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Markets

The worst may be behind for Wall Street - or not Wall Street puzzles over whether market has hit bottom and what catalyst might trigger rebound. Not long ago, it seemed like the worst was over. As the first quarter wound down, the credit crisis appeared to be easing, the housing market seemed like it might get some footing and Wall Street was growing confident that it had finally found a bottom after months of volatility. No one expected oil would shoot up 30 percent in just three months. But Stovall notes that investors tend to be more flexible that pinched consumers. "The confidence of Wall Street, I believe, fluctuates more rapidly than the confidence of Main Street," he said. "You can't really compare one to another." Barring some new shock, Stovall thinks the market has likely touched, or at least come close, to its bottom. "If we haven't gone any lower as a result of all these worries," he said, "it would have to be some new worries that have yet to be anticipated." Wall Street is about to get a host of new information that will help it decide what direction to head in. Investment banks start reporting second-quarter results Monday. May producer price and industrial production data, along with new housing figures will come in starting Tuesday, and the Federal Reserve's next decision on interest rates comes the following week. If that combines to even a modest positive, Stovall said, investors might start to take some chances that could boost the market.

Interest-Rate Derivatives Signal That Banks' Credit Woes Likely to Worsen Interest-rate derivatives traders are betting banks' difficulties obtaining cash to fund holdings and shore up balance sheets will worsen. The difference, or spread, between the three-month dollar London interbank offered rate, or Libor, and the overnight index swap rate, traded forward three months, is greater than similar spreads expiring this month, according to data tracked by Credit Suisse Holdings Inc. Derivatives trades are showing that while global markets have rebounded since March, the worst may not be over for banks after racking up $387 billion of losses and writedowns from mortgage-related securities since the start of last year. Lehman Brothers Holdings Inc. has tumbled 18 percent in the past two days on concern it will require outside funding to shore up its balance sheet. The three-month Libor-OIS spread traded forward to June 16, the date the June Eurodollar futures contract expires, was 67 basis points yesterday, while the forward spread corresponding to the September Eurodollar expiration was 72 basis points. The difference between Libor, which is an average rate based on a daily survey of 16 banks by the British Bankers' Association, and the OIS rate indirectly measures the availability of funds in the money market. Forwards give expectations for the future. The increased difference is primarily due to traders exiting ``soon-to-expire positions'' earlier than usual, amid questions over Libor's reliability.

Credit Recession May Last 2-Plus Years: Strategists A "credit recession" sparked by a downturn in the U.S. housing market and excesses in structured finance may last more than two years, and the financial sector may undergo "massive consolidation," according to two leading Wall Street strategists. The downturn may last for "two, two and a half years" which may help lead to a healthier market, Jack Malvey, Lehman Brothers' (NYSE:LEH - News) chief global fixed income strategist, said during a conference in New York. "Structured finance is not new. It is the case in credit that (the market) hungered to get in this space 20 years ago," Malvey said. "This is the biggest blowup that we've had.

FASB Bombshell: FAS 140 to Eliminate QSPEs The "qualified special-purpose entities" (QSPE) -- those not unlike Enron-style SPVs in which many leveraged financial institutions have been placing transactions that may turn into giant losses -- may no longer be allowed to be used for that purpose. At least, that is the concern if a new FASB rule (FAS 140) gets passed. To grossly oversimplify, Banks have been using QSPEs to effectively boost their leverage and hence, their return on capital. Without the balance sheet constraints of the old days, banks were encouraged to create assets -- by making lots of loans they shouldn't have -- that could, in theory, be sold off later. It hasn't quite worked out that way. QSPEs can have legitimate purposes -- but they also can obfuscate the true financial condition of a bank or broker. The purpose is not to simply hide losses off balance sheet, but to get those assets off balance sheet so leverage/Tier 1 capital ratios look better. Essentially you can be much more leveraged than you appear, so that ratios like ROA and ROE look stronger than they would if they weren’t employed. The author of this above article wonders if "The migration of exotics to the balance sheet may be inevitable." If he's correct, it bodes poorly a quick recovery for the financials. They have years worth of leveraged derivatives on their books, and writing them down won't be quick or painless.

Asset-Backed Market Depreciates With SEC Drive to Impose `Scarlet Letters' Regulators' plans to add a letter to credit ratings of asset-backed debt may constrict the $4.6 trillion market and choke off consumer credit at a time when Federal Reserve Chairman Ben Bernanke wants more lending to bolster the economy. The U.S. Securities and Exchange Commission may recommend this week that Moody's Investors Service, Standard & Poor's and Fitch Ratings include a new designation to the scale created by John Moody in 1909, according to people familiar with the plans. The changes may force investors to reassess the way they gauge the risk of securities backed by mortgages, student and auto loans and credit cards, said the person, who declined to be named before the announcement. The action could force banks to add capital to guard against losses or curb lending. The SEC staff is recommending giving ratings companies two choices, the people familiar with the agency's plans said. One option is to publish a report on how they came up with each ranking and how it could go wrong. The other would add a designation distinguishing the assessment of asset-backed debt from a corporate bond. The International Organization of Securities Commissions, a Madrid-based association of global regulators, issued a code of conduct on May 28 recommending a change in ratings codes for structured finance. Moody's said in February it may add ``.sf'' to assessments to signify structured finance. S&P said a day after the IOSCO announcement that it may add an ``s'' to rankings

