Tuesday, August 19, 2008

That bad huh?

CDS trading is looking real panicky this morning. Lehman is 40ish bps wider, other brokers 20 wider. Zero liquidity. Swaps wider again, although mildly. Fannie and Freddie senior spreads unchanged. MBS look slightly wider after finishing basically unchanged yesterday.

Dow currently down less than 100 points. Financials down ~2%. That ain't gonna be enough. I wouldn't be surprised if we suffer through another 200 point day.

The market continues to obsess about housing starts, which is a completely worthless statistic here. I'm looking at housing sales and delinquencies as the key stats.

FRE and FNM preferreds are down another 20% or so today, threatening the $10 area on FRE Z. One trader told me he's started to see bottom fishing here, which seems incredibly stupid to me. Bottom fishing can work as a strategy, but no one can put odds on whether the impending GSE nationalization will make preferred shareholders whole or not. This isn't about financial analysis anymore. I'd rather bottom fish in WaMu or Lehman or National City any day. At least those are actual businesses where management will be making every effort to survive. Fannie and Freddie are going to get taken out regardless of how the housing crisis plays out from here.


Unknown said...

AI: you have claimed for months that Fannie and Freddie only bought / insured above average mortgages.

But both ponzi schemes report they hold subprime debt... $168 billion in aggregate as of 2nd quarter

Also see The Washington Post article from today.

Will you finally admit these "safe" mortgage assets are a lot worse than you let on?

Accrued Interest said...

I said the GSE guarantee portfolio was above average and I'll stick by that. Above average and completely safe aren't the same thing. And saying their portfolio is above average isn't the same as saying they only guaranteed above average loans.

I'll admit (again) that I was way too sanguine on how this would all play out, particularly as of last fall. On the other hand, I've been saying for months that a GSE bailout would happen if it came to that. Now its come to that.

Unknown said...

The GSEs were a political monster / economic disaster the day they were created.

They borrow at Treasury subsidized rates, and lend to home owners at far less subsidized rates. The Fed did a study under Greenspan that showed the GSEs were able to borrow about 75bp cheaper than a private entity, but only about 25bp of that was passed on to home buyers. Left unsaid: the bulk of the tax payer subsidy, about 50bp, went to shareholders and/or CEOs like Franklin Raines.

As a "side venture", the GSEs sold under-priced insurance to Wall Street to allow securitization. I suspect this under-priced insurance ate up a bit of the 50bp tax payer subsidy all along, but now that home prices are correcting from a 5 sigma bubble, the bad insurance underwriting cannot be concealed by the 50bp spread.

The GSEs were never and have never been economically viable. FNMA started in the Great Depression as a government subsidy, Freddie later. The GSEs have always been tax payer financed -- even if accounting gimmickery concealed that for many years.

Unknown said...

What are your thoughts on the pfds being made whole in the nationalization process, as most of these pfds are held by participating banks?

Unknown said...

mari: economically, there is nothing to "make whole". Economically, dividends are supposed to be paid out of profits. If you subtract out the 50bp (average) tax payer subsidy from the GSEs, they never had a profit (and since they were created as a government subsidy, one might argue they were never intended to have a profit).

Politically, members of Congress have for years operated on a "spend now, let the next guy figure out how to pay for it" basis. This "crisis" has been in the planning stages for decades.

Obviously, the current politicians don't want to take blame for their own mistakes, much less the mistakes for the last 50+ years. So they will try to defer the problem further and let Obamacain deal with it.

The $64K question is whether our creditors (eg China and OPEC) will wisen up. Americans don't have the money to bail themselves out individually (see all the foreclosures)-- so its rather foolish to say we can bail ourselves out in aggregate ("the government" is also known as "we the people", who don't have the money).

America used to run on thrift; we used to live within our means. Since we our now deadbeat debtors, the decision of what to do is no longer ours.

Will China keep putting money in, knowing they will lose money in the long term? Why should Americans get to live in enormous houses and drive fancy cars (all on credit) while the Chinese person (who is paying for all this) lives in a tiny apartment? What is the incentive for the Chinese to keep this up?

For the past 10-20 years, their incentive was to stimulate trade-- but as the domestic market grows and other (non US) markets grow, that explanation fades.

You might make money **trading** (aka speculating in) the GSEs depending on how well you can handicap the political process, but since the GSEs do not and have never made money -- you will not make any money **investing** in the GSEs.

