Friday, November 30, 2007

No Bid

With respect to CDOs, naked capitalism describes them as “so arcane, so complex, and so highly differentiated on so many axes that one is likely to need to have a large number of CDOs trading to capture enough permutations to allow for realistic pricing.” For example, “underlying assets (they can contain any tranche of asset backed securities, other CDOs or even CDOs of CDOs, whole loans, mortgages), degree of credit enhancement (whether via overcollateralization or the use of guarantees), leverage, use of synthetics. As a result, the maturity of the deals vary, and the structures used to achieve the desired credit ratings are all over the map.”

In addition, NC says that “you can't get the deal documents.” Here’s his backup for that assertion: In "Where Did the Risk Go? How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions," by Joshua Rosner and Joseph Mason (pages 83-4) the authors state that “At present, even financial regulators are hampered by the opacity of over-the-counter CDO and MBS markets, where only “qualified investors” may peruse the deal documents and performance reports. Currently none of the bank regulatory agencies (OCC, Federal Reserve, or FDIC) are deemed “qualified investors.” Even after that designation, however, those regulators must receive permission from each issuer to view their deal performance data and prospectus in order to monitor the sector.”

That is an absurd state of affairs. NC’s logical conclusion is that “if regulators can't get the description of the securities, market participants certainly won't.” No wonder there is little to no bid for these securities. Adding to the confusion is the fact that “many CDOs are "active" or "managed" CDOs, meaning blind pools…That means the investors pony up money before the fund…is formed, and the manager gets to trade it over its three to five year life. No CDO manager is going to disclose his holdings (it would put him at a competitive disadvantage) but how can you value it otherwise?” So many of these CDO’s are essentially opaque mutual funds, not all that different from the garden variety scam where a promoter offers great returns on your money on something like diamond mines in Argentina but you can’t ask what they’re actually doing with your money.

So now that the values of assets making up some CDOs have collapsed, investors want to know what’s in all the other ones they’ve bought into and are discovering how opaque these things really are. So no one wants to buy unless they can see what they’re buying, and if CDO managers aren’t giving in on the disclosure issue no one is going to be making any offers. It would be like buying a used car just from an ad in the newspaper without going to inspect the vehicle at the lot. Now that this has all come to light, situations like the one described at Florida Schools Hit by Fund Freeze are going to appear everywhere. Managers of public funds aren't going to be going anywhere near this type of investment.

Tuesday, November 27, 2007

A different kind of credit cycle

Back in June, the following comment(slightly edited by me) was posted to a thread at Calculated Risk:

“A tougher market for LBO bonds/CLO's means less bank capacity(investment or commercial?) for additional lending, which means less deals. All this should remind us why this cycle is so different: the marginal dollar of credit is coming from levered lenders with concentrated portfolios and unstable sources of funding, or from "non-natural" buyers such as the hand-over-fist Chinese buying of Agencies. The nature of these creditors is that their provision of credit is a) correlated with one another and b) highly variable.

And yet we continue to compare this cycle to 2001, 1998, 1991, and 1981.

They are as different from today as chalk and cheese. It’s not about assets, it’s about how they are funded. We should prepare to see a different type of credit cycle, perhaps more similar to the "Golden Age" late 1800's downturns we experienced before the advent of regulated financial institutions.” David Pearson | 06.27.07 - 1:44 pm |

I agree with Pearson’s conclusion that this credit cycle will be different than any in the US since the establishment of the Federal Reserve system. None of the crises that Pearson mentions were brought about by asset overvaluations based on issuance of CDOs. According to the July 2007 issue of Bloomberg magazine, “Worldwide sales of CDOs—which are packages of securities backed by bonds, mortgages and other loans—have soared since 2003, reaching $503 billion last year, a fivefold increase in four years..” One aspect of CDO issuance is that these securities were designed so that illiquidity and low transparency were selling points; i.e. the risk due to those two factors implied that yields would naturally be higher than traditional asset classes. Given that in the post dot com bust recovery most asset classes were providing relatively low yields, the popularity of CDOs is not surprising. Of course, very few were paying much attention to what might happen should these investments run into trouble. People were ignoring the risk side of the risk-return equation.

Pearson comments a couple of days later at Calculated Risk along these lines

”I believe the opacity is very much by design, and that these securities are a direct analog to Enron's opaque "Special-Purpose Entities". The hedgies need securities which they can "mark to model" (again like Enron) so as to support claims of huge short-term profits from which to take their 20% cut.”

I don’t think there is any question that hedge funds have been a primary target market for securitizers. However, I believe that just about every type of investment vehicle out there has purchased some type of CDO during this boom.

To elaborate on Pearson’s comment above that this credit cycle will be similar to those that occurred pre-Federal Reserve, there is no regulatory agency in the US with the specific ability to manage debt securitization activity. One of the Fed’s purposes was to reduce the volatility of business cycles by regulating the creation of credit. Now that a major portion of credit creation has been occurring outside the control of the Fed, we have seen a massive explosion of credit and are likely to now see a massive implosion of credit.

Trends in land use and attitudes regarding the same in Europe

Newsweek International posted a story this summer to its website from its July 4, 2007 issue with a summary line as follows: “Economics and declining birthrates are pushing large swaths of Europe back to their primeval state, with wolves taking the place of people.” The article describes a trend in Europe’s rural areas of “ultralow birthrate(s) and continued rural flight”…to the extent that “rural flight continues to suck people into Europe's suburbs and cities.” The UN and EU are quoted to the effect that by 2030 the rural areas of the EU 25 “will lose close to a third of its population.”

The article describes some examples of changes in wildlife populations:

“In 1998, a pack of wolves crossed the shallow Neisse River on the Polish-German border. In the empty landscape of Eastern Saxony, speckled with abandoned strip mines and declining villages, the wolves found plenty of deer and rarely encountered humans. They multiplied so quickly that a second pack has since split off, colonizing a second-growth pine forest 30 kilometers further west.”

“In Swiss alpine valleys, farms have been receding and forests are growing back in. In parts of France and Germany, wildcats and ospreys have re-established their range.”

