Global Financial Crisis (Was: Subprime Meltdown)

[garo]

Couple of points here. First, the Telegraph is very Europhobic and their default editorial stance is Euro-bashing so I wouldn't swallow what they say hook, line and sinker.

Second, everyone on this side of the pond asking for the ECB to ease rates is from a bank/investment house. That smells! I don't think the ECB is doing this to spite the Americans, it's doing what it thinks is best. Look at the BoE where interest rates are 5.25% and the Brits are historically more inclined to be in sync with the Americans so why aren't they lowering their rates? The article says nothing about the UK monetary policy choosing to blame the Europeans as usual.

[ewmayer]

The San Jose Mercury News' Vindu Goel comments on the moral hazard aspects of the Fed's bailout of Bear Stearns: Bernanke's bailout for Wall Street puts taxpayers at risk

Over the weekend, the Federal Reserve chairman and his colleagues offered to swap good-as-cash Treasury bonds for hundreds of billions of dollars of risky securities that banks and investment firms can't unload on anyone else. The Fed also guaranteed $30 billion of Bear Stearns' diciest holdings to sweeten JPMorgan Chase's already toothsome deal to buy the investment bank for a mere $236 million.

...

The Fed is offering those deals to banks to increase the pool of lendable money and shore up public confidence in financial institutions. Unless a bank defaults on a loan, the government won't actually lose money, and some experts think the government could turn a profit once markets recover.

But if those securities are such a good deal, why isn't the private sector buying them?

A bigger problem is the precedent set. The Fed's deals ultimately transfer a lot of risk from private companies to the taxpayers. And that sends a bad message to the next generation of risk-takers: It's OK to gamble big because the government will protect you from losses.

The economists call this "moral hazard." It's the same whether the gambler is a bank or a family that doesn't buy flood insurance and counts on federal disaster relief to pick up the slack.

"If people don't bear the costs of their actions, they impose a cost on society," said Tom Davidoff, an assistant professor at University of California-Berkeley's Haas School of Business. In the case of Bear Stearns, "You have an investment bank that lost a bunch of money because they made some bad gambles. Will this induce banks in the future to say, 'Heads I win, tails I win, because I'll get bailed out.'?"

The repeated rounds of rate cuts are also troubling.

In theory, they should have prompted banks to lower rates for mortgages, credit cards and business loans.

In reality, banks have kept lending rates stubbornly high and cut way back on the number of loans to all but the most creditworthy. Despite jawboning from the Fed and the Bush administration, financial institutions have also been reluctant to relax loan terms for borrowers who are at risk of losing their homes to foreclosure.

So much for "passing the savings on to consumers".

[ewmayer]

The Times | Yen Carry Trade in Danger of Unwinding

Hedge funds have long used the carry trade for cheap leverage, but there are also thought to be vast exposures to yen volatility in the Thai, Korean and Indonesian banking sectors, where the Japanese currency has been borrowed heavily to meet funding needs. The British banking sector turned to a version of the carry trade - yen-denominated bond issuance - when credit conditions tightened around the Northern Rock crisis. Indian banks` use of the carry trade surged 180per cent between 2005 and 2007. Because the trade has been so popular, Goldman Sachs analysts said yesterday that the sharp fall in the US dollar against the yen had prompted them to reassess the “cash-call risks” for Asian banks and corporates.

But the practice is also uniquely sensitive to general global risk appetites: when investors batten down the hatches, as they have done in the wake of the Bear Stearns collapse, the carry trade unwinds, often spectacularly.

