1.54, 105, 1.45 — deleveraging continues …
It just seems like yesterday when the euro broke $1.50 and oil broke $100. Now the euro trades closer to $1.54 than $1.50 and oil trades closer to $105. Macroman doesn’t watch his Bloomberg screen quite as closely as he used to, but on Thursday morning he reported that a two year Treasury yielded 1.6%. By late Thursday in the US (early Friday in Asia), the two year was only yielding 1.45%.
The corporate credit market by contrast isn’t doing well. Nor is the housing credit market — including the Agency MBS market. (Agency MBS spreads are now significantly wider than in this chart) Agency MBS are mortgage backed securities guaranteed by one of the Federal Agencies. Thank Carlyle Capital, and perhaps others.
Talk of deleveraging has replaced talk of decoupling. And if Carlyle Capital is really geared up 32 times (it borrowed $32 for every dollar raised from investors), there may be more to come.
I am not close enough to the market to know what is going on. But experienced hands like John Jansen seem worried.
"The rolling crisis has turned the markets dysfunctional and malfunctioning. Liquidity has dried up and small chunks of bonds can drive spreads quickly tighter or wider. …
the cacophonous sounds emmanating from the fixed income trading rooms of the world can be deciphered into a warning that something is terribly wrong with the system.
That, together with the alarming quotes from bond market insiders that pop up regularly on Bloomberg and the latest from financial anthropologist Gillian Tett is more than enough to leave me worried.
I do have one question though.
Why aren’t the reserve managers of the world’s central banks stepping in to buy Agency MBS, and thus providing liquidity to the market?
Central banks have a ton of cash to invest. They haven’t shied away from Agencies: over the past year, the FRBNY’s custodial holdings of Agencies have increased by $230b while its Treasury holdings are only up $70b. The official sector is supposedly filled with investor with long time horizons who can afford to wait out temporary market disturbances.
True, most central banks — China excepted — have preferred the bonds the Agencies issue to the bonds the Agencies guarantee. But at some level Agency credit is Agency credit.
Agencies aren’t Treasuries, and the US will never suggest that they are. But I at least would be surprised if the US government allows the Agencies to fail at a time when they are a key source of support for the troubled housing market. And, well, a 3.5% spread should be attractive to central banks looking for a bit of yield. Mollenkamp and Ng:
In the early stages of the financial turmoil, the riskiest securities — such as those backed by subprime mortgages to people with poor credit — were hit by selling. Now, as margin calls intensify, hedge funds and others find they must unload even assets perceived as high-quality, such as bonds backed by the government-sponsored mortgage giants Fannie Mae and Freddie Mac.
Fannie and Freddie are perceived as having the backing of the U.S. government, so they’re usually seen as a safe haven.
"The fact that this is happening in top-quality agency paper is really worrying," said Tim Bond, a strategist at Barclays Capital in London. "It’s marking an extension of this stress into the group of players who only invest in the safest mortgage-backed stuff."
Amid waves of selling, bonds backed by home loans that are guaranteed by Fannie Mae and Freddie Mac were yielding 3.51 percentage points more than ultrasafe five-year Treasury securities. That spread is a record. A year ago it was 1.23 percentage points, and a month ago it was 2.48 percentage points.
I understand — I think — why central bank reserve managers (and even the managers of many sovereign funds) might be reluctant to jump into the market. They aren’t paid to take risks. They are paid not to loose money. To my knowledge, most central banks do not mark their bond portfolios to market (Japan is an important exception). But any central bank holding Agencies is also likely quite aware than Agency spreads have widened, and they are sitting on mark to market losses. That — and the risk that prices might fall still further – probably makes most reserve managers reluctant to seek permission to buy Agency MBS.
Judging solely from the widening of Agency spreads, a lot of sovereign money still seem to be in a defensive crouch.
Fair enough.
But it is a bit hard to argue that central bank reserve managers are an intrinsic source of stability if they are acting much like the rest of the private market at time of stress.
The Treasury market isn’t short of liquidity. Some other markets — including some markets that are close to traditional reserve assets — are.
UPDATE: The world’s central banks have plenty of euros too. They could perhaps consider providing a bit of "liquidity" to the market for Spanish and Italian government bonds as well.
So where are the helicopters ?
Deleveradging is fine. Has been expected for years now. But where’s all the printing presse money Bernanke promissed ?
THe USA should not rely on foreign central banks. They should be able to print their own money when facing an evident deflation threat …
Please note that this is just the beginning. The housing market has not fallen 10% thus far, and there are 30% more to go.
Same for the stock market.
So bring on the cash. Or enjoy watching the system crash.
I ve lived long enough to see Communism fall, and then financial capitalism…
Bye bye USA, your domination was short lived.
OT, but to follow up on a unique topic:
I just read this:
anonymous said…
Are you aware of this: Poole is an influential Fed official who voted against the central bank’s emergency rate cut of three quarters of a percentage point on January 22. He does not currently sit on the rate-setting Federal Open Market Committee, however, and he is retiring from the Fed shortly after next month’s meeting.
Retiring!
As you may recall with my latest heart attack posts related to Warsh, we have a Fed Board with 5, versus 7 members.
Without going back to notes, all 5 have been appointed by Bush and IMHO, Warsh is highly inexperienced, so with Poole retiring……isn’t this an Oh My God Moment, having less than 3 members to cover the overload of chaos??
>>This part is a few days older:
Because appointments of members are staggered there are currently only five members on the Fed board.) All current members of the Board of Governors have taken office during the presidency of George W. Bush.
