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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Rumors, rumors …

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Right on cue …. via the Financial Times:

US aids Iraq security forces with air strikes

By By Steve Negus, Iraq correspondent, and Demetri Sevastopulo in Washington

Published: March 28 2008 18:20 | Last updated: March 28 2008 18:20

President George W. Bush on Friday called the Iraqi government offensive in Basra a “defining moment” as violence continued to spread across the country and US troops were forced to send reinforcements to help Iraqi security forces.

“I would say this is a defining moment in the history of a free Iraq,” Mr Bush said. “This happens to be one of the provinces where the Iraqis are in the lead…and this is a good test for them.”

Nouri al-Maliki, the Iraqi prime minister, has stressed that the operation is primarily targeting ”lawless gangs” in the southern port city of Basra, but fighting has spread to other cities, with members of the Madhi Army, a group of Shia militants loyal to the cleric Moqtada al-Sadr, staging solidarity attacks.

Militias on Friday appeared to have seized control of the centre of the southern provincial capital of Nasiriya, while heavy fighting has also been reported in the towns of Kut, Amara, Diwaniya, and Hilla and in the Baghdad suburb of Sadr City. Militants in Baghdad have also kept up a heavy barrage of rockets and mortars at the heavily fortified Green Zone.

Iraqi security forces admitted on Friday that they were having difficulties subduing radical Shia militants. The death toll in the four days of fighting since Mr Maliki launched operation “Sawlat al-Fursan”, or Charge of the Knights, is unclear, but appears to have risen at least above 200.

While Mr Bush said the Iraqis were taking the lead in the operation, coalition forces were required to provide reinforcements on Friday, including air strikes at militants in Basra and Baghdad.

”We supposed that this operation would be a normal operation, but we were surprised by this resistance and have been obliged to change our plans and our tactics,” Abd al-Qader Jassim, the Iraqi defence minister, was quoted as saying by Reuters.

Stephen Biddle, an Iraq expert and former adviser to General David Petraeus, the US commander in Iraq, said the situation in Basra was “very serious”. He said the US was not clear whether Mr Maliki was targeting rogue elements of the Madhi army or taking on the mainstream faction of the umbrella group loyal to Moqtada al-Sadr, the radical Shia cleric.

Mr Biddle said another possibility was that Mr Maliki was taking the opportunity to crack down on political opponents ahead of provincial elections later this year. That would be the most dangerous scenario, he added, since it could jeopardise the ceasefires by the Madhi army loyal to Moqtada al-Sadr, the radical Shia cleric, and also by Sunni “local concerned citizens”.

Mr Maliki’s office on Friday said Basra residents had until April 8 to hand over heavy arms in return for cash bounties. The deadline is separate from an earlier ultimatum announced on Wednesday which gave gunmen 72 hours to surrender their weapons.

Iraq experts expressed concern that Mr Maliki had not co-ordinated the operation closely with the coalition, which some said could jeopardise its success. Mr Bush said he was unaware what trigged the timing of the offensive.

“I haven’t spoken to the prime minister since he’s made his decision, but I suspect that he would say, ”Look, the citizens down there just got sick and tired of this kind of behaviour,” said Mr Bush.

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China’s chronic undervaluation of its currency implies that the country should have a rate of inflation approximately proportional to its persistent current account surplus. China’s current account surplus has been exploding recently, which means that China is in the throes of an inflationary monetary trap. It also means that you can look at China’s forex reserves as an approximate indicator of what China’s real rate of domestic inflation is.

One of the methods by which China has kept its (stated) rate of inflation so low has been by a haphazard series of price controls, especially since last fall (justified by chronic “one-off events” — pork disease killing lots of pigs, a big snowstorm, etc). However, that system is breaking down.

