I'm not sure what's "complex." It is likely that as more claims are made, they will have unsufficient capital to meet their obligations. This would make them insolvent. It's not complex, just very very unpleasent.
ISI out this a.m. saying that there's no way the gov't can bailout the ABK's of the world, that such a move would have to be voted on by Congress, i.e. the Treasury Dept. can't just snap their collective fingers and 'solve' the problem.
Also, ISI says Dodd's plan to buy bum mortgages is never going to happen. Same reason: way too much legislative headwind to get that done. Plus, is $10B to $20B in bum mortgage bond purchases really going to help much of anything in the grand scheme of this mess?
Again, the banks are in a similar position who has caused an accident. If it's a minor fender bender, it's probably worth paying for the other party's repairs out of pocket so that one's rates don't go up and you continue with the same insurance. The banks are in a position of deciding whether to backstop the insurers so that they can continue to get insurance from them. They have to decide whether the current credit crunch is a minor fender bender or a major accident. Can the insurers be saved, and is it worth saving them?
"Mr. Dinallo, I'm Bart Sminsky from XyZ Bank and I have been asked to attend this meeting"
"Welcome Mr. Sminsky take a seat at the table if you please and what Department are you with?
"I cover all Departments, Mr. Dinallo, they all need their mail, everyday"
I love to read this blog, but I'm not in finance. That said - it seems that the banks are being asked to put up money to bail out the insurers that were supposed to pay the banks if the bonds went south ... am I thinking about this right?
This seems to be a real cat's cradle. The Muni business doesn't seem to be in real trouble at this point (at least pre-recession). Does the loss of AAA rating by the monolines look to have a disastrous effect on the muni's - they're not held by pension funds with a rating requirement. There may be some Mutual Funds or Banks, but is that a significant piece. The real problem, as I understand is the guarantees of CDO's or other structured finance. And the potential victims are the Banks and IB's. While the loss of the rating speeds up the recognition of the problem, the basic problem is lack of capital to pay the losses. Forming a bailout have the banks fund the capital to pay themselves claims for their CDO losses, seems to be a hide-the-baloney Japanese solution. With all due respect, the MLEC did serve a purpose in putting off the day of reckoning and giving the IB's and hedgies numerous pop opportunities to distribute their losses to the rest of us.
Am I missing something as to the direness of the monoline crisis?
So let me get this straight. The banks give them about 15 billion to keep their ratings, but the garbage they insured will still get downgraded and losses will arise, so banks should give them money to maybe have enough capital to weather the upcomming storm of resets?
Sounds like a plan.
In other news, the governments new plan will work to save the ecomnomy.
A bailout from the taxpayers for any large corporate scam or misfeasance.
Let's see, what is that form of government called that believes in corporate survival at all cost over individual rights? After all if the large corps go bankrupt the "terrists" win.
This is a classic zero-sum game, and some bond insurers are in worse shape than others. So, if your exposure is to an insurance company that is bad off, you want an umbrella bailout. But if your exposure is to one that's in better shape, you want to see capital injected in that company.
There's no way to get all the counterparties on the same page. Plus, Ambac falls under Wisconsin jurisdiction, not NY.
Yesterday was just a media event, and it worked. Now, for the encore...
"And indeed there will be time\t
To wonder, Do I dare? and, Do I dare?\t
Time to turn back and descend the stair,\t
With a bald spot in the middle of my hair\t
[They will say: How his hair is growing thin!]\t
My morning coat, my collar mounting firmly to the chin,\t
My necktie rich and modest, but asserted by a simple pin\t
[They will say: But how his arms and legs are thin!]\t
Do I dare\t
Disturb the universe?\t
In a minute there is time\t
For decisions and revisions which a minute will reverse."
It's only a zero sum game if the Fed does not play along. With interest rates falling, future losses can be slowed or avoided all together if people can refinance out of ARMs into 5.25% fixed rate mortgages.
So the banks can prop up the insurers now while hoping the liability of the insurers keeps decreasing with low refinance rates and high inflation.
Am I missing something as to the direness of the monoline crisis?
mbartv
You're missing the fact that all insured bonds have a right to protection, not just those that are currently distressed.
Regulators don't know that a muni revenue bond crisis won't be the next shoe to drop. It probably will be.
Other failing insurance companies have had to work through similar problems. One side of their business goes bust, affecting one class of policyholders. Consistently, regulators have had to take over these companies in order to play the same role as a bankrupcty referee and create a fair playing field for all policyholders.
The only reason regulators haven't moved faster here is they're afraid of wrecking the economy.
Oh man that would be sweet. Bankster Zombies with CDS's (Compact Dousing Sewers) spraying toxic waste. Boss fights with COO's and CFO's and CEO's with MBS's (Mega Bull Shot). Structure collapsing all around.
Sounds sweet, where can I download it? Is there a wardrobe mod? Kevlar 3-piece suits?
And then - how is this for an argument to use Federal money to bailout the bond insurers:
If the bond insurers fail, the stock market will tank out of proportion to the mortgage default losses. Just say you have 250 Billion in mortgage losses out there... but if the stock market tanks, the federal government will likely see what, a trillion or two dollars worth of stock losses claimed on income tax returns due to broad based stock losses?
I am just guessing on the trillion, but if people claim large stock losses on their 2008 income tax the federal government revenue takes a big hit... maybe bigger than a monoline bailout.
To address the mortgage crisis, the package also allows Fannie Mae and Freddie Mac government-sponsored companies that are the two biggest U.S. financers and guarantors of home loans to buy home mortgages much larger than the current $417,000 limit. Rep. Barney Frank, D-Mass., and chairman of the House Financial Services Committee, said that lending cap might reach as high as $700,000 in areas with the highest home prices.
The people who don't have much time are the bond insurer shareholders. As rich has said, these companies are going into runoff mode and the regulators will decide how and when claims get paid.
The only thing that makes sense to me is to figure out a way to get the munis reinsured by Buffet ASAP so that we don't have a pension fund crisis, then the CDOs can fight with the state regulators over the scraps.
"The only thing that makes sense to me is to figure out a way to get the munis reinsured by Buffet ASAP so that we don't have a pension fund crisis, then the CDOs can fight with the state regulators over the scraps."
Made the same mistake yesterday. The pensions have CDO's and other crap in them, not munis. Go check out Calpers assets.
The NY regulator's plan of self-funding is every bit as much of a scam as was the self-funded M-LEC Super SIV. You cannot finance your own protection plan which is largely designed to strictly provide protection to yourself and hope to maintain an ounce of integrity. Left pocket paying right pocket. Gimme a break.
My guess is that "zero sum" micharacterizes this situation. If these firms get the capital they need to keep their AAA ratings, then there are billions, on the way to trillions, in instruments that are less likely to change hands in quick fashion. That could make a huge difference.
I imagine old Eric sitting in his office, thinking about the implications for his state's governments. The municipalities will pay for more credit. The state and municipalities will find their budgets in a wreck because of declining earnings in the financial sector. Lots of lot jobs. So he says to himself, "why isn't anybody doing anything?" The next step is obvious. Eric does something. It doesn't mean he had anything available to him with good odds of working. Doing something, in this case, seems unlikely to hurt, and it might help. Why not try? Whatever happens, I think the guy deserves credit for stepping up.
Today's market action adds confirmation that one or more big quant long/short hedge funds unwound yesterday. This same pattern has happened twice before, and it could happen again, so take notice.
Suddenly, many crummy stocks rally while many quality stocks tank. Then, over the next few days, the arbs take over to bring it back to fair value.
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NEW YORK, Jan 24 (Reuters) - Fitch Ratings on Thursday cut its "AAA" ratings on bond insurer XL Capital Assurance Inc, part of Security Capital Assurance (SCA.N: Quote, Profile, Research), citing SCA's statement that it will not raise new capital at present due to market conditions."
Right now, ignorance of the true depth of the problem is working in the favor of the people who want to pass the bag on.
The problem with these bailout proposals is that it will educate more parties as to the depth of the problem.
As a result, fewer people are willing to taked the passed bag.
$5 billion now, $15 billion later...does it even come close? Not really. But they hope that once the parties have committed to some sum of money that they will be obligated for more.
ISI is a research shop run by Ed Hyman in NYC. He's been the #1 rated economist by Institutional Investor for the last 28 years.
Note that Ed has been pretty bullish on the US economy the last couple of years, believing in fact that we're headed for a mid-cycle slowdown and not a recession. I totally disagree with him on that. Nevertheless, I do pay attention to what he says about various stimulus packages and what the government can and cannot do to help the situation.
Today's market action adds confirmation that one or more big quant long/short hedge funds unwound yesterday. This same pattern has happened twice before, and it could happen again, so take notice.
Secondly he had an article on the overall point swing of yesterday's big negative-positive swing in the market based on a Paul Kerdrosky post. It was number 2 in total point swing (625.36), number 30 in market percentage (5.2%).
Insurers:
"Pay us some money so we can pay you some money to cover your losses."
Banks:
"Why should we do that? We can just take our losses directly"
Insurers:
"So we can make a profit on the transaction."
