Global Financial Crisis (Was: Subprime Meltdown)

[R.D. Silverman]

Originally Posted by ewmayer

<snip, snip>

I strongly suspect that "Undercapitalized" = Insolvent. IndyMac's specialty was the Alt-A or so-called "liar loans", but the rot is spreading into "prime" loans as well - one would expect the subprime and Alt-A-heavy portfolios to be the first to blow, and that is what is happening here. Mish Shedlock predicts that Washington Mutual and Wachovia [among others] will soon find themselves [or better, reveal themselves to be] in a similar state, and has been tracking the dramatic deterioration in one apparently-typical WaMu Alt-A mortgage pool for months to vividly illustrate his point..

An interesting question: Why aren't the senior executives of these (and I am
sure other) companies under indictment for securities fraud?

[cheesehead]

Originally Posted by R.D. Silverman

Why aren't the senior executives of these (and I am sure other) companies under indictment for securities fraud?

Ummm ... because it will take time for the next administration to rehire all those "underperforming" non-conservatives that have been purged from the Justice Department in recent years?

Patience: It was in 1990, over a year after the end of the Reagan administration, that the Wall Street Journal ran an article pointing out that over 500 presidential appointees of the Reagan administration had been indicted for felonies connected to the S&L scandal, whereas only about 50 Carter administration appointees had been similarly indicted for any reason by that time. (There are thousands of presidential appointees, most of whom we never hear about).

[ewmayer]

Fannie, Freddie plunge on rescue report: News that government has begun to consider what to do if mortgage finance giants collapse sends battered shares sharply lower again.

NEW YORK (CNNMoney.com) -- Shares of Fannie Mae and Freddie Mac tumbled again Thursday on a report that government officials have begun planning for a possible collapse of the mortgage finance giants.

The Wall Street Journal reported that Bush administration officials have held talks about what to do in the event the two government-sponsored firms falter.

The government doesn't expect the firms to fail and no rescue plan is imminent, according to the report. But it reported that talks, which it said had previously been part of normal contingency planning, have become more serious recently given the financial woes and downward spiral in their stock prices.

I call bullshit on the "normal contingency planning" bit. They would have us believe that during the eight of the housing bubble in 2003-2006, Fed and Treasury officials would have regular planning meetings about "what to do if Fannie and Freddie became insolvent." Suuuuuuuuuuuuure they did...this may have become part of their contingency planning in the past few months, but it is far from "normal" in any reasonable historic sense, except perhaps in the cold-war-style "A massive Soviet nuclear strike on all of our major cities is part of normal contingency planning" sense.

In addition, William Poole, the former president of the St. Louis Federal Reserve, told Bloomberg in a Thursday report that the companies are already "insolvent."

This is no CNBC loudmouth a la Jim Cramer saying this here - this is a high-ranking (former) Treasury official, moreover one of the few with the balls to question many of the recent Fed actions, including the massive rate cuts, the alphabet soup of unprecedented Fed-created discount lending facilities, and the Fed's ignoring [until very recently] of the effects of its moves on inflation.

Treasury Secretary Henry Paulson tried to allay some of the concerns about the firms Thursday. In testimony to the House Financial Services Committee, he said the firms are "working through this challenging period."

Translation: "OMFG, we are so screwed ... I just want to go home and cry, pleeeeeeease...". [His body language while speaking certainly didn't inspire confidence.]

And earlier this week James Lockhart, director of the Office of Federal Housing Enterprise Oversight, which regulates the two firms, said in an interview with CNBC Tuesday that he believes Fannie and Freddie have done a good job raising adequate capital.

Yeah, how many times have we heard that in the past 6 months? Let's see: Bear Stearns, Citigroup, Lehman, Ambac Financial, Countrywide...

The aforementioned Wall Street Journal article mentions government officials saying they believe that Fannie and Freddie will have an easy time raising more capital should they need it - not they do or anything, wink, wink - but the same WSJ report correctly calls BS on that claim as well:

Fannie and Freddie are trapped in a vicious cycle. The companies will have to raise capital through stock sales, and the multibillion-dollar amounts they have to raise could result in a massive dilution of shareholders' equity. In anticipation, investors have been dumping the shares, driving their prices sharply lower. And the devalued currency of Fannie and Freddie shares means they will have to sell even more shares.

