major participants in the derivatives market have agreed to what amounts to a significant overhaul of the OTC universe.

TO BE NOTED: From Alphaville:

"Wall Street makes significant concessions on OTC derivatives Posted by Stacy-Marie Ishmael on Jun 02 19:26.

Apoplectic regulators like CFTC chairman Gary Gensler - on the job for all of a week and already condemning the evils of credit default swaps - ought to welcome the news that major participants in the derivatives market have agreed to what amounts to a significant overhaul of the OTC universe.

Wall Street banks have committed to the following, according to a statement from the New York Fed issued on Tuesday (emphasis FT Alphaville’s):
* Recording all OTC derivatives transactions in trade repositories: Registering the complete universe of OTC derivatives trades in either central counterparties or trade repositories will improve the ability of regulators to monitor the OTC derivatives market and will increase transparency to the public. The signatories have committed to record all of their credit derivatives trades by mid-July and to establish centralized reporting infrastructures for interest rate and equity derivatives.

* Expanding CDS central clearing to customers by mid-December 2009: A key regulatory priority is to extend the risk reduction benefits of CDS Central Counterparties (CCPs) to all market participants. Dealer clearinghouse participants have committed to provide their clients* with access to any viable CDS CCP solution no later than December 15, 2009.

(*By “clients” read “hedge funds”)
* Expanding central clearing to a wider range of OTC derivative products: Market participants have set near-term targets to expand central clearing support for credit and interest rate derivative products. Expanding central clearing support for standardized OTC derivatives instruments will maximize the credit risk reduction and operational efficiency benefits provided through use of prudently managed, financially strong and regulated CCPs.

* Strengthening counterparty risk management: Major dealers have committed to implement daily reconciliation of portfolios, a requisite practice for robust counterparty credit risk management, by June 30, 2009. In addition, by September 30, 2009, market participants will publish a standard mechanism for timely and fair resolution of valuation disputes.

* Establishing broad-based and transparent industry governance: The industry commits to enhance its newly-established governance structure to ensure that a broad range of market participants will be included in open, transparent decision-making processes that fairly balance the interests of dealers and their customers.

* Continuing to drive operational performance improvements: Market participants have committed to improve operations in four key areas: matching trades on trade date, increased automation, increased standardization and continued reduction of trade confirmation backlogs.

Of course, not all of these are new - dealers have been promised to reduce trade confirmation backlogs for the better part of a decade - but they are notably more specific. Crucially, this is the first time industry participants have set dates and timelines for achieving their various “operational efficiencies.”

Wall Street’s letter to the Fed laying out its commitments is here; a summary (in handy table format) is here.

Related links:
BlueMountain set to earn $817m on CDS - Bloomberg
Central counterparties and CDS risk, a contrarian argument - FT Alphaville
US calls for OTC derivatives regulation - FT

This entry was posted by Stacy-Marie Ishmael on Tuesday, June 2nd, 2009 at 19:26 and is filed under Capital markets. Tagged with CDS, derivatives, Regulation."

Me:

Don the libertarian Democrat Jun 2 23:02

I'd like to know how this would help in a panic. The reason that CDSs and CDOs froze was because they were sitting right on the bottom of the Flight to Safety totem pole. In other words, in a Flight to Safety, they lost a good part of their worth, especially as compared to other assets. That left the owners of them in a quandary. Whether to sell or hold onto them. The crisis was a huge disparity between bid and ask. That will happen next time as well, if we have a Flight to Safety. The reason is simple: Safe is relative to other assets and the financial context. You cannot stop this reordering and revaluation of assets in a panic. You can only hope to smooth it out. This might help marginally, but, unless the assets are immediately callable, I don't see how.

If thought 275bp for the 2Y-10Y curve was wide, Reuters reports the curve hit a fresh record on Tuesday

From Alphaville:

"Benchmark US yield curve hits fresh record wide Posted by Stacy-Marie Ishmael on Jun 02 16:37.

If thought 275bp for the 2Y-10Y curve was wide, Reuters reports the curve hit a fresh record on Tuesday:

15:55 02Jun2009 RTRS-US 2-YR, 10-YR YIELD GAP HITS RECORD WIDE AT 277 BPS IN THE WAKE OF STRONGER-THAN-EXPECTED HOME DATA

Related links:
US pending home sales surge in April - FT
Bonds swamped in fair weather or foul - James Saft at Reuters

This entry was posted by Stacy-Marie Ishmael on Tuesday, June 2nd, 2009 at 16:37 and is filed under Capital markets. Tagged with Treasuries.

Me:

"Don the libertarian Democrat Jun 2 17:07

From Bloomberg:

“We would only consider buying Treasuries if 10-year yields come to around 4 percent,” said Shuhei Mochizuki, assistant manager in the foreign-bond section in Tokyo at Sumitomo Life Insurance Co., which oversees about $30.7 billion in non-Japanese debt. “We prefer European bonds for now.”

This is what we want. Here's how it works:

From my point of view, this is how you want QE to work against Debt-Deflation, which is a panic phenomenon.
1) Low Short Term Interest Rates, as a disincentive to buy guaranteed assets, and an incentive to buy stocks and corporate bonds. This attacks the Fear and Aversion to Risk.
2) Rising Longer Term Interest Rates, which signal an end to Deflationary Fears, and are an incentive for Longer Term Investing.As well, as you say, the Spread often ( which is as exact as this gets ) signals a recovery.

Now, what's interesting, is that I take it that this is what Bernanke and Geithner have been arguing, although not necessarily saying it the way I do. And, in fact, it seems to be working, which , again, is about as good as it gets, since none of us know the future.

Yet, as obvious as this is to me, others have been puzzled by this line of reasoning. I, on the other hand, do not understand the point of having interest rates move in tandem, insofar as incentives are concerned.

I understand the idea of rising interest rates being a problem, but the Fed has other means of addressing mortgages, in coordination with other parts of the government. However, I am not for keeping interest rates of mortgages artificially low at all, but certainly feel that this policy should now end. We need to see a plausible bottom on housing prices, without the perception of government still keeping housing prices artificially high.

Of course, Inflation will be the issue going forward, but I prefer that to a Debt-Deflationary Spiral. Call me silly, I guess.

Right now, a stimulus with QE is working as Geithner and Bernanke and I would like. It could all go sideways, but the fact that this is the plan seems to be missed by many people."

on review for possible downgrade

From Alphaville:

"Moody’s global bank review, redux Posted by Stacy-Marie Ishmael on Jun 01 18:24.

Moody’s comprehensive re-examination of its ratings on the world’s banks continues apace. Here’s an overview of the actions taken since May 21:

- Moody’s reviews five Kazakh financial institutions for downgrade

London, 22 May 2009 — Moody’s Investors Service today placed the issuer and deposit ratings of five government-owned Kazakh financial institutions on review for possible downgrade. Four of the five affected entities are government-related issuers (GRIs — government-controlled financial companies with specific policy mandates), while the other is a bank fully owned by the government.