March 28, 2008 | 1307 GMT

For the first time since Beijing imposed a temporary ban in January on all price increases for essential items, China’s National Development and Reform Commission has allowed a price rise application to slip through. In reality, this ban was more effective at calming social unrest ahead of March’s politically sensitive National People’s Congress than resolving China’s inflation problem at the root. Going forward, the government will have to look for other, more effective ways of curbing inflation — if none is found, a temporary ban will likely be reimposed.


China’s third-largest dairy producer, Bright Dairy & Food Co., said March 28 it plans to raise milk prices by 14 percent in some regions after having obtained approval from the National Development and Reform Commission (NDRC), Shanghai Securities News reported.

For the first time since January, when Beijing imposed a temporary ban on price hikes from all major producers of essential items such as milk, flour, rice, noodles and cooking oil — subject to central government approval — the NDRC has given a major producer permission to raise the price of an essential food item. […]

Currency manipulation is today’s favorite mode of capital allocation by authoritarian governments. One of the side effects of Bernanke’s war on the dollar has been to dramatically raise the cost of this policy, which pegs the national currency to the USD at an artificially low rate to boost exports, and misallocate capital to the export sector, at the expense of domestic purchasing power. A cheaper dollar drags down all currencies pegged thereto, which means that the purchasing power of phony-currency pegs’ citizenries erodes further, which causes more social instability and unrest.

The power of the 1989 Riot Which Shall Not Be Named was in the population’s rage at food price inflation … not the seductive appeal of the “goddess of democracy.”

A 14 percent price increase is going to hurt a lot of pocketbooks.

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I saw a lot of my extended family over the Easter holiday. We are all rabidly conservative, so naturally we discussed the 2008 elections in great detail.

Everyone else, being conservatives of the [obliviously] optimistic sort, was jubilant about the Wright controversy, was certain that it had badly damaged Obama’s prospects both for the Democratic nomination and the general election, and felt that McCain was at least a mild favorite to win the election in November. I snickered and said that in three to six weeks, nobody would even remember who Jeremiah Wright was, while Iraq would be going to hell in a handbasket, Israel and Iran would probably be fighting over Lebanon again, and America would be duking it out with Iran in Iraq (with both sides using their typical proxies).

I also emphatically disagreed with the conventional wisdom, that white tribalism will reassert itself in McCain’s favor as the Democrats increasingly fracture over their nomination fight.

Pew, NBC/WSJ, Rasmussen and Gallup all show, if anything, a mild tilt towards Obama since l’affaire Wright began. Once again Clinton is embarrassingly unlikely to win the nomination.

People need to understand how worthless and ephemeral these political “controversies” are. It’s like pushing on a string. They drive down the candidate’s approvals for a few days. But if the same outlets keep pounding on that story, a reaction sets in. People start wondering if the news organizations are pursuing their own agenda; and in any case, they get bored with the story. But if the news organizations back off, the candidate’s approvals rebound very quickly.

Meanwhile, the death toll in Iraq is mounting. 35% of Iraq’s crude exports (half a million barrels per day) have been shut down in the near term thanks to one bomb at a Basra refinery. That was why oil rallied so hard the other day.

The American public is watching – and that’s not a good thing for John McCain right now.

But I have also believed that the Republicans will need at least one terrible defeat before they realize what betraying scumbags their leadership is. Until then they will happily imbibe the “Reaganesque optimism” kool-aid, until both feet are over the cliff.

Speaking of Barack Hussein, he was on CNBC yesterday. After my Obama translator filtered Obama’s diarrhea of “well, you know,” “I think,” “Look, I’m not an ideologue,” “What you have is,” and other noise, it sounded like he was aiming for a capital gains rate of 21-26 percent. Whatever the rate is, it’s going to be significantly higher than today’s 15, which means that, assuming we get to September and Obama will be leading by as much as I think he will, there’s going to be a big selloff of US equities as people realize gains under the current rate rather than the future one.

By that time, the Beijing Olympics will be winding down, and the Chinese will slam on the brakes at the same time as the US political business cycle winds down (and on very unfavorable terms for capital).

