Vigilant Investor

As a kid, my first lessons in risk reward came from none other than Mr. Evil Knievel, daredevil motorcycle jumper, who made his final and greatest jump today into the great beyond.

Back in the 1970s, Evil jumped cars, buses, casino fountains, pools filled with sharks, and even the Snake River Canyon . What was to be learned? Excessive risk-taking clearly had penalties — like breaking every bone in one’s body.

Rest in Peace, Evil… And readers, I hope you enjoy this classic video of one of the greatest toys of my childhood. I can think of no better way to remember the legend.

In the bond market, commercial property investors are about as creditworthy as U.S. homeowners with subprime mortgages. “Commercial real estate is a full-blown bubble that feels very much at a bursting point,” said Christian Stracke, an analyst in London at CreditSights Inc., a fixed-income research firm. “There’s a fairly toxic mix of factors at work.”

Tha’s from an article worth reading on Bloomberg.com.   As our post earlier today indicated, the problem of inflationary induced dislocations is hardly confined. Entire economies bend to where the wealth is redirected.  Commercial real estate will be yet another shoe to drop.

This from Nouriel Roubini at NYU yesterday:

“Certainly yesterday’s (Wednesday’s) equities rally was totally driven by Fed governor Kohn signaling the obvious, i.e. that given that the liquidity and credit crunch is now worse than at its August peak the Fed will cut rates in December, January and for as long as needed. In this game of chicken between the Fed and the bond market (with the latter signaling already for a while that the Fed will keep on cutting) the Fed was obviously the one to blink: this was no surprise to anyone who had noticed the meltdown in financial markets (a ugly liquidity and credit crunch) in the last few weeks. But for some reason the stock market on Wednesday discovered what analysts, the bond market and credit markets knew all along, i.e. that the Fed will have to keep on cutting rates as we are headed towards an ugly recession that is now inevitable regardless of how much the Fed cuts rates.”

Call it a Bernanke Put if you believe that the Fed is trying to avoid a financial meltdwon; call it a need to bail out the economy rather than bailing out the markets if you believe - as I do - that the Fed actions are more driven by its concerns about the economy rather than an attempt to rescue investors; call it a moral hazard play if you believe that the Fed is trying to rescue investors and risks to create down the line another asset bubble. You can call it whatever you like but one thing is obvious: the Fed easing is perceived by the stock market as an action aimed to prevent a recession from occurring and stock prices rally - in spite of worsening macro news that are signaling recession ahead - because of the hope - that I will show is only wishful thinking - that the Fed will be able to avoid such a hard landing. Thus, what has been mostly driving up the stock market in the cycles since last summers is Fed policy expectations of easing.

Dr. Roubini raises some great issues. Just the same, we should not forget that all this policy action is engineered with the money printing press. The fed’s lower interest rate encourages more borrowing, which otherwise would normally dry up the naturally occurring pool of savings, which in turn would force interest rates back up. Instead the Fed provides the liquidity necessary to keep interest rates below the natural rate that the existing pool of savings would demand. Consequently, all these dollars that are freshly minted are suddenly bestowed with purchasing power. Of course, that’s not magic — It is simply inflation, which in turn comes out of the hide of all those who are storing their wealth in pre-existing dollars. Any wonders why gold, oil, and a host of other hard assets are up so dramatically since the gargantuan liquidity injections of Bernanke and his anointed predecessor, Alan Greenspan? Continue Reading »

It looks like Florida’s state investment fund had to shut its doors to prevent a run on the bank after cities, schools, and counties yanked $3.5 billion in one day! Reports the Orlando Sentinel,

The State Board of Administration — the governor, attorney general and chief financial officers — voted unanimously to at least temporarily halt a run on the fund, which has reported withdrawls totalling $10 billion in the past several weeks. That’s more than one-third of the fund’s assets of $28 billion.

Local governments fear they could lose their money because the state invested it in funds backed by loans to homeowners with questionable credit — the same loans that have triggered an international credit crunch.