Since retiring from the Fed in March, Poole obviously feels even more free to speak his mind: From a Bloomberg article on the story:

``Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer,'' Poole, 71, who left the Fed in March, said in the interview yesterday.

Poole roiled markets in 2003 when he said the government should consider severing its implied backing of Fannie Mae and Freddie Mac and the companies lack the capital to weather financial market disruptions. In 2006 and 2007 he called for lawmakers to strip Fannie Mae and Freddie Mac of their charters.

Fannie and Freddie's reply to this? A laughable attempt to brush Poole's statements off via a classic rhetorical ruse:

Sharon McHale, a spokeswoman for Freddie Mac counters with "Poole is a long-time critic".

...Which doesn't make him wrong, Sharon - although I'm sure that's what you're hoping the listener will infer from your statement.


Make no mistake, this not merely an issue of "technical insolvency" [as many of the media article are describing it], this is huge, if for no other reason [and there are in fact plenty of such] that loss of investor confidence will make it nigh-impossible for Fannie and Freddie to raise desperately needed capital.

It now seems increasingly clear that is not one or two [or even a dozen] large investment banks failing that is the linchpin of the U.S. economic crisis - it's the fate of the massive government-chartered mortgage companies.


p.s. to Bob's query in post #331: My answer would be "Because the SEC has fallen down on its job every bit as badly as the Greenspan-led Fed did with respect to out-of-control mortgage lending".

[ewmayer]

Nice catch by New York Times chief financial correspondent Floyd Norris:

Whistling Past the Graveyard

It is natural for a government official to look for signs that things are getting better. So we should not be surprised that Treasury Secretary Henry Paulson pointed yesterday to the few signs there are of improvement in the housing market.

I’ve done my share of looking for signs of such improvement. At some point there has to be a bottom, but it is not easy to find evidence that the housing market is improving. One statistic he cited particularly struck me as whistling past the graveyard:

“We are working through the excess new home inventory – the inventory of new single family homes is down 21 percent from its 2006 peak.”

Well, actually that is not the way it looks to homebuilders. The statistic he relied upon includes new homes that builders are offering for sale even though construction has not even begun. Those homes are typically in new subdivisions, and there are not very many of them these days. The number of unstarted new homes being offered is down 36 percent since June 2006, the month the overall figure he points to hit its peak. Part of that decline came because builders dropped plans to build, not because buyers appeared.

...

The inventory of new homes that have been completed and are available for sale is up 35 percent. In June 2006, there were 135,000 such homes. This May, the latest figure available, there were 182,000 such homes.

And the median age of those completed but unsold homes has gone up 136 percent over that period, from 3.6 months to 8.5 months. That later figure is the highest since the government started keeping that statistic. Some of those homes are in subdivisions where foreclosures are already climbing, and may be hard to unload at any price.

Classic - magically transmogrifying "plummeting new home starts due to housing market implosion" into "decline in excess inventory of fictitious new homes is a positive sign!!!" I`d speculate that perhaps Paulson is angling for a job as head "economist" [a.k.a. "chief propagandist"] for the NAR, except that the $700M he has stashed away from his days as the head of Goldman Sachs makes it unnecessary for him to work for wages ever again. Heading the U.S. Treasury wasn`t about the money [a relative pittance, especially for an ex-GS employee - even the rank and file there make a million a year, give or take], it was just that the position was one of much-too-high-visibility for someone like him to pass up.

[ewmayer]

Are “Dark Pools” Destined to be the Capital Markets’ Next Black Hole?

...Dark Pools are electronic "crossing networks" that offer institutional investors many of the same benefits associated with making trades on the stock exchanges’ public limit order books - without tipping their hands to others, meaning publicly quoted prices aren’t affected. This is the capital markets’ version of a godsend - especially for traders who desire to move large blocks of shares without the public investors ever knowing.

Some examples of so-called crossing networks include Liquidnet Inc., Pipeline, the Posit unit of Investment Technology Group (ITG), or the SIGMA X unit of Goldman Sachs Group Inc. (GS).

In an era in which "secret" transactions contributed to what’s shaping up to be the largest credit crisis in history, you’d think that any mechanism that allows insiders to trade in complete secrecy and with total anonymity would be scrutinized more closely than a Roger Clemens vitamin shot. But that’s not the case with Dark Pools.