The article also has the best "Carry Trade for Dummies" short-and-sweet exposition of this shadow financial system I`ve seen:

Yen carry trade: the appeal and the ploy

— The yen carry trade is a “cheap money” gambit that exploits the extraordinarily low borrowing rates available in Japan. It is notoriously hard to quantify but is understood to have supported a series of the asset bubbles around the world in the past few years, from Indian property to fine wine and art

— Japan`s low interest rates, an anomaly in the financial world, result from Japanese central bank monetary policy, which has, Richard Jerram, the Macquarie economist, said, “defied orthodox economic thinking for more than 20 years”

— The ploy involves borrowing yen and immediately selling them for a currency that is either itself a higher-yield instrument (eg, the New Zealand dollar) because of the interest rates in the other country, or using them to buy higher-yield or higher-risk instruments (eg, Turkish stocks). Because it combines risks of high leverage with risks inherent in a higher-yield asset class, the carry trade is highly sensitive to foreign exchange moves and liquidity fears

— Japanese individuals, after unhappily watching their stock market languish for years and their post office savings earning virtually nothing, were eager adopters of the yen carry trade. Online forex brokerage houses offered huge leverage opportunities and many Japanese leapt on the bandwagon

— Hedge funds and corporations conduct a bigger form of the trade. Central banks see the carry trade as a culprit in global mispricing of risk

Today's market news: Very briefly, the Fed agrees to backstop another huge chunk of toxic mortgage-back debt with US Treasuries -- keep digging yourselves [and the US economy] deeper, boys. Banks and Financial Bulls snort the latest lines of free Fed-supplied coke and go on a small rampage. Let's see how long this latest binge lasts - I'm guessing "not very", and that the hangover will prove quite severe.


And on humorous note to end the shortened week of turbulence in markets:

Uncle Sam Calls on Ditech: Last weekend, on his way home after being turned down at The Money Store and laughed out of the Washington, D.C. Payday Loan Center, Treasury Secretary Henry Paulson happened to notice a billboard displaying an ad for Ditech...

[ewmayer]

U.S. Existing Home Sales Unexpectedly Climb; Prices Drop Most in 40 Years - Looks like some bargain hunting going on

In the wake of this morning's news that JP Morgan raised its bid price for Bear Stearns from the Federal-Reserve-mandated [note: the question of "whether this came under their mandate at all" is addressed in the first-linked article below] $2 fire-sale price to $10 to quell shareholder outrage and the likelihood of a coordinated attempt to block the sale at the earlier price, 2 related articles:

John Hussman: Why is Bear Stearns Trading at $6 Instead of $2?

Bear Stearns is trading at $6 instead of $2 because unelected bureaucrats went beyond their legal mandates, delivered a windfall to a single private company at public expense, entered agreements that violate the public trust, and created a situation where even if the bureaucratic malfeasance stands, the shareholders of Bear Stearns will either reject the deal or be deprived of their right to determine the fate of the company they own. Very simply, Bear Stearns is still in play. Still, when all is said and done, my own impression is that the ultimate value of the stock will not be $2, but exactly zero.

In effect, the Federal Reserve decided last week to overstep its legal boundaries – going beyond providing liquidity to the banking system and attempting to ensure the solvency of a non-bank entity. Specifically, the Fed agreed to provide a $30 billion “non-recourse loan” to J.P. Morgan, secured only by the worst tranche of Bear Stearns' mortgage debt. But the bank – J.P. Morgan – was in no financial trouble. Instead, it was effectively offered a subsidy by the Fed at public expense. Rick Santelli of CNBC is exactly right. If this is how the U.S. government is going to operate in a democratic, free-market society, “we might as well put a hammer and sickle on the flag.”

The Fed did not act to save a bank, but to enrich one. Congress has the power to appropriate resources for such a deal by the representative will of the people – the Fed does not, even under Depression era banking laws. The “loan” falls outside of Section 13-3 of the Federal Reserve Act, because it is not in fact a loan to either Bear Stearns or J.P. Morgan. Bear Stearns is no longer a business entity under this agreement. And if the fiction that this is a “loan” to J.P. Morgan was true, J.P. Morgan would be obligated to pay it back, period. The only point at which the value of the “collateral” would become an issue would be in the event that J.P. Morgan itself was to fail. No, this is not a loan. It is a put option granted by the Fed to J.P. Morgan on a basket of toxic securities. And it is not legal.

The Fed overstepped and the Treasury overstepped. At the point where unelected bureaucrats pick and choose who to subsidize – who prospers and who perishes – in a free capital market, and use public funds to do it, more is at risk than just $30 billion. Instead, we cross a line, and stumble off a very clear edge down an interminably slippery slope. We speak up now, or forever hold our peace.

