The Collection Agency - Weekly Report
Welcome to the weekly report. The turmoil in credit markets continues and attention moves to CDS, the Federal Reserve gets worried about its credibility and the US markets get a boost 15 minutes from the end of Fridays close. We finish with a quick recap of some stocks we looked at last week and look around to see if anything else catches our eye.
Firstly an update to the continuing and widening collapse of the Municipal Bond prices as the failures in the auction rate bond (ARB) markets grow. Last week I mentioned 3 market makers who had stopped supporting ARB with their own capital to support prices. That list has grown, in addition to Citi, Goldman Sachs and Lehman Bros you can now add UBS, Morgan Stanley and Merrill Lynch. Without wanting to labour the point that's 6 of the biggest Investment Brokers / Banks that are effectively saying either the Muni bond market is toxic or they do not have the capital to support the Muni market. I firmly believe it is the latter.
I want to show you one chart that supports my assertion. It's from the Fed:
Colin Twiggs of Incredible Charts produced the chart, which saved me having to do it. You have seen this chart in my previously written articles. Clearly the situation has deteriorated at a rapid pace and is much more serious than the credit scare last August. US banks have no reserves; they are for all intents and purposes, broke. In fact they are beyond broke and as I suggested last year banks are now sub-prime. 150% of the reserves at depository institutions are borrowed. That can only mean one thing, the banks have "lost" 1.5 times their original non borrowed reserves. Not only have they lost what they had, they went on and lost half as much again. If you or I did that, we would be bankrupted and probably arrested for attempting to defraud the lender.
Notice the amount of total reserves (yellow line) is roughly equal and appears cyclical to the Federal Reserve TAF lending programme. The Fed is no longer the "lender of last resort" it has become the de-facto Bank of the USA.
I am amazed that so little attention has been paid to this state of affairs. The Northern Rock debacle, one overstretched bank in the UK, has had all the headlines, yet with the WHOLE banking industry in the US insolvent you hardly see it mentioned.
Now, I am not going to give you advice on what to do about your cash on deposit and I don't want you to think I am being overly bearish but??.I have called this whole fiat credit collapse correctly from the beginning. No, I don't want a pat on the back. I just want to read the next line carefully.
If I had money in a US bank today, I would be worried. So worried I would withdraw the cash before new regulations are passed restricting account activity. I know it sounds alarmist but then the first warnings always do.
This week saw talk of problems becoming apparent in the Credit Default Swap markets, a leveraged, counterparty insurance and re-insurance scheme designed to protect a buyer of debt against a default event using a third party who sells the protection.
For some of us, this is old news and signs of trouble have been around for sometime. Spreads on corporate debt have widened significantly of late. The Markit iTraxx Europe Index (yes Europe, you didn't think it was just the USA having problems did you?) composed of the prices of CDS for 125 investment graded companies saw spreads widen to 135 basis points, up from 91bp just 2 weeks ago. The higher the spread, the more perceived risk is seen in the markets. Get this, investors in this market are getting compensated for possible default rates up to 5.5 times higher than the highest recorded levels in the past 50 years.
Maybe I'm wrong to point out rising risk, maybe it's just over reaction and the spreads will fall back. Then again it is the market telling you about risk, not me.
The Federal Reserve seems to have a problem. It is becoming clear that even members of the committee are worried about the direction of Fed policy. The concern seems to be rooted in very economic soul of the committee members. Those that believe interest rates should go no lower or, indeed rise, are becoming more vocal. The latest to speak out was Dallas Fed President Richard Fisher. Although he has attracted a reputation for speaking "off message" thanks to the 8th innings remarks about interest rate rises, he has since then been a very clear and concise speaker. After voting against the latest cut in FFR (9-1) he has been explaining why he is worried.
