• Blog

    Daily Digest – March 6

    by Davos

    Friday, March 6, 2009, 4:04 PM

  • Comedy Central (3:00 blunders)
  • Chávez turns to Russians in gold venture
  • Country Default Risk Continues Its Rise
  • Country Default Risk Chart
  • Europe’s banks face a $2 trillion dollar shortage
  • UK: BoE Cuts Rate to 0.5%, Begins Quantitative Easing
  • Ukraine’s Tymoshenko warns of a new Iron Curtain
  • Venezuela’s Chavez tightens state control of food amid rocketing inflation & food shortages
  • Stock doom and gold boom (H/T CP)
  • Citi Breaks the Buck
  • Warren Buffett Insights
  • Lodging bubble
  • Malls
  • The Treasury Mortgage Mod Program: Should We Hope It Doesn’t Work?
  • Geography of a Recession (Zoom to get your county)
  • U.S. cities face tough questions in budget squeeze
  • 50,000 Protesters in NY, NY
  • Report: Record 5.4 Million U.S. Homeowners Delinquent or in Foreclosure
  • Negative Equity/Upside Down
  • "The End of Wall Street" Author Interview
  • Top Strategists Still Expecting a 46% Gain From Here
  • Fed Refuses to Release Bank Data, Insists on Secrecy (Update3)
  • Minyan Mailbag: Why Marked-to-Market Refuses to Die
  • Chanos on What’s Ahead



Comedy Central (3:00 blunders)


Chávez turns to Russians in gold venture

As the helicopter skims low over one of the largest undeveloped gold deposits in the world, just south of the ragtag mining town of El Dorado, the pilot shrugs bleakly.

"It’s a great shame," he says, gesturing at the scar blighting the pristine forest in south-eastern Venezuela, cleared by thousands of small-scale, illegal miners in their hunt for gold.

But after a decades-long free-for-all in which prospectors have wreaked environmental havoc while private companies have failed to extract an ounce of gold from Las Cristinas, Hugo Chávez, the president, has said it may be exploited in a joint venture between the state and a Rusoro Mining, a Russian miner.

Since oil provides more than 90 per cent of export revenues and more than half of government spending, collapsing energy prices have ignited the government’s interest in the sizeable gold reserves in order to bolster its earnings, as well as in commodities such as coffee and cacao – once Venezuela’s biggest export.

The partnership between the socialist president and the Russian company is one of the fruits of a budding friendship between Caracas and Moscow – part of the strategy of Venezuela’s anti-imperialist president to challenge US influence in the region.

"The spirit of goodwill between the two governments has certainly helped us a lot," says George Salamis, president of Rusoro, which has already acquired and turned round two struggling mining operations here in the past year.

Some foreign companies have had a rough ride in Venezuela in recent years as Mr Chávez sought to make an example of capitalist companies while deepening his socialist revolution.

As well as companies affected by the state’s drive to take over "strategic" industries during the past two years, one of the companies with the most disappointing performance has been Canada’s Crystallex, which has been waiting for a permit to develop Las Cristinas since it was granted the concession in 2002.

"My main concern is removing the perception that Venezuela is a risky place to do business, which has been exacerbated by what has happened at Las Cristinas over the last 15 years," says Mr Salamis.

After buying the operations of US-based Hecla and South Africa’s Gold Fields in 2008, Rusoro is the only international company extracting gold in Venezuela. With control of Las Cristinas as well as the neighbouring Brisas project, which is controlled by US-based Gold Reserve, Rusoro would add to its 10m ounces of reserves a further 27m ounces of gold, accounting for the majority of Venezuela’s 50m ounces of deposits.

But there are significant hurdles. The unpredictability of doing business in Venezuela is exemplified by the insistence of Crystallex that it has not been notified of the government’s intention to work with Rusoro instead, despite "continual communication with senior Venezuelan officials".

Rusoro’s attempt to take over Gold Reserve’s Brisas project has also not gone as smoothly as hoped, after a Canadian court derailed its all-stock offer, ruling that it had gained improper access to Gold Reserve’s confidential information.