Fed Nominees Pressed on Political Ties
Questions Raised Over Their Service in Administration, but Confirmation Is Likely
By Nell Henderson
Washington Post Staff Writer
Wednesday, February 15, 2006; Page D03
http://www.washingtonpost.com/wp-dyn/content/article/2006/02/14/AR2006021401909.html
President Bush’s decision to elevate three former administration economic advisers to the Federal Reserve Board prompted questions yesterday about whether they would be able to steer the economy independently of the White House they have served.
“This is inevitably going to create the impression that the board is more political than in the past,” Schlesinger said. “This creates more of a burden on Bernanke and company to prove they’re not taking their cues from [White House Deputy Chief of Staff] Karl Rove.”
Warsh, 35, who has served on Bush’s National Economic Council for the past four years, is a special assistant to the president for economic policy.
It is becoming clearer that a new currency is in the works a la Euro. U.S. dollar is a structural shambles and the world knows it.
Bring on the Amero or whatever the new currency will be called. Maybe it will be worth the paper it’s printed on.
“But it is a bit hard to argue that central bank reserve managers are an intrinsic source of stability if they are acting much like the rest of the private market at time of stress.”
Other countries need to support Agencies but the US has no responsibility to support the dollar ? Explanation ?
Brad — “Why aren’t the reserve managers of the world’s central banks stepping in to buy Agency MBS, and thus providing liquidity to the market?”
Why would they do that if “something is terribly wrong with the system”? Their intervention would just postpone the problems. The dry-up of liquidity would probably happen again in the future. If they don’t want to loose a lot, then the only thing they can do is to wait for the maturity of those bonds. How long is the maturity of the papers they could buy now?
“…”The credit-default swap market is completely distorting reality… Given what these spreads imply about defaults, we should be in a deep depression, and we are not.”…” http://www.bloomberg.com/apps/news?pid=20601109&sid=aB8RuoKZoKRM&refer=home
“…A growing number of money managers, from BlackRock Inc. to Och-Ziff Capital Management Group LLC, are looking to profit from buying whole residential mortgages..” http://online.wsj.com/article/SB120407245460695053.html?mod=googlenews_wsj
Selling short is the new frontier: http://www.ft.com/cms/s/2/efacbf46-e90e-11dc-8365-0000779fd2ac.html
“…Owing to recent developments in the fixed-income market, long-short strategies can now be used for credit risk selection…” http://www.iijournals.com/JFI/DEFAULT.ASP?Page=2&ISS=21156&SID=605420
any idea what the reverse fund is for SKF? Once the arket crashes, I’d like to get in some of it. Thanks to all for posting…..:>
re: “something is terribly wrong with the system”
Buffett provides a clue…
“This is our doing, not some nefarious plot by foreign governments. Our trade equation guarantees massive foreign investment in the U.S. When we force-feed $2 billion daily to the rest of the world, they must invest in something here. Why should we complain when they choose stocks over bonds?” http://www.economist.com/daily/columns/businessview/displaystory.cfm?story_id=10794220
…and then CFIUS blocks 3Com, for example… so you have a buyers’ strike — no mystery. Central bank reserve managers/SWFs are just waiting around for better terms; only when the US comes begging hat in hand will they come around because that’s when they’ll be at their maximum advantage…
Neoliberal Klepto-Capitalism Drives US Financial Meltdown
http://www.terradaily.com/reports/Klepto-Capitalism_Drives_Sub_Prime_Meltdown_999.html
The bursting of the housing bubble, which punctured the credit bubble, was a criminal enterprise at the outset, pooh-poohed at first by those who should have known better, that has now triggered a global economic crisis. The U.S. prison population is at an all-time high with 2.3 million behind bars, but the subprime con men are enjoying the fruits of their scams.
Near worthless mortgage-backed securities were repackaged by greedy predatory operators to look like soul food for the brainless. Some 10 million American homeowners will have no equity left in their houses by year’s end.
With 6 percent of the world’s population, America’s prosperity in recent years has been its ability to borrow $2 billion to $3 billion a day from the rest of the world in return for Treasury paper to maintain the world’s highest standard of living, which, in turn, is based on conspicuous consumption at a time of growing world shortages.
Financial System Broken - Markets ‘Utterly Unhinged’
Let’s not be too gloomy here. Other than overleverage, bad debts, sinking home prices, no jobs, shrinking wages, cash strapped US consumers, rising oil prices, a sinking US dollar, $500 trillion in derivatives not marked to market, rampant overcapacity, underfunded pension plans, looming boomer retirements, no funding for Medicaid, no funding for Medicare, and no Social Security trust fund, everything is just fine.
And even though the Federal Reserve, central bankers in general, and governments combined to create this problem, the irony is nearly everyone is begging for them to fix the problem by encouraging still more speculation in housing, commercial real estate, and the markets.
Sorry folks, it’s the end of the line and payback time for the world’s most reckless financial experiment in history.
http://globaleconomicanalysis.blogspot.com/2008/03/financial-system-broken-markets-utterly.html
Question: Why should central banks buy Agencies when the US isn’t supporting the dollar?
My answer — sovereigns are free to stay in treasuries if they want. but it is pretty hard then to make the case that they are adding to the stability of the market. a lot of money is piling into treasuries. there are bargains to be had elsewhere for investors who kept their powder dry and avoided the excesses of the credit boom. Agencies pose none of the issues of control associated with SWF equity investments — there is no political downside.
I fully recognize that one of the inequities of today’s world is that the us doesn’t have to worry about its currency — and directs monetary policy toward other goals. but that is a function of other country’s decision to peg to the $ no matter what, and buy $ no matter what. the US doesn’t have to support the dollar so long as others are so willing to do so.
that isn’t fair. I agree.
note tho that a lot of the policies I have advocated would over time force the us to rely more on market financing, and thus pay more attention to the dollar’s external value.