If the insurers go under then it isn't just the current losses the banks will have to cover. Everything else that was insured will lose value when the insurance disappears.
What is the market value of a beachfront house if the insurance disappears and it is hurricane season?
The banks want the taxpayer to bail out the insurers. They will wait and see if the government rides to their rescue.
What happened to "need to get this done in 48hours?" Whoops.
In the book Panic of 1907, the author lists as one feature of a mounting financial crisis is a series of failed fixes. We now have the M-lec failure, the teaser freezer failure, and this seems likely to be added to the list...
If this doesn't happen soon, and there are more downgrades, and the Fed sits pat next week, or only cuts another .25%, look out below...
If the insurers go under then it isn't just the current losses the banks will have to cover. Everything else that was insured will lose value when the insurance disappears.
If the insurers go under that just means we have to bail out the actual bond holders.
Maybe it's just a question of which requires less paperwork.
It's only a zero sum game if the Fed does not play along. With interest rates falling, future losses can be slowed or avoided all together if people can refinance out of ARMs into 5.25% fixed rate mortgages.
The only reason borrowers were able to get into these homes was because the teaser rate lowered their monthly payments. They couldn't afford the house otherwise. Plus, most of these houses are worth less then what they paid for. A.) If these people could afford a fixed rate, why would they opt for an ARM. B.) Who is going to give these folks a loan when what they owe is more then the house is worth? Not even Fannie or Freddie are able to do that.
Okay, I have several questions for my betters here:
1.) Who exactly are the payees on these policies. Are the purchasers on the bonds the beneficiears, or are the IBs issueing them the beneficiaries? If the Insurers go Tango Uniform are the banks still liable?
2.) Is the insurance prepaid for the duration of the bond, or is some kind of annual payment made from proceeds? Can the IBs change insurers? In either case, are they contracturally obligated to get new insurance if the insurer is defunct or is downgraded?
3.) To what extant are the bond insurers specialized? Are there some that mostly insure MBS's and others Munis? Or is the risk spread widely among them.
i think what ur seeing in the gold mkts today reflect the increasing realization that UST's are NOT going to provide u with any real return. in fact, negative return. hence ur seeing a shift in bond mkt money into the only true money, gold and gold stocks.
This is in regard to the investment holdings of regular insurers, not to regulation of the bond insurers themselves. It's not just pension funds, but insurers that can't have too much crap on their books. Basically, its saying that if there is an "S&P Underlying Rating" (i.e., w/o the ACA guaranty) of the bond, they report that rating. There is a procedure for other situations, but basically, as I'm reading it the upgrades from the bond insurance are to be ignored.
It's only a zero sum game if the Fed does not play along. With interest rates falling, future losses can be slowed or avoided all together if people can refinance out of ARMs into 5.25% fixed rate mortgages.
The problem, again, is that is both desirable and easy for many people to simply default.
I talked to someone currently behind on their payments and they were actually elated at the prospect of walking away from their current home and renting in the same neighborhood at far less than their mortgage payment. Even much lower interest rates don't erase negative equity and large payments on an artificially bloated principal. Default does.
"If the insurers go under then it isn't just the current losses the banks will have to cover. Everything else that was insured will lose value when the insurance disappears."
According to today's nyt's...
On Wednesday, for instance, some short-term insured municipal bonds, which typically trade at a premium to other bonds, were trading at a discount of as much as 1.5 percentage points to similar uninsured bonds, said Michael S. Downing, an account manager at Thomson Financial.
its also looking like the stock mkt is increasingly relying upon economic stimuli, rate cuts, to levitate on a daily basis. i've been busy day trading this morning and i see real weakness despite the major indices being green. my feeling is their is continual distribution going on from big to little guys.
In other words....the value of the insurance is now Negative!!!!
Therefore, on the muni side, there is no urgency. It's done. They won't be able to collect new premiums based on the market, not ratings or regulators.
I've been watching my portfolio wink from red to green all day and had just begun to note the emerging pattern when you posted on revaluations.
I suppose this means I'm not only in the same church, but also sharing a pew with a few quants and hedgies. That inspires an odd mixture of confidence and loathing.
The black box quants weren't programmed for a 75 bs pt. emergency fed cut because it hasn't happened before. They got fried yesterday, just like we did.
They have to unwind because billions have been lost and they have risk parameters. But for us, a week from now, it will be like a passing storm.
As theroxylander wrote yesterday: "Overall it means money are just leaving the market and at some time later that will show up as another step down."
ac - I agree that someone whose 'credit is shot' and who is way, way underwater on their home isn't going to want to refinance or be able to refinance. But, according to the charts CR posted of how many people are underwater, and by how much the low rates will help some people refi into a stable situation.
Someone who is underwater by a few % may still be able to refinance depending on which valuation model is used to value their home. Valuations are probaby still higher than the market, good for some people I suppose.
Also - there are many people who don't want to move just because they are somewhat underwater, maybe they are optimistic about a rebound in prices, maybe they don't want to admit failure or maybe their kids are happy in their current school. The refinancing opportunity will help some of these people - not to mention just the lower rates on the resets than would have otherwise been.
We eagerly await word on what effect January had on hedge fund returns:
-all those long-short funds long "the four horsemen", agriculture, commdities and emerging markets; and short financials.
-the quant funds for whom the 30th widest trading day range in history spelled disaster -- a six sigma event.
Here's the question: hedge funds managed to grow from about $300b in 2000 to $1.8tr today. What will the number be two years from now?
I say $500b.
That single delta -- from 1.8 to .5, is what will drive the real economy for the next two years. Everything else will follow in an extreme form of "reflexivity" (the concept that the markets create rather than just observe reality).
Federal Reserve Chairman Ben S. Bernanke and U.S. Treasury Secretary Henry Paulson are guilty of ``Zimbabwe economics'' by failing to step in to support the dollar, said Forbes Inc.'s Chief Executive Officer Steve Forbes.
That sounds about right.
There's a danger that the US could become seen as an increasingly unstable and unattractive destination for investment capital.
Given that this country is no longer the only viable free market destination, that could turn out to be a much more serious liability than a strong dollar.
its also looking like the stock mkt is increasingly relying upon economic stimuli, rate cuts, to levitate on a daily basis.
what took the market up above 10K, corporate stock buybacks and LBO noise, what took the market up to 10K, MEW.... see ya @ 8500..sooner then you think
There's a danger that the US could become seen as an increasingly unstable and unattractive destination for investment capital.
take a look at a long term chart of the Nikkei and compare it to the dow, what you will see is that in the early 90's money started to move out of Japan into the American markets. Japan in 1989 was the center of the world financial markets.
Good chance the same end awaits us.
everyone buy an Ipod with the rebate... I can see Jobs startin the ad campaign today !
Saw a newspaper ad yesterday from a meat market (the kind that will sell you a whole side of beef -- 2.09/lb, by the way) saying to Invest Your Tax Refund! with a purchase at their store. (Although putting a side of beef in the freezer might not be too bad of an inflation hedge.)
IN our little city, a bond issue is put together, and bids on insurance are sought from the monolines. Our city's underlying rating is A1 or something like that...not positive...in any event it is investment grade but not AAA.
The insurance (from an AAA insurer) makes the city's bonds AAA, which reduces the interest rate the city needs to pay to the investors who buy the bonds.
So when those bids come in, the city takes the lowest bid and does the math: Does the savings on interest make up for the cost of the premium?
If the answer is yes, they buy the insurance. (Sometimes the answer has been no.)
In any event, the bonds are then issued, the city gets the money, and the insurance is covering the bondholders for the life of the bond. They accept a lower rate of return because they have the added security of that AAA insurance.
If the insurer is downgraded, it's no skin off the city's nose. The bondholder is no doubt disgruntled, especially if that bondholder wanted/needed to sell the bond in the market rather than just hold it to maturity. Its market price would now be lower because its rating is lower, even tho still pretty good. (For those who were planning on holding the bond anyhow, and were satisfied with the interest rate, nothing is really going to happen.)
Going forward, if there are no monoline insurers to deal with, municipalities with good credit won't be out of the borrowing business, but their interest costs will be higher in some cases. (Our city officials tell me they expect this to be manageable.) Municipalities with suspect credit may have some problems, but they had problems before all this happened, didn't they? And they were (one would hope) paying a lot more money for the AAA insurance, so maybe the impact on them will be incremental as well.
It does make it harder for investors to gauge the security of a bond. I'm guessing that in the past, some people just said, "what the heck...it's insured" and bought the bond. Now somebody is going to have to look at the issuing municipality, its tax base etc. Either than or rely on the city's ratings from Moody's and the gang.
"The black box quants weren't programmed for a 75 bs pt. emergency fed cut because it hasn't happened before. They got fried yesterday, just like we did."
While I always listen to well formed arguments which are contrary to my opinion, its hard to read stuff which is just flat out made up. How anyone can claim to have any idea of what the net black box position is in the stock market or any individual position is beyond me. For several years I ran a black box futures model in the quant division of a big fund along side people who were doing long/short equity, bond arb, forex etc. They knew about as much of my positions as I knew of their and that number was zero.
