Con-tango

Fed throws lifeline to home buyers

According to this Reuters article, the Fed announced a new rescue package of $800 billion USD to lower the cost of home purchases, credit card and student loans.

Under the new mortgage program, the Fed will buy up to $100 billion of debt issued by government-sponsored mortgage enterprises Fannie Mae, Freddie Mac and the Federal Home Loan Banks.

It will also buy up to $500 billion of mortgage securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae.

The central bank also launched a $200 billion facility to support consumer finance, including student, auto, and credit card loans and loans backed by the federal Small Business Administration. This will lend to investors who hold securities backed by this debt.

Great news, although somewhat anticipated by Paulson's change of heart in the direction of the spending of the previous $700 billion USD bailout plan.

Under the current ominous economic conditions, one could almost say, that no one is willing to lend. It's not worth the return on the interest rate —nor any other compensation—, to risk losing it all. Or, lenders are asking themselves: how will borrowers be able to pay back their loans if the economy is spiraling down out of control? 

So, the Fed is playing its role as lender of last resort, lending to Freddie and Fannie, and any lender guaranteed by them, which in turn provide the mortgage funds  to homeowners. It is also buying (or lending to) credit card, student, car and consumer loans, guaranteed by the SBA.

It is a step in the right direction, which I whole-heartedly support, the Fed has to reach the final consumer to stimulate the economy. There will be no trickle down, whilst the intermediaries are too afraid to lend, and are much too worried covering their huge wrong sided derivatives positions.

It also makes sense to bailout the consumer, he carries the weight of 2/3 of our GDP growth, he has the power to jump-start the economy, unlike financial institutions which are proving to be a stumbling block under the current environment.

We must also expect the government to step up its fiscal stimulus by building and repairing  US infrastructure, which happens to be in dire need of TLC.

From Paulson to Wall Street

I guess everybody is as shocked with Paulson’s change of heart…

Instead of the 3 pager proposal to request $700 billion, 1 page for the title, 1 for the thank you and goodbye, and 1 single page with the gravy of the plan; now, he doles out an “I’m not afraid to make changes if the facts change”.

Granted, I think he’s right in trying to get ahead of the curve, or putting the carrot ahead of the cart, or in laymen terms: making the loans available to those who will buy things –making it easier to buy a house or a car.

So, it’s with mixed feelings that we move on. On the one hand, there are still all those derivatives left behind littering the landscape like a mine field, and, on the other hand, the new consumer oriented lending is sure to give some needed traction to the economy.

And you already know that the markets reacted bitterly to the waivering Paulson attitude. If you stop for a minute to think about it, trillions are at stake, and Paulson reads like he’s thinking it out for the first time… I mean, we could’ve had a couple of DC buildings full of well paid geniuses, like they do in the military, working out all the possible economic what if scenarios.

But, we didn’t. Human nature, I guess. High price to pay, though.

Reading here and there, trying to get my bearing on Paulson’s comments, I ran into this fantastic piece by Michael Lewis, which he wrote in his early twenty’s and is self explanatory…

[T]he willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grownups remains a mystery to me. I was 24 years old, with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall. The essential function of Wall Street is to allocate capital—to decide who should get it and who should not. Believe me when I tell you that I hadn’t the first clue.
[…]
I’d never taken an accounting course, never run a business, never even had savings of my own to manage. I stumbled into a job at Salomon Brothers in 1985 and stumbled out much richer three years later, and even though I wrote a book about the experience, the whole thing still strikes me as preposterous—which is one of the reasons the money was so easy to walk away from. I figured the situation was unsustainable. Sooner rather than later, someone was going to identify me, along with a lot of people more or less like me, as a fraud. Sooner rather than later, there would come a Great Reckoning when Wall Street would wake up and hundreds if not thousands of young people like me, who had no business making huge bets with other people’s money, would be expelled from finance.

Why are we getting half baked plays from the ones we should be getting double chess plays?

Libor: Excellent news

Libor Rates. Courtesy of Economagic.

It can't all be that bad, short term Libor rates have dropped dramatically, signaling that the Fed's bypass surgery to the clogged arteries of the bank to bank lending has been a success –we have eluded the worse, a sudden death of the financial system.

Now, will they be able to stop the bleeding of AIG, GM, Chrysler..?

