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9 Responses to “March 20, 2008”

1. prefhound says:

   March 20, 2008 at 11:27 pm

   OK, I have to protest S&P claiming the most volatile year in 70 years based on the percentage of days>1% in less than three months, when presumably the other years were compared on the basis of 12 months percentage of volatile days.

   The markets have been way more volatile for 3-month periods in the past few decades than they are now. Just look at the historical record of the S&P-500 volatility index (Vix), which was much higher in 1987 (crash), 1993, 1998 and 2001-02. However, in these other years, the volatile period ocurred later in the year and would have been diluted by lower volatility earlier in the year.

   I hate seeing alarmist bumpff coming from a supposedly serious market analyst like S&P. Yes, it is volatile (probably juiced by hedge funds, the death of the up-tick shorting rule, and the elimination of 1987 crash-inspired circuit breakers less than a year ago).

   Secondly, I tend to agree, based on “hunches” rather than evidence or deep analysis, that hedge fund deleveraging is forcing them to sell off commodities. I’d love to see both these dominoes fall and good luck to the brokers that take them on at high leverage — they could be the next Bear Stearns.

   In a forced deleveraging vein, I noticed today that TD Waterhouse is prohibiting short sales in Bear Stearns and not giving any margin value for long positions “due to recent volatility”. The credit crunch is coming to Wall Street and Main Street, and will likely get worse until banks staunch their losses and need the customers again. For now, fewer customers with higher profits (Spreads) suits them just fine.

   Lastly, I wonder if Freddie Mac and Fannie Mae will be allowed to maintain their newly relaxed lending rules permanently. When credit markets return to normal, and short-termism has evaporated, leaving these behemoths incented to make lots of loans to just about anybody in vast quantities will just crank up the systematic risk (not to mention executive bonuses). I would argue for a time limit on relaxed rules for the GSEs, but there are no votes in that…..

2. jiHymas says:

   March 21, 2008 at 2:02 am

   S&P Volatility: I agree, the comparison of a three-month period to full years is more than just a little suspect. Maybe I shouldn’t even have included the observation, but I’m looking at CDS spreads – not just on CIT, on everything, that’s what brought down Sitka / Apex, inter alia – and I’m desperate for any scrap of rationale on offer.

   TDW / BSC margining: Huh. I wonder how often they do that sort of thing?

   GSEs: I agree, the relaxation of GSE capital requirements should have been accompanied by a schedule that would get things back to not just normal, but sanity … and by sanity I mean regulate ’em as the banks they are! There’s no necessity to make such a schedule too stringent – and a doctrinaire approach would probably backfire – but something like … relaxed for 2008, after that you calculate your risk-weighted assets using standard rules and the capital requirement goes up by, say, 0.25% per year until parity with banks is reached. And then give the OFHEO director discretion to pause the schedule a year at time, up to five times. I’d go for that.

3. prefhound says:

   March 22, 2008 at 9:48 am

   #3: Now that we are in resounding agreement, we can share despair about what is likely to happen with GSEs.

   #2: TDW also had the same rules for Air Canada when it was trading around $2 before heading into bankruptcy. It does happen from time to time, but BSC is (supposedly) not heading into bankruptcy.

   Also, to be fair, options are volatile and their is no margin value to long options, but there are straightforward rules for option shorting (though crucially, the short option does not need to be borrowed, but is just created out of thin air). These days, BSC common is closer to an option (but with limited numbers).

   #1: CDS spreads are the metric du jour, but haven’t been around that long (and are not so available to us normal investors who can’t afford Bloomberg). My history of spreads is from the Federal Reserve (Baa – Aaa – Treasury averages) and they have behaved similarly to today in most recessions. Of course, an average that widens by 100 bp contains some individual bonds that have done much worse. Sometimes I look at junk bond spreads, or just the level of a junk bond ETF (HYG most recently), and they have widened maybe only 200 bp on average in a year, when recessions open them up 400-600+ bp.