There is so much real time data out there that is useful for forming opinions, it seems a shame to float ideas that are complete fantasy and might persuade otherwise uninformed persons to make investment decisions based upon them.
It seems that this weeks turmoil in the markets is related to the unwind of the huge "rogue" trade by SocGen.
If this is true and the Fed responded with an emergency 75bips rate cut its more than disasterous. The markets will then keep throwing little tantrums and keep building up the tantrum scale and when there is a real need for the rate cuts there will not be any that will be meaningful.
This is not good news when folks realize that the Fed has become Wall Streets bitch! And it has now added a new job description of guaranteeing equity prices - it will fail in this mission.
This whole banks bailing out insurers who are bailing out banks business model seems based on the lyrics of 80s punk band Husker Du:
We are starting a cat ranch and taking one hundred thousand cats.
Each cat will have twelve kittens a year.
The catskins will sell for thirty cents each.
One hundred men could skin five thousand cats a day.
We could be dealing a profit of over ten thousand dollars.
But what should we feed the cats?
We will start a rat ranch next door with a million rats.
The rats will be twelve times faster than the cats.
So we can have more rats to feed each day for each cat.
But what should we feed the rats?
We will feed the rats the carcases of the cats.
After they have been skinned.
Now get this!
We feed the rats to the cats and the cats to the rats
And get the catskins for nothing
I still hold the view that Bernanke & Co. were not and are not attempting to prevent an unwind here, but doing what they are able to prevent its becoming disorderly.
Does jerome's faux pas influence fed to hold rates constant at next meeting?
("Well we see now you got your early birthday present, and now it's your birthday today and you really ARE NOT getting another present")
It seems that this weeks turmoil in the markets is related to the unwind of the huge "rogue" trade by SocGen.
We don't know if the SocGen's unwind caused global markets to plunge - yet. Is $50B in bad positions enough to destabilize several trillion dollar markets, all on the same day? Doesn't seem like it to me, but the question is a bit above my pay grade.
The Fed definitely panicked, either way, and that we will all regret for years.
david in ct
i do not contest the first part of your statement-eg the net position of quant funds is unknown and possibly unknowable. Still, wound not some of these be dramatically affected by dramatic swings? and if a few blow would that cause further dislocations and turmoil?
This is just . . . disgraceful? Embarrassing? Criminal? I don't even know what to say.
"It also raises the disturbing question of whether the Federal Reserve was spooked into making an emergency rate cut on the back of what was just technical selling. The Fed by its own admission met Monday night - after the overseas selling was clear."
King Peasant, the best Eliot reference to date was when Tanta asked Sebastian whether the corpse he planted in his garden had begun to sprout (Sebastian was widely believed to be holding NEW shares at the time of implosion).
Misean: Good point, the division between crap and munis is not that clear. But I don't think there is much that can be done about pension funds holding actual crap. The policies on the decent bonds will need to be transferred to a solvent insurer at some point, and they should do it relatively soon if they want to prevent a market dislocation based purely on ratings disruption for pension funds, insurers, and any other regulated bond holders.
david: yeah, I guess RTH was going up while everything else was going down because 2008 looks so great for retailers right now, compared to pharma, etc.
david in ct
i do not contest the first part of your statement-eg the net position of quant funds is unknown and possibly unknowable. Still, wound not some of these be dramatically affected by dramatic swings? and if a few blow would that cause further dislocations and turmoil?
kratovil | 01.24.08 - 1:33 pm | #
About the only thing that I would venture to say about long short equity is that volatility is generally a good thing. Whatever the form of the model, be it pure price/volume driven, 'fundamentally driven', or more along the lines of 'classic' stat arb, where one takes a bunch of variables and creates some multifactor regression model and then trades outliers to the model, they all seem to do better in high vol environments.
The problem can be thought of as creating a calculation that gives you fair relative value at any point in time. To the extent that your model is good, price will revert to 'fair value' over time. The greater the volatility usually the more opportunities.
I don't doubt that if a big long/short fund was liquidated it would have some effect on the stocks that they were liquidating. Without know the fund and the particulars I have no idea as to how one would look at market action and ascribe the moves to this phenomena.
david: yeah, I guess RTH was going up while everything else was going down because 2008 looks so great for retailers right now, compared to pharma, etc.
albrt
birds fly for a lot of reasons, professional golfers hit balls OB for a lot of reasons. in this more than any other game there is just a lot of stuff you can never know. accepting it is good thing.
They might have time. The actual claims won't show up for months or years, correct?
As long as the ratings agencies can be convinced to delay their downgrades (on the theory that a "fix" is coming), there really isn't any rush, is there?
Saw a newspaper ad yesterday from a meat market (the kind that will sell you a whole side of beef -- 2.09/lb, by the way) saying to Invest Your Tax Refund! with a purchase at their store. (Although putting a side of beef in the freezer might not be too bad of an inflation hedge.)
How anyone can claim to have any idea of what the net black box position is in the stock market or any individual position is beyond me.
david_in_ct,
I think you are wrong. It is widely accepted that all long/short equity funds taken together as a basket are net long. We know that 130/30 strategies are widespread. We also know that there is a great variety of funds and that the industry cares about monthly performance and that there is lots of pressure from all sides.
On top of that, we have seen the same symptoms in August, only to find out that, yes, long/short equity funds had blown up.
One more bit on long/short.
To the extent that there is a long period of time where long/short underperforms straight equities, this will be bullish for the general equity market. If you have a long short/fund which is $1 long / $1 short for each dollar invested, then for all the cash put in them there is zero net equity buying. Should the returns suffer over time, it stands to reason that money will flow out of these strategies and into those which have more directional exposure which in the scheme of things is almost always long.
Again you are potentially wrong. I used to think the same thing as you but I now learned something from the housing bubble: Assets serve as collateral for debt, overvalued assets mean that we can leverage more. And less-then-normal volatility means that a hedge fund can lever more. Now that volatility is back, there cannot be as many assets out thee and if debt/equity ratios stay the same, margin calls and fund halts should lead to a total reduction in stock market assets, to that extent.
"I think you are wrong. It is widely accepted that all long/short equity funds taken together as a basket are net long. We know that 130/30 strategies are widespread."
It is a matter of semantic to call the 100 long, part of long short, when all that is long/short is the 30.
In any event, even if I grant you that they are blowing up, how do you know which stocks are which?
If you also think that we have a good analogue to the august turmoil, why on earth would you be bearish?
1) the ones go up signal short covering, the ones that go down signal liquidation
2) we see some correlation in these groups. i.e. financials and retailers going up, other stuff more mixed but generally down as of yesterday mid-day.
3) hedge funds who run into trouble usually pile up into a similar trade, which seems logical, again, short financials long AAPL type stocks.
If you also think that we have a good analogue to the august turmoil, why on earth would you be bearish?
I don't understand the question. Are you talking about me, probert? Who told you I'm bearish?
Probert
I accept that I am always potentially wrong. Its part of life.
Most of my experience leads me to believe that the vast majority of leverage in the equity markets revolves around market neutral strategies. So to the extent that the world delevers i don't think it will have a negative effect on equities and quite possibly as to my prior post a positive.
In any event, I am stuck in my world of doing math and listening to the opinions of those that are opposite of mine. I tend to spend more time here when I am bullish, so I can potentially gauge the errors in my thinking. Its sort of awkward.
Most of my experience leads me to believe that the vast majority of leverage in the equity markets revolves around market neutral strategies.
david_in_ct,
That's an interesting thought.. what do you mean exactly by market neutral? 50/50 short long; long stock, short calls; short stock, short puts? All of that.. more?
I like this idea.. since I am not on the inside of these blackbox quant shops.. I'm stuck guessing about the result of deleveraging.
eli,
market neutral can be any of the things that you have pointed out. again, i have never been part of the marketing effort so i dont really know the stats on how much goes where, but surely the plain vanilla stuff predominates. an interesting factoid, is that nyse short interest is about 2x what it was in 7 years ago.
JIM A: "1.) Who exactly are the payees on these policies. Are the purchasers on the bonds the beneficiears, or are the IBs issueing them the beneficiaries? If the Insurers go Tango Uniform are the banks still liable?"
The beneficiaries are whoever that owns the bond. Investment banks are just intermediaries. The reason investment banks are posting losses is because they got stuck with some bonds that they planned to sell to investors but just never got around to them. Most of the losses on risky bonds (such as CDOs) are likely, in my opinion, going to be posted by hedge funds and other investors that you will never hear about (just like if I take a loss on an equity position, you won't hear about me taking a loss).
JIM A: "2.) Is the insurance prepaid for the duration of the bond, or is some kind of annual payment made from proceeds? Can the IBs change insurers? In either case, are they contracturally obligated to get new insurance if the insurer is defunct or is downgraded?"
No one has any obligation to get insurance. I forget the details but I believe municipal bonds are prepaid but things like CDOs are annual payments. Don't quote me on that because I'm not entirely sure. In some rare cases I believe the bond owners can change insurance (this is basically the same as cancelling the insurance contract). Generally though they are committed to the insurance contract. If bond owners were concerned, they will go and buy insurance on top of their existing insurance from another party. Some bondholders who need to maintain AAA on their muni bonds have done this. Even if you have two parties insuring it, the cost of insurance is very miniscule compared to potential losses. It's sort of like how insuring you house may cost $1000, but the cost of the house is $100,000. Even if you sign up with 3 insurers and pay $3000, the cost is very low compared to potential loss.