Unknown said...

The GSEs are to the US Government what the SIVs were to Citibank et al. They are overly elaborate "off balance sheet" financing vehicles that many people are only now beginning to realize are far from off balance sheet.

Citi (et al) were forced to take their off-balance sheet SIVs back onto their books.

The US government will be forced to take its off balance sheet financing (the GSEs) back onto its balance sheet. It was always a question of when, not if.

If Citi had allowed SIV creditors to take a hit, which they were legally allowed to do, it would have made it very difficult for them to ever get financing again.

For the US government, there isn't "business continuity" issue. As a sovereign entity, the question is whether creditors believe the government can raise sufficient revenue from a declining tax base, or will the debt be "paid" via depreciated currency?

This is a political question -- so its rather absurd to sit here and argue about whether preferred stock has a "seniority claim" over non existent profits.

As more people realize the US government's debt position is far more precarious than commonly thought, the relevant question is "what do our creditors think?". If our creditors give us more time, then you have to ask which special interest group has the most influence over Congress.

PNL4LYFE said...

Totally agree with this post and your previous on housing starts. How can more supply possibly be considered a good thing?

I also agree that there's little edge in predicting how the eventual bailout will impact the capital structure. I can't imagine that the common will be worth anything unless the eventual cost to taxpayers is zero (which seems unlikely). With pfd and sub debt, it seems like a coin flip with a very binary outcome.

Kurt Osis said...

I love the smell of napalm in the morning.

I personally think the GSE equity is oversold. I don't think the current president nor either of the candidates has the balls to put Fannie or Freddie into conservatorship. It would be a huge fucking political liability, they'll run ads saying the "the government will bail out Bear Stearns but it won't help the poor workin man" Do you have any idea how much easier it would be to just write the GSE's a check for $20bn a piece?

I'm just buying '10 $5 and $2.5 puts and then scaling into the calls from $7.50 to $20.0

Anyway, I could be wrong so I want to cover my ass in case the equity goes to Zero. But I plan on riding the gamma on the calls to the promised land. I might retire off this one, like those people who bought Chrysler shares right before the government bailed them out.

@not: You're exactly right. I like to call the GSE's america's side pocket. I can answer your question the debt will be paid by depreciating the currency If the EU and china didn't have more than twice our inflation rate their might be a viable alternative for these countries. But there's not. So the "ponzi scheme" lives on. Anyway fiat currency was always a Ponzi scheme, go read John Law. As you pointed out, politicians will kick this can down the road and the government can stay solvent longer than yo can bet against it. Might as well invest to profit from the continuation of the Ponzi scheme.

Unknown said...


your Chrysler analogy is a good one. They had a "pop" after the bailout, they suckered Daimler-Benz (and more recently a hedge fund) into buying them -- but once you subtract out all their myriad of liabilities, they still aren't making any money.

Speculators made short term (and perhaps intermediate term?) trading profits, but Chrysler was (and still is) a terrible investment.

The major difference between then and now is Uncle Sam's financial position in the world. The US *was* a net creditor to the world back then.

Thirty some odd years of zero growth (negative in real terms) and we are now the largest debtor the world has ever known. Debt financed "growth" is not the same thing as real economic growth. Any chimpanzee can "expand" the business by levering it up.

I mention this only to suggest that the FNM/FRE bailout isn't going to be decided by Washington, nor by voters whining about Bear Stearns. When you are in debt up to your eyeballs, your fate is decided by your creditor committee.

If you were China (and OPEC, etc), I would think you would want to protect your own interests first.

If I am a Chinese central banker, I don't want to be arrested for losing "the people's money" in some ill fated U.S. mortgage scheme.

So how do our creditors cover their backsides? When we figure out the answer to that, only then will we know how to *trade* the GSEs

Kurt Osis said...

Investing is like robbing a bank, plan in advance, get in, take the money and get out as quickly as possible. In the long run they're losers man, as Keynes said, in the long run, we're all dead. I only care about how much I make no the long term viability of the business model, they're all obsolete.

There's a key difference between the US and a company, companies can't print their own money to pay off their debt. So the only decision to be made about FRE/FNM is how much money too print. The GSE's both have access to the discount window, and the Fed accepts GSE paper as collateral. The GSE's can both just issue $20bn notes to the Fed. While this is an over simplification its what will ultimately end up happening.

