Tuesday, September 30, 2008

How that effects this globalisation that we’re a part of

If you're too busy wiping the tears of laughter from your eyes to keep up with her, here's the transcript, courtesy of FT Alphaville:
Katie Couric: Some top republicans and democrats, may not support this bill if Senator John McCain doesn’t because it may be unpopular and they’re not willing to take the political risk. If it doesn’t pass, what is the alternative?

Gov. Palin: Th..the alt.. as I say inaction is not an option we have got to shore up our economy. This is crisis moment for America. Really the rest of the world also. Looking to see what the impacts will be if America were to choose not to shore up what has happened on Wall Street because of the…the ultimate adverse effects on Main Street and then how that effects this globalisation that we’re a part of on… in our world. So the rest of the world really is looking at John McCain - the leadership that he’s gonna provide through this and if those provisions in the proposal can be implemented and make this proposal better make it make more sense to taxpayers than again, John McCain is gonna prove his leadership.

But ultimately what the bailout does is help those who are concerned about the healthcare reform that is needed to help shore up our economy um helping the… oh - its gotta be all about job creation too - shoring up our economy and putting it back on the right track. So healthcare reform and reducing taxes and reigning in spending has got to accompany tax reductions and tax relief for Americans and trade we’ve got to see trade as opportunity not as competitive um scary thing but one in five jobs being created in the trade sector today we we’ve got to look at that as more opportunity - all those things under the umbrella of job creation - this bailout is a part of that.


Palin Says Couric Interviews Colored by Annoyance

"The Sarah Palin in those interviews was a little bit annoyed," the Alaska governor told Carl Cameron of Fox News today. "It's like, man, no matter what you say, you are going to get clobbered. If you choose to answer a question, you are going to get clobbered on the answer. If you choose to try to pivot and go to another subject that you believe that Americans want to hear about, you get clobbered for that, too."

The Fox interview may represent a new Palin media strategy of making her available to journalists and commentators deemed more sympathetic.

Yeah, maybe. Maybe she's just trying to to fairly catch her balance after stumbling so horribly.

Titanic Panic

Guambat is amused but not humoured by the rapid, raised and razzled voices on CNBC as the DJIA plunges, off over 500 points as Guambat posts. The buzzword/buzzphrase seems to be "demand destruction".

Well, Guambat Pellets! There is no more, or less, "demand" destruction than there was demand concoction, attributed to the inscrutability of insatiable Chinese growth over the last several years, but in reality being the bulging derivative debt, as discussed in that last post.

This is de-leveraging, plain and simple. If there was any truth to the story of fundamental growth in the Chinese, Indian, etc. countries, that will remain, burdened in some small way by the waning US consumer, but bolstered by the longterm growth curve of those huge and developing economies that are more internally growth oriented as every year passes. Real demand will put a floor on this financial meltdown, at some point, which might not occur until just as the last lemming passes over the cliff.

It will be very instructive to clear the deck of the Titanic debt overload to see what the real, fundamental demand of those countries is, without the skewing influence of all the front-running speculation that the financial bust-up dust-up has created.

Now de-leveraging, however plain and simple, like everything else, can create its own serious problems if taken to extreme. It is a problem that will have to be addressed. But we must not confuse the issues by suggesting demand is being destroyed. Most of what was passed off as demand in the first place was simple financially engineered bloat.

The economic treatment and therapy for debt obesity is entirely different from demand anorexia.

Lessons derived derivatively

With the prospect, though not inevitability, of another Greatish Depression upon us, some are trying to write of the lessons to be learnt from recent events.

The ever-analytical Brits, for instance, at FT.com have this commentary bylined as analysis:

Washington’s waning way: how bail-outs poison a free market recipe for the world
Reluctant liberalisers around the world now have a great deal more ammunition when faced with American visitors saying: “We’re from Wall Street and we’re here to help.”

A model of freewheeling finance the US has pushed around the world, which had already undergone some tactical withdrawals over the past decade, appears in headlong retreat.

That package may have started with advocating lower import tariffs on goods, a policy which commands relatively wide support among orthodox economists. But it has expanded to include more controversial strategies: allowing foreign institutions to buy local banks or set up their own subsidiaries, deregulating domestic financial markets and ending controls on cross-border capital movements.

Jagdish Bhagwati of Columbia University, a leading trade economist, has long warned that this is a dangerous confusion of liberalised financial markets, which are subject to repeated bubbles, panics and crashes, and the international movement of goods and services, which is not. Yet in practical terms the two have often been bundled. Washington has sought, for example, to export its own financial model through its trade deals.

This, Mr Bhagwati says, is the result of a “Treasury-Wall Street nexus” that has an irrevocable attachment to deregulation. “Wall Street tries to exert pressure on US policy in a big way wherever possible,” he says. “It is an ideological commitment. You are made to feel like a socialist freak if you argue against any part of it.”

Yet such liberalisation often still forms an important part of Washington’s international economic diplomacy, embedded as it is in its trade policy. US financial services companies have traditionally been among the more enthusiastic lobbyists for trade deals.

Yes, there is anger in Berlin and Paris at Washington’s refusal – up until after the outbreak of the subprime crisis – to heed European calls for more regulated markets.

“We must civilise financial markets, and not just through moral appeals against excess and speculation.”

Nicolas Sarkozy, the French president, said the world would have to learn the lessons of the financial crisis and rethink the values and practices of globalisation. This would mean shifting the emphasis from speculation to entrepreneurship and restoring a proper balance between the market and the state.

“The market economy is a regulated market, a market that is at the service of development, at the service of society, at the service of all. It is not the law of the jungle,” he said, predicting the end of laisser faire capitalism.

“The lesson is not that there were too many innovations in the US and so we should not innovate at all ... It is wrong to say that all these sophisticated products are just bad things,” says Fang Xinghai, director general of Shanghai’s Financial Services Office. “If we learn the lessons [of the crisis] we may even speed up financial reforms because we will know the kind of precautions we will need.”
Problem is, these "lessons" were already part of the syllabus. It's just that the rowdy boys on Wall Street didn't come in from recess and only attended the rocket science 101 classes, failing to show up for the afternoon session on how not to blow yourself up.

You'd think they'd been to a jihadist madras rather than a business school and never made it past the suicide belt tailoring class.

At the pleasurable risk of saying "I told you so", the writing of these lessons was written on the chalk boards years ago. For instance:

March 16, 2006
Say you're in your garage of a Saturday night, sitting around the card table with your mates, knocking back a few tinnies and playing a bit of cards. Most of the bets are done with coins.

When in walks a very savvy looking kinda bloke, with a big wad of notes and wants in. Do you reckon it would change the character of the game? You betcha it would.

In ways I cannot put together in a coherent, scholarly study, I have noticed a distinct change in the character of the equity markets over the last decade. It is becoming dominated by big, lightning quick money. Oh, the Big Boys have always had a major impact, and in that regard there is nothing new. They've always enjoyed their power to push the market this way or that. They've always enjoyed a clubiness that allowed for information to be shared in ways that didn't quite pass the "insider trading" bright lines. But they usually bought stuff to own it, to manage it, to work it, to put it in thieir trophy room.

But these new guys are not just big bullies; they're bold, cold Matrix-like machines. Just listen to CNBC at the number of times they mention how dominant block trading has become. Do you remember the term "hedge fund" being common parlance more than a decade ago? What about "black box" trading?

A black box is not some fatcat in a pin-striped suit and a big cigar. It is a streak of cyberdata, a stateless, motherless virus hellbent to ambush, arbitrage and retreat faster than a ninja.

And they are everywhere, in to everything. Their bytes permeate every conceivable market, like a monstrous whale seiving the nutirients and little, bottom-of-the-food-chain investors and small players from the oceans of cash that trade the world's goods.

They derive their gains from diverse derivatives of incalculable numbers and varieties, trading the shadows of what used to be a currency or a commodity or a stock or a bond, but now come under the most obtuse and arcane of names that only financial rocket scientists can understand. Their trade is in ideas and concepts and notions and algorithms, not things and companies.

And, importantly, these new guys push around greater wads of money than the old fashioned pin-striped broker because they don't have to use as much (if any) of their own money, and the "products" they deal in control vastly greater amounts of the "real" underlying stuff than that stuff would cost in its own markets.

May 08, 2006
Mr. Li is a Stanford professor widely credited with developing a computerized model that helped turn credit derivatives into the fastest-growing segment of a $270 trillion global market. Ms. El Karoui is a French mathematics professor whose courses have become, as the Journal noted, "an incubator for experts in the field."