Brad,
I think people get scared, even FCBs. Who know what will happen to GSE? What if U.S.gov won’t back GSE? There are plenty of talks that U.S. gov would let GSE stand on their own. Given the little credibility U.S. gov has right now, even the promises that support GSEs cannot completely help markets. Now people are talking about defaults in GSE…
Everytime I read this blog I shake my head and realize how outrageously unstable this whole system is. The chinese must be braindead.
Hi Brad,
I remember you foresaw that the Economist’s cover on the collapse of the dollar was a good predictor of its recovery. It was two-three months ago, wasn’t it? With the Euro at 1,47-1,49, the dollar afterwards rallied a bit, according to your prediction, but now maybe it is time to concede that they weren’t so wrong after all. The dollar can go much lower -even if on the long run not so much. It depends on the Fed’s stance.
On the Agencies, after analysing the enormous black hole there is on their books (they were recording astonishing losses last week), I would not characterize their market pricing as dysfunctional. Furthermore, the US government wants to load them with even more financial burdens… No wonder they might need a bailout.
On SWFs, I agree on your position, and your arguments are very well put, very rigorous. Still, I wonder whether SWFs should be so high on the agenda. I consider much more worrying the problem of the exponential increase in central bank holdings - that is, global imbalances -and the fact that the US (and the IMF) are misdiagnosing the problem and recommending the wrong (expansionary) remedies.
P.S. The fact that non-productive entities such as central banks are accumulating such bewildering quantities of assets (reserves etc) means that they are indirectly confiscating a massive quantity of real assets from the private sector.
Mick Rolland -
fully agree on the “exponential” increase in central bank holdings.
that is relevant for the global liquidity picture: when risk seeking investors dump money into an emerging economy that the emerging economy’s central bank vacuums up and send s back to the us and europe, there is a fall in the “liquidity” the market for risk assets — and a surge in demand for safe assets.
as for the euro/ dollar — fair points. i missed the move through 1.50. i saw a clearer case for asia to adjust. And i do stand by my argument that at 1.45 to 1.5, the real economy will adjust — and the US deficit with Europe will come down. I wish I had emphasized a bit more than markets can always overshoot and so on, but I won’t deny that in december I was wondering if the euro has come close to peaking v the $.
that said, I do not think I can be charged with being a dollar cheerleader.
Carlyle’s creditors are selling off its assets. willy nilly.
http://customwire.ap.org/dynamic/stories/B/BRITAIN_CARLYLE_CAPITAL?SITE=NDBIS&SECTION=HOME&TEMPLATE=DEFAULT&CTIME=2008-03-07-08-09-50
Don’t forget that MBS have prepayment risk (eg when long rates fall, their duration shortens), which is quite difficult to analyse, especially at unprecented yields when borrower behaviour is difficult to predict. Their spread to treasuries does not only reflect the issuer. I am no expert in MBS, but I believe that they are very illiquid too, because the holder owns lots of small loans. I was surprised to hear from Brad that any central bank buys MBS - apparently China does. Bullet agencies are easier to understand, but even they suffer from the vagueness of their status. If the US government denies that an “implicit guarantee” exists, then agencies will trade nearer their “standalone” credit rating typical of a bank.
rebel — true, bullets are easier. but at some point a central bank looking for yield has to take the plunge. Treasuries don’t cover sterilization costs anymore!
My assertion that China does stems from the large chinese holdings of Agency MBS in the last US survey of foreign portfolio investment.
“…”We believe the euro will not survive in the long run in the absence of some kind of political support…” http://www.ft.com/cms/s/0/a5ec1838-eba8-11dc-9493-0000779fd2ac.html
“Many leading private equity firms are raising tens of billions of dollars for new funds in spite of declining returns on old deals… The amounts being raised are comparable to the fundraising efforts at the peak of the private equity boom in 2006 and early 2007 and suggest ample liquidity remains in the financial system in spite of the market turmoil… While pension funds have scaled back their contributions to private equity firms in the face of market setbacks, investors say, sovereign wealth funds have become relatively more important investors in the sector…” http://www.ft.com/cms/s/0/f7f0eb56-e638-11dc-8398-0000779fd2ac.html
“…skirmishes signal cracks in the vast and unregulated market for such credit default swaps… The market for such swaps has soared to nearly $45 trillion, a number comparable to all the bank deposits world-wide…”
http://online.wsj.com/article/SB120459196434709061.html?
bsetser: Why aren’t the reserve managers of the world’s central banks stepping in to buy Agency MBS, and thus providing liquidity to the market?
Because they like everyone else is spooked by anything with the word “mortgage” in it.
RebelEconomist: I am no expert in MBS, but I believe that they are very illiquid too, because the holder owns lots of small loans.
MBS’s are very liquid. They are also very good investments if you are interested in principal protection. They are however the worst possible investment if your goal is predictable cash flow. The big risk in MBS’s is prepayment risk, and if you have an uncertain interest rate enviroment, you run the risk that people will refinance and you end up losing interest payments. The hard part about this is that since you are dealing with human psychology and life events, it is very hard to model prepayment.
RebelEconomist: Bullet agencies are easier to understand, but even they suffer from the vagueness of their status. If the US government denies that an “implicit guarantee” exists, then agencies will trade nearer their “standalone” credit rating typical of a bank.
I’m not sure what is meant by bullet agencies. If you mean corporate debt issued by Freddie and Fannie, I don’t see *any* reason to think that there is any government guarantee, implicit or otherwise behind them. If Freddie or Fannie were to go bust, then I can imagine the government stepping in and doing a bailout of the ABS’s issued by Freddie or Fannie, but I can’t imagine any bailout of the corporate debt that they issue.