Now as for our "creditors" those aren't bonds the Chinese and Japenese own. They're fixed for floating swaps! Yeah the Chinese can unwind the swap if they want to, but I hope they put their bicycles in storage, cause when the Yuan the appreciates there crappy products aren't going to have a comparative advantage anymore. And of course if OPEC switches out of dollars the Chinese are going to get it on both ends declining revenue and rising energy costs! I wish 'em good luck with that.

What's the other alternative to dollar, the Euro? The europeans have all of Americas problems plus they're not reproducing, and they're less productive.

To sum up, the dollar is the most worthless currency, except for all the rest.

Unknown said...

I think the Chinese would have a lot of trouble unwinding their existing positions -- if for no other reason than so many people are watching.

But if I was China, I would be worried and looking for a hedge. Having got myself caught in the bear trap, I certainly don't want to put my other foot in as well.

The obvious solution is to go "buy" debt from other countries -- with the aim being to develop export markets that are an alternative to the U.S. If whatever country(ies) become regular customers of Chinese goods, it may not matter if they pay back the debt per se. At the very least, I keep more Chinese people employed (good for political stability) and I diversify away from 100% dependence on the U.S.

Irregardless of what the future holds for the U.S. -- diversification would be prudent.

If (when?) China does this, it severely reduces demand for US Treasuries (and off balance sheet pseudo Treasuries) at the margin.

At the margin, demand goes down -- and supply is going to be stable or go up given the GSEs are money losing entities-- this means that prices, over time, would be expected to decline

You might get lucky in your trading, and have your bond mature at "the right time" -- but for the most part, you are picking up pennies in front of a steam roller. The odds are not in your favor

Too many Wall Street types (including AI) have been minimizing the downside for far too long. I know senior CDO tranches are AAA, and so are GSEs and Treasuries. Fool me once, shame on you, fool me twice...

Jim Rogers gave an interview last month in which he pointed out that the U.K. went from undisputed world super power in 1917 (at the end of WW I) to begging on their knees at the front door of the IMF by 1975. Only the discovery of oil in the North Sea prevented (delayed?) the UK from joining every other former spendthrift country in the history section of the bookstore.

There is no sane reason to invest in the GSEs, period. They are bankrupt, AI's comments not withstanding. Their "sugar daddy" (aka the US tax payer) is in no shape to bail them out -- well, not unless we "fix" the entitlements problem by killing all the old people.

As for alternatives -- there are plenty for "small" accounts. Jim Rogers claims he is completely out of USD. The problem is the exit door is too narrow for all of us to leave.

God bless AI for tricking the masses into sticking around so the rest of us can leave quietly!

Accrued Interest said...

I can't agree that the GSE's business model is inherintly flawed. They are basically a mortgage insurer, which is a perfectly viable business.

The problem is you can't have a quasi-public quasi-private business. They can't serve two masters, so to speak. They never would have gotten away with the leverage they had without the implicit Treasury support.

Now, I wish we'd follow Lacker's advice and nationalize, then spin off the GSE's, making them "credibly private."

Unknown said...

AI: I can't agree that the GSE's business model is inherintly flawed. They are basically a mortgage insurer, which is a perfectly viable business.

Well, AMBAC and MBIA and GE and a host of other companies were unsuccessful, even though they had only one master.

The GSEs have enjoyed (on average) a 50bp subsidy for decades -- and they still can't make money.

Paul Tudor Jones has said in many interviews that he avoids mortgages-- its a negative gamma trade and you almost never get paid a sufficient amount to compensate for the risk. Its not worth the expense and distraction of monitoring mortgages year after year for the very rare occasion when risk is properly priced.

If you can't make money as an investor (like MBIA or AMBAC) and you can't make money as a trader (like Tudor) -- its a sure thing you won't make money with Congress "helping".

Kurt Osis said...

I was going to say earlier that you reek of Jim Roger's nonsense but I thought maybe you had arrive at this conclusion on your own. Unless Rogers is living on the moon (and doesn't plan of coming back) he's still net long the USD. "From 1917 to 1975", 58 years? I'll be dead by then, what the fuck do I care?

For every 1% of its reserves the Chinese diversify away from the dollar the more competitive American exports become. Let the Chinese switch to a basket peg, the US will still be their largest customer for exports. We'll have just as much leverage over them and our exports will be more competitive.

