Told Ya So: Reality Meets Denials with Ben and Spitzer
Love some of the headlines today. Especially the ones on Prof Ben's testimony from Marketwatch and Fortune. You've really got to be kidding - the Oct. Fed notes, which we excerpted here pretty well laid it out almost four months ago. And there have plenty of folks doing first rate truth telling since, e.g. Paul Kasriel. We'll even include ourselves in that a bit (check the Economy archives, to much to re-link). But really - not just in the spirit of "told ya so" but also in trying to measure the gap between realities and what the pundits, MSM and the Street would like to believe, which is huge - will point everyone back at the last two day's posts that focus on the contrast. The one between what's going on and what's being said - you know that one.
In the midst of all the drop in the market as they're told that not only has the punch bowl been taken but it was taken months ago you likely missed some other news which should be much more scary. Which is a whole slew of stuff on the metastisizing of the credit cancers to whole other markets. And with NY's testimony on breaking up the bond insurers bet they're sorry to have turned down Warren; but not as sorry as their stockholders. Does the phrase "gun to their heads" mean anything to you ? That's not where it's really at but let's pretend to politeness.
Below the line, continuing the spirit and letter of schadenfreude, you'll find a few stories on the economy, especially real retails sales (HT - TheBigPicture) and a whole slew on the credit problems. Did you ever see the movie Outbreak with Dusin Hoffman and Morgan Freeman - about the spread of Ebola ? Remember the maps that showed how quickly it could spread ? Well, guess what...
We'll put up two of the top stories (& hope you find the Fortune/Marketwatch headlines as hysterical as we do; note that's hysterical not hysterically funny) and let the rest speak for itself:
Bernanke Signals Fed May Reduce Rates Again as Economy Continues to Weaken Federal Reserve Chairman Ben S. Bernanke indicated that policy makers are prepared to lower interest rates further as the economy continues to deteriorate. The Fed ``will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks,'' Bernanke told the Senate Banking Committee in Washington today. ``A significant worsening in financial conditions or in credit availability would certainly be a warning bell that we need to take further action.'' Fed officials have lowered their forecasts for economic growth after the U.S. lost jobs in January and consumer spending was threatened by falling home and stock values and rising energy costs, Bernanke said. Traders anticipate the central bank will cut rates a further half-point by March 18 after 2.25 percentage points of reductions since September. Bernanke appeared at the hearing with Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox, the first time the heads of the three agencies testified together on the economy at the panel since the aftermath of the Sept. 11, 2001, terrorist attacks.
· Heartbroken over economic woes (Fortune/CNN)
· Now Bernanke's telling us (Marketwatch)
Bond insurers have days to re-capitalize, Spitzer says Bond insurers have four to five business days to re-capitalize themselves enough to keep their crucial AAA credit ratings, New York Governor Eliot Spitzer said during a Congressional hearing on the $2.4 trillion industry on Thursday. If that doesn't happen, regulators will have to step in and separate bond insurers' municipal businesses from their more troubled structured finance units. "We will need to move in that direction. It is not our first choice but time is short," Spitzer said. "In the next for or five bus days we would like to see a resolution," Spitzer added. "It's time for deals to get done."
Credit Markets & Investing
Credit Woes May Widen A widening array of financial-market problems threatens to trigger a new phase in the global credit crunch, extending it beyond the risky mortgages that have cost banks and investors more than $100 billion in losses and helped push the U.S. economy toward recession. In the past few days, low-rated corporate loans -- the kind that fueled the buyout boom of recent years -- have plummeted in value. As a result, banks are expected to try to unload some of those loans this week at fire-sale prices. Nervous buyers also have retreated in recent days from the market for securities backed by student loans and municipal bonds, roiling some corners of the short-term money markets. Similarly, investors have recoiled from debt backed by commercial real estate, such as office buildings.
