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Friday, December 14, 2007

Inflation, SIVs and Balance Sheets

On top of the largest spike in PPI since 1973, European inflation isn’t exactly tame.

European Inflation Rises More Than Initial Estimate (Update2): “European inflation accelerated more than initially estimated in November, to the fastest pace since May 2001, preventing central bankers from cutting interest rates as economic growth slows.

The inflation rate in the 13-nation euro area rose to 3.1 percent from 2.6 percent in October, the European Union's statistics office in Luxembourg said today. That exceeded an initial 3 percent estimate published on Nov. 30. Prices rose 0.5 percent on the month.

The European Central Bank has refrained from following counterparts in the U.S., U.K. and Canada in reducing borrowing costs, citing the risk that surging commodity prices and declining unemployment will trigger an inflationary spiral. ECB President Jean-Claude Trichet said Dec. 6 some governing council members favored raising interest

Citigroup Rescues SIVs With $58 Billion Debt Bailout (Update2): “Citigroup Inc. will take over seven troubled investment funds and assume $58 billion of debt to avoid forced asset sales that would further erode confidence in capital markets. Moody's Investors Service lowered the bank's credit ratings.

The biggest U.S. bank by assets will rescue the so-called structured investment vehicles, or SIVs, taking responsibility for their $49 billion of assets, the New York-based company said in a statement late yesterday.”

The balance sheet is feeling the pressure and Moody’s reacted swiftly.

“Moody's lowered Citigroup's credit rating to Aa3, the fourth-highest level, from Aa2 late yesterday. The bank will probably ``take sizable writedowns'' for securities backed by home mortgages and collateralized debt obligations, Moody's Senior Vice President Sean Jones said in a statement.”

That makes borrowing for Citigroup more expensive.

“Citigroup got a $7.5 billion cash infusion last month by selling a 4.9 percent stake to the ruling family of Abu Dhabi after the bank's capital ratio fell below the company's target.”

With the SIV now packed into the balance sheet, another round of writedowns will definitely result in the need for more cash infusions from sovereign wealth funds.

Money-Market Rates Fail to Respond to Bank Measures (Update4): “Money markets failed to respond for a second day to the biggest effort by central banks in six years to restore confidence in the world financial system.

The euro interbank offered rate banks charge each other for three-month loans stayed near a seven-year high, falling 1 basis point to 4.94 percent, the European Banking Federation said today. That's 94 basis points more than the European Central Bank's benchmark interest rate, close to the highest since 1999. The two- week rate soared a record 80 basis points to 4.95 percent.”

The market clearly doesn't believe central banks can do anything about this crisis.

“Two-week rates soared because today is the first day on which a cash loan in euros for that term will cover a borrower's needs through to the end-of-year holiday period. The rate rose 81 basis points to 4.95 percent, the highest since April 2001, the BBF said. The two-week rate for dollars jumped 73 basis points to 5.11 percent.

Australian money-market rates climbed to the highest since 1996 earlier today and Japanese rates held near a 12-year high.”

This is definitely a sign of distress.

Thursday, December 13, 2007

Grand Alliance of Central Banks Fails to Impress

A grand alliance of Central Banks makes for great headlines. Unfortunately it doesn’t accomplish much beyond generating a fleeting warm fuzzy feeling… $24 billion? That’s not even enough for one troubled financial firm. Countrwide, Washingto Mutual, UBS, Citigroup could each blow through that by themselves in an attempt to stay solvent.

Euribor Stays at 7-Year High, Defying Central Banks (Update1): “Interest rates on loans in euros stayed at a seven-year high, a day after global central banks teamed up in an attempt to thaw a freeze in money markets.

The three-month borrowing cost was at 4.95 percent, its highest level since December 2000, according to prices from the European Banking Federation today. That's 95 basis points more than the European Central Bank's benchmark interest rate and up from 4.18 percent at the start of July, before losses related to subprime mortgages contaminated money markets.