JIM A: "3.) To what extant are the bond insurers specialized? Are there some that mostly insure MBS's and others Munis? Or is the risk spread widely among them."
Risk profile is totally different between them. MBIA and Ambac are the two largest and are far larger than the rest. More than 50% of revenue for most bond insurers come from so-called muni bonds (muni also refers to public-private partnerships; quasi-private entities; etc). The rest come from so-called structured products like RMBs, CDOs, and other ABS products. Muni bonds are fairly safe but the structured products are what is causing problems.
MBIA has high exposure to RMBSes; Ambac has high exposure to CDOs; companies like Assured Guaranty are safe and haven't insured many risky stuff since 2005; companies like Radian and MGIC are mortgage-only insurers and have different characteristics from the rest; and so on. It's all different...
JIM A: "4.) Who holds the problem bonds?"
The problem bonds are mortgage backed products such as subprime RMBS
RUSS DOGG: "SOME OF THESE BOND INSURER EXECUTIVES SOLD THEIR OWN stock not long ago. Would someone in the GOVT pleaser remember to prosecute them and reclaim those assets? "
Since when was it illegal to sell stock that you own? Unless you think it was based on insider information, there is nothing wrong with any of that... just because you--or me--may have lost money on the stock doesn't mean anything.
The problem bonds are mortgage backed products such as subprime RMBS (residential mortgage backed security) products, CDO of ABS (where subprime RMBS is the ABS), and CDO-squareds (i.e. CDO of CDO of ABS). In the future, other ABS such as credit card debt, auto loans, student loans, etc may become a problem but they are not expected to cause anywhere near the damage of subprime RMBS.
I don't think anyone knows who holds the questionable bonds. I suspect most of it is held by banks, hedge funds and investors (which can include foreign investment funds, foreign investors, etc).
I suspect most of the losses will be borne by hedge funds and some investment funds. Note that not all the risky RMBS has insurance on them (insurance is also generally written on the super-senior AAA tranche). People with non-insured bonds will take massive losses as well.
David-
"So to the extent that the world delevers i don't think it will have a negative effect on equities and quite possibly as to my prior post a positive."
You may be right that most leverage in equity markets is by mkt neutral funds. But the vast majority of all leverage occurs outside equity markets. Unwinding this leverage would have a negative effect on all markets. Credit crunches obviously affect earnings and demand for things like oil. I suspect the reason the delevering of mkt neutral funds is reflective of the fact that everyone is delevering.
By the way, thanks for testing bullish ideas. I hate echo chambers.
. Generally though they are committed to the insurance contract. If bond owners were concerned, they will go and buy insurance on top of their existing insurance from another party. Some bondholders who need to maintain AAA on their muni bonds have done this. Even if you have two parties insuring it, the cost of insurance is very miniscule compared to potential losses.<
Are you sure that this is being done??? Who would they buy insurance from?
I suppose you could always buy a CDS from someone, but I would be surprised if this is being done. Do you have a source?
Appreciate your input. I agree we don't know what is in each black box, but I think people who are immersed in the details frequently perceive that their models and strategies are a lot more complex and different from each other than their eventual performance would suggest to the outside observer. I think the suggestion that one or more of the supposedly market neutral boxes blew up is a good working hypothesis when we see indexes suddenly trading the inverse of an approach that was being mentioned in a familiar fashion on a place like, say, Minyanville a few weeks ago.
"Unwinding this leverage would have a negative effect on all markets. Credit crunches obviously affect earnings and demand for things like oil. I suspect the reason the delevering of mkt neutral funds is reflective of the fact that everyone is delevering."
rc,
I am not in disagreement with this idea in general its just a question of timing , duration and magnitude.
In historical cycles the credit has been used to fuel various things. In this one the big beneficiaries were residential housing and private equity. I don't think I can add much to the housing discussion, but I would say that with it plastered all over the media, and it taking front and center stage of the political arena, its not like whatever happens is going to be a surprise to anyone unless you are a subscriber to the general deer hunting for grog scenarios.
The private equity bubble is over, but the consequences are likely to be crappy returns for the people who bought the paper and maybe some even some spectacular defaults down the road but its more of a long run problem than a short term blight.
The big hinge point, seems to be whether the banking system impairment coincident with the housing debacle is going to be enough to toss the whole world economy over the edge.
Right now there are a lot of stocks pricing in this scenario so the question to me is where might the pricing be wrong.
All the data that I look at points to the same bet, and that is against the pricing of the recession. First off, from just a technical perspective, the vast, vast majority of sentiment indicators point to historic extremes. From a pure value perspective you can buy giant worldwide actors as cheap as they ever really get relative to their current pricing power. Now it is certainly true that the pricing can change, but why haven't we seen any of it? You point to oil, but where is the price decline? Certainly anyone who had the recession idea has had more than ample opportunity to place their bets, but nothing has happened.
If you go to Intrade, you will see that the market odds of a US recession are about 2:1 in favor. If you look at the price of some equities it looks like 100:1 with 1:1 for a depression. IF, it turns out that all this recession talk is coming from people (bankers, brokers, etc) who are getting killed, but is overstating the global case, then the payoff for betting against them is going to be spectacular.
So this is where two passed out party-goers are leaned against each other, to make it look like they are (1) awake, and (2) just enjoying the music with a little dance?
Given that this is an election year, I don't believe that the Administration will allow the bond insurers to go under with all the resulting chaos without a concerted emergency effort to create a Federal gubbermint bailout plan. The potential political costs to the GOP in November are too dire to simply allow AMBAC, MBIA, and the others to collapse.
That's not to say that a bailout plan will work or make sense. It's only politics I'm talking about here.
"Dinallo met with a group of banks on Wednesday to press them to put up capital to bail out the wobbly bond insurers."
. . . and the banks said no thanks.
The one thing the insurers don't have is "some time." Unless the bailout is up and running in a couple months, it's game over.
I hope the clock runs out!
Blow 'em up. Blow 'em all up.
I'm not sure what's "complex." It is likely that as more claims are made, they will have unsufficient capital to meet their obligations. This would make them insolvent. It's not complex, just very very unpleasent.
ISI out this a.m. saying that there's no way the gov't can bailout the ABK's of the world, that such a move would have to be voted on by Congress, i.e. the Treasury Dept. can't just snap their collective fingers and 'solve' the problem.
Also, ISI says Dodd's plan to buy bum mortgages is never going to happen. Same reason: way too much legislative headwind to get that done. Plus, is $10B to $20B in bum mortgage bond purchases really going to help much of anything in the grand scheme of this mess?
Starting to sound like the M-LEC success
Again, the banks are in a similar position who has caused an accident. If it's a minor fender bender, it's probably worth paying for the other party's repairs out of pocket so that one's rates don't go up and you continue with the same insurance. The banks are in a position of deciding whether to backstop the insurers so that they can continue to get insurance from them. They have to decide whether the current credit crunch is a minor fender bender or a major accident. Can the insurers be saved, and is it worth saving them?
"Mr. Dinallo, I'm Bart Sminsky from XyZ Bank and I have been asked to attend this meeting"
"Welcome Mr. Sminsky take a seat at the table if you please and what Department are you with?
"I cover all Departments, Mr. Dinallo, they all need their mail, everyday"
I love to read this blog, but I'm not in finance. That said - it seems that the banks are being asked to put up money to bail out the insurers that were supposed to pay the banks if the bonds went south ... am I thinking about this right?
Doesn't ACA have till Feb 19th to work out a deal?
This seems to be a real cat's cradle. The Muni business doesn't seem to be in real trouble at this point (at least pre-recession). Does the loss of AAA rating by the monolines look to have a disastrous effect on the muni's - they're not held by pension funds with a rating requirement. There may be some Mutual Funds or Banks, but is that a significant piece. The real problem, as I understand is the guarantees of CDO's or other structured finance. And the potential victims are the Banks and IB's. While the loss of the rating speeds up the recognition of the problem, the basic problem is lack of capital to pay the losses. Forming a bailout have the banks fund the capital to pay themselves claims for their CDO losses, seems to be a hide-the-baloney Japanese solution. With all due respect, the MLEC did serve a purpose in putting off the day of reckoning and giving the IB's and hedgies numerous pop opportunities to distribute their losses to the rest of us.
Am I missing something as to the direness of the monoline crisis?
This strikes me like being asked to buy a State Farm bond issue so they can pay me the claim I filed for the accident I had last week...
We need to pull the plug on this insanity rather than add a new level of Doom to play through.
cd
So let me get this straight. The banks give them about 15 billion to keep their ratings, but the garbage they insured will still get downgraded and losses will arise, so banks should give them money to maybe have enough capital to weather the upcomming storm of resets?
Sounds like a plan.
In other news, the governments new plan will work to save the ecomnomy.
A bailout from the taxpayers for any large corporate scam or misfeasance.
