Every morning between 11 and 11:10 a.m. a consortium of large banks send data to Reuters Group PLC in London to "fix" the London Interbank Offered Rate (LIBOR). This rate is being used to determine the rate that banks charge each other for short term loans. According to the WSJ there has been concern dating back as late as September last year that banks are understating the rates they report for LIBOR fixing. Recently the British Bankers Association (BBA) got involved and is now investigating these allegations. The accuracy and transparency of LIBOR has wide ranging implications since it is used as base for a number of loans. Misstatement can prove costly for borrowers around the world. One measure that reflects the general cost of borrowing is by comparing the three-month LIBOR with the yield on a three-month Treasury bill. The gap between the two stood at 1.58 percentage points Tuesday, and has averaged 1.39 percentage points since the crisis began in August. In the five years before the financial crisis started, it averaged only 0.28 percentage points.
Citigroup's Mr. Peng believes banks could be understating even those abnormally high Libor rates. He notes that the Federal Reserve recently auctioned off $50 billion in one-month loans to banks for an average annualized interest rate of 2.82% -- 0.1 percentage point higher than the comparable Libor rate. Because banks put up securities as collateral for the Fed loans, they should get them for a lower rate than Libor, which is riskier because it involves no collateral. By comparing Libor with that indicator and others -- such as the rate on three-month bank deposits known as the Eurodollar rate -- Mr. Peng estimates Libor may be understated by 0.2 to 0.3 percentage points.
A counter argument to Mr. Peng can be found in the way how LIBOR is calculated every day. Reuters throws out the highest and lowest quote submitted by banks. This practice likely curbs manipulation. Contributing banks would have to collude to achieve manipulation. The argument that banks are understating to hide financial stress does not hold up either. There are other distress signals, like CDS spreads on banks, that can be used .
source: LIBOR FOG - Bankers Cast Doub On Key Rate Amid Crisis
By CARRICK MOLLENKAMP
http://online.wsj.com/article/SB120831164167818299.html
Wednesday, April 16, 2008
The earnesty of being LIBOR
JCT - The man who saved the world
At the morning of August 9th last year Jean-Claude Trichet, the president of the ECB, stepped in and provided unlimited funds for financial institutions. His actions have saved the industrialized world from a financial meltdown of colossal proportions and are still the only really effective measure countering the financial turbulences to date.
Here is a first hand account from the engagement of the ECB during the current financial turmoil. I have picked some of the pearls:
"...First liquidity response came on morning of 9th of August last year...overnight rate of LIBOR increased significantly...The ECB injected liquidity into the market with full allotment ( 95 bn euro or $130 bn)."
on credit derivatives:
"...the resilience of that time (bursting of the dot.com bubble) had been wrongly attributed to the use of financial derivatives. Now of course is the real test."
click for video
With JCT as the most influential central banker of our time I am now more confident that the financial system can weather the storm.
source: video
Bloomberg
http://www.bloomberg.com/avp/avp.asxx?clip=mms://media2.bloomberg.com/cache/v9Q2KPGB0VqA.asf
source: The Big Picture
Barry Ritholtz
http://bigpicture.typepad.com/
CPI March 2008
Barry Ritholtz, Fusion IQ CEO and author of The Big Picture blog, reflects on the most recent CPI data. His thoughts circle around the stark divergence between input costs and consumer costs that has been growing lately and represent enormous price pressures for manufacturers and retailers.
But that can only go on for so long, and it seems to have reached a peak several quarters ago. How do we know this? The "inflation spread" between the crude goods and finished goods. Its now at record levels. This spread is even greater than it was in the late 1970s/early '80s.
click to enlarge
surce: CPI March 2008
The Big Picture, Barry Ritholtz
http://bigpicture.typepad.com/
How effective is Bernanke?
BizzXceleration takes a detailed look into "Interest Rates, Money and Rates" to get and idea about the effects of Fed actions on the current credit crisis. He looks at the spread between 3Mo Treasuries and paper (3MoSprd) which are still wide but have narrowed to less than 100 bp since the beginning of this year. The spread between Fed Fund rate and 10Yr Treasury (10Yr-FF) widened which could indicate a move towards a more normal yield curve. Most compelling is the inflation adjusted Monetary Base indicator (MBase) which reflects the amount of funds available to run the economy. MBase is down 3% year over year which leads the author to conclude:
No matter what the Fed has done the real money supply has been shrinking
since the start of the credit crisis and nobody has noticed....If the Chinese and the ME ever stop pegging their currencies to ours interest rates will have to take a huge jump to protect the dollar AND keep pulling in the foreign fund flows that are keeping us afloat. Comes 'round, goes 'round indeed.
click to enlarge
source: BizzXceleration: Performance, Value and Profit
http://llinlithgow.com/bizzX/2008/03/economic_dashboard_current_hig.html
Google's paid click growth awful again in March
Google is reporting earnings after the close tomorrow. ComScore came just out with the new numbers for paid click growth which were as bad as in February -- up only 2.7%. In all of Q1, Google's U.S. paid clicks rose only 2% year-over-year versus 25% in Q4 and 48% in Q3. That spells trouble for the companies top and bottom line results.