Ouch! Mind you, this is a fund for short term interest used to invest tax proceeds that are to be used for salaries and road repairs.
This toxic waste — CDOs of all stripes is in all sorts of places, and is a minefield of sorts. Expect more and more of it to turn up in places where folks expected immediate liquidity. Just wait until commercial real estate hits the skids!

UPDATE

Bloomberg has released an update. Snippets include:

“If we don’t do something quickly, we’re not going to have an investment pool,” said (executive director of the State Board of Administration, Coleman) Stipanovich at the meeting in the state capitol in Tallahassee…

Local governments including Orange County and Pompano Beach that use the pool like a money-market fund asked for their money back after the State Board of Administration disclosed in a report earlier this month that holdings in the fund were lowered to below investment grade.

… he pool has invested $2 billion in structured investment vehicles and other subprime-tainted debt, state records show. About 20 percent of the pool is in asset-backed commercial paper, Stipanovich said at the meeting today. “There is no liquidity out there, there are no bids” for those securities, he said.”

And the real kicker:

The board also considered adopting a more conservative investment policy and seeking a top credit rating for the pool from Standard & Poor’s.

Fiduciary lack of oversight is hardly and excusable offense in the private sector. Will it cost these public officials and bureaucrats?   Which reminds us, make sure you’re taking care of your fiduciary responsibility and those you’ve entrusted with your investments are doing the same!

Bloomberg published a story on November 21 noting JPMorgan analysts are suggesting that ACA Financial Guarantee Corporation, one of the nations largest bond default insurers of collateralized debt instruments, may be “thrown to the wolves.” This comes after S&P placed its “A” rating of financial strength on “CreditWatch with negative implications” based on a variety of factors on November 9. S&P is the only ratings company that has a rating on ACA.

That downgrade was in response to ACA Capital’s (the parent company ACA FGC) announcement that it had $1.04 billion net losses in the 3rd quarter, compared with earnings of $16.1 million over the same period in 2006. Meanwhile, Pershing Square Capital’s William Ackman yesterday predicted ACA wil go bankrupt.

Now, if a downgrade takes place, counterparties that insured their CDOs with ACA FGC would find themselves with a big problem. Reported the Financial Times on the day of the S&P warning,

Because ACA Financial is rated A – well below the industry norm of AAA – its CDO CDS contracts contain a provision requiring it to post collateral in the event of a downgrade, said the market participant. Such provisions require ACA to post cash equivalent to the mark-to-market loss of the CDS contract pursuant to a ratings cut.

ACA said in a 10-Q filing this week(from Deloitte Touche) that it won’t meet collateral requirements if its rating falls below A-. In other words, ACA FG would become insolvent and default on its insurance agreements, as the FT story points out.

Which brings us back to JPMorgan’s observations noted above. Reported Bloomberg, Continue Reading »

We often describe Vigilant Investor as a publication that helps readers successfully surf the giant credit bubble waves that are crashing ashore. Successfully surfing the big wave involves skill, guts, and art. Enjoy this report from Hawaii’s North Shore where the first big ones of the winter roll in, and good luck with the big credit bubble sets yet to come.

Citigroup Inc., the biggest U.S. bank by assets, will receive a $7.5 billion cash infusion from Abu Dhabi to replenish capital after record mortgage losses wiped out almost half its market value.

$ 7.5 billion is what the Sovereign Wealth fund of Abu Dhabi is going to send to Citigroup to help it shore up its balance sheet. But $7.5 billion ain’t enough. The problem plaguing so much of the credit market is far too deep. That’s because capital ratios are a requirement when it comes to banking.

For a simple example, consider the required capital to asset ratio is 1 to 10, so if Citigroup has to take an $11 billion charge / write down as they’ve announced they will for the 4th quarter, they have to jettison $110 billion of assets. Keep in mind that Citigroup has the single highest exposure — $50 billion — to high loan to value mortgages (LTVs), which are very risky for default given we’re talking a pool of 90% + loan-to-mortgage value amid the current imploding housing environment that’s feeling the pain of adjustable rate and interest only mortgages on declining property values. There are also rumors that Citi is going to have to cut as many as 45,000 jobs to stem the bleeding, which itself will require further charges!

