I have been a huge fan of Tanta's work at Calculated Risk. Over the years she has provided some of the most in-depth analysis and insight available into the mortgage industry (readers have possibly noticed that EconomPic heavily links to Calculated Risk).
It comes with great sadness to me that Calculated Risk posted that Doris "Tanta" Dungey passed away after a long battle with cancer.
Calculated Risk will soon be posting a charity of Tanta's choice for those interested in making a donation in her name.
Sunday, November 30, 2008
I have been a huge fan of Tanta's work at Calculated Risk. Over the years she has provided some of the most in-depth analysis and insight available into the mortgage industry (readers have possibly noticed that EconomPic heavily links to Calculated Risk).
I am a bit more optimistic about the economy these days (up to a 3 on a 10 point scale, up from a 1 a few weeks back). Why? Well, before I go into my theory lets rewind and review some theory by some actual economists.
John Maynard Keynes, whose work is becoming mainstream once more, suggested that a developing recession can be cured through an expansionary monetary policy (i.e. increasing the money supply) when the desire of individuals to increase savings leads to an environment in which the demand of individuals is less than that required to employ all the economy’s resources.
On the other hand, Milton Friedman believed that a spike in the money supply wasn't the answer. The reason is that Friedman believed when the money supply increases, it will increase both productivity and inflation; the more expected / transparent this increase, the more likely it will only be reflected in a new inflated price level, as prices for goods and services are quickly increased ahead of the money supply. Friedman famously quoted Abraham Lincoln in explaining why this type of move had worked in the past, but would not work going forward:
"You can fool all of the people some of the time, and some of the people all of the time. But you can't fool all of the people all of the time."Expected Deflation + Increased Money Supply = Good
So, where does this leave us? We are without question increasing the money supply by an amount without compare in our nation's history. However, expectations for inflation are not only low, but as can be seen below negative (as of Friday's close, you can purchase inflation swaps based on CPI that price in deflation at 2% annualized over the next two years!).
I believe this is a good thing (not deflation, but expected deflation in the wake of expansionary money supply). If this money gets into the proper channels (i.e. mechanisms / individuals that will "recirculate it"... this helps), while both corporations / households expect deflation so keep prices / wage demands low or negative, then the "real" price of goods and services could become strikingly cheap, thus increasing productivity.
For any of this theory to work in the short-run, inflation needs to come in above the "expected" level. Thus, it now becomes a race between the deflationary pressures associated with the natural course of deleveraging and the inflationary pressures associated with quantitative easing (great post here at Credit Writedowns about the latter). While I am not yet outright optimistic, I am MORE optimistic that new policy will be ahead of the curve and inflationary pressures will win out.
If this happens, then our economy should be saved from a depression.
Friday, November 28, 2008
Japanese Production Shows a Worsening Global Recession
Personal Consumption and Spending (October)
Durable Goods: New Orders Down 6.2%
Case Shiller Price Index (September)
Leading Economic Indicators (October)
Equities / Fixed Income
Global Equity Markets Rally
Some Swap Spread Normalization...
Market Rallies, Except for Warren
Missed Chance to Get Warren as Asset Manager on the Cheap
Uncertainty... The Only Thing That's Certain
The Only Equity Fund up Through Thursday, Down Through Friday
Pledges by Fed, FDIC, Treasury, and FHA = $90k per...
Bailout Pledges More than $8 Trillion
Relative Size of Pledges... Part III
Citi Bailout Details
Problem Banks: It's the Assets That Matter
Will an Auto Bailout also Act as an Ad Bailout?
NFL Scoring Differential
Japan’s recession deepened last month as companies cut production, consumers spent less and fewer people looked for work.
Factory output fell 3.1 percent from September, when it rose 1.1 percent, the Trade Ministry said today in Tokyo. Household spending slid 3.8 percent, the eighth consecutive drop.
Companies surveyed said they plan the sharpest production cuts in 35 years as exports decline in the wake of the worst financial crisis since the Great Depression.
- Transport equipment
- Electronic parts and devices
- General machinery
Japan’s economy shrank last quarter, entering the first recession since 2001. The International Monetary Fund predicts the U.S., Europe and Japan will all contract next year, the first simultaneous downturn since World War II.