Mark Mahaney of Citi comes up with two reasons for this surprising development:
- Google's ongoing efforts to improve both lead quality for advertisers and the user experience for searches.
- A macroeconomic dampening of commercial queries by searchers
click for video
source: Google: March Paid-Click Growth Awful (Again)
http://finance.yahoo.com/tech-ticker/article/11370/Google-March-Paid-Click-Growth-Awful-(Again)?tickers=goog
Euroland infaltion soars - ECB rate cut forecast pushed back
European inflation rose more than expected to 3.6% in March, nearly a 16 year high. Food-price inflation accelerated to 6.2 percent in March from 5.8 percent in February, the highest since Eurostat began the current series in 1997. Energy-price inflation accelerated to 11.2 percent from 10.4 percent, the highest since May 2006.
Price increases are "not out of control, but this inflation rate is intolerable and the ECB will fight it,'' former ECB chief economist Otmar Issing said in a Bloomberg Television interview in Frankfurt. "The ECB has a clear mandate: maintaining price stability.''
Westpac senior economist James Shugg pushes back ECB rate cut forecast. He talks about Euroland inflation, the ECB, EM and China, and US housing.
"European growth story is probably holding out better than the UK and US. The EU does not have a housing driven consumer boom."
click for video
source: Shugg Says Westpac May `Push Back' ECB Rate Cut Forecast
Bloomberg, James Shugg Westpac senior economist
http://www.bloomberg.com/avp/avp.asxx?clip=mms://media2.bloomberg.com/cache/vV9.VixWyUPM.asf
Tuesday, April 15, 2008
Be careful what you wish for
NABE president Martin Feldstein opines in todays WSJ "Enough With the Interest Rate Cuts" that it is time for the Federal Reserve to stop cutting interest rates. Back in January he was still a strong advocate for more aggressive Fed action (see video for more info).
The rise in the U.S. inflation rate, and the adverse effects in emerging market countries, might be defensible if lower interest rates could significantly stimulate demand and reduce the risk of a deep recession. But under current conditions, reducing the federal funds interest rate from the current 2.25% by 50 or 75 basis points is not likely to do much to stimulate demand.
The current conditions in the housing industry and in credit markets mean that a further lowering of interest rates will have a smaller impact on demand than in previous recessions. In previous recessions, lower rates stimulated aggregate demand by inducing increased home building. But with the massive inventory of unsold homes – up 50% from a few years ago – a further cut in the fed funds rate would have little effect on housing construction.
Moreover, lowering the fed funds rate has not brought down mortgage interest rates. While the fed funds rate is down three percentage points from this time last year, mortgage interest rates are down by less than 0.5 percentage points.
click for video
source: Enough With the Interest Rate Cuts
By MARTIN FELDSTEIN
http://online.wsj.com/article/SB120822025943314699.html?mod=opinion_main_commentaries
source: Recession Risks & Remedies
CNBC
http://www.cnbc.com/id/15840232?video=620804209
Intel Posts Record First Quarter Revenue of $9.7 Billion
INTC 1Q earnings beats expectations, confirms FY gross margin.
click for video
key stats:
Its LTCM just bigger
It is LTCM all over again, only this time its bigger. The credit default swap market has mushroomed from $700 billion in 2000 to $45.5 trillion in 2007. This is truly a staggering number and more than half the size of the entire asset base of the global banking system. The opinion of how much money is actual at risk differs depending on the person or institution asked. The International Swaps and Derivatives Association (ISDA) estimates that the net exposure of the $50 trillion global derivatives market is likely under $1 trillion. Assuming 2.0 percent of that debt defaults, and that the debt recovers 25 percent of its principal, protection sellers would likely face losses of around $15 billion.
Bill Gross, manager of the world's largest bond fund begs to differ. In his January 2008 Investment Outlook he writes:
While the exact amount of reserves supporting the Bank of Shadows is undeterminable, let’s go back to the $45 trillion BIS estimate of outstanding CDS for more insight. If total investment grade and junk bond defaults approach historical norms of 1¼% in 2008 (Moody’s and S&P forecast something close) then $500 billion of these default contracts will be triggered resulting in losses of $250 billion or more to the "protection selling" party once recoveries are inserted into the equation.
The difference of opinion centers around the actual money at risk of default. ISDA's estimate of only $15 billion in losses seems to be unrealistic given the current market dislocation. It is obviously the job of the dealer to balance CDS contracts on both sides of the counterparties to minimize risks. Market dislocation, such as fewer investors considering selling protection, is making this job more difficult.