Bizarrely, some environmental groups in Europe don’t want farmland to revert to a wild state. The article claims that “The scrub brush and forest that grows on abandoned land might be good for deer and wolves, but is vastly less species-rich than traditional farming, with its pastures, ponds and hedges”, and quotes Jan-Erik Petersen, a landscape biologist at the European Environmental Agency in Copenhagen as saying that "Once shrubs cover everything, you lose the meadow habitat. All the flowers, herbs, birds and butterflies disappear…a new forest doesn't get diverse until it's a couple of hundred years old." Such ideas seem to contradict the goals of environmental groups in the US which as far as I can tell seek to allow farmland to revert to a natural state. I doubt that there is meaningful research that supports Petersen’s assertion.

The article states that ‘Keeping biodiversity up by preventing the land from going wild is one of the reasons the EU pays farmers to mow fallow land once a year. France and Germany subsidize sheep herds whose grazing keeps scenic heaths from growing in.” That seems absurd to me. The article goes on to say that “Outside the range of these subsidies—in Bulgaria, Romania or Ukraine—big tracts of land are returning to the wild.” I seriously doubt that biodiversity will be a problem in these areas.

The article describes an attitude toward the landscape such that it “is glued to the European identity, reflecting what the Germans call "Kulturlandschaft"—a landscape shaped by centuries of human care”, and says that “Many Europeans are reluctant to just let nature do its thing.” This attitude doesn’t seem to square with the seeming momentum of Europe’s Green movement, and certainly has received very little attention in the US.

Friday, November 09, 2007

US gasoline prices have hit a wall

I found the news that oil refiners' margins have been squeezed by the high crude oil prices to be quite remarkable; typically I think it has been safe to assume that crude price increases were immediately passed on to the gas pump. As Calculated Risk points out, the implication is that domestic gasoline demand is weak. Another way to say it is that gasoline has reached a price point where US users either limit their use or find a substitute. I don't have hard data at my fingertips, but I believe that businesses have been a strong driver of finding ways to limit or reduce gasoline consumption. It is interesting to know that gasoline prices can't just spiral to the stratosphere. Here is a chart of US gasoline prices posted 11-7-2007 by the US Energy Information Administration:

Tuesday, November 06, 2007

Black Tuesday?

General Motors has dropped a $39 billion bomb described here: by my calculations that puts the company's stockholder equity in the range of -$43 billion. We'll see what the actual number is tomorrow. It must have taken a long time for GM's executives to swallow making this move; usually it is the accountants that push for writedowns like this and they typically don't have much sway. Maybe GM's accounting firm was threatening to quit.

This link points to a Bloomberg story posted at 2 PM Eastern today that "Japan's Leading Economic Index Drops to Decade-Low 0". The explanation in the story states that "A reading of below 50 indicates the economy may slow in three to six months" the actual reading was ZERO! So Japan's economy is literally going nowhere. I had assumed on seeing the news item about this index that the result of zero was due to an equal number of positive versus negative components. That is not the case...if you follow the link in this post you will see that every single available component was negative. So the headline number is a bit misleading if you are not familiar with the details of how the index is calculated. It's hard to see how Japan can avoid a recessionary 4th quarter.

Meanwhile, " The U.S. doesn't have enough information to predict the outcome of events in Pakistan or whether President Pervez Musharraf can hold on to power, according to a Bush administration official." So the US's primary partner in restraining Islamic militants in south Asia is teetering on the brink of political collapse. It's hard to say whether this crisis will lead to increased insurgency in Afghanistan as Pakistan's military is focused on events in its own capital; or whether the insurgents focus on Pakistan themselves to try and help topple Musharraf. I think it's safe to say that there are more than a few people in Washington not getting a lot of sleep at the moment.

Wednesday, October 31, 2007

US dollar now upside down vs Canadian dollar

Take a look at these two charts borrowed from Yahoo Finance:

This is noteworthy as Canada is one of the USA's largest trading partners and this exchange rate reversal is a first for the USD versus the Canadian dollar. The strength of the Canadian dollar has likely driven up US exports to Canada in the third quarter GDP number that was just reported.

I see the Fed's cuts as making sense primarily in terms of helping banks' cash margins by widening the spread on loans they have outstanding that aren't in default. Banks that might be on the edge of solvency could be pulled back from the brink of receivership depending on their size.

Even though the Fed Funds rate has been lowered, there's still the issue in the interbank market of counterparty risk. I don't recall if it was the Fed Funds rate or LIBOR but recently one day's intraday data showed a high of 15%. So there are still confidence issues.

I could see the Fed raising by a quarter point by the end of the year depending on what happens with GDP. I think Trichet of the EU still needs to raise given the data that Claus Vistesen points out over at Alpha Sources.

Monday, October 22, 2007

Recent market trends

My interpretation of these three indexes is that many investors shifted cash from credit markets to equities due to the crunch and now are recognizing that equities will suffer due to economic slowing in the US and the effects of tighter credit on net income for public companies. Also, even though foreign buyers may be reducing their purchases of Treasuries, domestic demand for same has increased due to the desire to shift cash to the least risky investment.

Tuesday, October 09, 2007

Housing collapse hits Portland, OR

The link to the Portland Oregonian describes how
"Today, the John Ross has seen so many canceled purchases that developers actually have fewer buyers -- 192 -- than they did two years ago.
The John Ross got caught in the first slowdown after a historic run-up in condo construction that has reshaped Portland's skyline. For the first time, Portland's condo pioneers are suffering through an inevitable downturn.
The city has a condo glut, and thousands more are rising out of the ground. In the past six years, developers built 4,042 downtown condos, more than twice the figure from the previous 30 years. Today, developers have nearly 2,114 condos under construction. '

So much for the "it's different here" view pushed by so many city boosters. The article elaborates that "Two towers already switched from condos to apartments. Other projects were shelved, and construction has stalled on smaller projects from Beaverton to Northeast Portland"...

Tuesday, October 02, 2007

Can China avoid becoming the next Japan?