- Moody’s reviews four banks in Belarus for downgrade

Moscow, May 26, 2009 — Moody’s Investors Service has placed the ratings of four Belarusian banks on review for possible downgrade. The banks affected are Belagroprombank, Belarusbank, Belinvestbank and Belpromstroibank

- Moody’s reviews eight banks in Poland for possible downgrade

London, 26 May 2009 — Moody’s Investors Service has placed the ratings of eight Polish banks on review for possible downgrade. The affected entities are Powszechna Kasa Osczednosci Bank Polski , Bank Polska Kasa Opieki, Bre Bank, Bre Bank Hipoteczny, Bank Zachodni WBK, Bank Gospodarki Zywnosciowej, Lukas Bank, Europejski Fundusz Leasingowy. The outlook for the long-term deposit ratings of ING Bank Slaski was changed to negative from stable.

- Moody’s reviews several Czech banks’ ratings for downgrade

London, 26 May 2009 — Moody’s Investors Service today placed on review for possible downgrade the bank financial strength ratings (BFSRs) and the long- and short-term local and foreign currency deposit ratings of the following banks: Ceska Sporitelna (rated Aa3/A1/P-1/C), Komercni Banka (Aa3/A1/P-1/C) and Ceskoslovenska obchodni Banka (CSOB, Aa3/A1/P-1/C). In addition, Moody’s placed on review for possible downgrade the Aa1 long-term foreign currency issuer and senior unsecured ratings of Czech Export Bank (CEB), the E+ BFSR of J&T Banka and the national scale ratings of the following institutions: J&T Banka (Baa2.cz/CZ-2), Home Credit (HC, A3.cz) and BH Securities (Baa3.cz).

- Moody’s reviews nine Slovak financial institutions for downgrade

New York, May 26, 2009 — Moody’s Investors Service today placed the ratings of nine Slovak financial institutions on review for possible downgrade. The affected institutions are Slovenska sporitelna, Vseobecna uverova banka, Tatra banka, Unicredit Bank Slovakia, Ceskoslovenska obchodna banka, Privatbanka, Tatra leasing and Home Credit Slovakia. OTP Bank Slovakia’s deposit ratings were downgraded to Baa3/Prime-3 from Baa1/Prime-2 following the downgrade of its parent, OTP Bank Hungary (Baa1/P-2/D+) on 19 May 2009, and placed on review for further possible downgrade together with its D- bank financial strength rating (BFSR). The A1/Prime-1 issuer ratings of the government-owned Eximbanka were not
affected by this rating action.

- Moody’s reviews two banks in Uruguay for downgrade

New York, May 26, 2009 — Moody’s Investors Service has placed on review for possible downgrade the local currency deposit ratings of Banco de la República Oriental del Uruguay (República) and Banco Hipotecario del Uruguay (BHU) in both the global and national scales.

- Moody’s reviews four banks in Vietnam for possible downgrade

Singapore, May 27, 2009 — Moody’s Investors Service has placed the deposit and issuer ratings of four Vietnamese banks on review for possible downgrade. The banks affected are Asia Commercial Bank (ACB), Bank for Investment and Development (BIDV), Techcombank (TCB) and Vietnam International Bank (VIB). At the same time, Moody’s has placed the bank financial strength rating (BFSR) of VIB on review for possible downgrade.- Moody’s Changes Outlook for Italian Banks to Negative from Stable

Milan, May 27, 2009 — Moody’s Investors Service today changed the fundamental credit outlook for the rated Italian banks to negative from stable, reflecting the spread of the financial crisis into the real economy and the resultant adverse effect on Italian banks’ asset quality and profitabilityMoody’s places deposit ratings of two Armenian banks on review for possible downgrade

- Moody’s places deposit ratings of two Armenian banks on review for possible downgrade
Limassol, May 27, 2009 — Moody’s Investors Service has today placed on review for possible downgrade the global local currency (GLC) deposit ratings of two rated Armenian banks (ACBA-Credit Agricole and Ardshininvestbank). All other ratings assigned to these banks were not affected by this action.

- Moody’s places deposit ratings of three Lebanese banks on review for possible downgrade

Limassol, May 27, 2009 — Moody’s Investors Service has today placed on review for possible downgrade the global local currency (GLC) deposit ratings of three Lebanese banks (Bank Audi, Blom Bank and Byblos Bank). All other ratings assigned to these banks are not affected by this action.- Moody’s reviews two Pakistani commercial banks for downgrade

Limassol, May 28, 2009 — Moody’s Investors Service has today placed on review for possible downgrade the Ba2 global local currency (GLC) deposit ratings of Habib Bank Ltd and United Bank Ltd in light of its global review of systemic support indicators for the banking systems.

- Moody’s takes rating actions on 13 Indian commercial banks

Limassol, May 28, 2009 — Moody’s Investors Service has today placed the ratings of 13 Indian commercial banks on review for possible downgrade in light of its global review of systemic support indicators for the banking systems.

Related links:
Moody’s global bank review, a roundup - FT Alphaville

This entry was posted by Stacy-Marie Ishmael on Monday, June 1st, 2009 at 18:24 and is filed under Capital markets. Tagged with Banks, india, kazakhstan, moody's, nab, pakistan.

Me:

Don the libertarian Democrat Jun 1 22:17

"review for possible downgrade"

What does this mean? What if the x gets upgraded? Why not just say that they're being reviewed? Is this supposed to a heads up or words to the wise kind of thing?

main one is that the UK does not disclose results, nor the detailed assumptions in terms of loss rates

TO BE NOTED: From Alphaville:

“The US and the UK stress tests have two very different objectives” Posted by Stacy-Marie Ishmael on May 28 19:03.

BNP Paribas has come out with an analysis of the UK’s methodology for stress-testing its banks. Conclusion? Meh.

Analysts Olivia Frieser and Andrea Cicone concede the test is a “real one”, in so far as the parameters - 12 per cent unemployment, 50 per cent fall in house prices and a six per cent decline in GDP from peak to trough - are reasonably demanding:

The assumptions seem severe enough to us and therefore the stress test seems real

However, they note:

if we were picky, we would say that they remain static tests, and that these assumptions are merely in line with the base case of our admittedly bearish economists.

Moreover:

In blunt terms, some disclosure is better than none, but we still feel we do not have enough disclosure to feel that UK banks will not need any additional capital in coming years.

Frieser and Cicone currently have a ‘reduce’ recommendation on RBS and Lloyds Banking Group.

As for how the UK’s methodology compares with the US, they highlight two main differences:

The main one is that the UK does not disclose results, nor the detailed assumptions in terms of loss rates, while the US has provided plenty of information in this regard, down to the individual bank holding company level.

The UK stress scenarios look sufficiently “stressing”, whereas even the more adverse scenario used by the Fed was fairly generous for the banks, being more benign than our own forecasts.

These differences, they say, confirm the fact that the US and the UK have two profoundly different objectives (emphasis ours):
the UK one is a tool used by the FSA and Treasury to truly assess the possible cost of the APS programme (hence the more stressing scenario, the “confidentiality” of the results, and the fact that is an ongoing practice);

on the other hand, the US one was fundamentally a confidence-building exercise for the benefit of investors (hence the more accommodative scenarios, the disclosure of detailed information about the results, and the one-off nature)

In other words, one’s a model and one’s PR - but that may just be FT Alphaville’s typically jaded take on the matter.

Related links:
Stress testing, a retrospective view - FT Alphaville

This entry was posted by Stacy-Marie Ishmael on Thursday, May 28th, 2009 at 19:03 and is filed under Capital markets. Tagged with Banks, Lloyds Banking Group, rbs, stress tests, UK, us."

