Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.

Not liquidity. Solvency.

by Jerome a Paris Mon Dec 17th, 2007 at 03:48:44 AM EST


Krugman in the New York Times

the problem with the markets isn't just a lack of liquidity -- there's also a fundamental problem of solvency.


Wolfgang Munchau in the Financial Times

 The idea was that a co-ordinated response [by Central Banks, as done last week] would reassure the markets, but it had the opposite effect. It turned out that market participants are not infinitely stupid. They know by now that this is not a liquidity crisis at its core. If it had been, it would be over by now.


A liquidity crisis is when your underlying financial situation is sound, but you have a temporary cash-flow problem: you need to pay out money before you get your income, but you'll have enough. So a short term loan can tide you over, and will get repaid quickly.

A solvency crisis is when the underlying activity is not sound, and there will not be enough money altogether to repay all that's due.

Central banks can do something about the first one, but very little about the second.

And in this case, the problem is simple: too much recent debt is underpinned by imaginary value, mostly in the real estate sector.  


Krugman

we had an enormous housing bubble in the middle of this decade. To restore a historically normal ratio of housing prices to rents or incomes, average home prices would have to fall about 30 percent from their current levels.


Munchau

the latest upward movement has lasted 10 years and on my calculation prices started to rise above the trend line somewhere between 2000 and 2002. That would suggest that the downturn phase is going to last as long - possibly longer since downward moves often undershoot the trend line. Unless there has been some structural shift, there is going to be one of the most serious housing downturns ever.

The first credit shock in August was banks suddenly noticing that their balance sheets were looking possibly shaky, and wondering what other banks' balance sheets looked like - and curtailing lending just in case. 5 months later, and more than $80bn of writedowns later (despite the fact that defaults in the real estate sector have barely started), banks know that other banks' balances sheets are full of holes, and are avoiding loans as much as they can.

One sign that cannot be spinned away is the sheer number of banks that have had to get emergency capital injections from the outside to improve their balance sheets:


Abu Dhabi buys Citi stake (27 November)

NEW YORK (AP) -- The Abu Dhabi Investment Authority will invest $7.5 billion in Citigroup, offering the nation's largest bank needed capital to offset big losses from mortgages and other investments.


Chinese Firm To Buy Big Stake In Bear Stearns

NEW YORK, Oct. 22 -- China's Citic Securities would acquire up to a 9.9 percent stake in Bear Stearns under a joint venture that marks the first time an entity controlled by the Beijing government has obtained a significant stake in a major Wall Street investment bank.


China's Ping An buys Fortis stake for $2.7 billion (29 November)

HONG KONG (Reuters) - Ping An Insurance (Group) Co, China's No.2 life insurer, bought a 4.2 percent stake in Dutch-Belgian financial services firm Fortis for $2.7 billion, the latest in a spate of overseas investments by Chinese financial firms.


Singapore Investment Arm To Sink Billions Into UBS (10 December)

The Swiss bank is raising a total of 13 billion Swiss francs ($11.48 billion) in fresh capital from two investors. The Government of Singapore Investment Corp., which invests the city-state's foreign-exchange reserves, will contribute 11 billion Swiss francs ($9.75 billion); the other investor was not identified, but was said by Reuters to be the government of Oman, which has been attempting to diversify its economy away from reliance on oil production.

What these sales have in common is that they take place at pretty lowish valuations for the banks (whose market values have been hammered over the past few months), and that they are desperately needed to tide the banks over, and in particular to allow them to fulfill their capital adequacy requirements, ie their obligations to have enough capital to cover the risks they are taking. Their existing capital was depleted after writing down (ie taking losses on) massive portfolios backed by hitherto exuberantly valued assets.

And again, this is before actual defaults and losses in their underlying businesses have happened. I have likened this to a car driver, driving very fast, suddenly seeing an obstacle in front of the car on the road, brutally brakes. With no seat belt, the driver will first hit the windscreen as the car brakes - before the actual smashing into the obstacle happens. We're at the windscreen-hitting phase right now.

:: ::

The only open question is whether the new investors, who are buying into our banks at this delicate point in time, will make any money. There are two reasons they might: the first is that we have indeed reached the bottom of the market, after a lot of panicky selling, and that things will perk up (that's the optimistic scenario). The other is that we will not let our banks fail, because they play too important a role in our economy, and public authorities (ie taxpayers, us) will bail them out and save the shareholders to some extent - in hich case the most recent buyers are those with the best chance of breaking even.

But given that these investors have the money to acquire these stakes because they've been accumulating that wealth by selling us stuff on credit and thus being forced to save a good chunk of the proceeds (in the form of IOUs), it is only fair that they get a chunk of the wreckage of our economies, whatever it's worth today.

Display:
I see market manipulation at work here. The default rate on mortgages is not high enough (or even projected to be high enough) to seriously impact the value of the mortgage-backed securities. Suppose the default rate rose to 10%. The banks could be expected to recoup a good deal of the principal through foreclosure, so the overall lose might be 5%.

If so then, say, a $100 million pool would be worth $95 million. Factor in the loss of future income when the loan is closed out and you might have another 5% or so per year. Because of the panic these instruments are being valued at half or less of their face. This makes no sense. I'm betting there are some clever investors out there hyping the panic and buying things up at bargain prices. Just look at the Citigroup deal. Sounds like a steal to me.

Those worrying about where the world was going to put their accumulated dollars from the continual trade deficits may be finding out. When the smoke clears much of the US financial sector will be under foreign control.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Sun Dec 16th, 2007 at 06:27:26 PM EST
I guess this bit by Munchau has some bearing on the issue:

"It is a fully fledged solvency crisis that has arisen because two giant and interlinked bubbles burst simultaneously - one in property, one in credit - leaving banks and investors on the brink of bankruptcy, some hanging on by their fingertips."
by Metatone (metatone [a|t] gmail (dot) com) on Sun Dec 16th, 2007 at 06:41:08 PM EST
[ Parent ]
but you are wildly optimistic if you think the losses are going to be only 5-10%. where do you get that "the default rate on mortgages is not high enough (or even projected to be high enough) to seriously impact the value of the mortgage-backed securities"???

