Thursday, March 27, 2008

Something big just happened ...

And Guambat was totally at sea whilst it occurred.

Ten Days That Changed Capitalism by David Wessel (WSJ)
The past 10 days will be remembered as the time the U.S. government discarded a half-century of rules to save American financial capitalism from collapse.

On the Richter scale of government activism, the government's recent actions don't (yet) register at FDR levels. They are shrouded in technicalities and buried in a pile of new acronyms.

But something big just happened. It happened without an explicit vote by Congress. And, though the Treasury hasn't cut any checks for housing or Wall Street rescues, billions of dollars of taxpayer money were put at risk. A Republican administration, not eager to be viewed as the second coming of the Hoover administration, showed it no longer believes the market can sort out the mess.

First, over St. Patrick's Day weekend, the Fed (aka the Lender of Last Resort) and the Treasury forced the sale of Bear Stearns, the fifth-largest U.S. investment bank, to J.P. Morgan Chase at a price so low that a shareholder rebellion prompted J.P. Morgan to raise the price. To induce J.P. Morgan to do the deal, the Fed agreed to take losses or gains, if any, on up to $29 billion of securities in Bear Stearns's portfolio. The outcome will influence the sum the Fed turns over to the Treasury, so this is taxpayer money; that's why the Fed sought Treasury Secretary Henry Paulson's OK.

Then the Fed lent directly to Wall Street securities firms for the first time. Until now, the Fed has lent directly only to Main Street banks, those that take deposits from ordinary folks. That's because banks were viewed as playing a unique economic role and, supposedly, were more closely regulated than other types of lenders. In the first three days of this new era, securities firms borrowed an average of $31.3 billion a day from the Fed. That's not small change, and it's why Mr. Paulson, after the fact, is endorsing changes to give the Fed more access to these firms' books.

the clear and present danger that the virus in the housing, mortgage and credit markets is infecting the overall economy is too great to ignore. The Great Depression was worsened because the initial government reaction was wrong-headed. Federal Reserve Chairman Ben Bernanke spent an academic career learning how to avoid repeating those mistakes.

Is it working? It is helping.

Is it enough? Probably not.

Saturday, March 08, 2008

Giving the markets the finger ... of instability

OK, one more before the "road".

Danny John and Jacob Saulwick have tried, in the SMH, to come to grips with the Big Squeeze in the markets, primarily the credit market but that is not too far removed from the equity bone.

Here are some excerpts from the story they write:
Bond traders with decades on the floor; bankers bruised by innumerable sharemarket tumbles; financiers hardened by the graft of years spent rustling up cash. All describe the scale of the present crisis as entirely new to their experience.

A career banker who spent 30 years with HSBC before taking on the leadership of Australia's third largest bank last October, [ANZ CEO Mike] Smith recalled the words of Wells Fargo chief executive John Stumpf as he addressed the Australian British Chamber of Commerce yesterday: "It's interesting that the industry has invented new ways to lose money, when the old ways seemed to work just fine."

WHAT BEGAN with pockets of the American lower-middle classes not being able to pay their mortgages - better known as the subprime crisis - has escalated into a full-blown global liquidity crunch. Every day, the headlines get worse as yet another obscure part of the vast subterranean market for debt starts to implode.

Sean Keane comes from the centre of the maelstrom. For more than 20 years the regional head of short-term interest rate trading for Credit Suisse, he has bought and sold the financial instruments that now have the world's attention.

"The extent to which the market has needed liquidity, and the speed at which credit has disappeared, is something I have never seen in any previous crisis," says Keane.

What has made the present crisis worse than any he has seen before is the scale of the markets for complex financial products that have now become paralysed.

"These markets have become so very large in the last five to 10 years," he says.

Until recently, this had been a great blessing. A vast array of new-fangled credit products allowed banks and other investors to spread the risk of borrowing and lending across a wide range of participants. The lower perceived risk had emboldened lenders, strengthened the hand of borrowers, and driven deal after deal after deal.

During the good times, all of this debt was spread far and wide to banks, hedge funds, superannuation funds - even local councils across NSW. This, says Keane, has been one of the great developments in markets that's allowed them to grow. "But what's happening now is that part of that model is being unwound very quickly," he says. Investors are no longer willing to buy the financial contraptions that have enabled the spread of risk. They want cash. And cash is now very scarce.

More broadly, questions are being asked about the business model of companies that depend on low interest rates and climbing asset values to support a flurry of deal-making - in short, the Macquarie model.

Most assumed that it would not come to this. Even as the subprime meltdown began to undermine the citadels of US banking, the global financial services industry was saying as recently as Christmas that this was an American phenomena and was almost ring-fenced. Normal service would soon resume. "Everyone was hoping that January 1, you'd come in, and things would be different. But here we are in March and things are as bad if not worse," says Febo. Initially, the major Australian banks thought they would largely escape the direct impact of the crisis and the subsequent flow-on effects through specialist debts sectors such as the mortgage securitisation market.

The low interest rates that followed the 1997-98 Asian financial crisis and the 2000 "tech wreck" helped drive what became five years of powerful and seemingly unstoppable growth for the banks and their customers.