Bill Gross also points out, as equity and subordinated tranches comprising 10 or 20% of the repackaged loans shrink due to underlying defaults, the "pyramid begins to unravel". The problem is the lack of a reserve cushion within this pyramid scheme:
Credit default swaps (CDS) are perhaps the most egregious offenders. While margin does flow periodically to balance both party’s accounts, the conduits that hold CDS contracts are in effect non-regulated banks, much like their hedge fund brethren, with no requirements to hold reserves against a significant "black swan" run that might break them.
The important question for investors is: What is to come out if this "pyramid scheme" collapses? Bill Gross also has an answer ready.
Financial innovation will inevitably march forward, if not in distinctly new forms, then into new asset markets and even unexplored continents. For now, however, its current surge is spent. Investment survivors will have to learn to live in a different world, filled with new risks, lower leverage, and at some point, hopefully greater rewards.
Recent assertions coming from the International Monetary Fund that bank write offs will likely amount to $1 trillion is better understandable in the light of a continued meltdown in derivatives. In this uncertain and scary times "the air of suspicion is so deep-rooted given the opacity regarding the size and leverage, type and quality of the structured products that were developed since 2004, that it is causing funds to fail and financial institutions to be bailed out," an analyst wrote in a note to clients.
source: Pyramids Crumbling
Investment Outlook
Bill Gross | January 2008
http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2008/IO+January+2008.htm
source: Credit protection sellers may lose $15 bln-ISDA
Reuters
http://www.reuters.com/article/companyNews/idUSN2245675820080122
ISDA 23rd annual general meeting
I'd like to be all eyes and ears at this year's 23rd annual general meeting of the International Swaps and Derivatives Association (ISDA). The experts are gathering in Vienna this week discussing the prospects of the business. My guess they don't have much to celebrate.
Here is a part of the itinerary that caught my attention:
Complexity, Obscurity, and Perverse Incentives: Derivatives and Other Factors in the Credit Market Crisis
An expert panel of regulators, economists, lawyers, and risk managers examine the financial crunch of the millennium to identify causes and cures.
This is the understatement of the year.
source: International Swaps and Derivatives Association, Inc. (ISDA)
ISDA 23rd Annual General Meeting
April 15–17, 2008
Vienna
https://www.isdadocs.org/conf/AGM2008/index_agm2008agenda.html
Wholesale prices soar in March
from The Big Picture blog comes the following chart on rising input costs:
Foreclosure filings worse in March 2008
Foreclosure filings are getting worse again in March according to RealtyTrac. In a very alarming sign bank repossessions are up 135 percent from March last year which indicates that a large number of homeowners are throwing in the towel and refuse to refinance into new loans.
Here are the key stats for March 2008:
total foreclosure filings up 5% mom
total foreclosure filings up 57% yoy
234685 total filings on the Mid March
1 in 538 households with foreclosure notices
click to enlarge
James J. Saccacio, chief executive officer of RealtyTrac., comments on bank reposessions:
“The March numbers show that overall foreclosure activity so far this year continues to run nearly 60 percent above the levels we saw last year. On a year-over-year basis, default notices were up nearly 57 percent and bank repossessions were up nearly 129 percent, but auction notices were up only 32 percent, indicating that more defaulting homeowners are simply walking away and deeding their properties back to the foreclosing lender. This deed-in-lieu-of-foreclosure process allows the lender to take possession of a property without putting it up for public foreclosure auction.”
Diana Olick, CNBC real estate reporter, is in Florida :
click for video
source: FORECLOSURE ACTIVITY INCREASES 5 PERCENT IN MARCH
By RealtyTrac Staff
http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=4450&accnt=64847
source: Diana Olick, CNBC Real Estate Reporter
http://www.cnbc.com/id/15840232?video=712869446
VISA IPO balances bad loans for Regional Banks
The much anticipated balance sheet deterioration in U.S. regional banks has not materialized yet, although first quarter earnings show a concerning trend of increases in write offs and provisions for loan losses. Shares of regional banks rallied on Tuesday as analysts said that first quarter credit trends were not as bad as some had feared. Strong gains from transaction processor VISA Inc's IPO also helped bolster earnings reports.
here are some examples:
In Alabama, Birmingham-based Regions Financial Corp.'s net loan charge-offs rose to $125.8 million, or an annualized 0.53% of average net loans, in the first quarter of 2008, up from $107.5 million, or an annualized 0.45%, in the prior quarter.
In Minnesota, U.S. Bancorp saw quarterly loan-loss provisions soar to $485 million from $177 million.
In Milwaukee, Marshall & Ilsley said first-quarter charge-offs totaled $131 million, as the company raised its provision for loan and lease losses all the way to $146.3 million from $17.1 million.