Thursday, November 27, 2008
Wednesday, November 26, 2008
This is the last relative comparison I'll make of the pledges to date... for now. Below is a chart of some interesting analysis posted at Riholtz.com from Jim Bianco detailing past "big budget" government expenditures:
These massive expenditures pale in comparison to the current pledges made by the Fed, FDIC, Treasury, and FHA to date (again pledges, not costs).
Hey, I'd rather bail out banks than have another war, but a trip to Mars would have been awfully exciting.
New orders for manufactured durable goods in October decreased $12.7 billion or 6.2 percent to $193.0 billion, the U.S. Census Bureau announced today. This was the largest percent decrease in new orders since October 2006 and followed two consecutive monthly decreases including a 0.2 percent September decrease. Excluding transportation, new orders decreased 4.4 percent. Excluding defense, new orders decreased 4.6 percent.
The difference between the two-year swap rate and the benchmark Treasury note yield, known as the swap spread, narrowed to 94.5 basis points from 112.25 yesterday. The 17 percent drop is the biggest one-day decline since September 2003. Swap spreads with maturities from three through 30 years were down between 8 basis points and 14 basis points.
Gee, if you took it at face value, the FDIC's report, which says that problem banks increased by 46%, reaching a level not seen since the mid-1990s, says things are not as bad as in the savings and loan crisis. But of course, we are seeing this deterioration despite the Fed and Treasury throwing money at banks. Oh, just large banks.The problem thus far hasn't been in the number of problem banks, but in the concentration of their assets. While the number of banks in trouble were still "relatively" small (but growing), the relative size of failed or assisted banks in terms of assets is staggering. In fact, the amount was already greater than anything seen during the S&L crisis.
Unfortunately, as Yves states:
Things are sure to get worse in 2009.Source: FDIC
Tuesday, November 25, 2008
We noted earlier the absolute size of this, but assuming 90 million taxpayers (there were ~86 million that actually paid taxes in 2004), max pledges made by the Fed, FDIC, Treasury, and FHA to date amount to ~$90,000 per taxpayer (or ~$30,000 per U.S. citizen).
Not that I don't believe it's needed, but this puts it all in a little perspective.
I previously detailed that CPI may overstate inflation for an individual who:
- does not own a home
- would like to own a home
- will likely soon buy a home
Hot off the press, Part I. Term Asset-Backed Securities Loan Facility at $200B. Details per the WSJ:
Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans.
The Fed says it will purchase up to $100 billion in direct obligations from mortgage giants Fannie Mae and Freddie Mac as well as the Federal Home Loan Banks. It also will purchase another $500 billion in mortgage-backed securities, pools of mortgages that are bundled together and sold to investors.
This pushes the bailout "pledged" to date to over $8 Trillion. I understand it is NOT likely that all of these pledges made to date will be spent, but who thinks this is the last of them? Not me...
Volatility continues in all markets. Here we'll take a look at what we've seen in equities and what it all means, as well as in "risk-free" Treasuries, of which investors may be in for a rude awakening at some point in the near future.
Equities (per Bloomberg):
U.S. stocks posted the biggest two-day rally since 1987 after the government guaranteed $306 billion of troubled Citigroup Inc. assets and lawmakers pledged to pass another economic stimulus package.
The last two trading days provided the 12th largest two-day return in Dow history, according to Paul at Infectious Greed (my 11/24 figure is different as it's through the end of day). This must be a great sign, right? Well, 10 of the 11 larger two-day runs took place during the Great Depression. In other words, when markets are as uncertain and illiquid as these (in depression-like markets), expect large moves.
Interest Rates (also Bloomberg):
Treasuries rose for the first time in three days before reports that economists estimate will show consumer confidence held at the lowest level in more than 40 years and house prices extended declines.
It's good to see the volatility isn't only taking place in "risk-assets". HOWEVER, a Treasury sell off (i.e. rising) because consumer confidence may still be as bad as it has been in 40 years... when did that become a sign of improvement?
