US - Subprime

Re: Subprime

Postby millionairemind » Mon Sep 22, 2008 8:16 am

Treasuries Prove Irresistible as Deflation Bet Trumps Paulson
By Daniel Kruger and Sandra Hernandez

Sept. 22 (Bloomberg) -- As details of Treasury Secretary Henry Paulson's plan to revive the U.S. financial system by pumping as much as $700 billion into the markets emerged Sept. 19, bond investor Michael Cheah was reminded of Japan.

When that country's real estate bubble burst, leaving a trail of bad real estate loans, officials flooded the economy with cash only to see banks hoard the money instead of lending it out. The result has been a series of recessions and persistent deflation for more than a decade.

``Although the government tried to debase the yen by printing a lot of government bonds, the economy went into a standstill,'' said Cheah, an official at the Monetary Authority of Singapore from 1991 to 1999 who manages $2 billion at AIG SunAmerica Asset Management in Jersey City, New Jersey. ``The banks used the money to buy safety. I see a repeat happening here. The banks will use it to buy Treasuries.''

While U.S. bonds tumbled on the plan to buy soured mortgage-related assets from financial institutions in the most far-reaching federal intrusion into markets since the Great Depression, they still ended the week little changed.

To investors such as Cheah, that's a clear sign the economy is facing many of the same risks that have afflicted Japan. The yield on the benchmark 30-year Treasury bond, which stands to benefit the most of any government maturity from a drop in inflation expectations, fell to 3.89 percent last week, the lowest level since the U.S. reintroduced the security in 1977.

`Same as Japan'

Only Japan offers inflation-linked bonds that pay lower rates than similar securities issued by the Treasury.


For maturities up to four years, the difference in yields between Treasury Inflation-Protected Securities and nominal bonds is 1 percentage point or less. The so-called breakeven rate represents the pace of inflation investors expect over the life of the securities.

``The current U.S. situation is the same as Japan's case,'' said Hiromasa Nakamura, senior fund investor at Tokyo-based Mizuho Asset Management Co., which oversees $36.5 billion as part of Japan's second-largest bank. ``The economic slowdown and credit crunch are creating a downward spiral.''

Nakamura, who correctly forecast the rally in Treasuries last year, said two-year note yields will fall to 1.1 percent by year-end, while the 10-year will decline to 3 percent. The 2.375 percent note due August 2010 ended last week at 100 11/32 to yield 2.20 percent, while the 4 percent security maturing in August 2018 finished at 101 10/32 to yield 3.84 percent.

Rate Expectations

Just last month, traders, concerned that rising food and energy costs were trickling into the broader economy, saw a 65 percent probability the Federal Reserve would raise borrowing costs by the end of 2008 to contain consumer prices. Now, there's a 100 percent chance its 2 percent target rate will either stay the same or be cut, futures on the Chicago Board of Trade show.


The Labor Department in Washington said last week that consumer prices fell 0.1 percent in August, the first decline in almost two years, as fuel costs dropped from record levels. The yield on the 10-year Treasury is 1.55 percentage points below the consumer price index, the most since 1980 and a sign that traders expect inflation to slow. The yield typically averages about 3.4 percentage points more than inflation.

Traders think ``they're looking at Japan,'' said Dominic Konstam, head of interest-rate strategy at Credit Suisse Securities USA LLC in New York, one of 19 primary dealers that trade with the Fed. ``Long-term rates can drop another 100, 200 basis points if things continue to deteriorate.''

Far to Go

The U.S. has far to go before matching what Japan has gone through. Since 1995, inflation in the world's second-biggest economy after the U.S. has averaged zero percent, while growth has averaged 1.4 percent. The Bank of Japan maintained what it called a ``zero interest-rate policy'' from 2001 through 2006 to try to stimulate the economy.

The yield on Japanese inflation-linked debt maturing in 10 years averaged 0.59 percentage point since being introduced in April 2004 and is currently negative 0.21 percent. The comparable U.S. yield is 1.92 percent.

Rather than a decline in consumer prices, a more likely scenario is a slowdown in inflation, said Stewart Taylor, a senior investment-grade debt trader at Boston-based Eaton Vance Management, which oversees about $6 billion of taxable bonds.

``Do we move into a full-blown deflation as opposed to disinflation? I doubt it,'' he said.

