap.
The hedge fund entered into a credit default swap with Wachovia under which the bank bought protection on a $10 million security issued by a CDO, which had a credit rating of double-A and was issued in April 2007.
Over the next several months as the mortgage market swooned, Wachovia repeatedly demanded the hedge fund -- which had put up an initial $750,000 -- deposit additional collateral for the swap. The hedge fund said in the suit it made more than a dozen additional payments, totaling roughly $8.2 million. In late November, Wachovia requested still more margin, which the fund said brought the total it was asked to fork out to $10.4 million.
The hedge fund refused to pay the final request for collateral of $1.49 million, and Wachovia foreclosed on the fund's nearly $9 million in collateral, meaning the hedge fund got stuck with the losses. "We are concerned that Citi and Wachovia are attempting to take advantage of smaller hedge funds to seek return of capital...to minimize their own exposure in the marketplace," says Steven Mintz, a lawyer for the fund.
Donald Uderitz, the hedge fund's manager, says he believed there was little likelihood of having to pay out insurance to cover losses from the CDO. In an interview, he says he bought the investment to earn the fees the banks would pay the hedge fund, equal to 5.5% of the $10 million notional amount of the swap from Citigroup and 2.75% from Wachovia. Mr. Uderitz says he feels "suckered."
Citigroup and Wachovia say they did nothing wrong and are fighting the suits.
Some other hedge-fund managers say they've been bullied by securities firms when they've tried to cash out on profits from such positions. When one hedge-fund manager considered selling out of a credit-default swap -- in which his fund bought protection on $10 million of bonds of Countrywide Financial Corp. -- he says there was a condition attached by two securities firms. He says the firms -- Bear Stearns Cos., which sold him the swap, and Morgan Stanley -- told him they would cash him out of his profitable position, only if he would simultaneously enter into another swap-selling insurance protection on the bonds equal to his fund's $3 million profit. Eventually, he says, his fund sold the position through Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc., allowing him to book the $3 million profit.
It wasn't.
In separate lawsuits filed in a New York federal court, a $58-million-asset hedge fund alleges that Citigroup Inc. and Wachovia Corp., respectively, improperly required the fund to pay out more money from insurance derivatives contracts known as "credit default swaps" amid a steep decline in the value of mortgage-backed bonds.
The hedge-fund manager says he didn't view the insurance-related trades as particularly risky and now says he feels "suckered." Citigroup and Wachovia each say the fund's claims are "without merit."
Meantime, other financial players say they have been stiff-armed by trading partners when they've tried to cash out on profits from such insurance-related transactions. In one instance, a hedge-fund manager says he was blocked from selling out of a swap position, unless he made another credit-default swap trade.
The skirmishes signal cracks in the vast and unregulated market for such credit default swaps, where banks, hedge funds and others trade insurance against debt defaults. In these swaps, one party pays another to assume the risk that a bond or loan will go bad. The market for such swaps has soared to nearly $45 trillion, a number comparable to all the bank deposits world-wide, according to the International Swaps and Derivatives Association, or ISDA, a trade group.
Hedge funds have played both sides of this market -- in some cases buying this insurance and cashing in when mortgage bonds faltered, and in other cases, selling insurance to other players.
Not everyone who buys these contracts has bonds to insure; because the value of an insurance contract rises or falls with perceptions of risk, they are also bought as a speculation. If the value of the debt changes, parties in a swap may be required to make large payments to each other. Now it looks like reckoning day for some of the speculators.
Deep problems already have emerged in the role of traditional bond-insurance companies such as MBIA Inc. and Ambac Financial Group Inc. involving these contracts. They wrote guarantees on billions of dollars in complex mortgage securities. Such bond insurers in recent years represented a small but psychologically important part of the credit-derivative market, comprising 8% of the sellers of credit protection, according to estimates from the British Bankers Association.
But hedge funds are an even bigger player in this arena. Hedge funds provided roughly one-third of trading volume in all credit derivatives in 2006 -- up tenfold from 2000, the BBA says. And hedge funds accounted for 60% in credit-default-swap trading in high-grade debt and 80% in low-grade debt in the 12 months ending April 2007, Greenwich Associates estimates.
During the credit bubble, even small hedge funds made speculative bets by selling big banks insurance protection on mortgage-backed bonds. Banks bought the protection, reckoning it wouldn't be needed.
"The problem with banks and brokers buying credit protection from hedge funds is that you just don't know when they are going to go dark, turn out the lights and say this is now the brokers' problem," says David Lippman, a managing director of Metropolitan West Asset Management, a bond manager in Los Angeles.
