Archive for March, 2008

Evans-Pritchard, again:

… UBS is also gearing for a big rebound, convinced that the Fed’s move to shoulder $30bn of Bear Stearns liabilities has changed the game.

In its latest report -“Ready for a Rally” – it said financial shares rose 448pc in the 12 months after the Swedish rescue in 1992, 88pc after Japan’s Revitalisation Law in 1998; and 82pc after Roosevelt’s Emergency Banking Act in 1933.

The pessimists at Société Générale remain sceptical, even though the Fed has gone nuclear. “We expect global equity prices to fall by up to 75pc from their peaks as a deep global economic downturn unfolds over the next few years,” said Albert Edwards, their global strategist. He fears a 50pc collapse in earnings, compounded by an “Ice Age derating of equities”.

It may echo the Lost Decade in Japan, where stocks fell 80pc. The yields on state bonds kept falling as debt deflation engulfed the banks, thwarting efforts to nurse lenders back to health by the usual device: “steepening yield curve”. The authorities were left chasing their own tails. Having lived through this, Japan’s chief regulator Yoshimi Watanabe has advised Washington to go for a quick taxpayer rescue, rather than trying “to fix the hole in the bathtub”.

Whatever happens, there will always be tactical rallies. Mr Edwards cites four Wall Street bounces above 25pc in the 2001-2003 bust. The buying cue is when investor gloom nears black despair. The put/call ratio on options is now at a bearish extreme of 0.90.

“That would historically suggest that a joyous 25pc spring rally is close at hand,” he said. Yet Mr Edwards remains wary as long as analysts cling to their belief that earnings will rise 11pc in 2008. This is not the sort of “washout” level of gloom required to clear the air.

Still, the oldest adage on Wall Street is “never fight the Fed”. In short order, Ben Bernanke has slashed interest rates by 300 basis points to 2.25pc, and invoked the emergency clauses of Article 13 (3) of the Federal Reserve Act for the first time since the Great Depression to take on direct credit risk.

The Bush administration has told the housing agencies Fannie Mae and Freddie Mac to absorb $200bn of extra mortgage debt. It has implicitly nationalised them in the process. The network of Federal Home Loan Banks has mopped up $900bn of mortgage securities. Congress has rushed through a $170bn fiscal blitz.

This is not to be sniffed at. It is worth a good spring rally, until the inexorable logic of a 25pc house price crash prevails once again.

Bernard Connolly at Banque AIG, who foresaw this crisis with uncanny accuracy, believes central banks will resort to full-throttle reflation, setting off a fresh boom in shares and gold. But this will occur only after the economic slump has spread to Europe and beyond.

The authorities will wait too long to act, believing their own decoupling myth. Unemployment will ratchet up. Civil unrest may rock Latin Europe.

In the end, the whole industrial world will stoke a fresh credit bubble to put off the day of reckoning, for another cycle.

The capitalist system is now so deformed by debt that it requires ever lower interest rates to keep going. It survives on perma-bubbles. Monetary rigour at this late stage would endanger democracy. …

Volcker and Thatcher proved that democracies can weather more pain than conventional wisdom will ever expect. Other than that I have nothing to add …

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Not sure where they got the ‘reluctant’ from …


Comrade Ben is determined that there will be no financial meltdown and no depression while he is in command,” economist Ed Yardeni wrote to clients. “Given the initial reaction [on Wall Street], I suppose this means we are all financial socialists now.”

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When a country’s government starts to blame “unscrupulous dealers” for economic collapse, reach for your wallet.

Iceland Bank Default Swaps Rise Amid `Unscrupulous’ Speculating
By Abigail Moses

March 31 (Bloomberg) — The cost to protect the bonds of Iceland’s three biggest lenders from default rose after central bank Governor David Oddsson said “unscrupulous dealers” are trying to break the country’s financial system.

Credit-default swaps on Kaupthing Bank hf, the nation’s largest lender, increased to a record 1.65 million euros ($2.6 million) in advance and 500,000 euros a year, up from 1.58 million euros upfront, CMA Datavision prices show. The cost implies a 59 percent risk of default within five years, according to a JPMorgan Chase & Co. valuation model.