Spring and summer look passable at the moment, for US equities. Autumn looks chilly.

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Chase mortgage memo pushes ‘Cheats & Tricks’

The bank says it never backed the strategies, which detail how to get an iffy loan approved
Thursday, March 27, 2008


The Oregonian Staff

A newly surfaced memo from banking giant JPMorgan Chase provides a rare glimpse into the mentality that fueled the mortgage crisis.

The memo’s title says it all: “Zippy Cheats & Tricks.”

It is a primer on how to get risky mortgage loans approved by Zippy, Chase’s in-house automated loan underwriting system. The secret to approval? Inflate the borrowers’ income or otherwise falsify their loan application.  … (link)

Sorry, I’m having flashbacks to Henry Blodget and pushing “total crap” onto investors …

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King to consider special help for UK banks

By Chris Giles, Economics Editor

Published: March 26 2008 12:08 | Last updated: March 26 2008 12:23

Mervyn King indicated on Wednesday that the Bank of England was poised to take a revolutionary step and buy or swap illiquid assets on banks’ books for cash or liquid assets as way to find a “longer-term resolution” to the problems faced by British banks.

The Bank governor also indicated the Bank was more predisposed to cutting interest rates now than in February.

Commenting on the “fragility” that exists in the financial system, Mr King said there was an “overhang on banks’ balance sheets of assets in which markets have closed”

“These assets cannot now be sold or used to secure funding in the market – they are difficult to finance. That has created uncertainty about the strength of banks’ financial positions”.

In the short-term, he said the Bank would continue to lend against mortgage-backed securities and other asset-backed securities where markets are closed, but he added that such lending, while “a useful bridge to a longer-term solution” can “be only a temporary measure”.

He was not specific about the longer-term resolution, since he said “it is too soon to say where these discussions will lead”, but he indicated more radical moves were necessary because “it is unrealistic to assume that markets for many asset-backed securities are likely to re-open speedily or, when they do, to their previous levels of activity”.

Mr King’s comments before the Treasury Committee come a week after shares in HBOS, the owner of the Halifax building society and the country’s largest mortgage lender, fell nearly 20 per cent on rumours it had sought emergency funding from the Bank of England.

The Bank of England was forced to deny the rumours and the FSA has launched a criminal investigation into the distribution of the claims. But the share price response shocked senior banking executives and regulators and led to a plea for help for the industry.

The Financial Times reported last week that discussions in central banks around the world include the purchase of mortgage-backed securities or swapping illiquid assets for UK government bonds, a move similar in effect to outright purchase.

But Mr King stressed there were two principles he would insist upon if the Bank was to take illiquid assets off commercial banks’ books to improve their financial positions.

“First,” he said, “the risk of losses on their lending should remain with banks’ shareholders”. This implies the Bank would only accept assets at well below face value, or would insist on banks’ indemnifying taxpayers for the credit risk they would adopt if they took hold of the assets.

“Second,” he added, “a longer-term solution must focus on the overhang of assets and not subsidise issues of new assets”. Mr King is keen not to allow another frenzy of lending and it implies the Bank would not be willing to take any new mortgage-backed securities on its books.

The second condition would be difficult to achieve in full, since improving banks’ finances would improve their ability to lend compared with the extremely strained current conditions. Any action could be perceived as a subsidy, but the Bank governor‘s words indicated he would not be willing to assist banks with new lending.

The governor made it clear that the problems for banks were not confined to the UK. “There is concern in all financial markets around the world that fragility remains today,” he said.

Mr King made it clear that he wanted to separate the financial crisis from monetary policy and said that the two interest rate cuts so far had offset tighter conditions in mortgage markets, so monetary conditions were broadly unchanged.

Asked whether current market conditions made the Monetary Policy Committee more predisposed to a cut in interest rates, he replied: ”Yes”.