China: Would you believe?

The Chinese government announced a stimulus package to their economy worth $685 billion USD.

I’m sorry, but, I’m not buying. Nice try and nice gesture, though.

Out of the top of my head, I know this would be a significant portion of their PBOC reserves, which stand at $1+ trillion USD, give or take. It’s not like they’re printing the USD, they can’t, for them it’s hard currency.

And, if my wetted thumb estimates do not betray me, their average labor costs still lie below 15% of their western counterparts, so what in the hell are they going to build to spend an equivalent seven times in labor –another Chinese wall?

Sorry, I’ll pass on this one.

On a related note, Bloomberg had this short video with professor Frankel’s opinion on the subject and the extension of the ongoing recession –bleak was the word that kept coming up.

CDS ratings

From this Bloomberg article, I thought it would be interesting to see a list of companies with their CDS prices, which shows how the market is pricing their relative risk to a debt default.

In other words, if I wanted to insure $10 million of General Motor’s debt, I would have to pay upfront $6.7 million, plus a yearly premium, in the order of $800,000.

The scorecard

Courtesy of Prophet

From this Bloomberg article I learn the tally on the markets pain, so far…

Stock markets and commodities have tumbled along with currencies this year amid growing concern that governments, central banks and finance ministers are powerless to counter eroding corporate earnings and a global recession.

Oil-producing nations haven’t escaped the carnage as crude plunged 56 percent from its July peak to $64 a barrel.

More than $10 trillion has been erased from the market value of equities so far this month, accounting for about one-third of the total value wiped off stocks this year. MSCI’s index of developed and emerging stock markets plunged 48 percent in 2008 and is heading for its worst year on record as credit-related losses topped $660 billion.

The Standard & Poor’s 500 index is down more than 40 percent this year, poised for its worst annual retreat since 1931. The S&P 500 has lost 26 percent since U.S. investment bank Lehman Brothers Holdings Inc. declared bankruptcy on Sept. 15, while the U.K.’s FTSE 100 has fallen 25 percent, Japan’s Nikkei 225 has tumbled 37 percent and Germany’s DAX has dropped 29 percent.

Staggering losses

I'm trying to make sense of this BIS September report, so, please bear with me and my ramblings.

Toni, from Prudent Investor had this wonderful piece about the size of the derivatives markets, which for December 2007 stood at $596 trillion –what an alarming figure!

It's important to understand that these are notional values, which are leveraged with good faith deposits of around 1.25%, or $7.2 trillion for each side of the trade.

Trouble is, that the 4 to 7% daily movements that we have been experiencing lately in the underlying stock markets, send shocks of 3.2 to 5.6 times their derivative stakes in one day! Worse, CDS involved in debt defaults, which are occurring at a brisk pace, represent much larger payouts, in the order of 833 times!

Now, if you've been paying attention, the above $596 trillion are the more shadowy counterparty OTC derivatives, which do not include an additional $84.3 trillion from the less riskier exchange traded derivatives (from page A108 Table 23A).

Another salient issue is that the interest rate derivatives are the
heaviest item weighing in the derivative's total, with $393 trillion
outstanding notional value, and a net trade stake of $3.6 trillion by
the end of last year.

Courtesy of Economagic

If (the short term) Libor violent movements are a reflection of the interest rate sector derivatives, with an enormous 170% rate increase during the last month or so, then, holder's of interest rate derivatives are making a 136 (170 / 1.25) times profit or loss –depending on the holder's side of the trade, which if outstanding deposit volumes had unwound an estimated 50% to $1.8 trillion by September, would represent a $244 trillion payout to clear these trades (= 136 x $1.8 trillion).

Of course I'm thinking out loud. But, the above figures are reasonable. If these numbers are close to reality, then, someone has been either clearing their positions out of $200 trillion or so, has gotten horrible margin calls, or is praying to all gods and the devil that these rates come down while holding to what can only be called staggering unrealized losses!

In any case, it's definitely a mess out there.

Update October 24:

Ok, so $244 trillion is too much. On a spike in voltage, breakers should go off. Since we can't  tell where these stop limits or margin calls are, let's suppose an average stop at 10%. Then, losses would be in a more sanish $14.4 trillion (= $1.8 trillion x 10 / 1.25), which is quite distressing anyhow.