Me:

Don the libertarian Democrat May 29 15:48

You're correct about what the Stress Tests became in the US, but they should have done what the UK has done. The confidence in CAP should have followed from clear government guarantees.

U.S. has the “enormous privilege of controlling the world’s most important reserve currency,” allowing it “to borrow almost without limit

TO BE NOTED: From Alphaville:

“Why the USA will not get downgraded” Posted by Stacy-Marie Ishmael on May 27 15:55.

Gluskin Sheff’s David Rosenberg weighed in on Wednesday on the likelihood of a sovereign downgrade for the US of A (emphasis FT Alphaville’s):
I realize this it is borderline heresy to say anything positive about the U.S. economy so I will just say something that is less positive. It is highly unlikely that the U.S. government will ever default. Why? Well, it can always print dollars — and all its liabilities are in dollars.

Not only that, but it was comical to see the markets focus on the U.S. dollar and the Treasury market following the downgrade to the U.K.’s credit outlook. There is no use comparing the diversified economic base between the two countries.

Not only that, but the taxing capacity in the United States is much larger — government revenues absorb 42% of national income in the U.K. versus 33% in the U.S.A. Those comparable figures are 43% in Germany, 46% in Italy, and 49% in France. In Canada, it is 40%. But here is the grim reality for American workers, especially those in the upper income echelons. The President ran on a campaign to redistribute income, and at the same time he has beefed up what was already a near-intolerable deficit, and as we saw in the 1930s as the top marginal tax rate climbed to nearly 80%, Uncle Sam is going to be increasing its revenue take for a long, long time. The era of the word ‘tax’ being a dirty three-letter words in the United States is about to come to a close, if it hasn’t already in areas like New York, where the top rate has already risen to 46%. Shades of Ontario during the Rae years of the early 1990s.

Which is somewhat more optimistic than he said last Thursday, after S&P revised its outlook on the UK to negative from stable:

Don’t think for a second that the same cannot happen to the USA at some point judging by the massive runup in government debt and debt guarantees.

In fairness, last week he was responding specifically to the possibility of an outlook revision, which is much more likely than an outright downgrade of the US credit rating.

Moreover, S&P seems to want to allay concerns that it is even considering any such thing. Here’s Bloomberg on the matter:

Standard & Poor’s decision to cut its outlook on Britain’s top credit rating doesn’t signal a similar move for the U.S. will follow, said Moritz Kraemer, S&P’s head of sovereign ratings for Europe, Middle East and Africa. “I want to make it very clear that the negative outlook on the U.K. is not a secret message to Washington,” Kraemer told reporters at a media briefing in Johannesburg today. If we wanted to talk about the U.S. then we’d talk about the U.S.”

And, echoing Rosenberg:

The U.S. has the “enormous privilege of controlling the world’s most important reserve currency,” allowing it “to borrow almost without limit,” Kraemer said. U.S. debt has a “top notch credit rating” and is “very safe,” he said.

S&P estimates that 48 percent of all U.S. Treasuries are held abroad, “mostly by central banks,” Kraemer said. The percentage of U.K. gilts held by foreign central banks “is in the lower thirties” and less than that for Germany, he said. There is no “serious contender” to threaten the dollar’s status as a global reserve currency, Kraemer added. The euro is the “only credible alternative” to the dollar, though it’s “not mature enough,” he said.

Everyone calm down, then (and here’s looking at you, Bill Gr0ss).

UPDATE at 16:45 - Moody’s is now weighing in, with a press release titled “US government’s Aaa stable despite increased debt burden” (emphasis ours):

New York, May 27, 2009 — Even with a significant deterioration in the US government’s debt position, its rating has a stable outlook and demonstrates the attributes of a Aaa sovereign, says Moody’s Investors Service in its annual report on the United States. These attributes include a diverse and resilient economy, strong government institutions, high per capita income, and a central position in the global economy.

“Moody’s expects that, because of these factors, US economic strength will emerge after the crisis without major impairment,” said Moody’s Vice President Steven Hess, author of the report. “The global role of the US currency also contributes to the ability of the economy and government finances to rebound.”

He said the government balance sheet has been weakened by the combination of efforts to stabilize the financial system, the effects of the sharp economic recession on federal finance, and the $787 billion federal stimulus package passed earlier this year. The result has been much higher debt ratios that may persist for some years to come. While these ratios are deteriorating in the US, they are also doing so in most other advanced economies due to the global recession.

Furthermore, the level of debt is less important than the government’s balance sheet flexibility, which Moody’s believes is still high in the case of the US. Despite a worsening government balance sheet, Moody’s cites other factors in support of the Aaa rating. “The current economic downturn has only temporarily altered America’s productivity dynamic, and productivity has risen in the recession period, as is typical,” said Hess. “US labor market flexibility has been a key factor in this trend.”

A higher rate of US population growth through 2025 relative to other advanced economies will also contribute to continued economic growth — and government revenues.

“While our outlook for the US rating is stable, a reassessment of the long-term growth prospects of the economy and the ability of the government to return to a sustainable debt trajectory could put negative pressure on the rating in the future. How the economy and fiscal policy fare after the recession will be key,” said Hess. He added that, over the longer term, contingent liabilities related to Social Security and Medicare programs could also pressure the rating.

Related links:
Exploding debt threatens America - FT
Marc Faber: Hyperinflation coming to the USA - FT Alphaville
On the not-unlimited appetite for government bonds - FT Alphaville

This entry was posted by Stacy-Marie Ishmael on Wednesday, May 27th, 2009 at 15:55 and is filed under Capital markets. Tagged with Debt, sovereign ratings, usa."

Moi ( Me, in French ):

The question of default by the US is not an economic issue, but a political issue. The question is really about whether or not US politicians would favor a default at some point. The clear answer to that is that they would, under the right circumstances, such as needing the issue to win an election. I would look to whether or not politicians start blaming China and the giant foreign pool of money for US problems. That is a good default indicator.

Likely. No. But aren't we all a bit dubious now of our ability to predict the future?

Perhaps I'll Change My Name To " capital markets "

Stacy-Marie Ishmael is a New York-based reporter for the Financial Times and blogger for FTAlphaville, the award-winning markets blog. Her beats include credit, derivatives, structured finance, capital markets and emerging markets.

Stacy-Marie joined the FT as a graduate trainee in August 2006 after attaining a BSc in International Relations from the London School of Economics and Political Science. During her two-year stint as a trainee she wrote for both the paper and for FT.com, including FT Alphaville, with a particular focus on capital markets.

Nothing to see - until there is.

From Alphaville:

"Sovereign downgrades: some perspectives Posted by Stacy-Marie Ishmael on May 22 11:45.

In the aftermath of S&P lowering its outlook on the UK from stable to negative due to the country’s rising debt levels, there has been a flurry of commentary from analysts, other ratings agencies and (inevitably) political journalists.

And of course, there’s been a market reaction - while the sterling has regained its footing, in late trade in the US on Thursday, the US dollar, bonds and equities were facing severe selling pressure

What hurt sentiment across the pond was the fear that the US, too, is vulnerable to the loss of its triple-A credit rating. As David Rosenberg (formerly of Merrill Lynch, newly of Gluskin Sheff) put it in a note on Thursday morning:

Don’t think for a second that the same cannot happen to the USA at some point judging by the massive runup in government debt and debt guarantees.