Country Default Risk Continues Its Rise

Below we highlight sovereign debt default risk as measured by credit default swap prices. The list below is sorted by year to date percentage change, and as shown, Japan’s default risk is up the most in 2009, although it remains on the low side when compared to other countries. The United States’ default risk is up 41% year to date. All CDS prices, with the exception of the US, are priced in US dollars, while US CDS prices are quoted in Euros. Sovereign debt insurance makes you wonder, especially for the big countries that are probably "too big to fail." If the US defaults, will anyone that sells the insurance contracts really be able to pay off the claims?

Lots of traders out there don’t use CDS as an actual hedge for bonds they own, but instead they buy them simply because they think default risk will rise so they can sell the CDS at a higher price. Traders could care less if the firms writing the contracts can pay off the insurance as long as they’re not the last ones holding the bag when the music stops. And those that do buy something like a US sovereign debt CDS as a hedge do it in order to meet compliance and risk regulations, not because they think it will pay off. As these examples and the mess with the Lehman bankruptcy and the AIG bailout illustrate, the whole CDS game is pretty messed up.

Country Default Risk Chart

Europe’s banks face a $2 trillion dollar shortage

European banks face a US dollar "funding gap" of almost $2 trillion as a result of aggressive expansion around the world and may have difficulties rolling over debts, according to a report by the Bank for International Settlements.
The BIS said European and British banks have relied on an "unstable" source of funding, borrowing in their local currencies to finance "long positions in US dollars". Much of this has to be rolled over in short-term debt markets.
"The build-up of large net US dollar positions exposed these banks to funding risk, or the risk that their funding positions could not be rolled over," said the BIS.

The report, entitled "US dollar shortage in global banking", helps explain why there has been such a frantic scramble for dollars each time the credit crisis takes a turn for the worse. Many investors have been wrong-footed by the powerful rally in the dollar against almost all currencies, except the yen.

British banks had accumulated a dollar "funding gap" of $300bn by mid 2007. The latest BIS data up to the third quarter of 2008 shows that this exposure has been trimmed by "deleveraging" but it still largely hanging over the UK financial institutions.

Swiss banks had a funding gap of $300bn at the onset of the credit crunch, an extremely high figure relative to Swiss GDP. German banks were $300bn short, and Dutch banks were $150bn short. Belgian and French banks were neutral.

The BIS said the total "funding gap" in dollars was around $2.2 trillion at the peak, when money market liabilities are included. This had fallen to around $2 trillion by the time of the Lehman Brothers collapse. The data is collected with a lag but it appears that there are still huge dollar liabilities to be covered.

Simon Derrick, currency chief at the Bank of New York Mellon, said the implications are obvious. "The global bullion of the last eight years was funded on dollar balance sheets, so the capital destruction we’re seeing leaves banks starved for dollars. Dollar is clearly going to appreciate a lot further," he said.

UK: BoE Cuts Rate to 0.5%, Begins Quantitative Easing

From The Times: Bank to ‘print’ £75bn of new money as it cuts rate:

The Bank of England … confirmed it is beginning a strategy of so-called "quantitative easing".

The MPC ordered another half-point cut in base rate from an existing 1 per cent that was already the lowest in the Bank’s 314-year history to a new all-time low of 0.5 per cent.

The MPC’s decision to press on rapidly with QE, signalled a fortnight ago in minutes of its last meeting, means that it will now begin buying from commercial banks a range of corporate bonds (businesses’ IOUs) and Treasury gilt-edged stock or "gilts" (Government IOUs).
With quantitative easing, the Fed (or the BoE in this case) prints money to buy treasuries (gilts) or other assets. The goal is to expand the monetary base.

But as Krugman noted last year, the results might be disappointing: The humbling of the Fed (wonkish).

[T]he Bank of Japan tried that, under the name "quantitative easing;" basically, the money just piled up in bank vaults. To see why, think of it this way: once T-bills have a near-zero interest rate, cash becomes a competitive store of value, even if it doesn’t have any other advantages. As a result, monetary base and T-bills – the two sides of the Fed’s balance sheet – become perfect substitutes. In that case, if the Fed expands its balance sheet, it’s basically taking away with one hand what it’s giving with the other: more monetary base is out there, but less short-term debt, and since these things are perfect substitutes, there’s no market impact. That’s why the liquidity trap makes conventional monetary policy impotent.

Note: Krugman’s comments apply when the T-bill (or other assets) have a near-zero rate. So it depends on what assets the BoE buys.