Also, the line of credit that Freddie and Fannie from the Federal government is a poison chalance. $2.25 billion is not enough to really save Freddie or Fannie if either got into serious trouble, and tapping that LOC would send a sign of desperation and all of the private credit lines would instantly dry up.
brad, you just have little idea how those reserves are managed, no offence.
there is a certain policy, which says you can buy this or that, only of the highest quality and your portfolio should hold
no more than this % of that…
all reserves, not SWFs, are extremely risk averse, after all they are managing their national resrves, they are not hedgefunds.
any move beyond that policy from the manager may be a criminal case in countries like China and Russia and i think Japan.
and changing the policy requires time and it’s not so straight forward, it is politics, since in all countries there are political parties who think there are better ideas than financing US…
so this reserve management thing is not like “I see opportunity - let’s grab it!”. it takes a lot of time to change their investment strategy.
And another 2 cents:
1. financial markets are not a place there people “do good” to each other. It’s a place there they fight for money. So, if without sovereign financing the US mortage and fixed income market will goes to total collapse it is a perfectly rational strategy to sit on the sidelines - they can later buy cheaper bonds and stakes in financial institutions.
2. The guarantie on agencies is “implied”, not real, rather supposed. And US is supposed to favor strong dollar, as they reapitedly said. you do the math.
A senior journalist friend just informed me of something disturbing about the Fed. He invited a senior economist from the FRB-Dallas to speak on a panel. The economist, who is often a speaker in energy events, declined. Reason? The panel was to discuss energy issues in the event of a recession and the FED economist told him, “I am not allowed to talk about a recession.” Politicized? They’re trying to prop up faith by ensuring everyone totes the party line. Problem is, the party’s over and their effort to “control the message” looks more and more like a drunk overstaying his welcome. “Come on dudes, let’s Party On!”
In the US founded on a Gov’t of,by,for people, the Fed Reserve seems the absolute contrarian. Instead of protecting the weaker common man from the predations of others by law, regulation, security, stability…They back ruinous monetary policies while Legislature enacts ruinous fiscal policy.
Then, they proceed to devalue the currency to palliate the hangover. The predators, having similar character, recognize the ruse and move their capital into wealth preserving commodities.
Common man loses business, employment, stored wealth while having to pay higher prices in all necessities because of inflation heightened by speculation.
Like having tapeworms, ringworms, gangrene, malaria, and tree leeches while being diagnosed whole and healthy. Unconscionable cruelty upon one’s fellow man.
Maybe a brand in the forearm of all for 1.54 could be a symbol of the economic gulag we reside in. However, methinks it must be revised up daily!
flipper — you are right, both on how Japan and Russian reserves are managed (tho I think Russia’s new future fund has the flexibility to buy Agency MBS) and on the status of the Agencies. Most reserve managers work within pretty strict guidelines. But i also know that several already hold Agency MBS or have outsourced their agency MBS portfolio to a third party manager. My point — and I am guilty of being a bit ironic — was that central banks (and SWFs) are not always the stabilizing force in the market they now claim to be. right now they are piling into treasuries just like everyone else.
accepting your basic point about the constraints most reserve managers are under, my general sense is that those constraints have been lifted in at least some cases for some pools of money — SAFE seems to have its hands in things like Australian equities, and, according to rumors, a less-than-plain vanilla instruments as well ..
Dallasenergyguy –
at times like these, the fed worries about self-fulfilling prophecies and talking the us into a recession. that creates a natural inclination to clam up. Especially as the fed’s views on the economic outlook influence rates and folks bet on rates …
the fed has made its share of mistakes. its regulation of the big money center banks for example seems to have left a little to be desired. at the same time, they aren’t quite as clueless as some thing — at an event yesterday, NY fed president Geithner was asked if the fed was aware of the interest rate differentials that worked against the dollar and Geithner sort of looked back incredulous and then stopped before he seemed ready to say something to the effect “do you think we are total idiots … “. His actual response was diplomatic and focused on the core of the question (i.e. the impact of dollar weakness on the fed’s thinking)
i, too, thought there would be strong resistance to the euro rising above $1.50. perhaps there was.
pity poor ireland. the setting of interest rates is with the e c b and out of our hands. low rates appropriate to the german economy inflated property prices to a level from which they are now in decline. our banks have lent disproportionately for property investment.
.
we have u s multinationals who export to america and thus suffer along with the unfavourable exchange rate. they will lay off people.
warren buffet has the picture, but he still makes it the fault of the u s, whereas it is simply the zeitgeist - the mentality that results from the natural learning process of a long long boom. buffet seems to understand that if you force feed $2 billion / day to the rest of the world, much of it will come back into the u s economy to buy up stuff of their own choosing.
and i called that ‘confetti blowback.’
- a useful expression ?
“…Was this preventable? I don’t believe that asset price and credit booms are preventable. They cannot be effectively diffused preemptively. There is no reliable early warning system for financial shocks…” http://www.ny.frb.org/newsevents/speeches/2008/gei080306.html
*cough*bullshit*cough*
I used to work for Geithner and am a big fan, but I also had a bit of trouble swallowing that particular bit of his speech. Maybe no early warning system is 100% reliable, but there were plenty of signs of trouble. Of course, if the fed is going to start taking asset prices into account when they rise not just fall, geither was not the right person to make that kind of announcement.
natural question being why don’t you work for geithner now - (and who is it you’re working for now?)
and what is the main purpose of these (always?) closed cfr meetings - press conferences? - who is there?
due respect to geithner, midst the plenty of signs of trouble, isn’t one of the problems that it’s much less clear what to do about it? hearing too many comparisons between nasdaq 2000 bubbles and 07/08 credit and commodity bubbles when the causes and possible consequences are very different.
p.s. isn’t ‘full disclosure’ generally a statement of current personal portfolio allocations and business lines which may influence a view you are expressing.
references to past employers and former co-workers is of limited value as we don’t know the reasons, terms and conditions of your apparent departure or the nature of any on-going relationships.
