A Sacramento mortgage lender's vision

In a bit of a shocker, Alan Greenspan, the longtime Federal Reserve Chairman and predecessor of Ben Bernanke, opened his mouth yet again, to say that he was wrong. Interesting thing to note is that after he stepped down in January 2006, right when the subprime issue started to raise it's ugly head, he would periodically make public statements that would scare the living daylights out of the market; once the DIJA plunged several hundred points.  Under large amounts of pressure, he finally took a more private approach.

Anyway, today he said that ``Yes, I found a flaw,'' Greenspan said in response to grilling from the House Committee on Oversight and Government Reform. ``That is precisely the reason I was shocked because I'd been going for 40 years or more with very considerable evidence that it was working exceptionally well.''

There are schools of thought that lay the blame for the cheap money causing irresponsible subprime lending directly at Greenspan's door, as a result of his financial policies from 1999-2006. Greenspan even released a report in 2004 as Fed Chairman, with such gems as "Indeed, the surge in mortgage refinancing likely improved rather than worsened the financial condition of the average homeowner." mixed in with the boilerplate. The document shows a remarkably detached analysis of the exponential growth of credit during the time period with almost no cautionary language. Course, hindsight is 20/20, and in all fairness he did manage our finances well for over 18 years at the Fed, but that was then, and this is now. 

As predicted by the Chicago Board of Trade fed funds futures, the Fed funds rate was cut to 1% this morning. The central bank's new loan programs have expanded assets on its balance sheet by 104 percent during the past year to $1.804 trillion, or 12.6 percent of GDP. Incedentally, the futures reflect a 100% chance of another qaurter point cut by December. Federal open market committe language in was very terse and vauge. In reality, the Fed may end up facing a Bank of Japan in the early 90's style deflationary scenario. In this time period BoJ cut rates to near zero during severe economic depression; and held them that way for quite some time. 

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"The Conference Board's confidence index tumbled to 38, lower than forecast and the worst reading since monthly records began in 1967, the New York-based research group said today." Full article here

The data is based on polls and surveys. Elsewhere, the US department of Labor reported that the economy as a whole has lost 760,000 jobs this year, continuing a streak for 9 consecutive months.

Overall the damage to the economy has been severe. In recent months, the liquidity crisis spread from mortgages into the car business, seeing auto loan giant HSBC exit the business and the Big Three auto manufacturers step up price breaks and incentives sharply as their stocks fell and vulture style merger and bailout rumors surfaced.  Reportedly, it takes a 700+ fico score to obtain an auto loan these days. An estimated 700 car dealerships will close this year if the reported trends continue.

Treasury bonds have been taking a heavy beating over the last week. Overnight mortgage rates spiked in response. This condition is being caused by the $700 billion bailout- I mean, did you think the money was going to magically appear? No, it's all financed on T-bills, and this massive borrowing is causing a large supply problem in the Govie bond market. As a side note, the money isn't really being used to buy bad securities (as originally sold), but instead is going as a cash infusion directly into banks. I don't normally go this direction, but you should watch this video of Ron Paul shooting massive holes into the Bailout. He called it the "Destruction of the Dollar" and a "contest between inflation and deflation". Think what you like about Ron Paul's domestic policy, but his stance on the economy is brilliant.

In other political news, the power issue between Obama and Mccain continues to be the economy. Obama continues to be perceived as stronger on this issue while Mccain continues to try and shake the "old boy, old money" image. For a little commentary try this ABC news article.

Bernanke publicly advocated additional economic stimulus today in a message to the House Budget Committee. A plan is currently on the table for an additional 150 billion to shore up federal unemployment, among other things.  Like other programs of the kind, it is meeting opposition.

In other news, the futures are predicting a 100% chance of another rate cut at the fed's next meeting at the end of October.  This time however, other global banking centers are expected to cut as well.

A little bit of statistical analysis...

September 3rd, 1929: The dow reaches an all time high of 381.17.

July 8, 1932: In the depths of the Great Depression, it finishes its slide at 41.22, erasing 36 years of gains. This is a 9.247:1 reduction from the high close, or a 924% decline.

October 9, 2007: The dow reaches another all time high of 14,100. Today, October 20th, 2008: As of 155PM EST, the dow is at 9063.21. This is only a 55% reduction off peak.

However, the Dow took about 4 years to make that great slide. Let's look at September 15th, 1930, exactly 1 year and 12 days after the all time high in 1929, near exactly the amount of time we are now away from the 2007 peak. A reliable source gives the close price on that day at 236.62. Applied against the 1929 high, this figure is only a 61% decline off peak.

Throwing out for the moment the difference in time, culture, politics and inflation...these raw numbers show a correlation, of our present market decline, to the infamous stock market crash which preceded the Great Depression.

***A few qaulifications: 1. I do not have a degree in economics. 2. The above idea is based purely on simple math of market close ratios, and discards all other factors. 3. Speaking of other factors, that would include information, credit, law etc. 4. it is intended to be only a starting point, for observation on the energy and momentum of human psychology in market operations; which is timeless in my opinion, and a very important factor in economic analysis.***

You may be aware that the Dow Jones posted the largest single day advance since 1933 yesterday, 936 points. (NY Times article here) This was followed by massive gains in both the Nikkei and the Europe markets.  Predictably, the bond market (which was closed for the monday holiday) got creamed today as traders bet that the recent involvement of central banks will improve the economy, and that the financing of this manoeuver will increase the supply of government debt.

There has been a lot of coverage of credit default swaps in the news; these are very complicated financial instruments that would take an entire post in and of itself to explain. But I've ran across an incredibly well written article that explains the risks and benefits to credit defaults and US treasury bonds, and in the process explains what is happening the yield of latter.