Unlike most other big players in the swaps market, hedge funds aren't subject to heavy oversight by regulators or capital requirements. Financial firms usually guard against the risk of their hedge-fund trading partners being unable to pay by requiring they put up cash or collateral for their swap trades.
The legal cases underline the gridlock that can emerge when such insurance agreements break down. One suit, filed Feb. 14, outlines a credit-default-swap agreement in which Citigroup bought $10 million of protection against a security backed by subprime-mortgage assets from a small Florida hedge fund with just $58 million in capital. The security was a "collateralized debt obligation," known as a CDO, or a thinly traded investment that packages pools of loans.
The fund -- VCG Special Opportunities Master Fund Ltd., which is owned by an investment firm that also owns a Puerto Rican investment bank -- alleges that Citigroup breached its contract after the bank demanded the fund post additional collateral. By this January, the hedge fund says, the collateral Citi sought from it nearly equaled the $10 million "notional," or underlying, amount of the swap.
The hedge fund entered into a credit default swap with Wachovia under which the bank bought protection on a $10 million security issued by a CDO, which had a credit rating of double-A and was issued in April 2007.
Over the next several months as the mortgage market swooned, Wachovia repeatedly demanded the hedge fund -- which had put up an initial $750,000 -- deposit additional collateral for the swap. The hedge fund said in the suit it made more than a dozen additional payments, totaling roughly $8.2 million. In late November, Wachovia requested still more margin, which the fund said brought the total it was asked to fork out to $10.4 million.
The hedge fund refused to pay the final request for collateral of $1.49 million, and Wachovia foreclosed on the fund's nearly $9 million in collateral, meaning the hedge fund got stuck with the losses. "We are concerned that Citi and Wachovia are attempting to take advantage of smaller hedge funds to seek return of capital...to minimize their own exposure in the marketplace," says Steven Mintz, a lawyer for the fund.
Donald Uderitz, the hedge fund's manager, says he believed there was little likelihood of having to pay out insurance to cover losses from the CDO. In an interview, he says he bought the investment to earn the fees the banks would pay the hedge fund, equal to 5.5% of the $10 million notional amount of the swap from Citigroup and 2.75% from Wachovia. Mr. Uderitz says he feels "suckered."
Citigroup and Wachovia say they did nothing wrong and are fighting the suits.
Some other hedge-fund managers say they've been bullied by securities firms when they've tried to cash out on profits from such positions. When one hedge-fund manager considered selling out of a credit-default swap -- in which his fund bought protection on $10 million of bonds of Countrywide Financial Corp. -- he says there was a condition attached by two securities firms. He says the firms -- Bear Stearns Cos., which sold him the swap, and Morgan Stanley -- told him they would cash him out of his profitable position, only if he would simultaneously enter into another swap-selling insurance protection on the bonds equal to his fund's $3 million profit. Eventually, he says, his fund sold the position through Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc., allowing him to book the $3 million profit.
Fannie, Freddie Set Stricter Appraisal Rules
Fannie Mae and Freddie Mac announced an agreement with New York Attorney General Andrew Cuomo to discourage inflated appraisals by enforcing new standards in the home-mortgage market.
Seeking to head off the threat of lawsuits from Mr. Cuomo, the two government-sponsored providers of funding for mortgage loans agreed to a code of conduct due to take effect next Jan. 1. Because Fannie and Freddie are the dominant sources of funds for home loans, the code will become an effective standard for the industry.
The code bars lenders and their representatives from pressuring appraisers to supply inflated estimates of property values, which are widely viewed as an important contributor to the mortgage crisis. Appraisers have long complained that they risked losing business if they didn't appraise homes at values that would allow loans to be made.
Bank employees who are involved in making loans won't be allowed to choose appraisers. And lenders won't be able to make loans on the basis of appraisals from their own employees or from other companies they control.
The code also bars lenders from using appraisals ordered by mortgage brokers. The National Association of Mortgage Brokers said that rule could drive many brokers out of business. Officials of the trade group said appraisals ordered by brokers sometimes can be used for more than one potential lender, giving the consumer more flexibility. Under the new code, they said, consumers who use brokers might end up paying for two appraisals. Mr. Cuomo said he didn't believe the code would hurt brokers who follow "legitimate" practices.
An inflated appraisal can cause lenders to advance more money than a house is worth, exposing both lender and borrower to losses, especially when home prices fall.
Seeking to head off the threat of lawsuits from Mr. Cuomo, the two government-sponsored providers of funding for mortgage loans agreed to a code of conduct due to take effect next Jan. 1. Because Fannie and Freddie are the dominant sources of funds for home loans, the code will become an effective standard for the industry.