Brad Setser recently tipped readers to commentary by from Stephen Jen of Morgan Stanley as follows:
"Many in China have concluded that the blame for Japan's economic malaise in the 1990s lay largely with the appreciation of the yen. Beijing has therefore allowed the yuan to rise by only 10% since July 2005. But Japan's real mistake was its loose monetary policy to offset the impact of the rising yen—which further inflated the bubble—and then its failure to ease policy once the bust had happened. By holding down the value of the yuan and allowing a consequent build-up of excess liquidity, China risks repeating the same error."

I think Jen has the right idea here and gets to the heart of the problem that both China and Japan are in: they are caught between the Scylla of export decreases and hence negative GDP growth and the Charybdis of domestic inflation fueled by the desire for positive growth. You'll recall that in the early 1980's the US was in a somewhat similar situation with galloping inflation and due to a unique pair of strong leaders in Ronald Reagan and Paul Volcker, the political will existed to take the harsh economic medicine necessary to control inflation. I believe that Americans bought into that because President Reagan projected a strong sense of optimism about America's future and that absorbing problems in the short term would lead to long-term prosperity. Which I think has been borne out by subsequent American history.

This relates to the China vs Japan policy problem in that "Japan's real mistake" was the unwillingness to reign in monetary policy because it benefited vested interests. Which has led Japan to the fix it is in now. China needs to do something different or it will repeat the same error. The main wild-card for China is that taking the necessary economic medicine could lead to serious social instability.

Setser's stand-in over at RGE in recent weeks, Michael Pettis, has a very worthwhile post commenting that "
It is hard to overestimate the importance to China's near-term and longer-term prospects of the 17th Plenum in two weeks. These meetings, held every five years, are the main events of China’s political cycles"...Pettis further comments that
"the months leading to the congress are rife with factional infighting, sweetheart deals, attacks on frontrunners, corruption scandals, and the all-important maneuvering for promotion. Unfortunately, on the assumption that that any serious contender must at all costs avoid doing anything that may give rise to criticism before the promotions are decided, the period before the meetings tends to be a time in which very little, no matter how urgent, gets done"...

Wednesday, September 05, 2007

Commercial real estate appears to be in same quagmire as residential

Calculated Risk has several good posts on this, but today CR pointed out a Bloomberg piece with the following quote:
U.S. commercial real estate prices may fall as much as 15 percent over the next year in the broadest decline since the 2001 recession as rising borrowing costs force property owners to accept less or postpone sales. ``People aren't willing to do deals right now,'' said Howard Michaels, the New York-based chairman of Carlton Advisory Services Inc., ... ``The expectation is that prices will come down.'' Investors in July bought the fewest commercial properties since August 2006 and apartment building acquisitions were down 50 percent from June, data compiled by industry consultants at New York-based Real Capital Analytics Inc. show. ...``There are so many deals falling apart,'' said David Lichtenstein, chief executive officer of Lakewood, New Jersey- based Lightstone Group, an owner of more than 20,000 apartments and 30 million square feet of office and retail space. ``People who can get out are getting out.''
I added some bold appears to me that the loosening of lending standards took place in CRE as well as in residential; not a big surprise there. So it makes sense that CRE would be grossly overvalued now that credit is tight. It seems a bit surprising that apartment acquisitions would be down as there are a lot of people who are going to be foreclosed out of or forced to sell their homes and therefore will be looking for rentals.

Wednesday, August 29, 2007

US gas prices at the pump not going down much anytime soon

According to the US government agency in charge of keeping track of such things, as of this week
Apparently, prices have gone down recently: "The average retail gasoline price is down 47 cents per gallon since its peak the week before Memorial Day"...but "with gasoline demand set to fall significantly after Labor Day, the low level of inventories is not likely to cause a sharp spike in retail prices, but more likely will limit the usual seasonal decline seen after Labor Day, with the possibility remaining of an atypical slight increase over the next few weeks."

Gasoline prices in the US didn't keep up with inflation for many years; and it was uneconomic for oil companies to build new refineries as a result. As a result, we can expect that the days of gasoline for less than $2 per gallon are gone for a long time.

Tuesday, August 28, 2007

The Panic of 2007

seems an appropriate phrase to describe the market volatility that has hit global markets late this summer. Calculated Risk compares today's issues with the "Panic of 1907", and M. Shedlock has a post up today titled If You're Going To Panic, Do So Before Everyone Else...also see my earlier post A Genuine Financial Crisis for some examples of panic that have occurred in the last few weeks...

Monday, August 27, 2007

My experience with closing on a house in the US housing market-August 2007

I can give you my personal experience on an escrow process that took place during August. We had made an offer on a home being offered by a flipper in a rural community within 20 miles of Portland, OR. We expected to close the first week of August, and used a major bank based in Seattle as our lender. We had successfully closed the sale of our home in another state that first week of August and expected the closing on our purchase of this existing home quickly.

I had plenty of cash for a downpayment and a good credit score. The escrow process was a nightmare. The bank would literally call each day and ask for a new piece of documentation. They should have given me a list up front, but instead dragged it out. Then one day, the branch lending officer called me up and told me the underwriters wanted an extra 5% down. Fortunately for me and my family, I had realized enough cash from my sale that I just had to say, "No problem, do it." I imagine there are a lot of folks out there that received the same message from their lenders and couldn't come up with the cash.

Then the bank's underwriting department didn't seem to think that closing my loan was particularly important, as we would send them the information requested and then hear nothing for an entire day. I had my attorney send the bank branch an email asking why the bank didn't consider the closing an urgent matter and I called and complained to the branch manager as well. Their response was that the underwriting department (located in Chicago) wasn't being very responsive. So we finally get the keys two weeks after the original expected closing date. Of course, this was all going on at the same time that the credit markets were seizing up, so I had a few heart palpitations there. This is just my story, but I suspect that there are quite a few others out there who could relate.

Thursday, August 23, 2007

Asset backed commercial paper and lock-up of market for same

Bloomberg has a story today headlined Banks Have $891 Billion at Risk in CP, Fitch Says in which the authors state that "Some companies that use commercial paper to buy asset-backed securities or collateralized debt obligations backed by subprime mortgages are having trouble finding investors." That shouldn't be a surprise. Given that the valuations of no ABS's or CDO's related to mortgages can be trusted right now, why would anyone want even the shortest term CP related to these as there could be insta-default loans hidden in said CP.