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Sun Dec 16th, 2007 at 06:42:21 PM EST
[ Parent ]

America's property crisis (Oct 4th 2007)

Nationally, people are defaulting on mortgages at a faster pace than at any point in recent decades. According to the Mortgage Bankers Association, some 5% of all mortgages are delinquent and the share rises to almost 15% for "subprime" mortgages--those lent to people with shaky credit histories. In the second quarter of 2007, almost 3% of subprime loans entered foreclosure (the process of default and repossession). RealtyTrac, a company that tracks foreclosures, reckons up to 1.5m households will enter the process this year (see chart), double last year's figure. And with some 2.5m adjustable-rate mortgages resetting to higher rates before the end of 2008, everyone knows there is much worse to come.




Cracks in the façade (Mar 22nd 2007)
A recent report by analysts at Credit Suisse estimates that 80% of subprime loans made in 2006 included low "teaser" rates; almost eight out of ten Alt-A loans were "liar loans", based on little or no documentation; loan-to-value ratios were often over 90% with a second piggy-bank loan routinely thrown in. America's weakest borrowers, in short, were often able to buy a house without handing over a penny.

Lenders got the demand for loans that they wanted--and more fool them. Amid the continuing boom, some 40% of all originations last year were subprime or Alt-A. But as these mortgages were reset to higher rates and borrowers who had lied about their income failed to pay up, the trap was sprung. A new study by Christopher Cagan, an economist at First American CoreLogic, based on his firm's database of most American mortgages, calculates that 60% of all adjustable-rate loans made since 2004 will be reset to payments that will be 25% higher or more. A fifth will see monthly payments soar by 50% or more.



In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Mon Dec 17th, 2007 at 04:12:26 AM EST
[ Parent ]
As we discussed last week; it would be prudent for rdf to read the following link to a California mortgage broker's explanation how all the mortgages sold in the last 6 years will effect foreclosure rates, insolvency etc. Link is: http://blogs.marketwatch.com/greenberg/2007/12/straight-talk-on-the-mortgage-mess-from-an-insider/

Besides the greed factor; these bubbles have been created to mask the inherent weakness in western economies for the past 25-30 years, particularly in the US and UK. When you have a system in which the vast majority of the population-60-70%- have not had an increase in their wages for many years, leads to disastrous effects on our societies.

The fact that comments about the current financial/housing crisis throughout the msm and blogosphere ignores the underlying human and economical problems tells me we can not avoid a meltdown which may be different from the great depression but nonetheless, the consequences will be widespread and painful. Anotherwards, 'NO ONE GETS OUT OF THIS WITHOUT PAIN'

by An American in London on Mon Dec 17th, 2007 at 07:19:27 AM EST
[ Parent ]
An American in London:
Besides the greed factor; these bubbles have been created to mask the inherent weakness in western economies for the past 25-30 years, particularly in the US and UK. When you have a system in which the vast majority of the population-60-70%- have not had an increase in their wages for many years, leads to disastrous effects on our societies.

This is THE key point here. It's the single most relevant way to gut-punch the wave of sleazy, self-serving con-artist crap about reform.

There is no lack of money in the system - even if a fair chunk of it is fictitious, there's enough to still have real value.

But beyond the Anglo Disease we have Anglo Disease squared - another textbook example of explosive economic self-immolation, which seems to be the inevitable and predictable outcome of the 'reform' these snake-oiled chuckleheads are touting as a cure-all.  

Constraining upstream cash supply so it stops circulating among the peasants doesn't just bankrupt the peasants - it bankrupts everyone upstream too.

So semi-socialised income distribution, currency stability, long-term investment and regulations that prevent insane lending and even more insane speculation are the only reliable solutions. They may not be as exciting and hungry as a quarter-by-quarter free-for-all, and a tiny minority of not very interesting people will have to give up their private jets.

But by god, they actually work as good solid economic principles, and are somuch less likely to trash the place than anything we've had since WWII.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Dec 17th, 2007 at 11:55:56 AM EST
[ Parent ]
:-)

Apologies to Robert for joining the mob.

You're forgetting the impact of mortgage foreclosures on CBO market and all the various instruments financially engineered (sic) over the last 20 years.  Most of the latter were leveraged meaning the downside is much worse than the money owed for the mortgages.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sun Dec 16th, 2007 at 07:10:57 PM EST
[ Parent ]
"CBO?"  typo I meant CMO - Collateralized mortgage obligation


She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
by ATinNM on Sun Dec 16th, 2007 at 08:21:59 PM EST
[ Parent ]
However, the default rate overall is a quite different thing from the default rate in a particular Collateralized Debt Instrument ... since of course the primary means of meeting the demand for these instruments was in granting mortgages that otherwise would not have existed, some of them will contain a far higher concentration of that 10% default rate.

If the instrument is divided into four equal tranches, and you hold the 25% riskiest tranche a 10% default in the pool is a 40% loss for you ... a 20% default in the pool is an 80% loss. A 40% loss in the pool, which is certainly likely to be seen in many of the instruments that have concentrated the systematic risk of a downturn in the housing market, and the riskiest tranche is wiped out, and the second riskiest tranche has 60% of its backing in default ... and the remaining 40% is the absolute worst risk remaining in the pool.

And consider the higher quality tranches now ... someone bought the second best tranche for slightly better returns than the top tranche while still expecting, absent a meltdown in the housing market, low default risk and low pre-payment risk ... indeed, given that this was rated as an investment grade instrument, you were focusing on the pre-payment risk when deciding between the first and second tranche. But now you are, in effect, mostly holding the junk tranches of the mortgages still standing.

The top quality tranche, which is the best sheltered from default risk, was bought by an institution looking for a rock solid, steady stream of income for a number of decades, and all of a sudden is holding an asset with a clear pre-payment risk, when the returns available to pre-payments is lower than when the top quality tranche was originally lost.

