Wednesday, March 19, 2008

What I'm hearing...

  • Bank and brokerage bonds continue to perform well. The most recent quotes I've seen on Lehman Brothers, for example, are as tight as I've seen over the last couple days. It doesn't look like they've backed off materially during this late-date stock market swoon. We'll see.
  • CMBS spreads are moving much tighter today. I'm not big into that market, so I'm just throwing that out there for color.
  • Credit spreads outside of finance appear to be mildly tighter, if anything.
  • Swap spreads are mixed, with 2-year spreads 4bps wider while 10-year 3bps tighter. Agency spreads moving similarly.
  • Deleveraging continues. All the big brokers know that the surest way to avoid a Bear Stearns problem is to make sure they aren't over exposed to hedge funds. Supposedly there have been several commodities-oriented funds which are selling today. Gold getting crushed. Haven't heard anything about equity-oriented funds but that might be part of what's going on today as well.
  • Also hearing that good old John Merriweather's fund, JWM Partners, is down 20%+ in March. Supposedly had exposure to Carlyle.
  • Agency MBS spreads are tighter today. News that FNM and FRE will be allowed to expand their portfolio may well be a game changer in the MBS world. Two weeks ago news like the JWM rumor would have just killed the MBS market.
  • Put the deleveraging story and the stock market story together with the mildly tigher credit/MBS spread story and it doesn't seem to fit. I can only conclude that there aren't alot of hedge funds left that are both 1) net long credit and/or MBS and 2) haven't already been hit with margin calls.
  • Also interesting to note that even hedge fund trades that have been working, e.g., long commodities, are getting hit by deleveraging. It may have merely been that the credit and MBS-oriented funds were the first to get hit by deleveraging.
  • Speaking of popular hedge fund trades, my bet would be that fast money is net short investment-grade credit. That could be another reason why credit spreads have been resilient today.

I'd love to hear comments on what others are seeing today.


Anonymous said...

Nice move in the VIX and TED Spreads..... more better??

Accrued Interest said...

VIX was way up today, not surprisingly. We need to give it a couple days to see if things calm down. Tomorrow is a quadruple witching day, so there might also have been people trying to get ahead of that. Day before a holiday is usually a bad time to do a lot of trading.

TH said...

Heard Meriweather also attributed his problems to the sharp widening between 7 and 30 yr UST.

Anonymous said...

As long as it's not because of a widening between off-the-run and benchmark italian bonds...

Anonymous said...

Sheila C. Bair keeps talking up the idea of a large scale homeowner bailout to save the credit markets. Says that the Congress, Exec Branch and other agencies are working non stop to trying to agree on a large scale plan but they havn't figured out how to separate the good guys from bad, or various moral hazards. She is a very sharp lady but this idea that the gov't can somehow create a program that involves millions of mortgages and doesn't destroy the market in the process seems Disney ish. but I live and work in the real world so what do I know.

Anonymous said...

Yves Smith has just posted what Citigroup said about the great unwinding.

From Citigroup:

The difference, or spread, between interest rates on investment-grade corporate bonds and Treasury bonds has jumped in recent months, even though most companies aren't very leveraged.

This widening may be caused by leveraged investors such as hedge funds having to sell good quality assets to meet margin calls, or requests for more cash or collateral.

"It is the leverage of the investors who hold these bonds that is now being brutally exposed," Matt King, a Citigroup credit strategist, said.

"We are now confronted by a broad bloodbath in the credit markets," Citigroup said. " The most leveraged paper is falling in value because it is leveraged, and now the least leveraged paper is also falling in value because it is owned by leveraged investors."


Accrued Interest said...

For better or for worse, I think there is a very good chance of a large-scale government program to address housing. Its unfortunate because I really believe we can get through this without govt. intervention and we'd be better off in the long run. But Barney Frank doesn't care what I think.

NN said...

Anyone looking at EM bond spreads? I look at JPM EMBI Spread and it closed ~326 yesterday, up from 280 when I started looking at near the end of February....

