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Financial yo-yo - so many confusing news [items]

by Jerome a Paris Fri Feb 22nd, 2008 at 05:23:06 PM EST

Yet another day of astonishing volatility on the markets today, with the Dow Jones jumping from -1% to +1% in a few minutes after it emerged that a bailout for monoline insurer Ambac was apparently imminent. Financial stocks, which had been sharply down on news of downgrades of Freddie Mac and Fannie Mae by analysts, brutally shot up.

What this makes clear is that the markets no longer know how to value stocks, in particular financial ones, and fluctuate wildly as new "input" becomes available, whether hard news like financial statements or corporate decisions, or soft news like  analyst recommendations or expectations of decisions... And as hard news are coming out in random blobs over time, this uncertainty is unlikely to change.

This might make market watching a lot more exciting, but it is also beginning to have an impact on the real economy, as the logical reaction of the financial world in the face of this uncertainty is to batten hatches, tighten lending criteria, and reduce down credit and investment activity.

Euphoria is followed by revulsion, and boom by bust.


Monoline insurers are entities that (used to) have a single activity (hence the "monoline" moniker): providing guarantees to municipal bonds. Thanks to a difference in regulatory requirements between banks and insurers, they could take the same risk (essentially, credit risk on US municipalities) at a lower price, and that (stable and somewhat unexciting) business developed steadily over the past couple decades. With a relatively small capital base, they could get a AAA rating (the best there is), and turn, via their AAA-guarantee low-risk municipal bonds into ultra-low risk bonds much appreciated by various classes of investors (many of which are obliged by their rules or regulatiosn to invest only in AAA-rated securities). That provide cheap financing for municipalities - and thus to local investment, a stable investment product for long temr investors, and a decent return for the insurers.

But, as i noted, this was somewhat unexciting, and monolines started diversifying into other businesses where they thought the same model could apply. One was asset-backed securities, which were deemed to be low risk (at least for the tranches that got an investment grade rating, but as we know now, these we handed out a bit too exuberantly), and could be turned into AAA-rated paper thansk to the monoline's guarantee. The other was credit default swaps (CDS), another new instrument designed to ensure against default by corporate buyers - in effect another form of financial guarantee, except that it was possible to buy or sell these without even touching the underlying security.

As we know, the asset-backed securities have turned out to be "toxic sludge", ie worth a lot less than they were sold for and, alongside most of the banking world, the monolines have been caught with massive exposure to these and have lost huge amounts of money. In addition, there are now increasing worries about CDSs:


Markets assess the costs of a monoline meltdown

Until recently, the monolines insisted that this structured finance "sideline" was as safe as their main business of guaranteeing municipal bonds. However, in the past year default rates have risen sharply on subprime mortgages, with economists now estimating that as many as one in four of the mortgages written since 2005 will not be repaid - an unprecedented level of non-payment and foreclosure.

These defaults have already triggered more than $120bn (£62bn, €82bn) of writedowns at western banks. However, analysts now calculate that the monolines, too, could eventually face $34bn of losses as insurance contracts are activated. While this estimated hit - if it materialises - should be spread out over many years, it has caused huge alarm given that, in last year's accounts, the monolines only had $48bn of funds on hand with which to pay claims. Indeed, credit rating agencies have already removed the all-important AAA tag from some small monoline groups and are threatening to downgrade the largest companies, most notably Ambac and MBIA.


Red Lights Flash in Credit Nooks
Crunch Now Impinges On Highly Rated Firms As Taint Spreads Out

The global financial squeeze is spreading to investments linked to the corporate-debt market, slamming the value of contracts that provide insurance against defaults and marking one of the first times that the debt of major companies has been affected by the turmoil. (...) In recent days, investors in credit-default swaps, which act as insurance policies against defaults, have grown increasingly gloomy because of worries about the global economy and the possibility of problems in the market.