Both have warned that some of those who buy and sell these complex instruments don't fully understand the risks involved. Instead of reducing their exposure to unwanted perils, they may well be adding to it.

Making matters more difficult, however, is the fact that the value of certain complex varieties, such as options, asset-backed securities, and credit-default swaps, depends on many inputs. That often necessitates the use of complicated formulas and high-powered computers, especially when portfolios of derivatives are involved.

Yet the mathematical certitude this conveys is misplaced. In truth, pricing often depends on fickle or otherwise fast-changing financial relationships, less-than-adequate histories of how certain markets will perform under a wide range of scenarios and guesstimates about how volatile conditions will be in future.

That means a major financial institution with significant derivative exposure could easily find itself hit with a very expensive and potentially destabilizing loss if even one of its assumptions is wrong

A lack of transparency and inadequate regulation, particularly where OTC derivatives are concerned, make it difficult to identify where the dangers lie. Historically, banks, Wall Street firms and hedge funds have been left to their own devices, on the assumption they were sophisticated operators who would act appropriately.

The fear is not derivatives, but the misuse of derivatives via too much leverage.

The take-away here, from my point of view, is that someone's misuse of the product, which is likely to happen, has a very low probability of triggering a widespread meltdown.

the notional value of derivatives outstanding is approaching the $300 trillion mark.
[Guambat here notes, for those who think the current demand for $0.7 trillion dollars to be used by the US Treasury to "stabilize" the US financial system may be way, way too much, might consider the possibility that it is way, way too little.]
At the same time, risk has become more concentrated with respect to firms, markets and "events." In 1997, for example, the 10 largest banks controlled less than 34% of industry assets; by 2005, it was 44%. At the end of last year, the top five banks accounted for more than 96% of outstanding derivatives contracts versus 83% in 1998. And reportedly, there are more than $200 billion of credit default swaps riding on the financial health of General Motors alone.

Moreover, increasing sophistication and an aggressive hunt for higher returns have spurred hedge funds and proprietary trading desks to exploit a growing array of intermarket arbitrage opportunities, which frequently depend on derivatives to circumvent structural and operational hurdles.

More important, perhaps, is the fact that despite their differences, the one thing many synthetic securities have in common, as Roger seems to have alluded to earlier, is an inherent leverage component. In that respect, he may have made a more salient point. Maybe derivatives won't be the trigger for financial disaster. Maybe they represent just one small part of a far greater threat: too much debt.

Now that is a problem that has led to financial Armageddon--again and again throughout history.

May 03, 2006
COPPER users have threatened to turn their backs on the London Metal Exchange, alleging hedge funds are driving copper prices to speculative extremes that no longer reflect supply and demand.

In a letter to the LME and the Financial Services Authority, the International Wrought Copper Council said that its members faced severe difficulties financing deliveries.

"This market, where speculators can buy what does not exist, is doing serious damage to our industry

"This is a feeding frenzy driven by hedge fund speculation. This would not be happening if the price was left purely to industrial supply and demand.

May 08, 2006
excess begets more excess. It is not momentum anymore; it is a game of chicken.

Commenting on the commodities market in general, Buffett said: "What the wise man does at beginning, the fool does in the end... any asset that has a big move based on fundamentals will attract speculators..."

"At the start of the party, the punch is flowing, everything's going well, but you know at midnight it's all going to turn into pumpkins and mice," he said.

"The problem is that, in commodities there are no clocks on the wall," he added. Buffett said Berkshire didn't make any money on his silver investment because he "bought it very early and sold it very early. Other than that, everything I did was perfect."

Tuesday, September 23, 2008

Much indebted to ya

Mrs Guambat eats books. One of her authors of choice is Margaret Atwood. Mrs Guambat would happily have one of hers for lunch.

The WSJ carried an article written by her today. Marching to the meme du jour, it was about debt, delightfully entitled Debtor's Prism.
The hidden metaphors are revealing: We get "into" debt, as if into a prison, swamp, or well, or possibly a bed; we get "out" of it, as if coming into the open air or climbing out of a hole. If we are "overwhelmed" by debt, the image is possibly that of a foundering ship, with the sea and the waves pouring inexorably in on top of us as we flail and choke. All of this sounds dramatic, with much physical activity: jumping in, leaping or clambering out, thrashing around, drowning. Metaphorically, the debt plot line is a far cry from the glum actuality, in which the debtor sits at a desk fiddling around with numbers on a screen, or shuffles past-due bills in the hope that they will go away, or paces the room wondering how he can possibly extricate himself from the fiscal molasses.

In our minds -- as reflected in our language -- debt is a mental or spiritual non-place, like the Hell described by Christopher Marlowe's Mephistopheles when Faust asks him why he's not in Hell but right there in the same room as Faust. "Why, this is Hell, nor am I out of it," says Mephistopheles. He carries Hell around with him like a private climate: He's in it and it's in him. Substitute "debt" and you can see that, in the way we talk about it, debt is the same kind of placeless place. "Why, this is Debt, nor am I out of it," the beleaguered debtor might similarly declaim.

Which makes the whole idea of debt -- especially massive and hopeless debt -- sound brave and noble and interesting rather than merely squalid, and gives it a larger-than-life tragic air. Could it be that some people get into debt because, like speeding on a motorbike, it adds an adrenalin hit to their otherwise humdrum lives? When the bailiffs are knocking at the door and the lights go off because you didn't pay the water bill and the bank's threatening to foreclose, at least you can't complain of ennui.

It's the kind of article that can almost give debt a good name, much in the same way that hedge funds and the investment banks uplifted "leverage" to a holy grail.

And Guambat wonders if that is a good thing. How can we concoct stories for the grandkids, or live them through, about meanness and despair in a time of desperation if it's all just a plot line, merely "one damn thing after another, as we glibly say in creative writing classes", as Atwood frames it?

Perhaps it's the difference between living the blues and singing the blues, but Guambat reckons this is not going to be much of a depression if we're already singing the blues before we live them. If market bottoms are born of window-jumping fear and anguish, we're not going to put one in as long as we trivialize and alienate the actor from the antagonism.

Which is not to take away from Mrs Guambat's mid-afternoon snack on an Atwood short tale. Her discussion of debt as game and storyline, her "conversation" with Scrooge, are all engaging and well told. It's a pleasant diversion, and the sidebars about the literature and history of debtors provides a relishing touch of presentation.

Monday, September 22, 2008

What the hell kinda system is it when ...

... a lot of people were dependent upon each other?

I dunno ahso.

But it must be really, really treacherous. Or so it must seem to President Bush.

This from his recent joint communique/press conference with Columbian President Uribe:
look, I'm sure there are some of my friends out there saying, I thought this guy was a market guy; what happened to him?

My first instinct was to let the market work until I realized, upon being briefed by the experts, of how significant this problem became.

And so I decided to act and act boldly.

It turns out that there's a lot of interlinks throughout the financial system.

The system had grown to a point where a lot of people were dependent upon each other, and that the collapse of one part of the system wouldn't just affect a part of the financial markets; it would affect the average citizen -- and how.

Well, it affect their capacity to borrow money to buy a house or to finance a college loan.

It affect the ability of a small business to get credit.

In other words, the system risk was significant, and it required a significant response, and Congress understands that.

And we'll work to get something done as quickly and as big as possible.

I told our people I don't want to be timid in the face of a significant problem that will affect the average citizen.

You know, some said, this is -- we can contain this to just the financial community.

In my judgment, based upon the advice of a lot of people who know how markets work, this wasn't going to be contained to just the financial community.

You know, you hear them talking about Wall Street and Main Street -- well, this is Wall Street plus Main Street

I asked Hank Paulson -- I said, what's it going to take to make sure Main Street doesn't get affected by the policies of Wall Street? And this is what they came up with, and this is big ticket, because it's a big problem.

And I understand it's important to have confidence in a financial system. And so the move, as well, is to say, we understand the significance and the depth of the problem.

creative destruction, in my judgment, wouldn't work. This requires a -- you know, it required addressing certain problems.

At first I thought we could deal with this -- deal with the problem one issue at a time.

We made the decision on Fannie and Freddie because there was systemic risk to our mortgage markets.

And then obviously AIG came along --

and Lehman came along and it was -- it declared bankruptcy;

then AIG came along and it --

the house of cards was much bigger, beyond --

started to stretch beyond just Wall Street,

in the sense of the effects of failure.

And so when one card started to go, we were worried about the whole deck going down, and so therefore moved, and moved hard.

And we took our time to come up with a strategy and a plan that would address the problem. And you bet it's big, because it needed to be big.