Policy makers in the U.S., U.K., Canada, Switzerland and the euro region agreed to the first coordinated action since the Sept. 11, 2001, terrorist attacks. The Federal Reserve said it will make $24 billion available to increase the supply of dollars into Europe. Banks have reported more than $66 billion in losses linked to U.S. subprime mortgages this year.

“It's not going to help us find an exit to this crisis,” said Cyril Beuzit, head of interest-rate strategy at BNP Paribas SA in London. “These measures aren't going to address the root cause of the crisis. Banks are still reluctant to lend money to each other because there are serious concerns about potential further bad news.””

Banks SHOULD be reluctant to lend money to each other because a couple of them aren’t going to be able to pay it back.

“The U.S. central bank also plans four auctions that will add as much as $40 billion. The Bank of England said it would widen the range of collateral it will accept on three-month loans.”

‘Widening’ the range of collateral is a clever way of avoiding saying ‘we are going to lower the quality of collateral’. Brilliant. Loose credit standards created this mess in the first place. Time to loosen the credit standards exactly where they are supposed to be the tightest to ‘save’ the markets.

U.S. Treasuries Little Changed as Central Banks' Efforts Fail: “Treasury notes were little changed as interest rates charged by banks for loans in the euro region stayed near a seven-year high, suggesting a Federal Reserve-led plan to revive credit markets is failing.

The three-month borrowing cost for euros was at 4.95 percent, its highest level since December 2000, according to prices from the European Banking Federation today. Policy makers in the U.S., U.K., Canada, Switzerland and the euro region announced the first coordinated action since Sept. 11, 2001.

The so-called “TED” spread, the difference between three- month Treasury bill yields and the London interbank offered rate for the same maturity, was at 2.20 percentage points, near the widest since August. The increase indicates banks are charging more to lend to each other.”

Yen Climbs From One-Month Low Against Dollar on Credit Losses: “The yen rose from a one-month low against the dollar on speculation a Federal Reserve-led plan to provide banks with extra funds won't resolve credit-market turmoil, prompting investors to exit so-called carry trades.

The yen gained against all 16 most-active currencies after Bank of America Corp. and Wachovia Corp. said provisions for loan defaults will increase, spurring investors to repay funds borrowed in Japan to buy higher-yielding assets. The yen strengthened the most against the Brazilian real, South African rand, Australian dollar, beneficiaries of the carry trade.”

Time to unload risky assets… again.

U.S. November Producer Prices Rise 3.2%; Core Up 0.4% (Update1): “Prices paid to U.S. producers climbed at the fastest pace in 34 years in November, pushed up by surging costs for fuel. Excluding food and energy, prices rose the most since February.

The 3.2 percent gain, twice as much as economists had forecast, follows a 0.1 percent increase in October, the Labor Department said today in Washington. Core prices, which exclude food and energy, jumped 0.4 percent after no change the prior month.

The rising prices highlight the Federal Reserve's concern that energy and commodity costs may feed inflation at the consumer level. The Fed this week cut its benchmark rate for a third time in four months and said it would “continue to monitor inflation developments.”

Economists had forecast a 1.5 percent increase in producer prices, according to the median of 77 estimates in a Bloomberg survey. Forecasts ranged from 0.3 percent to 2.5 percent. Excluding food and energy, the median forecast was for an increase of 0.2 percent following no change the prior month.

November's gain in producer prices was the biggest since August 1973, according to Labor Department figures.”

Makes sense now why the Fed only cut 25 basis points. Greatest increase since 1973. Hmmmmmmm. I don’t see anything in the near term that would change that since the US dollar slide is not likely to reverse anytime soon. Stagflation here we come… (You did notice Chinas recent inflation numbers right? China Inflation Reaches 11-Year High, Trade Gap Grows)

U.S. November Retail Sales Rise More Than Forecast (Updated1): “Retail sales in the U.S. increased twice as much as forecast in November, easing concern near- record fuel prices and falling home values would trip up consumers.

The 1.2 percent increase, the biggest since May, followed a 0.2 percent gain the prior month, the Commerce Department said today in Washington. Purchases excluding automobiles jumped 1.8 percent, the most since January 2006.