Let's see, what is that form of government called that believes in corporate survival at all cost over individual rights? After all if the large corps go bankrupt the "terrists" win.
Socialism for Ambac, servitude for the peasants.
This is a classic zero-sum game, and some bond insurers are in worse shape than others. So, if your exposure is to an insurance company that is bad off, you want an umbrella bailout. But if your exposure is to one that's in better shape, you want to see capital injected in that company.
There's no way to get all the counterparties on the same page. Plus, Ambac falls under Wisconsin jurisdiction, not NY.
Yesterday was just a media event, and it worked. Now, for the encore...
"And indeed there will be time\t
To wonder, Do I dare? and, Do I dare?\t
Time to turn back and descend the stair,\t
With a bald spot in the middle of my hair\t
[They will say: How his hair is growing thin!]\t
My morning coat, my collar mounting firmly to the chin,\t
My necktie rich and modest, but asserted by a simple pin\t
[They will say: But how his arms and legs are thin!]\t
Do I dare\t
Disturb the universe?\t
In a minute there is time\t
For decisions and revisions which a minute will reverse."
It's only a zero sum game if the Fed does not play along. With interest rates falling, future losses can be slowed or avoided all together if people can refinance out of ARMs into 5.25% fixed rate mortgages.
So the banks can prop up the insurers now while hoping the liability of the insurers keeps decreasing with low refinance rates and high inflation.
Its not bad really.
You're missing the fact that all insured bonds have a right to protection, not just those that are currently distressed.
Regulators don't know that a muni revenue bond crisis won't be the next shoe to drop. It probably will be.
Other failing insurance companies have had to work through similar problems. One side of their business goes bust, affecting one class of policyholders. Consistently, regulators have had to take over these companies in order to play the same role as a bankrupcty referee and create a fair playing field for all policyholders.
The only reason regulators haven't moved faster here is they're afraid of wrecking the economy.
CD,
"add a new level of Doom to play through."
Oh man that would be sweet. Bankster Zombies with CDS's (Compact Dousing Sewers) spraying toxic waste. Boss fights with COO's and CFO's and CEO's with MBS's (Mega Bull Shot). Structure collapsing all around.
Sounds sweet, where can I download it? Is there a wardrobe mod? Kevlar 3-piece suits?
Cheers,
shucks. I'm a big fan of easy and quick fixes.
And then - how is this for an argument to use Federal money to bailout the bond insurers:
If the bond insurers fail, the stock market will tank out of proportion to the mortgage default losses. Just say you have 250 Billion in mortgage losses out there... but if the stock market tanks, the federal government will likely see what, a trillion or two dollars worth of stock losses claimed on income tax returns due to broad based stock losses?
I am just guessing on the trillion, but if people claim large stock losses on their 2008 income tax the federal government revenue takes a big hit... maybe bigger than a monoline bailout.
Look at this......
From fox biz news/.....
To address the mortgage crisis, the package also allows Fannie Mae and Freddie Mac government-sponsored companies that are the two biggest U.S. financers and guarantors of home loans to buy home mortgages much larger than the current $417,000 limit. Rep. Barney Frank, D-Mass., and chairman of the House Financial Services Committee, said that lending cap might reach as high as $700,000 in areas with the highest home prices.
The people who don't have much time are the bond insurer shareholders. As rich has said, these companies are going into runoff mode and the regulators will decide how and when claims get paid.
The only thing that makes sense to me is to figure out a way to get the munis reinsured by Buffet ASAP so that we don't have a pension fund crisis, then the CDOs can fight with the state regulators over the scraps.
T.S. Eliot on a finance blog.
Awesome.
Friggin' awesome.
Vega,
Pardon me, but what is ISI?
Sounds like I like it already tho.
Like M-LEC, it's preposterous and it's not going to happen.
It's another sick joke, a ploy to prop up a plunging market if only for a little while, so the bigger players can get their houses in order.
albrt,
"The only thing that makes sense to me is to figure out a way to get the munis reinsured by Buffet ASAP so that we don't have a pension fund crisis, then the CDOs can fight with the state regulators over the scraps."
Made the same mistake yesterday. The pensions have CDO's and other crap in them, not munis. Go check out Calpers assets.
Cheers,
50 bps cut next week is now rated at 90%.....
do I hear 75bps ?
Check this letter from Bill Ackman to the rating agencies (copied urbi et orbi):
Goode Value Investing & Trading Blog » Bill Ackman’s Letter to Rating Agencies Regarding Bond Insurers
The NY regulator's plan of self-funding is every bit as much of a scam as was the self-funded M-LEC Super SIV. You cannot finance your own protection plan which is largely designed to strictly provide protection to yourself and hope to maintain an ounce of integrity. Left pocket paying right pocket. Gimme a break.
My guess is that "zero sum" micharacterizes this situation. If these firms get the capital they need to keep their AAA ratings, then there are billions, on the way to trillions, in instruments that are less likely to change hands in quick fashion. That could make a huge difference.
I imagine old Eric sitting in his office, thinking about the implications for his state's governments. The municipalities will pay for more credit. The state and municipalities will find their budgets in a wreck because of declining earnings in the financial sector. Lots of lot jobs. So he says to himself, "why isn't anybody doing anything?" The next step is obvious. Eric does something. It doesn't mean he had anything available to him with good odds of working. Doing something, in this case, seems unlikely to hurt, and it might help. Why not try? Whatever happens, I think the guy deserves credit for stepping up.
OT
Today's market action adds confirmation that one or more big quant long/short hedge funds unwound yesterday. This same pattern has happened twice before, and it could happen again, so take notice.
Suddenly, many crummy stocks rally while many quality stocks tank. Then, over the next few days, the arbs take over to bring it back to fair value.
fitch is not waiting-
"Featured Broker sponsored link
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NEW YORK, Jan 24 (Reuters) - Fitch Ratings on Thursday cut its "AAA" ratings on bond insurer XL Capital Assurance Inc, part of Security Capital Assurance (SCA.N: Quote, Profile, Research), citing SCA's statement that it will not raise new capital at present due to market conditions."
RPT-UPDATE 1-Fitch cuts XL Assurance's AAA rating by 5 notches
| Reuters
The "fix" - just like a junkie.
is ther e amore perfect illistration on what a sham the financial ecoenomy is:
We'll pay you, to pay us, so that we can pay you back when you pay us to cover our losses, from paying you...
of course we have to charge fees at every step in the process....
Right now, ignorance of the true depth of the problem is working in the favor of the people who want to pass the bag on.
The problem with these bailout proposals is that it will educate more parties as to the depth of the problem.
As a result, fewer people are willing to taked the passed bag.
$5 billion now, $15 billion later...does it even come close? Not really. But they hope that once the parties have committed to some sum of money that they will be obligated for more.
Shades of Bank of America and Countrywide.
can I just complain that CD rates at my bank have gone from 4.67% for a 6 month to 2.83%.
What a crock!
can I just complain that CD rates at my bank have gone from 4.67% for a 6 month to 2.83%.
Saving is for chumps. So glad I don't have... oh, wait, my MMA statement just arrived... brb...
stealthwii,
ISI is a research shop run by Ed Hyman in NYC. He's been the #1 rated economist by Institutional Investor for the last 28 years.
Note that Ed has been pretty bullish on the US economy the last couple of years, believing in fact that we're headed for a mid-cycle slowdown and not a recession. I totally disagree with him on that. Nevertheless, I do pay attention to what he says about various stimulus packages and what the government can and cannot do to help the situation.
Today's market action adds confirmation that one or more big quant long/short hedge funds unwound yesterday. This same pattern has happened twice before, and it could happen again, so take notice.
thanks Rich, great take on the market
OT - I don't know if anyone posted this yet, however, Barry Ritholtz had a couple of interesting posts recently on perspective.
First of all he noted that Moody's has placed ITSELF on negative watch.
The Big Picture
Secondly he had an article on the overall point swing of yesterday's big negative-positive swing in the market based on a Paul Kerdrosky post. It was number 2 in total point swing (625.36), number 30 in market percentage (5.2%).
The Big Picture
Paul Kedrosky: Dow Bouncebacks: A Trip Through the Data
Insurers:
"Pay us some money so we can pay you some money to cover your losses."
Banks:
"Why should we do that? We can just take our losses directly"
Insurers:
"So we can make a profit on the transaction."
I love this stuff. You couldn't make it up!
There is an excellent post at Naked Capitalism on this attempt to prop up the bond insurers. Can you say hopeless?
Page not found « naked capitalism
Eric only does what his boss, NY Gov. Elliot, tells him to do.
Elliot supports NY Sen. Hillary, who is running for Pres. on an economy-first platform, and NY voters go to the polls in 10 days.
So, this has absolutely nothing to do with politics.
If the insurers go under then it isn't just the current losses the banks will have to cover. Everything else that was insured will lose value when the insurance disappears.
What is the market value of a beachfront house if the insurance disappears and it is hurricane season?
The banks want the taxpayer to bail out the insurers. They will wait and see if the government rides to their rescue.
What happened to "need to get this done in 48hours?" Whoops.