And in my -- sometimes in my line of work you get criticized. But the American people have got to know that I made this decision

We got smart, capable people; our workers are great; small business sector is thriving and vibrant; we're productive people.

And, you know, I know a lot of people here in Washington, Mr. President, saying, well, who to blame? Now is not the time to play the blame game.

And so, there you have it.

The American financial system is a house of cards. What the hell kinda system is it?

And you, dear reader... You who have not, despite the despair and destruction, thrown yourself out the window onto the Wall Street below...

Now are you ready?

Please don't.

At least until after you vote.

God forbid America would hold this election and no one came.

Rest in pieces, Glass-Steagall

Our grandparents' generation felt it worthwhile to separate bankers from card dealers to prevent banks from imploding like a house of cards.

But then, they had the fear and experience of the Great Depression as their mentor. Today's economy is a not so great one, just your run of the mill laconic affair.

Guambat wrote last week about the demise of Glass-Steagall and the return of the banking dinosaurs.

Events of this last weekend, in addition to draining the credit default swamp, also put some flesh on those dinosaur bones:

Goldman, Morgan to Become Full-Fledged Banks
Goldman Sachs and Morgan Stanley, the last two independent investment banks, will become bank holding companies, the Federal Reserve said Sunday night, fundamentally altering the landscape of Wall Street.

Announced without fanfare on Sunday night, the move signals the final end to the Glass-Steagall Act, the epochal legislation of 1933 that signaled a split between investment banks and retail banks.

The move fundamentally changes one of the mainstay models of modern Wall Street, the independent investment bank, soon after the federal government unveiled the biggest market intervention since the New Deal. It heralds new regulations and supervision of previously lightly regulated investment banks, as well as an end to the outsized paychecks that underpinned the traditional image of the chest-thumping Wall Street banker.
Guambat read that last sentence with a bit of a sputter.
By becoming bank holding companies, Goldman Sachs and Morgan Stanley ... lays the groundwork for additional deal making. Given the expected bank failures this year, it is possible Goldman and Morgan Stanley could seek to buy them cheaply in a “roll-up” strategy.

Being a bank holding company would also give the two [continuing] access to the discount window of the Federal Reserve.

Goldman said that it will now become the nation’s fourth-largest bank holding company, with its small existing deposit-taking units to be rolled into GS Bank USA. Morgan Stanley will convert its Utah industrial bank into a deposit-taking national bank, to be called Morgan Stanley Bank.

Guambat fears the Fed hasn't the resources or resolve to regulate these behemoths, and that the SEC model will prove to be the default choice.


This SECs

Guambat missed this story last week, but caught up via John Mauldin via Barry Ritholtz. Before proceeding, recall that America started out this year with 5 large broker-dealers: Goldman Sachs, Morgan Stanley, Merrill Lynch, Bear Stearnes and Lehman Bros. The last 3 have left the building, the remaining 2 are buckled but standing, so far.

Ex-SEC Official Blames Agency for Blow-Up of Broker-Dealers
The so-called net capital rule was created in 1975 to allow the SEC to oversee broker-dealers, or companies that trade securities for customers as well as their own accounts. It requires that firms value all of their tradable assets at market prices, and then it applies a haircut, or a discount, to account for the assets' market risk. So equities, for example, have a haircut of 15%, while a 30-year Treasury bill, because it is less risky, has a 6% haircut.

The net capital rule also requires that broker dealers limit their debt-to-net capital ratio to 12-to-1, although they must issue an early warning if they begin approaching this limit, and are forced to stop trading if they exceed it, so broker dealers often keep their debt-to-net capital ratios much lower.
That rule was so relaxed it fell asleep in 2004 under the Bush Administration's SEC.
Using computerized models, the SEC, under its new Consolidated Supervised Entities program, allowed the broker dealers to increase their debt-to-net-capital ratios, sometimes, as in the case of Merrill Lynch, to as high as 40-to-1. It also removed the method for applying haircuts, relying instead on another math-based model for calculating risk that led to a much smaller discount.

The SEC justified the less stringent capital requirements by arguing it was now able to manage the consolidated entity of the broker dealer and the holding company, which would ensure it could better manage the risk.

"The Commission's 2004 rules strengthened oversight of the securities markets, because prior to their adoption there was no formal regulatory oversight, no liquidity requirements, and no capital requirements for investment bank holding companies," a spokesman for the agency, John Heine, said.

In addition to computerizing the risk calculations, the new program required time-consuming oversight of the broker dealers by SEC officials, and in many cases, the use of subjective judgment calls.

"An important component of the CSE program is the regular interaction of Commission staff with senior managers in the firm's own control functions, including risk management, treasury, financial controllers, and the internal auditor, as well as onsite testing to determine whether the firms are implementing robustly their documented controls," SEC chairman Christopher Cox testified in a hearing of the House Committee on Financial Services in July.
Guambat rather doubts that it is mere coincidence that the only broker-dealers who qualified to take advantage of those 2004 rules were those same 5 Names.

For its part,
The SEC said it has no plans to re-examine the impact of the 2004 changes to the net capital rule....
"The SEC modification in 2004 is the primary reason for all of the losses that have occurred," former SEC official, Lee Pickard,, who is now a senior partner at the Washington, D.C.-based law firm Pickard & Djinis, said.


Bloomberg has quite an extensive examination of Chairman Cox, which includes an aside about Paulson, in this Exclusive: Cox `Asleep at Switch' as Paulson, Bernanke Encroach (Update1).

The article points out that Cox has received judgments of about $100 million against violators, chiefly the easy to pick stand-outs from the stock option back dating days. But that sounds like a pretty good record.

Until you consider his predecessor:
Cox is the third SEC chief appointed by Bush. Unlike his two predecessors -- Pitt, a prominent securities lawyer, and William Donaldson, former CEO of the New York Stock Exchange -- Cox had little background in the securities industry when he took office in August 2005.

Cox was named head of the SEC -- Vice President Dick Cheney offered him the job -- in the wake of years of scandal that led to the Sarbanes-Oxley law and a raft of new regulations.

Donaldson, who served from 2003 to '05, also battled with Republican commissioners Paul Atkins and Cynthia Glassman over their opposition to imposing multimillion-dollar fines on public companies for fraud, misrepresentation and accounting violations.

Under Donaldson, total penalties increased 10-fold to $3.1 billion in fiscal 2005 from two years earlier.

According to a person who worked with him, Donaldson was pressured by aides to Cheney to jettison a proposal to make it easier for shareholders to pick corporate board members.

The message, one former top Donaldson staff member says, was that this was not the policy of the Republican Party.

As for Paulson, he took office determined to relieve the financial services industry of some of the burden of the new regulations imposed by Cox's predecessors, as he made clear in his first speech as Treasury secretary in August 2006.

The next month, he issued a statement backing the Committee on Capital Markets Regulation, a group that sought to amend the 2002 Sarbanes-Oxley Act, which imposed new strictures on corporate boards and managers.

In 2007, Paulson set up a panel to examine the pressures on the auditing industry, another area under the SEC's jurisdiction. The group is co-chaired by ex-SEC Chairman Arthur Levitt and Donald Nicolaisen, who headed the agency's accounting office from 2003 to '05. "It seems clear the Treasury Department is intruding," says former SEC chief accountant Turner.

Then, in March of this year, came the Treasury Department's ``blueprint'' for restructuring federal regulation of the financial industry, which called for the merger of the SEC with the Commodity Futures Trading Commission.

Since then, Paulson the deregulator has evolved into Paulson the interventionist, with his shepherding of the Bear Stearns takeover by JPMorgan and the government's appropriation of American International Group Inc. and federally backed mortgage packagers Fannie Mae and Freddie Mac.

Cox says he wasn't consulted about Treasury's plan for merging the SEC with the CFTC and doesn't think Congress will enact it.

Meanwhile, Henry Paulson is moving ahead with his plan for a regulatory overhaul that would abolish the SEC.

The SEC will celebrate its 75th anniversary in 2009.

Friday, September 19, 2008

Wanted: a roll of 2-ply commercial paper

Problems with the commercial paper market are back.

It seems the markets are once again throwing up thin trade-sheets of commercial paper, and its making a mess of things. You don't want your fingers poking through credits when you're relying on asset-backed paper.

Commercial Paper Market Roiled
The U.S commercial paper market shrank by a whopping $52.1 billion in a week of financial turmoil where investors shied away from investing in short-term debt, according to data released by the Federal Reserve Thursday.

according to a note from Moody's Credit Trends, "Any further significant erosion to the commercial paper market would remove or raise the cheapest borrowing options available to many corporations,"

On Thursday morning, investors -- mostly money market funds -- are not buying commercial paper, according to a trader at a primary dealer.