More Financial Turmoil For the past year, we have been advising investors to steer clear of the Finance sector. As we noted yesterday, Lehman was in the market buying shares as they fell 9%, according to the WSJ: Why a company in need of additional capital is out buying shares requires a little explanation for the uninitiated: Any deal for a capital infusion will be based on share price. The firm is likely seeking to shore up that price -- and a bit of confidence in management -- through open market purchases. Although this strategy reduces the total shareholders dilution (what % the new buyers get) in the long, run, it has potential to be very problematic. Indeed, this strategy proved to be disastrous in the 1929 crash: The 1929 situation had as a key factor the Trusts cornering stocks, implementing short squeezes, aggressively plying rumors, and engaging in other unsavory trading situations. These came on top of more than a decade of stock gains. In the present case, the situation is based on highly leveraged financial companies, complex derivatives, and collapsing housing market. So while many of the elements are very different, the one consistent parallel between the two periods is the excessive usage of leverage by banks and brokers. The bottom line: We remain wary of the Financial sector, for reasons I have enunciated over the past year. There are likely more write downs coming, more capital raises and dilution -- and lower finacial share prices.  For those who believe the crisis is in its 9th inning, best of luck to you . . .

BlackRock's Doll sees credit crisis lasting 2-4 yrs Fund manager BlackRock expects the global credit crisis to last another two to four years as a weakening U.S. economy triggers more writedowns by banks, its chief investment officer for equities said on Monday. The prediction was one of the starkest so far by a global investor about the length of a crisis that began last year with the collapse of the U.S. subprime mortgage market, roiling financial markets. The turmoil has led the $1.4 trillion money manager to be underweight on financial shares.Doll, an ex-Merrill Lynch executive, said the worst of the crisis has passed after the Federal Reserve-led rescue of crippled investment bank Bear Stearns in March, but warned a slowdown in the United States threatens more credit-related problems in the months and years ahead. "We've seen the worst of it in terms of crisis, writeoffs, but there is still more to come," Doll told a group of reporters during a visit to Singapore. "A slowing below-trend growth in the economy will expose more of them. Whether it is in the mortgage area...or in other consumer loans, auto loans, credit card loans -- there are more writeoffs to come."

Whitney Tilson: Fairfax can offer a port in the post-bubble storm In Irrational Exuberance, published in 2000, Yale economics professor Robert Shiller defines a speculative bubble as "a situation in which temporarily high prices are sustained largely by investors' enthusiasm rather than by consistent estimation of real value". Such phenomena have become all too familiar in the past decade as markets have lurched from bubble to bubble, in internet stocks, housing and - most likely today - commodities. Because human nature plays such a central role in speculative excesses, it is inevitable that such manias will recur. This inevitability makes it important for investors to understand why bubbles happen - if for no other reason than to limit the damage inflicted on their portfolios by the next one. Crucial lessons in all this are: make your own decisions independent of what the crowd is doing; rely on your own estimate of intrinsic value rather than a stock's current price to tell you what it is truly worth; frequently challenge your investment assumptions, and enlist others you respect to do the same; and learn from your mistakes. Post-bubble periods can provide opportunities for smart value investors, as indiscriminate selling hits stocks of even the best companies in out-of-favour sectors. I would like to report such opportunities in the financial and real estate sectors today, but I cannot. Bottom-fishing requires believing the bottom is near, which I do not think it is with the unfolding mortgage and credit crises.

Timothy Geithner Gets It Right  Geithner's address to the powers-that-be on Wall Street this week showed the firm grasp that he has on what needs to be done to get us past our present difficulties. It should soothe frayed nerves and relieve the thick anxiety. First off, Geithner met with 17 major firms in his office Monday afternoon to discuss plans to form a clearing house for trillions of dollars in complicated derivatives contracts. The sooner this can be accomplished, the better off we will be. Bringing credit default swaps (CDS), which have been negotiated party-to-party without any transparency, into the sunlight of exchanges will reduce the scale of counterparty risks. Everyone on Wall Street knows what they don't know, but they don't know who owes what amounts to whom. They don't have a record of counterparty transactions. It's still one big opaque maze until Geithner can obtain agreement from 17 strong-willed firms. In the meantime, Croesus suggests you ponder Geithner's frank message to the financial community. Geithner spoke of the continuing fragility of the system and warned that "confidence in the markets depends on confidence in the management of the institutions." The process of deleveraging can cause damage, he suggested. "Crisis begets regulation and regulation can beget crisis," he added, revealing that he himself recognized how tricky it will be to get just the right amount of finetuning into the diverse structure of the markets.