More jobs and higher incomes may cushion the damage from $3-a-gallon gasoline and declining home prices, preventing a collapse in demand, economists said. The increase bears out the Federal Reserve's decision this week to reduce the benchmark interest rate by just a quarter point. Policy makers took additional steps yesterday to spur bank lending.”

Not bad actually. All things considered.

Wednesday, December 12, 2007

The Global 'Decoupling Theory' is Garbage

Asian Stocks Fall Most in 3 Weeks on Growth Concern; Banks Drop: “Asian stocks declined, sending a regional benchmark to its biggest loss in three weeks, after the Federal Reserve said U.S. economic growth is slowing and Morgan Stanley said Japan may enter a recession.

Mizuho Financial Group Inc. and HSBC Holdings Plc led banks lower on speculation a quarter-point interest-rate cut by the Fed yesterday won't rekindle growth in the world's largest economy. Canon Inc., BHP Billiton Ltd. and PetroChina Co. retreated on concern demand for electronics and raw materials will slump.

“Market sentiment has been shaken,” said Yang Haeman, who manages the equivalent of almost $1 billion at NH-CA Asset Management in Seoul. “A U.S. slowdown is already quite certain and investors now are also worried that this will result in a global slowdown.””

They should be worried. The ‘decoupling theory’ was a weak one at best.
Naked Capitalism presents the case in the post America Faces Day of Reckoning With Debt:

“Evans-Pritchard explicitly disagrees with the "decoupling" thesis, which says that even if the US has a sharp contraction, the rest of the world need not be affected.”

Nouriel Roubini has taken issue with this idea since 2006. His updated views: Recoupling rather than Decoupling: the Forthcoming Contagion to China, East Asia and Emerging Markets

This is a global economy. This is a global credit bubble. This is a global credit crunch. Therefore, the consequences will be GLOBAL.

Tuesday, December 11, 2007

Fed Decisions Ruins The Charts for the Bulls

Fed Lowers Rate by a Quarter Point to 4.25 Percent (Update4): “The Federal Reserve lowered its benchmark interest rate by a quarter-point to 4.25 percent, while signaling officials are open to further cuts if the housing slump and credit squeeze worsen.

Stocks fell and Treasury notes surged after the decision, which some economists said fell short of what's needed to spur lending and avert a recession. The central bank also pared the discount rate by a quarter-point to 4.75 percent, counter to speculation among investors that the Fed would make a deeper reduction.

"Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation,'' the Federal Open Market Committee said in a statement after meeting today in Washington. The change ```should help promote moderate growth over time.''

The Fed dropped language from its previous statement that risks of slower growth and faster inflation were ``roughly'' balanced. The economy is faltering after a third-quarter surge as house prices drop, consumer spending slows and banks tighten lending standards for even their best customers.”

Treasuries Rise Most in Three Years as Fed Rate Cuts Disappoint: “Treasuries rose the most in more than three years on concern that the Federal Reserve's quarter- point reductions in borrowing costs won't be enough to avoid the risk of recession.

The rally pushed yields on two-year notes, more sensitive to expectations of further rate cuts than longer-maturity debt, back below 3 percent. The central bank lowered its target for overnight loans between banks to 4.25 percent and the rate it charges banks for direct loans to 4.75 percent, disheartening investors expecting a bigger reduction in the discount rate.”

U.S. Stocks Fall After Fed Cuts Benchmark Rate by Quarter Point: “U.S. stocks tumbled the most in a month as investors speculated the Federal Reserve's quarter- point interest-rate cut will fail to prevent a recession.

Bank of America Corp. and Citigroup Inc. led all 93 companies in the S&P 500 Financials Index lower, and homebuilder shares fell the most ever after the Fed said the housing slump is getting worse. Washington Mutual Inc., the largest U.S. savings and loan, posted its steepest drop in a month on plans to write down the value of its home-lending unit. Freddie Mac, the second-biggest mortgage-finance company, slid for a third day after forecasting a wider loss than analysts estimated.