"There is a buyers' strike," he said, adding that these funds are holding back on buying commercial paper "in anticipation of redemptions." In the asset-backed corner of the market, funds have begun "pulling money out."

Money has flowed out of money market funds this week as investors fear that their funds may not even be safe in what had been considered an equivalent to cash. Sparking concerns this week were troubles at the Primary Fund, a $62 billion money market fund that is part of the Reserve Fund, that "broke the buck" -- or had the value of its shares fall below par -- on Tuesday.
Guambat recalls an old slur, "as useless as John Wayne toilet paper". What's that, you ask? Well, John Wayne wouldn't take sh!t off nobody.


Oct 2 (Reuters) - The U.S. commercial paper
market contracted dramatically for a third straight week as
business lending and borrowing effectively shut down, Federal
Reserve data showed on Thursday.
The weekly drop was the largest in at least seven years for
commercial paper, which is a vital source of short-term funding
for daily operations at many companies. Over a quarter of the
market has disappeared since the start of the global credit
crisis in the summer of 2007.
For the week ended Oct. 1, the size of the U.S. commercial
paper market fell by $94.9 billion to $1.607 trillion, from
$1.702 trillion the previous week, Federal Reserve data showed.
That brings the cumulative shrinkage of this market to $208
billion in the last three weeks, including the previous week's
$61.0 billion fall.
"There is almost no area of credit markets or even of the
banking system where companies are raising money -- banks are
not lending, it's just unbelievable," said Tony Crescenzi,
chief bond market strategist, Miller, Tabak & Co. in New York.
And the dire situation for company funding could get worse,
Crescenzi warned.
"Commercial paper matures on average within 30 days to 45
days. There are lot of rollovers to come. It could be very,
very problematic if this isn't fixed soon," he said.
"This is a direct link between the credit market turmoil
and the real economy," said Lou Brien, market strategist at DRW
Trading in Chicago.
As an example of how the lock-up in commercial paper is
hurting companies, the Wall Street Journal reported on Thursday
that USA Today publisher Gannett Co Inc had drawn on a
$3.9 billion credit line due to the stalled short-term credit

For what it's worth

There's something happening here
What it is ain't exactly clear

Paranoia strikes deep
Into your life it will creep
It starts when you're always afraid
You step out of line, the man come and take you away

We better stop, hey, what's that sound
Everybody look what's going down

-- Buffalo Springfield

When even "permabears" start to chill at the thought of how much carnage there's been of late, and the chasms of despair and destruction that have opened up by the rupture in the credit markets, perhaps it should not be surprising that they turn their thoughts to the rapture envisioned by those whose very reason for being is to bring it all tumbling down, every last mother and child.

Maybe it shouldn't be, but it is. Really, this is just a very serious market meltdown. We only flatter the power and foresight and evilness of the "Dark Forces" when we utter, in hushed tones, the phrase "terrorists".

Thus, Guambat was gobsmacked to read his lodestone's blog,
Terror Attack on US Financials? Joe is a thoughtful money manager, a great stock picker, and a thoughtful guy. He raised an intriguing issue: None of the many hedgies he knew were pressing there bets. The recent bear raids on the financials were NOT a case of piling on by US funds. And from what he was seeing and hearing about in terms of order flow, the vast majority of the recent finacial short selling was being done overseas. Through the grapevine, itm appears the lion's share of shorting was coming out of overseas bourss, such as London and Dubai.

Then there is the coincidence of the huge increase in shorting the financials occurring on the anniversary of 9/11. And on top of that, the same institutions attacked on 9/11/01 were the ones suffering in recent days.

Joe asks the question: MIs anyone investigating whether this is a case of financial terrorism?

its an interesting theory, one that seemed kinda out there -- until last nights emergency action. Nothing else really explains the insanity of banning short sales
Ah, that's not paranoia, that's just Barry's hyperbolic way of pointing out how positively ludicrous it might be to continue to blame this implosion on short-sellers.
The grand irony of all this is that Naked Shorting has been very profitable for the big broker dealers, like Morgan And Goldman and Merrill and Lehman.

If you want to know who to blame for the past 5 years of naked shorting, you only have to places to look: The financials themselves, and the nonfeasance of a feckless SEC.
As Guambat has said before, it may be ludicrous, and it may be punitive to some to crack down heavily on them in their moment of glory, and it may lack the symmetry that would be required to "prick the bubble" before it bursts, there are certainly times when reins need to be tightened on all horses to keep the carriage from careening over the cliff.

For what it's worth.

FOLLOW UP 20 Sept:

Barry's alluring cynicism popped up in this post, as well:

The "New" New Deal
If you are a fan of irony, consider this: The conservative movement has utterly hated FDR, and his New Deal programs like Medicaid, Social Security, FDIC, Fannie Mae (1938), and the SEC for nearly 80 years. And for the past 8 years, a conservative was in the White House, with a very conservative agenda. For something like 16 of the past 18 years, the conservative dominated GOP has controlled Congress. Those are the facts.

We now see that the grand experiment of deregulation has ended, and ended badly. The deregulation movement is now an historical footnote, just another interest group, and once in power they turned into socialists. Indeed, judging by the actions of the conservatives in power, and not the empty rhetoric that comes out of think tanks, the conservative movement has effectively turned the United States into a massive Socialist state, an appendage of Communist Russia, China and Venezuela.

To paraphrase Floyd Norris, we have become Marxists, but of the Groucho, not Karl, variety . . .
Floyd Norris also said, in that link, and consistent with Guambat's prior post:
It is a sad commentary that the authorities are most worried about a market that they were unwilling to do anything about when it was growing and growing.

Alan Greenspan, then the chairman of the Federal Reserve, thought it would be wrong for regulators to try to, as he frequently said, “outguess the market.”

There's more from that Floyd Norris article in the follow up to The Creature from the Credit Default Swamp, which provides the best explanation Guambat has read of what credit default swaps are and how they were misused. Highly recommended reading.

When all roads only lead out

Houston has millions of inhabitants, counting all the contiguous towns and communities which spread outward from it, cancerlike, down to the coast and east to the bayous.

When major hurricanes come its way and all those folk need to get out, the authorities make all the major roads one-way, leading outward, temporarily. If you must go the other way, you have to rat-run the minor roads.

It was something analogous to that that the UK Financial Services Authority invoked today, reversing the tide of the market and prevent it from spiraling down the whirlpool it had become.

Some might view this as dastardly, others more prophylacticly. FT Alphaville, in reporting the event, seems to adopt the tone that it is the end of markets as ever we've known them:
The regulator has snapped. With the government having torn up the competition rulebook earlier in the day, the FSA has now abandoned the free market in financial stocks.
Guambat generally holds the view that sellers should be allowed to sell, but recognizes that, at some point, highly geared, highly organized and highly mobile institutional selling, with motives ulterior to any intrinsic thought of the target of those sales, is overly destructive, self-serving and market manipulative. At the point, or anywhere near it that comes anywhere close, Guambat is sympathetic to a bit of the cold-shower approach.

Guambat points out that the evil of rumour-mongering and manipulative selling is not worse, however, than the evil of rumour-mongering and manipulative buying, and that it is the latter that created the credit bubble and commodity bubble and the opportunity for short-sellers to be so destructive in the first place.

Turn about will not only be fair play, it will be just as imperative.

FOLLOW UP 20 Sept:

There is some agreement "out there" with Guambat.

The issue at hand is not that short selling is evil. It is that some short sellers engaged in illegal practices, manipulating the market by spreading rumors to push stocks lower.

It is such manipulation, not the practice of short selling itself, that the SEC should crack down on.
Guambat would add, that any such crack down should not remain temporary.

Short sellers perform a vital function. By bringing market prices in line with an asset’s true worth, they provide a mechanism of price discovery. Yet last week short sellers morphed into price creators. It is one thing to short China’s ICBC believing it to be overvalued at three times book value. It is another to short HBOS when it is trading at 0.5 times. The first is an opinion; the second equivalent to inciting a bank run.

Thursday, September 18, 2008

Are these dots connected?

First dot:
Crude oil for October delivery rose $6.01 to close at $97.16 a barrel on the New York Mercantile Exchange

Second dot:
the price of gold notched the biggest one-day advance ever. Gold for delivery in December increased as much as $90.40, or 11.6 percent, to $870.90 an ounce

one of the functions gold serves for investors is it's a source of liquidity in a time of crisis. That's why people want gold, because if things get really nasty in the financial markets: "I've got gold, I can sell to raise cash."