Monday, November 24, 2008
As Paul at Infectious Greed states:
I'm not suggesting that the disappearance of the U.S. auto companies represents the end of the ad industry, or that we should care if that is the case. Instead, it's just another interesting way of looking at some of the short-term implications for a related industry.
I'll agree with Paul that it wouldn't mark an end to advertising, but it does provide reasoning that many companies will feel secondary effects in this economic environment. For one, with an advertising slump, maybe Google isn't as "cheap" as many think.
Inflation Swaps are currently pricing in "expectations" of deflation of 1.5% over 2 years and inflation just over zero over five years. Ten and twenty year numbers are both well below 2% each.
U.S. TIPS price in a much greater chance of deflation as hedge fund unwinds and a flight to liquidity have put extreme pressure on the TIPS market (per Bloomberg).
The breakeven rate, or the difference in yield between two- year inflation-protected and nominal debt, suggest traders are betting the economy may face deflation over the next two years. The two-year breakeven rate was minus 3.96 percentage points.Also an interesting point from Robert Barrow (via Greg Mankiw):
The basic idea is that, in the present environment, nominal Treasuries have a negative beta. If we go into Depression, the expectation is that this will be accompanied by substantial deflation, so that Treasuries will do well in real terms. In contrast, the typical pattern is different--perhaps bad times are usually accompanied by high inflation or at least average inflation. Therefore, especially at the shorter end, the relation between indexed and conventional Treasuries has shifted--the real rate on indexed bonds now has to be well above the expected real rate on nominal bonds.
USG share will be allocated as follows:
- Institution absorbs all losses in portfolio up to $29 bn (in addition to existing reserves)
- Any losses in portfolio in excess of that amount are shared USG (90%) and institution (10%).
- UST (via TARP) second loss up to $5 bn;
- FDIC takes the third loss up to $10 bn;
In return, US Taxpayers receive:
Institution will issue $7 bn of preferred stock with an 8% dividend rate (under terms described below). $4 bn of preferred will be issued to UST. $3 bn will be issued to the FDIC.Citi shareholders, in return for not getting wiped out, will see their dividend all, but wiped out:
Institution is prohibited from paying common stock dividends, in excess of $.01 per share per quarter, for 3 years without UST/FDIC/FRB consent.And customer's are already hearing "good news" from Citi in a mass email sent just this morning (hat tip Dom):
Good news! Citibank is participating in the FDIC's Temporary Liquidity Guarantee Program. Through December 31, 2009, all of your non-interest and interest bearing checking deposit account balances are fully guaranteed by the FDIC for the entire amount in your account.
Better late than never... leading economic indicators for October (released last Thursday) were down 0.8 percent:
The leading index declined sharply in October as stock prices, building permits, consumer expectations and the index of supplier deliveries made large negative contributions to the index, despite continued positive contributions from real money supply and the interest rate spread.
In the past two months, without the very large positive contributions from inflation–adjusted money supply (the largest in seven years), the leading index would have been substantially weaker. Between April and October 2008, the leading index declined 2.4 percent (a -4.7 percent annual rate), falling considerably faster than the 1.2 percent decrease (a -2.3 percent annual rate) over the previous six months.
Sunday, November 23, 2008
With everything going on in the economy, it is nice to sit back, relax, and just enjoy the smaller things in life. As a New Jersey native and current New Yorker, this has meant dwelling in the success of New Jersey's own (they play west of the Hudson river) J-E-T-S and Giants.
Struggles in Detroit... unfortunately that's where differences between the NFL and economy end.
Source: Yahoo Sports
Business Week reports:
Out of the 11,585 U.S. and international stock mutual funds tracked by Morningstar Inc., 11,584 have lost money in 2008, according to fund data through Nov. 20.
In other words, just one fund hasn’t lost money this year—and that is the APX Mid Cap Growth Fund, which was flat through Thursday’s close. That’s right, folks, its return—or lack thereof—is a mere zero thus far in 2008.
Unfortunately, the APX Mid Cap Growth Fund took a turn for the worse on Friday, dropping 3% and turning year to date returns negative.
Hey look at the positive, the equity turnaround Friday probably turned one of those other 11,584 funds positive... right?
Friday, November 21, 2008
What's the Deal with Long Credit?