Pimco’s Bill Gross told Reuters much the same thing after markets started to slide, i.e. that investors fear the US is “going the way of the U.K. — losing AAA rating which affects all financial assets and the dollar.”

Which is an exaggeration - a negative outlook is hardly a downgrade - but Gross may well have a point.

Analyst Alan Clarke at BNP Paribas noted that in some cases (like Ireland) “the progression from outlook negative to downgrade can still be just a matter of weeks.”

On the other hand (emphasis ours):
The Irish experience reflected a sharp deterioration in conditions over a short space of time. For the UK, it is likely that the bulk of the bad news has largely surfaced; it is now a case of whether or not it looks like the situation will be fixed in a timely manner. That implies a much longer review period than we saw in Ireland. Nonetheless, this week’s news does represent a step closer to a possible downgrade.

Clarke also provides a handy breakdown of the speed with which other countries have moved from a negative outlook or CreditWatch negative to an actual downgrade:

Moreover, in the case of the UK, “the election is the key to reassessment.” As a result, Clarke thinks the base case for the timing of subsequent rating action, “at least from S&P”, is around the time of the election.

However, he argues, there is a risk of a much earlier rating action:

This could be triggered by a failed gilt auction, a run on sterling, even worse than expected data on public finances in the near term or another bailout event.

Of these, he says, a failed auction or another slump in sterling are probably the biggest risks.
Overall, the change in the S&P outlook represents a shot across the bows for both political parties: either plan to get the public finances back in order after the election, or face a downgrade.

They conclude that while is it not inevitable that the UK is downgraded, the possibility remains a threat between now and next year’s election.

In any event, some commentators were little moved by the prospect of a sovereign downgrade for the UK or the US. Arguing for the Brits was Michael Riddell of the Bond Vigilantes blog, who noted:

So does it matter if the UK does eventually get downgraded to AA? Judging by [Thursday morning’s] very successful UK government bond issue, not much. The UK’s Debt Management Office issued £5bn of UK gilts maturing in 2014, and the issue attracted bids for 2.6 times the amount offered. This was impressive considering that, as RBC have pointed out, it was the biggest ever nominal amount of bonds sold in a single operation.

Also, a credit rating downgrade doesn’t necessarily mean government bond yields will rise - Moody’s downgraded Japan to A2 in June 2002, which was lower than the credit rating of Botswana at the time, and that didn’t stop 10 year Japanese government bond yields getting to 0.4% in May 2003.

On the other side of the Atlantic, Felix Salmon postulated that the US triple-A was “nothing to worry about”. Salmon takes the increasingly common approach of dismissing the prognostications of ratings agencies outright:
The most important thing to remember here, however, is that ratings agencies don’t matter any more. They lost their credibility when structured finance blew up, and the number of people buying Treasuries because S&P says that they’re triple-A rated is exactly zero.

And adds:
There are lots of triple-A rated securities; people buy Treasuries because they’re liquid. The US triple-A may or may not disappear at some point, but if and when that happens it’ll be a lagging indicator, and there will already be a select group of alternative securities which are trading at lower yields in dollars. So long as Treasuries have the lowest yields in the dollar-denominated world, they will retain their triple-A, and there are much more important things to worry about.

Which is, in a sense, precisely the stance taken by Her Majesty’s Treasury, one that translates to “move along people, nothing to see here.”

Timothy Geithner, at least, is attempting to dissuade markets of the likelihood of a similar threat to the US, telling Bloomberg Television that reducing the spiralling US deficit was “critically important”:

May 21 (Bloomberg) — Treasury Secretary Timothy Geithner said the Obama administration is committed to reducing the federal budget deficit after concerns rose that the U.S. debt rating may eventually be threatened with a downgrade.

“It’s very important that this Congress and this president put in place policies that will bring those deficits down to a sustainable level over the medium term,” Geithner said in an interview with Bloomberg Television. He added that the target is reducing the gap to 3 percent of gross domestic product or smaller, from a projected 12.9 percent this year.

Nothing to see - until there is.

Related links:
The sovereign ratings on the wall - FT Alphaville
Sovereign stress, UK edition - FT Alphaville
Fitch cuts Ireland to AA+, outlook negative - FT Alphaville
Portugal, Italy, Greece, Spain to S&P slaughter - FT Alphaville

This entry was posted by Stacy-Marie Ishmael on Friday, May 22nd, 2009 at 11:45 and is filed under Capital markets. Tagged with sovereign ratings, UK, usa."

Me:

Don the libertarian Democrat May 22 15:54

There is a conundrum in relying upon these ratings agencies, especially when rating countries. When I looked up the methodology that they used to determine these ratings for countries, I seem to remember thinking that they were a bit on the subjective side, including factors like, as you say, their assessment about who's running the country.

Now, I don't particularly trust ratings agencies to rate simple investments with clear guidelines, let alone giving them credence in the subjective realm of rating investments. Am I wrong about how they create this rating?

By the way, if people use it, it's hard to claim that it's worthless.

Merrill Lynch undertook a rushed campaign to find parties willing to hedge or provide protection on its remaining CDO positions

TO BE NOTED: From Alphaville:

"Bond insurers vs investment banks, redux Posted by Stacy-Marie Ishmael on May 01 18:00.

Funny thing, déjà vu.

About one year ago, Merrill Lynch and SCA Capital - known, somewhat ignominiously, as the first triple-A rated bond insurer to be stripped of that designation - were involved in a messy legal dispute over insurance on collateralized debt obligations. Now, history is repeating itself - only this time, it’s MBIA and Merrill that are busting out their lawyers.

First, some background:

SCA Capital used to be a fully-owned subsidiary of XL Capital. In 2006, SCA debuted in the US equity markets in what MarketWatch described as “the richest US initial public offering from the insurance sector in more than two years”. XL retained a 46 per cent stake (the valueof which it had completely written off by July 2008).

Somewhat confusingly for anyone not familiar with the minutae of the bond insurers, SCA also operated a financial guarantee subsidiary known as XL Capital Assurance (XLCA). Last year, Merrill sued XLCA over the latter’s attempt to get out of $3.1bn of CDS it had written on CDOs held by Merrill. The bond insurer counter-sued, asserting (emphasis ours):

Merrill Lynch undertook a rushed campaign to find parties willing to hedge or provide protection on its remaining CDO positions… Determined to get these CDO risks off its books at all costs before the third quarter of 2007 closed, Merrill Lynch made the decision to blatantly ignore its prior commitments to XLCA.

Attorneys specialising in the business of derivatives and in insurance told FT Alphaville at the time that XLCA’s claims were unlikely to hold water in court.

“Bond insurers are supposed to be extremely sophisticated. Any argument that they didn’t know what they were getting into is not going to cut it in court,” one NY-based lawyer who asked not to be named said. “And any claim that there was fraud involved is going to come up against a very high bar - it takes a lot to prove fraud.”

Still with me? Good. Merrill and XLCA eventually settled the dispute: Merrill agreed to tear-up the CDS contracts in exchange for $500m.

Subsequently, XLCA rebranded as Syncora Guarantee Inc - except that, legally, that had been its denomination since 2006.

