The housing market shouldn’t bank on a PBoC put …
Yes, Virginia, seeking higher dollar returns to offset the dollar’s depreciation does mean taking on more risk. And Steve Schwarzman wasn’t going to underprice his IPO just because China underpriced its bank IPOs — and gave early strategic investors an even better deal.
But forget the arguments about the wisdom of China’s investment in Blackstone.
The real news in Keith Bradsher’s superb story last Friday about the internal debate over China’s investment strategy is that China has stopped buying US mortgage-backed securities:
“Over the last several years, the People’s Bank of China has led the way among central banks in buying American mortgage backed securities, accumulating $100b worth, according to people familiar with the central bank’s trading. The People’s Bank of China has reportedly chosen some of the most creditworthy tranches of these securities. But with the current malaise in the American housing market, even the value of some mortgage investments once seemed conservative is starting to erode. In May, the central bank abruptly halted further purchases of American mortgage-backed securities, although it does not appear to be liquidating existing holdings, said one person who follows the bank’s trading practices closely but insisted on anonymity because of its policy of banning transactions with any individual or institution that discloses information about it.” [Aside: Voldemort!]
The PBoC doesn’t trade securities with RGE, so I am under no such constraints.
The available data leaves little doubt that the PBoC has led the way among central banks in purchasing both MBS with an Agency guarantee (as opposed to the debt the Agencies issue directly to finance their own mortgage book) and “private” MBS. The June 2006 US Treasury survey shows that China holds $107.5b of “Agency ABS” and total official holdings of Agency ABS are only $118b. In June 2006, Chinese investors – public and private – held $58.5b in corporate debt (likely private MBS). Most of that is likely in the hands of the PBoC – and if so, it would account for roughly two-thirds of all recorded official investment in corporate debt ($96.4b as of June 2006). That data is now a year old – which means it misses about $400b of Chinese reserve growth. $100b in Chinese holdings of private MBS would be very consistent with the available data.
A shift from PBoC buying of MBS toward PBoC buying of T-bills could explain the unusual surge in T-bill prices (and resulting fall in yields) in early June. And since then, I suspect PBoC demand for longer-dated Treasuries has contributed to the Treasury rally – though certainly it certainly is not the main reason for the rally. The PBoC is still accumulating reserves, and funds that don’t flow into American MBS have to go somewhere, whether into euros or “safe” Treasuries.
I get a sense that a set of institutions with relatively similar positions (long complex CDOs) have discovered that the majority of folks who think they understand how to value complex structures have relatively similar positions. And at least right now, more want reduce their exposure than add to their exposure. That has added to the problems facing parts of the credit market. Randall Smith and Serena Ng of the soon-to-be Murdoch Journal report:
A Wall Street executive who markets hedge funds and other alternative investments said the valuation of some collateralized-debt-obligations pools backed by other securities such as mortgages — which sport nominally top-notch credit ratings — has become highly uncertain. "Someone says they're worth 50, and someone else says 90, and you can't sell at 30 because there aren't any bids," he said.
Such uncertainty creates a challenge for Wall Street firms that have made loans backed by such securities. Should they be marked down? And should investors who hold them with borrowed funds be forced to sell assets to give the lenders an extra cushion of safety?
Several institutions – AXA, for example; see Gillian Tett's story about how subprime losses have shown up in some strange places – have concluded that they don’t want to sell at current market prices.
They are hoping new buyers for these securities will emerge. Bradsher’s story, though suggests that the buyer of last resort won’t be the PBoC (sorry, Felix). If the PBoC doesn’t want more high quality MBS tranches, it presumably doesn’t want securities assembled out of the more risky tranches (even at a deep discount).
Perhaps the CIC will try to make up for its Blackstone losses with a big win on deeply discounted CDOs filled with subprime loans. Or by betting on Bear itself, the former MBS king. Both prospects seem somewhat unlikely though. My guess is that the CIC will become more, not less, conservative after Blackstone, not less. Plus, the CIC may be rather busy managing its participation in the restructuring of ABC (The Agricultural Bank of China).
The Gulf could be a better bet. The big oil-exporting states have roughly $1.5 trillion in assets, and with oil at $75, the major funds in the Gulf collectively have at least $10b to place every month …
UPDATE: I should have noted that the big Chinese state commercial banks were large buyers of US securities last year, using funds raised in the IPOs and as well dollars likely obtained through swap contracts with the PBoC. The Chinese BoP data shows over $100b in "private" debt purchases by Chinese institutions in 2006, and Goldman's sums (reported here) seem to imply even larger purchases, with the Bank of China leading the way. The PBoC is not the only Chinese financial institution with exposure to the US housing market.
UPDATE 2: Sovereign wealth funds may have a bit more risk appetite than I thought. The New York Times reports that a couple may be interested in taking a minority stake in Bear:
While it was unlikely that Mr. Cayne would sell the company at these stock prices, people close to Bear say that large overseas investors have been expressing interest in taking a minority position in the firm.
I assume large overseas investor means a large government investment fund …
Phew, long time no visit–it’s good to be back! By coincidence, I too have featured the same Bradsher article today–call it my RGE psychic scar (me=Potter, RGE=Voldemort
Unusually though, I have some nits to pick:
1. To me, it isn’t an “internal debate” as that would imply apparatchiks duking it out over official policy; there is little of the sort here. Rather, regular Chinese citizens are (rightly) becoming outraged that (a) their purchasing power is deliberately being held down just as (b) the proceeds from their blood, sweat, and tears are being placed in crappy investments like Treasuries, MBSs, and falling Flint–I mean, Blackstone stock.
2. If you think holding all those MBSs from Fannie Mae and Freddie Mac is bad for China, consider the harebrained scheme some in congress are cooking up forcing Fannie and Freddie to mop up all sorts of “toxic waste” from the subprime fallout.
Rhetorical question: Why fear China with its William Hung-like investment “prowess”?
I think the fear is that at some point china will decide it doesn’t want to add to its ever-growing losses on its investment in the us at the same pace that it has been, and the Chinese government will stop intermediating between global demand for RMB and the US need for financing … plus, there is a legitimate fear about the consequences of Chinese competition on parts of the manufacturing economy, both from those who are hurt directly and from those who think that the us needs a growing not a shrinking tradables sector to ultimately be able to “repay” (with repay here technically meaning shifting from a trade and transfers deficit to rough balance to stabilize the us external debt position over time — repay means not growing rather than pay back) its external debt.
I would bet the outrage among Chinese citizens mirrors an internal debate inside the CIC (and between the PBoC/ SAFE and MoF) over Chinese investment policy … i strongly got the sense that the CIC was set up and started making investments before there was full internal agreement on what it should be investing in …
and China isn’t just holding Fanny/ Freddy MBS (it has at least $400b); it holds and until recently was buying a lot ($100b per Bradsher) of “private” MBS, that is MBS without an agency guarantee. that is the only portion of its portfolio that it exposed to housing related credit risk.
Under tremendous pressure from the Chinese internet blog, I’m sure the China PBoC is lambasted for its mediocre performance with its investments in mortgage CDO’s and Blackstone shares. In fact, the China PBoC has been blasted by some Chinese internet bloggers who attack the central bank for squandering the nation’s hard-earned economic wealth. While China is not a Western democracy, there is relatively free debate on economic and financial issues. The China PBoC can’t continue to purchase poor performing US mortgage CDO’s that default on principal without its Governor receiving a late night telephone call from Premier Wen Jiabao asking some pointed questions.
One should be careful not to extrapolate from one (or even a few) blog postings into “widespread outrage”.