Its lost value across the board ... sure, loss of value in the lowest quality tranches, loss in quality in the highest quality tranches, but still, lost value as financial assets.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Mon Dec 17th, 2007 at 05:58:42 AM EST
[ Parent ]
Typical senior tranches go to the 82% watermark. At least, that's the attachment point for which base correlation is quoted. So AAA feels the pain at 18% default rate. Hence the freeze: we are almost there.

Pierre
by Pierre on Mon Dec 17th, 2007 at 10:21:43 AM EST
[ Parent ]
... AAA starts to feel sore before it feels real hurt, because the quality of a tranch declines as the original junk tranches are zeroed out.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Tue Dec 18th, 2007 at 06:01:19 PM EST
[ Parent ]
Interfluidity :: Insolvency is philosophy, illiquidity is fact
Insolvency is philosophy, illiquidity is fact

Take a look at a snippet of GM's last-quarter balance sheet (courtesy of Yahoo! Finance). It's the part that contains what accountants quaintly call "Shareholder Equity":

[Follow original link to see the graphic.]

Yes, the accounting value of the firm's equity is negative 41.7 billion dollars. Now, answer me this. Is GM insolvent?

There is no definitive answer. It's a philosophical question, a matter of opinion. The market says GM's equity is worth $15B dollars. All we can say with any confidence is that GM is liquid, it has not yet failed to pay its bills, it is capable of borrowing to finance its operational needs despite a balance sheet with no vital signs. The patient walks and breathes, so it is not dead. Somehow.

There is a meme going around the blogosphere, and now the mainstream-press-o-sphere, that the Fed is helpless in the current crisis because the problem is one of solvency, not liquidity. Here's Paul Krugman (hat tip Mark Thoma):

In past financial crises... the Fed has been able to wave its magic wand and make market turmoil disappear. But this time the magic isn't working... Why not? Because the problem with the markets isn't just a lack of liquidity -- there's also a fundamental problem of solvency.

Here, here, Dr. Krugman. And you too, Dr. Roubini. And Michael Shedlock. And Kevin Drum. I agree with you all. From the tiny legal entities known as asset-backed securities, way up through to a couple of large money center banks, there are a lot of entities out there which, by my Victorian standards, are simply insolvent. But by those standards, GM oughtn't be able to fog a mirror, let alone borrow money from people. It's the living dead, a zombie, to use a term fashionable when discussing Japan but never, ever appropriate to the hypercapitalist U.S. of A.

by Metatone (metatone [a|t] gmail (dot) com) on Sun Dec 16th, 2007 at 06:30:50 PM EST
There is some truth to it - the only thing we ever see is illiquidity, ie the inability by someone to pay a liability when due.

Then it's indeed a question of opinion as to what the inability means. But there is a conceptual difference between a temporary mismatch between resources and debts, and a long term inability to pay one's debts. The first kind can be solved by liquidity injection, the second cannot.

So, after the failure of the recent liquidity injections, one can infer that we are no longer in a temporary mismatch situation.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sun Dec 16th, 2007 at 06:40:16 PM EST
[ Parent ]
Unless it's a question of psychology and not of temporary mismatch or long term inability.
by vladimir on Mon Dec 17th, 2007 at 06:17:34 AM EST
[ Parent ]
GM hasn't made money making/selling automobiles for donkey's years.  They have been making money making loans to people to buy their automobiles through GMAC -- General Motors Acceptance Corporation.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
by ATinNM on Sun Dec 16th, 2007 at 07:27:54 PM EST
[ Parent ]
As I understood it, the GM group as a whole has been losing money.

i.e. GMAC profits are less than GM Auto losses.

by Metatone (metatone [a|t] gmail (dot) com) on Sun Dec 16th, 2007 at 07:50:32 PM EST
[ Parent ]
That is what they have been reporting.  The truth?  I don't know. I haven't looked at their financial statements in 20 years.

I do know they make crappy cars no one wants to buy, even with cheap loans as an inducement.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sun Dec 16th, 2007 at 08:16:34 PM EST
[ Parent ]
I do know they make crappy cars no one wants to buy, even with cheap loans as an inducement.

Amen.  Ditto Ford and Chrysler.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Mon Dec 17th, 2007 at 06:38:28 AM EST
[ Parent ]
That's my understanding as well.  I was under the impression that GMAC was being sold off though.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Mon Dec 17th, 2007 at 06:36:41 AM EST
[ Parent ]
Call to relax Basel banking rules - Telegraph

The Government must suspend a set of key banking regulations at the heart of the current financial crisis or risk seeing the economy spiral towards a future that could "make 1929 look like a walk in the park", one of Britain's leading economists has warned.

  • Cutting through the normal banking rules
  •  
    Peter Spencer has called for a suspension of the Basel system of banking regulations

    Peter Spencer, of the Ernst & Young Item Club, said conflicts caused by the Basel system of banking regulations, which determine how much capital banks must raise to keep their books in order, are the root cause of the crunch and were serving to worsen the City's plight.

    The regulations meant that banks forced to take off-balance sheet assets from troubled structured investment vehicles on to their books had little choice but either to raise money from abroad or cut back dramatically on their spending, he said.

    He warned that, if London's money markets remained frozen and the authorities retain the strict Basel regulations, the full scale of the eventual credit crunch and economic slump could be "disastrous".

    Dismissing the assumption that banks are not lending to each other on the money markets because they lack confidence in each others' potential solvency, he argued that they were, in practice, prevented from lending the cash at all because it could leave their balance sheets falling foul of the Basel regulations.

    by Metatone (metatone [a|t] gmail (dot) com) on Sun Dec 16th, 2007 at 06:38:02 PM EST
    Just to win a little more time, but for a bigger bang.
    by das monde on Sun Dec 16th, 2007 at 08:12:37 PM EST
    [ Parent ]
    This can only come from the UK where the banks are not subject to regulatory reserve requirements. If they keep a 3% reserve ratio it's voluntarily. That is, before Basel came around.

    We have met the enemy, and he is us — Pogo
    by Migeru (migeru at eurotrib dot com) on Mon Dec 17th, 2007 at 03:50:42 AM EST
    [ Parent ]
    No reserve requirements?! Wow. I had not realized that. That must be unique in the industrialized world.

