Dead Men Walking
Too many Hedge Funds, banks and lenders are dead men walking. They continue to move and talk and walk but it is just a matter of time before the cord is cut.
Citigroup is probably one of the most zombie-like. The waited untl after markets closed friday to announce that they would include the SIV on its balance sheet. The SIV is the packaging around the CDOs which, in itself, is just a packaging of mortgages and associated loans.
Citi's SIV contains $58B in debt, $13B in cash, and $49B in CDOs. In essence, $107B of non-performing nightmares. Citi has $2.3T in assets, so this is ~5% of their position. They have to raise cash - which means selling assets, paring back expenses, and making fewer loans.
And then there is the Bank of America fund that refuses to let investors access their money. Some $31B is unavailable, meaning it is invested in CDOs that are worthless.
A third datapoint I want to raise is the clear inability of the Fed to influence the credit markets. In less than 3 months, the Fed has lowered interest rates a total of 100 basis points (1%). Yet mortgage rates stay flat.
The 30 year mortgage rates are flat and even up since the recent cut.
The 3 Year ARM rate is also up since the recent rate cut, and is down only 40 basis points.
Part of the rate flattening comes from the return of the risk premium. But the rest really has to do with inter-bank lending. Go back to the Citi group and BoA examples: both major lenders need cash to stay afloat. A mad scramble for credit is driving up lending rates. And with BoA, the bigger problem is that their investors ($25M is the minimum investment in that fund) can not get to their assets. Everybody needs cash but nobody has it.
This is the liquidity problem facing the world credit markets. But there are really 2 parts:
1. Access to cash and credit - This is handled easily. There is plenty of cash around, and the market is already responding to the higher demand. One way is to charge more for loans. The other is for Central Bankers to print and provide more cash.
2. Eradication of wealth. Much of the money that flows through today's sytem derives from leverage. A $1 deposit gets loaned out by Citi until it is $10 in loans. A market crash or default in loans erases assets (aka cash or wealth). The drop in a stock price should not be more than a loss of paper profits, except that hedge funds used the paper profits as leverage for more buying and lending.
The chain breaks. At the minimum, no more buying can take place. But generally a frenzy of raising cash occurs - Investors may demand money back, forcing the fund to sell assets, further eroding values. Or funds may want to borrow and their assets are not sufficient because the value has dropped.
At heart, this is actually a healthy thing. Assets inflated beyond common sense are returned to reality. So why the panic? Why is Mauldlin posting a panicky newsletter spreading doom and gloom? Money is very cheap and very available. If money were a problem, how could someone borrow $300B to buy ETrade assets last month?
Sure, money just got more expensive, but it is low in nominal terms, in absolute terms, and even historically. Sure, it isn't 1%, but neither is it 10% like it was in the recent past. And 6% is not that bad in absolute terms, especially considering the availability of gnerous terms (I get plenty of offers from credit agencies for 0% rates for 12 month loans). And speaking nominally, 6% is really just inflation plus 2% (I am, of course, speaking of real inflation rates that the economy faces and not the doctored CPI).
So the first part of the liquidity issue - scarcity of funds - is really a non issue. It's certainly tighter, but China, Russia and the Arab states have Trillions of dollars to spare.
The reason for the panic - fund managers are realizing that they are soon to be jobless. mauldlinand his chums atthe funds are scared for themselves, not the economy at large. For the broader economy, the liquidity problems are overstated. Let me repeat - there is plenty of money. It may be a tad more expensive, but there is plenty of it. And it's likely that there will be plenty of funds and money managers looking around desperate for investors.
The big losers are these funds and money managers. Asset value is the next big loser. Because fire sales erode prices. And with funds on the run, they will not be able to bid up stock prices. That was the defining moment of the dotcom crash - suddenly nobody was buying and stock prices aligned with actual sales and profits. Actually, they went below.