Mr Fisher is no career economist, he is not from the Bernanke school. It may well explain why he feels strongly about the current situation. From the Dallas Morning News here is a quick run through his roots:
"Even more intriguing than Mr. Fisher's lonely vote at the Fed is the path this globe-trotter, self-made man and failed politician took to get there. After his birth in Los Angeles to a father who had emigrated from Australia and a Norwegian mother who grew up in South Africa, Mr. Fisher moved with his parents to Mexico City, where he grew up speaking Spanish at school and playing on a youth baseball team coached by Norman Borlaug, the future Nobel Peace Prize winner.
Soon afterward, the family fell on hard times and moved back to the U.S., to Miami. Mr. Fisher, then about 11, remembers going with his mother to a pawn shop there, where she sold her engagement ring for cash to buy clothes for her children.
In another shift in fate, the boy won a scholarship to a private military academy.
Years later, after studying at England's Oxford University and collecting a degree from Harvard, as well as a Stanford University MBA, he would become a wealthy fund manager - moving between the financial world and government service in a career distinguished by intellectual curiosity and an independent streak."
I fully suspect Mr Fisher does not rely on computer models of the economy to get his "feel" for how things are going, unlike the Fed committee chairman. This guy has been there and done it, successfully too, unlike Greenspan.
Mr Fisher understands poverty, he lived it. He knows the effects it has and the struggles it causes. He is genuinely afraid of price inflation devaluing the money in peoples' pockets. Another snippet from the Dallas Morning News tells us all we need to know about Mr Fisher:
"There's a photo of Mr. Fisher with current Fed Chairman Ben Bernanke, and a portrait of former Fed Chairman Paul Volcker, one of Mr. Fisher's heroes."
Mr Fisher understands a simple rule, if you lower interest rates you ignite $ devaluation. Do this during a period of commodity bullishness and the basics become more expensive. It also raises what the Fed calls inflation expectations. Simply put that means if people perceive that prices are going to rise, they demand more money for their labour. True monetary inflation then follows. (NB, this is mainstream thinking, not mine - I see a different outcome.)
I suspect what is really worrying Mr Fisher is that despite repeated large cuts in the FFR, real interest rates for consumers, especially those hurting right now, have not fallen. Indeed the rates at Freddie and Fannie, for instance, have been rising of late. Why administer a medicine that has no effect on the illness?
His latest remarks in a speech at Fort Worth seem to be alluding to such:
'We're trying to bridge the gap, between what most people believe will be two quarters of 'anemia' in the economy, and prevent that turning into a recession, but not at the same time 'stir those dreadful embers of inflation.'
He went on to mention that the fallout from the credit markets cannot happen without some pain and that pain cannot be removed by the Federal Reserve.
With Bernanke talking of a "consensus committee" my bet is that although only Fisher voted against a cut at the last meeting, many of the committee share his reservations on current Fed policy. As the last Fed minutes pointed out:
"When prospects for growth had improved, a reversal of a portion of the recent (rate)-easing actions, possibly even a rapid reversal, might be appropriate,"
That should be taken as a warning by anyone intending to borrow at current low rates. You do not want to be on the wrong side of a 1% rise in FFR.
A funny thing happened on the way to the market close on Friday. The markets took off with about 40 minutes of the session left, tagging on around 250 points.
The reason touted around appears to be this announcement:
"US BONDS/INSURANCE: CNBC is cited saying a bailout at bond insurer AMBAC may be reported Mon. or Tues; this news is aiding stocks."
I saw this happen, I was trading at the time and had closed out a long (I don't hold Index trades over weekends). The sell side of the Dow futures went away on holiday, resulting in trades on the buy side leap-frogging higher. A shame I didn't hang on a little longer but that's trading. It looks to me as though the market believes, or wants to believe the bail-out is good news. I have a couple of worries on that score.
Firstly, since when are bail-outs "good" news?
Secondly, another announcement on Friday hasn't been picked up on and it's much more important:
To read the rest of the Weekly Report with updates on last weeks watchlist, click here.