    The fact is that what we're experiencing right now is a top-down disaster. -Paul Krugman
    by dvx (dvx.clt t gmail dotcom) on Mon Dec 17th, 2007 at 04:05:01 AM EST
    [ Parent ]
    I think it's basically the same in the US since 1994 when "sweeps" were authorized. Check the funny nut at globaleconomicanalysis.blogspot.com, he has interesting posts in his archives about that.

    Pierre
    by Pierre on Mon Dec 17th, 2007 at 05:26:28 AM EST
    [ Parent ]
    Reserve requirement - Wikipedia, the free encyclopedia
    The cash reserve ratio is also known as the cash asset ratio or liquidity ratio. The Bank of England holds to a voluntary reserve ratio system. In 1998 the average cash reserve ratio across the entire United Kingdom banking system was 3.1%.


    We have met the enemy, and he is us — Pogo
    by Migeru (migeru at eurotrib dot com) on Mon Dec 17th, 2007 at 10:45:29 AM EST
    [ Parent ]
    What's the betting the current average liquidity ratio is negative?
    by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Dec 17th, 2007 at 11:45:10 AM EST
    [ Parent ]
    dvx:
    That must be unique in the industrialized world.
    According to the wikipedia article none of Australia, Canada, Mexico, Sweden or the United Kingdom have a reserve requirement.

    We have met the enemy, and he is us — Pogo
    by Migeru (migeru at eurotrib dot com) on Mon Dec 17th, 2007 at 02:57:06 PM EST
    [ Parent ]
    That seams to be a popular list around these intertubes, but from what I can gather, the worldbank disagrees (xls-warning) and instead says it is 8% in Sweden.

    Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se
    by A swedish kind of death on Mon Dec 17th, 2007 at 08:42:21 PM EST
    [ Parent ]
    Hmm, that wiki list has been sourced from some macroeconomics textbook. Would you mind going in and correcting the mistake?

    We have met the enemy, and he is us — Pogo
    by Migeru (migeru at eurotrib dot com) on Tue Dec 18th, 2007 at 03:00:28 AM EST
    [ Parent ]
    Munchau:  Unless there has been some structural shift, there is going to be one of the most serious housing downturns ever.

    Let me expand on what he is saying.  

    In 1928 the US housing market started to lose value.  The market value of these homes did not return to pre-28 values until the 1950s.  Mr. Munchau is saying this downturn will be worse.

    (eek)

    Jerome: The only open question is whether the new investors, who are buying into our banks at this delicate point in time, will make any money.

    For those in euro-land it's an open question.  Partially it depends on the total exposure of the total financial system, the strength or lack of it for the individual entities, and what moves the euro makes versus other currencies. None of which do I know enough about to comment.  Tho' I would like to note: in theory international investors could lose money on their investment when accounting in euros and make money in their currency-of-record.  

    In US dollars, pumping money into the banking system is one way for holders of US dollar denominated financial instruments to trade their paper into claims on real assets.  The holders get to trade a depreciated claim (those financial instruments) at par - a buck still buys a buck in the US.  

    She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

    by ATinNM on Sun Dec 16th, 2007 at 07:03:21 PM EST
    In 1928 the US housing market started to lose value.  The market value of these homes did not return to pre-28 values until the 1950s.  Mr. Munchau is saying this downturn will be worse.

    Munchau's little calculation is about UK housing market, not the US one.

    by Sargon on Mon Dec 17th, 2007 at 05:13:56 AM EST
    [ Parent ]
    Correction noted.  Thanks!

    She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
    by ATinNM on Mon Dec 17th, 2007 at 11:30:40 AM EST
    [ Parent ]
    OK, I'm willing to be educated.
    I take a bunch of mortgages which mature in 30 years and have interest rate of, say, 8%. I sell these as a mortgaged-based security. The buyer has to expect less than 8% return, since the one doing the bundling has to take his cut.

    Now this buyer doesn't really have the money to pay for this purchase so he buys on margin. How much is his lender going to provide and at what rate of interest? If this secondary lender charges more than 8% than the buyer of the bundle is a fool.

    If this secondary lender charges less than 8% he is the fool, since he his not being compensated for his risk. You can keep bundling and reselling into as big a Ponzi scheme as you wish, but the principal remains the same.

    Now the original bundle suffers a partial loss. I said 5-10% default. Does anyone have figures that indicate that the overall mortgage default market is going to exceed this?

    Now the secondary lender gets cold feet and calls in the loan. The CBO buyer can't come up with the money - a liquidity problem. He is forced to sell at a loss. He loses money, so does the firm he borrowed from. Were their losses based upon the decline in value of the original mortgage pool?

    I think not. So I'm on the side that says it's not a shortage of capital, it's a liquidity problem caused by panic. Are the banks having a real decline in income or are their "losses" just bookkeeping entries as they write down the value of the securities they can't sell or are forced to buy back?

    What happens in a few years when these securities go back up in value as the panic passes? Who cleans up?

    What am I missing?

    Policies not Politics
    ---- Daily Landscape

    by rdf (robert.feinman@gmail.com) on Sun Dec 16th, 2007 at 07:35:14 PM EST
    You missing the leverage part of the whole thing.

    The problem isn't the CMOs (note my correction to my original comment.)  The problem is what happens once derivatives are spun using the CMO as the underlying asset.  derivatives have come far from their original use and the risks to the financial system have grown alongside.  

    She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

    by ATinNM on Sun Dec 16th, 2007 at 08:48:13 PM EST
    [ Parent ]
    i wonder how many hosts a parasite kills before it realises it needs to restrain itself to co-evolve.

    society recapitulates botany?

    'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

    by melo (melometa4(at)gmail.com) on Sun Dec 16th, 2007 at 09:55:36 PM EST
    [ Parent ]
    Trouble is it's not a parasite, but a cancer...

    "The future is already here -- it's just not very evenly distributed" William Gibson
    by ChrisCook (cojockathotmaildotcom) on Mon Dec 17th, 2007 at 09:17:38 AM EST
    [ Parent ]
    Nothing says the parasite and host have to co-evolve. Our planet's evolutionary history is littered with those species that didn't.