Bloomberg.com: JPMorgan Raises Bear Stearns Bid to Woo Shareholders.

JPMorgan Chase & Co. agreed to quadruple its offer for Bear Stearns Cos. in an effort to overcome opposition from shareholders of the crippled securities firm. Bear Stearns stock almost doubled.

The original bid, more than 90 percent lower than the securities firm's market value at the start of the month, drew opposition from shareholders led by U.K. billionaire Joseph Lewis. Dimon met with Bear Stearns employees to seek their support last week.

"Finding a counterbidder is attractive but a lot more difficult," the Sunday Telegraph cited Lewis as saying in a report yesterday. "There are two ways to block the deal: first by a shareholder no vote and second by litigation. We should be able to block the deal by one of these ways."

The Fed adjusted its financial support today, the two firms said. JPMorgan will now be responsible for the first $1 billion of potential losses from the sale of Bear Stearns assets, while the Fed will fund the remaining $29 billion.

Can anyone say "colossally disproportionate assumption of risk?"

[cheesehead]

Originally Posted by ewmayer

Can anyone say "colossally disproportionate assumption of risk?"

Perhaps it's just that they're still bargaining, and the Fed is simply avoiding the classical mistake of raising their bid too fas-- ... wait a minute ... that would be the other... oh -- the shareholders are haggling the Fed out of its boots.

[ewmayer]

Good grief - Just lost the last shred of respect I had for Hillary:

Clinton proposes Greenspan lead foreclosure group

WHITE PLAINS, New York (Reuters) - Former Federal Reserve Chairman Alan Greenspan and other economic experts should determine whether the U.S. government needs to buy up homes to stem the country’s housing crisis, Democratic presidential candidate Hillary Clinton will propose on Monday. Clinton, a presidential candidate and senator from New York, said the Federal Housing Administration should “stand ready” to buy, restructure and resell failed mortgages to strengthen the ailing U.S. economy.

Home prices: Down record 11%: The S&P Case/Shiller Home Price index of 20 key markets shows that home prices plunged 10.7% over the last 12 months, their lowest level since the index launched in 2000.
Be interesting to see if the National Association of Surrealtors can put a positive spin on that one - I've learned never to underestimate their propagandistic creativity. Oh wait, here`s some suitable spin; not from the NAR, but from some good buddies of theirs:

Mike Schenk, senior economist for the Credit Union National Association, says the decline in home prices is a symptom of serious economic problems, but adds that the environment is improving for home buyers.

"Affordability is actually quite high," he said. "This is a pretty good market to consider taking the plunge. And it's going to get better as we go forward."

Repeat after me: "It`s always a great time to buy surreal estate." Then: "Now is an even better time than normal to buy surreal estate." Lastly: "Better times are just around the corner - you don't want to miss this once-in-a-lifetime opportunity to buy surreal estate!!!"


Consumer confidence at 5-year low: The Conference Board, a business-backed research group, said Tuesday that its Consumer Confidence Index plunged to 64.5 in March from a revised 76.4 in February. The March reading was far below the 73 expected by analysts surveyed by Thomson/IFR.
So much "spending our way out of the recession" this time around.


Wall Street May Be Facing up to $460 Billion Credit Losses, Goldman Says[/url]: Wall Street banks, brokerages and hedge funds may report $460 billion in credit losses from the collapse of the subprime mortgage market, or almost four times the amount already disclosed, according to Goldman Sachs Group Inc.
Of course knowing how the folks at Goldman operate, they probablyu figured out a way to cash in big-time on the news before releasing it.


Update on the "Bernanke Panky", a.k.a. taxpayer-on-the-hook-Ponzi-finance front:

Hey, Bernanke: Just say no to banks!: More banks may want help from the Federal Reserve to buy out struggling financials at fire-sale prices. The Fed should show some restraint.
Speaking of restraint, the author of the above article shows admirable restraint in the "More banks may..." phrasing. "Gee, I`m not sure if JP Morgan got a good deal - let`s hold off until we see what the Fed-mandated discount on the next imploded financial institution is...we wouldn't want to be on the hook for more than 3% of their debt ... but 1% sounds nice ... maybe even 0%. No, wait - let's wait for the USGov to *pay* us to buy up Imploded Savings and Trust's assets, while they assume all the toxic liabilities. Brilliant!"