Clearly the issuers of ABS CP do so as a sort of bridge financing while they find long term buyers of the ABS. Personally, I think that the seize-up of the market for this sort of CP is healthy as it will force issuers of ABS to demonstrate plainly that the mortgages they are selling warrant the ratings they receive.

Friday, August 17, 2007

A Genuine Financial Crisis

This has been a bizarre, yet fascinating week. We have seen (so far):

-a genuine run on a bank...Worried about the stability of mortgage giant Countrywide Financial, depositors crowd branches.
Anxious customers jammed the phone lines and website of Countrywide Bank and crowded its branch offices to pull out their savings because of concerns about the financial problems of the mortgage lender that owns the bank.
At Countrywide Bank offices, in a scene rare since the U.S. savings-and-loan crisis ended in the early '90s, so many people showed up to take out some or all of their money that in some cases they had to leave their names.

-a liquidity crisis in short term money markets that prompted central banks around the world to take emergency action... ECB Injects €94.8 Billion To Ease Jittery Markets... Bank of Canada Says It Will `Provide Liquidity' to Aid Markets...Fed Enters Market To Tamp Down Rate...

-whipsaw volatility in global stock markets resulting primarily in major declines...

-mortgage lenders going bankrupt...Aegis Mortgage files for Chapter 11 bankruptcy...
"Aegis has described itself as one of the 30 largest U.S. mortgage lenders. It made "prime" and "Alt-A" wholesale loans, and "subprime" retail and wholesale loans to residential borrowers who couldn't qualify for the best rates.

In court papers, Aegis listed more than $100 million of assets, and estimated it owes more than $600 million to creditors. The latter included $178 million of unsecured debt owed to Madeleine LLC, a Cerberus affiliate that has an 80.9 percent equity stake, the papers show"...

-exchange rates move radically...the yen has strengthened quite a bit against the dollar...this suggests that many investors are exiting the "carry trade"...

Tuesday, August 14, 2007

Portland, Oregon has real estate problems too

From the Portland Business Journal, an article tells us that
"Nearly every day, home appraiser Terry Bernhardt tells mortgage brokers that homes they're seeking to finance are badly overvalued.

Their response, often, is to threaten to withhold Bernhardt's payment until he raises the home's appraisal value. If he doesn't, they'll find an appraiser who will, thereby ensuring they close the deal and collect a commission.

"The perception is, if you don't play ball with them, you won't get their business," said Bernhardt, an appraiser for Portland-based Valuation Trust Corp. "It puts us between a rock and a hard place."

Such high-pressure tactics have helped generate more complaints to Oregon's Appraiser Certification and Licensure Board than ever, said Bob Keith, the board's administrator. Overall mortgage-related complaints now exceed 300 annually, a fourfold increase since 2001."
What this means is that there is plenty of over-priced housing in the Portland metro, and the local real estate industry is trying to hide that fact. So expect to see falling home prices here for a while...

Ignoring risk and the credit bubble

The linked article is titled "Robert Rodriguez On the 'Absence of Fear'" and describes Mr. Rodriguez's "concept of RISK since there appears to be little concern about risk in the financial markets currently." Per the link, "Rodriguez is CEO of First Pacific Advisors, an $11-billion investment management company located in Los Angeles."

Rodriguez says that
"Two years ago, we noticed a problem developing in our bond portfolios involving Alt-A securities. Despite having average FICO scores of 718 on the underlying loans, these securities experienced rapidly escalating delinquencies and defaults after just nine months. We sold them since we did not want to wait around to find out the reason why this was happening."
Doubtless, his firm had little trouble selling the bonds at the time. He follows up by stating that
"Our worst fears were recently confirmed in a study by First American Financial entitled, "First American Real Estate Solutions Report, Alt-A Credit: The Other Shoe Drops" This report shows the following changes in underwriting standards between 1998 and 2006, with the major changes occurring in the last two or three years:

* ARM % of originations rose from 0.7% to 69.5%
* Negative Amortization rose from 0% to 42.2%
* Interest Only rose from 0.1% to 35.6%
* Silent Seconds rose from 0.1% to 38.7%
* Low Documentation rose from 57% to 79.8%
* FICO scores were essentially unchanged at an average of 706.

What is interesting is that the origination volumes for the last two years, when the most egregious deterioration in underwriting standards occurred, total more than the previous seven years of originations combined. "
There is much more in the linked post...well worth your time. To me, this data just confirms the emerging picture that financially sound homeowners got caught up in the tide of buying larger houses than they could afford, or sucked out all of their equity to spend.

Friday, August 10, 2007

Good move by President Bush

According to Bloomberg, which seems to be the free internet financial news provider of record these days, "President George W. Bush said Fannie Mae and Freddie Mac must complete a ``robust reform package'' before the government will allow the two largest mortgage finance companies to buy home loans beyond current federal limits.

Congress needs to get the companies ``reformed, get them streamlined, get them focused, and then I will consider other options,'' Bush told a White House news conference today in response to a question about whether the two companies would be allowed to buy more mortgages to help spur the housing market. "

That's the right move, Mr. President. No bailouts for bogus loans or folks whose eyes were bigger than their wallets.

Thursday, August 09, 2007

Recent global market activity

I found an interesting quote in a Bloomberg piece this evening regarding Asian markets:

``There are indiscriminate sell orders from panicked investors,'' said Liu Juming, a fund manager at Ta Chong Investment Trust Corp., which manages $1.1 billion of assets. ``The old saying in the investment world that `cash is king' came about because of days like today.''

Referring to US markets, Marketwatch says
"Stocks got crushed Thursday, plunging right out of the gate; and every attempt to buy on the day's dips was met with even stronger waves of selling pressure. Renewed fears about credit risk, this time from across the pond, prompted investors to take a deeper look at the severity of the ongoing subprime problem and the difficulties that diminishing liquidity is having on banks and brokers to accurately value assets...The news out of Europe prompted a 50-basis point jump in Libor (London Interbank Offered Rate) to its highest level in six years and prompted the ECB to inject nearly 95 bln euros ($130 bln) into money markets. The Fed also chimed in by adding $24 bln in banking reserves. Such attempts to temporarily ease the pain of a possible credit crunch, however, were viewed with a glass half empty and merely exacerbated the worst of liquidity fears."