Willem Buiter’s recommendations (published in the FT, which King has apparently copied word for word) are not a good idea. You can’t separate monetary policy from a systemic financial crisis, because monetary policy defines the system. The whole point is to transfer risk of loss to the BoE — if risk of loss to future earnings remains on the banks’ balance sheets, why bother with the transaction at all?

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Gold has potential to double: UBS
Posted: March 25, 2008, 12:19 PM by David Pett

Gold may have eased back from last week’s record high of US$1,030.80 an ounce, but the yellow metal is well positioned for growth and could potentially double in price, Tony Lesiak, analyst at UBS, says in a note to investors.

Mr. Lesiak says gold appears relatively cheap compared to oil on a historical basis, holding the potential for gold to more than double to levels where it will regain its long term average relationship. However, he said the price of gold was hard to call at present and prices may not move much in the coming weeks.

“In the near-term, fundamental value will not mean very much: positioning and the need to raise liquidity will determine what happens to precious metals – and indeed other asset classes,” Mr. Lesiak says.

“This environment is one where gold should do well, although de-leveraging may prevent the metal from moving higher, it should certainly outperform other metals and has a genuine chance of trading much higher should the dollar weaken further and de-leveraging become overwhelmed by safe haven buying.”

In the equity markets, Mr. Lesiak says gold valuations are in “fair territory” following last week’s sell-off.

He says Goldcorp remains UBS’s top stock pick among the senior gold producers due to its low political risk, leverage to gold, excellent internal growth potential, and the possibility of numerous re-rating catalysts in 2008.

Iamgold is the top pick among the mid-tier gold stocks. He says the stock looks to have been overly punished for underperforming, and holds good exploration potential.

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Economies have lots of forms of leverage besides the borrowing of money by hedge funds through prime brokerages.

For example, a national deficit is also a form of leverage. Thus, lower-than-long run average taxation is a form of leverage. Inflation, being a tax, is a form of leverage.

Another form of gearing would be weakness in workers’ bargaining power (strength of unions).

Market idiots reel from one retrenchment of leverage to the next. Every week is a different once-in-100-years crisis, for them. So they lose half of their investors’ money, and bullsh** their investors with “26-sigma”s for long enough to lose 90 percent of the remaining 50 percent, before they are finally held accountable.

Those of us who need to survive, and who do not wish to destroy our credibility with the investors who have placed so much trust in us, need to understand the most realistic distributions of outcomes over the next eighteen months which most threaten our ROI.

Hedge funds are not the only victims of bank failures. Other segments of society are also deleveraging.

Unions are one presidential election away from getting “card check” passed, which would change the face of labor organization in the United Sates. Currently unionized businesses (airlines, car manufacturers) are underpriced in this respect relative to industries that currently are holding unions at bay (Wal-mart for example).

As for taxes …

I think Barack Obama is the prohibitive frontrunner for the Democratic nomination; you can already see this Wright thing ebbing away, notwithstanding the best efforts of the Clinton-Republican unholy alliance.

So let’s say we get to July, and Obama is still the prohibitive frontrunner. Ahmadinejad is re-running the script which sold so well in 1979, and took down Jimmy Carter, against the outgoing Bush Administration. So Obama would also be the presidential frontrunner, surfing a new wave of anger over Iraq.

At that point, the market would be forced to price in a capital-gains tax hike to at least 20 percent (if not 28), as well as an income-tax hike — and thus dividend taxation — back to 39.6 percent, as well as the potential raising of income tax beyond 40 percent if Obama implements Austan Goolsbee’s recommendation to lift the Social Security cap, currently at around $96,000, as well as higher unionization rates (= lower ROI).

This will add to all the headwinds the market already faces … August would be a good time for all these concerns to crescendo.

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The FT indicates that little Iceland, which in 2006 had a current account deficit of 26 percent of GDP (“only” 16 percent in 2007) has gotten mauled by the credit contraction. Considering that Iceland’s economic profile — low taxes, low regulation, small finance-centric economy, massive current-account deficit — is so similar to Eastern Europe (particularly the Baltics), perhaps it will serve as a useful leading indicator for those countries.