Continue Reading »

A few articles we thought were worth a read:

Dollar Displaces Yen, Franc as Carry Trade Favorite

A basket of currencies including the British pound, Brazilian real and Hungarian forint financed with dollars returned 17 percent this year, compared with 9 percent when funded in yen and 7 percent in Swiss francs, according to data compiled by Bloomberg. Falling U.S. interest rates and increasing volatility in the yen and franc are making the trade even more appealing.

Bank of England warns credit crisis to worsen

Charles Bean said that the banks have so far reported “only a relatively small fraction of the likely losses associated with the US sub-prime market… It is quite likely that, over the coming months, there will be more revelations to come out, not necessarily just in this country,” he added.

Bet your bottom dollar tensions will follow

The weak dollar used to be an economic issue. But the greenback has now dropped so far, and has so much further to fall, that its decline is of profound political importance. The dollar isn’t any old currency. And it isn’t just the currency of the biggest economy on earth. The dollar is the world’s “reserve currency” - which means central banks everywhere use it to stockpile wealth. No less than two-thirds of all sovereign foreign exchange holdings are denominated in dollars.

Our Thoughts: The dollar problem is only now being exposed thanks to the collapse of the credit bubble. This makes other players very nervous — which includes currency tension between Europe and China, and with the Euro trading at $1.50, it creates problems among those in the European Union. Yet to be exposed is that the dollar problem is really a global fiat currency problem.

PNC just completed its annual “Twelve Days of Christmas” cost-analysis, and it looks like lower and middle-income labor will find it harder than ever to afford even snippets of the extravaganza described in the song.

PNC found the overall cost to run the 12-day-long shebang described in the famous Christmas song is up 4%, to $78,100. Rebekah McCahan over at PNC actually solicits real quotes on fixed quantities mentioned in the song, and uses what she finds to compose PNC’s Christmas Price Index — something she’s been doing so since 1986. (PNC started this act in 1984 when $61,319 could get it done.)

What can we learn from the figures? No doubt, wage leverage at the moment is tough in the United States.  With the exception of “Eight Maids-a-milking” who’ve benefited by the minimum wage increase, up 13.6%, labor in the service sector portion of the song is clearly lagging commodity inflation.  Add to that the contraction of easy credit this past year, it would seem that the “True Love” in the song (e.g. , “On the first day of Christmas my true love gave to me…”) now more than any time recently is among the moneyed-class given the cash required to keep up with the climbing costs!

Continue Reading »

In April 2006, GM ditched GMAC — its highly profitable finance unit — ostensibly to raise cash given its ongoing struggles to keep the head above water.   Back then we questioned the motives, and in todays credit-crisis environment, it appears as if Sun Tsu is terribly proud despite GM Vice Chairman, Bob Lutz’s comments to the contrary.  Says Lutz, “… we thought we were doing it to raise cash … but it turns out what we were really doing was reducing our exposure to ResCap.”

Whatever the case, GM claims that it has no contingent liabilities from the unfolding credit crisis that has cost GMAC a $1.6 billion 3rd quarter loss, although Lutz admits “The only downside is if … ResCap (the residential mortgage arm of GMAC) keeps doing worse and worse, and we keep having to absorb our 49 percent of the worse and worse.”    GM already slopped in $1 billion as part of their agreement with 51% stakeholder Cerberus Capital Management LP, but otherwise claims it has a firewall in place.   ResCap lost $ 2.3 billion due to the subprime problems in the 3rd quarter alone.

Well, that hardly is a vote of confidence for ResCaps future for those who believed the credit markets would have serious problems long before things really imploded this past August.

But as we suspected, Sun Tsu is likely very proud of GM’s work.  Now, if only GM could sell more cars and solve that massive unfunded pension and health care liability hangover.

We knew there was a problem well over a year ago when Freddie and the girls (the other GSEs) were incapable of providing financial numbers that any legitimate accounting firm could feel comfortable with. Today they’re still having problems giving investors legitimate numbers and with the mounting chaos unfolding in the U.S. housing market, it appears that the market place is throwing up its hands waiting.