I made a few comments regarding asset valuation at my Hedge Fund Failometer page, specifically in regard to the BNP Paribas events.

The liquidity moves by the ECB and the Fed are intended simply to prevent panicky actions by banks; the extra funds availability will likely be very short-term. Today's situation is precisely what central banks are set up to handle. The extra funding will be pulled back by the central banks once their member banks get a handle on what their true market positions are. With the volatility that we've seen, I see it as humanly impossible for financial institutions to keep up with the market fluctuations. The central bank actions reassure their member banks that funds will be available, so the banks can review their positions without feeling the need to take rash actions.

I don't have a link for a quote, but I recall seeing a comment on a discussion thread suggesting that the spike in LIBOR rates could mean that banks didn't have confidence in their own balance sheets and thus were looking to get capital quickly, which would of course drive up the rates. This clearly prompted the central bank actions. Today would seem to be a red letter day in that we have seen an actual short term credit crunch. It doesn't happen that often.

I just spotted a great quote over at
Calculated Risk:

"So, today the monetary base in the North Atlantic economies is 7% higher than it was yesterday--an annualized growth rate of 2100% per year.This is indeed a significant liquidity event...Professor DeLong, August 9, 2007 "

The calculation provided by Dr. DeLong is eye-popping; however as I said previously the extra liquidity will be out there for a short time period only. Clearly the central banks aren't going to add funds every day at the same rate that they did today.

I would definitely check out Calculated Risk's postings today; the posts as a whole pretty much sum up the global economic situation as it stands today.

Here are the NASDAQ charts for the last 5 days and the last 3 months:

As you can see the 5 day chart starts and ends at about the same position, with wild swings in between. This is what I would expect to see when investors realize that their assumptions may be without merit, and so you see a variety of reactions from market participants leading to volatility. I see volatility as indicating that investors as a group have diverse opinions on the direction of the securities making up the market. However, a big chunk of the trading volume is due to algorithm driven computer trades, as Calculated Risk notes in a discussion of how investors using this trading method are faring.
To sum up, we are seeing an inflection point in global markets. Investors of all sizes and outlooks are rethinking their strategies and are experiencing the pain of leverage.

Thursday, August 02, 2007

S&P, Nasdaq 3 month charts as of today

Although there has been a bit of a bounce the last two days, said bounce has been insignificant compared with the overall downtrend. It appears that more of the buyout premium was priced into the Nasdaq Composite, which would make sense as the proportion of stocks in the S & P that have been considered buyout candidates would have been relatively smaller.

Wednesday, August 01, 2007

Oil majors now have incentive to focus on alternatives to wells

Reuters is reporting that Marathon Oil Corp "said on Tuesday it agreed to buy Canada's Western Oil Sands Inc. for about $5.56 billion, giving the U.S. oil company a foothold in one of the world's most promising streams of new crude oil."

In my post
Why major oil companies aren't making new finds I presented information from an oil industry expert which seems to indicate that the major independent oil companies have very limited prospects for new finds of traditional oil fields. Based on that the purchase by Marathon makes great sense, and I would be surprised if the other majors listed below do not follow suit with investments in alternative sources of petroleum such as shale, tar sands and coal. Oil can be extracted from all three of those sources, and given current oil prices the extraction processes should be economically viable.

BP...British Petroleum
CVX...Chevron Corporation
E... Eni S.p.A.
[XOM...Exxon Mobil Corporation

Thursday, July 26, 2007

Buyout premium disappearing from US stock market

Here are two charts from this morning:

Influence of rating agencies on international debt markets

In "The Global Credit Channel and Monetary Policy" Claus Vistesen raises the issue of the importance of credit rating agencies with respect to the effect of global financial liberalisation on the global economy.

With respect to the rating agencies, I think one of the major problems has been that investors, whether institutional or retail, have been accepting the ratings assigned to securities at face value without really digging into the guts of the ratings reports or doing much independent analysis. In the case of portfolio managers for institutions, this is really a kind of failure to perform their job.

I am sure that a conversation between a investment bank rep and an institutional buyer like the following hypothetical has happened many times:

Banker: I have X billion of automaker Y bonds available; they're going fast!

Institution: Moody's says these bonds are BAA; no problem..I'll take $100 million as fast as you can get them to me. I need the yield...

So I agree that the ratings agencies have been incentivized to shade their ratings to the optimistic side, but as always the rule of "buyer beware" applies. Buyers of issues rated by the three major raters used the reputation of the raters to cover their butts in case of default: "Well, Moody's said it was BAA!"...

With respect to the ratings agencies and sovereign debts, I am not all that sympathetic to the agencies. Both the buy-side and the investment banks wanted the agencies in place to help justify pricing of issues, and governments frequently have touted their ratings. All four groups of entities have had a stake in the system as it currently exists. If the raters downgrade a country's debt, instead of complaining about the raters, it's up to that country's policymakers to convince the market that the rating is incorrect by providing information or policy changes that demonstrate that the country's issues warrant the desired pricing.

Wednesday, July 25, 2007

The LBO market appears to have seized up

Headlines in the financial press today and recently:

-KKR Banks Fail to Sell $10 Billion of Boots Loans..."Kohlberg Kravis Roberts & Co.'s banks, led by Deutsche Bank AG, failed to sell 5 billion pounds ($10 billion) of senior loans to fund the leveraged buyout of Alliance Boots Plc, two people with direct knowledge of the deal said"...

-Chrysler, Facing Resistance, Abandons Loan Sale Plan..."Chrysler abandoned plans to sell $12 billion of loans to complete its purchase by Cerberus Capital Management LP after investors balked at purchasing the high-yield, high-risk debt, according to investors who were briefed on the decision...Banks led by JPMorgan Chase & Co. will assume $10 billion of that debt"...

