PrefBlog

Well, there’s a day and a half!

US T-Bill yields plunged again and Fed Funds futures are now showing certainty of a cut to 4.25% in January, down from the current 4.5%. In what may be assumed to be related news, the Bank of Canada intervened to boost the overnight rate – presumably, there’s a lot of cash-equivalent money looking for a home.

There are alarming reports of gloomy consumers, but the direct catalyst is, as usual, more bad news from the banks. CIBC, ‘bank most likely to walk into a sharp object’, is taking a $463-million CDO/RMBS writedown, which offsets their gains from the VISA restructuring (TD has managed to hang on to its profit). Rumours that Barclays is looking at a big write-off triggered a temporary collapse of their share price, but they staggered back to more usual levels by the end of London’s trading day – Barclays’ CEO has stated “his refusal to comment on subprime writedowns indicates there is no truth to speculation about losses that wiped 29 percent off the bank’s market value in the past month”. Wachovia has disclosed $1.7-billion mark-to-market losses in October alone. Nouriel Roubini somewhat gleefully forecasts a total of $500-billion on a mark-to-market basis.

It’s almost a relief to see news of the first CDO liquidation:

Carina is the first CDO to begin unwinding after a slump in the credit worthiness of the underlying assets, S&P said. Thirteen others have informed S&P of an event of default, a precursor to liquidation. A widespread fire sale by CDOs, which package asset-backed securities and resell them in pieces, may further exacerbate declines in subprime-mortgage securities.

As these structures unwind it will become easier to sort out the winners from the losers … and easier for investors to price the assets!

On November 7 I made the comment:

Even worse, Citigroup has increased its exposure to CDO-issued CP, which has had the effect of ballooning the amount of Level 3 ‘Mark-to-Make-Believe’ assets. Citigroup’s cost of borrowing, as proxied through Credit Default Swaps, is skyrocketting.

I should make this more clear; banking & investment strategy is sometimes a little more complicated than can be summarized in a couple of casual sentences – particularly when discussing an institution that has more capital in the business than the Canadian Big Five-and-a-Half put together. It is not necessarily a Bad Thing for Citigroup to accumulate CDO paper and Level 3 assets. Panic has hit the markets and panics are the perfect time for an organization that has already done its homework to make an absolute killing taking unwanted assets off other people’s hands.

However, there are knock-on effects. If this same panic causes their borrowing costs (as proxied by CDS levels) to increase beyond the expected winnings, then the strategy becomes defunct. No matter how stupid the market is being in increasing the funding costs of such an investor. Blind fear in the marketplace can paralyze even a well-prepared investor.

What’s needed is for “real money” investors (those who will be perfectly happy holding on to the paper until maturity, like pension funds, retail investors and such, since they’re not completely at the mercy of mark-to-market; as opposed to “hot money” investors who want to flip it next week) to step up and buy the stuff. I suspect, however, that any pension fund manager who suggests such a plan at this stage of the game to an ordinary, unsophisticated pension board will get a blank stare and a chuckle instead of a mandate.

But at least one major player has gone bottom-fishing in the bond-insurers market:

MGIC Investment Corp. and PMI Group Inc., the two largest U.S. mortgage insurers, rose in New York trading after insurer Old Republic International Corp. disclosed it became the biggest investor in each company.

More news on the bond insurers’ front, as well. Fitch is reviewing the bond insurance industry, which may need to raise capital at one of the worst possible times to do so (typical!). Josef Ackerman, CEO of Deutsche, warns of a very strong impact on financial assets if a downgrade comes to pass, as has been previously stated by Accrued Interest. Naked Capitalism passes on the report that Fitch is outraged by the Financial Times misuse of technical terms in reporting the concerns … in times like this, when a misplaced comma in a Bernanke speech could cost billions, the technical guys want precision above all else! Two major municipal refinancings have been delayed due to market instability.

Naked Capitalism has a very good piece about Cuomo’s investigation of WaMu regarding possibly deliberately inflated appraisals of properties. I didn’t discuss it at the time, thinking it was just minor league grandstanding, but it seems more serious – especially since it appears Cuomo knows little about the business – or is disingenuously overstating his case. Lockhart’s letter, linked by Naked Capitalism, is priceless; Accrued Interest translates the refined prose into more every-day language.

However, I must take issue with Naked Capitalism’s characterization of the GSEs::

Cuomo astoundingly called the GSEs investment banks, and as the article points out, raises doubts about the value of their even though they are government backed. Huh? That is likely the basis for Lockhart’s “you may not understand remark.”

The last thing the securities market needs is doubts being cast on the creditworthiness of Freddie’s and Fannies’ paper.

GSEs are not, in fact, government backed. There is certainly a market perception that they are government backed … but if push comes to shove, Congress can let them rot. There is a very dangerous ambiguity in Fannie & Freddie’s status that should be clarified; they walk like banks, talk like banks and write cheques like banks – they should be regulated like banks. I often link to James Hamilton’s presentation to the Jackson Hole conference which addressed the issue: now I’ll link to it again. Speaking of Fannie Mae, they too aren’t doing too well in the current environment:

Fannie Mae, the biggest source of money for U.S. home loans, said its third-quarter loss more than doubled to $1.39 billion as a deepening housing slump increased mortgage delinquencies.

The net loss was caused by a $2.24 billion decline in the value of derivative contracts and $1.2 billion in credit losses among the $2.7 trillion of mortgage assets Fannie Mae owns or guarantees, the Washington-based company said today in a U.S. Securities and Exchange Commission filing.

Fannie Mae has a minimum capital requirement of $30-billion and maintains a 30% surplus over this figure. So say they’ve got twice the capital of Royal Bank (Fannie Mae is far more highly leveraged, due to the inadequacies of the legislation) … can you imagine the consternation if Royal Bank lost $700-million in a quarter?

A relatively calm day for preferreds, with good volume.

There were eighteen other index-included $25.00-equivalent issues trading over 10,000 shares today.

This entry was posted on Friday, November 9th, 2007 at 11:23 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.