Really Scary Fed Charts: MAY, False Alarm?

The scary Fed charts are making the rounds on various blogs now.

Over at CalculatedRisk they are being interpreted as a “false alarm” in Non-Borrow Reserves and the Fed’s Balance Sheet.

Over at MarketTicker they are being interpreted as evidence that “the system as a whole is insolvent” in Tall Tale Tuesday.

While I’m not sure (yet) that “the whole system is insolvent”, I definitely do NOT think this is a “false alarm”.

CalculatedRisk: Non-Borrow Reserves and the Fed’s Balance Sheet: ““This graph, from the St. Louis Federal Reserve, shows the non-borrowed reserves of financial institutions. Looks like some serious cliff diving, but with a little research, we discover this graph is misleading.

The explanation is pretty simple. The Federal Reserve decided to classify the TAF and the primary dealer credit facility as borrowed reserves (see this table). If we back out these collateralized borrowings, you get the total reserves, and that has been very steady. False alarm.”

My Comment: First, lets start with “total reserves have been steady” if you exclude the Term Auction Facility (TAF). This, as I understand it, should not be done. This facility was specifically designed for depository institutions to replenish reserves:

Term Auction Facility (TAF): “Under the term auction facility (TAF), the Federal Reserve will auction term funds to depository institutions. All depository institutions that are eligible to borrow under the primary credit program will be eligible to participate in TAF auctions. All advances must be fully collateralized. Each TAF auction will be for a fixed amount, with the rate determined by the auction process (subject to a minimum bid rate). Bids will be submitted by phone through local Reserve Banks.”TAF FAQ

The TAF is currently at $100 billion and that has been drawn (Chart: TERMAUC). Bernanke raised the TAF limit to $150 billion on May 2nd. (Fed Officials Warn About Inflation, Say Markets Still Unsettled) Obviously there is a need for this liquidity. The chart measures exactly what it should: Non-Borrowed Reserves. The TAF is so large now, that Non-Borrowed Reserves are deeply negative.

What does this mean? Is “the system as a whole insolvent”? I would say POSSIBLY. We don’t know for sure YET and it may take years before we find out.

The Federal Reserve requires collateral from those borrowing through the TAF. We need to first understand the collateral, and margin rules on that collateral to determine how risky the TAF facility is.

Collateral FAQ
The Discount and PSR Margins Table

A good chunk of what can be used of collateral is low risk and transparent. For example, US Treasuries and Fully Guaranteed Agencies, Government Sponsored Enterprises, International Agencies, Brady Bonds, Foreign Governments, and Foreign Government Agencies are all liquid, can be valued and are transparent in the sense that you know what it is you’re holding.

BUT, then things get sketchy and they get really sketchy really quickly.

Municipal Bonds are mostly good collateral. I say mostly, because municipal defaults are generally very low. HOWEVER, the last 5 years of revenues and the projections of all future revenues are based on an illusion. That illusion was of perpetually rising real estate prices and therefore perpetually rising property tax income. Furthermore, the churn in real estate, the sheer volume of sales, also generated a large, non-reoccurring revenue stream from one time transaction taxes. Municipal expenditures rose with these income increases and future projections, on which bonds were floated, extrapolated this income stream into infinity. Some municipals are already under severe stress as their tax bases collapse. (See Tax Assessors Nightmare of at Mish’s for an in depth analysis of the pending tax implosion.)

Corporate Bonds Rated AAA are generally fine. On average only 23.3% of all bonds rated AAA were downgraded to AA over a 5-year horizon. This means that the collateral pool will gradually shrink as AAA corporate bonds slowly get downgraded as economic fundamentals deteriorate. Basically as AAA rated bond that gets downgraded won’t be eligible at the TAF any longer. So when the 28 day period expires, the bond is swapped back by the Fed. Default is almost impossible in such a short time frame.

BUT, that assumes that AAA today is as solid and reliable as AAA used to be years ago. Even sudden implosions, such as that of Bear Stearns, don’t tend to be a problem because the ratings of such firms generally aren’t high enough. Bear Stearns had been rated A+ before it imploded and therefore Bear Stearns debt wouldn’t have been eligible as collateral. The ratings agencies don't exactly inspire much confidence in their skills.

Further down the list we hit Asset Backed Securities, Commercial Mortgage Backed Securities, Mortgage Backed Securities, and Collateralized Mortgage Obligations. THIS is where the wheels come off…

First, OBJECTIVELY valuing these instruments is damn near impossible. That is WHY these markets have seized up. Second, they are not transparent. To figure out and hunt down the underlying assets in these derivatives of derivatives is also damn near impossible. Even worse is the fact that both AAA rated and NON-AAA are eligible when we already know that even AAA ratings in these instruments are deeply FLAWED and UNRELIABLE. Unlike corporate bonds, these instruments can suddenly collapse without warning. Therefore, the Fed really is taking a big risk on these.