Seeking a Haven

Instead of a referendum on inflation, much of the rally in bonds may be tied to investors seeking a haven from financial market turmoil that led to the government's takeover of Washington-based Fannie Mae, Freddie Mac in McLean, Virginia, and American International Group Inc. of New York and the bankruptcy of New York-based Lehman Brothers Holdings Inc.

Some of that flight to safety was reversed Sept. 19 after Paulson and Fed Chairman Ben S. Bernanke announced a plan to buy troubled assets from financial institutions. The U.S. may have to borrow an extra $700 billion to $1 trillion to fund the rescue of the financial system, flooding bond investors with more supply, according to Barclays Capital Inc. interest-rate strategist Michael Pond in New York.

Bond bulls point to a still weakening housing market for why they expect inflation to slow and yields to remain low.

Home prices have plunged 19 percent on average from their peak in July 2006, according to the S&P/Case-Shiller index of 20 cities. Economists at New York-based Goldman Sachs Group Inc. said this month they expect prices to drop another 10 percent.

Cutting Back

Though consumer prices in the U.S. rose 5.4 percent in August from a year earlier, the Goldman economists noted it took almost four years ``from the bursting of the financial bubble in 1990 until prices first fell on a year-over-year basis'' in Japan.

The housing weakness is causing consumers to cut back on spending. The Labor Department in Washington said last week that new-vehicle prices dropped 0.6 percent in August, the most since November 2006, and hotel fares tumbled 1.1 percent.

``There are deflationary events out there and debt default is one of the primary drivers,'' said Jeffrey Gundlach, chief investment officer at Los Angeles-based TCW Group Inc., which oversees $90 billion in fixed-income. ``It's what they call a debt deflation cycle, and there's definitely one underway.''

The percentage of Treasuries in a diversified bond fund Gundlach manages is the highest it's ever been, he said.

The world's biggest banks have taken more than $500 billion in writedowns and losses on securities tied to subprime mortgages since the start of 2007, according to data compiled by Bloomberg. Almost a year ago, Goldman economists said just $400 billion of losses would cut banks' lending by $2 trillion.

``There's a huge amount of deflationary pressure when you get this kind of capital destruction,'' said Brian Edmonds, head of interest rates at Cantor Fitzgerald LP in New York, another primary dealer.
"If a speculator is correct half of the time, he is hitting a good average. Even being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he has been wrong" - Bernard Baruch

Disclaimer - The author may at times own some of the stocks mentioned in this forum. All discussions are NOT to be construed as buy/sell recommendations. Readers are advised to do their own research and analysis.
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Re: Subprime

Postby millionairemind » Mon Sep 22, 2008 8:58 am

Government Assistance
What We Need To Know About The Bailout Plan

Liz Moyer, 09.20.08, 1:08 PM ET

Treasury Secretary Henry Paulson said Friday that there's a "bold" plan afoot in Washington to relieve banks of their toxic assets, and that details would be hashed out this weekend. Panicked stock markets fell in love instantly, even though the only certainty is that a plan will be expensive. Necessary, but expensive.

Saturday, a brief proposal was unveiled by the White House: Price tag? $700 billion, paid for by expanding the ceiling on the national debt to $11.3 trillion. The Treasury would be authorized to buy and sell bad debt from banks as it sees fit, hiring the employees it needs to get the job done, as well as enlisting the help of outside firms. It would report to Congress on progress a couple times a year, and the entity would be chartered to run for two years.

It's a bare-bones plan, one likely to draw criticism from lawmakers looking for more detail--and Democrats angling for a bailout for homeowners to go along with one for Wall Street. Expect grumbling and argument this week as Congress hashes out the particulars.

As they do, we hope they ask the following 10 questions. Do you have questions to add? Post them in the comments section below. See earlier responses from readers.

1. Who gets to participate?

The outlines of the plan call for the creation of either a branch of the Treasury Department or an independent agency to buy or take on troubled assets, with the goal of either selling them at a profit later or working them off. In past iterations of this idea, like 1989's Resolution Trust Corp., failed institutions were the focus. The 1932 Reconstruction Finance Corp. lent $9 billion to ailing banks, thrifts, railroads, insurance companies and farm mortgage associations.