The thing about investing in the stock market is that *gasp* stocks go down!!!! If you want a guaranteed return, don’t invest in the stock market, invest in treasuries. As far as the Blackstone deal, this is part of the learning curve and this is why people involved invested $3 billion instead of $30 or $300 billion.
LOL. Given China’s Keystone Kops-inspired track record of managing (mangling?) reserves, I’m thinking of creating a short PBoC/CIC hedge fund; call it the “Reverse Midas Fund.” My investment strategy? Easy: short whatever Chinese officials are piling their reserves into. Screw the dollar, MBSs, and private equity stocks–damn, it’s good not to follow the Chinese. With any luck, I should be able to afford a Viking 54 Convertible in no time
Dave Chiang: MBSs are not quite the same thing as CDOs.
While it may seem that there is no turkey of an investment vehicle which Chinese officials haven’t been suckered into buying, there is a difference.
Emmanuel: Screw the dollar, MBSs, and private equity stocks–damn, it’s good not to follow the Chinese.
So what *would* you buy?
I don’t think that the PRC has been pretty incompetent at managing currency reserves. Buying Treasuries and MBS’s is the standard operating procedure when you have a lot of money and very little investment expertise.
The other thing is that I think people here are going into “headline-itis” mode. If you make any stock investment, you should be prepared for a 30% drop the day after you buy it for some news event that hits you the wrong way. If you aren’t prepared for that, you shouldn’t buy stocks. And if you don’t buy stocks, what’s left is fixed income and commodities.
China has shot itself in the foot by bad market timing on diversification - a diversification forced by their concentrated treasury position. MBS is a massive market that has been tainted by sub-prime contagion. Blackstone is a high profile strategic investment that was a specific market timing embarrassment. But just about any risk asset would have produced the same result. It’s actually bad luck for them given the lack of foundation established in their diversification program - this would induce paralysis into any investor’s strategy. Nevertheless, in order of magnitude terms, the losses are really equivalent to falling off your bike while on training wheels. The ‘public outrage’ angle is interesting. Do the leaders actually consider themselves accountable to that kind of sentiment in this case?
jkh: It’s actually bad luck for them given the lack of foundation established in their diversification program - this would induce paralysis into any investor’s strategy.
I don’t think that it is “bad luck” so much as an illustration of how complex and unpredictable world markets are. China thinks that it has too much money in MBS’s, wants to diversify into private equity, in doing so they make the MBS market less liquid, which means that that the sub-prime situation has more of an impact which then means the private equity, which has a lot of US real estate holdings, that they invested in got hammered.
It’s more or less obvious what happened now, but I doubt that anyone could have figured out six months ago that this would be the chain of events. The good thing about all of this is that it is moving slow enough (over days/weeks) that you can think about what is going on and adopt countermeasures if things spin the wrong way. If all this was unfolding over the course of minutes, we’d be in deep trouble because there wouldn’t be enough time to think and react.
This is the big reason why I think that a gradual revaluation is a good idea and a sudden one is a very bad one. There are so many moving parts in the system, and no one knows what don’t happen if you pull this lever or push this button. So you pull the levers and push the buttons very, very slowly, but not too slowly.
jkh: The ‘public outrage’ angle is interesting. Do the leaders actually consider themselves accountable to that kind of sentiment in this case?
Yes. As it is the amounts involved are really pocket change, so I doubt there will be anything other than angry blog posts. If the amount invested was tens of billions rather than billions, the posts would have gotten a lot worse.
So many donkeys in China are ready to burden the US sustained and increasing debts.
Crash in the US… No way!
“…A consequent risk is that the equity market will experience something similar in corporate governance to the collapse in lending quality that has afflicted credit markets… In fact, argues Mr Plender… this is already happening… the reality is that the Blackstone IPO currency is no more than junk equity”, and the prospectus “represents a low point in US corporate governance”. The conclusion might be that this $3bn investment for China is “peanuts” and that good governance at Blackstone matters less to the Chinese than obtaining access to US intellectual capital and management skills for use in their own fledgling private equity sector. “The message, once again, is that China’s role in globalisation brings costs as well as benefits…” http://ftalphaville.ft.com/blog/2007/06/22/5387/china-blackstone-and-the-unseen-risk-in-sovereign-wealth-funds/
wouldn’t the public outrage in China be much greater if ‘US economic health’ dependent exports, jobs and investments suddenly tanked in China? think plender makes a good point that they are seeking more than immediate capital gains from their investments. Their investment in Blackstone is allegedly longterm, whether it’s also possible that additional shares may have been bought outside the agreement and immediately sold to take advantage of the surge in the initial trading of the shares. Looking at today’s NYT story about immigrant labour riots in Dubai, if some of the GCCs wealth may, somehow, have to be invested at home, although as you imply, the GCC too should have an equal interest in preventing a US ‘crash’, along with Russia?
“Rhetorical question: Why fear China with its William Hung-like investment “prowess”? ”
so have i got this right ? - the big fat chinese guy who recently arrived in the gambling saloon is a really lousy player - he just happens to have all the chips ?
What difference does it make if China and US investors lose buckets of money on Blackstone, as long as Steve Schwartzman gets to take one more huge bite of the apple. These private equity, leveraged looters are just the latest reincarnation of the late 80s junk bond dealers. Cdo, clo, lbo; what’s in a name? Insiders will always find ways to make buckets of money dumping toxic waste on pension funds and other unconnected public investors who listen to the incantations of these neuvo-milkens. Maybe the Chinese, once they decouple their currency from the USD, should spend their sovereign fund money on trophy properties like the Pebble Beach Golf Course.
I’m sure Blackstone’s local connections (ie an anglo face on Chinese acquisitions) might be useful for muting political opposition. They bailed out of the CDO/CMO market and two months later things are falling apart. In a few more weeks they can discreetly pick up what they were buying at full price for 1/3 price. I could see a repeat. Sit out of treasuries a month or two, then put the $300 Billion in Sovereign wealth money to work, then open the floodgates and make up for your absense in the treasury markets. Next time Hank comes to Beijing and asks you to let your currency float, show him the monopoly cards you picked up for pennies on the dollar and ask him if he really wants to play that game again. It’s a lot easier to buy low if you can move the markets.
From Forbes magazine, China’s Central Huijin Investment to invest $60 billion domestically after Blackstone investment fiasco with $400 million loss.
http://www.forbes.com/markets/2007/08/06/china-bank-recapitalization-markets-equity-cx_vk_0806markets04.html
After taking a loss from its investment in the Blackstone Group, generating a backlash at home, Central Huijin Investment, the investment arm of China’s central bank, has decided it may be on safer ground investing $60 billion domestically in planned capital reforms by the Agricultural Bank of China and China Development Bank.
Central Huijin Investment plans to invest $40 billion in the Agricultural Bank of China, in a move to kick-start the bank’s capital reform. “Central Huijin will only take part in capital injection, leaving the non-performing loans to the central bank or the Ministry of Finance,” the mainland weekly journal Economic Observer reported over the weekend, citing unnamed sources in Beijing.
Chinese Banks May Take Heavy Losses On U.S. Subprime Toxic Waste
http://www.forbes.com/markets/2007/08/03/asia-subprime-exposure-markets-equity-cx_jc_0803markets1.html?partner=links
Goldman Sachs is concerned about big mainland Chinese banks with so-called H-share listings in Hong Kong. These banks could be negatively exposed to the housing credit crisis in the U.S. due to large investments they made in foreign securities following their initial public offerings in recent years, the American investment bank said in a research note released Thursday.
Goldman Sachs said the most vulnerable could be Bank of China, the country’s second-largest bank and its biggest foreign exchange institution.
According to Goldman Sachs’ estimates, Bank of China made $90.1 billion worth of investments in U.S. securities last year, accounting for 53.4% of its foreign securities investments and 19.3% of its earning assets.