Furthermore, the ‘haircut’ on all this collateral is ridiculously LOW. Most are only 1% - 3%. The lendable value of the worse of these is still 70% and that is only when there is NO MARKET PRICE AVAILABLE. I can tell you this, when there is no market price, there is also no way in hell the instrument is worth 70 cents on the dollar. No price and you can generously assume you’re not going to get more than 50 cents on the dollar and I say that would be a best case scenario.

“A more interesting chart was present by Dr. Janet Yellen this morning showing the Fed's balance sheet.

This graph shows that about half the Fed's U.S. Treasuries have been committed to fight the liquidity crisis.”

My Comment: Interesting indeed. Frightening as well. The Fed has basically traded in high quality instruments, US treasuries, for low quality instruments that the market doesn’t want at all or is pricing at levels deemed unacceptable by those market participants still denying reality. The Fed has committed half of its $800 billion balance sheet to battle the RESIDENTIAL real estate bubble implosion. The COMMERCIAL real estate bubble implosion has yet to get well underway. Revolving credit, such as credit card debt has yet to implode as well. Job losses have yet to accelerate. The recession has yet to gather steam.

I’ve said it before, The Fed Is Almost Out Of Ammo, Citigroup and UBS Too.

Total Borrowings of Depository Institutions (Chart: BORROW) are fast approaching $150 billion. This does not include the effect of the $50 billion increase in the TAF limit to $150 billion.

This has already pushed Non-Borrowed Reserves (Chart: BOGNONBR) to a NEGATIVE $100 billion. This is likely just to get worse as the balance sheets of financial institutions continue to deteriorate.

The balance sheets of almost all financial institutions, whether they be depository institutions or prime brokers WILL DETERIORATE further. They have to. The vast majority of their balance sheets are now in the Level 2 or Level 3 asset buckets. As I said in Bulltrap: ABCP, and Level 3 Bombs, I can’t imagine that these assets are currently being undervalued or even conservatively valued.

That just NOT how these fellows roll. This is Wall Street man! Privatize the profits, and socialize the losses!

Related Posts:
Really Scary Fed Charts: APRIL
Really Scary Fed Charts: MARCH
Fed CHANGES Really Scary Fed Charts
Really Scary Fed Charts, Why Bernanke Will Furiously Cut

Bank Of America Raises Loan Losses, What About The Countrywide Deal?

Bank of America Raises Forecast for Home-Equity Loan Losses: “Bank of America Corp., the second- biggest U.S. bank, raised its forecast of home-equity loan losses to more than 2.5 percent.

Liam McGee, president of the Charlotte, North Carolina- based company's consumer division, gave the new forecast at a conference in New York sponsored by UBS AG. The bank previously projected a loss rate of between 2 percent and 2.5 percent.

McGee also said the bank's credit-card customers are “showing stress” as they increase spending on necessities instead of travel and entertainment.”

The Federal Reserve Statistical Release on Consumer Credit was freakish. The annual rate of increase in revolving (credit card) debt was nearly 8% in March, more than double the annualized rate of increase in wages.

Consumers or maxing out on their cards and hoping things improve…

Well, since Bank of America (BAC) is raising its own loan loss projections, there is no way they intend to guarantee Countrywide (CFC) debt… and it is becoming increasingly likely they could walk away from the CFC deal entirely. That would strand about $38 billion in CFC debt.

I write about BAC beginning to quietly back off the CFC deal in my post Finally, Dollar Smile Theory In Play?:

Bank of America May Not Guarantee Countrywide's Debt (Update6): “Bank of America Corp., the second- biggest U.S. bank, said it may not guarantee $38.1 billion of Countrywide Financial Corp.'s debt after taking over the mortgage lender, increasing the likelihood of a default.”

BAC is in a tight range. Its break down and out or bounce time. A break below $36 would result in tests of the $35 area and the $32 area. A bounce to the $40 area wouldn't necessarily result in an immediate break out and up.

Related Posts:
The Bears Are Backs: Consumer Credit, AIG Misses, Oil Moons
Cracks In The Bear Wedge
Dollar Smile, Global Decoupling, Oil Super Spike and Yields
Bulltrap: ABCP, and Level 3 Bombs

Libor Poised For Shake-Up, Credibility GONE

Libor is back in the news. Much like everything else, the banks have been faking this too.