Ukraine’s Tymoshenko warns of a new Iron Curtain

The Ukrainian Prime Minister Yuliya Timoshenko warned in a newspaper commentary of a new "Iron Curtain" in Europe and calls on the European Central Bank to support those countries not in the euro zone. The euro should not lead to an Iron Curtain, which puts non-Euro countries into a higher risk class, which investors would no longer dare trust, Timoshenko wrote in Le Figaro.

Ukraine has asked the International Monetary Fund (IMF) for emergency aid to stabilize the economy. The country has been hit hard by the global crisis. The currency has lost more than 40 percent of its value since the autumn. The IMF, however, has delayed the transfer of the second loan tranche of a total of 16.4 billion U.S. dollars (13 billion euros) and called on the country to make its crisis management more urgent.

After the Fed also offered currency swaps to Brazil, Mexico and South Korea, Tymoshenko has called for a similar scheme in Europe: "The ECB should also provide access to these tools to countries outside the monetary area."

Venezuela’s Chavez tightens state control of food amid rocketing inflation & food shortages

White rice, the staple for many Venezuelans, can now only be sold at a price of 2.15 bolivares (71p) per kilo. Private companies insist that production of that kilo costs 4.41 bolivares (£1.46) and that government regulations are impossible to fulfil and companies will quickly go broke. Companies that are dedicated to rice production must ensure that 80 per cent of their efforts are dedicated to white rice. The new regulations set production percentages, as companies were rebranding their products to avoid the government controls, like flavouring the rice, as the price restrictions apply only to white rice.

"Forcing companies to produce rice at a loss will not resolve the situation, simply make it worse," said Luis Carmona of Polar, a rice company that has been singled out by the government for trying to sidestep restrictions.

Stock doom and gold boom (H/T CP)

#1 – The Banking Crisis Will Drag On

The International Monetary Fund keeps raising estimates on bank losses, but even its recent estimate of $2.2 trillion in losses is probably way behind the curve.

On the other hand, economics professor Nouriel Roubini, who has been very prescient on this crisis, estimates total losses for in the financial industry will reach $3.6 trillion. Of the total, he calculates that American banks face half that risk. The rest is overseas.

I think there’s much more dirty laundry to be aired. We haven’t even seen much bad news yet on offshore banks, which thrive on secrecy. Maybe they’re all fine, conservatively managed institutions. Or maybe, with the financial tide going out, we’ll find a lot of the Caribbean banks have been swimming naked.

Force #2 – Real Estate Crisis is Nowhere Near a Bottom

Home prices follow income. Incomes are going down, and we are in a deflationary spiral now. I expect we’ll see both incomes and home prices fall into 2012.

Citi Breaks the Buck 

Citigroup (C) shares fell below $1 per share today, cementing its status as a penny stock. Citigroup is now the only stock in the Dow and one of six stocks in the growing list of S&P 500 stocks (AIG, ETFC, ODP, GNW, and THC) currently trading under a dollar. The only question now is when does Citi get pulled from the Dow. Although at this point does it really matter? Consider the fact that if Citi dropped to zero, given its weight in the index, it would have less than an 8 point impact on the overall price of the index. 

Warren Buffett Insights

Lodging bubble


The Treasury Mortgage Mod Program: Should We Hope It Doesn’t Work? 

First, it appears the program is a five year payment reduction program. While the guidelines are silent here, reasonable people would infer that the payment relief will be added to principal (particularly since the monthly borrower incentive for keeping current, is paid the servicer on behalf of the borrower to reduce principal, which suggests it is to offset principal increases). From the guidelines:
The Home Affordable Modification program has a simple goal: reduce the amount homeowners owe per month to sustainable levels to stabilize communities. 

Yves here. I think they mean "pay" when they say "owe".

The program keeps the previously announced construct of having the lender reduce mortgage payments so they are no more than 38% of income, then Uncle Sam kicks in and provides a subsidy to bring the level down to 31%. Now we get to the doozy:
To ensure long-term affordability, the modified payments will be kept in place for five years and the loan rate will be capped for the life of the loan. After five years, the interest rate can be gradually stepped-up by 1% per year to the conforming loan survey rate in place at the time of the modification.

So effectively, the borrower gets a teaser that over time adjusts to a fixed rate mortgage at current (low) interest rates.