The losses are tracked by several indexes, which track the cost of buying insurance on bonds issued by 125 big companies. Two of the indexes are at records and have doubled since the start of the year, meaning investors who sold this insurance suffered losses.

(...) Credit-default swap contracts have been written on the equivalent of some $43 trillion in all types of bonds, according to the Bank for International Settlements.

The issue is that the "side businesses" that were meant to provide a bit more pizzazz to the staid municipal bond underwiting activity of the monolines is now about to wipe them out altogether, and is right now endangering their municipal bond activity - and the ability of municipalities to borrow. Last week, panic spread through municipalities as they were completely unable to sell the commercial paper they use to finance their short term needs, on worries that they would no longer be able to find long term finance.

So they have been talks, engineered by Eric Dinallo, the insurance superintendant of the State of New York (and a protégé of Eliot Spitzer), to try to save the monoline insurers. Two ideas are being followed: one would be a bailout of the monolines (effectively, a massive capital injection) by banks to protect their ability to pay on those bonds that are defaulting and maintain their AAA-rating. Banks might be "encouraged" to participate to such a bailout because they hold a lot of securities and CDSs backed by monolines, and they stand to lose yet more billions if those are downgraded. The other idea would be to separate the municipal bond activity from the rest, to protect the ability of the municipalities to finance themselves. That part of the business is still seem as fundamentally sound, so it could keep on functioning as it did in the past But that would leave the rest of the activities of the monolines (pretty much all toxic) - and banks would probably be left holding that bag in any case...

So ther's been a lot of pressure on banks to cough up more funds to save the monolines - both for financial reasons, and via regulatory means (Dinallo has suggested that he could impose the breakup of the monolines), and thus, today's announcement that an agreement might be close was seen as real good news by the markets, as it would help solve one of the biggest problems in the market right now - the uncertainty over the value of all bonds and CDS guaranteed by monolines.

But as bad news continue to trickle out of the financial markets (including totally unrelated, but terribly unnerving losses from rogue traders (Société Générale) or trading valuation mistakes (Credit Suisse)) and out of the real economy (yet more bad news from the real estate market, declining orders and morale, and increasing inflation), it's still much too early to call an end to that phase of "revulsion" in the markets.

Everything still points to a massive economic crisis (for an account of how that could play out, read this), and underlines the need for a robust political reaction. So far, the traditional mix of interest rate cuts and tax cuts (the vary cause of the problem in the first place) has been provided - but you don't give more candy to someone suffering from massive indigestion. At the heart of things is the stagnant living standards that were supplemented by debt. That debt bubble is now imploding, and a real solution that does not involve a massive demand crash can only come from income support - real jobs, real wage increases coming from necessary and useful activity (say, building renewable energy infrastructure rather than blowing up stuff and people in Iraq). Instead, we are going for the inflation route - an effective way to reduce the debt burden, but one that also crushes the wage earners along the way. Oil at $100 and gold coming to $1000 suggest that this is only going to cause more pain along the way.

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http://www.dailykos.com/storyonly/2008/2/22/16741/0259/636/462117

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Feb 22nd, 2008 at 05:24:51 PM EST
I am just hearing of this notion. Thoughts?
Another smart man, Warren Buffet, has proposed a way to bring US trade into balance. Exporters would be awarded import certificates in the dollar value of their exports. The certificates would be sold in a market to importers, who could import goods in the dollar amount of the certificates. This way imports cannot exceed exports. Moreover, as the certificates would be profit to exporters, it encourages more exports. Free trade theory never intended for economies to be in permanent trade disequilibrium. The US experience of a worsening disequilibrium over a quarter century is outside the bounds of trade theory.


Jeff Wegerson - Prairie State Blue
by wegerje on Sat Feb 23rd, 2008 at 07:41:05 PM EST
[ Parent ]
Seems like a riff on the International Clearing Union Keynes put forward at Bretton Woods.