The Equity Market has Nothing on Credit
Equity Market Snow Balling...
The Former Untouchables
Obvious Statement of the Day: Banks Struggling
Up is Down... Down is Up
Thursday, November 20, 2008
Paul Krugman says:
Don't panic about the stock market...
Panic about the credit markets instead. Interest rate on 3-month Treasuries at 0.02%; interest rate on high-yield (junk) bonds over 20%.
This is an economic emergency.
It is unbelievable to me how quickly things have changed. The willingness of an investor to move from a AAA Government Backed Treasury Bill with 90 days to maturity, to a below investment grade (i.e. formerly known as "junk") bond with additional interest rate risk (i.e. more duration) was priced at just over 2.5% per year all the way back in the Spring of 2007 (i.e. 5 lifetimes ago).
At 20%+ interest rate levels, this pretty much knocks out any expected return on equity for most corporations. I have to go with Paul on this... equities still seem priced at high relative (to credit) levels.
Per the WSJ:
The CDS’s of Citigroup, which lost 23% Wednesday, reflected a cost of $400,000 for protecting $10 million in bonds against default over five years. That’s up from $240,000 on Tuesday, according to Phoenix Partners Group.
The data in the fixed-income market is no more encouraging. Investment-grade banking bonds closed Wednesday at an average spread of 5.35 percentage points over comparable Treasurys, according to Barclays Capital.
The cost of protection for Morgan Stanley was $455,000, Goldman Sachs was $335,000, and Merrill Lynch’s CDS were at $230,000. Markit’s index of key investment-grade credit default index rose to $260,000.
Swap spreads are currently trading through Treasuries on the long end of the yield curve. Not just a few bps, but 30+ bps.
What does this imply? It "implies" that investors are willing to lend to a counter-party (bank, hedge fund, etc...) at a lower rate than the U.S. government. While this isn't the reason for the inversion (I detailed back in October some technical factors that caused this), it still shows how distressed this current environment is.
How strange is this? Well back in October when the spread first inverted, we get this from the FT:
“Negative swap spreads have been considered by many to be a mathematical impossibility, just like negative probabilities or negative interest rates,” said Fidelio Tata, head of interest rate derivatives strategy at RBS Greenwich Capital Markets.
In this environment, nothing is impossible.
Should Mack Whittle have been able to receive $18 million in "severance" when he retired from South Financial Group? You make the call (all the following bullets come from this Propublica article Bank Got Bailout, CEO Got Golden Parachute, but were rearranged to get a clearer timeline of the events):
- Under Whittle, the bank grew to be the largest based in South Carolina, with $13.7 billion in total assets and 180 branch offices in Florida, North Carolina and South Carolina.
- But the bursting of the housing bubble has hit the South Financial Group hard. Since the beginning of 2007, the bank's stock has fallen sharply from above $26 to about $3.50 today.
- Whittle's plans to retire had been announced Sept. 5 -- before the worst of the credit crisis and a month before Congress passed the $700 billion bailout. The company said then that Whittle would retire by year's end.
- The bank booked a $25 million net loss in its third quarter.
- But on Oct. 24, shortly after the bank announced that it would be applying for bailout money, the bank decided that Whittle would be retiring early the next week.
- Whittle's successor had yet to be named, and no reason was given for the earlier date.
- The South Financial Group, South Carolina's largest bank, announced earlier this week that it had been approved to receive $347 million from the U.S. government.
- Because of the timing, he's free from golden parachute limits that come with accepting bailout money.
I don't know near enough about Mack Whittle or South Financial Group to understand why he retired early. However, does it make sense that a bank that just lost more than 85% of its equity value, and is in such need for liquidity that it tapped the U.S. taxpayer for equity, reward its CEO at the height of the financial crisis when they are leaving the problems behind?
The finishing paragraph in the article from corporate governance analyst Paul Hodgson rings true:
"If you and I decided to retire, we might get what's left of our 401(k). But for some reason the rules seem to be different for executives. They get severance even though they're retiring. There's no logic to it at all."
We have some big names struggling...
Berkshire Hathaway per Bloomberg:
Warren Buffett's Berkshire Hathaway Inc. fell the most in at least 23 years, dropping for the eighth straight day since reporting a 77 percent decline in third- quarter profit.