The code bars lenders and their representatives from pressuring appraisers to supply inflated estimates of property values, which are widely viewed as an important contributor to the mortgage crisis. Appraisers have long complained that they risked losing business if they didn't appraise homes at values that would allow loans to be made.
Bank employees who are involved in making loans won't be allowed to choose appraisers. And lenders won't be able to make loans on the basis of appraisals from their own employees or from other companies they control.
The code also bars lenders from using appraisals ordered by mortgage brokers. The National Association of Mortgage Brokers said that rule could drive many brokers out of business. Officials of the trade group said appraisals ordered by brokers sometimes can be used for more than one potential lender, giving the consumer more flexibility. Under the new code, they said, consumers who use brokers might end up paying for two appraisals. Mr. Cuomo said he didn't believe the code would hurt brokers who follow "legitimate" practices.
An inflated appraisal can cause lenders to advance more money than a house is worth, exposing both lender and borrower to losses, especially when home prices fall.
Monday, March 3, 2008
how big are petrodollars
How big are petrodollars? They are big and getting bigger with the rise of oil prices. We can look at this in terms of the financial worth of the stocks of proven oil reserves underground, or in terms of flows – ie the value of the annual oil exports. At $100 a barrel, the total proven reserves of the oil exporting countries is about $104,000bn – equivalent to the combined total value of publicly-traded equities and bonds in the world. About $48,000bn of this belongs to the Gulf Co-operation Council member countries – which include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. The rest of Opec owns another $44,000bn, while non-Opec countries (Canada, Norway, Mexico and Russia) own some $12,000bn worth of oil reserves.
The flows are massive too. At the current pace of production and exports, and at $100 a barrel, collectively, oil exporters are projected to earn a total of $2,100bn in oil export receipts annually.
Such large windfall receipts/profits could in theory be invested in domestic physical infrastructure. However, the size of the GDP of most of these oil exporters is relatively modest. What would be considered ‘significant’ investment, equivalent to 5-10 per cent of GDP, would amount to only about 5-10 per cent of their annual oil revenues. Thus, the bulk of the petrodollar windfalls for most oil-exporting countries will still not be spent, but will be saved and deployed in the global financial markets.
There are two key implications. First, the deployment of petrodollars is likely to favour equities over bonds. Second, they should favour emerging market currencies at the expense of both the dollar and the euro. These two themes are identical to the financial market implications of the emergence of Sovereign Wealth Funds, because about half of the petrodollar receipts may be invested through SWFs, and close to three-quarters of all assets under management by SWFs are derived from petrodollars.
Thus, from the perspective of maximising the risk-adjusted long-term return on the combined underground wealth (crude oil) and above-ground wealth (financial assets), an exporter should be expected to embark on a multi-generational transformation from crude oil to equities.
At the same time, if we assume that SWF/petrodollar portfolios have benchmarks of 25:45:30 on bonds, equities, and alternative investments, the currency composition of these portfolios will look significantly different from that of the official reserves. In fact, some 95 per cent of the world’s official reserves are held in only three currencies: the dollar, the euro and the pound.
While many observers focus on the shift in reserves between dollars and euros, the deployment of petrodollar investments will in fact likely tilt the balance in favour of emerging market currencies, at the expense of both the dollar and the euro. Specifically, we calculate that the theoretical share of emerging market assets in total petrodollar portfolios could be as high as 25 per cent, compared with the current exposure of official reserves to emerging market currencies of zero.
The flows are massive too. At the current pace of production and exports, and at $100 a barrel, collectively, oil exporters are projected to earn a total of $2,100bn in oil export receipts annually.
Such large windfall receipts/profits could in theory be invested in domestic physical infrastructure. However, the size of the GDP of most of these oil exporters is relatively modest. What would be considered ‘significant’ investment, equivalent to 5-10 per cent of GDP, would amount to only about 5-10 per cent of their annual oil revenues. Thus, the bulk of the petrodollar windfalls for most oil-exporting countries will still not be spent, but will be saved and deployed in the global financial markets.
There are two key implications. First, the deployment of petrodollars is likely to favour equities over bonds. Second, they should favour emerging market currencies at the expense of both the dollar and the euro. These two themes are identical to the financial market implications of the emergence of Sovereign Wealth Funds, because about half of the petrodollar receipts may be invested through SWFs, and close to three-quarters of all assets under management by SWFs are derived from petrodollars.
Thus, from the perspective of maximising the risk-adjusted long-term return on the combined underground wealth (crude oil) and above-ground wealth (financial assets), an exporter should be expected to embark on a multi-generational transformation from crude oil to equities.