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Sat Feb 23rd, 2008 at 08:28:12 PM EST
[ Parent ]
wegerje:
Free trade theory never intended for economies to be in permanent trade disequilibrium.
Free trade theory was not intended to defend free international movement of capital.

We have met the enemy, and he is us — Pogo
by Migeru (migeru at eurotrib dot com) on Wed Feb 27th, 2008 at 10:54:55 AM EST
[ Parent ]
So "much" confusing news?

"Pretending that you already know the answer when you don't is not actually very helpful." ~Migeru.
by poemless on Fri Feb 22nd, 2008 at 05:25:43 PM EST
Some think it's correct European English...

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Feb 22nd, 2008 at 05:50:32 PM EST
[ Parent ]
Well I have never heard or seen it before in my life.  But I'm just a native English speaker of the American variety.  Any Brits in the house want to weigh in?

("European English?"  wtf?  I hope by this you mean the UK and not continental Europe.  But I'm worried because you don't usually acknowledge the UK as "Europe."  Hm...  Good concept though.  Whenever I mess up French grammar, I will call it, "American French."  hahahaha)

It does seem charming, though.  Probably someone who says "maths" would say this...

"Pretending that you already know the answer when you don't is not actually very helpful." ~Migeru.

by poemless on Fri Feb 22nd, 2008 at 06:23:37 PM EST
[ Parent ]
Well it would be standard english if there was another, missing word on the end as I assumed from the ellipsis. on its own though it's rubbish.

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Fri Feb 22nd, 2008 at 06:34:27 PM EST
[ Parent ]
oh and the missing word I assumed is Items.

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Fri Feb 22nd, 2008 at 06:35:18 PM EST
[ Parent ]
would it not be "so many confusing news items?"

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sat Feb 23rd, 2008 at 05:07:55 AM EST
[ Parent ]
or much ado about nothing?

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sat Feb 23rd, 2008 at 05:08:56 AM EST
[ Parent ]
I pretty much gave up on watching the business channels after the dotcom bust.  It wasn't interesting anymore.  But lately, I have taken to watching British financial "experts" pontificate on late-night / early morning Bloomberg TV.

If you want to hear the conventional wisdom from sufferers of Anglo disease, this is a good way to get it.  These guys are well coached, well-dressed, and of course, have perfect Oxbridge accents and grammar.  They are also, with very few exceptions, brain-dead and clownishly ugly.  Cleese made a living out of mocking such twits on Monty Python.

So as for me, I actually appreciate a few English-as-a-second-language mistakes from someone I don't know personally.  It means the speaker / writer is MUCH less likely to be suffering from acute Angle disease.  This is important for me because I consider Anglo disease about 1000 times more lethal than even our esteemed Jerome.

"Remember the I35W bridge--who needs terrorists when there are Republicans"

by techno (reply@elegant-technology.com) on Sat Feb 23rd, 2008 at 05:50:45 PM EST
[ Parent ]
This is important for me because I consider Anglo disease about 1000 times more lethal than even our esteemed Jerome.

Now I am having a grammar panic of my own.  I meant to say that even thought Jerome is absolutely correct about his assessment of the danger of the Anglo disease, there are times when he understates the effects because he only watches it happen from the relative safety of Paris whereas I have been living in the middle of the plague for 35 years.

I HOPE that this sentence is more clear and accurate.

"Remember the I35W bridge--who needs terrorists when there are Republicans"

by techno (reply@elegant-technology.com) on Sat Feb 23rd, 2008 at 05:58:48 PM EST
[ Parent ]
I like the first one too!

Don't fight forces, use them R. Buckminster Fuller.
by rg (leopold dot lepster at google mail dot com) on Sat Feb 23rd, 2008 at 06:38:05 PM EST
[ Parent ]
"Rubbish"? You guys are certainly extremely forgiving to foreigners making the effort to write in your language ;-)

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi
by Cyrille (cyrillev domain yahoo.fr) on Sat Feb 23rd, 2008 at 03:10:24 AM EST
[ Parent ]
Ah I was using Rubbish, as in "makes no sense" not in a dismissive way, but more as a casual it's unimportant sense.