Snarkiness aside, here's an actual quote saying pretty much just that:

Wells Fargo CEO John Stumpf said the financial crisis is presenting the bank with more acquisition opportunities. “I would not be averse to a Fed-assisted transaction,” Stumpf said in a recent interview. “Fixer-uppers don’t bother us.”

...Especially if you can put someone else on the hook for the dirty old "fixer" part and then enjoy the taxpayer-financed "upper".


Pimco's Bill Gross on the Shadow Banking System: NYTimes: What Created This Monster?

By NELSON D. SCHWARTZ and JULIE CRESWELL
Published: March 23, 2008

LIKE Noah building his ark as thunderheads gathered, Bill Gross has spent the last two years anticipating the flood that swamped Bear Stearns about 10 days ago. As manager of the world’s biggest bond fund and custodian of nearly a trillion dollars in assets, Mr. Gross amassed a cash hoard of $50 billion in case trading partners suddenly demanded payment from his firm, Pimco.

And every day for the last three weeks he has convened meetings in a war room in Pimco’s headquarters in Newport Beach, Calif., “to make sure the ark doesn’t have any leaks,” Mr. Gross said. “We come in every day at 3:30 a.m. and leave at 6 p.m. I’m not used to setting my alarm for 2:45 a.m., but these are extraordinary times.”

Even though Mr. Gross, 63, is a market veteran who has lived through the collapse of other banks and brokerage firms, the 1987 stock market crash, and the near meltdown of the Long-Term Capital Management hedge fund a decade ago, he says the current crisis feels different — in both size and significance.

The Federal Reserve not only taken has action unprecedented since the Great Depression — by lending money directly to major investment banks — but also has put taxpayers on the hook for billions of dollars in questionable trades these same bankers made when the good times were rolling.

“Bear Stearns has made it obvious that things have gone too far,” says Mr. Gross, who plans to use some of his cash to bargain-shop. “The investment community has morphed into something beyond banks and something beyond regulation. We call it the shadow banking system.”

It is the private trading of complex instruments that lurk in the financial shadows that worries regulators and Wall Street and that have created stresses in the broader economy. Economic downturns and panics have occurred before, of course. Few, however, have posed such a serious threat to the entire financial system that regulators have responded as if they were confronting a potential epidemic.

As Congress and Republican and Democratic presidential administrations pushed for financial deregulation over the last decade, the biggest banks and brokerage firms created a dizzying array of innovative products that experts now acknowledge are hard to understand and even harder to value.

On Wall Street, of course, what you don’t see can hurt you. In the past decade, there has been an explosion in complex derivative instruments, such as collateralized debt obligations and credit default swaps, which were intended primarily to transfer risk.

These products are virtually hidden from investors, analysts and regulators, even though they have emerged as one of Wall Street’s most outsized profit engines. They don’t trade openly on public exchanges, and financial services firms disclose few details about them.

Used judiciously, derivatives can limit the damage from financial miscues and uncertainty, greasing the wheels of commerce. Used unwisely — when greed and the urge to gamble with borrowed money overtake sensible risk-taking — derivatives can become Wall Street’s version of nitroglycerin.

Bear Stearns’s vast portfolio of these instruments was among the main reasons for the bank’s collapse, but derivatives are buried in the accounts of just about every Wall Street firm, as well as major commercial banks like Citigroup and JPMorgan Chase. What’s more, these exotic investments have been exported all over the globe, causing losses in places as distant from Wall Street as a small Norwegian town north of the Arctic Circle.

With Bear Stearns forced into a sale and the entire financial system still under the threat of further losses, Wall Street executives, regulators and politicians are scrambling to figure out just what went wrong and how it can be fixed.

[Full Article]

Three guesses as to who one of the influential early cheerleaders for unfettered proliferation of the derivatives markets was...