Oddsson called for an international investigation into attempts to drive Iceland’s economy “to its knees,” in a speech on March 28. The central bank was forced to raise its benchmark rate to a record 15 percent last week to defend the krona after a 30 percent slump against the euro this year.

“The longer this goes on, the worse it gets,” said Olivia Frieser, a London-based bank analyst at BNP Paribas SA, France’s biggest lender. “It is a question of confidence.”

The cost to protect the country’s lenders from default is the highest of 81 banks worldwide with credit-default swaps listed on Bloomberg.

Credit-default swaps on Glitnir Banki hf, Iceland’s third- biggest bank, traded at 1.7 million euros upfront and 500,000 euros a year, according to CMA, up from 1.6 million euros in advance. The cost implies a 60 percent risk of default, according to the JPMorgan model. The contracts have soared from 202,000 euros with no upfront payment at the start of the year.

Landsbanki Islands

Contracts on Landsbanki Islands hf, the second-largest lender, rose 25 basis points to 807, CMA prices show. The credit-default swaps traded at 950,000 euros upfront and 500,000 euros a year before closing at 782 basis points with no advance payment on March 28, according to CMA.

A basis point on a credit-default swap contract protecting 10 million euros of debt from default is equivalent to 1,000 euros a year.

Attacks on the country’s Reykjavik-based banks “give off an unpleasant odor of unscrupulous dealers who have decided to make a last stab at breaking down the Icelandic financial system,” Oddsson said at the central bank’s annual meeting in Reykjavik. “They will not get away with it.”

Debt Speculation

Investors use credit-default swaps to speculate on a company’s ability to repay debt. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

“Its very important that the Icelandic financial supervisory authority, in cooperation with other countries, investigates the market and determines whether the allegations are true,” Glitnir spokesman Bjoern Richard Johansen in Reykjavik said in a phone interview today.

Landsbanki spokesman Andrew Walton and Kaupthing spokesman Jonas Sigurgeirsson were not immediately available for comment.

Kaupthing may take legal action against Bear Stearns Cos., the collapsed U.S. broker, which arranged a trip to Iceland in January by three of its own executives and representatives of four hedge funds, the Financial Times reported today. If Kaupthing decides to file a lawsuit, it will be able to subpoena e-mails and records from Bear Stearns and possibly the hedge funds, the newspaper said.

Bear Stearns London-based spokeswoman Jessica Shepherd- Smith didn’t have an immediate comment.

Credit-default swaps on the Markit iTraxx Crossover Index of 50 companies with mostly high-risk, high-yield credit ratings increased 22 basis points to 577 today, according to JPMorgan.

The Markit iTraxx Europe index of 125 companies with investment-grade ratings rose 3.75 basis points to 121.25, JPMorgan prices show.

The CDX North America Investment Grade Index increased 1.25 basis points to 142.75 in New York, according to broker Phoenix Partners Group.

I am sure a few large hedge funds are doing most of the “damage,” as they always do. It’s basic to functioning markets — a “run on the bank” effect usually doesn’t start until the biggest players yank all their money out of the country.

The level of Iceland’s banks’ CDS is shocking. The international markets are treating the entire country as one pile of toxic waste.

The Federal Reserve can move to protect US banks, and US debt. It cannot, however, stop a run on Eastern Europe. Iceland is the leading edge of a brutal rebalancing in Eastern European assets, banks in particular … the regional profile is even worse than Thailand/ Indonesia/ the Philippines/ Korea/ Taiwan in 1997.

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Ambrose Evans-Pritchard:

The Fed has been criticised for its rescue of Bear Stearns, which critics say has degenerated into a taxpayer gift to rich bankers.

A senior official at one of the Scandinavian central banks told The Daily Telegraph that Fed strategists had stepped up contacts to learn how Norway, Sweden and Finland managed their traumatic crisis from 1991 to 1993, which brought the region’s economy to its knees.

It is understood that Fed vice-chairman Don Kohn remains very concerned by the depth of the US crisis and is eyeing the Nordic approach for contingency options.