- Back to Business: Pimcos co-chief investment officer Mohamed El-Erian is back to business, reports CNBCs Michelle Caruso-Cabrera
Solvency Worries Stalk Credit-Derivatives Market Counterparty risk isn't a new concept, and there are mechanisms in place to mitigate the hazards of a trade failing because one side is unable to meet its obligation. In the interest-rate futures market, in particular, collateral agreements mean you don't let the other guy owe you too much without booking some of the profit ahead of time. The issue gains added urgency, though, as liquidity concerns mature into deeper worries about solvency. This isn't scaremongering. The damage now inflicted by U.S. bond insurers, known as monolines, shows the increased danger of owning a security that relies for its well-being on a single firm, however well-capitalized it may seem and however high its credit rating. The correct number of banks to go bust in the current environment isn't zero. Which means you might think twice before buying a credit-default swap from, say, a small Spanish bank with a ton of real-estate loans, or a minor Japanese securities firm with a shrinking capital base. Who you trade with is becoming as important as which instruments you buy and sell.
Crisis Moves Into 'Auction' Bonds Auction-rate securities -- an unusual type of long-term bond that behaves like a short-term bond -- have become a keystone of modern finance. They are routinely used to fund everything from college student-loan programs to municipal road-and-bridge projects. These bonds became popular with investors looking for cashlike investments, because they offered better returns than traditional money-market investments but were just as easy to buy and sell. Recently, however, that advantage has disappeared. The market for auction-rate securities has dried up amid fears about fallout from the subprime-mortgage crisis. This week, New York's Port Authority saw the interest rate on some of its debt jump to 20% from 4.2% amid disruptions in this market.
Ahead of Tape: Frozen Corners Thaw Last year, the problems centered on structured investment vehicles and conduits, off-the-books vending machines that spat out short-term commercial paper backed by mortgages and other longer-term debts. When investors got jittery about the value of mortgages, they stopped wanting to buy the short-term paper, no matter what kind of debts were backing them. Suddenly, the vending machines became dead weights around the necks of their backers. Some guy can't pay his mortgage, and the next thing you know Citigroup needs to raise cash. Who knew? Now, problems are bubbling in two other backwaters of the credit markets, auction-rate securities and tender-option bonds. Like SIVs and conduits, these financing vehicles issue supposedly safe short-term securities that are meant to appeal to the most conservative investors. But the credit-risk panic has shaken faith in those assets, as well, and suddenly your daughter can't get a student loan in Michigan. Once again, who knew? If this is truly a repeat of the credit-market dislocations in August and November of last year, then there's a risk these troubles will flare and spread again, once more seizing up the broader credit market. That would mean the credit calm that settled in around the turn of the year, thanks to huge injections of cash into markets by the Federal Reserve and other central bankers, was a massive head fake.
Heard on the Street: Woes Hit Tender Spot When the credit crisis began in August, shareholders were surprised to learn that some banks were potentially on the hook to provide billions of dollars in assistance to little-known entities called structured investment vehicles and conduits. Now, vehicles that issue short-term debt to fund purchases of municipal bonds and student loans are coming under pressure. If things get really bad, that could cause banks to shift more assets onto their books at a time when balance sheets are already under considerable stress because of the mortgage mess and sluggish economy. It is hard to tell how much the gridlock in the market for municipal and student-loan-backed instruments might affect banks, partly because the problems have emerged only in the past several days. It is unlikely that banks would face as much peril as they did from SIVs, which invested in far riskier assets such as subprime mortgages. Still, the mere possibility banks could be forced to absorb additional assets shows that off-balance-sheet activities continue to pose substantial risks for bank investors.
Buffett Bids to Assume Municipal Liabilities of Insurers MBIA, Ambac, FGIC Billionaire investor Warren Buffett said he offered to assume responsibility for $800 billion of municipal bonds guaranteed by MBIA Inc., Ambac Financial Group Inc. and FGIC Corp. Buffett's Omaha, Nebraska-based Berkshire Hathaway Inc. would provide so-called reinsurance for the debt, he said in an interview with CNBC television. The offer excludes the bond insurers' subprime-related obligations. One company has already rebuffed the proposal and the two others haven't responded, Buffett said in the interview. Berkshire Hathaway, which gets about half its earnings from insurance, is looking to make money in the municipal guaranty business that provided MBIA, Ambac and FGIC with 14 years of uninterrupted profit until last year. The three companies are on the verge of losing their AAA credit ratings that would cripple their sales to municipalities after losing $5 billion from insuring mortgage-related securities. ``The Buffett plan basically cherry picks out the only worthwhile parts of the portfolio,'' said David Havens, a credit analyst at UBS AG in Stamford, Connecticut. ``It leaves them with a terrible mix of business.''