Concern for Iceland grows after rate rise

By David Ibison in Stockholm

Published: March 25 2008 09:59 | Last updated: March 25 2008 19:08

Fears that Iceland could be the first country to fall victim of the global financial turmoil grew on Tuesday when its central bank abruptly increased interest rates 1.25 percentage points to 15 per cent in an attempt to restore confidence in its struggling currency and stave off a full-blown economic crisis.

The bank said “deteriorating financial conditions in global markets” had contributed to the emergency move. Confidence in the krona, Iceland’s currency, has been shattered this year because of perceived economic imbalances in the economy and fears the banking sector is in danger of collapse. The krona has weakened by 22 per cent against the euro so far this year.

The rapid weakening of the currency prompted the central bank to adopt unusually blunt language on Tuesday, warning if the decline was not reversed Iceland faced “spiralling increases in prices, wages and the price of foreign exchange”.

“Only time will tell if this works,” Ingimundur Fridriksson, governor of the central bank, told the FT. “We are a small open economy and we are obviously affected by moves in the international economy.”

Tuesday’s move saw the krona gain as much as 6.3 per cent against the dollar, while the country’s benchmark index of the 15-most traded stocks had its biggest gain in more than 15 years, rising 6.2 per cent.

The bank last raised rates in November 2007 and said then it would leave them unchanged until the middle of this year, but was prepared to take extraordinary action if the krona depreciated severely. Inflation was 6.8 per cent in February and has outpaced the central bank’s target of 2.5 per cent since 2004.

“It will be necessary to continue to pursue a very tight monetary policy in order to bring inflation and inflation expectations under control, and increase confidence in the krona,’’ the central bank said. Thor Herbertsson, co-author of an influential report in 2006 on Iceland’s economy with Fredric Mishkin, a member of the US Federal Reserve board, said Iceland could be thrust into crisis as a result of the global economic situation. “Let’s say Iceland is not in more danger than some Wall Street banks,” he said.

But at the same time as international investor confidence in Iceland has fallen sharply, policymakers and economists have tried to reassure markets by drawing attention to the country’s economic fundamentals and the underlying strength of the banks.

Richard Portes, president of the Centre for Economic Policy Research, and the author of a respected report on Iceland’s economy last year, has urged investors to pay more attention to the data.

He points out overheating is being tackled, with economic growth slowing, hitting 2.9 per cent in 2007 and zero this year.

He adds that Iceland’s current account deficit – the source of many of the concerns about the economy – has narrowed from 26 per cent of GDP in 2006 to 16 per cent in 2007.

He has also made clear that Iceland’s banks are sound by international standards, with deposit ratios in line with international norms, high capital adequacy ratios by European standards and credible funding profiles.

Finnur Oddsson, managing director of the Icelandic Chamber of Commerce, said: “The global turmoil is certainly hurting the financial sector, but the danger of things toppling over here is greatly exaggerated.”

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On March 17, Lehman dropped more than 40 percent in one day, at one point.

How’d they survive?

Portfolio, not normally my favorite magazine, has an interesting article on the subject:

Bear Stearns collapsed for two reasons. It had a short-term funding crisis where lenders pulled their loans and customers pulled their cash. But it also had a longer-term leverage problem. Last week’s crisis didn’t happen in a vacuum; that leverage eventually led to the collapse in confidence. […]

What actually happened to Lehman’s balance sheet in the first quarter? Assets rose. Leverage rose. Write-downs were suspiciously minuscule. And the company fiddled with the way it defines a key measure of the firm’s net worth. Let’s look at the cautionary flags:

Lehman’s balance sheet isn’t shrinking, as we’d expect.

Lehman finished the first quarter was total assets of $786 billion, up almost 14 percent from the previous quarter and 40 percent from a year earlier. Other financial institutions are taking down their exposure right now amid the market turmoil to be prudent. Lehman says it wants to. It is not.