Third dot:
"There's no God-given gift of a 'AAA' rating, and the U.S. has to earn it like everyone else." That's the word from S&P's John Chambers, the chairman of Standard & Poor's sovereign ratings committee.
(Curiously, that dot wasn't mentioned in this story in MarketWatch: S&P affirms U.S. 'AAA/A-1+' sovereign rating)

Fourth Dot:
The cost of insuring against default on 10-year US Treasuries jumped to an all-time high of 30 basis points yesterday, as measured by the credit default swaps (CDS) on the derivatives markets. Germany is at 13, and France is 20.

"This is historically significant because we have never seen anything like it before," Daniel Pfaender, sovereign credit strategist at Dresdner Kleinwort.

"What we don't know yet is whether this a liquidity issue or whether it reflects the credibility of the US financial system."

Not worthy

This is not news- or any other kind of worthy. It is trespass at least, an act of burglary perhaps. It has no ethical basis and shows a complete lack of moral compass.

Whoever did this, as well as those gawkers who are aiding and abetting the damages, should be stripped naked and paraded through the streets of Anchorage, in mid-winter.

The Creature from the Credit Default Swamp

There have been many vehicles which got us to this credit crunch, but the vehicle of choice has been the credit default swap. They are infinitely variable, unregulated and a plaything of the rich and ... well, rich is good enough, but big helps, too.

Without ever truly coming to a working knowledge of them, and without letting that ignorance get in the way of having an opinion or spew about them, Guambat has let the CDS topic pop up many times in posts over the last few years.

For instance, Guambat noted back in February that AIG was toying with CDS valuations in ways that were, shall we say, fanciful or eccentric.

But now they're being blamed, along with the nudists trading in shorts (which Guambat is having trouble envisioning), with the come-downance of the markets.

The WSJ's Deal Journal pins CDSs for the whackage done on Goldman Sachs and Morgan Stanley this week:
So what is driving the financial wolf-pack to tear down the stocks of two reasonably strong firms? Schorr points to an over-reliance on dour indications from two sources: ratings providers and the opaque market in credit-default swaps, which are contracts that bet on a firm’s chance of filing for bankruptcy.

The problem with CDSs is that their value often overreacts to short-term news without taking into account a firm’s long-term liquidity.

Additionally, the traffic in CDSs is even more opaque and prone to manipulation than the short-selling of shares: CDSs are traded very quietly, among a select group of sophisticated investors. Yet they have gained outsize influence over the stock prices of financial firms. “The world should really be concerned about this ...."
But the world didn't invent CDSs. The likes of Goldman Sachs and Morgan Stanley not only invented them, they spread them around the world and armed them with the poison tips that are now paralyzing the market participants. It's like Frankenstein, or the Creature from the Dark Lagoon, coming back to us in our nightmares. (Always count on Guambat to split his infinitives as well as his britches, and to mix his metaphors as well as his medicines.)

FOLLOW UP 19 Sept.:

One of Dr. Frankensteins nemesis-es, Jessie Eisenger, also points out that the creators and users of CDSs have only themselves to blame, at least in the case of AIG (HT Barry):
What's taking down these grand financial icons such as Lehman and A.I.G.? It couldn't possibly be that the companies themselves made stupid and shortsighted decisions. So it must be a conspiracy of the short-sellers. It must be some wrong-headed accounting rules and bad regulation.

For several years, A.I.G. dove headfirst into an insurance-like product called credit default swaps. It wrote hundreds of billions worth of protection mostly on the top slice of mortgage-backed structured financial products. Short-sellers and accounting rules didn't cause A.I.G. to enter the C.D.S. protection business.

Supposedly A.I.G. had an expertise in insurance, being the largest of its kind in the world. Insurance is hard to price correctly. When the hurricane hits, were you getting enough money from homeowners all those years? It's a difficult question. But when it was initially writing all that C.D.S. protection, A.I.G. thought it wasn't possible to take a penny of losses because its contracts were backstopping such highly rated, highly protected slices, according to an ex-A.I.G. Financial Products employee I spoke with this week. (That makes perfect sense since this was the same mistake made by the bond insurers M.B.I.A. and Ambac.)

Each time the company wrote one of those contracts, a grain of sand should have dropped to the bottom of the hourglass until an A.I.G. risk-management official said: "Enough. You can't write anymore." But that didn't happen. Short-sellers and accounting rules didn't make the company put little-to-no capital against these positions.

A.I.G.'s counterparties didn't require that the insurance company put up any collateral—called initial margin— because its rating was so high. This wasn't an accounting rule. This was a general agreement among the players in the C.D.S. market.

Then the underlying mortgage-holders started to default, leading to the value of the super-senior tranches to decline and the spreads on the C.D.S. to widen. Counterparties wanted some collateral to reflect the changes in the market. The credit-ratings agencies downgraded A.I.G., leading to even more demands for collateral.

Does anyone seriously think that the counterparties said to A.I.G., "Hey man, we don't want you to put up any cash. We know it's stupid, but our hands are tied by those damn accounting rules!" Hardly. They wanted their cash now. If these positions were marked-to-model rather than marked-to-market, does anyone think that the counterparties wouldn't have written any collateral triggers into the contracts?

Now for the sake of argument, let's say that the market overreacted horribly. Let's contemplate that short-sellers were too convincing. They caused needless panic, helping drive the spreads on the C.D.S. protection way too wide, in turn driving the value of A.I.G. equity down to absurdly low levels. This was causing paper losses, but there were also real credit rating agency downgrades. But it wasn't anything substantive—a mere liquidity crisis at the insurer.

If that were so, why didn't the insurer find buyers? Why didn't the private-equity firms swoop in? They did examine A.I.G.'s books this past weekend. What they found was that the amount that A.I.G. needed was undeterminable. It was an unfathomable black hole.

A.I.G. got into something it didn't understand and didn't protect itself properly. The market-based watchdog—the rating agencies—failed to assess its risk properly. In the market panic, A.I.G.'s counterparties acted rationally to demand more cash, their actions having nothing to do with accounting rules.

FOLLOW UP 20 Sept:

Floyd Norris provides the best description of how Credit Default Swaps work -- and don't work, in this NYT piece:
Credit-default swaps are a way of transferring the risk of owning a bond. If I own a bond issued by General Motors, and have also purchased a credit default swap on G.M., then I am covered if G.M. defaults. I can recover my losses on the bond from the institution that sold the swap to me.

There are now many more credit-default swaps outstanding than there are bonds for them to cover. They became a way to gamble with almost no money down. For a small fee, my hedge fund can bet that a company will go under. And your hedge fund can collect that fee, and produce instant profits. Years down the road, you may have to pay, but big companies rarely default anyway, so the risk is minimal. Or so people thought.

One way to think of the swaps market is as insurance that is issued by companies that do not have to keep reserves and may be totally unregulated. I can’t legally buy fire insurance on your house, since I have no stake in it, and letting me have insurance would give me an incentive to burn it down. But I can buy a credit-default swap on G.M. even if a G.M. default would not cost me a penny.

That brings up “counterparty risk.” If my hedge fund bought a G.M. swap from A.I.G., and sold one to your hedge fund, then my fund has laid off the risk. If G.M. defaults, I will have the money to pay you as soon as A.I.G. pays me.

But if A.I.G. has taken lots of those positions — and it did — then who knows which banks and funds and investors will be in trouble if A.I.G. cannot honor its obligations? My fund may have a perfectly matched book, but it is suddenly in deep trouble if a counterparty is defaulting. Since no one keeps track of all the moving parts, no one knows just who may get into trouble if one participant fails.

The theory that beguiled legislators and regulators was that the market could regulate itself. Each bank would be careful to deal only with counterparties it could trust, and so the whole system would be trustworthy. But even if you believe that, remember that most swaps are good for five years. Not long ago, A.I.G. was a Triple A company, whose credit was viewed as sterling by everybody.

It is worth remembering that A.I.G.’s credit standing did not fall even after it was caught helping other companies rig their financial statements. Nor was it hurt by evidence it had fudged its own numbers. Discovering that a company is run by people with what we might call flexible integrity should have been a red flag.

But who would have looked? The insurance subsidiaries were regulated by state insurance departments, and activities of the parent were not their focus. Had anyone suggested an aggressive audit to see what other games A.I.G. was playing, I am sure that neither the Fed nor the Treasury would have thought they had jurisdiction.

Now they say the national interest required them to step in. “A disorderly failure of A.I.G.,” the Fed said, “could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance.”

That may sound outrageous, but it is probably true. By the time A.I.G. was on the verge of failure, the government’s options were limited.