I am thinking now is a good time to sell euros. The Economist had an entertaining and prescient cover on the launching of the euro, showing grinning officials lighting a rocket aimed at the ground. Well, after a rocky start it has overshot its proper bounds. Looks like markets want to find the feet and head of this new critter.
How much of the U.S. downturn can Europe handle, without Asia taking its fair share of the hit? I expect when the slowdown finally hits Europe full-force, it will be a chance to buy euros rather cheaply, relative to their price today. The spike of the U.S. dollar in 1985 should give people pause, however, if they think rational investors will prevent the euro from going much higher.
Geithner’s remarks were on the record, open to the press and have been widely reported (see Felix, among others). His speech is also available at the fed’s web site.
I noted that I worked for Geithner because my (positive) experience working for him shapes my views of anything that he says. I give it more weight than I would the opinion of individuals who I do not hold in the same regard. That doesn’t mean I always agree with him, but it does mean that I have confidence that he has thought carefully about an issue before he airs his thoughts in public.
flipper: So, if without sovereign financing the US mortgage and fixed income market will goes to total collapse it is a perfectly rational strategy to sit on the sidelines - they can later buy cheaper bonds and stakes in financial institutions.
Actually it’s not. If the US mortgage and fixed income markets go into total collapse, then it will drag down everyone else with it. One problem is it doesn’t help you if you buy cheaper bonds and equity positions with cheaper dollars.
One thing that is important here is that I may have a different definition of total collapse than most people. Total collapse in my definition means something like Zimbabwe. It’s also important to distinguish between price shifts in which people are still buying and selling at a different price and market collapses in which no one is willing to buy or sell at any price.
DallasEnergyGuy: The panel was to discuss energy issues in the event of a recession and the FED economist told him, “I am not allowed to talk about a recession.” Politicized? They’re trying to prop up faith by ensuring everyone totes the party line.
Not really. The fear that everyone in finance has is that you’ll say something off the top of your head, and the next thing that you know, you get quoted in the front page of the New York Times, and then everyone starts screaming at you. There is a strong tendency to say nothing at all since saying anything could be bad. However the problem with saying nothing is then the general public has no idea what’s really going on.
Anonymous: isn’t ‘full disclosure’ generally a statement of current personal portfolio allocations and business lines which may influence a view you are expressing.
For the purposes of discussion, you can assume that I am working for Satan, and that anything that I say is intended to make me rich, make you poor, and help the Prince of Darkness in his evil attempt to enslave the world and you with it. Imagine any evil conspiracy, hidden agenda, or personal motive, and yes, I might be part of it.
The trouble with questioning someone’s views because of bias or possible conflict of interest is that anyone who doesn’t have bias or possible conflict of interest probably doesn’t know anything terribly useful or interesting. Also just because someone is biased and self-serving, doesn’t mean that they are wrong……
I find it useful to not argue about whether or not I’m unbiased or objective and just admit that, yes, I may be completely lying through my teeth. Up to you to figure this out.
bsetser: the fed has made its share of mistakes. its regulation of the big money center banks for example seems to have left a little to be desired.
Given the structure of financial regulation, it’s hard to imagine the Fed doing better than it did. The Fed is only allowed to monitor overall risk, and it’s expressly forbidden from regulating individual financial products. Basically the Fed can say to a bank, your risk levels are too high, lower them. It can’t tell a bank how to lower its risk levels. It doesn’t have the legal authority or the manpower to do this. The fact that no major bank has even come close to failing suggests that the Fed did the job that it was told to do.
One interesting exercise is to go back and try to come up with a better regulatory structure. It’s quite a bit harder than it sounds. One problem is that most financial regulations are intended to prevent fraud. Suppose something bad happens, and there *isn’t* any fraud. What then?
All and sundry : economy..dollar..china..SIV..blah blah
Twofish : NOT REALLY
Twofish: “Suppose something bad happens, and there *isn’t* any fraud. What then?”
Post Enron, it is hard to understand why the “build me a SIV to hide my liabilities off balance sheet” strategy wasn’t wearing a huge “fraud” sign on it. Big enough even for auditors with conflicts of interest to be sensitized.
Did the regulators give this all a wink and a nod?
I take your general point that hindsight is better than foresight, but why did Rag Rajan see this all so much more clearly IN ADVANCE than a lot of folks seem to see it even now? (And yeah, he’s smart, but it isn’t like he’s kept it all to himself either …)
STS: It is hard to understand why the “build me a SIV to hide my liabilities off balance sheet” strategy wasn’t wearing a huge “fraud” sign on it.
Except that unlike Enron, there were no off-balance sheet liabilities as long as the mortgages were paying. Now you can argue that any idiot could see that this would fall apart if the mortgages stopped paying, but the trouble is that stupidity is a valid legal defense against fraud.
STS: Did the regulators give this all a wink and a nod?
Not really. The trouble with SIV’s is that there are perfectly good reasons to use them, and perfectly good ways of avoiding any liabilities that result from them. You can structure an SIV so that the bank guarantees nothing if there are defaults in the SIV’s. What gets a bank in trouble is that if it says that it guarantees payment if there are defaults in the SIV. In that case its really hard to see where the fraud comes from. Who exactly is the bank lying to?