During the late 1990s, Wall Street fought bitterly against any attempt to regulate the emerging derivatives market, recalls Michael Greenberger, a former senior regulator at the Commodity Futures Trading Commission. Although the Long-Term Capital debacle in 1998 alerted regulators and bankers alike to the dangers of big bets with borrowed money, a rescue effort engineered by the Federal Reserve Bank of New York prevented the damage from spreading.

“After that, all was forgotten,” says Mr. Greenberger, now a professor at the University of Maryland. At the same time, derivatives were being praised as a boon that would make the economy more stable.

Speaking in Boca Raton, Fla., in March 1999, Alan Greenspan, then the Fed chairman, told the Futures Industry Association, a Wall Street trade group, that “these instruments enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it.”

...Especially if they know that their outsized risk-taking will be backstopped by the Federal Reserve at U.S. Taxpayer expense: Joe the local Garbage Man would be "able and willing" to make multibillion dollar derivatives bets with access to that kind of rigged game. Wonder what Mr. Greenspan has to say, now that he has the benefit of hindsight:

A representative for Mr. Greenspan said he was preparing to travel and could not comment.

Interestingly, like so much of the financial deregulation now biting the USEconomy in the butt, the key piece of legislation permitting the above was passed not during the current administration - which is not to let them off the hook for their own vast panoply of egregious misdeeds - but during the Clinton years, although Republican senator Phil Gramm originated it:

A milestone in the deregulation effort came in the fall of 2000, when a lame-duck session of Congress passed a little-noticed piece of legislation called the Commodity Futures Modernization Act. The bill effectively kept much of the market for derivatives and other exotic instruments off-limits to agencies that regulate more conventional assets like stocks, bonds and futures contracts.

Supported by Phil Gramm, then a Republican senator from Texas and chairman of the Senate Banking Committee, the legislation was a 262-page amendment to a far larger appropriations bill. It was signed into law by President Bill Clinton that December.

Hmm, wonder what Mr. Gramm is doing these days, and what he has to say about this baby of his, now that he has the benefit of hindsight:

Mr. Gramm, now the vice chairman of UBS, the Swiss investment banking giant, was unavailable for comment. (UBS has recently seen its fortunes hammered by ill-considered derivative investments.)

Now, for some really eye-popping numbers, using last week's Fed intervention to rescue Bear Stearns as a backdrop:

Still others say the primary reason the Fed moved so quickly [to prevent Bear from out-and-out bankruptcy] was to divert an even bigger crisis: a meltdown in an arcane yet huge market known as credit default swaps. Like C.D.O.’s, which few outside of Wall Street had ever heard about before last summer, the credit default swaps market is conducted entirely behind the scenes and is not regulated.

Nonetheless, the market’s growth has exploded exponentially since Long-Term Capital almost went under. Today, the outstanding value of the swaps stands at more than $45.5 trillion, up from $900 billion in 2001. The contracts act like insurance policies designed to cover losses to banks and bondholders when companies fail to pay their debts. It’s a market that also remains largely untested.

While there have been a handful of relatively minor defaults that, in some cases, ended in litigation as participants struggled over contract language and other issues, the market has not had to absorb a bankruptcy of one of its biggest players. Bear Stearns held credit default swap contracts carrying an outstanding value of $2.5 trillion, analysts say.

“The rescue was absolutely all about counterparty risk. If Bear went under, everyone’s solvency was going to be thrown into question. There could have been a systematic run on counterparties in general,” said Meredith Whitney, a bank analyst at Oppenheimer. “It was 100 percent related to credit default swaps.”

[ewmayer]

FDIC adds 140 workers to bank-failure division: WASHINGTON (AP) -- Anticipating a surge in troubled financial institutions, federal regulators will increase by 60% the number of workers who handle bank failures.

NAR chief economist Lawrence Yun adds: "Latest FDIC employment statistics show strong job growth - this is great news for the housing sector!"^*


And just in case you thought your "cash" was safe...