At the same time, if we assume that SWF/petrodollar portfolios have benchmarks of 25:45:30 on bonds, equities, and alternative investments, the currency composition of these portfolios will look significantly different from that of the official reserves. In fact, some 95 per cent of the world’s official reserves are held in only three currencies: the dollar, the euro and the pound.
While many observers focus on the shift in reserves between dollars and euros, the deployment of petrodollar investments will in fact likely tilt the balance in favour of emerging market currencies, at the expense of both the dollar and the euro. Specifically, we calculate that the theoretical share of emerging market assets in total petrodollar portfolios could be as high as 25 per cent, compared with the current exposure of official reserves to emerging market currencies of zero.
幸福
吉尔伯特2006年曾出版了一本叫《跋涉于幸福之上》的书，书中提及，当面对一个不二选择时，相比较还有其他选择的情况，人们往往在面对前者的结果时会更为开心。“恋爱与婚姻的区别正在于此。”吉尔伯特如是说。
在现实生活中，绝大部分情况下，正如吉尔伯特所说，“我们没有选择的道路在我们生活中消失的速度比我们想象的要快许多。”
所以，“当我们展望未来时，不要太相信自己的主观能动性。当然这并不意味着它永远是错的，只是不要太依赖于它。多停留，多问问，对你总没坏处。”这就是吉尔伯特所得出的结论。
在现实生活中，绝大部分情况下，正如吉尔伯特所说，“我们没有选择的道路在我们生活中消失的速度比我们想象的要快许多。”
所以，“当我们展望未来时，不要太相信自己的主观能动性。当然这并不意味着它永远是错的，只是不要太依赖于它。多停留，多问问，对你总没坏处。”这就是吉尔伯特所得出的结论。
Spreads on Consumer ABS
--Yields on three-year, AAA rated credit-card bonds withfloating rates rose to 75 basis points over the London interbank offered rate, up from 40 basis points at the start of the year,according to Deutsche Bank AG data. Spreads over three-year swaprates for three-year, AAA rated fixed-rate auto-loan securitiesrose to 140 basis points, up from 75 basis points. The averagespread over U.S. Treasuries on AAA rated commercial-mortgagesecurities climbed to 364 basis points, from 167 basis points onDec. 31, according to Lehman Brothers Holdings Inc. index data. A basis point is 0.01 percentage point.
--Spreads on European securities also jumped again last month,according to a Merrill Lynch & Co. report today. Reaching newhighs were: AAA bonds comprised of U.K. prime mortgages, creditcards, and commercial mortgages; Dutch home mortgages; and``eurozone'' auto loans. Some spreads were in or near``improbable three-digit territory,'' compared with less than 25basis points a year earlier, the report said. The widening has been ``in almost complete disregard for credit fundamentals in Europe,'' analysts including Altynay
--Spreads on European securities also jumped again last month,according to a Merrill Lynch & Co. report today. Reaching newhighs were: AAA bonds comprised of U.K. prime mortgages, creditcards, and commercial mortgages; Dutch home mortgages; and``eurozone'' auto loans. Some spreads were in or near``improbable three-digit territory,'' compared with less than 25basis points a year earlier, the report said. The widening has been ``in almost complete disregard for credit fundamentals in Europe,'' analysts including Altynay
Curbing Inflation of Yuan
--The yuan has gained almost 3 percent this year versus the dollar after climbing 7 percent last year. Gains by theurrency help curb inflation by cutting import prices and making China's exports more expensive, helping to staunch thenflows of trade cash that threaten to stoke price increases.
--Economists are split on whether policy makers will raisenterest rates in 2008, with forecasts ranging from noncreases to four. Alternative tools include boosting bankeserve requirements, already at a record high.
--Li, the former party chief of northeastern Liaoningrovince, is being groomed to replace President Hu Jintao in five years, the academics say. They say former Guangdong party secretary Zhang Dejiang, 61, may become a vice premier with aneconomic policy role, also under Li's oversight, and Ma Kai,61, the head of China's economic planning agency, may become secretary general of the State Council, China's cabinet.
--The failure to tame a surge in food prices since last yearhas led to stampedes, injuries and deaths at shops sellingdiscounted cooking oil, rice and eggs, illustrating the toll onthe 300 million Chinese estimated by the World Bank to beliving in poverty.
--Economists are split on whether policy makers will raisenterest rates in 2008, with forecasts ranging from noncreases to four. Alternative tools include boosting bankeserve requirements, already at a record high.
