Fed Cuts, Market Loses Gains, Ratings Downgrades Coming
A: I think reality is setting in that there is a reason the fed is acting so aggressively; risks to the economy. The drug injections Ben handed out today obviously wasn't his best stuff and the addicts on wall street feel shafted. In the meantime, reality wakes us up. Fitch cut the rating on FGIC, the 4th largest bond insurer and S & P lowered, or may lower ratings on up to a half a trillion, thats trillion with a 'T', of subprime mortgage securities and CDO's.
It brings me no pleasure to say that reality beat out a drug induced fantasy today on wall street. The fed used more of its precious ammo and cut both the FFR & Discount window by 50 bps, yet markets sold off by the end of the day due to the realization that there are valid reasons why the fed is acting so aggressively. Meanwhile, expect commodities to rise and inflation pressures to rise in the years to come as the fed clearly is pulling out everything in its arsenal to combat the problems bubbling under the surface. Sooner or later, a billion dollar write down starts to mean something.
Since the rate cut is not news anymore, lets get to what spooked the markets. According to Bloomberg (via Calculated Risk):
Standard & Poor's said it cut or may reduce ratings of $534 billion of subprime-mortgage securities and collateralized debt obligations as default rates rise.Then came Charlie Gasparino and his gut instinct of bond insurer downgrades coming as early as today; recall posts on UrbanDigs here & here and here about this possibility and likely effects. Then it happened. According to Bloomberg (again, via Calculated Risk):The downgrades may extend losses at the world's banks to more than $265 billion, S&P said.
Financial Guaranty Insurance Co., the world's fourth-largest bond insurer, lost its AAA credit rating at Fitch Ratings after missing a deadline to raise capital.As bond insurer's get downgraded, further write-downs in the financial sector becomes a reality. Again, we just don't know who holds what, whats insured, for how much, will the claims be paid, and on and on. Its all interconnected and being fueled by a slumping housing market, rising defaults, and a dysfunctional secondary mortgage market where these securities trade.Financial Guaranty, a unit of New York-based FGIC Corp., was cut two levels to AA, New York-based Fitch said today in a statement. The company had been AAA since at least 1991. Moody's Investors Service and Standard & Poor's are also reevaluating their ratings.
The loss of the AAA stamp jeopardizes ratings on bonds Financial Guaranty insured and limits the company's ability to generate new business. FGIC, along with MBIA Inc. and Ambac Financial Group Inc., are paying a price for expanding beyond their traditional business of backing municipal bonds to guaranteeing debt linked to riskier subprime mortgages and home- equity loans, as well as collateralized debt obligations.
What does this all mean? A few things come to my mind:
a) The fed is on our side. While we have pain to go through until the ship is righted, when the clouds clear there will be another fed assisted economic boom. The question is when. This will certainly help, but I'm afraid it will take some time.
b) I love gold.
c) The fire is fueled by deflation in housing prices across the country. As home values fall, so does equity withdrawal strapping the homeowner. Those holding homes whose loan balance now exceeds the value of the asset, are considering walking away from their homes. Those who cant afford to pay their mortgages, simply aren't. Its becoming socially acceptable to go into foreclosure these days as that may be the best financial option for the struggling homeowner. And guess who lent out the money, bundled it into a security, and sold off the bond to investors who are now holding the toxic waste?
d) As defaults rise, holders of the securities derived from these debts lose. Hence the billions of losses you are hearing about. So far, we've seen the lowest quality homeowners get hit; naturally. Risks to other debt classes?
e) Leverage. The unsustainable housing boom built from lax lending standards, rising home prices, speculative investing, and low low rates was leveraged up the wazoo! That makes the problem that much more complex and is clear by the struggling financials and those who bought up the risk globally. We will have to fix the financials before we can get through the downturn. Its clear the fed knows this and is taking aggressive action! It will help, but it will take time.
f) Over-estimating Losses? A very valid hope! It is entirely possible that if all this stimulus helps to stabilize housing as time goes on, that losses are overestimate. Way too early to tell now, but certainly a valid hope that I am clinging to and watching out for. I am NOT in this camp right now.
We will get through this. But we are talking about a housing/debt fueled problem, so it will take time. Housing is an illiquid asset, as opposed to stocks, and take time to sell on the open market. With inventory outside Manhattan a concern, it will take time to work through this process. All eyes should be on housing data for signs of:
1) decreasing iventory
2) rising sales volume
3) decreasing absorption rates
...for any clue as to when the clouds may clear.
Add to Newsvine
Comments (12)
Hey Noah,
Markets acted like a spoiled kid who just got a new expensive toy. Played with it for an hour and then tossed it to the side.
Look for a retest of the recent lows. If it punches through look out!
BTW- we're renting for a year in the city (couldn't take the commute). After a year, we'll see how the market is, and if ok, we shall start round 2 of the hunt!
Posted by Sang | January 30, 2008 6:38 PM
Sang - sounds like a plan! Ill be here when your ready.
As for markets, my analagy is:
'Ben, that heroin was garbage! Lasted only an hour!'