The country’s largest bank, Industrial and Commercial Bank of China, and its third largest, China Construction Bank, made smaller but still sizeable bets on U.S. securities last year: $25.6 billion and $39.3 billion, respectively.
thought one of the more interesting aspects of the Bradsher article was that midstream, towards the end it states:
“…In another sign of the growing role of sovereign wealth funds like China’s, Morgan Stanley announced on Thursday that it had hired [Dino] Kos to the new position of managing director and head of central banks and sovereign wealth funds…” before continuing with: “…Chinese officials have called for other countries to accept government investments in their companies. But China’s own record on this issue is murky…”
Interesting announcement, but the connection with the copy before and after that statement is not entirely clear to me.
DC - technically, you cannot invest $60b in fx domestically. fx can only be used to directly finance an external transaction — whether the purchases of goods (i.e. to cover current account deficit), to finance a capital outflow or to purchase another foreign asset. when chine uses its reserves to recapitalize various state institutions, it gives the fx over in name to central huijin but the fx is never sold and it is still invested in what it was invested in before. it just now is counted as regulatory capital.
a small point, but an important one.
The Forbes article implies a cause/effect relation with the Blackstone deal and the Agricultural Bank of China recapitalization that frankly seems ridiculous to me. It’s as if someone in Beijing, just gets up in the morning reads the news and suddenly decides to make a $60 billion investment in something.
The ABC recapitalization has been planned for years. The timing isn’t a cause-effect relation, but there is a correlation since the decision to go ahead with the ABC deal and the Blackstone deal was probably made at the big finance work conference early this year.
Also the Forbes article seemed ****very**** confused. The money for Blackstone didn’t come from Central Huijin which is under the control of the Ministry of Finance and it’s been around since 2003 and is the holding corporation which owns the big four banks. It has total assets of about US$1.5 trillion. The State Investment Corporation which funded the Blackstone purchase will report directly to the State Council.
Never mind. It turns out that I was a month behind and they decided to fold Huijin into SFIC.
Then again, all of the articles I found about Central Huijin and the China Investment Corporation merging were in English. The only thing I found in Chinese that was closely resemble all of this was this article
http://www.china.com.cn/policy/txt/2007-07/06/content_8487561.htm
The last line says that it is *possible* that Central Huijin would be an arm of the State investment corporation. It seems to be rather implausible since none of the numbers make sense. All this might seem like unimportant nitpicking, but it makes a huge amount of difference as to how the funds are to be administered and what the Chinese government is up to. IMHO, if you put Central Huijin together with the SIC, you have a total mess on your hands.
Emmanuel,
Yes, MBSs and CDOs are not the same thing but neither are they unrelated.
On that note:
“In summary, the structural changes in mortgage origination and servicing have interacted with complex RMBS and highly volatile CDO funding structures to place the U.S. housing market at risk. Equally as important, however, is that housing market weaknesses feed back through financial markets to further weaken financial instruments backing today’s CDOs. Decreased housing starts that will result from lower liquidity in the MBS sector will further weaken credit spreads and depress CDO and MBS issuance. This feedback mechanism can create imbalances in the U.S. economy that, if left unchecked, could lead to prolonged domestic economic implications for U.S. standing in the world economic order.”
Joseph Mason and Joshua Rosner, “Where Did the Risk Go? How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions”, 5/3/07
http://hudson.org/files/publications/Hudson_Mortgage_Paper5_3_07.pdf
I just don’t agree with Mason and Rosner. You are talking about a $200 billion blowup in a market that is trillions of dollars big. It’s not that big of a problem.
“…Oil producers have surpassed Asian central banks as the largest pool of global savings, accumulating an estimated $500 billion in 2006 alone, according to… [PIMCO]…” http://www.moscowtimes.ru/stories/2007/08/07/053.html
“…Financials… rallied strongly, led by mortgage giants Fannie Mae up 10.4 per cent at $62.50, and Freddie Mac, up 7.7 per cent at $60…” http://www.ft.com/cms/s/8c678cd4-441a-11dc-90ca-0000779fd2ac.html
“…Lehman Brothers… the largest U.S. underwriter of mortgage bonds, increased $2.49 to $58.27. “Anything that has to do with housing or mortgages, any stocks that have mortgages in their names, have been knocked down, and some of them have much lower-risk profiles than [others]… “There have been some good values created.” …”The U.S. has what we view as the best macro and micro policy response to slowing growth…” http://www.bloomberg.com/apps/news?pid=20601087&sid=ahQa7aQN7U5E&refer=home
While the sample size is admittedly small, and the future needn’t resemble the past, the historical record of humanity recycling outsized surpluses - be they petrodollar or mercantile trade - into reasonably productive, well-allocated investments for the future, is decidely uninspiring. By historical standards, merely pedestrian would be a marked improvement. And were the bookies to, presently, handicap the odds of China (having alreadybought a trillion in USD paper & USD Mortgages) or the oil states (such as those currently building private man-made private islands in the Persian Gulf that soon will [quite literally] be under water) doing any better, one would be forgiven for thinking that the odds of real return of principal, remain long, long, long in the tooth…
Brad Comment: DC - technically, you cannot invest $60b in fx domestically. fx can only be used to directly finance an external transaction — whether the purchases of goods (i.e. to cover current account deficit), to finance a capital outflow or to purchase another foreign asset. when chine uses its reserves to recapitalize various state institutions, it gives the fx over in name to central huijin but the fx is never sold and it is still invested in what it was invested in before. it just now is counted as regulatory capital.
My Comment: What about investment in military hardware? Maybe part is in fx to purchase technology and other capital goods for military production. See Article in the Economist .
http://www.economist.com/displaystory.cfm?story_id=9581310
The term “hedge fund” very shortly may become “ledge fund” as in the popular ediface people jump from….
Twofish,
You may be correct but then I wonder how you can be quite so certain of size, as though there are sharp well understood, not just defined, boundaries. Even if only $200 billion, I think it (overly?) optimistic to dismiss potential ‘ripples’, still, contra people like Fischer, I may be overly pessimistic in my assumption that there are limits to this process.
‘limits’ to the overall securitization process. (ultimately reside within the real, value creating, economy…which is not at all to say that real and financial are immediately/precisely reflective).
my understanding is that Huijin was under the PBoC and that it is going to be merged into the CIC/ SFIC/ SIC or whatever it will be called … which reports to the state council but seems a bit more influenced by the finmin than huijin. but i don’t have total confidence in my understanding of the internal politics of it all.
re: oil v asia, methinks asia will retake the lead in 07 on the back of:
a) same oil price (over the year) as in 06, but higher spending/ domestic investment so a smaller current account surplus in the oil exporters
and b) much larger surpluses in japan and china (just coincidentally, the two countries whose currency has depreciated the most v almost everyone over the past five or so years … )
“…In June 1998, U.S. Treasury officials made a plea to China that they would be reminded of repeatedly in the following years… Chinese officials, who pegged their currency to the U.S. dollar, “let it be known…that if things kept going this way they’d have no choice but to devalue,” recalls Ted Truman, a Treasury official at the time. The U.S., fearing such a move would trigger another round of devaluations, urged the Chinese to hold their peg, and praised them when they did so… Long after the crisis passed, China’s economic fundamentals suggested its currency should rise against the dollar. China let it rise only slowly, continuing to juice exports… When the U.S. pressed China to let its currency float, China reminded the U.S. of the fixed exchange rate’s stabilizing role in 1998…” http://online.wsj.com/public/resources/documents/info-Creditchrtbk0708-06.html
Chevron won the right to help develop a PetroChina natural-gas field, a rare inroad by a foreign firm into China’s energy output.