Lehman got more leveraged, not less.

The investment banks “gross” leverage hit 31.7 times equity, up from the fourth quarter and way up from last year’s 28.1. According to Brad Hintz, an analyst with Bernstein Research, Lehman’s leverage reached its highest point since 2000. Lehman, like all the investment banks, prefers to look at net leverage, excluding hedges, and that went down. And the firm says that the asset rise was mainly a result of increases in short-term items that have low risk. But we’ve heard a lot of that lately across the financial world. It’s quite simple: The more leverage Lehman has, the less room assets have to fall to wipe out its equity.

Lehman includes debt in its calculation of equity. Say what?

… In a note in its earnings release, Lehman said it has a new definition of “tangible equity,” or the hard assets that it has left over after subtracting its liabilities. This is a measure of net worth, the yardstick by which investment banks are valued. Lehman’s new definition allows for a higher portion of long-term subordinated borrowings (which it calls “equity-like”) in tangible equity. Previously, it had a cap on the percentage of “perpetual preferred stock,” a form of equity-like debt that doesn’t have a maturity date, in its equity. Now, it doesn’t have a cap. Think of it this way: If you borrow money from your parents to make your down payment on your house and they don’t expect to get paid back right away (at least not before you pay your mortgage off) is it equity in your house? No, it’s a loan. And Lehman hasn’t borrowed from mommy and daddy.

Lehman says it is merely conforming to the Securities and Exchange Commission’s definition of tangible equity and had contemplated making the change for a while. And the firm says the change didn’t result in any difference to its net leverage ratio.

Lehman reaped substantial earnings gains because investors thought it is more likely to go bankrupt.

For several quarters, all the investment banks have been taking gains on their liabilities. Say you owe $100 to your friend. But you run into severe problems and your friend starts to figure you can only afford to pay back $95. If you were an investment bank, the magic of fair value accounting dictates that you could get to reduce your liability. What’s more, that $5 gain gets added to earnings. Because investors thought Lehman was more likely to default, its liabilities fell in value and Lehman garnered earnings from this. How much did Lehman win through losing? $600 million in the quarter. How much was its net income? $489 million.

Lehman and all the other investment banks are following the accounting rules on this, but that $600 million is hardly the stuff of quality earnings. Indeed, Bernstein’s Hintz called the bank’s earnings quality “weak.”

Lehman’s write-downs seem tiny.

Lehman finished the quarter with $87.3 billion of real estate assets. These include residential mortgages and commercial real estate paper. The bank only wrote these assets down by 3 percent. And its Level III assets —the hardest to value portion of these instruments—were written down by only the same percentage. The indexes and publicly traded instruments and companies that serve as proxies for these securities generally fell more than that in the quarter. Lehman points out that took larger gross write-downs and then made money through hedges, for a smaller net number.

Lehman remains exposed to lots of dodgy mortgages, including a group labeled: “Prime and Alt-A.” Prime mortgages represent loans to good quality borrowers; Alt-A loans go to borrowers a mere step up from subprime, and represent an area with almost as many problem loans as subprime. The total amount of such mortgages on Lehman’s balance sheet was $14.6 billion in the first quarter and it actually rose from $12.7 billion in the previous quarter. Is this the time to be increasing exposure to questionable mortgages? More ominously, only $1 billion of that figure is prime and the rest is Alt-A, according to Hintz’s estimate.

The picture emerging is that of an investment bank that is dancing as fast as it can. If Lehman can keep piling up more assets, and if these assets come back, Lehman comes out a big winner. But if it didn’t properly mark down those assets during these bad times, the investment bank’s returns —and therefore its profitability—will be much lower in the future.

And that’s the good case. If the assets do not recover, then time is against the firm.

