bizzXceleration: Performance, Value and Profit

Credit Markets

The Roots of the Mortgage_Crisis  On Aug. 9, 2007, and the days immediately following, financial markets in much of the world seized up. Virtually overnight the seemingly insatiable desire for financial risk came to an abrupt halt as the price of risk unexpectedly surged. Interest rates on a wide range of asset classes, especially interbank lending, asset-backed commercial paper and junk bonds, rose sharply relative to riskless U.S. Treasury securities. Over the past five years, risk had become increasingly underpriced as market euphoria, fostered by an unprecedented global growth rate, gained cumulative traction. The crisis was thus an accident waiting to happen. If it had not been triggered by the mispricing of securitized subprime mortgages, it would have been produced by eruptions in some other market. As I have noted elsewhere, history has not dealt kindly with protracted periods of low risk premiums. Although central banks appear to have lost control of longer term interest rates, they continue to be dominant in the markets for assets with shorter maturities, where money and near monies are created. Thus central banks retain their ability to contain pressures on the prices of goods and services, that is, on the conventional measures of inflation. The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end. That will stabilize the now-uncertain value of the home equity that acts as a buffer for all home mortgages, but most importantly for those held as collateral for residential mortgage-backed securities. Very large losses will, no doubt, be taken as a consequence of the crisis. But after a period of protracted adjustment, the U.S. economy, and the world economy more generally, will be able to get back to business.

Greenspan's entire editorial is HERE. It's very short, well-written, compresses a lot into little space and largely accurate IMHO. Close as a must read as anything there is right now. 

Money-Market Strain May Be Slow to Fade Strains in money markets may be slow to fade and some emerging-market assets may face stiffer headwinds, the Bank for International Settlements warned in its quarterly report. The report, released yesterday, said that money-market concerns "were particularly acute with respect to the expected liquidity situation around the turn of the year -- a period when liquidity demand normally tends to be heightened and markets particularly vulnerable to illiquidity." The Switzerland-based organization warned that spreads between key short-term interest rates are "consistent with investors anticipating tensions to remain high in money markets for an extended period of time." It also warned that while emerging-markets stocks have been robust over recent months that may not continue. Money markets were hit hard in August as the subprime-mortgage market fallout spilled over into a credit crunch that affected a broad swath of financial markets. Rising short-term borrowing rates and the evaporation of liquidity forced central banks to act to alleviate the strains.

Loan Mess Rivals S&L Meltdown The U.S. mortgage crisis looks manageable compared with the savings-and-loan crisis of the 1980s, but its economic toll could linger for years. The home has long been the bedrock asset of most American families. Now, its value has become the biggest question mark hanging over the global economy and financial system. Over the past decade, Wall Street built a market for more than $2 trillion in securities sold globally and backed by loans to U.S. homeowners on two long-accepted beliefs and one newer one. The prevailing logic: The value of the American home would never fall nationwide, and people would almost always make their mortgage payments. The more recent twist: Packaging mortgage loans and turning them into securities would make the global economy more resilient if anything went wrong. In a matter of months, though, much of the promise of the new financial architecture -- together with its underlying assumptions -- has proven to be a mirage. As house prices fall and homeowners default on mortgages at troubling rates, the pain has spread far and wide. An examination of the resulting crisis shows that it is comparable to some of the biggest financial disasters of the past half-century. So far, the potential losses look manageable compared with the savings-and-loan crisis of the 1980s and the tech-stock crash of 2000-02. But the housing debacle could yet take years to work out, thanks to the sheer complexity of it. Until the mess is cleaned up, investors will remain jittery and banks will likely hold back on all kinds of lending -- a credit crunch that is already damping global growth and could tip the U.S. economy into recession. The new financial system -- shifting risk from banks to securities markets -- has worked "pretty well" up until now, says former Federal Reserve Chairman Paul Volcker. "We're going to find out if it works well for a major-league crisis." Veteran financiers see in the current episode a pattern consistent with classic financial manias: Investors' enthusiasm for an asset -- in this case U.S. houses -- drove up prices, attracted more capital and lifted prices to levels that preordained a fall. Home prices rose sharply elsewhere, too, including in the United Kingdom, parts of continental Europe and Australia. "Old fogies like me expected the bust to come earlier than it did," says George Soros, the 77-year-old chairman of Soros Fund Management. "A lot of us got tired waiting for it."  Charts: Genesis of a Crisis

