Vigilant Investor

Bush is claiming his bailout for subprime borrowers is not a bailout for big financial interests and rich hedge fund investors or reckless borrowers. But in this sinking ship, there’s no question all are tied to the other.

Were subprime borrowers — many of whom got into a mess by either allowing themselves to be suckered into fine print clauses and teaser rates (as if fine print is something new!) or they simply overextended themselves with reckless, hopeful thinking — allowed to default on their properties, undoubtedly the pain would be felt far upstream among Wall Streets finest and lessons would be learned all over.

And, that this is socialism for the biggest banks, bankers and hedge fund managers should not be lost. I suppose everyone but those in finance are allowed to fail in our system. We’ve pointed out for some time that this is nothing new. Wall Street bankers have a long history of doing things that shave away and make thin the hull of our economic ship for their own profits, while the hull deteriorates to precarious levels — so much so that when somethings inevitably pokes through (usually something the bankers themselves have also done), holes appear all over. Now there’s bailing to be done, leaving big problems for everyone on board to sort out.

Now, call us cynics, but in every case where “bailout” is the answer, those poor passengers’ health down in steerage are always anchored firmly to the problem. This is so common that we believe it is far from coincidentally acting as a life preserver for the 1st class passengers whose actions not only caused the problem, but also locked in the profits that assure for them only the finest linens and caviar are part of the ride (not to mention, record bonuses over the last few years). Recall, it was former Captain Alan Greenspan whose easy credit policies gave bankers the tools to create such problems, and both should be held accountable. But the gig appears to be protected — Were the ship to be allowed to go down, all classes of passengers would be affected. So, much like the proposition in the famous National Lampoon cover warning, “If you don’t buy this magazine, we’ll shoot this dog,” we have a situation where we rush to save the dog without permanently disarming the man with the gun in his hand. And, while it is serious business, no doubt like the magazine cover Bush’s denial of bailout is a joke.

We could list all the bailouts where big bank interests were protected by appeals to save the common man. For those of you interested in a detailed summary, consider G. Edward Griffin’s, The Creature from Jekyll Island: A Second Look at the Federal Reserve. Indeed, the subtext of the Federal Reserve has been a long road of bailouts.

Bad news this a.m. as analysts at Royal Bank of Scotland estimate that forced asset sales from two struggling SIVs and four troubled SIV-lites mean assets with a face value of up to $43bn worth are at risk of flooding on to the markets, according the the Financial Times. Such ongoing fresh news is one reason why the markets are continuing with volatility.

SIV and SIV-lites are structured investment vehicles are essentially an investment company structure often (though not always) used by banks that falls under the CDO category, which generates investment returns by playing yield curve arbitrage, primarily with high grade (AAA, AA) debt on the mid and longer term, while financing themselves with low cost short term senior debt, usually via the asset backed commercial paper (ABCP) market. Typically they are leveraged at 10 to 15 times. Many have invested heavily in the Mortgaged Backed Security (MBS) market, which is at the epicenter of the recent lock up, with many MBSs having an extremely tight market given the carnage from the U.S. housing bubble and mortgage default crisis is still unfolding.

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With the lock up in the short term money market, this primary source of funding is no longer forthcoming, adding substantial pressure to SIVs. Add to that the pressure of ratings downgrades due to their reliance on falling MBSs, and suddenly their backup liquidity from banks lines of credit vanish… and your int the mess we now have, where few dare to invest into SIVs when so little is known about what they hold. Continue Reading »

Here’s a recent piece from Ron Paul, one of the few in Congress who actually understands what is transpiring in the credit markets and the complicity to it of Congress.  He is the only member of Congress and presidential candidate willing to stick his neck out by discussing the serious implications of the situation.

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August 20, 2007 Credit RiskAs markets went on a rollercoaster ride last week, our economy is coming close to a day of reckoning for loose credit policies being followed by the Federal Reserve Bank. Simply, foreign banks we have been relying on to buy our debt are waking up to the reality of much higher default rates than predicted, and many mortgage backed securities have been reduced to “junk” ratings. Wall Street fears the possibility of tightening credit and the tightening of America’s belts. Why, they say, “if Americans spend only what they can afford, think of the ripple effects throughout the economy!” This is the cry, as the call comes for the fed to cut rates and bail out companies in trouble.

More inflation is, however, never the answer to inflation.