The stock plunged $11,550, or 12 percent, to $84,000 in New York Stock Exchange composite trading and has slipped 41 percent this year, compared with the 45 percent drop in the Standard & Poor's 500 Index. Berkshire, based in Omaha, Nebraska, rose in 17 of the past 20 years.
Goldman Sachs per Bloomberg:
Goldman Sachs Group Inc. closed at its lowest price since the firm first sold shares for $53 apiece to the public in 1999, as the profit outlook darkens for a company that set a record for Wall Street earnings last year.
The stock fell $6.85, or 11 percent, to $55.18 in New York Stock Exchange composite trading, giving the company a market value of $26 billion. The New York-based firm's value reached a high of $105 billion, or $248 per share, on Oct. 31, 2007.
Wednesday, November 19, 2008
Below is a chart of the cumulative return of the Long Government Index (U.S Treasuries and agency securities with a maturity of 10+ years) divided by the Long Credit Index (Investment Grade U.S. corporate and specified foreign debentures with a maturity of 10+ years ) since 1978.
From 1978-2007, the two indices performance was remarkably similar, with Long Credit outpacing Treasuries during the bull equity market of the 1980's - 1990's and the "great moderation" we saw from 2003-2007 when risk could be given away, while Treasuries roared back during the period of stress in the early part of this decade (and the the current period of turmoil).
We are at levels truly never seen before, with credit outpacing treasuries by almost 35% over the past year and a half. Questions I keep asking myself:
- Are an unprecedented amount of defaults on the way? Maybe...
- Is the recovery value of a defaulted bond less than history would lead us to believe? Maybe...
- Are long credit bonds yet another screaming buy? Maybe...
- Or are Treasuries just flat out too darn expensive? Maybe...
Per the AP:
Consumer prices plunged by the largest amount in the past 61 years in October as gasoline pump prices dropped by a record amount.
The Labor Department said Wednesday that consumer prices fell by 1 percent last month, the biggest one-month decline on records that go back to February 1947. The drop was twice as large as the 0.5 percent decline analysts expected.
The quick reversal in CPI was almost exclusively "fueled" by fuel. It will be interesting to see how other prices react to the slowing economy and crushed consumer demand.
As we've previously detailed here, here, and here, between increased escalating vacancy rates, asset deflation, the leverage used to finance these commercial loans, and the inability to refinance loans in this environment, commercial real estate is on a downward spiral.
This WSJ article marks what may be the beginning of the next stage of the crisis; the failure of two big issues backed by commercial real estate:
The market for debt used to finance hotels, offices and shopping malls tumbled Tuesday on worries that the long-feared rise in defaults for commercial mortgage-backed securities had begun, possibly ushering in the next phase of the financial crisis.
Analysts at Credit Suisse said two big commercial mortgages that had been packaged into securities in the past year were likely to default. The rapid deterioration of these loans fed worries that the weakening economy and higher unemployment rate would drag down the $800 billion market for commercial-mortgage-backed securities, or CMBS, which so far has withstood the credit crisis with low delinquency.
The financing rate for a commercial real estate loan has now more than tripled over the past four years. If rates remain this high, expect more failures and another round or two of bank write-downs.
Tuesday, November 18, 2008
Brad Setser points out that growth in exports, which had been a source of optimism in the first half of the year, has reversed course:
The non-petrol goods deficit is now moving in the wrong direction. It increased from $29.3b in June to $35.6b in August. Non-petrol exports fell by $9.9b over the last two months, while non-petrol imports fell by “only” $3.7 billion. The sharp fall in exports shows up clearly in a chart showing “real” non-petrol goods exports and imports. Real data tries to show what is happening if changes in price are taken out of the equation — it is meant to measure the actual quantity of stuff that is traded.Looking at year over year real exports (goods) by end-use category, we see a slowdown in September exports across the board, specifically for foods, feeds, and beverages:
As London Banker points out (via Yves at Naked Capitalism), a lot of this can be traced to letters of credit, which:
have financed trade for over 400 years. They are considered one of the more stable and secure means of finance as the cargo is secures the credit extended to import it. The letter of credit irrevocably advises an exporter and his bank that payment will be made by the importer's issuing bank if the proper documentation confirming a shipment is presented. This was seen as low risk as the issuing bank could seize and sell the cargo if its client defaulted after payment was made. Like so much else in this topsy turvy financial crisis, however, the verities of the ages have been discarded in favour of new and unpleasant realities.How bad can it get? As we detailed above, the biggest drop has been in foods and feeds...