Yesterday Freddie Mac shares dropped some 29% as a consequence.  It would appear that market players are also finally coming to terms with the severity of the housing problems in the U.S., although one can always be surprised by denial!

Meanwhile, The Economist has a sobering article on America’s mortgage giants, titled The Cracks Are Spreading, with the byline  “The supposed saviours of America’s mortgage market are its latest victims.”  The cover on this week’s issue seems to us to be an indicator that we’re nearing a tipping point of collective realization that things ain’t so rosy as everyone was led to believe.

Feeling blindsided? Feeling like there’s nobody who saw this coming??

If you’d been a regular reader of Vigilant Investor, you’d have been on this story 2 1/2 years ago. Some of our past gems include:

• April 19th, 2005: Real Estate Bubble - Housing Starts Drop 17.6%
• July 14th, 2005: Commercial Real Estate Bubble
• October 24th, 2005: “King of Real Estate” Quietly Liquidating U.S. Positions…
• November 18th, 2005: The Crazy (and dangrous) Mortgage Market
• April 7, 2006: Money Supply and Housing Bubbles
• July 18th, 2006: Stagflationary Recession? Say it ain’t so!

With that as our backdrop, we say to you: So much for the Efficient Market Hypothesis.   We still believe there is much carnage ahead for housing and mortgage related industries, as well as for those in the credit markets across the board.

Time to engage brain and think, readers!

From the “This can’t be good” department, we report that Europe has been forced to suspend trading in the $2.8 trillion mortgage debt markets in an attempt to halt the unfolding calamity in the credit markets. Reports Bloomberg,

“We are in a deteriorating situation,” Patrick Amat, chairman of the Brussels-based ECBC and chief financial officer of mortgage lender Credit Immobilier de France, said in a telephone interview. “A single sale can be like a hot potato. If repeated, this can lead to an unacceptable spread widening and you end up with an absurd situation.”

Clearly the problems are extremely severe when the better approach to pricing these securities at market is to simply force the market’s head firmly into the sand.

Suddenly it appears Western nations fear eating from the menu they recommended for Asian banks during their cirisis in the late 1990s, when the advice was to simply allow the dust to settle, as painful as that may be, so people can get back to work and move on.

Plan accordingly!

For those inclined, here’s a link to the Liberty Dollar founder being interviewed on Kudlow’s show last night. The comments from the panel are interesting, especially the annoyingly self-righteous fellow from Forbes Magazine.

The folks over at Liberty Dollar (issuers of gold and silver backed coins and paper receipts) were raided by the Feds for supposedly violating the counterfeiting laws. The FBI claims the liberty coins and paper look too much like the real deal. Also, the Feds claim that Liberty Dollar and its owners were attempting to create a competing currency with the intent of “undermining the U.S. government’s financial systems by the issuance of a non-governmental competing currency for the purpose of repealing the Federal Reserve and Internal Revenue Code,” according to the affidavit. Continue Reading »

The impact of the U.S. mortgage market crisis on the underlying economy could be “dramatic” as leveraged investors may need to scale back lending by up to $2 trillion, according to investment bank Goldman Sachs… “The macroeconomic consequences could be quite dramatic,” [chief U.S. economist Jan] Hatzius said in the note to clients. “If leveraged investors see $200 billion of the $400 billion aggregate credit loss, they might need to scale back their lending by $2 trillion” … “This is a large shock,” he said, adding the number equates to 7 percent of total debt owed by U.S. non-financial sectors.

That’s a huge problem given leveraged investors must cut lending in order to keep capital ratios from falling in the wake of losses. In other words, an institution with a a capital ratio of 10 percent would need to shrink its balance sheet by $10 for every $1 in losses.

That’s the problem with expanding credit from thin air: easy come, easy go! To bad the economy is hoodwinked into thinking the foundation was rock vs. sand now that the storm is firmly ashore. Plan accordingly!

You can read the rest of the dismal article quote above here.