This time, it looks like the government will take on assets from otherwise healthy institutions. But Paulson hasn't detailed whether it would be available to all 7,200 commercial banks and 1,200 thrifts or to just a portion of them deemed to be "at risk,"--or where that "at risk" bar would be set. Also, would the program welcome assets from investment banks (perhaps even the estate of Lehman Brothers (nyse: LEH - news - people )? Lehman Brothers), hedge funds and other funds that have exposures? What about the private equity funds that have been buying distressed debts or foreign banks or funds?

2. How much will individual companies be allowed to dump?

Wachovia (nyse: WB - news - people ) is said to be considering a "bad bank" for toxic assets, including some portion of a potentially lethal $122 billion portfolio of alt-A mortgages on its books. Citigroup (nyse: C - news - people ) is trying to work off $500 billion of its "legacy" assets. Paulson hasn't said what limits would be set for contributions from individual banks, if any. Does that mean banks could unload absolutely everything, or would they be required to retain some portions for their own books?

3. How will the assets be priced?

The new entity could buy the assets at a distressed price, but what would the price be? Collateralized debt obligations and mortgage-backed securities and their various iterations are sliced and repackaged so many times that one firm's holdings wouldn't necessarily match up with another's, making it impossible to just assign price marks per category.

Merrill Lynch (nyse: MER - news - people ), for example, sold its $30 billion CDO portfolio in July for 22 cents on the dollar. That didn't spark a wave of CDO portfolio selling. Last year, E*Trade sold its $3 billion portfolio of asset-backed securities for 27 cents on the dollar, and ditto--no mass selling elsewhere. Another thought is that the government could run an auction, which would force banks themselves to price their assets.

4. How open will the books be?

Herbert Hoover's Reconstruction Finance Corp. kept its books open, listing the names of the banks that borrowed money and the amount they borrowed. It slowed bankruptcies down a bit, but the mere appearance on the list threatened a run on deposits, an erosion of confidence that was exactly the opposite of the agency's mission.

Still, one of the problems of the current crisis is the lack of information about bank exposures. If the goal is to restore confidence and the efficient workings of the banking system, perhaps making the entity's portfolio an open book wouldn't be such a bad thing. Asset valuation information might even lead to a more robust secondary market to take some of these assets off the government's hands.

5. Who will run it?

There are plenty of bankers and finance types out of jobs these days. A few seasoned executives have landed at companies on shaky ground. That includes Robert Steel, who left the Treasury Department for Wachovia earlier this summer, Edward Liddy, this week named chief executive officer of American International Group (nyse: AIG - news - people ), David Moffett, named head of Freddie Mac (nyse: FRE - news - people ) last month, and Herb Allison, named head of Fannie Mae (nyse: FNM - news - people ).

John Thain might be looking for a job after selling Merrill Lynch to Bank of America (nyse: BAC - news - people ). Does Alan Greenspan need a hobby? There's no shortage of policy wonks and former and current regulators in the Beltway who could take on the task.

6. How long will this thing be around?

Paulson's initial proposal gives the program two years to get the job done. That seems ambitious. The RTC lasted six years: from 1989 until 1995, when its authority was transferred to the Federal Deposit Insurance Corp. During its life, the RTC closed or resolved 747 thrifts with total assets of $394 billion. The Reconstruction Finance Corp. lasted 21 years; after the 1930s, much of that was dedicated to the war effort. It was abolished as an independent agency in 1953. One of its affiliated entities, the Federal Deposit Insurance Corp., had its 75th anniversary this year. FDIC chairman Sheila Bair was in New York Friday, ringing the opening bell at the New York Stock Exchange.

7. How much will a new agency cost taxpayers?

Paulson's plan asks Congress for $700 billion, but as everyone knows, no initial government estimate ever jibes what the ultimate cost turns out to be. The RTC, initially funded with $50 billion, ended up costing taxpayers $160 billion. The Treasury has already pledged to inject $200 billion into Fannie and Freddie and $200 billion into AIG, plus a smattering of other spending. (It'll buy back more mortgage-backed securities from banks, it said Friday, for example). The out-of-the-gate cost of all these bailouts seems to be $1 trillion.

8. Doesn't this make it hard to say no to other bailouts?

Paulson refused to step in and save Lehman, insisting that just a week after seizing Fannie and Freddie, the government was no longer in the bailout business. Then a day later, the Treasury and the Fed were all over AIG--and now this. It doesn't take a great leap of imagination to assume the ailing U.S. auto industry might go and demand equal treatment. Homebuilders are hurting. Hey, how about homeowners? Paulson's plan is bound to be criticized for helping rich bankers out of a quagmire of their own making while leaving average Americans to pick up the tab.

