PrefBlog

Today’s phrase is “Minsky Moment” and today’s question is “Have we arrived at one?”.

Prof. Charles W. Calomiris of Columbia explains a “Minsky Moment” with:

The late Hyman Minsky developed theories of financial crises as macroeconomic events. The economic logic he focused on starts with unrealistically high asset prices and buildups of leverage based on momentum effects, myopic expectations and widespread overleveraging of consumers and firms. When asset prices collapse, the negative wealth effect on aggregate demand is amplified by a “financial accelerator”; that is, collapsing credit feeds and feeds on falling aggregate demand credit. A severe economic decline is the outcome. Many bloggers refer to this as a “Minsky moment” (see Minsky 1975 for the real thing.)

… in other words, a self-feeding collapse of the economy.

In an paper posted at VoxEU which summarizes his Not (yet) a Minsky Moment paper published by the American Enterprise Institute, he says (as one may surmise by the title) that we’re not there yet and provides eight reasons. Naked Capitalism takes violent exception to this view … so, let’s have a look at the reasons.

Calomiris: Housing prices may not be falling by as much as some economists say they are.

Smith: Real estate industry participants who have an incentive to say things are fine are instead saying they are terrible.

This is simply the old story: forecasts vs. experience. Neither player is particularly convincing.

Calomiris:Although the inventory of homes for sale has risen, housing construction activity has fallen substantially.

Smith: Per these charts, overhang is much worse than in 1988-1989, and rental vacancies are considerably higher as well. So you can’t take too much comfort from the fall off in housing starts.

I’ll award that point to Smith. Calomiris (both in the summary and the full paper) simply states that the trend in housing starts is in the proper direction; he performs no analysis of how long it will take to work of the excess inventory he acknowledges exists.

However, I would like to see more work done to relate the overhang to affordability. The latest NAHB Housing Affordability Index (MS-Excel File) shows a nationwide value of 43.1%. According to the NAHB:

“The latest HOI indicates that 43.1 percent of new and existing homes that were sold in the United States during this year’s second quarter were affordable to families earning the national median income,” said NAHB President Brian Catalde, a home builder from El Segundo, Calif.

… which is good enough, but I’m looking for something more like RBC’s Affordability Analysis, which indicates the percentage of household income taken up by ownership costs. Even this isn’t really good enough because what we are really interested in is the potential take-up of housing by those who don’t currently own houses. There must be somebody, somewhere, who’s devoted his life to the analysis of the work-out of housing inventory overhangs! Let’s find out who he is and talk to him … but I bet he’s a pretty popular guy at the moment.

Calomiris: The shock to the availability of credit has been concentrated primarily in securitisations rather than in credit markets defined more broadly (for example, in asset-backed commercial paper but not generally in the commercial paper market).

Smith Securitization has been taking market share from traditional credit intermediation (bank lending) for the last 30 years. Corporate lending, commercial and residential real estate loans, auto and credit card receivables and LBO loans are all securitized to a considerble degree. Residential real estate now depends on securitization; if there is no rebound in securitization, we will see a heap of trouble. That’s why policymakers are so keen to revive it.

Point to Calomiris. He is arguing that there is still credit around – albeit at a higher price – and (with the exception of Northern Rock) there are plenty of buyers around for commercial paper, provided the seller is willing to discount the price. Smith does not address the point raised.

Calomiris: Aggregate financial market indicators improved substantially in September and subsequently.

Smith: Events subsequent to the writing of his paper prove make this view inaccurate. The S&P 500 is on the verge of giving up its gains for the year. Bloomberg today reports that Treasuries are enjoying their longest rally in 5 years as investors seek safety.

Point to Calomiris. The fact that the S&P 500 “is on the verge of giving up its gains for the year” isn’t the most terrible thing that could happen, and hardly supports the idea that we have entered a self-feeding collapse. The point about Treasuries is stronger, but while spreads have widened, yields on mid-term bank & finance paper have more or less stayed the same.

Calomiris: nonfinancial firms are highly liquid and not overleveraged. Thus, many firms have the capacity to invest using their own resources, even if bank credit supply were to contract.

Smith: I’m not sure what his sample is. Average ratings of corporate issuers have declined, with nearly half the bonds now junk rated.

Point to Calomiris. He disclosed his sample, Federal Reserve Statistical Release Z.1, Table B.102, and Smith’s other points are irrelevant. They may be a cause for concern about the stability of the financial system, but they do not indicate that we are now in the midst of a collapse.

Calomiris: households’ wealth is at an all-time high and continues to grow. So long as employment remains strong, consumption may continue to grow despite housing sector problems.

Smith:  It won’t be for very long if housing continues on the trajectory that most anticipate, and will decline even more if the stock market follows.

Easy point to Calomiris (I should even consider giving him a bonus point). Smith is mistaking the existence of gloomy forecasts for evidence of horrible current conditions.

Calomiris: Of central importance is the healthy condition of banks.

Smith: Many are believed to be otherwise. Financial stocks hare dropped sharply this year, and large banks are now paying as much as 6% in dividends when Treasuries yield a mere 4%.

Point to Calomiris. Market prices – Smith’s idol – are down, but Tier 1 capital ratios are not showing evidence of disaster. Tough times are not a disaster. Citigroup is getting hammered – the stock is down 40% over the past year – but what’s really going on?

Deutsche Bank AG analyst Michael Mayo wrote in a report yesterday that Citigroup shares may fall to $29. He reiterated his “sell” rating and said the company may be prevented by regulators from making acquisitions because “recent risk management mishaps seem to violate” terms of an earlier agreement.