The outcome is simple to see:
1. Stock prices will ease without massive foreign investors
2. M&A activity will shift focus away from growth through acquisition and instead become a part of staying alive
3. Asset devaluation will make property values drop fast
4. Cash is King
Citigroup is probably one of the most zombie-like. The waited untl after markets closed friday to announce that they would include the SIV on its balance sheet. The SIV is the packaging around the CDOs which, in itself, is just a packaging of mortgages and associated loans.
Citi's SIV contains $58B in debt, $13B in cash, and $49B in CDOs. In essence, $107B of non-performing nightmares. Citi has $2.3T in assets, so this is ~5% of their position. They have to raise cash - which means selling assets, paring back expenses, and making fewer loans.
And then there is the Bank of America fund that refuses to let investors access their money. Some $31B is unavailable, meaning it is invested in CDOs that are worthless.
A third datapoint I want to raise is the clear inability of the Fed to influence the credit markets. In less than 3 months, the Fed has lowered interest rates a total of 100 basis points (1%). Yet mortgage rates stay flat.
The 30 year mortgage rates are flat and even up since the recent cut.
The 3 Year ARM rate is also up since the recent rate cut, and is down only 40 basis points.
Part of the rate flattening comes from the return of the risk premium. But the rest really has to do with inter-bank lending. Go back to the Citi group and BoA examples: both major lenders need cash to stay afloat. A mad scramble for credit is driving up lending rates. And with BoA, the bigger problem is that their investors ($25M is the minimum investment in that fund) can not get to their assets. Everybody needs cash but nobody has it.
This is the liquidity problem facing the world credit markets. But there are really 2 parts:
1. Access to cash and credit - This is handled easily. There is plenty of cash around, and the market is already responding to the higher demand. One way is to charge more for loans. The other is for Central Bankers to print and provide more cash.
2. Eradication of wealth. Much of the money that flows through today's sytem derives from leverage. A $1 deposit gets loaned out by Citi until it is $10 in loans. A market crash or default in loans erases assets (aka cash or wealth). The drop in a stock price should not be more than a loss of paper profits, except that hedge funds used the paper profits as leverage for more buying and lending.
The chain breaks. At the minimum, no more buying can take place. But generally a frenzy of raising cash occurs - Investors may demand money back, forcing the fund to sell assets, further eroding values. Or funds may want to borrow and their assets are not sufficient because the value has dropped.
At heart, this is actually a healthy thing. Assets inflated beyond common sense are returned to reality. So why the panic? Why is Mauldlin posting a panicky newsletter spreading doom and gloom? Money is very cheap and very available. If money were a problem, how could someone borrow $300B to buy ETrade assets last month?
Sure, money just got more expensive, but it is low in nominal terms, in absolute terms, and even historically. Sure, it isn't 1%, but neither is it 10% like it was in the recent past. And 6% is not that bad in absolute terms, especially considering the availability of gnerous terms (I get plenty of offers from credit agencies for 0% rates for 12 month loans). And speaking nominally, 6% is really just inflation plus 2% (I am, of course, speaking of real inflation rates that the economy faces and not the doctored CPI).
So the first part of the liquidity issue - scarcity of funds - is really a non issue. It's certainly tighter, but China, Russia and the Arab states have Trillions of dollars to spare.
The reason for the panic - fund managers are realizing that they are soon to be jobless. mauldlinand his chums atthe funds are scared for themselves, not the economy at large. For the broader economy, the liquidity problems are overstated. Let me repeat - there is plenty of money. It may be a tad more expensive, but there is plenty of it. And it's likely that there will be plenty of funds and money managers looking around desperate for investors.
The big losers are these funds and money managers. Asset value is the next big loser. Because fire sales erode prices. And with funds on the run, they will not be able to bid up stock prices. That was the defining moment of the dotcom crash - suddenly nobody was buying and stock prices aligned with actual sales and profits. Actually, they went below.
The outcome is simple to see:
1. Stock prices will ease without massive foreign investors
2. M&A activity will shift focus away from growth through acquisition and instead become a part of staying alive
3. Asset devaluation will make property values drop fast
4. Cash is King
posted by Andrew at
12:13 PM
0 Comments:
Post a Comment
Subscribe to Post Comments [Atom]
<< Home