Atonement
I have been quiet for a couple of weeks. During this Rosh Hashana/Yom Kippur period when Jews typically ask their family, friends neighbors and maker for forgiveness, I have been asking the financial gods to forgive me for my Spring 2007 article Black Monday 20 Years Later wherein I wrote:
Recently, several significant issues have been percolating beneath the surface of a buoyant stock market. Despite an otherwise sanguine investment outlook, I can’t help but continue to see parallels to the market environment of 1987: a buyout boom fueling stocks that are running up in the face of slowing profit growth, a weak dollar, bond yields backing up on inflation fears and even insider trading scandals.
Well, we got a bear market and then a crash on top of it...I'll admit I was a year early on the crash part and was only pointing out the possibility of one, not calling for one. I never even considered that if it happened it would be this bad.
I was also asking the market gods to forgive Noah and I for professing the following impolitic and profane ideas over the last many months including that:
1) The economic model of Wall Street would change for a long time and firms would be smaller and less profitable.
2) Job losses on Wall Street would be severe.
3) We were as good as in a recession as of December 2007.
4) Commodity prices were a bubble that would pop.
5) The US was not the only country swimming naked...not by a long stretch. In fact, it was a nudie Olympics, with bubbles in the UK, Ireland, Spain, Eastern Europe, India, China, Dubai, etc, etc.
6) States and municipalities, including the Big Apple would come under severe financial duress.
7) The CDO market was a disaster waiting to happen....I don't think we ever got around to calling hedge funds a bubble, although we did refer to private equity deals under that rubric.
8) The commercial real estate market would be shown to have had its share of nude free stylists.
9) The New York City land market was a bubble, and as the underpinning of real estate values in NYC, a negative harbinger for all real estate values in Gotham.
10) The stock market would get hit. I for one was too early in trying to think about what a bottom in the stock market would look like....but that's our job now, thinking about a bottom -one that is properly covered in the correct swim wear.
11) New York City residential real estate prices are headed for a fall, with the worst declines to be felt in the boroughs and Harlem.
So, since Urban Digs, with the help of many good blogs and information sources, warned you about this list of risks, which have now been pretty much accepted by the world, the question becomes, what other surprises are still ahead? Thankfully, I am not sure there are that many negative surprises left (let's all hope not). Here are a couple of surprising pieces of data I have run across in the last couple of weeks, which may explain some of what is going on in the world right now and may have portents for the future.
October 21 is reportedly settlement day for Lehman Brothers default swaps, apparently the markets were worried sick last week about the potential for implosions tied to what was thought to be many billions of dollars of notional exposure. It seems that theDepository Trust Company believes that investors may be overly concerned about the size of the CDS market, its relationship to sub prime debt and the total size of Lehman CDS exposure outstanding. The settlement of the oustanding Lehman CDS contracts, which amount to a less than cataclysmic $6 billion, may be something of a positive to credit markets.
Baltic Dry Freight rates have been tumbling for the last couple of months, which many have taken as a sign that world economies are plunging into recession. Of course collapsing commodity prices have also fueled this anxiety.
Interestingly, as much as the commodity bubble drove prices way ahead of fundamentals and was brought back to earth by the credit collapse, it also seems the credit crunch is impacting Baltic freight rates. According to an article in Seeking Alpha, shippers in Asia are finding it hard to get financing to pay for the shipment of goods. So don't be surprised to see some shortages develop due to the credit crunch. No, this is not a result of overboard money supply expansion or a robust rebound in world economies, it's due to the credit system being jammed up.
According to a tiny squib of an article in Business Week (my favorite kind, because the only really important news is usually in articles too small for anyone to bother with), the ratio of home price to household income in Beijing has hit an all time high of 28.8x, while the World Bank considers five times to be a healty norm. Many other things besides poisoned milk are amiss in the "Middle Kingdom" from what I have been reading lately, including imploding commercial property marts and under-capitalized small manufacturers, who are racking up bad debts. These debts are held by the massive shadow banking system, which stepped in to finance the boom, when officials started tightening credit at legitimate lenders. Chinese miracle?....we may need to re-think that.
Lastly, the Financial Accounting Standards Board (FASB) had a board meeting last week and discussed the highly topical subject of "Determining the Fair Value of a Financial Asset in a Market That is Not Active". It looks like the green eye shade set will be releasing an update to their standards that should give institutions a little more flexibility in making certain illiquid assets on their balance sheets look a little more..... green. I am personally very much looking forward to the Q3 data on bank credit quality from the Federal Reserve to see how non-mark-to-market loan defaults are tracking.
Posted by Noah
Mon Oct 13th, 2008 01:55 PM
dont forget settlement of other credit events....Fannie/Freddie and I heard WaMu in a few weeks. I didnt think WaMu was considered an event, but they had a guy specificially discussing it on CNBC. I assume he was accurate.
In the end, Lehman failure seemed to start the domino effect of carnage. CDS's are proving to be a very scary thing
Posted by jeff
Mon Oct 13th, 2008 04:32 PM
It occurs to me that the amounts of money that have to change hands to settle all these obligations is staggering and in and of themselves are pulling liquiditiy out of short term markets. Supposedly when Lehman went under JPM put over $100 billion into Lehman to settle various trades and was later paid back (much of the money came from the fed). This led to conspiracy theories that the fed was actually doing a stealth bail out of JPM. But the unwinding of these contracts are like seperate tornadoes being thrown off by the credit hurricane. I think in the end it required the feds to step in and say, no innocent bystanders will be hurt, regardless of what banks and hedge funds have to go under. We have gotten pretty far down the list though, with Sovereign bank likely being taken over by Santander. Not too many big impending failures left on the list, maybe Keybank and National City is already up for sale/liquidation. From here on out its apt to be smaller guys - except maybe GMAC.
Posted by Anonymous
Mon Oct 13th, 2008 04:59 PM
What do you guys think? Sucker's rally?
Posted by Noah
Mon Oct 13th, 2008 05:13 PM
Anon - I was long for this and started buying Thursday...(fcx, sso, ddm, drys, xme, tbt, uyg)
I sold 20% at 10AM and 20% at 3:50PM today. Still holding rest for trade. But there will be a time to short again as this slowdown hits the data/consumer and feels like it just wont go away
Posted by Jeff
Mon Oct 13th, 2008 10:18 PM
I put some 401k money back in stocks this morning...before the eruption, but will get end of day prices unfortunately, buying US small cap value, international large and small cap value. I think on a 2 year+ time horizon these will be great purchases, we have just been through a full on panic seen only a couple of times per century. If the market is going to make much lower lows this cycle your best buy is a shortgun and canned goods....maybe some gold, but I wouldn't even be too sure of that. Outside of that we have seen the lows or close to them for many years in my opinion.
Posted by joseph
Tue Oct 14th, 2008 08:43 AM
Jeff, another issue that that come to mind of late are the significant financing requirements of these bail-outs. The US alone is expected to issue $1.5 trillion (I've seen estimates of $2 trillion) of new debt during 2009 which is an enormous drain on savings that could have been otherwise employed for more productive purposes.
The question will become what will happen to the treasury yield curve as this enormous amount of new paper is placed. As we speak, the 10yr treasury has risen to > 4%. During 1987, one of the problems of the period was a reluctance by investors to finance the ever increasing federal deficits which caused a substantial bear market of intermediate and long dated treasury debt. Will history repeat itself yet again? We shall see.
Enjoyed the read. Thanks!