   Btw, I saw ^IRX (short term funds) fell as low as 20 bp last week — one of your notes discussed 40. I’m wondering who wants to buy 10-year treasuries at 3.3% — which might not cover inflation…..

4. jiHymas says:

   March 22, 2008 at 10:37 am

   There’s some alarmng commentary about writedowns coming for the GSEs:

   The fair value of Fannie’s exposure to mortgage insurers alone, for example — estimated by the GSE at $4.6 billion in the fourth quarter — is itself more than half of the excess capital now available to it.

   Yet it’s the more immediate mark-to-market activity in each GSE’s retained portfolio that could prove most problematic. It shouldn’t be hard for regular HW readers to fathom why, if you’ve been reading our front-page coverage recently.

   UBS analysts estimated that, net of write-downs already on the books for Q4, Freddie Mac could face as much as $30 billion in write-downs in the first quarter of 2008. Likewise, Fannie Mae faces a possible $15.5 billion in write-downs, based on UBS’ pricing estimates.

   It should be noted that whether such substantial expected write downs would actually impact regulatory capital would depend on whether a given security is likely to take a principal loss. And both GSEs are heavily hedged against such losses, as well. But the fact that those losses are there at all likely means neither will be rushing out to buy up non-agency paper, UBS said.

5. madequota says:

   March 24, 2008 at 12:24 pm

   ph . . . good analysis guys . . . I have a question: what was the “uptick shorting rule?” . . . obviously, I don’t short as a standard practice . . . many tks, madequota

6. jiHymas says:

   March 24, 2008 at 12:47 pm

   The “uptick shorting” rule was rule 80A of the NYSE. As described by the SEC:

   Currently, NYSE Rule 80A(a) and (b) require that, for any component stock of the S&P 500 Stock Price IndexSM, whenever the NYSE Composite Index® (“NYA”)5 advances or declines by a predetermined value from its previous day’s closing value, all index arbitrage orders to buy or sell (depending on the direction of the move in the NYA) must be entered as either “buy minus” or “sell plus.” [see footnote] The tick restrictions are imposed based upon a “two-percent value” change in the NYA from its prior day’s closing value, where the “two-percent change” is two percent of the average closing value of the NYA for the last month of the previous calendar quarter, rounded down to the nearest ten points. The order entry conditions are lifted if the NYA recovers to within one percent of the previous day’s closing value, and can be reimposed if the average moves away by two percent again during a trading session.

   [Footnote] NYSE Rule 13 defines a “buy minus” order as an order to buy a stated amount of stock provided that the price to be obtained is not higher than the last sale if the last sale was a “minus” or “zero minus” tick, and is not higher than the last sale minus the minimum fractional change in the stock if the last sale was a “plus” or “zero plus” tick. A “sell plus” order is defined as an order to sell a stated amount of a stock provided that the price to be obtained is not lower than the last sale if the last sale was a “plus” or “zero plus” tick, and is not lower than the last sale plus the minimum fractional change in the stock if the last sale was a “minus” or “zero minus” tick.

   The rule was eliminated effective Nov. 2, 2007. There is some controversy regarding whether repeal has made the market more volatile.

7. PrefBlog » Blog Archive » March 24, 2008 says:

   March 24, 2008 at 9:04 pm

   […] agree with his first point – as I said most recently in the comments to March 20, a slight relaxation in the GSE capital requirements may be justifiable, but should be accompanied […]

8. PrefBlog » Blog Archive » BoE Research: Decomposing Corporate Bond Spreads says:

   May 6, 2008 at 1:57 pm

   […] probabilities, which is similar to the Bank of Canada CDS Pricing research mentioned briefly on March 20. Further, the intrinsic default risk is differentiated from the premium demanded due to uncertainty […]

9. PrefBlog » Blog Archive » How Much Do Banks Use Credit Derivatives to Hedge Loans? says:

   August 24, 2009 at 7:16 pm

   […] in light of the CIT affair. When CIT drew down its credit lines – as reported on PrefBlog on March 20, 2008, CDS spreads spiked up to 27% up front and 500bp p.a. instantly – I recall, but cannot substantiate […]