Anyway - XLCA/Syncora is making headlines again, because it has “suspended payment of all claims and is operating only in the ordinary course and as necessary to complete a successful comprehensive restructuring.”

Clients, of course, are less than impressed. Per this FT story:

Banks and other investors face a bill of more than $1bn after a large US bond insurer became the first since the credit crisis struck to cease paying out claims, an event expected to trigger payouts on billions of dollars of credit derivatives.

Syncora has guaranteed more than $140bn of bonds, mainly municipal debt and structured finance. In spite of the pressures wrought by the credit crisis on the bond insurers, or monolines, such as Ambac and MBIA, no others have so far been forced to cease paying claims.

Banks, insurance companies and other investors involved in the market put up collateral against their credit derivatives exposures, which means some of the $1bn in payouts will already be in the hands of those due to receive them.

Syncora has been negotiating with banks since last July as it has attempted to write off or “commute” some of the $56bn of guarantees that SCA wrote on collateralised debt obligations (CDOs).

From mega-bucks IPO to “comprehensive restructuring” in just three years. How the mighty have fallen, etc.

Which brings us to another fallen bond insurer - and once the mightiest of them all - MBIA.

On Thursday, MBIA said it had filed suit against Merrill Lynch. From the statement, emphasis ours:
The lawsuit seeks the rescission of certain credit default swap contracts (”CDS Contracts”) and related insurance policies issued to Merrill Lynch as well as damages resulting from Merrill Lynch’s misrepresentations and breaches of contract in connection with MBIA’s $5.7 billion in gross exposure to a series of structured product transactions that Merrill Lynch arranged and marketed between July 2006 and March 2007.

More specifically, the suit seeks to void the policies and credit default swaps where Merrill Lynch is the counterparty and to recover damages for MBIA’s losses where the CDS Contracts and related policies were issued to third party counterparties other than Merrill Lynch. LaCrosse is a special purpose vehicle that entered into the CDS Contracts with Merrill Lynch and others that were in turn insured by MBIA.

MBIA believes that Merrill Lynch’s effort to market the CDS Contracts to MBIA was part of a deliberate strategy to offload billions of dollars in deteriorating U.S. subprime residential mortgages that Merrill Lynch held on its books by packaging them into collateralized debt obligations (”CDOs”) or hedging their exposure through swaps guaranteed by insurers.

Sound familiar? See XLCA v Merrill, above.

Further:
Based upon Merrill Lynch’s misrepresentations regarding, among other things, the credit quality of the collateral underlying the CDOs and the level of subordination protection, MBIA, through LaCrosse, insured over $5.7 billion of credit default protection on the super-senior and senior tranches of four CDOs. As a direct result of Merrill Lynch’s misrepresentations and breaches of contract, MBIA now faces expected losses on these four CDOs presently estimated to be in excess of several hundred million dollars. Various learned counsel contacted by FT Alphaville say the burden of proof required for MBIA to be successful in this suit remains enormous. No matter what happens, this case will be watched with interest, not least because it could set a precedent for other bond insurers to follow.

All of this is separate and distinct from questions over whether MBIA’s decision to split its bond insurance unit into a “good” municipal insurer and a “bad” insurer exposed to assets like CDOs triggered a CDS succession event.

Which is itself separate from the lawsuits filed by shareholders (the possibility of which FT Alphaville warned about back in February 2008).

Whew.

UPDATE: ISDA ruled on Friday that Syncora’s decision to halt payments resulted in a failure to pay credit event. In other words, anyone who sold protection (through CDS) on debt issued by Syncora will have to may payouts to their counterparties. Notional CDS contracts written against Syncora’s debt are about $18bn, but the net value - i.e. the amount that will have to be paid out, without accounting for collateral already posted - is about $1bn, according to DTCC data.

Related links:
MBIA not screwing around in suit against Merrill - Economics of Contempt
Who’s super senior? - FT Alphaville
More monoline trouble looms - FT Alphaville (March 2008)

This entry was posted by Stacy-Marie Ishmael on Friday, May 1st, 2009 at 18:00 and is filed under Capital markets. Tagged with MBIA, merrill lynch, SCA Capital, Syncora Guarantee, XL Capital.

he had to prove he was working and not merely impressing Minnie Mouse with his formidable knowledge of Bloomberg shortcuts

From the FT:

“People are loss averse and short sighted” Posted by Stacy-Marie Ishmael on Apr 30 16:23.

John Authers has decamped to Orlando, Florida (more precisely, Disneyworld) for this year’s Chartered Financial Analysts conference. The FT agreed to pay for his flights and accommodation, with the caveat that he had to prove he was working and not merely impressing Minnie Mouse with his formidable knowledge of Bloomberg shortcuts.

Enter a series of videos, dubbed “Long View Interviews”, shot live from sunny Florida. One of best of these videos is an interview with Richard Thaler, one of the founding fathers of behavioural economics and the co-author of “Nudge.” Worth watching.

There’s a similarly worthwhile video interview with Michael Mauboussin, chief investment strategist at Legg Mason, on the subject of psychology and markets. Mauboussin is known for his work comparing investors to gamblers.

Related links:
Behavioural economics - Archive of posts at the Economist’s Free Exchange blog

This entry was posted by Stacy-Marie Ishmael on Thursday, April 30th, 2009 at 16:23 and is filed under Capital markets, People. Tagged with John Authers, Michael Mauboussin, Richard Thaler."

Without further tax rises or spending cuts, the federal debt will reach levels not seen since 1949

TO BE NOTED: From Alphaville:

"The indebtedness of the US to the public Posted by Stacy-Marie Ishmael on Apr 27 16:10. Comment.

Via Reuters’ prolific columnist John Kemp, comes this grim reminder of the size of US public debt (emphasis ours):

The chart shows the scale of US federal government debt held by the public as a percentage of GDP since 1939 — with forecasts for the fiscal years 2009-2019 based on the Congressional Budget Office (CBO)’s analysis of the president’s budget proposals. More…

Via Reuters’ prolific columnist John Kemp, comes this grim reminder of the size of US public debt (emphasis ours):

The chart shows the scale of US federal government debt held by the public as a percentage of GDP since 1939 — with forecasts for the fiscal years 2009-2019 based on the Congressional Budget Office (CBO)’s analysis of the president’s budget proposals.

The cost of the bank rescue plan and fiscal stimulus makes the banking crisis the largest peacetime disaster to overtake the federal budget in the recorded history of the United States. Only the two world wars and war among the states have caused a larger deterioration in the fiscal position and build up of public indebtedness.

Federal debt is set to surge from 37.1% of GDP in 2007 (the last pre-crisis year) to 56.8% in fiscal 2009, the highest level since 1954.

Moreover, federal debt will continue rising thereafter — unless the president and Congress enact further tax rises or spending cuts beyond those already announced. The federal debt is projected to hit 71.4% by 2013 and peak at 79.9% of GDP in 2018.

Without further tax rises or spending cuts, the federal debt will reach levels not seen since 1949 and not much lower than during the 1941-1945 wartime emergency.