In the book Panic of 1907, the author lists as one feature of a mounting financial crisis is a series of failed fixes. We now have the M-lec failure, the teaser freezer failure, and this seems likely to be added to the list...
If this doesn't happen soon, and there are more downgrades, and the Fed sits pat next week, or only cuts another .25%, look out below...
I cant wait for the conforming limit to be raised.
All the Fannie/Freddie money will be soaked up by high cost states and the whole country will wonder why the heck sales slowed.
Even if done in conjuction with raising the capital cushion on the GSE (which just makes it twice as dangerous) it will be interesting to watch.
GSE bailout on the horizon in 5,4,3,2,1..
It seems that having the banks to "bail out" the bond insurers is like putting money from the left pocket into the right: it means nothing.
r c
Now that's a downgrade.
Cheers,
If the insurers go under then it isn't just the current losses the banks will have to cover. Everything else that was insured will lose value when the insurance disappears.
If the insurers go under that just means we have to bail out the actual bond holders.
Maybe it's just a question of which requires less paperwork.
It's only a zero sum game if the Fed does not play along. With interest rates falling, future losses can be slowed or avoided all together if people can refinance out of ARMs into 5.25% fixed rate mortgages.
The only reason borrowers were able to get into these homes was because the teaser rate lowered their monthly payments. They couldn't afford the house otherwise. Plus, most of these houses are worth less then what they paid for. A.) If these people could afford a fixed rate, why would they opt for an ARM. B.) Who is going to give these folks a loan when what they owe is more then the house is worth? Not even Fannie or Freddie are able to do that.
Okay, I have several questions for my betters here:
1.) Who exactly are the payees on these policies. Are the purchasers on the bonds the beneficiears, or are the IBs issueing them the beneficiaries? If the Insurers go Tango Uniform are the banks still liable?
2.) Is the insurance prepaid for the duration of the bond, or is some kind of annual payment made from proceeds? Can the IBs change insurers? In either case, are they contracturally obligated to get new insurance if the insurer is defunct or is downgraded?
3.) To what extant are the bond insurers specialized? Are there some that mostly insure MBS's and others Munis? Or is the risk spread widely among them.
4.) Who holds the problem bonds?
i think what ur seeing in the gold mkts today reflect the increasing realization that UST's are NOT going to provide u with any real return. in fact, negative return. hence ur seeing a shift in bond mkt money into the only true money, gold and gold stocks.
Here is what the National Association of Insurance Commissioners is doing with regard to the downgrades of ACA and Ambac:
NAIC Panel Rules On Bond Insurer Downgrades - Annuities - Life and Health Insurance News
This is in regard to the investment holdings of regular insurers, not to regulation of the bond insurers themselves. It's not just pension funds, but insurers that can't have too much crap on their books. Basically, its saying that if there is an "S&P Underlying Rating" (i.e., w/o the ACA guaranty) of the bond, they report that rating. There is a procedure for other situations, but basically, as I'm reading it the upgrades from the bond insurance are to be ignored.
It's only a zero sum game if the Fed does not play along. With interest rates falling, future losses can be slowed or avoided all together if people can refinance out of ARMs into 5.25% fixed rate mortgages.
The problem, again, is that is both desirable and easy for many people to simply default.
I talked to someone currently behind on their payments and they were actually elated at the prospect of walking away from their current home and renting in the same neighborhood at far less than their mortgage payment. Even much lower interest rates don't erase negative equity and large payments on an artificially bloated principal. Default does.
"My credit was shot anyhow."
"If the insurers go under then it isn't just the current losses the banks will have to cover. Everything else that was insured will lose value when the insurance disappears."
According to today's nyt's...
On Wednesday, for instance, some short-term insured municipal bonds, which typically trade at a premium to other bonds, were trading at a discount of as much as 1.5 percentage points to similar uninsured bonds, said Michael S. Downing, an account manager at Thomson Financial.
Next on the Worry List: Shaky Insurers of Bonds - NY Times
its also looking like the stock mkt is increasingly relying upon economic stimuli, rate cuts, to levitate on a daily basis. i've been busy day trading this morning and i see real weakness despite the major indices being green. my feeling is their is continual distribution going on from big to little guys.
In other words....the value of the insurance is now Negative!!!!
Therefore, on the muni side, there is no urgency. It's done. They won't be able to collect new premiums based on the market, not ratings or regulators.
Rich,
I've been watching my portfolio wink from red to green all day and had just begun to note the emerging pattern when you posted on revaluations.
I suppose this means I'm not only in the same church, but also sharing a pew with a few quants and hedgies. That inspires an odd mixture of confidence and loathing.
Steve Forbes Says U.S. Dollar Policy Amounts to 'Zimbabwe Economics'
Forbes Says U.S. Dollar Policy Amounts to `Zimbabwe Economics' - Bloomberg.com
burnside,
The black box quants weren't programmed for a 75 bs pt. emergency fed cut because it hasn't happened before. They got fried yesterday, just like we did.
They have to unwind because billions have been lost and they have risk parameters. But for us, a week from now, it will be like a passing storm.
As theroxylander wrote yesterday: "Overall it means money are just leaving the market and at some time later that will show up as another step down."
Deleveraging « The Theroxylandr in Flame
ac - I agree that someone whose 'credit is shot' and who is way, way underwater on their home isn't going to want to refinance or be able to refinance. But, according to the charts CR posted of how many people are underwater, and by how much the low rates will help some people refi into a stable situation.
Someone who is underwater by a few % may still be able to refinance depending on which valuation model is used to value their home. Valuations are probaby still higher than the market, good for some people I suppose.
Also - there are many people who don't want to move just because they are somewhat underwater, maybe they are optimistic about a rebound in prices, maybe they don't want to admit failure or maybe their kids are happy in their current school. The refinancing opportunity will help some of these people - not to mention just the lower rates on the resets than would have otherwise been.
Rich,
We eagerly await word on what effect January had on hedge fund returns:
-all those long-short funds long "the four horsemen", agriculture, commdities and emerging markets; and short financials.
-the quant funds for whom the 30th widest trading day range in history spelled disaster -- a six sigma event.
Here's the question: hedge funds managed to grow from about $300b in 2000 to $1.8tr today. What will the number be two years from now?
I say $500b.
That single delta -- from 1.8 to .5, is what will drive the real economy for the next two years. Everything else will follow in an extreme form of "reflexivity" (the concept that the markets create rather than just observe reality).
Federal Reserve Chairman Ben S. Bernanke and U.S. Treasury Secretary Henry Paulson are guilty of ``Zimbabwe economics'' by failing to step in to support the dollar, said Forbes Inc.'s Chief Executive Officer Steve Forbes.
That sounds about right.
There's a danger that the US could become seen as an increasingly unstable and unattractive destination for investment capital.
Given that this country is no longer the only viable free market destination, that could turn out to be a much more serious liability than a strong dollar.
its also looking like the stock mkt is increasingly relying upon economic stimuli, rate cuts, to levitate on a daily basis.
what took the market up above 10K, corporate stock buybacks and LBO noise, what took the market up to 10K, MEW.... see ya @ 8500..sooner then you think
They got fried yesterday, just like we did.
Not every permabear got fried yesterday.
Some people actually cover shorts when they're up 50% in a week.
Jerome did it.
http://www.marketwatch.com/news/story/socgen-probably-black-monday-culprit/story.aspx?guid=%7B9A84342A-D679-45B6-8C93-8804A898FE4E%7D
everyone buy an Ipod with the rebate... I can see Jobs startin the ad campaign today !
There's a danger that the US could become seen as an increasingly unstable and unattractive destination for investment capital.
take a look at a long term chart of the Nikkei and compare it to the dow, what you will see is that in the early 90's money started to move out of Japan into the American markets. Japan in 1989 was the center of the world financial markets.
Good chance the same end awaits us.
yah econmy is about to crumble guy here is why you shouldn't invest in bonds
Lively Money: Why you should not buy bonds!
David Pearson-That single delta -- from 1.8 to .5, is what will drive the real economy for the next two years.
i assume by that u mean downward?
everyone buy an Ipod with the rebate... I can see Jobs startin the ad campaign today !
Saw a newspaper ad yesterday from a meat market (the kind that will sell you a whole side of beef -- 2.09/lb, by the way) saying to Invest Your Tax Refund! with a purchase at their store. (Although putting a side of beef in the freezer might not be too bad of an inflation hedge.)
On how muni bond insurance works:
IN our little city, a bond issue is put together, and bids on insurance are sought from the monolines. Our city's underlying rating is A1 or something like that...not positive...in any event it is investment grade but not AAA.
The insurance (from an AAA insurer) makes the city's bonds AAA, which reduces the interest rate the city needs to pay to the investors who buy the bonds.
So when those bids come in, the city takes the lowest bid and does the math: Does the savings on interest make up for the cost of the premium?
If the answer is yes, they buy the insurance. (Sometimes the answer has been no.)
In any event, the bonds are then issued, the city gets the money, and the insurance is covering the bondholders for the life of the bond. They accept a lower rate of return because they have the added security of that AAA insurance.