Libor Poised for Shake-Up as Credibility Is Doubted (Update2): “The benchmark interest rate for $62 trillion of credit derivatives and mortgages for 6 million U.S. homeowners faces its biggest shakeup in a decade as lawmakers question if banks are understating borrowing costs.

For the first time since 1998, the British Bankers' Association is considering changing the way it sets the London interbank offered rate, according to Chief Executive Officer Angela Knight, who appeared before a parliamentary committee in London today. “We've put Libor under review,” Knight said in an interview yesterday. While she declined to discuss specifics, the BBA will announce changes May 30, she said.”

Why is Libor under review? Because the banks are liars…

“While the BBA set the one-month dollar Libor rate at 2.72 percent on April 7, the Federal Reserve said banks paid 2.82 percent for secured loans later that day. Secured loans typically yield less than unsecured debt.”

“The Libor numbers that banks reported to the BBA were a lie. They had been all the way along. The BBA has been trying to investigate them and that's why banks have started to report the right numbers.” - Tim Bond, head of global asset allocation at Barclays Capital in London.

“Libor rates jumped after the BBA said April 16 that any member banks found to be misquoting rates will be banned. The cost of borrowing in dollars for three months rose 18 basis points to 2.91 percent in the following two days, the biggest increase since the start of the credit squeeze last August. The one-month rate climbed 14 basis points, its biggest gain since November.

The cost of borrowing in dollars for three months should be as much as 30 basis points, or 0.30 percentage point, higher than the current rate, Citigroup Inc. said in a report last month. Banks are understating borrowing costs on concern they will be perceived as “weakened” by the credit turmoil that forced banks to record $323 billion of losses and credit-markets writedowns, said Peter Hahn, a fellow at the London-based Cass Business School.”

Depending on how serious this review is, expect Libor to creep up if it becomes more and more likely that the TRUE Libor rate will come out.

Related Posts:
RISE Dark Lord Libor! RISE!
Ambac Gets Crushed, Another Bank Wobbles
Fragile Banks: More Bailouts, More Capital
The Race To The Bottom Accelerates
The South Sea Bubble and Today’s Central Banks: FRB, BOE, ECB
Dammit, Why Won’t You Learn?
The TED Spread, LIBOR and EURIBOR = Scary Bad
Mortgage Insurers (Quietly) Downgraded: CDS Spreads Scream Trouble

BTW, if the banks would lie about Libor, what are the odds that they’re lying about the value of their Level 2 and Level 3 assets? >GRIN<

Think about it.

Related Posts:
Bulltrap: ABCP and Level 3 Bombs
Something To Think About: Goldman Sachs, Level 3
Level 3 Rules

MBIA Reports Scary Earnings; NEGATIVE Revenues

MBIA Posts Loss of $2.4 Billion as CDO Slump Deepens (Update1): “MBIA Inc., the bond insurer that lost 87 percent of its market value in the past year, posted a net loss of $2.4 billion as the slump in mortgage securities deepened.

The first-quarter net loss was $13.03 a share, compared with a profit of $198.6 million, or $1.46 a share, a year earlier, Armonk, New York-based MBIA said in a regulatory filing today. Unrealized losses from derivatives were $3.58 billion.”

Let’s put these numbers into context. MBIA (MBI) closed at $9.43 on Friday, giving the company a market capitalization of $2.23 billion. The loss of $2.4 billion this quarter alone is greater than the value of the entire company…

Now get this… because this is rather cool: REVENUE for the quarter was NEGATIVE. Yeah. You read that correctly. Revenue was -$2.96 billion. How could this even be possible? Well, as net premiums written fell by nearly half and losses on insured derivatives soared to $3.58 billion, MBI had to record NEGATIVE revenues on a $668 billion portfolio.

Somebody tell me how do you make money when your revenues are negative? I think I skipped that class, or killed those particular brain cells out at the bar.

An executive summary and discussion of MBIA's results and balance sheet position follow:

-- Credit Impairment: During the first quarter, MBIA conducted a thorough analysis of its housing-related exposures in order to update its estimates for impairments and loss reserves. As a result of this review, the Company recognized a total of $1.34 billion of pre-tax impairments and loss reserves on its housing-related insured portfolio in the quarter, bringing the cumulative total of incurred pre-tax credit losses for housing-related exposures to $2.15 billion over the past two quarters. The impairments and loss reserves are expressed on a net present value basis and are expected to be paid out over the next four years for direct and multi-sector CDO squared exposures, and up to 30 to 40 years for the Company's insured multi-sector collateralized debt obligations ("CDOs"). The Company does not anticipate material additional impairment for these exposures in the foreseeable future, unless the U.S. housing and mortgage markets perform materially worse than MBIA is projecting.