Wipro agreed to buy Infocrossing for about $600 million in one of the largest overseas purchases by an Indian software maker.
“…One of the most telling problems highlighted in recent weeks is the danger of hedge funds taking highly leveraged positions based on illiquid assets… while using short-term funding… One answer is longer lock-ups, like those enjoyed by private equity groups. They have roughly 10-year investor commitments and long-term debt to match with their illiquid assets (entire companies). Although they are also under pressure in today’s turbulent markets they do not face redemptions…” http://www.ft.com/cms/s/5ad3cb54-4223-11dc-8328-0000779fd2ac.html
” same oil price (over the year) as in 06, but higher spending/ domestic investment so a smaller current account surplus in the oil exporters ”
- I don’t follow this -
same oil price implies same GDP contribution from exports
higher domestic investment implies increase in GDP from increase in investment
but this implies nothing for current account
for current account to decline, this requires greater imports of capital goods to enable increased investment (or imports of something)
correct?
If China’s food industry problems and, as I understand it, Japan’s dependence on food imports as world food prices rise, might add to costs, domestic spending and currency pressures in both those countries:
“China issued an urgent notice Tuesday ordering stronger controls over unscrupulous pork selling practices amid soaring prices…” http://www.washingtonpost.com/wp-dyn/content/article/2007/08/07/AR2007080700261.html
“…even the most well-intentioned and smartest policies of China’s leaders have been… difficult to implement… information about new science often doesn’t trickle out to remote areas for months or years - if ever…” http://www.washingtonpost.com/wp-dyn/content/article/2007/08/05/AR2007080501480.html
re: “so have i got this right?” - misguided on the first, definitely wrong on the second
“…Sometimes a buyer’s reputation is so toxic that sellers might charge a higher price to compensate for the icky feeling the transaction gives them…” http://www.slate.com/id/2171601/
“…Berkshire Hathaway Inc. Chairman Warren Buffett is ready to spend $40 billion to $60 billion on an acquisition, and his opportunities are expanding as stocks fall and leveraged buyouts dry up…” http://www.bloomberg.com/apps/news?pid=20601109&sid=aN3quaYAaUDE&refer=home
re: oil exporters - If all of them, including, Russia may be more than an oil story:
“On Friday, the brutal correction in nickel prices, which have fallen more than 40 percent since May, dipped another 2 percent to reach a 9-month low of $29,325 per ton. Meanwhile, Norilsk Nickel, the largest nickel producer in the world, has weathered the correction without flinching… The record high came on May 9, taking the price in London to $51,800 per ton, nearly four times more than long-term forecasts for fair nickel prices, which value one ton at around $13,000. “To put that in perspective, it would be like the price of oil hitting $200 per barrel,”…” http://www.moscowtimes.ru/stories/2007/08/06/049.html
“… Base metals rose across the board on the view that US credit market turmoil will not have a global impact. Emerging countries are the main drivers for consumption in the world’s base metal markets…” http://www.ft.com/cms/s/610f6bb2-44e0-11dc-82f5-0000779fd2ac.html
“…In a sign of the times, Mikhail Gorbachev, the former Soviet president who tried to prop up Communism with his Perestroika reforms, announced last month that he would be starring in a new advertising campaign for Louis Vuitton. Demand for luxury hotel rooms has rocketed…” http://business.guardian.co.uk/story/0,,2143250,00.html
Off topic:
From Washington Times. Government supported Fannie Mae to purchase Subprime Toxic Waste from Wall Street Investment Banks. Ultimately, the US taxpayer will be on the hook for trillions in losses.
http://www.washingtontimes.com/apps/pbcs.dll/article?AID=/20070807/BUSINESS/108070057/1001/METRO&template=nextpage
Fannie Mae gave hope to gloomy markets yesterday by asking regulators for permission to purchase more mortgages from struggling lenders — a move that would help to ease the worsening Wall Street credit crunch.
The possibility of a rescue from Washington came as American Home Mortgage Investment Corp. filed for bankruptcy in Delaware, becoming the second-largest mortgage lender to go under this year.
Fannie Mae’s request helped spur a 287-point jump in the Dow Jones Industrial Average, retracing a 281-point loss in the blue-chip index Friday on news of widening credit woes.
current account = savings minus investment.
more consumption (and same income from oil) = less savings
more investment –
more of that “savings” is used at home and less is available to finance investment (or consumption, i.e. the absence of savings) elsewhere.
Thanks to the “cheap money” monetary Asset Bubble policy of the Greenspan-Bernanke Federal Reserve, who needs savings?
From Bill Fleckenstein,
http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/AmericaFollowsJapansMisguidedPath.aspx
It got me to thinking just how much the world has changed, and not for the better, due to the irresponsible behavior on the part of Alan Greenspan’s Federal Reserve over the past 20 years or so.
That essentially-free money has been part of the reckless lending and misallocation of capital that has proliferated around the planet.
I’m not going to recount all the mistakes made by Greenspan that precipitated the late-1990s equity bubble — which, suffice to say, was the biggest our country has ever seen.
After that bubble, Greenspan took a page out of the Bank of Japan’s book and lowered rates to 1%. That helped precipitate the housing bubble here that ended in 2005.
In the years since our equity bubble peaked, trillions of dollars’ worth of debt have piled up throughout corporate America. So now, as we enter recession, we will experience not just a weak economy, real-estate market and stock market, but the exacerbating effect of a mountain of bad debt, completing the analogy to Japan of the 1990s.
The mainstream news media and Wall Street aren’t interested in the big picture. Those are the folks who said subprime is not a problem. Then they said it was contained and that it wasn’t going to spread. Now that supposedly higher-quality Alt-A loans are a problem, they’re saying the same thing.
Eventually, they’re going to find out that there’s a problem in all mortgages, because people overreached to buy houses they couldn’t afford, because they believed the price would go up, as did the lenders, which is why anyone with a pulse could get money.
Hopefully, this synopsis will help readers see how the misguided money-printing policies of central banks have created a world fraught with financial risk, even as those policies have made Wall Streeters fabulously wealthy.
So if it doesn’t imply more imports, as I’ve contended, it must imply no necessary change in imports. If that’s the case, and also holding exports constant (same income from oil), the net export contribution to GDP doesn’t change and the current account doesn’t change, and the current account contribution to total savings doesn’t change. And an expansion of both consumption and investment must imply an equivalent expansion in domestic income (no change in imports), and an increase in GDP by the same amount. And this means total savings increases by the amount of the investment increase, and again, the current account is unchanged.
Which is a contradiction. So imports must change.
(If you’re 100 per cent sure this is wrong (as is previous commenter), no need to reply - it means I’m beyond help at this particular juncture, and will cease and desist for now - no problem - thanks and cheers.)
higher consumption (i.e. less savings) = more imports
more investment = more imports
guest — frankly, you are making this too complicated. go to the bank of russia’s web page and compare Russia’s h1 06 and h1 07 exports and imports. the rise in imports is very, very obvious!
Gilles asks if the Chinese have “all the chips” because they are unlucky gamblers.
Recent Chinese prosperity has come at a significant ecological and social cost. Of course, so did the Chinese poverty of the mid-late Mao era. Of the two, one would rather have the prosperity.
This century may be the Chinese century, just as the last century was America’s. But it will take extraordinary leadership. I see significant risks to Chinese prosperity which, as the blogger quoted by Bradsher said, is based on almost superhuman sacrifices.
The problem with DC’s article is it has no real numbers. What fraction of US wealth is in real estate mortgages? What are the economic impact of a 20% drop in housing prices? What happens if the stock market drops 50%?