The truth is that business involves risk, and businesses that miscalculate risk should be liquidated, so their assets can be reallocated to businesses that correctly judge risk and make profits. Instead, the Fed has injected $64 billion into the jittery markets, effectively amounting to a bailout that keeps these malinvestments afloat, but eventually they will become the undoing of our economy.

In addition to the negative reactions in financial markets, many Americans have taken on too much personal debt owing to exotic mortgage products and artificially low interest rates. Unfortunately, these families are now in the position of losing their homes in unprecedented numbers as the teaser rates expire and the real bills are coming due.

The real answers are, and always have been, found in the principles of the free market. Let the market set the interest rates. If we had been functioning under a true and transparent free market system, we would not be in the mess we are in today. Government, like the American household, needs to live within its means to get back on stable fiscal ground.

We’ve been headed in the wrong direction since 1971. This week marks the 36th anniversary of Nixon’s decision to close the gold window, which convinced me to seek public office to call attention to the runaway money train that would come in the aftermath of that decision. The temptation to print and spend money with impunity, like the temptation to max out lines of credit, is too strong to for government to resist. While Nixon brokered exclusivity deals with OPEC to prop up demand for the tidal wave of green pieces of paper the Fed pumped into the markets, the world is tiring of marching to the beat of our drum in order to secure their energy needs. The house of cards Nixon built is now on the verge of collapsing on our heads, and on our children’s heads.

As the dollar weakens, it becomes ever clearer that we need a return to sound, commodity-based money for a secure future. Money based on real value, not empty promises and secretive backroom machinations, is the way to get out of the current calamity without causing even bigger problems.

Dr. Ron Paul
Project Freedom

It is with sadness that we pass on to our readers news we just learned, that internationally renowned economist Dr. Kurt Richebächer died earlier this week on Monday at the age of 88.

Dr. Richebächer was a great devotee of the Austrian School of economics, and was extremely helpful and accurate in predicting the present breakdown in the world’s credit markets. While lately, those espousing Austrian critiques of the wild credit excesses of recent decades have been dismissed and ignored for being wet blankets at the party, Dr. Richebächer was more of a celebrity some years ago.   Once the head of the Dresdener Bank in Germany, his retirement party in 1982 was attended by luminaries such as Otto Pohl, then head of the Bundesbank, and Paul Volcker of the Fed.  After retiring, Dr. Richebächer continued publishing a newsletter (The Richebächer Letter)  that remained highly relevant up until its final issue in February of this year, when health issues prevented him from continuing.

We have quoted him often at both Vigilant Investor and through proprietary client materials via our wealth management firm, Ernharth Group. For years now I’ve retained a quote of his in my own email signature, as follows:

“Bulls of 1929 - like their 1990s counterparts - had their eyes glued on improving profits and stock valuations. Not a thought was given to the fact that the rising tide of money deluging the stock market came from financial leverage and not from savings.”
- Dr. Kurt Richebacher

What is astounding is that so many were blindsided recently despite his acute and well articulated warnings.  His clarity and insights will be deeply missed. Those seeking a deeper understanding of the current situation would do well to read whatever materials of his they can find, including the timeless wealth of knowledge contained in his past newsletters.

Update: We just found a wonderful tribute piece from Wilfred Hahn, a long time colleague of Dr. Richebächer, which provides substantial detail about his life and legacy.

If you don’t take my word, take that of David Walker, U.S. Controller General, whose been on tour telling the truth about the real Federal deficit vs. the headline number. The numbers used by politicians: $315 and $265 billion in 2005 and 2006. The real numbers: $3.5 and $ 4.6 trillion, when the slight of hand that returns to the balance sheet the many social obligations that were removed thanks to the creativity of L.B.J and Congress back in the 1960s.

Cut programs? Raise taxes? Show me a politician who’d dare run on that — a scarcity confirmed in this video.

To us, this smells like more money printing in the future. Add that to the current credit market fiasco, and suddenly there’s a real issue regarding the slumping dollar!

In one way, I’m sympathetic to the institutional reluctance to face the music. I’d give a lot to mark my weight to ‘model’ rather than to ‘market.’ - Warren Buffett, Fortune, 8/16/07 (On the financial institution practice of valuing subprime assets on the basis of a computer model rather than the free market price.)

For so long Ben Bernanke at the Fed, the folks at the National Association of Realtors, and on Wall Street kept trying to convince us there was no housing bubble. No out of control prices there, they said. When a slowdown emerged, the common theme was that it was just a return to more normal growth. Even Ben Bernanke suggested housing was still a good deal when the housing bubble was very long in the tooth, encouraging buyers to pile on an already bad problem.