Wednesday, September 17, 2008

You ain't seen nuthin' nyet

Russia suspends trading in just about everything (FT Alphaville)
Russia is showing us what happens to entire countries when mistrust sets in.

Russia’s Micex Stock Exchange and RTS Exchange suspended trading on Wednesday for a second consecutive day

While the government insisted there was no systemic crisis

market players said margin calls forced domestic traders to liquidate positions, banks were ceasing to lend to second and third-tier companies and brokers were pulling credit lines. Meanwhile, interbank money market rates climbed to 11 per cent, their highest since a mini-banking crisis in summer 2004.

Chris Weafer, chief strategist at Uralsib investment bank, told the FT “No one knows where this could stop.”

The share trading suspension followed the steepest one-day fall in stocks in more than a decade on Tuesday

As Andrei Sharonov, managing director of Troika Dialog, the Moscow investment bank, and a former deputy economic minister, told the FT: “This is a vicious circle…It is a situation of total mistrust. The liquidity crisis is being caused by a crisis of confidence in which people are frightened to borrow and frightened to lend.”
At least those who bought Putins were doing ok.

Beedy-eyed critics

The Real Time Economics blog in the WSJ has pointed to the legal basis for the eye-bursting $85 billion loan from the Fed to AIG to bail it, and the rest of civilization as we know it, out of its mess.

Although a good broker friend of Guambat advises that Paulson et al. got a very sweet rate on the loan and will likely return a tidy profit to the Fed treasury when the dust settles, the shrill from the comments section to that post was ear and eye-popping, but not as painful as their analysis, both economic and political, e.g., "This bailout was done to save McCain", and from another "Shame on Bush, Shame on McCain, Shame on Obama, Shame on Pelosi, Shame on Shumer and Shame on Dodd", which are all comments beside the point. The point being that shining spot you can see as you look cross-eyed down the bridge or your nose to the tip just before you cut it off to spite yourself.

But getting back to the legal nitty-gritty, it seems there is a fairly unrestricted authority for the Fed to do exactly what it did, whatever anyone, Congressional or otherwise, may think.

As explained by the Minneapolis Fed,
On June 19, 1934, President Franklin Roosevelt signed a bill into law that added Section 13(b) to the Federal Reserve Act, which authorized the Federal Reserve to "make credit available for the purpose of supplying working capital to established industrial and commercial businesses," according to the Federal Reserve Board's 1934 annual report.

he Federal Reserve System was established, in part, "to afford means of rediscounting commercial paper," according to the 1913 Act. Essentially, this means that member banks of the Federal Reserve System would borrow money from their district Reserve bank based on loans made at the member bank, and it worked like this:

* A bank makes loans to business customers.
* This bank eventually comes under high demand for loans and finds that its reserves are running low.
* The bank then takes some of its business loans, or paper, and borrows from its Federal Reserve bank, using the paper as security; this was known as rediscounting.
* Reserves at the bank would thus increase and, likewise, so would the reserves of the entire banking system in accordance with the economy's needs at the time.
* When the loans at the bank reached maturity, or were paid off, the bank would then be flush with reserves and would likewise pay off the Federal Reserve bank; this resulting decrease in bank reserves would keep reserves in line with the needs of the economy.

This was how the Fed was intended to provide an elastic currency for the economy, that is, a currency that could respond to the ups and downs of an economic cycle. An important point for our discussion is that this discount policy, which was based on high-quality bank loans backed by good collateral, was administered by the individual Reserve banks.

The 1934 bill that would open the Fed to industrial lending had its genesis under the Hoover administration two years earlier. Tucked inside a highway construction bill in 1932 was an amendment to the Federal Reserve Act allowing the Fed to allocate credit to individuals, partnerships and corporations in emergency situations. This language, amended again in 1991, as we shall see later, is still with us today. The major difference between this enduring legislation and Section 13(b) passed two years later is that the 1932 amendment is only meant to address crisis situations.

The 1932 bill became law on July 21, 10 days after President Hoover had vetoed similar legislation, arguing that such a plan would "violate the very principle of public relations upon which we have builded [sic] our Nation, and render insecure its very foundations."
The article chronicles the history of the rare usages of the loan facility, up to the market crash after 9/11, when the article was written. It particularly notes the many detractors who criticized the power, starting right off the bat when the law was first passed with
the chagrin of one Rep. C.L. Beedy:

"The Federal Reserve banks, 12 in number, which were never designed to do business with any individual or any person, but were banks of issue or rediscount to deal with other banks, ought never, in my opinion, to be put into the lending business. It is a perversion of the original purpose for which those banks were established."
It concludes,
To some this lending legacy is likely a harmless anachronism, to others it's still a useful insurance policy, and to others it's a ticking time bomb of political chicanery. Doubtless, the discount window will continue to evolve.

And so, here we have the Bush Administration boldly going forth under that banner of evolution.

Darwinian economics?

Morgan Stanley, I presume

According to CNBC, Morgan Stanley, about the only pin left standing, is preparing to blindfold itself and walk the plank into whomever's arms it can.
Morgan Stanley CEO John Mack wants to avoid the mistake made by Lehman Brothers CEO Richard Fuld, who brushed aside buyout offers until the market crushed shares of the firm and force it into bankruptcy.

Wall Street traders are increasingly betting that Morgan might not survive--the costs of so-called credit default swaps which are insurance policies against Morgan defaulting on its bonds, shot up on Tuesday, forcing the company's pre-announcement.

For this reason, Mack is carefully monitoring the market reaction and may indeed decide to do a deal if it looks like the firm could face a liquidity crisis as traders begin to pull funding from the firm.

That report is cited by a DJ Market Talk item, "S&P/ASX 200 Down 0.5% on Morgan Stanley Fears", with putting an "oh, really?" dampener on an earlier rally in Sydneytown. It quotes one trader as asking, rhetorically, Guambat supposes, "How many more dominos have to fall...?"

Dominos, pins, whatever.

Might the downturn not also have something to do with futures expiry? (Speaking here of index futures contracts, not Morgan Stanley's, of course.)

And how would you like your AIGs cooked this morning, sir

Sunny side up or scrambled, it will take some hard-boiled types to survive this one.

Image credit FCIT

AIG: The company at the heart of the world's financial system
Despite its low profile, AIG is the 18th largest company in the world and arguably the largest insurance and financial services firm. without knowing it, millions of us have links to American International Group, ranging from the warranty on our fridge to the aircraft which have flown us on holiday.

Its diverse assets also include the Stowe Mountain ski resort in Vermont, several American ports and a share of London City Airport. The firm was founded in 1919 when American Cornelius Vander Starr set up an insurance company in Shanghai, the first Westerner to do so.

He gradually expanded into Europe, South America and the Middle East, before handing over the reins to his chief representative in the US, Maurice “Hank” Greenberg in 1968.

Major San Francisco Bay Area insurance brokerages including ABD/Wells Fargo and Aon Risk Services were caught up Tuesday in the drama surrounding the fate of troubled insurance giant AIG.

AIG's Collapse May Be Felt By Companies Worldwide
Wall Street's top firms, and the biggest companies in Europe and Asia, have bought protection on $441 billion of fixed-income assets from AIG to guard their investments against potential bankruptcies. A failure by New York-based AIG may result in $180 billion of losses to financial institutions, RBC Capital Markets analyst Hank Calenti said in a report today.

"They have tentacles into everything, and they are certainly critical to the ongoing health of the financial markets, or lack of health," Anton Schutz, president of Mendon Capital Advisors Corp. in Rochester, New York, said in an interview today with Bloomberg Television.

It sells protection against some of the biggest risks, insuring planes and commercial shipping and providing coverage against terrorist attacks.

AIG Global Real Estate's portfolio includes over 53 million square feet of property in more than 50 countries, the company said on its Web site.

Lehman Brothers Holdings Inc.'s London landlord, Songbird Estates Plc, said rent payments on the bank's offices in the Canary Wharf financial district are insured by AIG.

AIG is the second-largest property and casualty insurer and the seventh-largest life insurer in the U.S.

The company insures high-end homes through its Private Client Group and sells auto coverage online through AIG Direct.

AIG provides coverage for offshore oil drilling platforms in the Gulf of Mexico, warrantees for televisions in Brazil, and insurance that complies with Islamic law in Bahrain.

"AIG poses a systemic risk because it's a large counterparty in the financial system," said Prasad Patkar, who helps manage the equivalent of $1.8 billion at Platypus Asset Management in Sydney.
The collapse of American International Group Inc. could be a drag on the entire aerospace industry if the insurance giant can't find a buyer for its aircraft-leasing business.