If cargo trade stops, the wheat doesn’t get exported. If the wheat doesn’t get exported, the mill has nothing to grind into flour. If there is no flour, the bakeries and food processors can’t produce bread and pasta and other foods. If there are no foods shipped from the bakeries and factories, there are no foods in the shops. If there are no foods in the shops, people go hungry. If people go hungry their children go hungry. When children go hungry, people riot and governments fall.Source: Census
Everyone along the supply chain should worry about their children going hungry.
When that happens, everyone in governments should worry about the riots.
Another mind provoking post by Paul Krugman questioning what will take up the slack in the U.S. economy post-stimulus package. He first points to the components of GDP, specifically the increased role of consumption in the U.S. economy.
Lets go to Paul for a guess into how this will play out:
Source: NY Times: Conscience of a Liberal - After the Stimulus
Consumption probably isn’t going back to a 2007 share of GDP — savings are back. So what will fill the gap, once the stimulus is gone? Housing? Not for a long time. Business investment? Hard to see why. The natural thing would be to trade lower consumption for a smaller trade deficit.
But that’s going to be hard if the rest of the world is also in a slump, and in particular if emerging markets are facing currency crises.
What all this suggests — and it’s a very rough cut — is that our emergence from the era when massive fiscal stimulus is needed may hinge crucially on getting the world financial situation, not just our own, under control.
Per the BLS:
The Producer Price Index for Finished Goods fell 2.8 percent in October, seasonally adjusted, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. This decrease followed a 0.4-percent decline in September and a 0.9-percent fall in August. At the earlier stages of processing, prices received by manufacturers of intermediate goods moved down 3.9 percent in October after declining 1.2 percent in September, and the crude goods index dropped 18.6 percent subsequent to a 7.9-percent decrease in the previous month. Month over Month
Year over Year
There is an interesting interview with Howards Marks, Chairman of Oaktree Capital, over at Barron's (hat tip Infectious Greed) explaining how innovation, leverage and risk-taking all lead to the problems the financial community is currently experiencing (bold navy is mine).
So there must be some risks in the overall proposition that are not captured merely by the yield curve. And those risks are that on a bad day, you could be asked to repay your borrowings, or you could be unable to roll over your borrowings. So to repay your borrowings, you have to sell assets. But assets could be either not sellable or only sellable at losses or prices well below what you think they are worth or what they are really worth.
You look at this and say: "OK, I can borrow money short-term at 3%, and I can buy 30-year bonds at 6%. I'm going to make 3% a year forever." That will work in the long run, if you can survive to enjoy the long run. It reminds me of one of the greatest adages in this business:Never forget the six-foot-tall man who drowned crossing the stream that was five feet deep, on average. It is not sufficient to get through on average. You have to get through every day.
As Howard points out, if you can borrow at 3% and invest in something that year in and year out returns more (equities have returned 8% on average over the past 20 years), you can make an absolute killing. The problem lies when you've borrowed at that 3% and then have a period like we've had over the past twelve months, one in which after dividends has seen the S&P 500 return -36%.
Monday, November 17, 2008
As reported in the NY Times (hat tip Laura R.):
When a company lays off 50 or more workers, the government considers this to be an “event,” almost as if it were a wedding or a concert. But no one is excited that more of these events occurred in the third quarter of 2008 than they did in the period a year earlier.Looking at just the September 2008 claims from mass layoffs vs. September 2007, we can see just how large an increase we've seen across the board. Interesting / unfortunately, it looks like the finance and insurance layoffs that have made the news were the least of the economy's problems to date (this will most assuredly change by year end).
According to preliminary data from the Bureau of Labor Statistics, 1,330 extended mass layoffs occurred in the third quarter, 312 more than in 2007.