-KKR, Blackstone Find `Tide Is Going Out,' Gross Says..."The cheap financing that fueled the leveraged buyout boom is over, according to Bill Gross, manager of the world's largest bond fund"...

-RLPC-Maxeda...The 1.075 billion-euro loan backing the buyout of Dutch retailer Maxeda DIY has been pulled from syndication after failing to clear a European loan market in the throes of a correction, banking sources said on Monday. The deal is Europe's first leveraged loan to be put on ice in the current market correction and was withdrawn from syndication on Friday after concessions failed to generate additional momentum, arrangers ABN AMRO and Citibank told Reuters Loan Pricing Corporation"...

Bloomberg reports:...

"At least 20 companies have canceled or postponed debt offerings since June 26 as credit markets grow tighter.

The extra yield investors demand to own high-risk, high- yield, or junk-rated corporate bonds has jumped 0.85 percentage points to 3.37 percentage points since the day before Expedia announced its share buyback, according to Merrill Lynch & Co. index data"...

The eminent Bill Gross of PIMCO agrees with me:
"That growing lack of confidence – more so than the defaults of two Bear Stearns hedge funds and the threat of more to come – has frozen future lending and backed up the market for high yield new issues such that it resembles a constipated owl: absolutely nothing is moving."

Why Japanese consumers are feeling even worse off than US consumers

I just discovered Japan Economy News & Blog, which has a recent post concerning "Increased tax burdens, consumer pessimism, excessively low interest rates, and the BOJ’s June Standard of Living Survey." That is certainly a mouthful; the gist of the article is that
"With many households nervous over future prospects, a potential rise in the consumption tax, sluggish (if negative when normalized) gains in wages and decreased consumer confidence in June, economy watchers should now be worrying whether these two reports might prove to be a nail in the coffin of an August interest rate hike by the Bank of Japan."

My sense from a US perspective, is that an arcane topic such as Japan's tax policy just doesn't cut it at the editorial desks of US media outlets at this time. Trade issues with China, the housing/mortage collapse, the Iraq war, oil prices, the seeming free-fall that is taking place at the three US automakers are all affect the US investor much more directly.

It is no wonder that domestic GDP in Japan is weak, given the factors listed above. I can understand the poll results showing that the public thinks interest rates are too low. The BoJ's interest rate policy at this time is to ensure that exports are not damaged by yen strength, particularly due to an unwinding of the carry trade. Significant rate hikes by the BoJ would almost certainly spark an unwinding of said carry trade, jacking up the yen and damaging the profitability of the country's export sector (which is the only thing holding Japan's GDP in positive territory). This is a continuation of Japan's long-standing policy of short-changing its domestic markets to benefit the export sector.

The Japanese public would obviously like to see interest rates higher so that they can realize better returns on their savings without exposing themselves to exchange rate risk. However, as various news reports indicate, the public is starting to engage in the carry trade themselves, as they likely don't see the BoJ's interest rate policy changing anytime soon. In addition, the impending collapse of the Abe government is seen as delaying any interest rate movement in the near term as well.

Japan is in an economic trap at this time; any major changes in policy will cause extreme volatility for the public, business, and the government. The current policy of not making any significant changes may provide short-term stability, but eventually difficult changes will occur.

Monday, July 23, 2007


From commenter Dave Chiang at Oil and the dollar at Brad Setser's blog:

"In order to compensate for the weak US dollar, the OPEC oil producers led by Saudi Arabia are keeping a tight rein on high energy prices by restricting supply."

That makes sense to me...

Friday, July 20, 2007

Foreign investor on the way

Dealbreaker points out that:
Dubai Investment Firm Plans U.S. Purchases (Dealbook) and says

"Hide your children, your mortgage deeds and your small businesses. Remove your stock holding from your brokerage account and put the certificates under your pillow. If you're a public company, it's time to go private -- right now. In short, time to go into lockdown mode. The Dubai money is coming. The private equity firm managed by the country's ruler, Sheik Mohammed bin Rashid al-Maktoum, will soon open an American office, so that he can add US firms to his portfolio. They're takin' over."

I say dust off your business plan that's been sitting on the shelf...there's a new prospect in town. Time to get back some of that gas money we've been hosing into our SUV's...

July 22nd-housing earthquake

Thanks to Seattle Bubble for pointing out that
"New guidelines making it tougher to qualify under interest only mortgage terms begins on July 22nd...In summary: “any mortgage containing an interest-only feature be underwritten at the highest possible interest rate or subsequent amortizing payment, and that any mortgage containing a negative-amortizing feature be underwritten at the highest possible balance and interest-rate adjustment”"
It may take a while for the effects of this to filter through the market, depending on ARM reset dates, but it will surely put severe pressure on home prices nationwide.

Wednesday, July 18, 2007

Oil prices at $80 a barrel

The US EIA says in "This Week in Petroleum" that "With the futures price increasing, some people are wondering if crude oil prices will reach $80 per barrel at some point this year. The trick answer to this question, though, is that light, sweet crude oil prices have already reached $80 per barrel, just not for West Texas Intermediate"...and that "Any premium on light, sweet crude oils has implications for retail prices for refined products, such as gasoline and distillate fuel."

"With fuel specifications evolving towards cleaner and cleaner refined products, refiners are looking to purchase more sweet (low sulfur) crude oils, thus putting an increasing premium on these types of crude oils. If not for the primary focus on WTI, this premium would be much more visible, but it exists nonetheless. As a result, a significant portion of the rise in retail gasoline and diesel prices is related to higher crude oil prices, particularly light, sweet crude oils...Regardless of where crude oil prices head over the remainder of the year, $80 per barrel prices have already occurred, both overseas and domestically."
Oil-exporting countries are raking in the cash now, but there are so many alternative sources of oil along with alternative fuel systems that are economically viable at oil price levels well below $80 that I think that it is likely that a sharp dropoff in demand for light sweet crude in the next 5 to 10 years. It is important to keep in mind that cycles in energy occur over long time frames.