In western New York, M&T Bank Corp.'s provision for credit losses increased to $60 million in the first quarter of 2008 from $27 million in the year-earlier quarter. Net charge-offs of loans during the recent quarter were $46 million, compared with the prior year's $17 million.
source: Bad loans paint grim landscape for regional banks
By Greg Morcroft, MarketWatch
http://www.marketwatch.com/news/story/bad-loans-paint-grim-landscape/story.aspx?guid=%7B49F2CCB2%2D93E1%2D4976%2DB391%2D0DFEF2D67948%7D&siteid=yhoof
Monday, April 14, 2008
New find casts doubt on "peak oil"
Brazil's National Petroleum Agency said on Monday a new oil find, known as Carioca, could contain 33 billion barrels of oil equivalent, five times the recent giant Tupi discovery. Government officials declined to confirm the discovery: "It's better to wait for official confirmation."
"It could be the world's biggest discovery in the past 30 years, and the world's third-biggest currently active field," Lima, head of the government's oil and fuel market regulator, told reporters at an industry event in Rio de Janeiro.
"This would lay to rest some of the peak oil pronouncements that we were out of oil, that we weren't going to find anymore and that we have to change our way of life," said Roger Read, an energy analyst and managing director at a New York-based investment bank.
source: Brazil oil field could be huge find
By ALAN CLENDENNING, AP Business Writer
http://news.yahoo.com/s/ap/20080415/ap_on_re_la_am_ca/brazil_oil
The Holy Grail - US AAA credit rating
Standard & Poor's Ratings Services sees the greatest threat to AAA credit rating of the U.S. in financial support for GSEs rather than bailing out Investment banks.
The maximum potential cost of assisting broker-dealers in a prolonged recession is less than 3 percent of gross domestic product, compared with as much as 10 percent to agencies such as Freddie Mac, Fannie Mae and Federal Home Loan Banks, the credit- ratings company said in a statement today. Damage to the U.S. rating from the agencies is unlikely, S&P said.
source: U.S. Rating Threatened More by Agencies Than Bailouts, S&P Says
Bloomberg
http://www.bloomberg.com/apps/news?pid=20602007&sid=aHYXWVtUiiFQ&refer=rates
A Silver Lining - ARMs at same levels 12 month ago
According to JP Morgan about $500 billion of adjustable-rate mortgage loans are due to reset this year and next. With this type of mortgage, periodic adjustments based on changes in a defined index are made to the interest rate. After a period of fixed rates the interest rate adjustments kick in. The most common ARM type loans are 2-28 and 5-1 with initial rates fixed for 2 and 5 years respectively. The new interest rate is computed by adding a predetermined fixed margin to a selected index rate. The margins remain fixed for the term of the loan and are not impacted by the financial markets and movement of interest rates. In addition most ARMs have interest rate caps to protect from enormous increases in monthly payments. The indexes are subject to interest rate movements and therefore pose the biggest problem for adjustable rate mortgages.
Thanks to the Federal Reserve cutting the target rate aggressively from 5.25 to 2.25 since September of last year, interest rates at ARM indexes have come down significantly. A year ago a one-year ARM averaged 5.43 percent and a 5/1 ARM was at 5.88 percent. According to HSH Associates the national monthly average of a 1 year ARM is now at 5.8 percent. The silver lining - this should help to mitigate the impact that adjustable rate mortgages have on the number of foreclosures.
ARM indexes:
Constant Maturity Treasury (CMT or TCM)
Treasury Bill (T-Bill)
12-Month Treasury Average (MTA or MAT)
Certificate of Deposit Index (CODI)
11th District Cost of Funds Index (COFI)
London Inter Bank Offering Rates (LIBOR)
CMT, COFI, and LIBOR indexes are the most frequently used. Approximately 80 percent of all the ARMs today are based on one of these indexes.
After rising in February and March ARMs are finally going down again.
source: Types of Mortgage Loans
Mortgage-X
http://mortgage-x.com/library/loans.htm#margin
source: HSH Associates
http://www.hsh.com/
To put it into perspective - spreads then and now
Here is a very good chart from The Big Picture blog.
source: Chart of the Day: Spreads Relative to Historical Highs
Barry Ritholtz, TBP
http://bigpicture.typepad.com/comments/2008/04/chart-of-the-da.html#comments
An account of a small business owner in Brooklyn
Tara Simone Powell, Barbara's Flowers Owner, discusses the challenges of running a small business.
click for video
S&P 500 earnings are expected to fall 12.3 percent in Q108 - Bloomberg
First-quarter earnings have been "awful'' and are a "harbinger of things to come,'' a team led by New York-based David Kostin, Goldman's U.S. investment strategist, wrote in a note to clients today. Profits at companies in the S&P 500 are expected to fall 12.3 percent in the first quarter and 3.8 percent in the second, according to analyst estimates compiled by Bloomberg.