9. What happens next week in Congress?

It's an election year, and Congress was expected to adjourn at the end of the week to go home and campaign. Now they face having to bomb through one of the most expensive pieces of legislation in U.S. history with one eye on the markets, another on the taxpayer and the clock ticking. To get it done, there will have to be compromises, most likely involving a big bailout for distressed homeowners for which Democrats are clamoring. There will also be hearings to probe the downfall of Lehman, and there are calls for investigating evidence of manipulative stock trading.

10. Will this end the credit crisis?

Stock investors certainly seemed enthusiastic about the plan Friday, driving the markets to erase all of their losses for the week. That may be the bounce in confidence Paulson was looking for, but there are more dark days ahead. Banks still face mounting loan losses, and the new entity isn't going to get off the ground quickly enough to prevent more write-downs.

In the longer term, the creation of the entity will be accompanied by regulatory reforms and a likely reshaping of the way financial companies are regulated. Banks are reducing leverage and shying away from risk, which will restore stability but lower profits. Eventually, though, someone will innovate another product that will become the hottest thing on Wall Street. The only question at that point: Will regulators have enough determination to keep it in check?
"If a speculator is correct half of the time, he is hitting a good average. Even being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he has been wrong" - Bernard Baruch

Disclaimer - The author may at times own some of the stocks mentioned in this forum. All discussions are NOT to be construed as buy/sell recommendations. Readers are advised to do their own research and analysis.
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Re: Subprime

Postby mojo_ » Thu Sep 25, 2008 4:35 pm

Don't Forget About Housing--Some Fairly Good News There
CNBC Trader Talk - Posted By:Bob Pisani
24 Sep 2008
The Street is so obsessed with the Congressional hearings that some fairly good news on existing home sales went virtually unnoticed. Remember, it's housing that is the source of the problem.

Existing home sales were slightly lower than expected at 4.91 m sales for August. While the inventory level of homes for sale is still well above normal, the good news is that it did come down, to a 10.4 months supply, the lowest in many months.

Put this together with the lower level of new-home inventories (housing starts have been plunging) and we can say that there is clearly some kind of bottom developing.

What we don't have yet is a dramatic move off the bottom.
Not what but when.
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Re: Subprime

Postby blid2def » Thu Sep 25, 2008 4:41 pm

mojo_, do you now what's the "preferred" supply level for the US housing market that the experts are looking at? I think I've read somewhere that it would be a good thing if this level dropped to somewhere in the region of about 6 months, but I can't recall where I read it, and whether 6 months is the correct number I saw.

Interesting times ahead, where bad news is good news. :)
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Re: Subprime

Postby mojo_ » Thu Sep 25, 2008 4:46 pm

GR, sorry I don't have that level of detail at this time... but it's something I think we should keep an eye on... ;)
Not what but when.
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Re: Subprime

Postby blid2def » Thu Sep 25, 2008 5:12 pm

Maybe I have a running ticker in the tickerbar for that...

Housing Supplies... 12 months.... 11.9 months... 11 months... :D
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Re: Subprime

Postby mojo_ » Thu Sep 25, 2008 5:21 pm

Great idea! when can we expect to see that? :D

You're right:

Six months' supply of homes at the current sales pace would reflect a balanced market for existing homes, according to the Realtors.

New homes ``should be around four or five months at the most,'' Dotzour said.
Not what but when.
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Re: Subprime

Postby blid2def » Thu Sep 25, 2008 5:30 pm

Image
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Re: Subprime

Postby financecaptain » Thu Sep 25, 2008 5:38 pm

Sub-primes and CDOs are not the only problems.
You have a CDS market that has a nominal value of US$60 trillion. They are traded OTC and not regulated. So difficult to estimate the damage.
Finally, economic slowdown will affect other parts of the credit markets like credit cards, consumer loans etc.
You have not seen technical recession in the US yet. Nor have you seen major earning downgrades in a big way.
Winter has not come, we are only experiencing autum.
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Re: Subprime

Postby fclim » Thu Sep 25, 2008 11:04 pm

eehhh... more info on the 58 trillion CDS market.

http://www.reuters.com/article/BANKSL/i ... 2720080923

have fun,
fc
Last edited by fclim on Fri Sep 26, 2008 9:46 am, edited 1 time in total.
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