Monday, July 16, 2007

Yen carry trade and New Zealand's economic prospects

Claus Vistesen at Alpha Sources notes today that the most recent inflation numbers for New Zealand
"beat the central bank's expectations. It is of course still too late to say anything but with today's inflation data the markets are gearing up for the RBNZ to raise the refi rate to an unprecedented 8.25% next week. In doing so the bank will clearly be playing into the hands of all those savvy retail investors and indeed institutional players playing the carry trade which is driven by very high global capital mobility and high interest rate differentials between central banks."

It seems to me that the prospect of the currency of one of the world's largest and most populous economies(Japan) being dumped for the currency of one of the world's smaller and more isolated economies is somewhat Kafka-esque.

A quick review of the Wikipedia entry on New Zealand shows NZ to be "a country heavily dependent on trade, particularly in agricultural products, and exports almost 28% of its output." Thus, the current carry trade situation looks to be particularly damaging to NZ's economic prospects.

As far as long term solutions for New Zealand go, the Wikipedia authors state that "the current government's economic objectives are centred on pursuing free-trade agreements and building a "knowledge economy". In 2004, the government began discussing a free trade agreement with the People's Republic of China, one of the first countries to do so. Ongoing economic challenges for New Zealand include a current account deficit of 9% of GDP[19], slow development of non-commodity exports and tepid growth of labour productivity. New Zealand has experienced a series of "brain drains" since the 1970s[20] as well educated youth left permanently for Australia, Britain or the United States." With a population of only 4.2 million and a below-replacement total fertility rate of 1.79, it seems to me that New Zealand likely lacks the human capital to generate sustained economic growth. Given the country's geographic remoteness, it seems unlikely to attract skilled immigrants in any meaningful numbers.

It seems that New Zealand's situation today is analogous to the Eastern European countries being discussed over at Demography Matters.

US national debt shrank during the first half of 2007

According to a Bloomberg report today,
"the Treasury Department sold less securities from January through June than matured, the first time that has happened since 2000...the fiscal outlook is so good that investors and strategists are beginning to handicap which maturities the government may stop selling or even buy back for the first time in five years."

This is in spite of continued military spending in Iraq. The Bloomberg piece also noted that
"The government has reduced the sizes of its auctions of two-, five- and 10-year notes to avoid letting cash pile up for the past two years. Ten-year notes were cut to $21 billion from $23 billion a quarter in 2005. Five-year notes, sold monthly, were reduced to $13 billion from $15 billion. Quarterly three- year note sales were suspended in May."

Also, "The deficit as a percentage of gross domestic product narrowed to 1.9 percent in 2006 from 3.5 percent in 2004"...

Conveniently, "The drop in supply comes just as international investors, owners of more than half of all Treasuries, slow their purchases. They bought a net $16.2 billion a month on average in the first four months of this year, compared with $28.2 billion a month in 2005."

It would appear that the US economy is experiencing a virtuous cycle. The fact that the US is needing to borrow less at the same time that foreign investors have decided that they wish to loan the US less is striking. Should the US reduce its spending in Iraq over the next year, as it appears likely to do, there should be even more improvement in the budget deficit.

Thursday, July 12, 2007

Trends in movie ticket prices

I was looking at the box office numbers from last weekend supplied by Yahoo; the main stream media roll out these figures every week and quite often the headlines are about recordbreaking dollar totals for the films in release. Sometimes the fact that ticket prices have been raised is mentioned. I have wondered exactly how often and how much movie ticket prices have been raised. Well, a Google search turned up "Admissions & Ticket Prices: Two Popular Myths" in a theater industry trade publication.

Two pieces of data from that article:

Here are some U.S. admissions numbers over the past 35 years (in millions):
1970 920.6
1980 1,021.5
1990 1,188.6
2000 1,420.8
2001 1,487.3
2002 1,639.3
2003 1,574.0
2004 1,536.1

The author argued that since ticket prices for other entertainment such as pro sports had increased radically over the same time frame as the above chart, that movie ticket price increases have not been out of line. The chart is rather poorly conceived, however looking at it closely shows that admissions basically tracked population growth from 1980 to 1991; then increased somewhat faster than population growth. I attribute the increased admissions to the wave of fancy new stadium theaters that were built and the film production companies' shift in strategy to aiming for blockbuster hits. The chart and the data show that admissions stagnated after 2002. I attribute that to ticket price increases hitting the wall where casual moviegoers are deciding that ticket prices are too high.

Update: I located the following information at the site of the National Association of Theater Owners, or NATO:)...

Average U.S. Ticket Prices

Here is a chart of this pricing information:

Since ticket prices increased every year after 1994, it would stand to reason that ticket sales might stagnate.

A quick look at who could lose big due to CDO problems

Jim Jubak of MSN wrote Deepening Debt Crisis providing an estimate of who is at risk(my highlights):

"First, the investors who elected to buy the equity tranche (which are the riskiest debts), attracted by the possibility of an equitylike return on a fixed-income investment, get killed...

Hedge funds bought about 10% of equity tranches in 2006, according to Bear Stearns. But pension funds bought more -- 18%. Insurance companies bought even more -- 19%. And asset managers bought even more -- 22%. When pension funds take big losses, parent companies have to make up the loss or workers have to take smaller pensions. When insurance companies take the loss, insurance rates go up. When asset managers take the loss, well, we all cry when we open our monthly mutual-fund statements.

It's hard to get a complete list of who owns equity-tranche CDOs. But some names that come up include the California Public Employees' Retirement System ($140 million), the Teachers Retirement System of Texas ($63 million), French financial giant AXA and the New Mexico State Investment Council ($223 million)"...