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Sat Feb 23rd, 2008 at 05:51:37 AM EST
[ Parent ]
poemless:
Probably someone who says "maths" would say this...

No, someone who says maths wouldn't.

It's not correct English. Probably not even in Europe.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Feb 22nd, 2008 at 08:31:42 PM EST
[ Parent ]
I love the smell of vindication in the morning.

Smells like... victory.

"Pretending that you already know the answer when you don't is not actually very helpful." ~Migeru.

by poemless on Mon Feb 25th, 2008 at 10:48:35 AM EST
[ Parent ]
ABX indices (reflecting the valuation of asset-backed securities) are at new record lows.
itraxx (corporate CDSs) are n new record territory.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Feb 22nd, 2008 at 06:15:44 PM EST

Banks look to bolster Ambac with up to $3bn

A group of banks is preparing to inject $2bn to $3bn into the troubled bond insurer Ambac, which is racing against time to come up with fresh capital to avoid a sharp cut in its triple-A credit rating that could trigger wider financial market turmoil.

The money from the banks would be part of a plan to split Ambac's operations, people involved in the discussions said.

Ambac is also considering raising fresh equity from shareholders. It is not clear how much capital it will need, or what credit ratings the split businesses would have.

The group of banks looking at supporting Ambac includes Citigroup, Wachovia, Barclays, Royal Bank of Scotland, Société Générale, BNP Paribas, UBS and Dresdner.

These are the ones with the most exposure to guarantees supplied by Ambac on structured bonds and derivatives, the value of which could fall sharply and result in billions of dollars of write-downs if the insurer's credit ratings fall far below the triple-A level.



In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Sat Feb 23rd, 2008 at 02:51:10 AM EST
"you don't give more candy to someone suffering from massive indigestion"

Well Jérôme, we are from the country of homeopathy, and injecting a diluted solution of the very germ that hit you in the first place is precisely what homeopathy claims will cure you, so maybe it's just that USA want to try that too.

Now, I didn't say I trusted homeopathy ;-)

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi

by Cyrille (cyrillev domain yahoo.fr) on Sat Feb 23rd, 2008 at 03:12:51 AM EST
would that be homeoeconomics?

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sat Feb 23rd, 2008 at 05:10:39 AM EST
[ Parent ]
Last week, panic spread through municipalities as they were completely unable to sell the commercial paper...

Do munies now issue ´commercial paper´ literally, or just ST notes?  Maybe my definitions are outdated.

Our knowledge has surpassed our wisdom. -Charu Saxena.

by metavision on Sun Feb 24th, 2008 at 10:04:08 AM EST
European Tribune - Financial yo-yo - so many confusing news [items]
So far, the traditional mix of interest rate cuts and tax cuts (the vary cause of the problem in the first place) has been provided - but you don't give more candy to someone suffering from massive indigestion. At the heart of things is the stagnant living standards that were supplemented by debt. That debt bubble is now imploding, and a real solution that does not involve a massive demand crash can only come from income support - real jobs, real wage increases coming from necessary and useful activity (say, building renewable energy infrastructure rather than blowing up stuff and people in Iraq). Instead, we are going for the inflation route - an effective way to reduce the debt burden, but one that also crushes the wage earners along the way.
Are you asking about a Keynesian stimulus package? I thought "we are all Friedmanites now".

What you're basically saying is that, like 70 years ago, in order to avoid the necessary Keynesian policy, the people responsible for the asset bubble and the market meltdown are going to give us hyperinflation. Maybe they will also give us a depression, Fascism and a war.

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

by Migeru (migeru at eurotrib dot com) on Wed Feb 27th, 2008 at 10:53:17 AM EST


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