Knock-on effect of AIG collapse
AIG is not just an American company. It operates in more than 130 countries worldwide and is very active in Britain. It is the top seller of investment bonds in Britain.

AIG is such a big company - it insures everything from loans to local authorities in America to bonds bought and sold in the London market. It also reinsurers other companies’ risks.
Why AIG matters to you
AIG is by far the world's largest insurer and its stock is found in many mutual funds, including any S&P 500 index fund. It is also a component of the Dow Jones industrial average. All by itself, it's been responsible for dragging the Dow down more than 400 points so far this year.

AIG is also active in the business of credit default swaps, complicated financial instruments used by investors to protect themselves from bond defaults. Lehman Brothers (LEH, Fortune 500) was another major player in that field. If both go away, it would create a tighter credit market for consumers and businesses trying to get loans.
The AIG Crisis, By the Numbers
$1.04 trillion: The size of AIG’s balance sheet as of June 30, down from $1.06 trillion in December.

$712 billion: The approximate size of AIG Investments, a 500-staff fund-management arm that puts money into private-equity funds and so-called funds of funds.

$15.2 billion: The amount of excess capital AIG had going into the second quarter, after a $20.2 billion capital raising that helped fund a $5 billion shortfall.

$0: The amount of excess capital now on hand.

$14.5 billion: The amount of money AIG needs to pay to its trading partners as a result of Monday night’s credit-rating downgrades by Moody’s Investors Service, Standard & Poor’s Ratings Services and Fitch.

$20 billion: The amount of cash AIG could pull from its own insurance subsidiaries as a result of a change in New York State insurance regulations announced Monday.

$23.8 billion: Year to date unrealized losses on AIG’s total portfolio, according to Morgan Stanley estimates last week.
AIG, From `Excess Capital,' Buybacks to Cash Shortage: Timeline

The generosity, constructive criticism and altruism of Hank Greenberg, as disclosed in this letter to the AIG Chairman of the Board, pointing out that "you and the Board have presided over the virtual destruction of shareholder value."

Greenberg resigned as chief executive [in 2005] after AIG was accused of exaggerating its financial performance. He was succeeded by Essex boy Martin Sullivan, 53, who had joined the company’s London office in 1970 as a 17-year-old clerk before working his way up to the boardroom.

News from September 16th, Stateside time, as The Bell rings:
European Stocks Tumble on AIG Debt Rating Cuts; UBS, HBOS Drop

Asian stocks rebounded in U.S. trading, led by financial shares, on speculation the Federal Reserve may extend loans to American International Group Inc. to prevent the collapse of the largest U.S. insurer.

From MarketBeat: Without a doubt, the market showed a bit of resiliency Tuesday, but the tensions have not been removed from the market. Most of them center, like a black cloud, over the headquarters of American International Group Inc., which fell 15% amid a swirl of rumors of government assistance, or perhaps no government assistance, in a package of loans to help the company, which reportedly seeks some unholy amount of capital in order to buy time. The dogmatic types who flinch at the idea of any bailout in the past — be it Bear Stearns Cos. or Lehman Brothers Holdings — are a bit more flexible on this company, because, as Marino Marin, managing director of investment bank Gruppo, Levey, puts it, “the option of a non-intervention in AIG could be really disastrous.” Choosing not to decide to do something is still a choice, and investors feel that in this case, that’s not a choice open to the markets. The emerging thinking is that the government will have to intervene, because nobody else is left: sovereign wealth funds have had enough of throwing good money after bad into U.S. financial institutions, private-equity buyers have no interest, and Warren Buffet only has so much, after all. “The problem with any of the financial institutions that are supposed to be involved is that their balance sheets stink too,” says Greg Church, founder and CEO of Church Capital Management, who holds shares of AIG. “There has to be a partnership — you’ve got to give these guys time to unload assets.” Ultimately a deal that gives the government warrants to purchase equity, similar to the Chrysler bailout, says Robert Brusca of Fact and Opinion Economics. “A plan to save AIG must include the government getting a big portion of the upside potential on its shares as well as a pledge for change,” he writes.
But after The Bell:

Both Senate Banking leaders cool to U.S. help for AIG
Connecticut Democratic Sen. Christopher Dodd, chairman of the financial market oversight panel, said he is generally "skeptical" about any potential federal bailout or bridge loan for AIG. He told reporters he wants the Bush administration to consult with him.... I want to have them come to me....

Alabama Sen. Richard Shelby, the top Republican on committee, said he flatly opposes any federal bailout for AIG.
A U.S. government source said on Tuesday that no federal agency has legal authority to place troubled insurance company American International Group Inc under conservatorship.... Insurance companies are typically regulated by states, not by federal agencies

U.S. stock-index futures retreated after the Reserve Primary Fund fell below $1 a share and investors speculated American International Group Inc. will be seized by the government.

But then, a flash of swords drawn and the drum of hoofs sounds from the Calvary:

Fed Readies A.I.G. Loan of $85 Billion for an 80% Stake
American International Group Inc., the biggest U.S. insurer by assets, has been offered an $85 billion U.S. loan in return for an 80 percent stake in the company, according to a person familiar with the situation.

In an extraordinary turn, the Federal Reserve was close to a deal Tuesday night to take a nearly 80 percent stake in the troubled giant insurance company, the American International Group, in exchange for an $85 billion loan, according to people briefed on the negotiations.

All of A.I.G.’s assets would be pledged to secure the loan, these people said, and in return, the Fed would receive warrants that could be exchanged for an ownership stake. Stock of existing shareholders would be diluted, but not wiped out.

The Fed’s action came after Treasury Secretary Henry M. Paulson and Ben S. Bernanke, president of the Federal Reserve, went to Capitol Hill on Tuesday night to meet with House and Senate leaders.

Attending the meeting on the Capitol Hill were Democratic Senate leaders that included Charles E. Schumer of New York, Richard J. Durbin of Illinois, Christopher J. Dodd of Connecticut and Kent Conrad of North Dakota A contingent of Republicans was led by Mitch McConnell of Kentucky, the minority leader, and included Richard C. Shelby of Alabama, Jon Kyl of Arizona and Judd Gregg of New Hampshire. House leaders included John Boehner of Ohio, the Republican leader; Spencer Bachus, Republican of Alabama; and Barney Frank, Democrat of Massachusetts. Members of the leaders’ staffs were asked to leave the meeting shortly after it began.

Until this week, it would have been unthinkable for the Federal Reserve to bail out an insurance company, and A.I.G.’s request for help from the Fed of just a few days ago was rebuffed.
And by 10:45 a.m. Sydney/Guam time on Sept 17, Reuters is reporting:
Japanese stocks rose 1.1 percent on Wednesday, as investors took hope that troubled U.S. insurer American International Group may avoid the same fate as
Lehman Brothers. Financial shares such as top lender Mitsubishi UFJ Financial Group <8306.t> were awash with buy orders.
And separately:
Hopes for a rescue grew after a source briefed on the matter told Reuters several hours after the market close that the Federal Reserve was negotiating roughly $85 billion in financing to keep AIG from collapsing. Index futures pointed to a higher market open on Wednesday after the news.

And would Sir care to have another Bloody Mary with those AIGs?

Tuesday, September 16, 2008

Just one disaster after another

First hurricane Ike hits Texas, then hurrican Yikes! hits New York, and now Malcolm Turnbull finally completes his take-over bid for the Australian Liberal Party.

Guambat is not a fan.

The return of the large dinosaurs amid the demise of the raptors

This extract is from an article from the WSJ and seems to encapsulate many ideas expressed in previous posts of the last couple of days.

Old-School Banks Emerge Atop New World of Finance
The rapid demise of 158-year-old investment bank Lehman Brothers Holdings Inc., together with the takeover of 94-year-old Merrill Lynch & Co., represent a watershed in the banking industry's biggest restructuring since the Great Depression.

For decades, the world of banking was divided largely into two kinds of businesses. Commercial banks took deposits and made loans, eking out a decent return under the burden of heavy regulations designed to protect depositors. Standalone securities firms such as Lehman, Merrill and the now-defunct Bear Stearns Cos. took no deposits and were lightly regulated, freeing them to take big risks and make fat profits at the cost of occasional losses.

Now, as many securities firms are consumed in the wake of a disastrous foray into financial wizardry, the balance of power is shifting. On the wane are the heavy borrowing and complex securities that financiers embraced in recent years. On the rise is a more old-fashioned business of chasing customer deposits and building branch networks, conducted with the backing of federal insurance programs to keep depositors from pulling out en masse.