Once you have no real numbers then all you are arguing about is credibility and ad hominem. Of course you believe X, because you are a Y. Worse yet, once you stop arguing numbers and facts, there is nothing to contradict your preconceptions. If you think that the US is going to collapse, then you won’t have anything to convince you otherwise.
Also, if you want to argue facts, you need to be accurate in summarizing facts. The Washington Times article did not say that Fannie Mae borrowed money in the past against subprime mortgages.
As far as ripples from the subprime fiasco, I just don’t see how it hits the wider economy. Defaults in the subprime can’t trigger defaults in prime in anyway that I can see. The investment banks and hedge funds that invested in subprime have the reserves to prevent this from spreading. It’s not eating up enough liquidity to cause major problems. (This is why precise facts are important, if Fannie Mae *had* invested in subprime, then all of these calculations would be gone. There is no reason to think that it had.)
Maybe there is something everyone has missed. On the other hand, maybe there isn’t, and spending time worrying about sub-prime, makes that no one is worrying about another issue that *will* cause major problems later.
I’ve found numerous English articles that suggest that the PRC wants to merge CIC and Huijin. I haven’t found any Chinese articles that suggest this, and my feeling right now is that someone got mistranslated, and the all of the English media repeated the mistake. This happens a lot.
Personally, I think it is more likely that the large overseas investor comes from the Middle East.
Buying a stake in Bear-Stearns is probably going to result in more publicity than Beijing wants at this point, and if Bear-Stearns wants cash fast and quiet, the last thing that it wants is another CNOOC or Dubai Ports battle.
The other thing is that Beijing moves slowly and gradually. It spends months/years thinking through its next move before acting. If getting a stake in Bear-Stearns wasn’t on its agenda in January, I doubt it is there now.
that’s why they bought bx and bcs, so they can use them as ‘intermediaries’ — fig leaf, façade or sock puppet?
Twofish,
Alt-A mortgage lender American Home Mortgage Investment Corp. filed for bankruptcy in Delaware. The American Home Corp which lent to good credit borrowers is an indication that the mortgage mess is no longer contained to subprime borrowers. If the lender weren’t having default issues, why would they be filing for bankruptcy. And why would Fannie Mae be asking regulators for permission to purchase more mortgages from struggling lenders? Doesn’t Fannie Mae have enough financial problems of its own with accounting fraud uncovered recently?
In your mind, the Wall Street Investment Banking casino that has permitted this sort of criminal fraud and massive US capital misallocation is somehow superior to the Chinese banking system. Today we have an 11 trillion dollar credit bubble in Housing with 3 trillion in subprime and Alt-A mortgages that will ultimately default. The pending economic slowdown will hit corporate profits and homeowner incomes and will lead to even more defaults. The mortgage default problem is so massive that even this week’s Businessweek issue is calling it “The Housing Crisis”.
Off-Topic
“GDP Declined in 2nd quarter”
http://unlawflcombatnt.proboards84.com/index.cgi?board=general&action=display&thread=1185652775&page=1#1185652775
DC: The American Home Corp which lent to good credit borrowers is an indication that the mortgage mess is no longer contained to subprime borrowers.
No it doesn’t. What AHC is going through is that it no longer has access to expected credit because the credit pools have dried up. There is nothing that I’ve seen that suggests that the underlying loans for AHC are bad. The liquidity problem that AHC has is unlikely to extend to Fannie Mae or Freddie Mac because they have reserve credit lines from the government.
DC: And why would Fannie Mae be asking regulators for permission to purchase more mortgages from struggling lenders?
Because they think that they can make money off of them.
DC: In your mind, the Wall Street Investment Banking casino that has permitted this sort of criminal fraud and massive US capital misallocation is somehow superior to the Chinese banking system.
Yes. It is. It will generate a few headlines for a few months, and then by the end of the year, everyone will have forgotten about all of this. At that point, you’ll likely be talking about the “doom postponed.”
DC: Today we have an 11 trillion dollar credit bubble in Housing with 3 trillion in subprime and Alt-A mortgages that will ultimately default.
If we assume a default rate of 50% on subprimes, that still doesn’t cause major problems. The actual default rate has been around 10-15%. This will kill you if you are a highly leveraged company investing on them, but it isn’t the type of thing that will cause major problems later on.
DC: The mortgage default problem is so massive that even this week’s Businessweek issue is calling it “The Housing Crisis”.
Which means that it is mostly over. Businessweek is a nice contratrian indicator. When Businessweek talks about how wonderful the Chinese economy is, then it means tough times ahead. When Businessweek talks about China has if it is going to collapse, it’s time to buy Chinese assets.
The business press likes drama, which is why it is always focused on yesterday’s headlines. You need to look at your own numbers and do your own analysis. You aren’t going to make any money following the herd.
Twofish,
AHC filed for bankrupty because of mortgage defaults. A company or individual doesn’t go into bankruptcy if their line of credit is cut, but will be forced into bankruptcy if it can’t pay its creditors. Virtually every problem in the credit arena, whether that be consumer credit, structured credit or junk debt is getting worse, and at a faster rate today.
PIMCO’s Bill Gross warns: “The subprime crisis is not an isolated event and it won’t be contained by a few days of headlines in The New York Times. And it will not remain confined to a neat little Petri dish in some mad financial derivative scientist’s laboratory.”
The Enron-style systemic fraud and corruption on Wall Street is NOT superior to the Chinese banking system. Why don’t you ask your Wall Street friends, why don’t they mark to market the trillions of dollars in CDO’s and derivatives, so we know what they are really worth.
Twofish said “You aren’t going to make any money following the herd”.
Maybe not, but I’ve found that getting out in front of the herd can get you trampled.
DC said “A company or individual doesn’t go into bankruptcy if their line of credit is cut…”
In fact, a line of credit cut often does cause severe stress if not bankruptcy. The problem is that almost any “solvent” company uses short term financing to finance short term assets. If the s/t financing is cut, the company has to look to illiquid assets to finance s/t assets, and may have to firesale them to raise cash. Imputing the firesale prices back to the balance sheet can result in liabilities > assets (technical insolvency). In cases where an entire industry is involved (eg. merchant power companies a few years ago), even otherwise healthy companies can end up offside on loan covenants etc. and be severely stressed. A similar effect may be rippling through mortgage finance now.
DC: AHC filed for bankrupty because of mortgage defaults. A company or individual doesn’t go into bankruptcy if their line of credit is cut, but will be forced into bankruptcy if it can’t pay its creditors.
No. That’s not the case. AHC had issued mortgage loans expecting them to be refinanced by banks. Banks stopped lending, AHC collapses.
DC: PIMCO’s Bill Gross warns: “The subprime crisis is not an isolated event and it won’t be contained by a few days of headlines in The New York Times.”
He is wrong. You can always find someone that says that the sky is falling.
DC: Why don’t you ask your Wall Street friends, why don’t they mark to market the trillions of dollars in CDO’s and derivatives, so we know what they are really worth.
They do. CDO’s and derivatives are marked to market on a daily (if not more frequent) basis. Doing this provides a lot of employment for former physicists and computer programmers.
People on Wall Street that I know don’t have any particular financial interest in putting on rose-colored glasses (at least in private conversations). If everything was about to fall apart, then they discussion would be on how to make money from the mess. Talk is cheap. If you really think that things are going to fall apart, then you should be able to come up with investment strategy that will take advantage of the mess, and the nice thing about having this strategy is that there are no excuses if it fails to pay off.
Any takers?
Twofish,
Wall Street refuses to mark to market its debt securities. Instead, Wall Street and the hedge-fund community have been able to ignore economic reality, thanks to the mark-to-theory fantasy by former physicists and computer programmers.