As has long been the case, the old boys really do like to operate behind closed doors, on the other side of the "velvet rope" - beyond which the un-anointed daily working stiff may never pass. And Dark-Pool operators are only getting more private as computerized trading becomes more sophisticated and large-scale-order placement evolves into a science all to itself.

Dark Pool ownership involves almost the entire institutional-trading sector, consisting of independents, broker/dealer-owned pools, consortiums and even - as hard as this is to imagine, given the public’s trust - the stock exchanges themselves (See accompanying chart).

And business is booming.

According to the latest data, nearly 12% of daily U.S. stock-trading volume is presently conducted via the 40 or so Dark Pools operated by the "usual suspects."

According to The Wall Street Journal, Credit Suisse Group AG (ADR: CS) is assembling a network of 30 Dark Pool partners, while JP Morgan Chase & Co. (JPM) is trying to become the Google Inc. (GOOG) of the Dark Pool world by aligning itself with Neovest Inc. Not to be left out, Goldman Sachs recently struck reciprocal deals with rivals UBS AG (UBS) and Morgan Stanley (MS) to allow previously proprietary trading algorithms to work on each other’s desktop trading systems.

This is something the stock exchanges don’t want to see because it strips them of order execution revenue. Which is why they’re getting into the game, too. At the present time, the Nasdaq (NDAQ) alone shunts some 18% of its volume - or roughly 350 million shares a day - through what insiders euphemistically refer to as its "non-displayed platforms," and also has struck a deal with five unnamed Dark Pool operators that are rumored to route nearly half of the total Dark-Pool volume in the United States today.

NYSE Euronext (NYX) plans to connect up to 30 such pools, so don’t think for a New York minute that this isn’t a global phenomenon - Dark Pools exist all around the globe.

We’re still in the early days of this movement. That means there are still lots of things to be worked out from a technical standpoint. For instance, there’s very little in the way of proprietary software that enables any Dark Pool operators to "talk" with their competition.

But we think that’s going to change in a real hurry in the next few years, when as much as 50% of all U.S. trading volume will be handled by "Dark Pool Alliances."
[Full article]

[ewmayer]

Prophets of the credit crisis: A trio of economists are talking to packed houses about the grim future of Fannie Mae and Freddie Mac, the causes of the credit crisis, and the failings of ratings agencies.

Among the gems tossed out to the crowd: "People say we're in the final innings of the credit crisis," said Rosner. "We're in the late innings of the first game, and this is the World Series."

Raynes, Rosner, and Whalen weren't always so popular. Since 2005 they have been telling anyone who would listen that banks don't generate real returns, Fannie Mae and Freddie Mac will crumble, and rating agencies aren't equipped to evaluate structured bonds. Like many an alternative act, they were ahead of their time. "People said it was easy for us to scream, because we had nothing to lose," says Raynes. "Of course, it should have been much easier for [rating agencies and risk committees] to scream, because they had everything to lose."

Cruelest summer for teen jobs since 1958: June employment for teenagers drops nearly 40% below 2007 levels as companies cut extra positions. Summer hiring for teens at lowest pace in 50 years.

According to an analysis of U.S. Bureau of Labor Statistics data by global outplacement consultant Challenger, Gray & Christmas, teen employment grew by only 683,000 jobs in June, 38.7% below the 1.1 million new positions that teens were able to fill in June of last year.

I find it interesting that the above is *based* on BLS data, but strangely, I didn't see any official BLS press releases announcing this rather-big news: rather, it was an independent firm which did the analysis and publication. But let's move on:

Teen employment also fell in the most recent recessions of 2001 and 1991, but the drop was not nearly as pronounced, noted Challenger.

"This is pretty drastic," [C,G&C CEO John] Challenger said. "You don't see drops like this too often unless the economy is in a recession."

Hiring Teens = the job-market analog of "consumer discretionary spending". Both are among the first things to go by the wayside in a serious economic crunch.


How Capitalism Committed Suicide: Very funny commentary piece by Bloomberg's Mark Gilbert:

Granddad, Tell How Capitalism Committed Suicide

July 10 (Bloomberg) -- ``Granddad Benny, is it true that capitalism committed suicide?''