    - Jake

    Friends come and go. Enemies accumulate.

    by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Dec 21st, 2007 at 08:09:55 AM EST
    [ Parent ]
    loans with teaser (that is, artificially, temorarily low) rates.  When the higher rates kick in, which they WILL DO since that is specified in the contract, the homeowners will be over their heads.  A majority of THEM will default.  What happens then is fun speculation but we are talking way more than 5 % or 10 % defaults.  

    This industry is set to crash and burn.  

    WE don't KNOW that the banks are insolvent (though we think they are) because they will not let us see their books.  If we saw their books we THEN would know.  

    But they are not fools:  There is no way they would let us see their books.  How bad is it?  Based on how rotten their own position is, they are not willing to other banks whose position is likely as bad.  

    And is that not bad enough for you?  What more, really, do you need to know?  

    If you were a rich foreigner holding dollars, why would you buy into these insolvent banks?  Well, your dollars are going to lose value no matter what you do.  By buying pieces of the financial system before the dollar loses value, you might--while taking the inevitable loss--acquire control.  

    The Fates are kind.

    by Gaianne on Sun Dec 16th, 2007 at 09:20:18 PM EST
    [ Parent ]
    Forgive my ignorant layman's question - this stuff always makes my head spin. But if you buy an insolvent bank, haven't you just bought yourself a dud business worth nothing? Don't insolvent banks ever get wound up? How do you get 'control' in those circumstances?
    by wing26 on Mon Dec 17th, 2007 at 02:02:25 AM EST
    [ Parent ]
    An insolvent bank is one whose liabilities exceed its assets, but both assets and liabilities include future cash flows which are estimated and discounted to a present value so the extent to which the company is insolvent is can change if the basis of estimation changes.

    The people who have bought into these banks have not bought when all shares in the open market (which keeps the balance sheet unchanged. I presume effectively the bank has issued them with new shares, and if they inject enough capital to make the bank barely solvent everything can keep running.

    We have met the enemy, and he is us — Pogo

    by Migeru (migeru at eurotrib dot com) on Mon Dec 17th, 2007 at 04:07:22 AM EST
    [ Parent ]
    I think the banks themselves really don't know where they stand. All the complexity around the new instruments and the on-off balance sheet operations has contributed fog to an already opaque situation. What good is it showing your books if you can't assess the quality of a large portion of your assets?
    by vladimir on Mon Dec 17th, 2007 at 07:34:14 AM EST
    [ Parent ]
    The secondary lender can charge less than 8%, becuase its cost of capital is much less than that of an investor (1/12th under Basel 1 rules - the Cooke ratio, and possibly less under the new Basel 2 rules).

    So with a 1.5% interest rate, it can still get an 18% return on capital invested. Also, as a lender, you get first dips at being reimbursed so, as long as you don't lend the whole amount, you let the initial investor take the first hit (the whole thing about CDOs was to create more tranches between the traditional "debt" and "equity" tranches, to fine tune risk taking even better - exactly as ChrisCook suggests should be done).

    But my point above is that the 5-10% default rate appears optimstic (see separate answer on that)
    While the amount of capital at risk has not changed (ie the amount that can potentially be lost), the overall amount of money at risk (in a more diluted way, sure) has gone up.

    In the long run, we're all dead. John Maynard Keynes

    by Jerome a Paris (etg@eurotrib.com) on Mon Dec 17th, 2007 at 03:49:39 AM EST
    [ Parent ]
    exactly as ChrisCook suggests should be done

    Bit confused here, Jerome, what do you think I'm saying should be done?

    "The future is already here -- it's just not very evenly distributed" William Gibson

    by ChrisCook (cojockathotmaildotcom) on Mon Dec 17th, 2007 at 05:55:57 AM EST
    [ Parent ]
    various mechanisms that move away from debt and equity and allow for tailor-made repayment flows and/or profit sharing. PIK (payment in kind), perpetual notes, profit sharing arrangements - it was all in those structures.

    Which brings me back to my point that the sharing arrangements are not the problem whrn the risk analysis is not done - and backed by credible players (ie banks and bankers doing their job).

    In the long run, we're all dead. John Maynard Keynes

    by Jerome a Paris (etg@eurotrib.com) on Mon Dec 17th, 2007 at 08:02:10 AM EST
    [ Parent ]
    I agree totally with you as to the reason for the state we are in: ie investment bankers simply not doing their job.

    That's not the issue: the issue is what is the optimal way out?

    Debt got us into this position, so how can more debt get us out? ie it cannot be a debt-based solution.

    So "Equity" (with no capital repayment) it must be.

    Corporations and trusts are both sub-optimal in their complexity and allocation of risk and reward between stakeholders.

    Applying Occam's Razor, the simplest form is the best, and there is no simpler mechanism than simply dividing property revenues into proportional shares or "nth's" using "open" corporate forms.

    "The future is already here -- it's just not very evenly distributed" William Gibson

    by ChrisCook (cojockathotmaildotcom) on Mon Dec 17th, 2007 at 09:15:37 AM EST
    [ Parent ]

    Debt got us into this position, so how can more debt get us out? ie it cannot be a debt-based solution.

    So "Equity" (with no capital repayment) it must be.

    Any debt not repaid needs to be covered by capital from someone (including that of the lending bank, if necessary, if repayment never happens)


    In the long run, we're all dead. John Maynard Keynes

    by Jerome a Paris (etg@eurotrib.com) on Mon Dec 17th, 2007 at 09:20:36 AM EST
    [ Parent ]
    I don't think that you are missing anything that is known. And that is part of the problem. There are unknowns, the largest of which is that the banks and other institutions don't really even know what they own. Nor do they know what amount of default there will be.

    Now, you are correct in that there will be some tranches which hold onto a value better than keeping money in a pillowcase. In particular, loans sold a few years ago or more are pretty good. Not only were they sold in an above board manner to people who could qualify for loans in an above board manner, but the houses were valued at a value more realistic than today's and they were 80% loans.