There is a larger, monetary policy issue here. The Federal Reserve has announced that it will lend to investment banks for the first time since the Depression, acting as a lender of last resort. At the very least, regulators should be demanding that the investment banks bring down their leverage and reduce their risk. Are the regulators sending a stern-enough message to Lehman? If so, it’s not getting through.

One constant of this crisis is that a very large number of rumors which were batted down early turned out to be correct later. Beazer, Citigroup, Countrywide, Lehman, Bear Stearns at the same time, Thornburg, and so on — all of them were jolted by massive rumors which smashed their stocks down. In some cases, government support has put off the day of reckoning postponed the day of reckoning, but the Fed’s ability to support the markets is limited.

The Fed has dumped huge amounts of Treasuries off its balance sheet to make room for the alphabet soup of financial-engineering junk.

I will trust the street. Lehman traded about 220 million shares on March 17. There were a lot of people selling, and they knew something.

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Iraq: Medhi Army Starts ‘Civil Disobedience’

March 24, 2008 1642 GMT
Members of Iraqi Shiite leader Muqtada al-Sadr‘s Mehdi Army on March 24 moved into Baghdad’s southern al-Ilaam, Shurta, Bayaa and Amil districts and western Washas district, ordering shop owners to close, Reuters reported, citing witnesses. Militia members used burning tires to close down roads in one neighborhood. Witnesses said the Mehdi Army had declared the beginning of a civil disobedience campaign, and an al-Sadr official said the militia is protesting “U.S. raids and the arrests of innocent people.” The campaign does not mean the Mehdi Army cease-fire is over, said al-Sadr‘s parliamentary bloc leader Nassar al-Rubaie, adding that only al-Sadr can end the truce. Sheikh Mahmoud al-Sabihawi of Sadr‘s Amil district office said the campaign will continue until the arrests stop.

March 24, 2008 1657 GMT
U.S. commander in Iraq Gen. David Petraeus said March 24 he thinks Iran backed the insurgents who carried out March 23 mortar and rocket attacks on Baghdad’s Green Zone, the British Broadcasting Corp. reported. Petraeus said the rockets used were made in and provided by Iran. Those who fired them were trained and funded by Iran’s Quds Force, he added.
March 25, 2008 0732 GMT

Heavy fighting broke out March 25 in the southern Iraqi city of Basra, where Iraqi troops have clashed with members of the Mehdi Army militia, Reuters reported, citing a witness. The Iraqi military has launched operations in Basra to “cleanse” the city of armed groups, a military official said.

March 25, 2008 1003 GMT
Iraqi Shiite leader Muqtada al-Sadr‘s headquarters in An Najaf placed Mehdi Army field commanders on high alert March 25 after Iraqi security forces launched an operation in Basra to contain the ongoing violence between rival militias, The Associated Press reported. The commanders were ordered “to strike the occupiers” and their Iraqi allies, an anonymous militia officer said. The security forces reportedly encountered stiff resistance from Mehdi Army gunmen.
March 25, 2008 1210 GMT
Shiite cleric Muqtada al-Sadr threatened a countrywide “civil revolt” if U.S. and Iraqi security forces keep targeting his followers, Reuters reported March 25. In a statement, al-Sadr called on Iraqis to stage sit-ins throughout the country as a first step. If demands are not met then, al-Sadr said the second step would be to “declare civil revolt in Baghdad and all other provinces.” Al-Sadr threatened a third step but said it was too soon to announce what it might be.
March 25, 2008 1257 GMT
Members of Muqtada al-Sadr‘s Mehdi Army took control of five districts in the southern Iraqi town of Kut on March 25, Reuters reported. Police sources told Reuters that the militia took over the Jihad, Shuhada, Zahara, Sharqiya and Hawi districts. An eyewitness told Reuters he could hear explosions and shooting and U.S. warplanes were circling overhead. Police Capt. Majid al-Imara said he has asked U.S. forces to help the local authorities with aircraft and vehicles, adding that eight to 10 policemen had been wounded in clashes in Aziziya, a town north of Kut. Police in Samawa, the capital of the southern province of Muthanna, imposed a curfew after Mehdi Army members appeared there. Curfews have also been imposed in Hilla and Kut.
March 25, 2008 1353 GMT

A blast was heard and smoke was seen March 25 in Baghdad’s “Green Zone” government and diplomatic compound, Reuters reported. The explosion was suspected to have been caused by rocket or mortar fire.