The S&P 500 lost 38.31, or 2.5 percent, to 1,477.65. The Dow Jones Industrial Average retreated 294.26, or 2.1 percent, to 13,432.77. The Nasdaq Composite Index decreased 66.6, or 2.5 percent, to 2,652.35. Almost 14 stocks declined for every one that rose on the New York Stock Exchange. Treasuries rallied and the dollar weakened against the euro and yen.

“It should have been more aggressive,'' said Quincy Krosby, who helps manage $330 billion as chief investment strategist at the Hartford in Hartford, Connecticut. “The market's instinctive reaction is that it's too little too late and that the Fed is behind the curve.””

Forget about too little too late. That’s not it at all. Its more that the cuts don’t matter much. They can’t ‘fix’ the situation. The cuts have little affect on what really matters: LIBOR and EURIBOR rates… these cuts won’t inflate risky assets because lenders of all kinds are cutting back on their risk exposures by tightening all their credit standards.

Monday, December 10, 2007

UBS Confessess, More SIVs go on Balance Sheet, Bond Sales Collapse

UBS to Sell Stakes After $10 Billion in Writedowns (Update4): “UBS AG will write down U.S. subprime mortgage investments by $10 billion, the biggest such loss by a European bank, and replenish capital by selling stakes to investors in Singapore and the Middle East.

Europe's largest bank by assets plans to raise 13 billion Swiss francs ($11.5 billion) selling bonds that will convert into shares to Government of Singapore Investment Corp. and an unidentified Middle Eastern investor, Chairman Marcel Ospel said on a conference call with reporters today.

UBS also plans to sell 36.4 million treasury shares that it previously intended to cancel, raising about 2 billion francs, and proposed replacing the 2007 cash dividend with stock, boosting capital by 4.4 billion francs. The convertible bond sale and dividend change must be approved by an extraordinary shareholders meeting in mid-February, the bank said.

UBS plans to raise a total of 19.4 billion francs through all the measures, which will improve its so-called Tier 1 capital ratio, a measure of financial strength, to more than 12 percent from 10.6 percent on Sept. 30.”

That’s a pretty massive write down and some serious dilution. UBS is trading up pre-market. Go figure.

Societe Generale Takes On $4.3 Billion of SIV Assets (Update3): “Societe Generale SA, France's second-biggest bank by market value, will bail out its $4.3 billion structured investment vehicle after losses related to the collapse of the U.S. subprime-mortgage market.

Societe Generale will take on assets including $387 million of bonds backed by subprime mortgages, the Paris-based lender said in an e-mailed statement today. The company rose 1.6 percent to 108.19 euros ($159.25) as of 1:35 p.m. in Paris.

The rescue of Societe Generale's SIV follows similar actions by London-based HSBC Holdings Plc and Rabobank Groep NV in Utrecht, Netherlands, to limit losses from a potential fire sale of assets. The falling value of Societe Generale's Premier Asset Collateralized Entity Ltd., or PACE, pushed it close to having to name a trustee to protect senior debt holders, Standard & Poor's warned on Dec. 7.”

Putting these assets on their balance sheets limits the amount of capital these institutions can throw around in new loans to businesses and consumers.

Global Bond Sales Tumbled 66% Last Quarter, BIS Says (Update1): “Governments and companies reduced sales of bonds and money-market securities by 66 percent to a net $396 billion worldwide in the third quarter as credit markets slumped, the Bank for International Settlements said.

Borrowing declined from a record $1.17 trillion in the second quarter, according to a report today by the BIS, which has monitored financial markets for central banks since 1930. The BIS figures subtract maturing debt from sales.

The biggest financial institutions cut lending after writing down more than $70 billion on securities related to bad U.S. home loans. Europe and emerging markets led the decline, with borrowing in Germany, France and the U.K. dropping 77 percent to $61 billion. That compares with a 56 percent decline in the U.S. to $165 billion. Emerging market borrowing plunged to $1.4 billion from $67.1 billion in the second quarter.”

This will definitely have a negative impact on the future earnings of the entire financial sector.