“Agencies aren’t Treasuries, and the US will never suggest that they are. But I at least would be surprised if the US government allows the Agencies to fail at a time when they are a key source of support for the troubled housing market. And, well, a 3.5% spread should be attractive to central banks looking for a bit of yield. Mollenkamp and Ng:”
USA is killing dollar with Fed’s liquidity policy. Do you think USA give a dame about agencies? With dollar continue to slide, that shows no one around the world trust the dollar or USA government. If they don’t trust dollar or USA, then when should they trust dollar denominated asset like bond?
Two points why SWFs would not buy Agencies
1. Surely the underwriters who packaged mortgages which had missed their first payment have some liability and or participated in a fraud. Of course the originating mortgage broker and the speculator or foreign national who took cash back at closing and ran away also committed fraud. Measuring this against any prudent underwriting would suggest negligence. Couple this with the GSEs inability to account for their derivative stakes/yield kickers to protect against prepayment AND boost quarterly earnings. This stuff looks nuclear and any quasi public official buying a mortgage security will be villified if the markets continue to seize up and mark to market losses are incurred sometime before maturity (even if 10 years from now bonds are paid at PAR).
Point 2. As for 32:1 leverage of a Carlyle and its deleveraging, a 20pc haircut on its agencies has cost its lender(s) 4.4 Billion. 40pc is 8.8 Billion. Who are these lenders? How many more Carlyle’s?
Point 3. Don’t count on Capex. Budgets are being slashed everywhere I go EXCEPT for the BRIC, Tigers and emerging markets - so far. Some of their institutions could wind up with a global franchise.
Point 4. If unemployment is heading up, house prices down, investment down today’s agency bonds likely will experience a default rate far higher than anticipated. The trend is NOT your friend on this one.
SO>>>
Yesterday’s rumors in NY are that AIG, GOLDMAN (yes, Goldman) and MERRILL have MORE multi-billion write-offs coming. Seems simple enough that ANYONE who lent money for leveraged funds is going to come up, well a bit short.
And finally as I read this fantastic blog with my weekend coffee:
Leverage should have been REGULATED. Mortgage Underwriting should have been REGULATED. This was all PREVENTABLE. Folks should be headed to JAIL for this. Others should have the lawyers hunt them down for gross negligence. Individuals who fed on the debt parade need only look into the mirror for why they chose an unsustainable lifestyle.
Meanwhile, and far more concerning is we sacrificed our productive base for what has to be something as misguided as paying more for TULIP bulbs Gold.
What a fine mess we are in. It’s that basic and that BIG.
Thanks, Brad and RGE, for being a place where folks who saw this one coming can continue to see where it is going…
Those USA agencies (GSE) were bailing out mortgage originating companies by taking their bad mortgage loan as collateral, when this thing hit us in summer of last year? Why put your money on USA agencies with portfolio of dubious and depreciating asset? Foreign investors have no responsibility to bailout USA agencies. Leave that to USA taxpayers…
How many trillion dollars can the other currencies absorb?
The dollar onslaught ironically forces the foreign reserve agencies to buy dollars and increase their local money supplies.
They must be getting that sinking feeling that they are paying to much for them.
And the people cop the the value haven/dollar devaluation driven increase in commodities.
People with dollar contracts are being ’squeezed’, Airbus says it can’t take any more.
Liberalizing foreign ownership of US equities and other assets would boost support for the dollar.
Everybody needs to support the dollar for now or they will get bitten.
Floating must be considered, the pegs are adding pressure to the floaters such as the Euro as well as making a rod for their own backs.
STS: Did the regulators give this all a wink and a nod?
“Not really. The trouble with SIV’s is that there are perfectly good reasons to use them, and perfectly good ways of avoiding any liabilities that result from them. You can structure an SIV so that the bank guarantees nothing if there are defaults in the SIV’s. What gets a bank in trouble is that if it says that it guarantees payment if there are defaults in the SIV. In that case its really hard to see where the fraud comes from. Who exactly is the bank lying to?”
“I find it useful to not argue about whether or not I’m unbiased or objective and just admit that, yes, I may be completely lying through my teeth. Up to you to figure this out.”
ohhhhhhh k
Twofish,
Why do you say that MBS are very liquid? Just asserting the opposite of my tentative opinion is not helpful. Do you know about the settlement of MBS? As far as I know, if you buy an MBS you get delivered a share of a pool of loans, which your back office has to deal with. I believe that some investors will only hold TBA MBS to avoid this problem. Remember that one of the main reasons central banks hold reserves is for use in contingencies such as sudden stops. A thorough understanding of liquidity is vital.
Agency MBS are clearly not liquid right now, unless you have access to the term auction facility or are a major broker dealer that otherwise has access to the fed’s repo window. That said, the big central banks no longer need to have all their assets in the most liquid paper — as they now hold FAR more assets than needed to meet any plausible liquidity need. indeed, both the BoJ and the PBoC’s treasury holdings are likely functionally illiquid, in the sense that they hold such a large stock that they could not sell big quantities for cash. that doesn’t really matter tho b/c they have enough that has be rolled over that they can always get “liquidity” that way.
anonymous — interesting (including the who’s next rumors). the how many more carlyle’s question is really important one. that said, at this point in time, i do think the Agencies are too systematically important to the housing market to fail. you cannot let the agencies be subject to market discipline and stimultaneously count on them to support the housing market and thus avoid an even bigger systemic problem.
so in that sense, i don’t think the agencies are much of risk; they really are indirectly us treasuries (for now). but i can also see why the rest of the world isn’t in a mood to buy into US institutions, not after all that has happened.
it will be interesting to see if the shift in central bank demand from treasuries toward agencies that was so strong over the past two years continues, or whether it reverses itself both during the crisis and in the aftermath, as there will be a much larger deficit and more treasury supply soon.