    The last few years the 100% loans and the illicit paper fixing to get someone fundable put a dent in the system. And if it were just taking a hit for those percent of foreclosures (suspected to hit more than 2 million additional to the standard in the next two years) perhaps your paper would return to value after the panic.

    But the houses were valued too high to begin with, just because of the easy money bubble. The foreclosures are going to force the house value down in every neighborhood, the fact that job loses are going to accelerate will take buyers out of the system which will force house prices down, the fact that only the most pristine buyers will be looked at will take more people out of the system, driving the prices down.

    Suddenly, even if you had the truanch based upon the best properties and were able to sit out the panic portion of this problem, the houses in your portfolio are not worth 60% of what they were loaned at. Or worse.

    I had a house that I bought in the 80s - put 50K in paint and a new kitchen so that I had 425,000 in it. Market collapsed.  Value was at less than 300K for a long time and didn't get up to 425 for a decade. If I had to sell (to follow a job, for example) or if there were a medical disaster (I was self employed, no insurance), that house would have been on the market and someone would have gotten a deal in your long run.

    And that is how I think that the best AAA tranche is short term, incalculable dust, and the worst are sand through the fingers...you just can't hold out that long for something that is going to stay undervalued for the length of time it would take to "normalize".

    And yet, many American corporations have a lot of cash, and have the ability to tighten up at home and sell more abroad. It will be an interesting game. So, what you are saying rdf about the houses might actually be true about the stock market...some parts might be a disaster, but they are not the majority and there are some parts that are just going to grow fine...though there are a lot of presumptions even in that (like, at which point can they just not afford to keep us old folks alive anymore on the high priced medicines and care that it will  take to do so?

    Never underestimate their intelligence, always underestimate their knowledge.

    Frank Delaney ~ Ireland

    by siegestate (siegestate or beyondwarispeace.com) on Mon Dec 17th, 2007 at 08:02:41 AM EST
    [ Parent ]
    So we're looking at a reasonable expectation of price drops of at least 50% in the more inflated areas - and possibly more.

    Problem - this immediately puts many buyers into negative equity, which means the resource against which the loan is secured is now worth much less than the book value.

    So even without defaults, any loan secured against property sold during the bubble is going to be worth 75% (generous) to 50% (more likely) of its nominal value.

    Once people start defaulting, the negative equity value becomes the likely realisation value. Given the fire sale nature of what's happening, and the dearth of buyers (no new lending, except for those with perfect credit) the realisation value will drop still further by perhaps another 50%.

    So my guess is that the actual write-off figure before leveraging is going to be around 40-50% across the entire US mortgage market, including stable older loans.

    If unemployment explodes that figure could be even lower, because some of those older loans will turn into defaults too.

    Of course, I could mention peak oil and food/energy inflation here, but that would just be depressing, wouldn't it?

    by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Dec 17th, 2007 at 12:22:07 PM EST
    [ Parent ]
    Anyone notice the dollar has been rising against the euro for the past several days? .67 to .695. Are non Americans starting to swoop in to buy cheap U.S. assets?

    Hey, Grandma Moses started late!
    by LEP on Mon Dec 17th, 2007 at 08:17:53 AM EST
    ... or is it a deal between the Federal Reserve and the ECB / EU National Banks. I read on the FT this weekend that the first month's 40B-50B injection scheme involved selling 20B-25B worth of US securities to Europeans!
    by vladimir on Mon Dec 17th, 2007 at 08:23:46 AM EST
    [ Parent ]
    I don't know much about this stuff but I'm guessing that $25B on the world currency markets is not enough to move anything. Since My income is in dollars but my expenses in euros, maybe it's the man (woman?) upstairs toying with me before he kicks me in the balls again.

    Hey, Grandma Moses started late!
    by LEP on Mon Dec 17th, 2007 at 08:42:33 AM EST
    [ Parent ]
    Here's the link. http://www.ft.com/cms/s/0/d9e03c62-a8bb-11dc-ad9e-0000779fd2ac.html 25B covers 40% of the US current account deficit for 1 month. That's good enough to keep things rolling for now - we'll deal with next month when it comes.
    by vladimir on Mon Dec 17th, 2007 at 08:48:02 AM EST
    [ Parent ]
    Minor, short term, fluctuations are always occurring in currency markets.  They come from the high and hyper-leverage by the various players.  Even a minor purchase of $100 billion (US), at the right (wrong) time, can move the market 1 to 2 percentage points.

    (I can't believe I just wrote "a minor purchase of $100 billion dollars.")

    She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

    by ATinNM on Mon Dec 17th, 2007 at 11:58:00 AM EST
    [ Parent ]
    But this has been a trend for the past week now.
    by vladimir on Mon Dec 17th, 2007 at 12:21:24 PM EST
    [ Parent ]
    My "short term" means "an eternity" to a Day Trader.  :0

    I view anything under 3 months as "short term."

    She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

    by ATinNM on Tue Dec 18th, 2007 at 10:15:54 PM EST
    [ Parent ]
    Something similar happened in Japan when the real estate bubble popped. The banks were actually insolvent, not just potentially insolvent as they are in the US.

    There was no disaster, just investment stagnation. Why? Because the rules were changed and the banks were allowed to evade capital requirement by calling bad loans "non-performing" and keeping them on the books rather than writing them off.

    I don't see why something similar won't happen in the US. The banking sector is the most favored sector in the economy. It has been protected by the marines when necessary (gunboat diplomacy). Keeping it afloat is the primary task of the Federal Reserve, despite what they legislative mandate says.

    I think there also needs to be a distinction made between real banks and pseudo-banks. If Lehman fails who cares beside a bunch of speculators that trade in its paper?

    If Bank of America fails then there is a real problem. The issue is cloudy in a case like Citigroup which has both sorts of business. I'm guessing that they are treated as separate subsidiaries in order to comply with the banking laws, so that a failure in the investment area may not affect the banking division. None of this would have happened if the Glass-Steagall hadn't been repealed.

    It was designed to prevent speculation by banks. Another disaster to place at the feet of the GOP.