Granddad looked up from the fire he was stoking with bundles of 2006 and 2007 vintage mortgage-backed bonds. ``In a way, Joel, yes. In developed countries, people got too greedy, especially bankers, and everyone borrowed too much. In less developed countries, people racing to improve their living standards reawakened the slumbering inflation monster.''

Joel put down the stick he was using to scratch the dirt. ``Why did the Gigantic Global Bubble Burst of 2008 catch people unawares? Weren't there any warning signs, Granddad?'' [More]

Moron of the Week: Republican Presidential Nominee John McCain

McCain Says Fannie, Freddie `Vital,' Must Not Fail

Senator John McCain, the presumptive Republican presidential nominee, said the federal government can't allow [the 2 GSEs] to fail.

Fannie Mae and Freddie Mac ``are vital to Americans' ability to own their own homes,'' McCain said in response to a reporter's question during a campaign stop at a diner in Livonia, Michigan. ``They will not fail; we cannot allow them to fail.''

"We'll bail them out at taxpayer expense, thus leading to a Weimar-like currency debasement and wrecking of the country's credit rating, if it takes as long as it would take me to end the war in Iraq..."

As if no Americans other than the ultrawealthy owned homes before the GSEs were created ... what a load of hogwash. In fact, before the government decided to get into the mortgage business, a much higher percentage of Americans actually *owned* their homes [as opposed to living in what amounts to an expensive rental with a massive debt servicing obligation], and house prices were much more affordable relative to people's wages than they are today. Of course, John could perhaps be forgiven his ignorance of such basic economic facts due to his having married money, in the form of that Stepford-wife beer heiress wife of his (although I give her credit for her philanthropic activity), and likely never having to deal with messy stuff like "can I afford this house on my salary?" like ordinary folks do.

White House spokesman Tony Fratto said today that the ``biggest thing we can do'' to help Fannie Mae and Freddie Mac is to pass legislation now in Congress that boosts oversight of the two companies.

As if "more oversight" is going to magically stem the deterioration of their loan portfolios.

[cheesehead]

Originally Posted by ewmayer

As if "more oversight" is going to magically stem the deterioration of their loan portfolios.

But isn't it refreshing to see the ongoing admissions by a conservative administration that liberals have good ideas, too? (E.g., negotiations in the Middle and Far Easts)

Too bad it's happening at the tail end of one of Schlesinger's "private interest" 30-year cycles (http://www.mersenneforum.org/showpos...&postcount=223). Here's a project for moderates: figure out how to educate future (30 years from now) conservatives to respect good ideas from liberals, and how to convince liberals, until then, not to dismiss good ideas from conservatives. What I fear is that the leftist backlash from this Bush administration's rightist extremes will push the pendulum so far to the left as to provoke a powerful rightist backlash three decades from now. (Yes, I recall that Schlesinger's "public purpose"/"private interest" don't equate to "liberal"/"conservative". By "leftist", I'm referring to liberal positions/ideas that go beyond "public purpose", and by "rightist" I mean conservative positions/ideas that go beyond "private interest". I need to work to make my wording more precise here.)

What I want to see is educating both extremes that, during their ascendancies, compromising with the opposition can ensure a longer lifetime for the policies they want, by minimizing future backlash. Sure, that's wishful thinking -- but moderates armed with modern analyses such as the cognitive science that led to George Lakoff's book Moral Politics could accomplish a great deal when not shackled by the older, traditional, inaccurate ideas about people that constrain so much political debate into certain ruts.

[ewmayer]

Alas, the latest news is not good:

Spain Economy Implodes | UK in "Flagrant Breach Of EU Spending Rules"

[Spanish] Government officials have been shocked by the intensity of the downturn now engulfing the country. Car sales fell 31pc in June, industrial production has fallen 5.5pc over the past year and the collapsing property sector is shedding almost 100,000 jobs a month.

Miguel Sebastian, the industry minister, said the economy had ground to a halt in the second quarter and was now in "virtual recession".

WTF is a "virtual recession"? Is that like the bullshit it`s-not-really-real-unless-we-say-so euphemisms used by U.S. government officials, such as "expectations of inflation" and "recessionary trends"?