Buffett Plan Saves Muni Market, Dooms Ambac, MBIA Yesterday, Buffett, whose Berkshire Hathaway Inc. entered the field late last year, told CNBC that he had offered to take all the municipal-bond business, some $800 billion worth, off the three major, imperiled financial guarantors' hands. The firms -- MBIA Inc., Ambac Financial Group Inc. and FGIC Corp. -- would have to pay Berkshire Hathaway billions of dollars to take over their municipal bond risk. They would be left with the stuff that got them into trouble in the first place: mortgage-backed securities, collateralized debt obligations, credit default swaps and all the rest of it. In other words, the insurers would give up all their future, in the form of the unearned premiums they have yet to draw down on the municipal bonds they have insured, and be left with all their bad, recent past. And, of course, they would have to pay for the privilege. What you think of this proposal depends upon where you sit. If you participate in the municipal bond market as an issuer, an investor, or an underwriter, Buffett is a savior. If you are one of the bond insurers or their stockholders -- and Buffett said one of the companies had already rejected his offer -- the deal is beneath contempt. The Buffett plan saves the municipal bond market, in general and in particular. And when the waters get too high, as they might (Buffett basically called the insurers' subprime liabilities unquantifiable), and if the insurers are downgraded, then their problem becomes the banks' problem. Here comes another round of losses and writedowns.
New York's Dinallo Says He Is Considering Splitting Bond Insurers in Two Bond insurers may be split into two businesses in what would be the biggest overhaul of the industry since it was created almost four decades ago. New York Insurance Department Superintendent Eric Dinallo said such a separation is one of the proposals regulators have been discussing with bond insurers, including MBIA Inc. and Ambac Financial Group Inc. Spitzer told the committee that the economy may face a ``financial tsunami'' as a result of potential downgrades to bond insurers and a tightening of credit markets that resulted from bad loans to homebuyers. Federal regulators blocked earlier efforts to tighten rules, and the Office of the Comptroller of the Currency allowed ``the problem to grow and the bubble to inflate,'' Spitzer said. Spitzer and Dinallo both said their focus is on the municipal market rather than banks and financial institutions that sought insurance on structured-finance securities.
Economy: Retail Sales
Retail Sales in U.S. Unexpectedly Climb 0.3% on Spending for Autos, Fuel Retail sales in the U.S. unexpectedly rose in January, easing concern that the world's largest economy has already slipped into a recession. The 0.3 percent increase was led by spending on autos, clothes and gasoline, the Commerce Department said today in Washington. The figure followed a 0.4 percent decrease the previous month. Purchases excluding automobiles and gasoline were unchanged. Excluding autos, gasoline and building materials, the retail group the government uses to calculate gross domestic product figures for consumer spending, sales rose 0.2 percent, after a 0.1 percent decrease the prior month. The government uses data from other sources to calculate the contribution from the three categories excluded.
Retail Sales Show Inflation, Not Growth Not for price changes means that these are nominal -- not inflation adjusted -- numbers. Hence, with Gasoline station sales up 23%, and non-store retailers (home oil delivery) up 10.6%, the surprise gains were all energy/inflation related. I have to wonder about the boost in demand for cars, considering what we have heard from all the auto makers -- they almost across the board announced weaker sales. I don't know what the Commerce department is looking at, but I cannot figure how its a positive sign for the economy. Take the Retail Sales EX Inflation (gasoline, food & beverage) and retail sales were DOWN. Excluding inflation, demand at all other retailers last month were unchanged to negative. Economically, speaking, how bullish is that?
Real Retail Sales Fall to 2003 Levels If we want to see Real Retail Sales, we need to fully adjust for the pernicious effects of inflation. Haver Analytics has done the heavy lifting for us, and as the chart below shows, Real Retail Sales fell to levels not seen in 5 years: This is the first negative Real number this cycle. This, strongly suggests a US recession is either underway or due any month now. And that's using CPI as the inflation adjustment factor. Its well understood amongst