    Policies not Politics
    ---- Daily Landscape

    by rdf (robert.feinman@gmail.com) on Mon Dec 17th, 2007 at 08:47:26 AM EST
    ... it was under Clinton's watch it was repealed.

    I agree that some form of long term "intensive care" ward for banks is something likely to happen. What's interesting is that the problems do not quite come only from the banks:


    Out of the shadows: How banking's secret system broke down

    (...) while investors are scrutinising some of the industry's best-known names, a spectre will be silently haunting events: the state of the little-known, so-called "shadow" banking system.

    A plethora of opaque institutions and vehicles have sprung up in American and European markets this decade, and they have come to play an important role in providing credit across the financial system. Until the summer, structured investment vehicles (SIVs) and collateralised debt obligations (CDOs) attracted little attention outside specialist financial circles. Though often affiliated to major banks, they were not always fully recognised on balance sheets. These institutions, moreover, have never been part of the "official" banking system: they are unable, for example, to participate in Monday's Fed auction.

    But as the credit crisis enters its fifth month, it has become clear that one of the key causes of the turmoil is that parts of this hidden world are imploding. This in turn is creating huge instability for "real" banks - not least because regulators and bankers alike have been badly wrong-footed by the degree to which the two are entwined.

    "What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending [that is] so hard to understand," Bill Gross, head of Pimco asset management group recently wrote. "Colleagues call it the `shadow banking system' because it has lain hidden for years, untouched by regulation yet free to magically and mystically create and then package subprime loans in [ways] that only Wall Street wizards could explain."




    In the long run, we're all dead. John Maynard Keynes
    by Jerome a Paris (etg@eurotrib.com) on Mon Dec 17th, 2007 at 09:18:40 AM EST
    [ Parent ]
    To me, CDOs and SIVs are banks. They may not look like a bank but they sure smell like one.

    The real failure is with the regulators who should have reacted on this one about 15 years ago when the growth of structured vehicles was first becoming aparent. Yet they didn't. Why?

    by vladimir on Mon Dec 17th, 2007 at 09:44:23 AM EST
    [ Parent ]

    To me, CDOs and SIVs are banks. They may not look like a bank but they sure smell like one.

    Indeed.

    And what I really, really don't understand is how banks managed to keep off their balance sheets contingent lines like many of the SIVs and conduits seemed to have (ie, the banks had no legal choice but to refinance, if all else failed and the conduit chose to exercise it) - and for pretty damn huge amounts. A contingent commitment is still a commitment. How on earth did these disappear?

    In the long run, we're all dead. John Maynard Keynes

    by Jerome a Paris (etg@eurotrib.com) on Mon Dec 17th, 2007 at 10:39:17 AM EST
    [ Parent ]
    How on earth did these disappear?

    Because the big audit firms can't or won't do their jobs?
    by Colman (colman at eurotrib.com) on Mon Dec 17th, 2007 at 10:46:08 AM EST
    [ Parent ]
    Because there's more money in not doing your job than doing your job. and because there are no real penalties for not doing your job.

    Any idiot can face a crisis - it's day to day living that wears you out.
    by ceebs (ceebs (at) eurotrib (dot) com) on Mon Dec 17th, 2007 at 11:26:53 AM EST
    [ Parent ]
    Because it's institutional fraud on a massive scale.

    It's the biggest bank robbery in history, with the banks as the criminals.

    by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Dec 17th, 2007 at 11:58:56 AM EST
    [ Parent ]
    and it's being followed up with blackmail. "You'd better let us get away with it, otherwise the banking system will collapse"

    Any idiot can face a crisis - it's day to day living that wears you out.
    by ceebs (ceebs (at) eurotrib (dot) com) on Mon Dec 17th, 2007 at 12:22:23 PM EST
    [ Parent ]
    So the banking system is too valuable to leave it to the vagaries of market corrections... Another strategic sector of the economy?

    We have met the enemy, and he is us — Pogo
    by Migeru (migeru at eurotrib dot com) on Mon Dec 17th, 2007 at 12:26:51 PM EST
    [ Parent ]
    In the UK sometime soon there will be the court case covering banking penalty charges, which could cost UK banks a further £4.5 billion per year (Plus they may have to pay back up to six years of charges if it turns out they were illegally taken)

    Any idiot can face a crisis - it's day to day living that wears you out.
    by ceebs (ceebs (at) eurotrib (dot) com) on Mon Dec 17th, 2007 at 12:36:14 PM EST
    [ Parent ]
    I read a story that when Jeff Rubin was summoned for the interim job at Citi, he learned in the subsequent briefing the concept of "liquidity put" - a clause that had become common in Citi's production of CDO's for the past couple of years. The tranche contracts embed a put clause, by which the buyer also buys an option to resell to Citi at par value (a put) anytime during the life of the product (american style). These were not factored into the exposure of the risk "because the tranches were AAA rated". Although in effect it only means that Citi's keeping the risk on its book (it goes back in the minute the shit hits the fan), while giving away (for free) the coupon between the issue and the event !!! The total absolute super cluster fuck.

    The write-offs revisions came from the fact that everybody wants to exercize the clause, and Citi's risk management staff did had not even realized the clauses where in the deals when they were made.

    Note that we have no way to be sure that all the shit is back into the books, only what Citi will want to tell us: since the only risk for the holders is the counterparty risk on Citi, their best strategy is to keep some of it as long as possible to cash in the high-yield coupon, and send it back when the default is effective or just before Citi actually goes belly up.

    Pierre

    by Pierre on Mon Dec 17th, 2007 at 10:55:43 AM EST
    [ Parent ]
    The total absolute super cluster fuck.

