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.

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.

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.

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.

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
COP...ConocoPhillips
E... Eni S.p.A.
[XOM...Exxon Mobil Corporation
TOT...TOTAL S.A.