Related links:
“The OECD forecasts a jump in US public debt of almost 40 per cent…” - Martin Wolf, FT
US debt puts strain on dollar - FT"

The strong appetite for EM funds seen this month triggered a “sell” signal on the asset class at Merrill

TO BE NOTED: From Alphaville:

“Extraordinary” flows into emerging market funds

Posted by Stacy-Marie Ishmael on Apr 24 15:00.

Funds dedicated to emerging markets posted $2.2bn in inflows during the week ending April 22, the strongest streak for the asset class since May 2008, Merrill Lynch’s Michael Hartnett said in a note released on Friday.

This week marks the seventh consecutive week of inflows for EM funds, which analysts at Deutsche Bank called “extraordinary”, noting:

between June 2008 and March 2009 there have not been more than two weeks of inflows in a row. This cumulated inflows in the last seven weeks for all EM equity funds amounts to nearly US$4.0bn.

Flows into exchange-traded funds continued to dominate; over the past five weeks EM-dedicated ETFs have seen inflows of $6bn, compared with $3.7bn for plain vanilla long-only funds, Merrill said.

Investors were also sanguine on Asia, with inflows of around $0.9bn.

The strong appetite for EM funds seen this month triggered a “sell” signal on the asset class at Merrill, a call which remains in place at the investment bank:

Trading rule says inflows in excess of 1.5% of total AUM in 4-week period = sell. Past 4-weeks of inflow = 2.9% of AUM so trading rule remains in “sell” territory

Following rally from March 2nd low, MSCI EM stalled in the 600-650 range since trading rule said “sell” 4 weeks ago i.e. upward EM momentum arrested

This entry was posted by Stacy-Marie Ishmael on Friday, April 24th, 2009 at 15:00 and is filed under Capital markets. Tagged with emerging markets."

And:

"Positive flows into emerging markets trigger a “sell” at Merrill Posted by Stacy-Marie Ishmael on Apr 03 14:45.

Dedicated emerging market equity funds posted a fourth consecutive week of positive flows during the week ended April 1, according to data from fund-tracker EPFR.

Investors poured just over $1bn into these funds during the week, equivalent to almost 0.4 per cent of total assets. This is the first four-week run of positive flows since May 2008.

Here’s a break down, via Merrill Lynch and Deutsche Bank data:

* Global EM funds saw $0.9bn inflow, Asia saw $0.4bn inflow

* EMEA and LatAm funds see small redemptions

* Flows for developed markets were mixed as US funds (ex. ETFs) and Western European funds (ex. ETFs) posted marginal inflows equivalent to 0.03% of AuM and 0.02% of AuM respectively.

* Japan funds (ex. ETFs) registered outflows equivalent to 1.26% of AuM.

* EM bond funds, which witnessed positive flows last week, registered outflows equivalent to 0.36 per cent of total assets

Merrill Lynch’s international investment strategist Michael Hartnett said the pace of inflows had triggered a “sell” according to an internal trading rule, although he advised caution (emphasis FT Alphaville’s):
Trading rule says: inflows in excess of 1.5% of total AUM in 4-week period = sell

Inflows in past 4 weeks = 1.7% of total AUM so sell signal is only just triggered

Important to note these sell signals work with lag (unlike buy signals): four big sell signals in April ‘06, July ‘07, Sept ‘07 & April ‘08 all worked with 2-4 week lag, so could be early

This entry was posted by Stacy-Marie Ishmael on Friday, April 3rd, 2009 at 14:45 and is filed under Capital markets. Tagged with emerging markets, Funds."

Blue-eyed Investors were particularly keen on Brazil during the week

TO BE NOTED: From Alphaville:

"Investors put billions into emerging market equity funds Posted by Stacy-Marie Ishmael on Mar 27 13:04.

Funds dedicated to emerging market equities reported their largest weekly inflows since May 2008 during the week ended March 25th, Merrill Lynch said in a report on Friday.

These funds attracted $2.3bn in a third consecutive week of inflows, including $1.6bn through ETFs.

The top talking points, according to Merrill’s Josh Hartnett international investment strategist:

The money is 1) going in via diversified “global EM” category, 2) going in via ETFs which indicates retail & hedge fund activity and 3) going to EM rather than developed market funds.

Retail interest in EM picking-up a bit; inflows should make LO investors less fearful of redemptions/encourage lower cash levels. But no doubt flow numbers show that HF’s are using EM ETFs as a way to quickly raise risk levels; note EEM up a staggering 24.3% in March (that’s 1784% annualized).

But Hartnett cautioned that the “BAS-ML fund flow trading rule” was now moving towards ’sell’ signal: “another $0.5-1bn in next week and you start taking-profits,” he said in the note.

Blue-eyed Investors were particularly keen on Brazil during the week; the country enjoyed outsized inflows - and its fifth-largest ever - of $267m.

In contrast, developed markets funds, notably those devoted to US equities, experienced significant withdrawals.

Related links:
IMF overhaul aims to help emerging markets - FT
Re-emerging markets - Lex

This entry was posted by Stacy-Marie Ishmael on Friday, March 27th, 2009 at 13:04 and is filed under Capital markets. Tagged with emerging markets."

Money, left in a large room to rot will not make prices go up, no matter how much is stuffed in.

From Alphaville:

“Filling the system full of money is insufficient to threaten a rise in inflation” Posted by Stacy-Marie Ishmael on Feb 09 15:02.

Citi’s US economist Steven Wieting is less than impressed by those who contend - with varying degrees of seriousness - that the country is heading for hyper-inflation because of the rapid expansion of the monetary base currently underway.

Wieting’s argument is based in part on the contention that there is unlikely to be any near-term recovery in demand (emphasis added):
What is most disturbing is the view that somehow, consumer prices simply move up because of the existence of more bank reserves, or actual measures of money. Money, left in a large room to rot will not make prices go up, no matter how much is stuffed in. The world’s producers and retailers don’t get a call from the central bank telling them it is time to raise their prices. Even commodities produced abroad require demand, meaning sales, to set a price for available supplies. After all, what is price, other than “what someone will pay for it?”

Many have decided that there will be a renewed bout of inflation, even as they’ve ruled out the potential for demand recovery. But we can’t simultaneously suffer inflation and deflation. Counter-cyclical fiscal and monetary policy actions are mere offsets to private restraint, which is a deflationary force. While one can call the expansion of bank reserves printing money, banks are not increasing lending in a proportionally large way, and should never be expected to. While the collapse in securitized credit markets away from traditional bank balance sheet lending is the larger driver of credit tightening, commercial banks won’t be able to double their balance sheets as the Fed has, even if boom times return.

On the first point, Wieting notes that “in every year since 1955, the stock of printed or coin money (currency in circulation) has gone up,” and that “unless the data are truly tortured with lags and transformations, there are no strong correlations between measured money growth and measured consumer price inflation over medium term periods of time.”

He also dismisses any suggestion that the money supply may expand beyond the country’s productive capacity, leading to a classic demand-pull inflationary cycle caused by too much money chasing too few goods. At present, Weiting says, money isn’t doing anything of the sort:
Consumer purchases are falling at lower price levels. The CPI posted record post-war declines in the fourth quarter. Retail expenditures also posted record declines, and nominal incomes are slowing while precautionary savings rise.