European Union finance ministers have voted to condemn Britain for flagrant breach of the Maastricht spending rules, irked that the UK government has not even tried to keep its budget deficit below the treaty limit of 3pc of national income.

By its own admission, Labour will need to borrow at least 3.2pc of GDP this year, even if the economy holds up well. Brussels described this as "prima facie evidence of a planned excessive deficit". It warned that UK public finances were no longer on a sustainable course after the spending blitz of recent years.

Yesterday's vote is the first time the EU has launched disciplinary action against a big Western state under the revamped Growth and Stability Pact. While France and Germany both violated the old pact, they did so at the bottom of the dotcom mini-slump.

Britain's sins are more serious. The breach has occurred at the top of the cycle when tax revenues should be at their peak. Brussels said there had been a "deterioration of the structural balance of 4.5pc of GDP" since 1999. Brussels said Britain did not qualify under the "exceptional" circumstances clause.

The UK now has the worst fiscal profile of any developed country in the North Atlantic sphere.

If the U.S. were bound by similar rules and honestly reported in national debt [rather than playing social-security-trust-fund and similar shell games with it], it would find itself in a similar embarrassment

[xilman]

Originally Posted by ewmayer

If the U.S. were bound by similar rules and honestly reported in national debt [rather than playing social-security-trust-fund and similar shell games with it], it would find itself in a similar embarrassment

The EU is especially irked because the UK can only (formally) be admonished for breaking spending rules up to which the country hasn't signed.

This observation, of course, neither adds nor takes away anything from the UK's economic position.

Paul

[ewmayer]

Paul, care to give us a man-on-the-street-eye view of how things are in the UK on various economic fronts? [E.g. Housing, jobs, consumer spending, national mood].

[ewmayer]

Originally Posted by ewmayer

AP | IndyMac stops new loans, to cut work force by half

I strongly suspect that "Undercapitalized" = Insolvent.

Well, that wasn't long in coming:

IndyMac Seized by U.S. Regulators Amid Cash Crunch

July 11 (Bloomberg) -- IndyMac Bancorp Inc. became the second-biggest federally insured financial company to be seized by U.S. regulators after a run by depositors left the California mortgage lender short on cash.

The Federal Deposit Insurance Corp. will run a successor institution, IndyMac Federal Bank, starting next week, the Office of Thrift Supervision said in an e-mailed statement today. Customers will have access to funds this weekend via automated teller machines. Regulators intend to eventually sell the company.

The Pasadena, California-based lender specialized in so-called Alt-A mortgages, which didn't require borrowers to provide documentation on their incomes. IndyMac's home state, where Countrywide Financial Corp. was also located before it was bought last week, has been among the hardest hit by foreclosures.

``Given their focus on Alt-A and a heavy concentration in California, they would have suffered meaningful losses in almost any scenario,'' Brian Horey, president of Aurelian Management LLC in New York, said before the seizure was announced. Aurelian is short-selling IndyMac shares to gain from declines.

Had IndyMac ``applied some common sense and changed their approach to underwriting as the housing market peaked, they might have lived to see the next cycle,'' Horey said.

IndyMac came under fire last month from U.S. Senator Charles Schumer, who said lax lending standards and deposits purchased from third parties left it on the brink of failure. In the 11 business days after Schumer explained his concerns in a June 26 letter, depositors withdrew more than $1.3 billion, the OTS said.

Liquidity Crisis

``This institution failed due to a liquidity crisis,'' OTS Director John Reich said in the statement. ``Although this institution was already in distress, I am troubled by any interference in the regulatory process.''

Again, a so-called expert confuses solvency with liquidity. IndyMac made huge bets which went bad, became insolvent [not by itself fatal], and eroding confidence in its ability to raise cash and weather the storm led to a classic bank run, turning a technical insolvency into a factual one. "Liquidity crisis" in this context is at best a sloppy catch-all term for the loss of confidence by investors and depositors. If Reich is in fact referring to IndyMac's failure to continue generating a sufficient volume of lending business, that is also off-base, because it seems all of the bank's lending business of late was only serving to dig itself deeper into the insolvency hole. Similar thing as happened to Bear Stearns, although the institutions were technically of different types [Bear = investment bank, a.k.a. "broker/dealer", not under the FDIC umbrella].