In the euphoria, Centro Properties, Allco Finance and ABC Learning, to name but a few, came up with ever more fanciful forms of financial engineering. It worked but it required ever more leverage. Debt, though, was easy to come by and even easier to sell to investors eager to join in the profitable binge.

But debt came back with a bang last October after the subprime crisis became a wider liquidity issue. The US investment banks, which rose a boom writing loans to people who could not afford them, had their balance sheets turn to mush. Write-offs and losses have since hit an estimated $US400 billion ($430 billion) and everyone thinks more will come.

WHAT BEGAN as a loan crisis in the US has since closed debt markets, drying up the supply of money throughout the world. Spreads - the difference between official interest rates and those that markets and banks charge to lend among themselves - have blown out to astronomical levels.

Even the spread on the most secure forms of debts - senior bank loans which, if they went bad, would take the bank and possibly the whole financial system with them - has jumped five-fold.

Other forms of corporate leverage have risen to a level where lenders are charging 100 basis points - a full 1 per cent - above official cash rates set by central banks. Meanwhile, troubled companies looking to refinance their existing facilities face crippling rates of 500 to 600 basis points.

For the banks, the possibility of a bad debt problem had started a slide in their share prices in mid-October. From the top of the bull market when the ASX200 hit 6800 points in November, the index of leading companies has since slid inexorably towards 5258 points, where it finished yesterday.

Five months ago, banking industry leader Commonwealth Bank was trading around $60. By the end of this week, at just $39.52, it had shed nearly $27 billion in market value.

The rest of the sector has suffered just as badly, with market capitalisation losses totalling a further $75 billion for the likes of Westpac, ANZ, NAB and St George.

And while Australia has largely escaped the "bloodbath" seen in the global financial capitals of New York and London and as described by the ANZ's Michael Smith last month, the crisis has certainly started to ooze into the major banks' balance sheets.

Is this a blip or just the beginning?

PUT THAT same question to seasoned observers and the answer is the same. They just don't know.

Deutsche's David Backler believes part of the answer lies with the banks, particularly those globally that have had massive write-downs, with the prospect of a lot more to come.

"The market is still dealing with the new liquidity conditions in real time and it will be a while before things settle and people start acting less reactively." And that probably means, he argues, more re-adjustments and possible asset write-downs.

His colleague, Marla Heller, who heads Deutsche Australian and New Zealand leverage finance division concurs. "This credit dislocation has affected the banking sector much more than was originally expected." It "has significantly altered the fundamentals of the sector resulting in a recalibration of pricing and terms".

For Curt Zuber at Westpac, the landscape of doing business has changed. "Liquidity has been redefined," he states baldly. "Duration that was there yesterday is hard to come by. Volume that was there yesterday is evaporating," which presented challenges both for borrowers and investors.

Many in the market "found that securities previously very liquid can't be sold in stressed conditions. Credits that normally could be bought and sold with a quick phone call at a fraction from mid-market, are no longer trading, at any price. And perhaps just as importantly, market intermediaries are no longer holding large inventories. This has greatly reduced secondary market trading and pressured primary market performance."

With the US staring into the abyss of recession, what we have seen already could indeed just be the start. Smith said yesterday the global economy was weakening on the back of an international financial system in turmoil.

What they fail to note is that many, many people far more "au fait" with the workings of these things have for years now been identifying many fingers of instability in the system that have contributed to the current landslide of liquidity.

As each such finger was mentioned, the financial geniuses of this age poo-pooed the very notions and the markets careened ever higher.

Guambat has not come up with one of them, himself, but has, over the last couple of years, passed along his observations that others have made.

It is an unsatisfactory smugness knowing that these geniuses are now having to pony up their margin calls. But having had to pony up margin calls of his own on the bet that this would unwind sooner than it did keeps that little spirit of revenge-at-last dancing on Guambat's shoulder.

But to put those base emotions to one side, and avoid an "I told you so" taunt, it is worth going back to that central model of instability mentioned by Guambat 2 years ago to obtain a less panicked perspective on the "international financial system in turmoil".

Thursday, March 06, 2008

Oh, you so fat now!

Guambat has tended to the apple shape in the two decades since he was 40 and moved from Guam to Sydney. As Cactus Jack might say, he'd gotten a bit "corporate". Guambat managed to avoid the mid-life crisis but ran smack dab into the mid-riff one.

On returning to Guam his old Western friends might express something along the lines of "life's been good to you" or the like, with a digging little chuckle. His old Asian friends were just as likely, or more so, to say "Oh, you so fat now!", with a big belly laugh.

So who was being rude?

Neither, Guambat reckons. They're just both cultural filters used to express the obvious truth, and any rudeness must be in the ears of the beholder.

Guambat has previously reported on the "Beautiful Country" WSJ column written by Li Yuan, recommending its delightful insights borne of new perspective. She's given us another one today, and Guambat again recommends it to you.