    Now THAT was funny :))

    by vladimir on Mon Dec 17th, 2007 at 11:39:04 AM EST
    [ Parent ]
    ... or was that a gallows laugh?
    by vladimir on Mon Dec 17th, 2007 at 11:39:51 AM EST
    [ Parent ]
    Jerome a Paris:
    A contingent commitment is still a commitment. How on earth did these disappear?
    According to US GAAP (Generally Accepted Accounting Principles),
    Footnotes [to financial statements] also contain disclosures relating to contingent losses. Firms are required to accrue a loss (recognize a balance sheet liability) when both of the following conditions are met:
    • It is probable that assets have been impaired or a liability has been incurred.
    • The amount of the loss can be reasonably estimated.
    If the loss amount lies within a range, the most likely amount should be accrued. When no amount in the range is a better estimate, the firm may report the minimum amount in the range.
    SFAS (Statement of Financial Accounting Standards) 5 defines probable events are those "more likely than not" to occur, suggesting that a probability of more than 50% requires recognition of a loss. However, in practice, firms generally report contingencies as losses only when the probability of loss is significantly higher.
    Footnote disclosure of (unrecognized) loss contingencies is required when it is reasonable possible (more than remote but less than probable) that a loss has been incurred or when it is probable that a loss has occurred but the amount cannot be reasonably estimated. The standard provides an extensive discussion of loss contingencies.
    In other words, a mess.

    We have met the enemy, and he is us — Pogo
    by Migeru (migeru at eurotrib dot com) on Mon Dec 17th, 2007 at 11:05:10 AM EST
    [ Parent ]
    That quote is the funniest thing I've seen this month.

    I think I'm developing a taste for dark humour.

    by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Dec 17th, 2007 at 12:01:08 PM EST
    [ Parent ]
    There's so much wrong with it I don't know where to begin.

    We have met the enemy, and he is us — Pogo
    by Migeru (migeru at eurotrib dot com) on Mon Dec 17th, 2007 at 12:11:11 PM EST
    [ Parent ]
    This just in:
    Citi reduced ratings to "Hold" from "Buy" on Bank of America, JPMorgan Chase & Co., Wachovia Corp., Wells Fargo & Co., PNC Financial Services Group Inc. and First Horizon National Corp.

    Charlotte, N.C.-based Bank of America, the nation's largest financial institution by market capitalization, saw its stock price target reduced to $42 from $58, versus a close Friday at $42.16. The analysts said BofA continues to be "one of the premiere banking franchises," but they expect significant declines in earnings per share in 2008 "largely due to our view that capital markets and credit losses will be worse than expected, and while the stock is cheap we see little upside potential."

    Notice they didn't say the bank was in trouble, just that its earnings would decline. For the Wall Street types it's not sufficient to be profitable, the firm has to see profits increasing. This mind set is fine for stock market speculators, but they are treating a weak stock market as being equivalent to weak firms.

    I'm holding on to my bank stocks, and planning to increase my investment in one of the "real" banks shortly.

    Policies not Politics
    ---- Daily Landscape

    by rdf (robert.feinman@gmail.com) on Mon Dec 17th, 2007 at 10:13:07 AM EST
    [ Parent ]
    You're not buying bank stocks today, rdf?

    Hey, Grandma Moses started late!
    by LEP on Mon Dec 17th, 2007 at 10:29:54 AM EST
    [ Parent ]
    about the bankers eating their own via downgrades of one another (done, of course, behind the protection of "Chinese Walls" so that analysts are not influenced by their management or commercial side people...)

    In the long run, we're all dead. John Maynard Keynes
    by Jerome a Paris (etg@eurotrib.com) on Mon Dec 17th, 2007 at 10:34:40 AM EST
    [ Parent ]
    Even more ironic (moronic?) is that there are investors who follow the upgrade downgrade recommends from behind the "Chinese Walls."  

    "Life shrinks or expands in proportion to one's courage." - Anas Nin
    by Crazy Horse on Mon Dec 17th, 2007 at 06:32:32 PM EST
    [ Parent ]
    If Lehman fails who cares beside a bunch of speculators that trade in its paper?

    All the corporates that get liquidity from Lehman's trades on the market and from direct investments.

    by vladimir on Mon Dec 17th, 2007 at 10:03:20 AM EST
    [ Parent ]
    When a man owes you €1000 it his his problem but when a man owes you €1,000,000,000 it's your problem.

    Money is a sign of Poverty - Culture Saying
    by RogueTrooper on Tue Dec 18th, 2007 at 05:13:51 AM EST
    Can someone please explain to me why the ECB has injected $500B whereas the Fed has only injected $20B over the past two weeks? It would have made more sense the other way around, unless it's a European bail-out of the US financial system (through European banks with heavy exposure to US)...
    by vladimir on Wed Dec 19th, 2007 at 02:02:34 AM EST
    Not sure, but I think the Federal Homes Loan Board - a sort of Coop of banks - has been busily pumping in the dollars.....

    "The future is already here -- it's just not very evenly distributed" William Gibson
    by ChrisCook (cojockathotmaildotcom) on Wed Dec 19th, 2007 at 03:02:27 AM EST
    [ Parent ]
    Maybe the Euro has already replaced the dollar as the world's reserve currency.

    We have met the enemy, and he is us — Pogo
    by Migeru (migeru at eurotrib dot com) on Wed Dec 19th, 2007 at 03:20:49 AM EST
    [ Parent ]
    Exactly what I was thinking....

    "The future is already here -- it's just not very evenly distributed" William Gibson
    by ChrisCook (cojockathotmaildotcom) on Wed Dec 19th, 2007 at 04:47:15 AM EST
    [ Parent ]
    made its intervention immediately public, whereas the Fed will announce what happened on Londay in the course of today.

    Plus, the Fed provides normal liquidity as well, there were headlines just because of the unusual procedure this time - and, as it happened in the European timezone, US banks took advantage of the available offer right away too.

    In the long run, we're all dead. John Maynard Keynes

    by Jerome a Paris (etg@eurotrib.com) on Wed Dec 19th, 2007 at 05:41:02 AM EST
    [ Parent ]
    Makes my financial support of ET seem very worthwhile. Oh, wait - there is no financial support. Wow - the miracle of functioning anarchy to borrow a phrase from TheRagBlog.


    paul spencer
    by paul spencer (spencerinthegorge AT yahoo DOT com) on Wed Dec 19th, 2007 at 11:51:56 AM EST


    Display:
    Go to: [ European Tribune Homepage : Top of page : Top of comments ]