Let’s think this through a second. The borrower is still under water (of course, Bernanke & Co. regard this as temporary misvaluation resulting from irrational pessimism, but the more data driven crowd sees housing prices as having moves way out of line with incomes. And the outlook for incomes isn’t exactly rosy either). The borrower therefore has no reason to invest in the house, including routine maintenance (assuming he can somehow scare up the dough). If the boiler goes, the roof leaks, he has no incentive to fix it. Similarly, if he were to sell the house (let’s say he got a good job elsewhere), he’s still faced with either negotiating a short sale or walking and leaving the bank with the property. Thus for the bank all this does is kick the can down the road, unless we assume a recovery from these levels.

Ah, but we have our good friend inflation! The Fed is desperately trying to create inflation, surely that will take hold, raising nominal prices and lifting some borrowers out of negative equity status.

Geography of a Recession (Zoom to get your county)

U.S. cities face tough questions in budget squeeze 

PHILADELPHIA (Reuters) – When a major city faces a budget shortfall of $175 million, should it close public swimming pools, reduce the size of the police force, spend less money repairing roads or raise taxes? 

Cities across America are struggling with such dilemmas as the recession blows holes in their budgets. In Philadelphia, city officials are asking the public to help them decide what to do.

With painful spending cuts, tax increases, or both on the horizon, the city has conducted a series of public meetings to give citizens the chance for the first time to have their say on the new financial plan before it is drawn up.

A majority of around 1,800 people who attended the four meetings were willing to pay higher taxes to preserve essential public services.

50,000 Protesters in NY, NY

Report: Record 5.4 Million U.S. Homeowners Delinquent or in Foreclosure 

More Americans struggled to pay their mortgage bills in the fourth quarter of 2008. A record 5.4 million U.S. homeowners with a mortgage, or nearly 12%, were either behind on payments or in foreclosure at the end of last year, according to an industry survey. 

The Mortgage Bankers Association said Thursday the percentage of loans at least a month overdue or in foreclosure was up from 10% in the July-September quarter and up from about 8% a year earlier.

The sharpest increases in loans 90-days past due were in Louisiana, New York, Georgia, Texas and Mississippi, reflecting a spreading recession and massive job losses nationwide.

The report also showed the delinquency rates for fixed-rate mortgages climbed in the fourth quarter, another sign that layoffs are taking a toll on homeowners.

The percentage of loans at least 30 days past due rose to a record 7.88%, up from 6.99% in the third quarter and 5.82% a year earlier — the biggest quarterly jump for delinquencies since the survey began in 1972.

Negative Equity/Upside down

"The End of Wall Street" Author Interview

Top Strategists Still Expecting a 46% Gain From Here

While two more Wall Street strategists lowered their year-end S&P 500 price targets recently, collectively they’re still looking for a 46% gain from the index’s current levels. As shown below, UBS, Goldman, and Credit Suisse have now lowered their year-end price targets since the start of the year. The UBS move from 1,300 to 1,100 makes Deutsche Bank the most bullish with a target of 1,140. Barclays has the lowest price target of 874, which would be a 27% increase from here.

Treasury secretary’s choice for deputy withdraws

The decision followed more than a month of intense scrutiny of her taxes and multiple interviews. No tax problems or other issues arose during Nazareth’s vetting, said the person, who requested anonymity because Geithner’s choice of Nazareth was never announced officially.

Fed Refuses to Release Bank Data, Insists on Secrecy (Update3)

March 5 (Bloomberg) — The Federal Reserve Board of Governors receives daily reports on bailout loans to financial institutions and won’t make the information public, the central bank said in a reply to a Bloomberg News lawsuit.

The Fed refused yesterday to disclose the names of the borrowers and the loans, alleging that it would cast "a stigma" on recipients of more than $1.9 trillion of emergency credit from U.S. taxpayers and the assets the central bank is accepting as collateral.

Fed secrecy was the focus of a Senate Banking Committee hearing today in which the panel’s top two members said the central bank’s reluctance to identify companies benefiting from the American International Group Inc. bailout risks undermining public confidence in the government.

"If the American taxpayer’s money is at stake, and it is, big time, I believe the American taxpayers, the people, and this committee, we need to know who benefited, where this money went," said Senator Richard Shelby of Alabama, the committee’s top Republican. "There is no transparency here. We are going to find out."