“It looks to us that recent problems with CDOs and their lack of disclosure reflect a serious risk management breakdown,” Mayo said. At $29, Citigroup would trade at eight times estimated earnings for 2008, he said.

‘Sell the stock!’ cries Mayo, ‘The earnings yield’s less than 12%!’ There may be no growth, and there may be more risks than were previously deemed to be the case, but Citigroup is still making lots of money. Dividends won’t grow much over the next few years as they rebuild their balance sheet … but this is not the end of the world. It’s a pause.

Calomiris: Banks hold much more diversified portfolios today than they used to. They are less exposed to real estate risk than in the 1980s, and much less exposed to local real estate risk, although US banks’ exposure to residential real estate has been rising since 2000

Smith: Not directly addressed.

Full point by default to Calomiris.

So I score the match 6-1 to Calomiris, with one point considered lost by both. And what’s more, I agree with him – which may, of course, have influenced my scoring. Times are tough. There’s a big indigestible mass of dubious debt on the books all over the place, but – as far as I can see – the financial system is not melting down and we are not in a depression. I’ll simply repeat what I’ve been saying for the past several months: Times are tough. Firms that have been living on the edge may find they fall off. There may even be a spectacular blow-up or two, if a financial institution finds out its risk controls aren’t what they might have wished them to be. And I most certainly would not want to be earning my living as a casual labourer in the US housing industry. But it’s a pause, nothing more.

There has been some news of interest to the carrion feeders: remember CPDOs? One of them is liquidating after a mark-to-market breached the terms of the deal. That’s the trouble with these things – it’s a great strategy, as long as there aren’t any margin calls or mark-to-markets. Moody’s assigned them a Aaa long term rating on July 6, 2007, put them under review for possible downgrade on August 21, and now they’ve defaulted. I hope UBS took its management fee in advance!

Highly leveraged muck – but, of course, when they work, they really work well. The problem with the market is, as always, stockbrokers: they’ll buy anything so long as somebody with a deep voice tells them it’s good. I cannot begin to tell you how much stuff I’ve been offered over the years that (so the salesmen say) may certainly be placed in a fixed income portfolio, but has a payoff based on something that won’t behave like a bond in the slightest. Somehow it sells. 

It’s a lot like buying an GIC from a bank with the return linked to the stock market and pretending to yourself that, because it’s a GIC, it’s really a fixed income instrument. It may be good, it may be bad – but it sure as hell ain’t a bond!

And another CDO is liquidating as the senior note-holders have decided they want their money back. I’ve had a look at the prospectus … I would like to say I can’t understand why anybody would invest in such a thing, but unfortunately, I know only too well. You can offer nice interest if you lever up to hell and gone.

The saga of Canadian ABCP continues, with Alberta Treasury Branches disclosing their write-down. They have assets of $22.5-billion, of which $1.2-billion is in ABCP and they’re taking a hit of 6.6%.

“ATB Financial has year-to-date earnings of $73 million despite absorbing a $79.6-million ABCP provision,” CEO Dave Mowat said in a release.

In more cheery news, there is a school of thought that predicts a takeover of E-Trade:

Ameritrade has an advantage as a potential buyer because it’s 40 percent owned by Toronto-Dominion Bank, Canada’s third- largest bank, Repetto said. “The bank has deep pockets and it has the ability to deal with some of the issues at E*Trade,” he said.

Exactly the kind of thing the bank should be doing … as long as they’re willing to walk away without a deal after starting negotiations.

Bond insurers, which I have discussed yesterday, took heart from the recent French bail-out and were up a lot on the day.

Still, on the lighter side, remember Flaherty and his Big Plans to Help Canadian Consumers? He was told about one of the problems at the time:

Diane Brisebois, of the Retail Council of Canada, said Flaherty should help retailers by cutting duties collected at the border.

“If you bring in sneakers from China, for example, retailers in Canada pay 18 per cent taxes. Retailers in the U.S. pay absolutely nothing,” she said.

So I thought of him today when I read this amusing snippet:

So how did the Buffalo-area mall prepare for the post-Thanksgiving shopping madness?

For one thing, Goodwill collection bins were situated at three entrances for all the clothes and shoes the crowds from the north have been ditching in restrooms and parking lots. Many shoppers have been wearing their new clothes home to avoid paying hefty taxes and duty at the border.

Good volume again in the pref market; Floaters got beat up again. It could be simply a credit thing on BAM; it could be that people are selling other BAM names to buy the perpetuals (and the derivative split share!); it could be that people are just getting out of floaters and picking on BAM to sell for other reasons. Who knows?

I continue to be utterly amazed by the yield on BNA.PR.C, which had yet another rough ride today, down 0.9444% to close at 17.83 bid, yield 8.39% to maturity. 8.39%! Basically, 11.75% interest equivalent!

I confess, I thought for a fleeting moment today that it might be inventory overhang from a barely successful underwriting … but that doesn’t seem to fit the data. They started trading January 10 and hung around at the $25.00 level until early May, when they – quite reasonably – got caught up in the downdraft. Markets were strong in the first part of the year – if the dealers had been left holding the baby, surely they would have, and could have, blown it out the door at $24.00 in, say, March.

The fund has a position in this issue and I’m getting killed on it. But how can it possibly be fairly valued at 160bp over the similar-and-parri-passu BNA.PR.B? On the bright side, looking at the price chart is highly entertaining … I’ve found a new illustration for the word “parabola”.

Such is the life of a preferred share investor …

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

This entry was posted on Friday, November 23rd, 2007 at 10:20 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.