Eyal Bar said...


I thought about what you were asking. This is so simple, it's not a conundrum at all! Lots of HFs were piling onto the short trade, but on a leveraged basis, and the banks interrupted that trade by asking for the borrowed portion to be returned.

But it actually goes much further than this. What is a leveraged hedge fund? It is an entity that borrows money from the prime brokerage division of, essentially, one of his competitors! (the IBs' prop desks compete with them). So unless you're a really outstanding manager (and if you only piled into the short trade in 2008, you're probably not) then you're not any better than any IBprop desk, not to mention that your shorting is having reverberations on the IBs' MTMs.

So why would an IB lend money to a hedge fund to do something that it can do itself? you're gonna say it's because the HF keeps the first loss piece because it's a loan, not equity. Well ya... but when IBs get into a liquidity crisis like now, and if it thinks HFs are getting unpopular, which they are, then BOOM - They will throw the HFs under the bus explicitly. That's what we're seeing.

Long gold is a levered trade, short credit risk is a levered trade. What we're seeing is deleveraging so massive that it transcends the logic of the underlying trade.

Accrued Interest said...

It will be VERY interesting to see if any HF get caught on the wrong side of credit spread momentum. That could be the variable no one saw coming. Spreads start tightening a bit... suddenly HF are caught on the wrong side... everyone heads for the exits at once...

I'm not ready to bet on such a thing, but it sure is possible. We have seen bigger moves in CDS the last couple day than cash bonds. That almost certainly means fast money is leading this.

Anonymous said...

from observing the equities market in HK time, I'd say that risk aversion continues. Intra day rallies appear unconvincing and pulls back on profit taking. Noticeably currencies like NZD, AUD seems to be hammered with JPY, CHF, USD gaining strengths.

3-Month T-Bill said...

$IRX hit .2% today (as in 2/10 of 1%). It was at 5% a year ago.

Massive demand for ST treasuries at negative real rates.

Anonymous said...

The yen had been strengthening for a few days, which I would say is all fast money. Now, it is beginning to pull back.

I sincerely pray that the doomsday HF predictions do not come true, but in the spirit of Holmes...

Eliminate the impossible, etc.

gramps said...

Its the end of the quarter, and for some people its the end of the fiscal year. After Sarbox, CEOs are reluctant to cook the books except via well established (and court tested) accounting loopholes.

And when the music stops on 31-March, you had better show you are delevering and that you have plenty of cash on hand with which to survive further delevering.

Secure cash or Treasuries. Not IOUs and not unrealized profits.

So take profits on your commodity and FX trades (and anything else that shows a profit). If you can sell any of the garbage on your balance sheet (without forcing a mark to market on the rest) do so now.

Fundamentally, nothing changed when the Fed agreed to **LOAN** money to brokers. Americans have borrowed way more than they are ABLE to pay back-- a loan delays the day of reckoning, but the loan is still for more than the collateral. And in all too many cases, the loans have negative carry -- the principal being paid off in the monthly payment is less than the depreciation of the home price (assuming the mortgagee is still paying the loan).

Even Bernanke is starting to realize that he cannot fix a problem caused by excessively easy credit by easing credit. Even he is realizing he is just about out of ammo. Practically speaking, rates can't really go below zero; and hurling money out of helicopters won't work if the dollar is already in free fall and your host government (Uncle Sam) is dependent on foreign money to fund its spending habits.

The world is not coming to an end -- but the fat lady has just started warming up. System wide, we have written off about $250 billion -- $170ish at major financial institutions and the balance at failed hedge funds and foreign banks. System wide, there is still somewhere between $750 billion and $1.25 trillion more to go. In a $12 trillion per year economy like the US, $1 trillion is going to hurt **bad**, but it won't kill us (unless its made worse). Some combination of banks, hedge funds, real money investors, and taxpayers will have to absorb those losses before the fat lady finishes singing.

The sooner that happens, the sooner we can get back to rebuilding the economy.

