Monday, January 14, 2008

TIME TO BUY? TIME TO HIDE? must see video Peter Thiel CNBC interview I do not like this index is falling signs of world economy slowing?

Mortgage Crisis to Corporate Debt Crisis:
The financial system fell under intense stress Wednesday. The epicenter of the crisis was in the “Credit default swap,” or CDS market, and “contagion” fears were building quite a head of steam. The pricing for Countrywide Financial default protection (5-yr CDS) surged a huge 469 basis points to a record 1,610 bps (it would cost $16,100 annually for 5-yrs to insure $100,000 of Countrywide debt against default). For perspective, Countrywide default protection was priced at a mere 30 bps one year ago and didn’t even trade above 600 during the subprime crisis this past summer and autumn. Rescap CDS surged an astounding 1,360 bps Wednesday to 3,746. This was up from the year earlier 95 bps. MBIA CDS increased 85bps to 849 (year ago 87) and Ambac 89 bps to 841 (year ago 70bps). Washington Mutual CDS increased 61 bps to 611 (year ago 54bps). Many indices of corporate debt spreads rose to their widest levels in years.
In the old Greenspan days, Wednesday’s circumstance would have most-likely beckoned a “surprise” inter-meeting Fed rate cut. There were rumors for as much. And while chairman Bernanke did not ease rates, Thursday morning he provided the markets the next best thing: “We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.” Bernanke didn’t plan on rambling down the Greenspan path. Actually, I believe he and other members of the FOMC would have preferred to avoid it – resist responding directly to Wall Street pleas for aggressive Federal Reserve accommodation. “Let the chips fall…”, as they say. But the Fed now knows what many on Wall Street have understood since this summer: The U.S. Credit system and economy are extraordinarily fragile and the Fed simply will not risk sitting back and watching an implosion without resorting to extreme measures. If nothing else, inter-meeting “surprise” rates cuts are back on the table. Wall Street must be quite relieved to know this mechanism is available in the event market selling pressure turns unwieldy.
This week brought back memories of the 2002 Debt Crisis. Weighed down by the telecom debt collapse, Enron, and other frauds, intensifying Corporate Debt problems late in the year were at risk of smothering the consumer sector. The nexus at the time was the auto finance subsidiaries and Household International. Consumer finance Corporate Debt spreads were widening significantly, and Household, in particular, was facing a liquidity crisis in early November. The failure of a major financial institution at that juncture would have created a major systemic issue.
Well, on November 14 HSBC agreed to buy (bailout) Household International. A week later, FOMC governor Bernanke gave his now (in)famous “Deflation: Making sure ‘it’ doesn't happen here” speech. With rates at 1.0% (until June 2004!), the Fed was now publicly discussing “electronic printing presses,” “helicopters” and other “unconventional measures.” Wall Street was trumpeting “deflation” risk. Sure enough, the crisis was soon resolved and Wall Street was emboldened to perpetuate history’s greatest Credit inflation and Mortgage fiasco.
The tables have been turned these days, with the Mortgage Crisis now evolving into a full-fledged Corporate Debt Crisis. The key nexus this time around has been Wall Street “structured finance,” especially as it relates to the major Mortgage lenders (certainly including Countrywide, Rescap/GMAC, and Washington Mutual) and the “financial guarantors (in particular, MBIA and Ambac). The unfolding Mortgage implosion has destroyed the value of innumerable “structured products;” has annihilated legions of mortgage companies; has impaired scores of major lenders; has severely battered general market confidence; and this week was in the process of taking down a few huge mortgage companies. Institutions with enormous liabilities to the “money,” “repo,” securitization, and derivative markets – not to mention large borrowings from the FHLB system - were in serious jeopardy. The risk of a domino implosion in the Credit default market and the “financial guarantor” industry had become a very real possibility. System Risk Intermediation was in peril.