Merrill and Bear Stearns, have been acquired by big deposit-taking institutions, Bank of America Corp. and J.P. Morgan Chase & Co. Other giant commercial-banking players, such as Wells Fargo & Co. in the U.S., as well as Germany's Deutsche Bank AG and Spain's Banco Santander SA, have emerged as some of the most powerful players in an industry that is likely to be safer but less lucrative for shareholders.

Banks are heading "back to basics -- to, if you like, the core purpose of the system with less bells and whistles," says Douglas Flint, finance chief at HSBC Holdings PLC

The shift reflects a broader reassessment of how best to do the essential business of banking, which plays a crucial role in the economy by turning their short-term liabilities -- savers' cash and deposits -- into longer-term investments such as mortgages and corporate loans. In recent years, commercial banks moved a lot of that business off their heavily regulated balance sheets and into the realm of securities firms.

But these banks' strategies backfired with the onset of the credit crunch last summer, as heavy losses on mortgage and other investments in some cases proved too much for their thin capital bases, and the markets on which they relied for funding dried up.

The repeal of Glass-Steagall, in 1999, allowed commercial banks to break into the securities business and ultimately gain the heft to compete with the likes of Bear Stearns and Merrill.

This universal banking model has proved hard to manage, with the likes of Citigroup and UBS knitting together a vast empire of operating units. Even so, these and other big deposit-taking banks that are required by regulators to maintain bigger cushions against losses, such as Bank of America, have so far survived the credit crunch better than some of the stand-alone securities firms.

Sticking to the basic banking model hasn't worked for everyone. Smaller banks in the U.S. and Europe have suffered, in part because they lack the scale and diversification to absorb heavy losses generated by growing defaults on mortgage and corporate loans.

To be sure, some stand-alone investment banks, such as Goldman Sachs Inc., are well funded. And some innovations and markets will rebound when the credit crunch fades. Consumer debts such as mortgages, credit-card balances and student loans will still be packaged into securities.

But such securitization, analysts say, will likely happen in smaller volumes and in more conservative forms, such as so-called covered bonds. Many of the instruments central to the current crisis were created and sold by banks with no stake in their performance. In contrast, covered bonds have payments that are bank-guaranteed regardless of how poorly the packaged loans perform. Covered bonds are the main source of mortgage-loan funding for banks in Europe, where a $2.75 trillion market has long thrived. Some analysts predict a U.S. market could grow to $1 trillion over the next few years.

"Securitization will play a lesser role for the well-capitalized, highly rated banks," says Ganesh Rajendra, a researcher at Deutsche Bank in London. "But it will still help them manage their capital and risks in many cases."

Internationally, banks that haven't been disabled by write-downs are moving aggressively to buy deposit-rich lenders. Deutsche Bank, which declined the opportunity to bid for Postbank a few years ago, chose to outbid Santander last week in part because it didn't want to see the large retail operation fall into the hands of a foreign rival.

Looking through the Glass-Steagall repeal

Guambat reckons the Bush administration has readily aided and abetted this financial market blow-up. If not by direct intervention, by putting people in places of responsibility who shunned it, or worse, shackled it. People like Harvey Pitt who, when put in charge of the SEC, felt Mr. Market would make better a regulator, so deferred.

But lets not get partisan. The Gramm-Leach-Bliley Act was a product of Bill Clinton's administration, and marked the pivot point where government of the financial markets shifted from consumer protection to market protection.

For background, Guambat turns to Investopedia.com, What Was The Glass-Steagall Act?, a product of Forbes, a product of the conservative Forbes family, Guambat suspects.
In 1933, in the wake of the 1929 stock market crash and during a nationwide commercial bank failure and the Great Depression, two members of Congress put their names on what is known today as the Glass-Steagall Act (GSA). This act separated investment and commercial banking activities. At the time, "improper banking activity", or what was considered overzealous commercial bank involvement in stock market investment, was deemed the main culprit of the financial crash. According to that reasoning, commercial banks took on too much risk with depositors' money.

Commercial banks were accused of being too speculative in the pre-Depression era, not only because they were investing their assets but also because they were buying new issues for resale to the public. Thus, banks became greedy, taking on huge risks in the hope of even bigger rewards. Banking itself became sloppy and objectives became blurred. Unsound loans were issued to companies in which the bank had invested, and clients would be encouraged to invest in those same stocks.

Steagall agreed to support the act with Glass after an amendment was added permitting bank deposit insurance (this was the first time it was allowed).

As a collective reaction to one of the worst financial crises at the time, the GSA set up a regulatory firewall between commercial and investment bank activities, both of which were curbed and controlled. Banks were given a year to decide on whether they would specialize in commercial or in investment banking. Only 10% of commercial banks' total income could stem from securities....

Financial giants at the time such as JP Morgan and Company, which were seen as part of the problem, were directly targeted and forced to cut their services and, hence, a main source of their income. By creating this barrier, the GSA was aiming to prevent the banks' use of deposits in the case of a failed underwriting job.

The GSA, however, was considered harsh by most in the financial community....

Despite the lax implementation of the GSA by the Federal Reserve Board, which is the regulator of U.S. banks, in 1956, Congress made another decision to regulate the banking sector. In an effort to prevent financial conglomerates from amassing too much power, the new act focused on banks involved in the insurance sector. Congress agreed that bearing the high risks undertaken in underwriting insurance is not good banking practice. Thus, as an extension of the Glass-Steagall Act, the Bank Holding Company Act further separated financial activities by creating a wall between insurance and banking. Even though banks could, and can still can, sell insurance and insurance products, underwriting insurance was forbidden.

The limitations of the GSA on the banking sector sparked a debate over how much restriction is healthy for the industry. Many argued that allowing banks to diversify in moderation offers the banking industry the potential to reduce risk, so the restrictions of the GSA could have actually had an adverse effect, making the banking industry riskier rather than safer. Furthermore, big banks of the post-Enron market are likely to be more transparent, lessening the possibility of assuming too much risk or masking unsound investment decisions. As such, reputation has come to mean everything in today's market, and that could be enough to motivate banks to regulate themselves.

Consequently, to the delight of many in the banking industry ..., in November of 1999 Congress repealed the GSA with the establishment of the Gramm-Leach-Bliley Act, which eliminated the GSA restrictions against affiliations between commercial and investment banks. Furthermore, the Gramm-Leach-Bliley Act allows banking institutions to provide a broader range of services, including underwriting and other dealing activities.

Although the barrier between commercial and investment banking aimed to prevent a loss of deposits in the event of investment failures, the reasons for the repeal of the GSA and the establishment of the Gramm-Leach-Bliley Act show that even regulatory attempts for safety can have adverse effects.
Guambat will just let that bit of historical perspective speak for itself.

And as far as the 1956 legislative action taken "to prevent financial conglomerates from amassing too much power", Guambat points out that of the 5 largest independent investment banks in the US at the beginning of this year, only 2 exist today: Bear Stearns, Lehman and Merrill Lynch are toast.

Bear Stearns was, of course, lathered in Fed money for jam and savoured by commercial bank JP Morgan, whose predecessor was one of the giants of the time that led to the enactment of Glass-Steagall in the first place. And so, like Alice, we have come backward through the looking glass.

An interesting aside is that, about that time, the Bank of America, which yesterday scarfed down Merrill Lynch, had cast off its Bank of Italy moniker and was expanding from the small Italian community in North Beach San Francisco under the commanding hand of its immigrant founder, A.P. Giannini, an irrepressible man whose Transamerica Corporation later also came into regulator's sights, for a while, at least.

Floyd Norris' NYT blog has a slightly different angle. Looking for "lessons" from the current debacle, which Guambat reckons were already learned and forgotten last century, he observes,
1. The capital rules were far too lax, and they still are. They may have made sense if you assumed perfectly liquid and smoothly functioning markets, but that is like saying a roof does not leak when it is sunny and mild.

2. The end of the rules separating commercial banks from investment banks — Gramm Leach Bliley — is one reason the government is much more deeply involved now. Bank of America and J.P. Morgan Chase, the fire-sale buyers of Merrill and Bear, have government guaranteed deposits. That amounts to a subsidy, and when times get tough the subsidized firm has a big advantage over the unsubsidized one. To keep the others going, the Fed now will lend them money secured by almost anything they can find, including common stocks.

3. Those who were complaining, only months ago, that excessive regulation was making American markets uncompetitive, had it exactly wrong. It was a lack of regulation of the shadow financial system and its players that allowed this to happen. The regulators might not have gotten it right if they had tried to put limits on leverage, or assure that it was clear what risks were being taken, in the world of derivatives and securitizations. But deciding not to even try, and assuming that risks traded secretly would somehow end up in the hands of those most able to bear them, reflected ideology, not analysis.