Scandinavia’s bank rescue proved successful and is now a model for central bankers, unlike Japan’s drawn-out response, where ailing banks were propped up in a half-public limbo for years.

While the responses varied in each Nordic country, there a was major effort to avoid the sort of “moral hazard” that has bedevilled efforts by the Fed and the Bank of England in trying to stabilise their banking systems.

Norway ensured that shareholders of insolvent lenders received nothing and the senior management was entirely purged. Two of the country’s top four banks – Christiania Bank and Fokus – were seized by force majeure.

“We were determined not to get caught in the game we’ve seen with Bear Stearns where shareholders make money out of the rescue,” said one Norwegian adviser.

“The law was amended so that we could take 100pc control of any bank where its equity had fallen below zero. Shareholders were left with nothing. It was very controversial,” he said.

Stefan Ingves, governor of Sweden’s Riksbank, said his country passed an act so it could seize banks where the capital adequacy ratio had fallen below 2pc. Efforts were also made to protect against “blackmail” by shareholders.

Mr Ingves said there were parallels with the US crisis, citing the use of off-balance sheet vehicles to speculate on property. All the Nordic banks were nursed back to health and refloated or merged.

The tough policies contrast with the Fed’s bail-out of Bear Stearns, where shareholders forced JP Morgan to increase its Fed-led rescue offer from $2 to $10 a share. Christopher Wood, chief strategist at brokers CLSA, says the Fed’s piecemeal approach has led to “appalling moral hazard”.

“Shareholders have been able to lobby for a higher share price only because the Fed took over the credit risk on $30bn of the investment bank’s dubious paper. The whole affair also amounts to a colossal subsidy for JP Morgan,” he said.

Any taxpayer bailout of the system needs to be combined with a massive purge of those not footing the bill for their own mistakes — banking management — and the complete slaughter of banking shareholders.

At the moment, Washington Mutual, Citigroup, and Countrywide are just three of the best-known “banks” whose debt to Uncle Sam — mostly to the Federal Home Loan Banks — exceeds their net assets. They are effectively the property of the US government.

A price must be paid. Under the free market ideal that never happens in real life, the banks fail, everyone freaks out for six months, and the economy experiences torrid growth afterwards.

In the real world, the future individuals of the (banking) institutions are forced to pay for the mistakes of the current institutional occupants. Future Wall Streeters will pay for the mistakes of today’s Wall Street by paying billions more in homage to stupid regulations, oversight that isn’t, and market share lost to more competitive, less cosseted overseas competitors.

The three regulatory options are as follows:

1) Do nothing; reward the bankers for their naked pursuit of risk without reward.

2) The aforementioned Nordic route.

3) A massive patchwork of new regulations and controls, which almost-exclusively subsidizes the institutional malfeasance of the past nine months at the cost of choking future Wall Street vibrancy.

The Nordic option is by far the most attractive of the three. It allocates responsibility, discourages future bad behavior, and punishes prior bad behavior. It keeps the system relatively healthy — assuming the banks are returned to private ownership within less than four years.

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Iran’s state of play is as follows.

  1. Ahmadinejad wants Barack Obama, not John McCain, as the next US president.
  2. Ahmadinejad is facing severe inflation at home, brought about by an oil windfall combined with US financial sanctions. This constitutes a political threat to his survival.
  3. The Ahmadinejad faction of the Iranian military-industrial apparatus has the most to lose in Iran’s upcoming second parliamentary round, and both presidential rounds of elections, scheduled for May 7, June 17 and June 24, 2008, respectively.
  4. Ahmadinejad appears to be losing control of its Iraqi proxies under heavy US and Iraqi pressure. Nouri al-Maliki’s Dawa party seems to be the main Iranian faction gone renegade, but segments of the Mehdi Army appear to be disobeying Iran as well.
  5. Nouri al-Maliki’s Dawa party, and the normally reliably pro-Iranian ISCI, are using the security operation to strengthen their own political hands at the expense of the Sadrites, Fadhila, and other smaller groups in Basra (Iraq’s richest province), ahead of Iraq’s October 1 elections.
  6. Therefore, Dawa and ISCI — who call the shots from Baghdad — have the motive as well as the means for destabilizing Iraq, 2 months before Ahmadinejad faces Iranian voters.