…the expansion of money and its precursors have yet to succeed in truly turning consumer demand

Moreover, he says, the expansion of the monetary base has not translated into more cash in consumers’ wallets, since the increase has largely been in Fed funds held on reserve.

this is not money in shopper’s hands. This is not money in the precautionary accounts of households or nonfinancial firms. It is not capital available to the banks to help them offset their losses.

And this money has also done little to increase nominal output - its velocity has in fact collapsed, as the chart below shows.

But Wieting does not believe inflation is gone for good, although its impact will be muted in the near to medium-term since it is a “long road back to conditions of easy credit, strong demand and rising consumer prices”:

The long history of fiat money and the current policy response, much different from the 1930s self-imposed austerity, suggests the longer-term risk is indeed inflationary, not a continuous sharp rise in the value of dollars relative to goods and services (deflation.) But we imagine that readers already can feel the increased value of their dollars against consumer goods prices, and certainly financial asset prices (in portfolios or not).

Time to retire the Zimbabwe analogy, then.

Related links:
Hyperinflation is a possibility, say Morgan Stanley - FT Alphaville
All QEs are not created equal - FT Alphaville

This entry was posted by Stacy-Marie Ishmael on Monday, February 9th, 2009 at 15:02 and is filed under Capital markets. Tagged with inflation, quantitative easing, usa."

Me:

when it comes to the Emirates, it’s time to remove those rose-tinted sunglasses.

From Alphaville:

"Shakeout in Dubai Posted by Stacy-Marie Ishmael on Feb 02 13:33.

The FT’s Dubai correspondent Simeon Kerr has been ahead of the rest in his (generally bearish) reporting on the state of the emirate’s finances, and now it seems the ratings agencies are catching on.

On Monday, Moody’s warned it would be reviewing the ratings of six government-owned companies in Dubai for possible downgrade:
The six affected companies are:
- Dubai Holding Commercial Operations Group (rated A1),
- DP World (A1),
- DIFC Investments (A1),
- Dubai Electricity & Water Authority (A1),
- Jebel Ali Free Zone (A1) and
- Emaar Properties (A3).

Moody’s said the deterioration in Dubai’s macro-economic outlook was the primary driver for the review, noting:

Dubai”s open economy has been hit harder by the global economic and financial crisis than most others in the region, largely because of its higher leverage, concentration in cyclical sectors, and more limited fiscal resources.

While the ratings agency does not expect the review to lead to any downgrades of more than two notches, its macro view on the emirate is worth noting.
Emphasis FT Alphaville’s:
Moody’s believes that the liquidity of most of its rated corporations is sound, thus minimising any potential calls — if any — on government funds from its rated entities. However, Moody’s believes that material alterations will be required to reign in capital spending and thus match lower investments with lower expected cash flows over the medium term. Accordingly, flexibility to adjust corporate plans to reflect weaker global demand will be vital for long-term rating stability.

While Dubai’s economy is more diversified than regional rating peers, it is dependent on cyclical sectors such as real estate, tourism, trade, and financial services. All of these are being adversely affected by the tougher external environment. Furthermore, given its close linkages with regional oil exporters, Dubai’s economy has been affected indirectly by the slump in international oil prices even though oil generates only a small portion of the emirate’s GDP directly. Moody’s continues to believe that the Dubai government is very willing to support the large and systemically important companies that it owns, should it be required. However, the government’s capacity to support seems limited and is likely to be impaired by the worsening economic situation. Unlike most other governments in the GCC, notably that of its oil-rich neighbour Abu Dhabi, Dubai’s government is not known to hold substantial offshore liquid assets that can potentially be tapped to finance fiscal deficits and bolster the operations of the wider public sector.

Moody’s is aware of the Dubai government’s announcement in November that it held at least $90 billion in assets. Yet the composition of these assets has not been revealed and therefore their liquidity cannot be taken for granted. A request for further information regarding these assets will form a core part of Moody’s ratings review. Moody’s would be reassured if a substantial portion of these assets were liquid and unencumbered, and therefore available should any government-owned company in Dubai require extraordinary assistance with debt repayments in either local or foreign currency.

There are some rather large ifs, buts and maybes in those paragraphs, but what is clear is that when it comes to the Emirates, it’s time to remove those rose-tinted sunglasses."

Moi:

Don the Libertarian Democrat Feb 2 16:08

Stacie-Marie, I'm sure you're correct about Dubai, where, if I'm not mistaken, they're trying to build another tower of Babylon. HaMigdal, kara shma Bavel. But Moody's. I'm sorry, but they couldn't rate rice cookers as far as I'm concerned.

Don the Libertarian Democrat Feb 2 16:12

Stacy-Marie, I really apologize for misspelling your name. I really need a preview button.
Sorry, Don

Whitney argues that the real problem is that banks are disinclined to lend

From the FT:

"Why Meredith Whitney thinks a “bad bank” is a bad idea Posted by Stacy-Marie Ishmael on Jan 29 16:10.

Meredith Whitney and her team at Oppenheimer remain steadfast in their opposition to the creation of a “bad bank” that would buy so-called “toxic assets” from Wall Street’s flailing institutions (and so, save the world).

Whitney argues that the real problem is that banks are disinclined to lend - and that simply removing these assets from their balance sheets will not change that fact:
Lending standards have tightened dramatically, and there is an unavoidable restructuring of risk taking place. Such causes money to come out of the system and lending to contract, with or without this “bad bank” structure. Lower asset bases, higher credit losses, and bloated expense structures will continue to pressure banks’ earnings power and capital creation. We remain cautious on the group.

Cautious, and consistently unimpressed.

Other highlights from the note, emphasis FT Alphaville’s:

We do not believe a “bad bank” structure addresses the root problem of contracting system capital.

Writedowns from structured securities and illiquid assets is only one challenge related to the commercial banks. A challenge of equal importance is rising defaults from on balance sheet loans. Due to the pro-cyclical nature of loss reserving, banks are required to build reserves when their earnings power is weakest.

If a bank were to sell its “bad” assets into a “bad bank,” it would still be left with lower earnings power from higher losses on “good loans” and the requirement to build reserves, lower earnings power from lower assets and a higher legacy expense structure, or both.

The greatest unknown regarding the “bad bank” is at what price the gov’t would pay for “toxic assets.” If the government elects to pay fair market value, the banks will likely not elect to participate as capital hits would be too dear; however, if the gov’t pays above market, the burden on an increasingly “taxed” taxpayer grows.

We would be most encouraged by banks selling “crown jewel” assets to cover their own losses. We believe private capital will readily invest in businesses that make money and grow. However, the banks do not fit this description. We remain cautious on the group.

Moreover, Whitney believes a handful of lenders would “dominate the lion’s share of the ‘bad bank’”. Those lenders, she argues, should monetize their “good” assets to cover their “bad” assets.”

And who might the lenders be? Well, by Whitney’s reckoning (and others), Merrill and Citi have the biggest exposure to residential mortgages, at $44.6bn and $26.7bn respectively. Citi also has a fairly significant exposure to US ABS CDOs, at $18.9bn gross and $6.9bn net. So does Bank of America, with $11.9bn gross and $5.3bn net. (Gross means after writedowns but before hedges, in Oppenheimer parlance).

Oppenheimer also points out that in addition to the question of how these assets will be priced, it is not clear what will be held to constitute a bad loan: “will it be by loan product, loan quality, or geography?”
This is an important consideration, not least because, as Oppenheimer notes,

A large percentage of banks’ exposures are to areas with the greatest home price declines and the most vulnerable negative equity positions. Will these too become “bad loans,” and if so, what will be left of banks’ “good loan” earnings bases?