The longer the Fed tries to fight the tide from coming in, the worse it will be when the inevitable happens.

And regardless of the time frame, survivors will need to be a lot less leveraged. 20-1 leverage (home owner or hedge fund) is just a disaster waiting to happen. 10-1 is pushing the limits of prudent investing.

I too heard that Merriweather had losses from Carlyle, but I don't know if I believe the rumor. I hope there is a lot more to it. If Merriweather is charging 1 plus 20 for managing other people's money, its pretty lame if he farmed out 20% to Carlyle -- it would make him an overpriced fund of funds? I also heard (another unconfirmed rumor) that he had on some flattening trades this quarter -- that would make a little more sense (in explaining the losses) if true.

The markets are going to be really volatile for the next few months, as portfolios are **forced** to delever. The fundamentals of whatever stock or bond are irrelevant if some highly leveraged portfolio manager has a big position that must be unwound at any cost.

That means market prices will continue to be really bad indicators of underlying economic activity. Until prices reflect market based price discovery (and not desperation of failing funds), you have to be careful about relying on traditional indicators.

Darth Toll said...

great summary gramps, agree fully. The only thing I would caution about is the sanguine view of losses, "$1 trillion is going to hurt **bad**, but it won't kill us"

Sure, $1TR doesn't sound like that much when stacked against a $12TR economy, but the leverage is going to be a real bitch. It's going to be more like $30 or $40TR in lost "money" (fictitious capital), which will crater the economy and thrust us into a deep depression. Even the GSE's can take $3B and lend out $100B against it with 33X leverage. So when FNM losses $3B, really $100B in lending "money" has evaporated.

Anonymous said...

gramps has explained the action in commodities.

Everything is currently motivated by panic.

AI, what is going on in the trenches, on the front lines?

Apolitical said...

"Americans have borrowed way more than they are ABLE to pay back-- a loan delays the day of reckoning, but the loan is still for more than the collateral."

Gramps, does the fed loan at market value or par?

Anonymous said...

Al / Gramps,

could you pls explain in laymans terms why we now have negative rates on the short term stuff ?

Accrued Interest said...

I'd say the 2-year is in the 1.50 area because of fear and a focus on return of capital.

I'd say T-Bills are below 1% in part because so much cash has flowed to govt. MM accounts recently. Now, that also has to do with people focusing on return on capital, so the basic sentiment isn't very different. But remember that before 4/15, money market balances usually rise substantially then fall after people make their tax payments. Some of the run up in T-Bills has to do with this.

gramps said...

Not sure exactly how Goldman defines "Wall Street" -- but if they mean just the big bulge bracket sell side firms, then I have to agree with this from Bloomberg.

I am still guessing total system-wide losses will be between $1 trillion and $1.5 trillion -- although I am starting to lean more toward the higher number because of the actions taken by the Federal Reserve and the federal government (Treasury, OFHEO, FHLB, FNMA/FHLMC -- and God help us if Congress succeeds in "helping".

To answer APolitical's question from last weekend -- the Fed isn't really being forthcoming with how they will value the assets they take in as collateral. But you can easily guess that they must be doing it at the borrower's cost basis (i.e. NOT market value).

If the borrowing institution were to value the assets at market value (for the loan) -- they would then be acknowledging the assets are worth less and they would have to take the write down... For most, that would be a massive loss-- and for more than a few it would mean admitting they are insolvent (and they would go out of business).

If the banks were willing to mark their collateral to market, they could most likely get private financing and wouldn't need the Fed at all (except for the insolvent guys-- who shouldn't get any loans except possibly DOP financing under the supervision of a bankruptcy court).

gramps said...

darth toll: I apologize if my comments are coming off as being a sanguine view of $1-1.5 trillion losses. In my mind, I am viewing even the lower number as a very big chunk of the total capital in the banking industry.

A number of big sell side houses will cease to be: either they will be absorbed into a more solvent house or they will simply fold up.