The problem with your thinking is the GSE's shareholders aren't the equity holders. The GSE's shareholders are the American people, and they're also its debtors. They're just using leverage to juice the return on equity of their homes, transferring the value of the debt tax shield from the holders of the GSE paper to the American people. Whether the GSE's are "solvent" or not is irrelevant. The tax payers make way more money in equity appreciation of their homes what they would lose by plugging up any capital deficiency. There absolutely no incentive to privatize the GSEs.

As for the equity, its worth however many dollars the Fed decides to print and I don't really care. I'm buyer of the volatility not the cash flow. I'll bet 2 things, 1) the current situation will not stand. 2) All things equal politicians will patch over a problem rather than fix.

Unknown said...

kurt: From 1917 to 1975", 58 years? I'll be dead by then, what the fuck do I care?

As long as you can find a bigger fool, you may not care. I was just pointing out that they went from world power to beggar inside one generation -- truth be told, investors in the UK were in trouble no later than WW II (and arguably sooner)

you reek of Jim Roger's nonsense

Are you a billionaire? Did you start Quantum fund before anyone even knew what a hedge fund was? Rogers is human with faults like everyone else, but I have to laugh at all the Wall Street "experts" who know everything but still have to work.

For every 1% of its reserves the Chinese diversify away from the dollar the more competitive American exports become

The USD depreciated by more than half against the Yen (just for example) between 1980-ish and 1990-ish. Against the D-mark it depreciated almost as much. All that depreciation did zilch to "make us competitive". We need good products, not accounting tricks. No country ever got rich by depreciating its currency.

Whether the GSE's are "solvent" or not is irrelevant

Everyone reading this blog should send their next year's tax bill to kurtosis... money is irrelevent to him

Kurt Osis said...

"Everyone reading this blog should send their next year's tax bill to kurtosis... money is irrelevent to him"

the solvency of the GSEs is irrelevant because you make more money back from cheap mortgages than you spend in providing capital to the GSE. This is not an accounting trick. so please send me your tax bills and a call option on all future increases in the value of your house and the future houses of any children you have or plan to have, i will be happy to take difference.

Rogers has been saying America was doomed as long as anyone has known who he was. Sure eventually all empires fall, if he keeps saying it long enough eventually he'll be right. He's a smart guy, smart enough that not trade based on this theory because if he had, he'd of gone broke 20 years ago.

"The USD depreciated by more than half against the Yen (just for example) between 1980-ish and 1990-ish. Against the D-mark it depreciated almost as much. All that depreciation did zilch to "make us competitive". We need good products, not accounting tricks. No country ever got rich by depreciating its currency."

Really? I could have sworn the US Started the 1980's in a prolonged economic malaise and ended as the sole super power after a decade of massive growth. Do you even have any idea what you're talking about? What do you think happened when the west went off the Gold standard,it seems to me a lot of countries got rich by devaluing their currencies.

A country thats growing has to devalue its currency to adjust for the increase in population size. No country ever got rich deflating its currency is more like it.

"As long as you can find a bigger fool, you may not care. I was just pointing out that they went from world power to beggar inside one generation -- truth be told, investors in the UK were in trouble no later than WW II (and arguably sooner)"

Right so like I said we'll sell it to the Chinese.

Unknown said...

We might have become sole superpower (because the Soviet Union beat us to bankruptcy) -- but our devalued currency did not make our products competitive in Japan or Europe. The discussion was about our trade competitiveness, not our military position.

Read the post before you comment, and try to complete your own posts without cursing. An occasional curse is no biggie, but constantly throwing f-words around makes you sound very insecure -- kind of like a guy who wishes he had been wrong (and profitable) as often as Rogers.

Kurt Osis said...

Yes and why did the Soviets go bankrupt because the US borrowed huge sums of money to build weapons. This absolutely made US exports more competitive the only reason the US didn't reduce its current account deficit with Japan is because the Japanese were devaluing their currency even faster than we were. As a result they were unable to manage inflation in their own country and had a 15 year recession following the 80's. Basic money multiplier effect really, they were buying dollars and lending in yen without letting their currency float, every time we inflated they inflated 10x that amount.

The trick with monetary policy is not avoiding devaluation, but rather managing expectations of devaluation. By surrendering control of it monetary policy to the US, Japan was no longer able to do this.

As for cursing:
1) I am very insecure, most successful people are. If you're already secure there's no reason to work very hard.
2) I don't believe in using or not using arbitrary words because they offended some people
3) Dude are you fucking kidding, what're you my fucking grand'ma?