Beware of the "It's just like a Money Market fund, only better!" scam - here's a poster child for this:

Schwab YieldPlus Select (SWYSX)

Check out the last month`s performance, not yet reflected in the YTD return number on the Yahoo page - the message board is also unusually "chatty" for a "safe as cash" type fund. As Mish Shedlock puts it:

Words To Avoid

* High Yield
* Yield Plus
* Structured
* SIV
* VIE
* Enhanced
* "Almost" Like Cash
* Toggle
* Junk
* Vehicle
* Leveraged

Those in or thinking about getting into any product that uses those words may wish to reconsider.

Furthermore, when it comes to funds or products that use the word "Government", make sure the fund invests in genuine government backed securities such as US treasuries or Ginnie Mae securities not agency debt like Fannie Mae or Freddie Mac.

[rogue]

Originally Posted by ewmayer

Good grief - Just lost the last shred of respect I had for Hillary.

Really? Didn't you lose your last shred of respect for Hillary just 80 minutes earlier in this post? I have to wonder how you might have regained some respect for her during that time...

[ewmayer]

Originally Posted by rogue

Really? Didn't you lose your last shred of respect for Hillary just 80 minutes earlier in this post? I have to wonder how you might have regained some respect for her during that time...

You forget that I'm posting from a dual-core machine - that means I was losing my respect in parallel, "multishredded" fashion.

[ewmayer]

Bear Stearns Sale to JPMorgan to Be Probed by Senate

The Bear Stearns arrangement has divided Senate Democratic leaders. While [Senate Majority Leader Harry] Reid says the transaction is unfair to taxpayers, Senator Charles Schumer of New York, the No. 3 Democratic leader, has praised it, calling the Fed's role ``smart'' and ``totally necessary'' to avert a broader meltdown of financial institutions.

The fact that the Fed's intervention was also "totally illegal" appears to not register with Senator Schumer. No coincidence that he's from New York, a large chunk of whose tax revenues and employment depends on being in bed with Big Finance.

Medicare on fast track to fiscal ruin: Social Security funds are also running out

Treasury Secretary Henry Paulson, one of the trustees, warned of a fiscal train wreck unless something is done.

"Without change, rising costs will drive government spending to unprecedented levels, consume nearly all projected federal revenues and threaten America's future prosperity," he said.

Let`s review the facts here: For decades, the U.S. Government has treated the Social Security and Medicare trust funds as giant zero-interest-rate slush funds, "borrowing" tens of billions of dollar a year from each in order to support ever-increasing federal spending and to help paper over gargantuan budget deficits. In other words, spending way beyond their means. Isn`t that just the perfect metaphor for what caused the current economic crisis? Government, Financial institutions and consumers, all playing with huge amounts of borrowed money, hoping no one would wake up and call bullshit on the whole Ponzi scheme at some point.

Around 20 years ago, me and some college buddies were discussing the future of Social Security - most of them thought me an unreasonable pessimist for saying that I had no faith whatsoever that the rampant-spending baby boomers and USGov would leave any crumbs in Social Security for GenXers like myself, which is why I was fully committed to a 100% self-funded retirement portfolio. One of those bets you hate to "win". Of course, the USGov will surely find yet more ways [besides near-zero interest rates on savings and a near-30% tax on interest and short-term dividend income] to punish us non-profligate-spenders ... perhaps a "luxury tax" on large personal retirement accounts, to bail them out of their fiscal misdeeds w.r.to the Social Security trust fund. At this point, I wouldn't put anything past those folks.

Housing Price Update: Check out this enhanced Case-Shiller chart, which gives separate curves for several distinct regional housing markets. That's about as neat a reconvergence-toward-the-historic-mean trend as one could imagine. It also indicates that prices still have a long ways to go down in order to revert to historic, pre-Greenspan-bubble norms. More perspective on the data here.

[cheesehead]

Originally Posted by ewmayer

Good grief - Just lost the last shred of respect I had for Hillary:

Clinton proposes Greenspan lead foreclosure group

Suppose she'd specified that inflation-stopper Paul Volcker (http://en.wikipedia.org/wiki/Paul_Volcker) be chair instead?