My Comment: “MBIA had insured bonds backed by home equity lines of credit and closed-end second loans totaling $21 billion at the end of 2007, according to the company's Web site. Almost $9 billion of those securities were originated in 2007.”

Equity lines of credit and second loans are worth exactly ZERO on any home that goes into foreclosure. The guys holding the first mortgage end up taking about a 40% haircut now. That $21 billion in loans that they’ve insured are worth a lot less than they think they are, especially since $9 billion or 42.9% of that was written in 2007 just after home prices PEAKED. I also think it is safe to assume that the U.S. housing and mortgage markets will perform materially worse than MBIA is projecting.

-- Capital Position and Liquidity: MBIA successfully raised $2.6 billion in the quarter to support its Triple-A ratings, the most raised by any monoline insurer in the current troubled capital market. With the elimination of its shareholder dividend, the holding company, MBIA Inc., has enough cash on hand to cover a multiple of its required cash outflows in 2008, and the asset/liability management business has sufficient cash and assets to cover all of its maturing liabilities in 2008 and beyond. MBIA Insurance Corporation's liquid assets and operating cash flow are expected to be more than sufficient to cover both current and anticipated future claims payments.

My Comment: MBIA Inc, the parent company, is holding the last $1.1 billion raised. This means that the executives can keep paying themselves while MBIA the insurance unit goes bust.
MBIA Keeps $1.1 Billion, Raised to Save Insurer AAA (Update1): “MBIA was criticized by Fitch Ratings, which said on April 4 the decision raised the risk that the cash may not end up as capital for the insurance unit as MBIA had promised. While Fitch downgraded MBIA to AA from AAA, Moody's Investors Service and Standard & Poor's cited the capital raising as a reason for keeping the insurance unit at AAA.”

Maybe NOT? Ha! Guaranteed WON’T. This is how the big swinging dicks make sure they get paid. If you’ve got a pension, YOU’RE most probably the sucker taking the hit. If you see any MBIA executives or accountants in the street, think of the FinancialNinja and drop quick them real quick for me.

“Regulators are waiting for MBIA to contribute the funds, according to New York State Insurance Department Deputy Superintendent for Property and Capital Markets Michael Moriarty.

“It was never our expectation that the funds raised would go anywhere other than to the insurance subsidiary,” Moriarty said. MBIA spokesman Jim McCarthy declined to comment.”

That was the plan all along. Golden parachutes for the guys who messed it all up from their giant corner offices, and pink sheets for the innocents crammed into their cubicles who just followed orders and executed corporate policy.

-- Ratings Position: In late February, Standard & Poor's and Moody's affirmed MBIA's Triple-A ratings with negative outlooks. At year-end 2007, the Company exceeded Standard & Poor's target capital requirement by $400 million and met Moody's minimum requirements for a Triple-A rating but fellshort of Moody's target capital requirement by $1.7 billion. MBIA expects to meet this target over the next two quarters.

My Comment: Nobody cares about the Triple-A rating anymore. Standard & Poor's and Moody's have squandered all credibility. Even Warren Buffet couldn’t take it anymore.

Buffett Says Bond Insurers Don't Deserve AAA Rating (Update3): “Billionaire Warren Buffett, whose Berkshire Hathaway Inc. has begun competing with MBIA Inc. and Ambac Financial Group Inc. to insure municipal bonds, said some rivals don't deserve their AAA credit ratings.

Credit-rating firms shouldn't be giving top grades to bond insurers that borrow money at 14 percent or whose stock has dropped 95 percent, Buffett said at a press conference today in Omaha, Nebraska, a day after Berkshire's annual meeting.”

-- New Business Generation: The Company had very little new business production until its Triple-A ratings were affirmed with negative outlooks by S&P and Moody's in the last week of February. Since March 1, the Company wrapped 24 new public finance issues (primary market) totaling $9.1 million in Adjusted Direct Premium, or ADP, (a non-GAAP measure), and insured 222 bonds previously purchased by investors (secondary market) for a total of $17.9 million of ADP. The Company expects continued growth in opportunities to write profitable new business.

My Comment: Hahahaha. New business was $9.1 million plus $17.9 million. That will NOT feed the monster $668 billion portfolio that MBIA currently holds. New business wont’ be there to provide the cashflow to cover the losses on their existing portfolio. With solid, stable companies, such as Warren Buffett’s new insurer, why would anybody go to MBIA? MBIA would have to cut prices drastically to entice anybody. Translation: They would have to under price risk significantly to land new business… which is exactly what got them into this mess.