Some of the comments above about who decides what central banks buy raises an interesting issue. I would expect that many central bank reserves portfolio managers are given a benchmark that allows some leeway to add agencies as a “active” management strategy. Since agencies normally yield more than treasuries, the portfolio managers probably use this leeway practically permanently, and so will have been caught out by the widening of agency spreads. I dare say that some central bank portfolio managers are reporting some hefty losses against their benchmarks right now which are leading to some interesting internal discussions!
“so in that sense, i don’t think the agencies are much of risk; they really are indirectly us treasuries (for now). but i can also see why the rest of the world isn’t in a mood to buy into US institutions, not after all that has happened.”
i doubt world believe agencies and treasury are worth getting. USA government’s treasury doesn’t deserve AAA rating, because of recent dollar policy. I would probably mark treasury to toxic waste, because it is paying declining rate and value of treasury is weakened daily be declining dollar.
please note that so far the Debt/GDP ratio is still rising and housing prices have barely fallen, unless major inflation kicks in, I seriously doubt it, they ll have to fall by more than 50% to get below their long term mean. That’s a lot of problems ahead.
DC this is not specific to the USA. Europe and Asia have the same housing bubble. Theirs is simply a bit smaller though not everywhere. Spain and UK for instance are going to be hit very hard.
Hey Brad any comment on Iceland ?
Basically the US lives from its international credit. It can borrow because of its credit reputation. Don’t you think, Brad, that this reputation is going to be crushed, indeed destroyed, by the present crisis? It may not happen at once, but how can a nation that constantly pays its obligations off in depreciated script retain any reputation for credit-worthiness? The US may not be defaulting on its debt in one fell swoop, but it is defaulting slowly and inexorably on its debt. I would think the rest of the world would be scrambling rapidly to find ways to stop extending credit to the US. If not, why not?
guest –
I suspect the reputation of the US (not the greatest right now) will take a hit. But so too will the reputation of the countries that made the political decision to link their currencies to that of the US and hold so much of their national wealth in us dollars.
Rebel economist — I agree with you. the spread widening on Agencies and resulting losses for any central bank reserve manager with a bit of discretion looking to beat a treasury benchmark will indeed generate some interesting discussions. the hubbub in Russia hints at this. of course, if central banks respond by buying only treasuries they will add to the liquidity pressures in the market and be “destablizing” players not stabilizing long-term investors. they don’t have to mark to market/ deleverage right now.
bsetser puts it very elegantly.
CBs need to be considering systematic nationalization of arbitrarily sized classes of securities. The Fed could announce tomorrow that it is buying all ARS, at their price as of such and such a date. Why doesn’t it? Beats the heck out of me. As far as I know, which admittedly is not very far, it has all the statutory authority it needs.
By definition, if such a purchase does not affect the number on everyone’s little portfolio statement, it does not affect purchasing power and is neither inflationary nor deflationary. Nor, perhaps more importantly, does it reward or punish any class of debtor, creditor or investor. And you get to look like a decisive, ballbusting leader. What’s not to like?
Actually, there is something not to like, which is that rebooting large parts of the postwar financial system is a way of admitting that the system was never exactly a thing of beauty and a joy forever. The sooner this bullet gets bit, the better.
Twofish:
“The trouble with SIV’s is that there are … perfectly good ways of avoiding any liabilities … structure an SIV so that the bank guarantees nothing if there are defaults …”
Indeed!
“What gets a bank in trouble is that if it … guarantees payment if there are defaults … In that case its really hard to see where the fraud comes from.”
If the bankers couldn’t move the SIV’s without the guarantees, then those guarantees had value. I doubt that value was advertised prominently to regulators for the liability it was. Or that those regulators were particularly eager to discover it. The large actual value of those contingent liabilities is currently torpedoing those bankers’ balance sheets.
Was that fraud? It might have been merely “sharp practice.” It might not have been fraud by the *letter* of the rules, but it’s hard to see it as anything but fraud according to the *spirit* of those rules.
Talking down the oil bubble would help.
When tankers have to sit around because the product tanks are full, i.e. they can’t process any more crude because there is nowhere to put it, there is no “shortage”.
They seem to be disguising this as “refinery downtime”
I suppose that would start another stampede of hot money into some thing else, but the net effect would be good, as consumers could direct more expenditure to domestic spending.
re: “For the purposes of discussion, you can assume that I am working for Satan…”
or a virtually anonymous, self-important crank with too much time on his hands who feels called upon to remark on EVERY comment…
“…The TAF has been criticised for muddying the credit waters in allowing banks to borrow against all types of collateral and in increasing the reliance of the banking system on indirect government support…” http://ftalphaville.ft.com/blog/2008/03/07/11443/the-fed-rumour-recast/#comments
Bernanke said “…derivatives “increased the resilience” of financial markets over 2006. Moreover, banks such as morgan stanley, bear stearns and deutsche bank have gone on record this year as stating that derivatives have helped them to achieve record profits. For example, Morgan Stanley said a jump in revenue from credit products helps spur a 70% increase in its first quarter profits for 2007… Julian Day, policy director at the [ISDA] elaborates: “Our end of year volume survey for 2006 was interesting in terms of the rate of growth of derivatives. In credit, the growth rate was in excess of 100%. If you unbundle the actual size of the market as a whole, by far the largest share is rate products…”… we’re still seeing the full potential of that market being realized in terms of new products, users and market makers. These are still nascent products… next year will be an interesting one in terms of the take up of electronic trading in the derivatives space… the overall portion of trades executed via these venues is still relatively small, but increasing…
Derivatives are now a major contributor to investment bank earnings… The fact that large pension funds are currently investing or planning to invest in derivatives is a testament to their ubiquity. [CALPERS] has recently announced that it is considering using credit default swaps to speculate on declines in the credit-worthiness of corporate bond issuers…”
http://www.smartstream-stp.com/~/media/Files/Internet/NewsEvents/InThePress/Fund%20Alternatives%20Fashion%20of%20the%20season.pdf
“…Interest rate derivatives accounted for $292 trillion, 70% of notional market value at end 2006, while foreign exchange derivatives made up $40 trillion, nearly 10%. The share of both had eased back from end 2004 mainly due to growth in credit derivatives. The latter increased fourfold from notional value of $6 trillion at end 2004 to $29 trillion at end 2006, reaching a 7% share of the OTC market. Commodity derivatives rose fivefold over this period to $7 trillion, reflecting the increased interest in commodities as an alternative investment…”
http://www.ifsl.org.uk/uploads/CBS_Derivatives_2007.pdf
@anonymous
Who says CALPERS is smart or always correct? Their internal systems and risk controls are not what you would expect them to be. The number of public funds with increased exposure to private equity, real estate, infrastructure, lbos and other ILLIQUID Investments is skyrocketing.