The blowup of Bear Stearn’s High-Grade Structured Hedge Fund only occurred because manager Ralph Cioffi had tried to hedge some of its weaker credits with an ABX index that did get marked to market. Thus the fund was forced to show it really lost money and was hit with massive redemptions.
As Jim Grant wrote in recent issue of Grant’s Interest Rate Observer, Wall Street has a totally different opinion on the mark to market issue, “Price discovery can wait until the return of blue skies and normal pulse rates. The first order of business is price suppression.”
The Enron-style systemic fraud and corruption on Wall Street is NOT superior to the Chinese banking system.
DC: Wall Street refuses to mark to market its debt securities.
They do. Everything is marked to market on at least a daily basis. For actively traded securities, things get marked to market every thirty seconds or so.
DC: As Jim Grant wrote in recent issue of Grant’s Interest Rate Observer, Wall Street has a totally different opinion on the mark to market issue.
He has no idea what he is talking about.
The comments on the CIC investment in BX are rather silly. CIC is buying a piece of the business. What the stock trades now has little bearing on its ownership interest. BX only floated about 10% shares so there is no other way for CIC to buy a significant stake. It is not as if it could have bought at the current price.
BTW I have more respect for the BX guys for the way they fully priced their shares. If they don’t know the value of their own shares or are not able to maximize the sales price what would that say about their ability to invest in other companies.
Twofish,
Unlike an US Treasury Bond, Wall Street doesn’t really mark-to-market its debt securities. Instead, Wall Street and the hedge-fund community have been able to ignore economic reality, thanks to the mark-to-theory fantasy by former physicists and computer programmers.
PIMCO’s Bill Gross knows what he is talking about when he writes, “As for even higher-rated triple-A’s, the point is that there are hundreds of billions of dollars of this toxic waste and whether or not they’re in CDOs or Bear Stearns hedge funds matters only to the extent of the timing of the unwind.”
According to a July 11 article in Bloomberg, Wall Street took in about $27 billion in revenue from underwriting and trading asset-backed securities last year alone. There is plenty of incentive to “cook the books” with mark-to-theory fantasy models.
DC: Unlike an US Treasury Bond, Wall Street doesn’t really mark-to-market its debt securities.
Unfortunately, I can’t say more anything to this except, yes they do….. And that if you were right, then I wouldn’t be doing what I’m doing right now….
DC: According to a July 11 article in Bloomberg, Wall Street took in about $27 billion in revenue from underwriting and trading asset-backed securities last year alone. There is plenty of incentive to “cook the books” with mark-to-theory fantasy models.
No there isn’t. Wall Street has lots of internal controls to get you honest valuations. And lot’s of people from Federal Reserve Bank of NY and the Securities and Exchange Commission looking over your shoulder to make sure that those internal controls work.
*That* is why Wall Street works better than the Chinese financial system in which these controls are not as well developed.
In the words of one of my “Wall Street friends.”
If people don’t trust the markets, they people don’t trade, and if people don’t trade, we don’t make money. The more open and honest about what we do and how we do it, then more people feel comfortable trading. The more people trade, the more money we make.
That’s actually one of the reasons I post.
Twofish,
I am impressed with your knowledge of China, but I think you should look at US financial markets with a bit more cynicism.
CDOs are marked-to-model, which involves a lot of assumptions about the correlation between asset returns for example, not marked-to-market, which would not require anything other than a telephone. I guess that valuation is more of a concern for fund managers, especially at hedge funds (Greenwich) than dealers (Wall St).
The relationship between Fannie/Freddie and the government is highly political. Despite the fact that the government protests that they are not government guaranteed, the market treats their debt as quasi-goverment, making them highly profitable. One good turn deserves another. In fact their credit line with the Treasury is fairly small, and use of it would be highly controversial.
I read the UK FT, and almost every day, there is a story about some dodgy practice in financial markets - today’s leader is about insider trading on Wall St. I leave it to you and DC to debate whether the US is worse than China though!
Twofish,
Unlike an US Treasury Bond, Wall Street doesn’t really mark-to-market its debt securities. How else do you explain why there is no market right now for many of these subprime collateralized debt obligations; “no” buyers equates to “no” market. The mark-to-theory fantasy models utilized on Wall Street to justify pricing of securities is a variation of former Enron Corporation’s accounting practices.
A large Wall Street campaign contribution works wonders to reduce US government regulatory oversight. Wall Street has lots of internal controls to only protect their capital. Did the Federal Reserve and SEC protect the average citizen investor from corruption scandals at Enron, MCI-Worldcom, Tyco Corporation, Fannie Mae, etc.?
The undeniable truth is that without adequate regulation and oversight, there is a huge incentive for fraud and corruption. At least the Chinese once in a while, execute a high level government official convicted of corruption. In the United States, with the right political connections, the convicted felon Marc Rich was able to purchase a pardon from former President Bill Clinton.
RE is correct is identifying a marked to market/model problem specific at least to CDOs.
DC is correct in identifying a problem, but incorrect in generalizing it.
Twofish is correct in that the problem is not pervasive, but incorrect in alleging that no problem exists.
Nice debate.
Reb: CDOs are marked-to-model, which involves a lot of assumptions about the correlation between asset returns for example, not marked-to-market, which would not require anything other than a telephone.
You can take the current market values for liquid securities which then give you parameters that you feed into the CDO’s. You can also stress test things by assuming that things end up worse than the current market values. Also, people don’t use telephones for this type of pricing, you get data feeds which are then run into the systems that come up with the number.
There’s also another safety check in that once you come up with a mechanism for valuing an illiquid security, you are not allowed to change the parameters or the model, without a lot of paperwork.
Reb: The relationship between Fannie/Freddie and the government is highly political.
Yes it is, but there is no reason to think that Fannie/Freddie were involved in the relaxation of credit standards that killed the subprimes.
Dave: How else do you explain why there is no market right now for many of these subprime collateralized debt obligations; “no” buyers equates to “no” market.
Because people are scared.
Dave: A large Wall Street campaign contribution works wonders to reduce US government regulatory oversight.
People on Wall Street don’t want to reduce US government regulatory oversight. There is some grumbling at times on certain regulations, but there is no financial interest in weakening the rules.
Dave: Did the Federal Reserve and SEC protect the average citizen investor from corruption scandals at Enron, MCI-Worldcom, Tyco Corporation, Fannie Mae, etc.?
The case of Enron is interesting because all of the bad news about Enron was fully available in their financial statements. So yes, the SEC and Federal Reserve did force Enron to publish all of the information that indicated that there was a problem. It’s unfortunate that not enough people knew enough to read the reports. Similarly, I just pulled up the last annual report for American Home, and under risks, it went into great detail that would happened last week could have happened.
Dave: The undeniable truth is that without adequate regulation and oversight, there is a huge incentive for fraud and corruption.
And Wall Street is a good example of how the system works. It doesn’t work perfectly, but it works a lot better than the Shanghai market.
Guest: Twofish is correct in that the problem is not pervasive, but incorrect in alleging that no problem exists.
I didn’t say no problem exists. I’m saying that the problem isn’t big enough to cause major a collapse of the US economy. That is a completely different statement.
I can go into more detail than you probably want me to about the difficulties in valuing CDO’s, but that problem isn’t enough to cause the problems that David Chiang talks about.
DC: Unlike an US Treasury Bond, Wall Street doesn’t really mark-to-market its debt securities.
Twofish: Unfortunately, I can’t say more anything to this except, yes they do….. And that if you were right, then I wouldn’t be doing what I’m doing right now….
Suggests a specific problem doesn’t exist re marked to model on CDOs as per RE’s correct analysis.