Its over. MBIA is dead.

-- Investment Management Services: MBIA's asset management business continued its new business activities in the quarter, growing its external fee-for-service advisory business by almost $1 billion in assets under management. It also continued to raise funds in the asset/liability management business at advantageous pricing levels, issuing approximately $700 million of investment agreements, signaling continuing strong demand for this product. Total average assets under management for the first quarter, including conduit assets, were $64.6 billion, down 1 percent from $65.4 billion for the first quarter of 2007.

My Comment: Total average assets under management continue to shrink, despite all the talk of growth.

-- Unrealized Losses: MBIA reported a pre-tax unrealized loss on insured credit derivatives (mark-to-market) of $3.6 billion in the first quarter, which includes $0.8 billion of credit impairments and which reflects the net present value basis of the amount of the mark-to-market that MBIA expects to pay as actual losses. While attention-getting, the mark-to-market loss is far less reflective of MBIA's business than credit impairments, and does not accurately indicate actual or expected losses. In addition, mark-to-market losses, except for the impairment, do not affect the insurance company's statutory capital or rating agency capital requirements. Unlike financial institutions with tradable, liquid portfolios of derivative assets and liabilities, MBIA's contingent insurance liabilities are not typically tradable, and are not subject to acceleration or collateralization. Fair value accounting, however, results in some inappropriate comparisons of MBIA's position to those of other financial institutions who must transact or collateralize at current market values or who could be subject to accelerated payments. This causes confusion about the true impact of mark-to-market losses on the value of the Company in the current environment. The Company does not expect the full amount of cumulative mark-to-market losses to be realized, except to the extent of the $1.0 billion in impairments estimated to date.

My Comment: What are they talking even talking about? They marked-to-market when things were good and when it pumped up their balance sheet. Now that they have to mark-to-market when things are bad ‘it doesn’t matter’ and ‘isn’t relevant’. Bullshit.

-- Disclosures: In order to further facilitate investors' understanding of its insured portfolio, the Company is substantially increasing its disclosures, including providing sensitivity analysis around key assumptions. With respect to estimates of loss due to the housing downturn, MBIA is providing certain stress estimates as well as the expected amount of losses as recorded in the financial statements.

My Comment: After a 90% drop in stock price management decides to become more TRANSPARENT. Brilliant.

-- Book Value: Financial institutions are typically valued by reference to their book values, as investors' confidence in the accounting for earnings ebbs and flows. However, in estimating MBIA's economic value, management believes that investors should adjust MBIA's GAAP book value to eliminate the impact of uneconomic factors like the unimpaired portion of the mark-to-market. MBIA's book value excluding the mark-to-market loss, but including all credit impairments, is approximately $24 per share. Adjustments, primarily representing deferred and contracted future premiums, net of a loss provision, add $18 to book value per share. With these adjustments, Analytical Adjusted Book Value(a non-GAAP measure) would be approximately $42 per share, and provides an economic basis for investors to reach their own conclusions about the fair value of the Company.

My Comment: Book value INCULDING mark-to-market losses is $8.70 for March 31st, 2008, down from $29.16 for December 31st, 2007. Mark-to-market is mark-to-market. When MBIA writes these values back up, THEN that will be reflected in book value. Analytical Adjusted Book Value is a non-GAAP measure for a reason. It is NOT a generally accepted accounting principle for the simple reason that it can be ADJUSTED as needed.

Monoline Related Posts:
Quiet, Sneaky Little Downgrades: CFC, MBI
Ambac ‘Bailout’: Why Bother?
Ambac Bailout: The Wheels Come Off
Monoline Bailouts: The Great Circle Jerk

Related Posts:
Fragile Banks: More Bailouts, More Capital
The Race To The Bottom Accelerates
The South Sea Bubble and Today’s Central Banks: FRB, BOE, ECB
Dammit, Why Won’t You Learn?
The TED Spread, LIBOR and EURIBOR = Scary Bad
Mortgage Insurers (Quietly) Downgraded: CDS Spreads Scream Trouble

UK Bubble

UK Bubble: "It will all come down. Not one stone shall stand upon another."

I recently came across the blog UK Bubble.

After reading a few posts I suddenly found myself devouring the archives to catch up on everything I had missed.

The quality, depth and clarity of each argument and each post is truly impressive. Very informative. Very practical.

The UK Bubble is now on my daily 'must read' blog list. I most definitely recommend people check it out.