Today we learn that home prices have experienced their steepest drop in 20 years, compounding the already bad news that for the first time ever, housing in all regions is dropping in value. Previously, crunches — which in various cases have been severe — were generally confined to one region or another, such as the infamous real estate collapse in Florida prior to the Great Depression. Continue Reading »

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We’re live 3:30 NYT to discuss the recent weeks events with the giant credit bubble unwind. Has the Fed been nearly as liquid as many suspect, or have they been stingy? The market seems to think all is ok, but should it be so quick to jump back on the carry trade and drive equities yet higher?

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We missed this last week, but the President’s Working Group on Financial Markets (PWG)– a,k.a. the market Plunge Protection Team (PPT) — has indeed been busy.

“The market turmoil prompted the President’s Working Group on Financial Markets — the Treasury, the Fed, the SEC and the Commodities Futures Trading Commission — to trigger protocols established by Mr. Paulson shortly after he took office last year. They include a detailed list of who is going to call financial institutions, risk managers, traders and chief executives to keep tabs, how often they should call and the like. When he first joined Treasury from Goldman Sachs, Mr. Paulson instructed Emil Henry, then the Treasury official in charge of financial institutions, to craft guidelines for five or six “meltdown” scenarios. One was a catch-all “General Withdrawal from Risk Taking.” Others include a liquidity crisis, stock-market meltdown and oil shock. The Working Group has held conference calls, principally among staff, at least once a day in recent days.”

That’s from an article last week in the WSJ. Today, John Crudel over at the NY Post has this to say:

“The Treasury is still ignoring The Post’s long-standing requests for information on the PWG under the Freedom of Information Act. And Treasury Secretary Hank Paulson hasn’t gotten back to me on my recent request for an interview. But the rest of the media is suddenly tracking this mysterious organization. Trouble is, while the press now seems to understand the PWG’s importance, nobody is asking the big question - what is the group willing and able to do in a crisis? Now that it suits the group’s interest, the PWG wants everyone to know it’s on the job.”

Well, that’s entirely expected in our opinion. This is largely about managing expectations, and the powers that be will do what they can to make it appear that things are far better than they are. This serves the primary purpose of allowing the markets to remove panic, never mind how substantiated.

But it also allows for some last minute shifting of assets: “Any buyers out there? Things are NOT so bad, you see? The market’s up!?!!”

We think market rigging is market rigging. In such an environment, what should happen is prevented or delayed, reinforcing the old saying “Don’t Bet Against the Fed.” To that, don’t count on the credit bubble meltdown to unwind without a fight. That’s betting against the PPT!

Concern that money markets may not be so sound as many investors expected, investors have been jettisoning their positions in favor of T-Bills at a level not seen since the 1987 market crash. T-Bill yields have fallen from 4.69 % on August 13 to 2.96% on today’s trading (1:57 p.m. NY) per Bloomberg. That’s a drop that exceeded the post 9/11 drop of 39 basis points.

Worries are that the commercial paper market cannot be rolled over due to liquidity issues, and that CDOs that trickled down to the MMs in the overly risk friendly environment earlier this year do not merit anything close to the AAA ratings they received. Money market funds hold $ 2.5 trillion in assets, most of it in T-bills, hence the situation does not affect all investors. Yet the murkiness surrounding subprimes presents the possible for losses in such funds, especially in those billing themselves as higher yield — which are more prone to hold mis-rated debt.

Hence, while the commercial paper market has most questioning what lurks beneath the surface, T-Bills are T-Bills no matter what… (At least for the moment, lest we consider the longer term insolvency issues associated with the U.S. debt and deficits.)

Meanwhile, another hedge fund is in it deep. Solent Capital Partners LLP, a U.K. based manager handling $8.8 billion in funds has lost its short term funding for its Mainsail II Ltd fund — a mortgage originating operation. Like Countrywide, Mainsail is being forced to draw into its emergency bank lines to stay solvent when its asset-backed commercial paper failed to sell.

Also Read:

• Subprime Infects $300 Billion of Money Market Funds, Hikes Risk
• Look Out. This Crunch Is Serious
• Flight to safety hits yield on Treasury bills

As we write, Asian indexes are rising on the Fed’s half percent cut in the discount rate, and pundits are touting the move as saving global markets. We say – “Please!” We also ask the simple question, “What’s fundamentally really changed?” (Hint – “Nothing)!