Take Bank of America, which partly through its Countrywide acquisition has $94bn in exposure to Californian mortgages - or five per cent of the company’s total assets.

And as the table below makes clear, these kinds of exposures are no less significant for Citi, JP Morgan, Wells Fargo and Wachovia:

Whitney is right to contend that a bad bank would only treat some of the existing ills - and that is unlikely to be enough.

Related links:
The 20 worst housing markets in the US - FT Alphaville
Citi’s Parsons calls for ‘bad bank’ - FT

This entry was posted by Stacy-Marie Ishmael on Thursday, January 29th, 2009 at 16:10 and is filed under Capital markets. Tagged with Bailout, bank of america, citi, countrywide, JP morgan, merrill lynch, wachovia, wells fargo."

I then add:

Don the Libertarian Democrat Jan 29 17:10

When the plan to buy Toxic Assets was shelved, the price of Toxic Assets dropped dramatically, and investors like John Paulson bought some of the better deals. If the government gets back in, the price will magically rise. The only way that the purchase can help the banks is for them to transfer some of their losses to us at a better price. Such losses will be real.

A correction would therefore portend the return of risk appetite and improved investor confidence.

From Alphaville, Stacy-Marie Ishmael:

"Will CDS spreads tumble in February? Posted by Stacy-Marie Ishmael on Jan 27 19:04.

Fortis certainly thinks so.

The bank’s analysis, which is based on Didier Sornette’s research into bubbles (think US housing and oil circa 2008), holds that recent increases in CDS spreads in both US and European markets have reached unsustainable levels and are due for a correction - sharpish.

Per the report, by Peter Cauwels, Ken Bastiaensen and Amjed Younis:
Based on our findings, it is likely that the peak for the 4 major indices will be reached between the 2nd and the 12th of February, and as a result they will fall. This is particularly significant since these indices are closely watched as a “fear gauge” for Financial Markets, alongside the VIX Index, Libor-OIS spread and the spread between German bond yields versus other Euro Area government yields.

Their conclusion is based, in part, on the application of the mathematical model of Sornette’s general theory of crashes, which they backtested using the performance of the US dollar weighted average as a data series:

On December 5th, the toolset detected a bubble-like behavior and reported December 10th as most likely crash

Starting on December 9th, the DXY began a consecutive drop of more than 8% until December 17th. This drawdown was the largest since the start of the daily DXY index in 1971and can thus statistically be considered a crash.

In addition to this forward test, a wide range of historical crashes have been analysed and the results used for calibration.

The formula, which according to Fortis represents a so-called “log periodic power law” (LPPL), is given by:

p(t) ≈ A + B(tc - t)-β + C(tc - t)-β cos(ω log(tc - t) +ϕ )

Fortis believes four of the major CDS indices - the iTraxx Crossover and Main, and the CDX High Yield and Investment Grade - which all recently hit record highs, show a ‘bubble-like formation in spreads’, per the graphs below:

As for just what a bubble in CDS means:
… in the case of CDS, the spread can be viewed as the cost of buying protection against default and the bubble can be interpreted as a rush to buy protection at ever spiralling prices.

The fundamental picture does add weight to the thesis that the cost of protection could be overvalued. Viewing the implied probabilities as the breakeven levels when buying protection can be useful when assessing the value of CDS protection. For example, the iTraxx Crossover index is a 5Y contract that implies a projected default rate of 60% over the coming 5 years for the constituent companies 16.

The implied probability of default embedded in the spreads is higher than the realised default rate during the worst point in the Great Depression, and is higher than the 15.1% global default rate for speculative grade names projected by Moody’s for 200917. For European speculative grade issuers this is expected to rise to 18.3%. However this figure is not directly applicable to the iTraxx Crossover since the index also includes low investment grade names which normally have a lower default rate.

A correction would therefore portend the return of risk appetite and improved investor confidence.

Mark your calendars, then.

Related link:
Brace yourselves for record corporate defaults in 2009 - FT Alphaville

This entry was posted by Stacy-Marie Ishmael on Tuesday, January 27th, 2009 at 19:04 and is filed under Capital markets. Tagged with bubble, CDS."

Here's my reply:

Don the Libertarian Democrat Jan 27 20:34

Since the spreads rose because of the fear and aversion to risk, they will fall when there is a diminution to the fear and aversion to risk. In other words, people will behave differently. What's the point of the math? Are they arguing that when spreads reach a certain point people automatically change their behavior? Or are they saying that,based on a few examples, expect the spreads to go down from here? It has a veneer of science to it, which, it seems to me, allows investors to place some trades feeling awfully damned proud of themselves. If it doesn't work out as planned, they can say that it's just a model. If it does, they can say it worked. In the end, the spreads will go down when investors start sensing a change in sentiment and putting money on it. I agree that's it's likely to be soon, and I base my view on the fact that someone is pitching this model in public. When investors start doing this, they're saying we're ready to ride, so who's with us? It's like a bike race, or drafting in Nascar."

Then Stacy-Marie's reply:

Stacy-Marie Ishmael, FT Jan 27 20:38
FT Alphavillain

Don - actually, and not fully represented here, some of the thinking behind the model fits precisely into that 'drafting in Nascar' paradigm. Here's some more from the note:

"Due to their very nature, financial markets exist of interacting players that are connected in a network structure. These interacting players, often referred to as interacting agents, are continuously influencing each other. In scientific literature it is said that such a system is subject to non-linear dynamics. Modeling such a system in full detail is practically impossible to do. That is why
the long-term behavior of the global economy or the weather is quite hard to predict. Recent research, however, has provided new tools to analyze complex non-linear systems without having to go through the simulation of all underlying interactions. When interacting agents are playing in a hierarchical network structure very specific emerging patterns arise"

(snip snip snip)

"These all fit in the framework of Complexity Economics, which describes the properties that emerge from interacting agents. It has become clear that herding behavior in financial markets results in positive or negative feedback mechanisms causing price accelerations or decelerations and (anti)-bubble formation, where asset prices become detached from the underlying fundamentals"

Then my reply:

Don the Libertarian Democrat Jan 28 01:41

Stacy -Marie,

Thanks. You are the best That's actually what I believe. I use Fisher's Debt-Deflation for what I call a Calling run. My approach comes from philosophy. Specifically, my view of the philosophy of action. Some of what is described fits in with my views about social theories in general, which are drawn from Anthony Giddens work on sociological theory. It does bear some relation to what used to be called Chaos Theory as well. It also helps understand what I call a Proactivity Run, which is what we are in. Businesses are trying to shed jobs before demand actually falls. This is my explanation of why productivity is still increasing for now. Namely, the layoffs are larger than the actual downturn in demand. All of this relates to the negative feedback loop of the fear and aversion to risk in a Calling Run, followed by a Proactivity Run. The next phase is a saving spree. What all these things have in common is panic. In that sense, my view, focused on human agency, is like Shiller's, or any of what we used to call Political Economy theories. I will look into complexity economics. I hope that some of what I said makes sense. What you should clearly understand is how much I appreciate and value your response.
Cheers, Don