If the insurer is downgraded, it's no skin off the city's nose. The bondholder is no doubt disgruntled, especially if that bondholder wanted/needed to sell the bond in the market rather than just hold it to maturity. Its market price would now be lower because its rating is lower, even tho still pretty good. (For those who were planning on holding the bond anyhow, and were satisfied with the interest rate, nothing is really going to happen.)
Going forward, if there are no monoline insurers to deal with, municipalities with good credit won't be out of the borrowing business, but their interest costs will be higher in some cases. (Our city officials tell me they expect this to be manageable.) Municipalities with suspect credit may have some problems, but they had problems before all this happened, didn't they? And they were (one would hope) paying a lot more money for the AAA insurance, so maybe the impact on them will be incremental as well.
It does make it harder for investors to gauge the security of a bond. I'm guessing that in the past, some people just said, "what the heck...it's insured" and bought the bond. Now somebody is going to have to look at the issuing municipality, its tax base etc. Either than or rely on the city's ratings from Moody's and the gang.
"The black box quants weren't programmed for a 75 bs pt. emergency fed cut because it hasn't happened before. They got fried yesterday, just like we did."
While I always listen to well formed arguments which are contrary to my opinion, its hard to read stuff which is just flat out made up. How anyone can claim to have any idea of what the net black box position is in the stock market or any individual position is beyond me. For several years I ran a black box futures model in the quant division of a big fund along side people who were doing long/short equity, bond arb, forex etc. They knew about as much of my positions as I knew of their and that number was zero.
There is so much real time data out there that is useful for forming opinions, it seems a shame to float ideas that are complete fantasy and might persuade otherwise uninformed persons to make investment decisions based upon them.
It seems that this weeks turmoil in the markets is related to the unwind of the huge "rogue" trade by SocGen.
If this is true and the Fed responded with an emergency 75bips rate cut its more than disasterous. The markets will then keep throwing little tantrums and keep building up the tantrum scale and when there is a real need for the rate cuts there will not be any that will be meaningful.
This is not good news when folks realize that the Fed has become Wall Streets bitch! And it has now added a new job description of guaranteeing equity prices - it will fail in this mission.
This whole banks bailing out insurers who are bailing out banks business model seems based on the lyrics of 80s punk band Husker Du:
We are starting a cat ranch and taking one hundred thousand cats.
Each cat will have twelve kittens a year.
The catskins will sell for thirty cents each.
One hundred men could skin five thousand cats a day.
We could be dealing a profit of over ten thousand dollars.
But what should we feed the cats?
We will start a rat ranch next door with a million rats.
The rats will be twelve times faster than the cats.
So we can have more rats to feed each day for each cat.
But what should we feed the rats?
We will feed the rats the carcases of the cats.
After they have been skinned.
Now get this!
We feed the rats to the cats and the cats to the rats
And get the catskins for nothing
malabar,
Umm, the FFR cut was panic. But the monoline problem is real.
Cheers,
malabar,
I still hold the view that Bernanke & Co. were not and are not attempting to prevent an unwind here, but doing what they are able to prevent its becoming disorderly.
We're on opposing sides of the razor.
WSJ - Citi Prunes Its Branch Expansion Abandons Plans to Open 100 Branches a Year In U.S.
Citi Prunes Its Branch Expansion - WSJ.com
Does jerome's faux pas influence fed to hold rates constant at next meeting?
("Well we see now you got your early birthday present, and now it's your birthday today and you really ARE NOT getting another present")
It seems that this weeks turmoil in the markets is related to the unwind of the huge "rogue" trade by SocGen.
We don't know if the SocGen's unwind caused global markets to plunge - yet. Is $50B in bad positions enough to destabilize several trillion dollar markets, all on the same day? Doesn't seem like it to me, but the question is a bit above my pay grade.
The Fed definitely panicked, either way, and that we will all regret for years.
david in ct
i do not contest the first part of your statement-eg the net position of quant funds is unknown and possibly unknowable. Still, wound not some of these be dramatically affected by dramatic swings? and if a few blow would that cause further dislocations and turmoil?
This is just . . . disgraceful? Embarrassing? Criminal? I don't even know what to say.
"It also raises the disturbing question of whether the Federal Reserve was spooked into making an emergency rate cut on the back of what was just technical selling. The Fed by its own admission met Monday night - after the overseas selling was clear."
This is a pretty good thread.
King Peasant, the best Eliot reference to date was when Tanta asked Sebastian whether the corpse he planted in his garden had begun to sprout (Sebastian was widely believed to be holding NEW shares at the time of implosion).
Misean: Good point, the division between crap and munis is not that clear. But I don't think there is much that can be done about pension funds holding actual crap. The policies on the decent bonds will need to be transferred to a solvent insurer at some point, and they should do it relatively soon if they want to prevent a market dislocation based purely on ratings disruption for pension funds, insurers, and any other regulated bond holders.
david: yeah, I guess RTH was going up while everything else was going down because 2008 looks so great for retailers right now, compared to pharma, etc.
SOME OF THESE BOND INSURER EXECUTIVES SOLD THEIR OWN stock not long ago.
Would someone in the GOVT pleaser remember to prosecute them and reclaim those assets? The corrupt nature of our businesses never ceases to amaze me.
Did they think we wouldn't notice?
david in ct
i do not contest the first part of your statement-eg the net position of quant funds is unknown and possibly unknowable. Still, wound not some of these be dramatically affected by dramatic swings? and if a few blow would that cause further dislocations and turmoil?
kratovil | 01.24.08 - 1:33 pm | #
About the only thing that I would venture to say about long short equity is that volatility is generally a good thing. Whatever the form of the model, be it pure price/volume driven, 'fundamentally driven', or more along the lines of 'classic' stat arb, where one takes a bunch of variables and creates some multifactor regression model and then trades outliers to the model, they all seem to do better in high vol environments.
The problem can be thought of as creating a calculation that gives you fair relative value at any point in time. To the extent that your model is good, price will revert to 'fair value' over time. The greater the volatility usually the more opportunities.
I don't doubt that if a big long/short fund was liquidated it would have some effect on the stocks that they were liquidating. Without know the fund and the particulars I have no idea as to how one would look at market action and ascribe the moves to this phenomena.
This sounds a lot like the Enron off balance sheet shells that were used to 'hedge' Enron and 'lock in profits'. Skilling would be proud.
You cant hedge yourself. Some outside party to the transaction has to hedge.
david: yeah, I guess RTH was going up while everything else was going down because 2008 looks so great for retailers right now, compared to pharma, etc.
albrt
birds fly for a lot of reasons, professional golfers hit balls OB for a lot of reasons. in this more than any other game there is just a lot of stuff you can never know. accepting it is good thing.
Relax; the fix is in.
They might have time. The actual claims won't show up for months or years, correct?
As long as the ratings agencies can be convinced to delay their downgrades (on the theory that a "fix" is coming), there really isn't any rush, is there?
Saw a newspaper ad yesterday from a meat market (the kind that will sell you a whole side of beef -- 2.09/lb, by the way) saying to Invest Your Tax Refund! with a purchase at their store. (Although putting a side of beef in the freezer might not be too bad of an inflation hedge.)
Anyone else remember the I Love Lucy episode?
How anyone can claim to have any idea of what the net black box position is in the stock market or any individual position is beyond me.
david_in_ct,
I think you are wrong. It is widely accepted that all long/short equity funds taken together as a basket are net long. We know that 130/30 strategies are widespread. We also know that there is a great variety of funds and that the industry cares about monthly performance and that there is lots of pressure from all sides.
On top of that, we have seen the same symptoms in August, only to find out that, yes, long/short equity funds had blown up.
So there is some logic behind the argument.
One more bit on long/short.
To the extent that there is a long period of time where long/short underperforms straight equities, this will be bullish for the general equity market. If you have a long short/fund which is $1 long / $1 short for each dollar invested, then for all the cash put in them there is zero net equity buying. Should the returns suffer over time, it stands to reason that money will flow out of these strategies and into those which have more directional exposure which in the scheme of things is almost always long.
in this more than any other game there is just a lot of stuff you can never know. accepting it is good thing.
david_in_ct,
..oh shush.. it's no fun if we can't pretend to know things we don't know.
Rich is inclined to make completely un-informed pronouncements. The other day, it was the insistence that Proshares UltraShort funds don't use swaps.
Well.. they do.. and they pretty much only use swaps. Oh well, reality can get in the way of pontificating.
david_in_ct
Again you are potentially wrong. I used to think the same thing as you but I now learned something from the housing bubble: Assets serve as collateral for debt, overvalued assets mean that we can leverage more. And less-then-normal volatility means that a hedge fund can lever more. Now that volatility is back, there cannot be as many assets out thee and if debt/equity ratios stay the same, margin calls and fund halts should lead to a total reduction in stock market assets, to that extent.
"I think you are wrong. It is widely accepted that all long/short equity funds taken together as a basket are net long. We know that 130/30 strategies are widespread."
It is a matter of semantic to call the 100 long, part of long short, when all that is long/short is the 30.
In any event, even if I grant you that they are blowing up, how do you know which stocks are which?
If you also think that we have a good analogue to the august turmoil, why on earth would you be bearish?
how do you know which stocks are which?