The Fed responded with what the market has interpreted as a promise of aggressive rate cuts, while Bank of America has apparently for now resolved the Countrywide debt issue. Citigroup’s stock rallied on rumors of a major new investment from Prince Alwaleed and others. Washington Mutual’s stock price rallied sharply on rumors of merger talks with JPMorgan. Countrywide’s stock surged as CDS prices collapsed, a dynamic sure to have caused considerable grief to those shorting the stock to hedge against default protection written.
Curiously, the general market took little comfort from developments. A case can be made that the rally in CDS and financial stocks was destabilizing for much of the leveraged speculating community (including “market neutral” and “quants”) keen to short financial stocks against (now sinking) technology shares. Overall, the market was hammered, while MBIA and Ambac CDS prices barely budged from record levels. Friday's market was one of those that surely caused havoc for numerous sophisticated trading strategies. And it is worth noting that an index of Junk bond spreads to Treasuries actually widened an additional 4 basis points to 603 bps, rising this week above 600 for the first time since – not coincidently - the 2002 Debt Crisis.
But the general environment is nothing like 2002, and I don’t expect Fed words and actions – in concert with financial bailouts - to have similar effects. For one, 13% household mortgage debt growth in 2002 provided powerful financial and economic stimulus that will not be forthcoming in 2008. With consumer Credit relatively stable, 2002’s Corporate Debt Crisis was not a serious systemic issue. Moreover, “Wall Street finance” was in an aggressive expansionary mode and the global banking community was developing quite a hankering to participate in the U.S. Credit Bubble. The economy was emerging from a shallow recession.
The world is a much different place today. The Mortgage Finance Bubble is a bust, Wall Street finance is imploding, and foreign financial institutions are keen to cut and run from the business of providing U.S. Credit. Countrywide’s mortgage problems will be absorbed – along with so many other risks – by our own highly vulnerable domestic banking system. Worse yet, the economy is quickly succumbing to recessionary forces. With a high degree of confidence we can proclaim that the Mortgage Crisis has now evolved into a Corporate Debt Crisis – and this crisis will not be resolved anytime soon – by rates, by helicopters, or by bailouts.
Unlike 2002, today’s Credit crisis is systemic. Consumer and financial sector fragilities – the heart of our Credit system - are now impaired to the point of imperiling the capacity of the Credit system to finance business spending and intermediate corporate lending risk. To be sure, prospects for a faltering U.S. consumer sector, massive financial sector Credit losses, and an imminent economic downturn have quite negative ramifications for business lending and valuations. In particular, unfolding dislocation in the CDS and Credit “insurance” markets will severely restrict Credit Availability for small, medium and large firms – especially those less than top-tier borrowers.
I’ll go further and suggest that a severe tightening of Financial Conditions has abruptly made many business borrowing plans unviable; many a balance sheet and debt load untenable; and vast numbers of business strategies - crafted in altogether different financial and economic times - much less viable. Some companies will make the necessary adjustments and many will not. The unfolding backdrop definitely makes a lot of stock buyback plans imprudent and growth strategies highly risky. The aggressive risk-taking business manager – having previously capitalized on the protracted boom - will now be at a similar handicap to that which afflicted the zealous home buyer and lender.
For those searching for explanations behind the stock market’s dismal start to the New Year, I suggest contemplating the many serious ramifications of the Mortgage Crisis having now evolved into an Incurable Corporate Debt Crisis. This week, the Bursting Credit Bubble passed another significant inflection point – one perhaps subtle but with major economic consequences.

1 comment: said...

Someone needs to say something about this! IS THIS LEGAL? No wonder why we have the subprime mess we have when lenders USE FAKE DOCUMENTATION to help PUSH the loan through Quickly SO THAT EVERYONE DOWN THE FOOD CHAIN (from loan processor to the loan officer to the actual lender) can make the commissions they "WERE" making during the booming 90's!!! Now we are BAILING OUT THESE CROOKS....SOUNDS LIKE the good ol' 1980's Savings and Loan BAILOUT DAYS to me! see it with YOUR OWN EYES!