Posted by Noah | January 30, 2008 6:40 PM
Any thoughts on how this will impact Manhattan real estate? According to Miller Samuel. Q1 '07 inventory was 5900 units, and that was considered low. We are currently at, according to Streeteasy, 5300. What effect, if any, will the rate cuts have on the Manhattan market?
Posted by mh23 | January 30, 2008 9:15 PM
Noah - Here's a real life scenario. Tell me what you think.
First, a little background. 799 FICO score, several million in liquidity, looking at a 2BR in the $1.5M range, solid mid-6 figure income.
I spoke to Chase today and the jumbo rate they quoted was 7% for 30y fixed, 0 points. Conforming (assuming I pay an outsized down payment to get me there) is 6.25%.
What the fuck, right?
When I asked about the Fed's moves, Chase's response was that mortgage rates would actually RISE.
Yes, you heard me right - Chase said that rates WILL GO UP TOMORROW as a result of the Fed. Why?
Because the yield on the 10 year jumped. Because inflation expectations have gone up.
My read is that what the Fed does has little to zero effect on mortgage rates. In fact, it hurts mortgage rates. It does, however, have a beneficial effect on credit card rates, auto loans and student debt.
On another note, I'm pretty confident shopping around will get me a better rate. I will definitely do so, but is Chase blowing smoke up my ass?
Posted by anon | January 30, 2008 11:32 PM
anon 11:32pm,
Put yourself in the position of the investor buying your loan:
- 1.2 million loan
- Fed is printing money like crazy and throwing it from a helicopter.. fanning inflation
- Gold, oil, commodities soaring.. proof inflation is VERY real
why would the investor accept low 5% when the long term outlook for inflation appears to be MUCH more inflation?
Posted by uwsider | January 30, 2008 11:56 PM
Also, Noah - to your point that "the Fed is on our side". Here's another anecdote.
You know what products investment banks are now offering?
They are providing loans to individuals and hedge funds that are under margin pressure, to get them out of margin pressure and enable them not to liquidate there portfolios. What does that mean? Basically, it means the Fed is prompting banks to (1) take on greater risk by (2) bailing out investors who made poor decisions by (3) converting their credit risk from short-term to long-term. Two conclusions: the Fed's actions just throw banks back into the unacceptable risk game AND massive moral hazard problems for investors.
The Fed's actions are criminally negligent. As John Ryding said, the Fed's actions are creating a new asset bubble, and that's the CPI. It's not helping mortgage rates at all.
Posted by anon | January 31, 2008 6:40 AM
anon - well the lending markets are operating under their own rules now that the world changed and risk means something.
With last cut, rates eased a bit, not much. I thought the same effect would occur. I think the core PCE number in yesterdays GDP also played into the bond markets fear of future inflation.
Fed will certainly have to take back rate cuts once this mess looks to clear up.
Ive said both on discussions, and on comments, that fed rate cuts are not correlated directly with lending rates anymore; now you see why. Yes I do agree that it hits credit cards, auto loans more directly.
Thank you for the real time/life evidence you provided here. Very interesting.
Posted by Noah | January 31, 2008 8:20 AM
as to your other point, I agree wholeheartedly. The fed is on our side in the sense that they are clearly bypassing inflation to use anything to encourage risk/investing and make sure liquidity is not a problem.
The side effects: inflation, another asset bubble, moral hazard. Cant argue there. I've spoke about this stuff in detail, and most know my stance on this. I think we need less fiscal stimulus and let a recession work the problems out. But its clear intervention wont stop. Like the bond insurers. Why are they still AAA rated? Cmon now. They are delaying the downgrade because if they do get downgraded that will spark the next fire selloff.
Its all BS..thats why Im in gold.
Posted by Noah | January 31, 2008 8:23 AM
923.20 at 923.60
getting out of Feb's here!!
Rgds
Posted by johnny | January 31, 2008 11:38 AM
Don't forget, the real issue here is the CDO market, not necessarily the Subprime MBS. These CDO's which investment banks purchased and underwrote were on the BBB tranches, not on the AAA tranches. So while defaults are definitely up, it's tough to say that they're up enough to break the hard CE for a true AAA tranche on a properly structured security.
What is more likely to create issues for these AAA tranches is the credit downgrades of the secondary mortgage insurers and the prepayment speeds on these subprime securities. If prepayment speeds normalize, the duration of these securities may shrink enough to aviod a catastrphoic metldown in the market.
Also, Subprime is not a type of security, it's a type of borrower. A subprime security can take many forms. The ones to look out for are the subprime Home Equities and Alt-A securities. These are the most at risk.
I think come 2/28 when financials are actually issued, segment reporting is going to be a key disclosure. How are these portfolios at risk to geographic dispersion?
Posted by MBS Playa | January 31, 2008 12:03 PM
Inventory remains non-existent:
http://curbed.com/archives/2008/02/01/three_cents_worth_inventory_upside_down.php#more
Posted by Buyer | February 1, 2008 9:43 PM
I agree with you about the fed cuts. You are right on.
Posted by Guy Law | February 12, 2008 5:25 AM