The other half of losses will show up on the books of hedge funds -- who were basically selling very overpriced (and leveraged) beta as though is was alpha-- and various real money accounts (pensions, insurance cos, muni reserve funds, etc).

I think your scale ($40 trillion?) of "fake capital" is exagerated -- but I agree with the general sentiment of what you are saying.

I have described this problem in earlier posts to this blog as a really big accounting error-- which is why I don't subscribe to the deflation theory (and also because all the prices that I am paying are going **UP**).

If you want to claim that the destruction of this imaginary credit is deflationary, then I think you need to explain why its creation was not hugely inflationary. From roughly 2001-2006, this "credit" was expanding 15% per annum (roughly) -- but inflation during the period was reported as 2-3%? Heck, Bernanke got his helicopter nickname because he said the massive credit expansion was deflationary???

How can the credit expansion be deflationary AND the credit collapse also be deflationary?

I suggest the credit expansion was a really big accounting error, and the Fed's bungled response was (and is) inflationary.

As the accounting error (over priced housing and associated credit) gets corrected, we find that many financial intermediaries were nothing more than an over-leveraged bet on the accounting error continuing indefinitely. This is not inflationary or deflationary -- its just bad risk management.

Now the smart money (and the confused?) are shifting everything into the perceived safety of US Treasuries. Getting 1-2% on short notes is awful, but its better than a loss.

Roughly 40% of mortgages are just fine, another 40% have a lot of credit risk and may have a problem but they will more likely be OK, and 20% are just trash... but because of all the accounting shenanigans, you don't know which of those groups a given mortgage pool falls into.... Prudent investing requires you to assume the worst until you get more information -- and that means shifting into Treasuries.

The govt entities (FNMA, FHLMC, and even GNMA / FHLB) play by different accounting rules than private companies -- but even the Roman Empire can and did go insolvent. Great Britain needed an IMF bailout during the 1970s. We can all argue about to what degree Congress will/should use taxpayer money -- but we are talking about a problem that is pushing the financial limits of what the US Treasury can realistically afford; and there is the matter of existing debt, perennial deficits and an actuarially insolvent entitlement system.... In short, even if Uncle Sam wants to bail out this problem -- its not obvious that he is able to. Push comes to shove, who will Uncle Sam abandon first? FNMA / FHLMC holders or US Treasury holders? Uncle Sam's self preservation doesn't bode well for GSE holders.

Anonymous said...

PennyMac - named to sound like Freddie Mac but not really, but yes, but no -- is going to be run by one of the rocket scientists who flew Countrywide into the side of a mountain...

The Fed is bailing out Wall Street fat cats who spent the entire last decade preaching free markets and telling us how much smarter MBAs are compared to the unwashed masses.

And ALL THREE presidential candidates are talking about new programs (aka new spending) when we already have massive debt, massive deficits, two unresolved wars (Afghanistan as well as Iraq), and entitlement programs that have always been thinly veiled pyramid schemes. All three idiots want to spend even more money that we don't have... Hilary even wants to put the federal govt in charge of all health care -- you know, the govt that thinks $10,000 is a fair price for a toilet seat and $1 billion is "reasonable" for an airplane. The other two candidates lack even a stupid plan for healthcare.

And all the while, Americans just shrug their shoulders and smile as their car drives off the edge of a cliff.

If this was any other country (besides our own) -- would Americans invest in it? After you answer that question, ask yourself why we are paying 15-20x earnings for the S&P and NASDAQ

Zagen Germaine said...

If you had the choice between taking out $40,000.00 of your inherited cash which is part of a larger IRA to pay off debts (but did not have to sell stocks to get that $ & your tax bracket is $15% but perhaps less since I am on SSD & earn less than 14,000.00 a year) or take out a 9% re-fill on a 2nd home, which is being rented for $1000.00 a month that will be sold in 3 years with a contract)- is it as simple as comparing interest rates to decide that a 9% re-fill is a better deal than a 15% deal? ( the 9% is non-negotiable as I can only get a "no doc/no asset loan" at that tax brackets unfortunately)or are there other matters to consider.