--Li, the former party chief of northeastern Liaoningrovince, is being groomed to replace President Hu Jintao in five years, the academics say. They say former Guangdong party secretary Zhang Dejiang, 61, may become a vice premier with aneconomic policy role, also under Li's oversight, and Ma Kai,61, the head of China's economic planning agency, may become secretary general of the State Council, China's cabinet.
--The failure to tame a surge in food prices since last yearhas led to stampedes, injuries and deaths at shops sellingdiscounted cooking oil, rice and eggs, illustrating the toll onthe 300 million Chinese estimated by the World Bank to beliving in poverty.
SS's VIE exposure
--The 2007 annual report of the State Street Corporation, a Boston bank, is a model of what disclosures should be, in laying out the risks of some special purpose entities it set up to hold assets. Those entities, known as conduits, borrowed money to pay for the assets, with State Street promising to come up with the cash if the conduits could not find other lenders.
In the report, State Street explains why it has not taken any write-off on those conduits, which contain $28.8 billion in what the bank believes to be high-quality assets.
--It can avoid consolidation because other investors would suffer the first $32 million of losses — about one-tenth of 1 percent of the assets. After that, State Street would be on the hook. But State Street says its model indicates defaults on the underlying assets will not cost that much.
--So long as the conduits stay off its balance sheet, State Street does not have to adjust them to reflect the market value of the assets in the conduits. But if State Street ever concludes that defaults are likely to be a little higher — say $100 million, only three-tenths of a percent of assets — it will have to put the assets on its balance sheet. And if it does that, it will have to write them down to market value.
--At the end of last year, State Street estimates that market value was about $850 million below face value. Had it been forced to consolidate the conduits, that loss would have been posted, leaving a write-down of about $530 million after taxes. About 40 percent of the bank’s 2007 profits would have vanished.
In the report, State Street explains why it has not taken any write-off on those conduits, which contain $28.8 billion in what the bank believes to be high-quality assets.
--It can avoid consolidation because other investors would suffer the first $32 million of losses — about one-tenth of 1 percent of the assets. After that, State Street would be on the hook. But State Street says its model indicates defaults on the underlying assets will not cost that much.
--So long as the conduits stay off its balance sheet, State Street does not have to adjust them to reflect the market value of the assets in the conduits. But if State Street ever concludes that defaults are likely to be a little higher — say $100 million, only three-tenths of a percent of assets — it will have to put the assets on its balance sheet. And if it does that, it will have to write them down to market value.
--At the end of last year, State Street estimates that market value was about $850 million below face value. Had it been forced to consolidate the conduits, that loss would have been posted, leaving a write-down of about $530 million after taxes. About 40 percent of the bank’s 2007 profits would have vanished.
What is behind Muni's yield shot up
--Municipal debt has been offering richer-than-normal yields compared with Treasurys since late last year. Only in the past week have they shot up significantly. Behind the move: forced selling by hedge funds and other traders as they unwound complex bets gone wrong.
--Although municipal debt historically is the domain of individual investors, in recent years hedge funds had flocked to a trading strategy that hinged on the normally reliable wide gap between yields on short-term and long-term municipal securities.
--The hedge funds sought to profit from that gap by borrowing at the lower short-term rates, buying longer-term higher-rate municipal debt and pocketing the difference. They magnified this trade by borrowing heavily to make this bet, sometimes using 10 times debt for every dollar of investor money they were putting to work. At times they also layered on bets against U.S. Treasury securities.
--The strategies have gone haywire lately, with both Treasury yields and municipal-bond yields going against these trends -- with Treasurys strengthening and municipal debt weakening. One problem: many municipal bonds are guaranteed by bond insurers such as Ambac Financial Group Inc. and MBIA Inc., which in turn enable those offerings to receive the highest credit rankings from rating providers. The b
--Although municipal debt historically is the domain of individual investors, in recent years hedge funds had flocked to a trading strategy that hinged on the normally reliable wide gap between yields on short-term and long-term municipal securities.
--The hedge funds sought to profit from that gap by borrowing at the lower short-term rates, buying longer-term higher-rate municipal debt and pocketing the difference. They magnified this trade by borrowing heavily to make this bet, sometimes using 10 times debt for every dollar of investor money they were putting to work. At times they also layered on bets against U.S. Treasury securities.
--The strategies have gone haywire lately, with both Treasury yields and municipal-bond yields going against these trends -- with Treasurys strengthening and municipal debt weakening. One problem: many municipal bonds are guaranteed by bond insurers such as Ambac Financial Group Inc. and MBIA Inc., which in turn enable those offerings to receive the highest credit rankings from rating providers. The b