So what does Ahmadinejad do? He has one of his main allies, Ahmad Jannati, call for “dialogue” and “reconciliation”: “Oh [al-Sadr], if you have something to say, come sit with the government. The government is popular and so are you.” A day later Sadr had received Teheran’s orders, so he called upon his militias to stand down.

Iraqi Shia cleric Moqtada Sadr has ordered his fighters off the streets of Basra and other cities in an effort to end clashes with security forces.

He said in a statement that his movement wanted the Iraqi people to stop the bloodshed and maintain the nation’s independence and stability.

The government, which had set a deadline to hand over weapons in return for cash, called the move “positive”.

The fighting has claimed more than 240 lives across the country since Tuesday.

In Baghdad, the city’s military command has extended a round-the-clock curfew for an indefinite period. The curfew had been due to end on Sunday morning. …

Al-Maliki, however, prefers to continue consolidating power, and the Americans want to turn the screws on Ahmadinejad with as much local help as possible, because they believe Ahmadinejad will do likewise after he wins Iran’s presidential election. Since Sadr’s call falls short of what the Iraqi government is calling for, my guess is that the crackdown will continue, despite the Sadrites’ attempted voluntary cease-fire.

Iraqi troops will continue their operation in the southern city of Basra even though Shiite cleric Muqtada al-Sadr called on his followers to stop fighting, Reuters reported March 30, citing comments from Iraqi government spokesman Ali al-Dabbagh. Al-Dabbagh said the six-day-old operation is targeting criminals, not al-Sadr’s followers.

Iran seems to have elected to spend the next three months in a defensive crouch. Judging from everything out of Iraq and Syria, they have a lot of militia reorganizing to do on multiple fronts. Asif Shawkat, Syria’s head of intelligence, is suspected to be complicit in the Mughniyeh assassination, which means that Syria is effectively immobilized until Shawkat is eliminated.

If Ahmadinejad survives June 24, he will have a lot of new leverage, the Iraqi militias will snap out of their defensive crouch, and Iran will hold the initiative in Iraqi bloodletting while McCain prays that the violence doesn’t cripple his election prospects.

Until then, it appears that the initiative will be with the United States and its Iraqi allies.

The three months between now and June 24 would also be the ideal time for Israel to hurl a body-blow operation at Hamas, in Gaza. It would further diminish Ahmadinejad’s credibility, but would probably not provoke a response from Hezbollah.

I’m not sure anyone knows the extent to which Ahmadinejad might be able to rig the outcome of Iran’s elections. My impression is that so many Iranian elites hate Ahmadinejad, that Ahmadinejad’s “freedom to fudge” is fairly limited.

In terms of market outcomes this would imply a moderate tempo of oil-related bombings, and geopolitical jolts to the price of oil, over the next three months, followed by a dramatic upswing if Ahmadinejad goes all-in to secure a better bargaining position, by getting Barack Obama, not John McCain, elected to the presidency (through a cycle of Teheran-driven unrest in July through October).

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The SEC:

… Fair value assumes the exchange of assets or liabilities in orderly transactions. Under SFAS 157, it is appropriate for you to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, unless those prices are the result of a forced liquidation or distress sale. …

Considering that pretty much every credit market has been defined as a “forced liquidation or distressed sale,” this amounts to a gigantic escape hatch from any semblance of objectivity in terms of pricing garbage level 3 assets.

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Things started getting very difficult with the internet about six months ago as the great firewall got tighter, but in the past few weeks internet access has been far more frustrating than it has ever been during my over six years living in Beijing.  It takes me hours (literally) to post anything on my blog.  My Peking University students tell me that they waste two or three hours a day more than they used to trying to access information on the internet.  When I ask them why it has become so difficult, they tell me that there are a lot more things now that the government doesn’t want them to know – although they don’t usually specify what that may be. …


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