The sub-prime fiasco is far from resolved. In September, an estimated $60 Billion of adjustable mortgages begin to re-set through next year. Because the riskiest lending practices took place during the final years of the real estate bubble – and thus the shakiest mortgage loans are soon going to cost borrowers more to pay off — there has to be a lot of breath holding taking place on Wall Street and in the credit markets. In other words — we would not be surprised to see a dramatic increase in defaults which, could make current problems with mortgage-backed bonds look minor. The subsequent required bailout could make that performed by central banks over the past few weeks – seem miniscule in comparison. All of this has nothing other than inflationary implications.

If you really boil it down to it’s simplest – central banks – Fed included – are giving institutions a place to get rid of their garbage. Only a central bank (certainly not a private one) would offer loans AT A DISCOUNT for collateral of highly questionable quality (of course with money created out of thin air)! Well, not exactly folks. That money is being taken from your hard earned savings. Yep — as the monetary system is flooded with newly created money designed to bail out reckless lending, banking, and Wall Street business practices – your hard earned savings (and purchasing power) is diluted commensurately. In other words – you are paying for this. And you are going to keep paying.

All along we’ve been cautioning that continual injections of liquidity – whether through cheap credit, increased government borrowing, or central bank bailouts will have inflationary ramifications. We’ve also said that the Fed is between a rock and a hard place. If they try to fight inflation by keeping rates higher (or raising them) – the credit dependant, consumer based U.S. economy could go over the cliff. If rates are lowered to re-stimulate (or bail out credit markets) – the Dollar will be sacrificed. Based on the last few weeks, the latter has begun.

More than a few traders these days know of a routine where very loud trades enter the market in the final half hour to drive the closing price above comfortable technical thresholds, whatever they may be. From a technical trading perspective, when those support levels are broached, a recalculation of lower expectations takes place, and corresponding sell trades are made to either mitigate potential losses or capture the downside momentum. Noisy trades seem quite contrary to the whole idea of buying as low as possible by slowly easing into the market and buying at lows before everyone else catches on, thus leading to suspicions about who is behind the clumsy buying power at crucial times?

Above we have the Dow and note the 200 day moving average in green — which some say is a crucial support point for a Friday’s close. Yesterday’s surprise late day move and today’s jump out of the gate certainly left many wondering about the sudden change in attitude. Enter suspicions that the President’s Working Group on Financial Markets (a.k.a. The Plunge Protection Team) is hard at work supporting such levels in order to keep the market from “irrationally” selling itself into the abyss. At least that’s the theory behind the creation in 1988 of this low profile U.S. Treasury related department — in the wake of the 1987, 40% plunge, to provide vital support during irrational events.

A battle raging for the Dow’s 200 day simple average?  Some say a close below that mark for any week will be a bad omen for equities.

You make the call. In the meantime, feel free to peruse our past articles on the secretive Plunge Protection Team.

Don’t miss today’s show at 3:30 p.m. NY time, broadcast live worldwide over the internet and available as a podcast download 24/7.

Today we’ll discuss the last week’s happenings, from market drops to sudden rebounds, to Fed bailouts, and more unfolding problems in the credit markets. Moreover, we’ll explain why there is still a long way to go in the unwind and why the Fed’s money printing press will only make problems worse in the long run.

Don’t miss out, but if you can’t make it live, download our podcast. You can even subscribe via iTunes. Just click the image in this post which will take you to our TalkShoe broadcast headquarters!

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Note: We’ve been told of quality issues regarding our podcast recordings vs. our live broadcasts. We’ve made some adjustments so give us another try if you’ve liked the subject matter, but had problems with the sound quality.

“Anxious customers jammed the phone lines and website of Countrywide Bank and crowded its branch offices to pull out their savings because of concerns about the financial problems of the mortgage lender that owns the bank.Countrywide Financial Corp., the biggest home-loan company in the nation, sought Thursday to assure depositors and the financial industry that both it and its bank were fiscally stable. And federal regulators said they weren’t alarmed by the volume of withdrawals from the bank.”

Read more from the above quoted LATimes article here.

Countrywide Financial is the largest mortgage lender in the U.S., collecting payments on about 14% of all outstanding U.S. mortgages.  Such credit lines exist but are rarely if ever used, and analysts suggested this was a desperate move that signaled how ominous the locking credit environment had become. It was this news that supposedly rattled markets yesterday before their amazing final hour recovery.