The bank provides "select members and staff of the Board of Governors with daily and weekly reports" on Primary Dealer Credit Facility borrowing, said Susan E. McLaughlin, a senior vice president in the markets group of the Federal Reserve Bank of New York in a sworn statement. The documents "include the names of the primary dealers that have borrowed from the PDCF, individual loan amounts, composition of securities pledged and rates for specific loans."

Information Shared

The Board of Governors contends that it’s separate from its member banks, including the Federal Reserve Bank of New York which runs the lending programs. Most documents relevant to the Bloomberg suit are at the Federal Reserve Bank of New York, which isn’t subject to FOIA law, according to the Fed. The Board of Governors has 231 pages of documents, which it is denying access to under an exemption under trade secrets.

"I would assume that information would be shared by the Fed and the New York Fed," said U.S. Representative Scott Garrett, a New Jersey Republican. "At some point, the demand for transparency is paramount to any demand that they have for secrecy."

Bloomberg sued Nov. 7 under the U.S. Freedom of Information Act, requesting details about the terms of 11 Fed lending programs.

The Bloomberg lawsuit said the collateral lists "are central to understanding and assessing the government’s response to the most cataclysmic financial crisis in America since the Great Depression."

‘Deeply Troubled’

Fed Vice Chairman Donald Kohn told the Senate panel today that revealing the names of AIG’s counterparties would make companies less likely to do business with any recipient of government aid, risking further turmoil at the insurer and financial markets.

"I don’t consider that an adequate" response, "to put it mildly," Committee Chairman Christopher Dodd, a Connecticut Democrat, told Kohn at the hearing. "The public is deeply, deeply troubled."

Shelby told the Fed vice chairman that "your answer here is very disturbing."

"People want to know what you’ve done with this money," he said.

Kohn said the Fed wouldn’t reveal the counterparties in Maiden Lane III, a company formed by the central bank to purchase collateralized debt obligations on which AIG’s financial products unit had written credit-default swaps.

"The Fed and the Treasury can be secretive for a while, but not forever," Shelby said.

Commercial, Consumer Loans

The Fed stepped into a rescue role that was the original purpose of the Treasury’s $700 billion Troubled Asset Relief Program. The central bank’s loans don’t have the oversight safeguards that Congress imposed upon the TARP.

Total Fed lending exceeded $2 trillion for the first time Nov. 6 after rising by 138 percent, or $1.23 trillion, in the 12 weeks since Sept. 14, when central bank governors relaxed collateral standards to accept securities that weren’t rated AAA. Fed lending as of Feb. 25 was $1.92 billion.

On Feb. 23, the Fed disclosed a breakdown by broad categories for $1.81 trillion of collateral pledged by banks and bond dealers as of Dec. 17 after Congress demanded more transparency from the central bank.

$11.7 Trillion

The largest portions of collateral being held by the Fed at that time were $456 billion in commercial loans, $203 billion in consumer loans and $159 billion in residential mortgages, according to the central bank’s Web site. It didn’t identify any loans or provide their credit ratings and said it will update the figures about every two months.

Government loans, spending or guarantees to rescue the country’s financial system total more than $11.7 trillion since the international credit crisis began in August 2007, according to data compiled by Bloomberg. In return, banks left collateral with the central bank that effectively acts as a credit line that lenders can draw on without posting additional assets.

Bloomberg News, a unit of New York-based Bloomberg LP, on May 21 asked the Fed to provide data on collateral posted from April 4 to May 20. The central bank said June 19 that it needed until July 3 to search documents and determine whether it would make them public. Bloomberg didn’t receive a formal response that would let it file an appeal within the legal time limit.

Minyan Mailbag: Why Marked-to-Market Refuses to Die

My sense is that the accounting industry is telling the banking regulators and the SEC that it’s fine if the government wants to suspend marked-to-market accounting – but firms had better set up adequate reserves for the entire remaining life of these heretofore-marked securities and loans, and be prepared to add to those reserves if the economy worsens. Otherwise, the accountants won’t sign clean audit opinions.

And this is where the rubber meets the road. The regulators know the assets (particularly the funky tranches of CDOs, CLOs, etc.) aren’t adequately reserved for tough times (if they were, would you really need to stress-test the banks?).

So the stand-off continues. And unless the government is prepared to hold accounting firms blameless from lawsuits, I think the stand-off is likely to continue indefinitely.

Chanos on What’s Ahead

Related content
» More

No Comments