The reason I am say too much about what I’m doing has to do with US securities regulations. Anything that I say that even hints that I’m suggesting that the reader buys or sells a particular security could get me into a lot of trouble. There isn’t a problem with general economic analysis. The problem is that if I go into too much detail about the reasons why I think the problem with subprimes aren’t a general problem, I run the risk of seeming like I’m recommending or not recommending you buy certain securities, and that could (and honestly should) land me in some serious trouble.
(And yes, the SEC and legal/compliance does read blogs, and no the fact that I post under a pseudonym won’t help much. One rule in the industry is to assume that the government and your managers have access to all public messages you post.)
I think securities regulations are a good thing, but they do have some perverse consequences sometimes. One of them, is that people with first hand information and who respect the law tend to feel more pressure not to engage in discussion about what is going on, which means that the airwaves and blogs are dominated by people who really don’t have any first hand information. Without first hand information, there is a echo chamber in which people are repeating what they hear everyone else saying.
Imagine the frustration of arguing with someone that says that “Wall Street doesn’t mark to market securities” while sitting five feet away to someone who is actively doing just that.
twofish,
“ripples” = ‘repricing’ of risk, which, given the heterogeneity of the fund universe, of financial institutions, of instruments, the interactings of these as well as rating agencies’ actions/non-actions,,, cannot be some linear and mechanical process but one which unfolds unevenly. precise quantification of history and assumptions is handy for modeling but often proven unreal.
as you’ve noticed, risk modifies liquidity.
buena suerte
So many people here are jumping upside down in celebrating big investment loss by China on US MBS/CDO may end up disappointed.
The truth is NO ONE really knows, how much US$ Debt China still holds except those $3xx billion from the US treasury web site. And NO one really knows how much US MBS/CDO China still holds either.
The only thing I know, up till now, the PBoC and ICBC of China have only minimum loss on the US MBS/CDO investment. So minimal that the loss will NOT affect their earning at all.
BTW, China has NOT, and cannot taken loss in BX. Since they cannot touch those $3 billion for at least 4 years after BX IPO
Twofish,
Assuming that your marks are bid side, the real test is whether you would actually buy the security at that price. If you would, I dare say that there are some people at Bear Stearns, Macquarie, IKB etc who would love to talk to you!
I was not suggesting that Fannie and Freddie were involved in the relaxation of credit standards that led to the growth of sub-prime. In fact, they were probably against it, because it took business away from them. What I am suggesting however, is that now that that market is in a mess, Fannie and Freddie will allow themselves to help the government by supporting it.
It is hard to see why expressing an opinion that sub-prime is not a general problem does not amount to a recommendation to buy them, but explaining why in detail does.
Twofish,
Far from being a product of foreign journalists’ imagination, or another mistranslation by those silly hacks of the Chinese press, the idea of Huijin being integrated into the new state investment firm was laid out Hu Xiaolin of the PBoC in a speech. You can’t get more official than that.Richard McGregor. Here’s the link http://finance.jrj.com.cn/news/2007-07-03/000002383938.html
“The case of Enron is interesting because all of the bad news about Enron was fully available in their financial statements.”
Oh really? Like how their traders were committing fraud while gouging the people and state of California?
Like how various transactions were un-material sham “pseudo asset sales” meant to count (temporarily) as earnings?
The bad news was there in Enron’s statements only in the sense if you disbelieved nearly every description in the reports about the intent and significance of the various transactions. I..e the fact that such entities existed was indeed published. That such entities were designed to particularly enrich management outside of Enron employment was not exactly made very clear.
That’s not transparency in any sense.
“Imagine the frustration of arguing with someone that says that “Wall Street doesn’t mark to market securities” while sitting five feet away to someone who is actively doing just that. ”
Marking to market means at the price a potentially instantaneously-transactable bid with *real* *money* on the other side. On the major stock exchanges that’s possible now because there are non-retractable real-money bids from market makers.
Actual people who have these CDOs are saying that there is frequently no market maker on the other side willing to make a price.
Marking to model is nice but it is just a model.
Think about it this way. An apple may cost 50 cents in a supermarket. But when the sellers of apples know that the buyers are literally starving to death, what is their ‘ask’ price?
If that speech is the source used, then it looks to me that Western journalists *have* mistranslated the intent of the PBC.
The statement that Wu made was that the Central Huijin should be “integrated into the core” of the CIC. However, the next statement says “She added, that both Huijin and the future investment corporation should be truly marketized investment corporations.”
In the rest of the article, its pretty clear that what she means by “integrated into the core” is that CIC should use the lessons and processes of Central Huijin in its operations, and there is no hint at all that she thinks that CIC or Central Huijin should be merged.
“…there are three ways to look at these kinds of valuations - what the model says, what a distressed buyer would pay and where it would trade if not distressed. “From a prime broker’s perspective, they’re lending money through repo contracts on secured assets that might have three potential values… A prime broker can’t force a manager to choose a model that is more in line with his view, but he can adjust his margin requirements to adjust risk exposure”…” http://www.ft.com/cms/s/2555f186-4067-11dc-9d0c-0000779fd2ac.html
Reb: It is hard to see why expressing an opinion that sub-prime is not a general problem does not amount to a recommendation to buy them, but explaining why in detail does.
Suppose I have a business lunch with a group of people and my general impression is that these people at TransUnited MegaCorp are a bunch of idiots that are going to lose their shirts one day, and I’m glad people at Global Amalagmated aren’t like that. If I were to post that information, a sufficiently paranoid securities lawyer or compliance officer could get me into serious trouble for releasing “insider information.”
Since the whole discussion here is about how “deep is the rot” you see how this information is relevant. Suffice to say that I don’t think the rot is very deep, and I’m not surprised at the names of the people that got hammered, and I don’t think there will be too many new names.
Finally, it’s possible to get extremely philosophical about prices and values and models, but that sort of misses one major point, that nothing that has happened in the subprime fiasco is the result of CDO modeling ambiguities. In no case was what happened not forseeable, and one reason I don’t think the rot goes deep is that I think most people on Wall Street saw what was coming if they cared to look.
the ‘mathematical economists’ that I know, one of whom builds models to defeat other models, are generally aware of the contradiction between internal coherence and logic on one hand and predictive abilities on the other.
Twofish
Your knowledge of the PBoC is impressive but frankly your comments on mark-to-model etc are very unconvincing. I am sorry if this offends you but I don’t think your opinions are completely unbiased. Specifically I am not buying your paranoia about securities law liability for discussing details, it just sounds a little too convenient. If you are really that concerned about inside information you’d not be participating in this discussion in the first place.
You claim that “nothing that has happened in the subprime fiasco is the result of CDO modeling ambiguities”. Really? Why are S&P and Moody’s revising ratings on some of their securities then? More generally how do you mark something to market when a market does not exist?
Anon: I am sorry if this offends you but I don’t think your opinions are completely unbiased.
I never claimed that I was completely unbiased. I don’t think that there is such a thing as a completely unbiased human being. The closest thing that you can get is to the truth is to listen to a lot of people with a lot of different (and preferably opposing) biases.
Anon: Specifically I am not buying your paranoia about securities law liability for discussing details, it just sounds a little too convenient. If you are really that concerned about inside information you’d not be participating in this discussion in the first place.
The trouble here is then I sit by, and hear people say things that I consider nonsensical, and it drives me nuts. Also, since I think that it is better when people have better information, I do what I can to describe the world as I see it.
I do what I can to make the world a better place.
Anon: You claim that “nothing that has happened in the subprime fiasco is the result of CDO modeling ambiguities”. Really? Why are S&P and Moody’s revising ratings on some of their securities then?