Why 'You Look Great' Doesn't Translate in China
Shortly after I arrived in the U.S., I felt great about myself. Many of my professors at Columbia University's Journalism School wrote "well done!" or "nice job" on my assignments. That was music to the ears of a foreign student who felt like a fool most of the time in a new environment. And it was also the first time in my life had I gotten so much positive feedback for anything I did.

Before long, I found that the professors made those same sort of comments to many other students. If everybody got the same comments, what was the point?

Traditional Chinese wisdom holds that we will lose our motivation to succeed if we're satisfied with ourselves and not worried about our future all the time. We are taught to be modest and not to hold our head too high in front of others.

Chinese parents may be generous in saying nice things about other people's children, but most avoid praising their own children directly to guard against arrogance and self-conceit. At school, teachers may praise a good student in front of the whole class but rarely in person. In the office, young professionals aren't looking for thank-you notes. They often feel lucky for not getting yelled at by managers. As a result, Chinese tend to be driven and hard-working but some of them may not be as confident as their American counterparts.

Americans, on the other hand, always try to project optimism and confidence. Ask them, "how are you?" you'll probably hear "great," "good" or at least "fine." "OK" isn't even considered upbeat enough. And it's not just that. Many Americans are also willing to make an effort to make others feel good. "You look great today," is a default greeting for many people. Even when a manager summons staff into the office to discuss things not done properly, the conversation is likely to start with what the employee had done right. Self-assured Americans dare to ask any question and try anything. But some of them are reluctant to blame themselves when things go wrong.

As I looked deeper into America's tendency to heap on the praise, I discovered it's a fairly recent phenomenon and pretty much of a generational thing.

Amy Reed, a 42-year-old editor in Knoxville, Tenn., remembered that at her school, they got awards only when they actually placed in the top three and showed real skill or talent. But, at her children's school, everyone got a ribbon for participating in the science fair, regardless of whether the exhibit was any good. And at a gymnastics event, everyone got a trophy just for participating.

They're praised for everything. Some say this is a generation that wants to be praised for getting up every morning.

Guambat reckons its because Mummy and Daddy were so effusive with the praise for doing so, and so recalcitrant to apply a bit of discipline when they didn't, that caused the problem.

Don't blame the kids, blame the "don't say no" crowd. And try a little, just a teeny little, judiciously applied, honesty. "Teach your children well", as CS&N sang.

Guambat reckons Mr Happy Face has a lot to answer for. Remember when you first saw that insipid, blank face and wanted to punch its cheery lights out? So when was it that you started adding emoticons and :-) to your messages?

Guambat is almost certain he saw a brawl start when one bloke said to another, "YOU have a nice day, now", and then the other retorted, "No, YOU have a nice day, now", and then it all got out of hand.

Guambat will be going walk about (more like island-hopping about) pretty soon until the end of the month, so bids you g'day and happy trails for now.

And for Guambat's sake, have a nice day if you must, but don't shove it down everyone's throat.

Saturday, March 01, 2008

Yes, that makes your bottom look bigger

Barry Ritholtz asks, "Is the greater fear getting stuck with stocks that move lower -- or missing any rally?"

The anecdotal bits that come Guambat's way suggest many people are still rubbing their hands to jump on the "chance" to buy some cheap stocks or indexes.

It's when they start wiping their collective brow that the market will be cheap enough.

Barry says he's working up a piece on what market bottoms really look like, and Guambat hopes he doesn't miss it.

Which he might. You won't be reading much of Guambat until April.

Not that there are that many "youse" out there reading Guambat anyway.

$10 Billion Gaap between model and market

David Gaffen of the WSJ MarketBeat blog explains as how that $1 billion dollar loss earlier announced by AIG is not as bad as announced.

No sir, it's eleven times worse. It's "an $11 billion write-down in derivatives exposure to subprime debt that was originally estimated at a $1 billion loss".

The losses are related to the company’s exposure to what’s known as the “super senior” tranches of subprime debt.

The company says these losses are “not material”.

Because the losses may not materialize, — the mark-downs reflect expectations of default, not actual defaults — Morgan Stanley analysts say this should reverse, and they estimate perhaps a $900 million eventual actual loss, rather than the $11.25 billion “cumulative unrealized mark-to-market valuation losses embedded in the GAAP results recorded thus far.”

Guambat's broker calls that a "margin call", and it feels pretty material to Guambat.

The penny dropped

Guambat was amused and delighted by all the pretty little coins with exotic animals on them when he moved to Australia. Then he began to get holes in his pockets as all those coins bulged up, from pennies to pounds. There were not only pennies but two-penny coins as well.

Then Australia dumped the pennies, and two-pennies alike. Not dumped as in cutting a hole in the centre, but dumped as in dumped. Turns out it made sense to end the minted cents, and they haven't looked back since.

Coming back to America, with its plentiful pennies from heaven, was like running into an old friend you just rather wouldn't hadda done. They just aren't as lucky or useful as they used to was. Haven't even seen one in a Weejun in don't know how long.

So, those types of observations coupled with the commodious price of commodities has some folks renewing "the call" to dump the US penny.

But the Treasurer says he has too many other things on his plate at the moment.