Wednesday, July 11, 2007

Prospects for GAP as a clothing retailer

A really great analysis of the company can be found at "Can Gap Effectuate a Successful Turnaround?" The statement by the author that "You can’t be an edgy clothing retailer when you’re selling large volumes of goods to your desired market’s parents" should be carved into the wall of every Gap executive's office. I am in my late thirties and used to shop at Gap stores because they consistently had the basics, i.e. business casual and denim. When sales growth started to flatten because they had saturated the market with their stores, they started flailing around with more bizarre items and that pretty much turned me off. Their gimmick commercials with retread rock stars did damage to the Gap brand as far as younger shoppers were concerned, as well. Also, there is a limit to how much of the basics a clothing purchaser needs, especially those in their thirties and forties. You aren't growing physically(hopefully) so a few purchases of khakis, some polo shirts, and some denim jeans and shorts is going to last you a while. So I think that the Gap business is going to have to accept that it is a mature business and will need to be managed as a dividend-generating business. Based on that, I agree with the authors points of the signs of a Gap turnaround are:

1) Reestablishing the brand, with the first key being the company behaving as if it’s in touch with the customers it wishes to court.
2) A new attempt to court the female shopper in the 35-45 age range, only with them sticking with it this time around and getting the job done.
3) A stronger and more stable product mix that appears in tune with the Gap’s efforts to rebuild its brand.

as far as the Gap line is concerned.

I think that the Old Navy line should just be liquidated; long-term I don't think that the business model can survive against Target and Walmart. When your kids are shopping for discount clothes, they don't want to advertise the brand when they wear the clothes. Perhaps they could negotiate a deal to sell Old Navy branded product through Walmart's stores and eliminate the store overhead they have now.

Last time I looked, Banana Republic's prices were significantly higher for similar items that Gap's. I see BR as competing with Nordstrom. I suppose Gap's theory is that once you get to a certain income level you will shift to shopping at BR from Gap. That doesn't make any sense because it's shifting sales around within the company as a whole.

My answer to the question of "does the Gap actually understand its problems?" is that I don't think Gap management understands its problems and is basically throwing darts and hoping they hit something. I think the best course of action would be for a breakup of the company. Spin off BR as an independent company, liquidate Old Navy stores and cut a deal to market the product through an established big-box discounter, and focus on the Gap brand by reinforcing the denim and business casual product line and accept a position as a value stock rather than a growth stock.

Tuesday, July 10, 2007

Iranians like American made goods-smugglers supply them

says a Bloomberg report titled "Dubai Dhow Captains Defy U.S. Sanctions With Shipments to Iran." Says the report:
"Sailors with skin baked to leather by the Persian Gulf sun stack Hewlett-Packard Co. laser-jet printers alongside a 40-foot wooden dhow in Dubai Creek as Ali Reza, an Iranian merchant, watches them sweat. From his base in Dubai, the second-biggest member of the United Arab Emirates, Reza ships General Electric Corp. refrigerators and other American-branded products to Iran, even though re-exporting them is banned under U.S. sanctions. Within days, the printers will be snapped up by buyers in Iran. ``Anything made in America is popular,'' Reza, 55, says as his crew prepares for another voyage."

"The U.S. military inadvertently provides protection for dhows plying the Gulf. Coalition forces are charged with guarding Iraq's offshore oil facilities and check vessels sailing through the Strait of Hormuz for weapons. ``The pirates and the weather are our enemies,'' says Mohammed Ali Hussein, a 35-year-old boat captain who makes the journey to Iran about once a month. ``If we're lucky, our route will take us near Iraqi oil installations. That is a safe area.''

I'd like to see an estimate of US exports to Iran through this channel. According to the article, " Customs laws in the United Arab Emirates mean that officials only look at the port of origin for a cargo. With most of the U.S. goods coming through Asia, there are no legal grounds to seize them, says Marwan Ali Hasan, an inspector in Dubai."

Also, how does the US Navy tell the difference between a pirate and a smuggler? Nobody's flying a skull and crossbones...

Recommendation for change in MD education in the US

I think that eliminating the requirement of a four year college degree as a prerequisite to admission to medical school is long overdue. Prospective MD's basically mark time in undergraduate school, as the course of study in undergraduate is irrelevant to the medical school admissions process.

A better process would simply to base the admission decision in part on high school performance along with the MCAT result and whatever the other criteria that medical schools now use. The chain of predictors of success from high school performance to undergraduate performance to success in med school correlate well, I think. So cutting out the undergraduate step wouldn't change the quality of med school graduates and would eliminate a huge waste of time and money for taxpayers and prospective MD's.

Major concerns with the US health care system

In the July issue of HFM, the journal of the Healthcare Financial Management Association, an article included a list per the title of this post. The headline of each item on the list was as follows:

1. High and growing healthcare costs

2. Cost shifting

3. Clinical variation and inconsistent quality

4. Inconsistent access to care

5. Weak and/or perverse market incentives

6. Administrative complexity and high overhead

7. Shortages of clinicians

The biggest problems in my view are the perverse incentives that exist throughout the system, price opacity in that the patient has a difficult task in understanding what their care will cost and whether the cost is worth the benefit, and the high incidence of unnecessary medical procedures being performed.

Solutions to the above problems are welcome:)....

US anti-terrorism spending not necessarily effective

GCN has an article today titled "CRS: Mission creep at fusion centers" which describes "state intelligence fusion centers" which are intended to "fuse federal, state and local intelligence against terrorism." Unfortunately, apparently the money being spent on this is not being used for the intended purpose. Surprise, surprise!

The article is based on the findings of a report by the Congressional Research Service which concludes that "Antiterrorism information-sharing and analysis is taking a back seat to criminal intelligence at the more than 40 state intelligence fusion centers"..."
While many of the centers have prevention of attacks as a high priority, little ‘true fusion,’ or analysis of disparate data sources, identification of intelligence gaps and pro-active collection of intelligence against those gaps, which could contribute to prevention, is occurring”...according to the report.

While I think that the concept envisioned by these centers is good, we shouldn't be spending the money if the desired function of the program is not being met. It makes sense that local agencies would tend to focus more on domestic crime, as that is what they have to deal with on a day to day basis, but at the same time I can see where local law enforcement agencies have seen this as an opportunity to exploit the federal budget for local issues. So I say the program should be canned.

It reminds me of some of the absurd projects that money was spent on in the first couple of years after 9-11. At our local airport, there used to be a small parking lot where one could come and watch airplanes land and take off. That was closed off with concrete barriers and fencing. Well, about fifty feet away was a parking lot for a city golf course that had been developed next to the airport. If someone wanted to launch a shoulder fired missile at an airliner, the golf course parking lot would have worked just as well as the now-closed viewing lot. So a bunch of money was wasted on a knee-jerk idea...