For those who are careful stewards of their respective funds and have been doing this for a long time, this is a great investment strategy (i.e., Yale). I would doubt Yale has much derivative exposure as well.
Others I fear, with grave consequences, are just desperate to get investment returns up to pay benefits that simply cannot be afforded without massive employer contributions (our towns and cities) or cessation of current pension agreements. It’s that bad. They should heed that past performance is not indicative of future results…
There are bargains to be had elsewhere for investors who kept their powder dry and avoided the excesses of the credit boom.
It’s worth remembering that the vast majority of money lost in a recession/depression is not lost by the tiny number of investors who buy at the top of the market as it is turning down, but by the much larger majority of investors who buy the market as it comes down, thinking each time that they are buying the bottom or buying an asset that will be immune from the losses elsewhere. The way a liquidity implosion works through the economy and financial asset classes is a slow contagion, a cancerous hollowing out of capital values and strangulation of income growth. The SWFs, like many others, may be afraid of buying someone else’s problems, spending their valuable cash today on what will be disclosed as a problem asset class tomorrow. I would be in no rush to buy US asset classes of any stripe, not even Treasuries, and certainly not GSEs. Too much that was “impossible” in June of 2007 has eventuated already, too much that seems “impossible” today may evenuate in 2008.
Anonymous — I hope that you will realize that your attack on two fish as a “virtually anonymous” poster is patently absurd. two fish is about the least anonymous poster around here, apart from those who use their own names. I usually take down anonymous personal attacks, but in this case I think I’ll leave it up as a monument to the courage some display only when posting anonymously.
twofish — you are a welcome contributor here, even if motivated by the devil or self-interest:)
banker — fair point. too much that wasn’t supposed to happen has happened. i am perhaps immunized to the shock factor since i spent so much time with roubini, and from his point of view, so much that was expected to happen has happened.
but if CBs and SWFs take your point of view and hoard cash, they need to adjust their talking points. they cannot claim to be a force for market stability in all market conditions.
“Who says CALPERS is smart or always correct?”
“Anonymous - I hope that you will realize that your attack on two fish…”
if you can find it, do tell
how can I short the USD without buying FXE, FXY, FXF, et al? Is there an ultrashort ETF on this I don’t know about????? Thanks……..:>
i would bet that google blog search two fish would yield a fair amount of information …
in any case, the attack on two fish was unwarranted.
i stand by what i say. you are responsible for your own interpretations
i would recognize jw’s commentary under any moniker as you recognize mine. a google search of a moniker is not going to tell me any more than i already know - and i have absolutely no incentive to spend the time doing that.
i think you, rge and anyone or entity offering any form of financial advice should be required to disclose the ways in which they (intend to) profit from taking and encouraging a particular view. otherwise, how can the reader obtain the information they need to make informed decisions - or know how the information they submit to your blog may be used or abused?
“…By using Rgemonitor.com, You are indicating your acceptance to be bound by the provisions of these Terms of Use. Roubini Global Economics, LLC (”RGE” or the “Company”) may revise these Terms of Use at any time by updating this posting. You should visit this page periodically to review the Terms of Use, because they are binding on You. The terms “You” and “User” as used herein refer to all individuals and/or entities accessing this Web site for any reason….The contents of Rgemonitor.com, and of all other Web sites under the Company’s control, whether partial or otherwise (Rgemonitor.com and such other Web sites are sometimes collectively referred to as “RGE Sites”) such as text, graphics, images, logos, button icons, software and other RGE Content (collectively, “RGE Content”), are protected under both United States and foreign copyright, trademark and other laws. All RGE Content is the property of the Company or its content suppliers or clients. The compilation (meaning the collection, arrangement and assembly) of all content on the RGE Blog Sites are the exclusive property of the Company and protected by U.S. and international copyright laws…”
if you can think of a justification for your personal attacks on me, please let me know. the definition of ‘anti-roubini’ commentators or commentary is not clear to me - along with the consequences of acknowledging the existence of views which may fit that definition. and the active discouragement of balance is out of character on a blog which boasts that it is unbiased.
I liked the “selfimportant crank” better than virtually anonymous, but what the heck.
But I fail to see where you’re coming from, accusing this blog of offering financial advice!
‘kinell! It’s a MACRO blog, innit?
Arguing views on what’s happeing to the worlds economy hardly consists of giving financial advice. At least not on investor level.
Since when did you become a grumpy ******* anyway? Usually your posts are really enlightening, even if there may be more than one of you using that anonymous moniker.
brad is well over 21 - and 6′, which i am not and he knows that - and capable of writing his own remarks to responses to his comments - as is ‘2fish’
of course you fail to see where i’m coming from as you are not part of this conversation