• Interview Excerpts: Volcker, Soros Weigh In

UBS's Subprime Hit Deepens Credit Worries UBS AG became one of the biggest casualties of the U.S. subprime-mortgage meltdown yesterday, announcing that it would take a $10 billion write-down and sell a chunk of itself to the government investment arm of Singapore and an unnamed Middle Eastern investor. The disclosures stoked anxiety about potential losses lurking on the books of other banks. That UBS, long known as a conservative lender, could take such a financial hit suggests that the wave of industry write-downs, which so far total about $50 billion, may be far from over. In recent weeks, UBS began using a more conservative method for valuing complex debt securities tied to U.S. subprime mortgages. As a result, the bank said it might record a net loss for the year. The "ultimate value of our subprime holdings...remains unknowable," the bank said yesterday. Earlier this fall, as banks disclosed a first round of write-downs due to subprime problems, some investors expressed optimism that the worst was over -- that banks had used the third quarter as an opportunity to clean up their balance sheets. But the continuing erosion of the value of the mortgage securities now appears to be bringing another round of pain.

·         Expect More Like UBS When UBS announced a $3.4 billion loss related to subprime mortgages in October, investors believed the Swiss bank had thrown in everything and the kitchen sink. It turned out to be only the first phase of the remodeling. Other banks almost certainly are going to be cooking up similarly bad news.

·         Wachovia May Double to $1 Billion Quarterly Provision for Mortgage Losses

• Banks Sound Grim Notes  Bank of America said it expects a fourth-quarter provision expense of $3.3 billion, forecast larger write-downs on CDOs and said its fourth quarter will be profitable but "disappointing." Wachovia also warned of more market-related losses. Bank of America to Write Down CDOs' Value by About $3 Billion

Readings & Resources

Bill Fleckstein and others (Nouriel Roubini) have been waving their  arms about the emerging credit crisis and the structural problems entailed for some time now, for nearly a year or more in fact. Meanwhile the smarter banks, et.al. started digging into the risk management problems at the end of last year, e.g. Goldman which convened a major risk assessment and strategic management evaluation at this time last year. Others, such as Wilbur Ross, were re-positioning themselves early as well. Meanwhile Merrill, Citigroup, et.al. were  BUYING into the bubble – after all you gotta keep dancing. Below are a few selected readings that have helped me build up my picture of what’s going on, from some of the folks who’s views I respect because they make sense and have proven right – time after time after time. It may be time to pay more attention to them ! J

Bill Gross of PIMCO has been sounding the appropriate alarms for some time:

• 02/07 Ten Little Assets, 06/07 Looking for Contagion in All the Wrong Places,10/07 Shadow Dancing, 12/07 The Shadow Knows

Similarly Jim Jubak has also been running a string of things to read to get some insights:

• Debt-market bomb could hurt us all  (2/23/07), Drowning in cheap money ( 3/6/2007), Why the debt bubble hasn't burst -- yet (3/23/2007 ), Deepening debt crisis hits close to home (6/29/2007), The threat to your money-market fund (9/14/2007), Fed, Wall Street are playing chicken (11/30/2007)

Another of my favorite columnists who’s also picked up the ball with several power posts that take you even deeper into the crisis is Jon Markman, a colleague of Jubak’s at MSN Money:

• Are we headed for an epic bear market? (9/20/2007), What the big banks aren't telling you -- yet (9/14/2007)
• Homeowner bailout is a lousy idea (12/6/2007),Big rally doesn't mean all is well (11/29/2007),Getting rich off the subprime mess (11/27/2007), For an elite few, credit pain means profit (11/15/2007)