You have a CDO with 100 names in which you are responsible for defaults 30 to 45. If 29 people default, you lose nothing, if 46 people default, your CDO is worthless. Based on historical experience, you expect 15 people to default, and this gives you a value for your securities. Fast forward a year, and it turns out that 29 people default, at that point the credit risk on your securities increase since with the next default, you start losing money, and you are going to get a securities downgrade. Now it was also possible in an alternative universe, it turns out that only 3 people defaulted, in which case the credit rating on your securities would have increased.
In the case of the CDO/subprime mess, the question that needs to be asked was could the number of defaults that happened be reasonably forseen and the answer is yes. People were loaning things with poor credit risk management, and at some point if you keep rolling the dice, you are going get a bad roll. At that point you ask yourself what happens if you get a bad roll, and in any competent financial institution, the answer is “we lose money, but not enough to put the company at risk.”
Anon: More generally how do you mark something to market when a market does not exist?
I have a special fruit salad, and I’m the only one that sells it. It consists of 50% apples and 50% pears. The value of the salad is going to be 50% apples and 50% pears plus a premium for mixing the two. If the price of apples and pears changes, then the price of my salad changes, however the price of my salad can’t be too for away from 50% apples + 50% pears. If is willing to either buy or sell my salad $100000 or $0.01 for my salad, I can make a windfall. Since one assumes that the markets will not allow these windfalls for very long, these put limits on those windfalls.
In the case of CDO’s and other fixed income instrument, the question is averaged over all possible scenarios, how much money I’m a likely to made, and what is the different in income between different scenarios. There is some ambiguity about what my special fruit salad costs, but that ambiguity is surprisingly low. It might be $4.00, it might be $4.25, but its not $1000 or $0.01.
The interesting thing is that if you look at detailed enough scales, there is some ambiguity in all prices. What is the current exact price of Microsoft stock? At any moment, there are a set of bids and ask prices, and this isn’t a fixed number.
One final thing. The interesting thing about mortgage backed securities is that prepayment risk overwhelms default risk. It turns out that the chances that someone will prepay to refinance or move has *far* more influence on the price of the security than the chance that someone would default. The standard prime thirty-year mortgage is one of the most difficult instruments in the world to price accurately.
>
Correct. Wall Street banks, no doubt, have been smart enough to sell off the “toxic waste” to others. (Or at least most of it except for the bridge loans they got stuck with.) That doesn’t mean however that they will be unaffected by the meltdown in MBSs and CLOs. For one thing they lose the cash-flow from underwriting fees etc. There is also the real chance of contagion into other asset classes that will affect their own holdings. And then there is counter-party risk which, as I understand it, is completely ignored by the valuation models. Granted the stress-testing is supposed to handle this type of risk but these procedures are hardly perfect.
As a historical comparison Morgan Stanley, Goldman etc did not much direct investment in LTCM either. The risk to them was considered quite real anyway. How is today’s situation any different?
” In the case of CDO’s and other fixed income instrument, the question is averaged over all possible scenarios, how much money I’m a likely to made, and what is the different in income between different scenarios. There is some ambiguity about what my special fruit salad costs, but that ambiguity is surprisingly low. It might be $4.00, it might be $4.25, but its not $1000 or $0.01. ”
The point is the amount of ambiguity for CDO prices is huge compared to either fruit salad or traditional equities. Unlike fruit salad a CDO cannot be easily split into easily priced ingredients. Unlike equities, markets for CDO products are highly volatile and illiquid, if there are no asks at a particular time, a bid-ask spread may not even make sense.
The range of ambiguity may not be as large as seven orders of magnitude like $0.01 to $100000, but it is easily possible to mis-value something like the unrated tranche of a sub-prime MBS by one order of magnitude. And of course that level of ambiguity combined with leverage can be lethal, no need for seven order of magnitude ambiguity. Working on Wall Street you should know this.
Twofish, to press the point, here is another Chinese official, Wu Xiaoling, saying that Huijin would be ‘part of’ the new company. It is hard to disagree with this statement. Having said that, there is clearly tension between MoF and the PBoC on thie issue and hence the problems over the bond issuance to fund the company.
http://www.icbc.com.cn/detail.jsp?infoid=1172800283100&infotype=CMS.STD
It’s the same official speaking (Wu Xiaoling). The first article was by Wu not Hu, but I assumed that was a typo. She probably thinks that Huijin and CIC should be combined, but she doesn’t have nearly the status to combine them or to make any sort of official decision that they should be combined. It’s hard to tell from a single quote. One rule in figuring out what is going on is to find the Chinese characters for an official, and do a google. She’s probably spoken at length on this issue in Chinese thereby being able to explain what she means.
The problem here is that merging CIC and Huijin is a massive undertaking, and if there were definitely going to happen, there would be large amounts of discussion on it. The fact that the amounts that have been authorized for CIC ($300 billion) are about a third what they would need to be in order to fund a joint CIC-Huijin, which says pretty clearly to me that this is not going to happen immediately.
Anon: For one thing they lose the cash-flow from underwriting fees etc. There is also the real chance of contagion into other asset classes that will affect their own holdings.
On the other hand, underwriting fees have never been more profitable. Also, there might be the possibility of cotagion, but it is difficult right now to put together a concrete scenario in which there is a general meltdown, and things are happening slow enough so that if we figure out a general meltdown mechanism there is plenty of time to do something about it.
Anon: And then there is counter-party risk which, as I understand it, is completely ignored by the valuation models.
It’s not. However, counterparty risk isn’t considered a major factor since it is unlikely (note unlikely not impossible since nothing is impossible) that a major investment bank will be forced to default on its CDO or MBS obligations. You can also hedge against counter-party risk with a credit default swap (and yes that brings up the issue of counter-party risk against the person you signed the CDS with).
Anon: As a historical comparison Morgan Stanley, Goldman etc did not much direct investment in LTCM either. The risk to them was considered quite real anyway. How is today’s situation any different?
In the LTCM case, LTCM was dumping assets which drove down prices which cause the IB’s to be forced to dump assets, which drove down prices, etc. etc. etc. We aren’t in a “death spiral” right now. People are dumping assets, but it isn’t happening fast enough or deeply enough to cause a “death spiral.” One big difference is that the bets aren’t all in one direction. Bad things happen in markets when everyone bets in one direction, and in this situation the bets are distributed so that some people make money.
Anon: The point is the amount of ambiguity for CDO prices is huge compared to either fruit salad or traditional equities. Unlike fruit salad a CDO cannot be easily split into easily priced ingredients.
But pricing a CDO has fewer ambiguity or liquidity issues than real estate or used cars. The main thing that changes the CDO model is the expected coorelation of defaults. When one company defaults, chances are that times are bad and other companies will default. Once you fix that, there are few “wiggle terms” in CDO models, and you can get estimates of coorelations from the markets.
Anon: it is easily possible to mis-value something like the unrated tranche of a sub-prime MBS by one order of magnitude.
I think that it is actually pretty hard to mis-value a CDO by that much. Now the value changes with new information. On day X, the value of a lottery ticket is $1.00, on day X+1, it turns out to be zero or $15 million dollars, but if someone asks me the value of a lottery ticket on day X, and I say $1.00, it’s not a “mis-value.”
Anon: And of course that level of ambiguity combined with leverage can be lethal, no need for seven order of magnitude ambiguity.
But the problem wasn’t ambiguity. It’s liquidity and leverage. I think talking about ambiguities in the CDO valuation misses the point.
Twofish, not going to happen immediately doesn’t mean it is not going to happen. and obviously, there will be lots of discussion. there already is. the fact that Wu said it is evidence it is on the agenda. i have no idea whether it will go ahead in the long-run. in any case, my aim was to point you to senior Chinese sources for this to dispel your implication that it was a mistaken translation by foreign reporters in beijing, as you suggested. clearly it was not..