Which brings me to another article from PIMCO, this one from CEO [and legendary bond trader] Bill Gross, titled: Nothing to Fear but McFear Itself. It would be an injustice to this article to try and synthesize it so here are some quotes- "...believes that capitalism is the best and most effective economic system ever devised, but it has a flaw: it is inherently unstable"

"We believe that the Federal Reserve must now act as a clearing house, guaranteeing that institutional transactions clear (and investors receive) their Big Macs at the second window. They must also take another bold step: outright purchases of commercial paper. They should also cut interest rates to 1%, because we are experiencing asset deflation, and the threat of headline inflation is long past."

It is important to note that everything forecasted has come to pass.  G7 has met and all the central banks of major world powers are now letting unrestricted lending happen on all fronts, and rates have been cut to near 1%. There is historical preceedence to this agreement; it happened in the 80's and the two items of interest are the Plaza Accord and the Lourve Accord, which had the world cooperating to manipulate the value of the dollar.  Until the credit crisis is repaired, and liquidity is restored, we will not see the light at the end of the tunnel.

This week has been a bloodbath in the markets. Since September 29th, the Dow Jones has lost 25% of it's value.  The US Treasury announced that it will now be purchasing bank stock and taking ownership of financial institutions.

This update is short- I don't have the energy today to weave it all together so here are some links:

G7 discusses global market state

Rule forcing "fair market" valuation of financial assets such as MBS and credit default swaps challenged

Reacting to market conditions, many countries are banning short selling of financial stocks

Here's to a more sane Tuesday when the markets reopen.

I thought for a change I'd write about a country other than the U.S., center stage though it is. A very interesting article on Marketwatch: European Union is ill-equipped to tackle U.S. crisis examines the dis advantages of the vaunted Euro currency and highlights the desperate actions of individual countries in the Union.  In a meeting last week the president of the EU essentially gave carte blanche for member countries to do whatever it took to protect their own country's banks and assets; since the EU controls the currency and money supply, it's a little like as if the state of Texas here was having problems and decided to change their banking policies separately.  In other news prime minister Gordon Brown dumped about 87 billion into the UK banking system yesterday. Perhaps most disturbing of all is the news that the entire country of Iceland may declare national bankruptcy. Remembered in recent years as a wealth, progressive country and banking heavyweight, Iceland too has felt the crushing squeeze of illiquidity.

With good reason all this has prompted 4 central Europe banks and the US to slash rates this morning. In it's typical, censured language The Fed's Open Market Committee, which voted unanimously for today's move, said in its statement that ``incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial-market turmoil is likely to exert additional restraint on spending.'' I don't think the Fed was supposed to meet until the 29th, so this could represent an emergency unscheduled meeting, but I am not 100% on that.

What is for certain is the markets were not calmed by this action; it was already priced in. According to the futures, traders have been expecting this action for weeks; one wonders what would have been the reaction if no cut had been made...

For the first time since 2004, the DIJA is below 10,000. Bombshells over the weekend included a multi-billion German government bailout of the second largest commercial lender in the country.

CBOT fed funds futures now reflect a 100% chance that the Federal Reserve will cut interest rates on or before it's next scheduled meeting on October 29th.  Treasury bonds are rallying on [perhaps justified] fears the US bailout will not repair the economy; MBS and actual mortgage interest rates are not seeing much of a drop and most likely will not. While there is a corollary between the 10 year Tbill and mortgage rates, it is not cause and effect.  There is a spread between the Tbill and rates; which has been widening for over a year now, and is a direct reflection of the market's opinion of the quality of MBS. 

Another alarming factor is the LIBOR, which closed last week at 4.33 percent, up from 2.82 percent three weeks earlier. Christoph Rieger, a fixed-income strategist at Dresdner in Frankfurt stated: "With no interbank lending taking place, the daily Libor fixings are no more than a flimsy theoretical construct" In other words, since there is virtually no money being lent between backs, the LIBOR does not reflect reality. Based on other factors in credit markets Rieger estimates the true 3 month LIBOR should be about 6.33%. It soon may be.

In other news, President Bush signed into law the $700 Billion Bailout bill this weekend. US Treasury will immediately begin purchasing tainted securities. This may be good for people struggling to get their loan modified...everyone else watched with baited breath. In a related move last week the SEC moved to completely remove rules forcing Investment Banks to calculate or disclose the value of these securities. Sweet.

FHA has grown monstrously; current estimates show that by the end of 2008 it will guarantee one out of every three home loans. Story here

Read the story here. After much waffling and special interest legislature spliced into the bill, a revised version passed the House of Representatives at about 10:30 this morning, PST. Initial reaction in the markets was interesting...the Dow dipped about 200 points almost immediately, predictably, bond yields popped up... but not perhaps as much as expected. There were some very gloomy economy numbers put out yesterday (I can't find that article on the payroll numbers but it described the current US unemployment situation as at least rivaling the 1981-1982 recession). Banks are starting to play hardball and up the cost of money even to the most platinum quality borrowers. The LIBOR (or london interbank offered rate) tracks the willingness of banks to lend each other money, has seen a sharp spike of at least 50 basis points to as much as 200 basis points depending on the type of LIBOR. [LIBOR is an index upon which mortgage are sometimes based on, for more info click here].

Also today key members of California state government stated that they were having difficulties with their municpal bonds (debt used to finance public works like roads, schools, etc). The credit crunch has already been playing hell with the muni bond market for quite some time(we saw the cost of this debt in some cases triple) and unfortunately since everything is financed and nothing is built with cash, these increased payments are crippling. To the point where the frick'in State of California may need a federal bailout! I keep harping on the concept of liquidity... that's having enough cash to operate your business. Perhaps the government will just bail everyone out. But who bails out the government?