March 25, 2008 1517 GMT
People in southern Lebanon’s major population centers of Nabatieh and Tyr are stockpiling canned food, beans, cereals, cooking oil, rice, dried milk and prescription drugs in anticipation of an impending war with Israel, a Stratfor source reported March 25, citing reports from shop owners and pharmacists. The source also said a building contractor reported that construction in Southern Lebanon has come to an unprecedented halt.
Iraq is deteriorating rapidly.
This has enormous implications for the US presidential race — and therefore the rate of capital gains taxation in the next four years — as well as the price of oil, and to a lesser extent the value of the dollar.
I expect Lebanon to be ground zero of 2008’s long hot summer, but lots of collateral damage will be felt in Iraq.
Remember, Ahmadinejad has Carter’s scalp already. He knows how the US electoral game is played.

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Long-run inverse correlation between the USD (two methods of calculating its value used here), and CPI:


Hey, it looks like an inverse correlation to me. ;-)

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Federal Home Loan Banks May Buy $150 Billion of Bonds (Update1)
By Dawn Kopecki and Jody Shenn

March 24 (Bloomberg) — Federal Home Loan Banks were freed to increase their purchase of mortgage-backed bonds by about $150 billion as part of a government effort to pump money back into a market that slumped as the housing crisis deepened.

Directors of the Federal Housing Finance Board, the banks’ regulator, approved the temporary increase today, according to an e-mailed statement. The purchases will be restricted to securities guaranteed by Fannie Mae and Freddie Mac, the board said.

“It’s an opportunity for the Federal Home Loan Banks to supply more liquidity to the secondary markets,” said John von Seggern, president of the Council of Federal Home Loan Banks which represents the banks. “I think that’s a good thing and the market needs to get that liquidity as soon as possible.”

The approval for Federal Home Loan Banks to increase their purchases comes a week after Fannie Mae and Freddie Mac, the two government-chartered mortgage-finance companies, were cleared to buy at least $200 billion of mortgage securities.

The FHLBs are cooperatives created by President Herbert Hoover in 1932 to spur mortgage lending. The system’s 8,100 owners and customers range from New York-based Citigroup Inc., the largest U.S. bank, to the single-branch Custer Federal Savings & Loan in Broken Bow, Nebraska. Their government ties support top AAA ratings from Standard & Poor’s and Moody’s Investors Service.

Record Spreads

The government increased the limit on the 12 FHLBs’ investments to 6 times capital for two years, up from 3 times, the statement said. The statement said that would increase the banks’ spending by “well in excess” of $100 billion. Based on the banks’ capital of $54 billion, the change may increase the FHLB’s purchasing power by about $150 billion.

The increase failed to spur a rally in debt backed the agencies. About $4.5 trillion of mortgage securities backed by Fannie Mae, Freddie Mac or smaller federal agency Ginnie Mae are outstanding, according to Federal Reserve data.

The difference in yields on the Bloomberg index for Fannie Mae’s current-coupon, 30-year fixed-rate mortgage bonds and 10- year government notes widened by about 5 basis points to 182 basis points. The spread reached a 22-year high of 237 three weeks ago.

The spread helps determine the interest rate on new prime home mortgages of $417,000 or less. A basis point is 0.01 percentage points.

To the longtime loyalists of this blog, the FHLB story is an ancient one, pre-dating even the FT’s cursory coverage of this backstop behemoth by two weeks.

In other news, two impressive graphs illustrate the relative enormity of what Bernanke is doing. (A hat tip to a worthy Frenchman for these… ):



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