1) the ones go up signal short covering, the ones that go down signal liquidation
2) we see some correlation in these groups. i.e. financials and retailers going up, other stuff more mixed but generally down as of yesterday mid-day.
3) hedge funds who run into trouble usually pile up into a similar trade, which seems logical, again, short financials long AAPL type stocks.
If you also think that we have a good analogue to the august turmoil, why on earth would you be bearish?
I don't understand the question. Are you talking about me, probert? Who told you I'm bearish?
Again you are potentially wrong.....
Probert
I accept that I am always potentially wrong. Its part of life.
Most of my experience leads me to believe that the vast majority of leverage in the equity markets revolves around market neutral strategies. So to the extent that the world delevers i don't think it will have a negative effect on equities and quite possibly as to my prior post a positive.
In any event, I am stuck in my world of doing math and listening to the opinions of those that are opposite of mine. I tend to spend more time here when I am bullish, so I can potentially gauge the errors in my thinking. Its sort of awkward.
Probert,
My mistake on the bearish thing. I must have confused you with someone else.
So you must have been lead to the same trades as I put on yesterday, though our reasoning was different.
So when and why do I exit my copper and nat gas positiions?
d
Most of my experience leads me to believe that the vast majority of leverage in the equity markets revolves around market neutral strategies.
david_in_ct,
That's an interesting thought.. what do you mean exactly by market neutral? 50/50 short long; long stock, short calls; short stock, short puts? All of that.. more?
I like this idea.. since I am not on the inside of these blackbox quant shops.. I'm stuck guessing about the result of deleveraging.
Thanks for any insights.
oop.. should be..
short stock, puts and long calls
or
long stock, puts and short calls
eli,
market neutral can be any of the things that you have pointed out. again, i have never been part of the marketing effort so i dont really know the stats on how much goes where, but surely the plain vanilla stuff predominates. an interesting factoid, is that nyse short interest is about 2x what it was in 7 years ago.
JIM A: "1.) Who exactly are the payees on these policies. Are the purchasers on the bonds the beneficiears, or are the IBs issueing them the beneficiaries? If the Insurers go Tango Uniform are the banks still liable?"
The beneficiaries are whoever that owns the bond. Investment banks are just intermediaries. The reason investment banks are posting losses is because they got stuck with some bonds that they planned to sell to investors but just never got around to them. Most of the losses on risky bonds (such as CDOs) are likely, in my opinion, going to be posted by hedge funds and other investors that you will never hear about (just like if I take a loss on an equity position, you won't hear about me taking a loss).
JIM A: "2.) Is the insurance prepaid for the duration of the bond, or is some kind of annual payment made from proceeds? Can the IBs change insurers? In either case, are they contracturally obligated to get new insurance if the insurer is defunct or is downgraded?"
No one has any obligation to get insurance. I forget the details but I believe municipal bonds are prepaid but things like CDOs are annual payments. Don't quote me on that because I'm not entirely sure. In some rare cases I believe the bond owners can change insurance (this is basically the same as cancelling the insurance contract). Generally though they are committed to the insurance contract. If bond owners were concerned, they will go and buy insurance on top of their existing insurance from another party. Some bondholders who need to maintain AAA on their muni bonds have done this. Even if you have two parties insuring it, the cost of insurance is very miniscule compared to potential losses. It's sort of like how insuring you house may cost $1000, but the cost of the house is $100,000. Even if you sign up with 3 insurers and pay $3000, the cost is very low compared to potential loss.
JIM A: "3.) To what extant are the bond insurers specialized? Are there some that mostly insure MBS's and others Munis? Or is the risk spread widely among them."
Risk profile is totally different between them. MBIA and Ambac are the two largest and are far larger than the rest. More than 50% of revenue for most bond insurers come from so-called muni bonds (muni also refers to public-private partnerships; quasi-private entities; etc). The rest come from so-called structured products like RMBs, CDOs, and other ABS products. Muni bonds are fairly safe but the structured products are what is causing problems.
MBIA has high exposure to RMBSes; Ambac has high exposure to CDOs; companies like Assured Guaranty are safe and haven't insured many risky stuff since 2005; companies like Radian and MGIC are mortgage-only insurers and have different characteristics from the rest; and so on. It's all different...
JIM A: "4.) Who holds the problem bonds?"
The problem bonds are mortgage backed products such as subprime RMBS
RUSS DOGG: "SOME OF THESE BOND INSURER EXECUTIVES SOLD THEIR OWN stock not long ago. Would someone in the GOVT pleaser remember to prosecute them and reclaim those assets? "
Since when was it illegal to sell stock that you own? Unless you think it was based on insider information, there is nothing wrong with any of that... just because you--or me--may have lost money on the stock doesn't mean anything.
yikes.. hit msg length limit
...
JIM A: "4.) Who holds the problem bonds?"
The problem bonds are mortgage backed products such as subprime RMBS (residential mortgage backed security) products, CDO of ABS (where subprime RMBS is the ABS), and CDO-squareds (i.e. CDO of CDO of ABS). In the future, other ABS such as credit card debt, auto loans, student loans, etc may become a problem but they are not expected to cause anywhere near the damage of subprime RMBS.
I don't think anyone knows who holds the questionable bonds. I suspect most of it is held by banks, hedge funds and investors (which can include foreign investment funds, foreign investors, etc).
I suspect most of the losses will be borne by hedge funds and some investment funds. Note that not all the risky RMBS has insurance on them (insurance is also generally written on the super-senior AAA tranche). People with non-insured bonds will take massive losses as well.
David-
"So to the extent that the world delevers i don't think it will have a negative effect on equities and quite possibly as to my prior post a positive."
You may be right that most leverage in equity markets is by mkt neutral funds. But the vast majority of all leverage occurs outside equity markets. Unwinding this leverage would have a negative effect on all markets. Credit crunches obviously affect earnings and demand for things like oil. I suspect the reason the delevering of mkt neutral funds is reflective of the fact that everyone is delevering.
By the way, thanks for testing bullish ideas. I hate echo chambers.
Whoops-
I meant to say, "the reason mkt neutral funds are delevering is that the everyone is delevering."
Are you sure that this is being done??? Who would they buy insurance from?
I suppose you could always buy a CDS from someone, but I would be surprised if this is being done. Do you have a source?
david -
Appreciate your input. I agree we don't know what is in each black box, but I think people who are immersed in the details frequently perceive that their models and strategies are a lot more complex and different from each other than their eventual performance would suggest to the outside observer. I think the suggestion that one or more of the supposedly market neutral boxes blew up is a good working hypothesis when we see indexes suddenly trading the inverse of an approach that was being mentioned in a familiar fashion on a place like, say, Minyanville a few weeks ago.
The problem with these bailout proposals is that it will educate more parties as to the depth of the problem.
Exactly right. It was the "creation" of M-LEC that really got my attention, though I'd been watching the farce for a while before that.
"Unwinding this leverage would have a negative effect on all markets. Credit crunches obviously affect earnings and demand for things like oil. I suspect the reason the delevering of mkt neutral funds is reflective of the fact that everyone is delevering."
rc,
I am not in disagreement with this idea in general its just a question of timing , duration and magnitude.
In historical cycles the credit has been used to fuel various things. In this one the big beneficiaries were residential housing and private equity. I don't think I can add much to the housing discussion, but I would say that with it plastered all over the media, and it taking front and center stage of the political arena, its not like whatever happens is going to be a surprise to anyone unless you are a subscriber to the general deer hunting for grog scenarios.
The private equity bubble is over, but the consequences are likely to be crappy returns for the people who bought the paper and maybe some even some spectacular defaults down the road but its more of a long run problem than a short term blight.
The big hinge point, seems to be whether the banking system impairment coincident with the housing debacle is going to be enough to toss the whole world economy over the edge.
Right now there are a lot of stocks pricing in this scenario so the question to me is where might the pricing be wrong.
All the data that I look at points to the same bet, and that is against the pricing of the recession. First off, from just a technical perspective, the vast, vast majority of sentiment indicators point to historic extremes. From a pure value perspective you can buy giant worldwide actors as cheap as they ever really get relative to their current pricing power. Now it is certainly true that the pricing can change, but why haven't we seen any of it? You point to oil, but where is the price decline? Certainly anyone who had the recession idea has had more than ample opportunity to place their bets, but nothing has happened.
If you go to Intrade, you will see that the market odds of a US recession are about 2:1 in favor. If you look at the price of some equities it looks like 100:1 with 1:1 for a depression. IF, it turns out that all this recession talk is coming from people (bankers, brokers, etc) who are getting killed, but is overstating the global case, then the payoff for betting against them is going to be spectacular.
So this is where two passed out party-goers are leaned against each other, to make it look like they are (1) awake, and (2) just enjoying the music with a little dance?
Given that this is an election year, I don't believe that the Administration will allow the bond insurers to go under with all the resulting chaos without a concerted emergency effort to create a Federal gubbermint bailout plan. The potential political costs to the GOP in November are too dire to simply allow AMBAC, MBIA, and the others to collapse.
That's not to say that a bailout plan will work or make sense. It's only politics I'm talking about here.