They whispered…..

“Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth. In recent weeks, yields on longer-term Treasury securities and fixed-rate mortgages have risen. These increases appear to reflect concerns about large federal deficits but also other causes, including greater optimism about the economic outlook, a reversal of flight-to-quality flows and technical factors related to the hedging of mortgage holdings” Ben Bernanke testifies before the House of Representatives

“Today, I pledge to cut the deficit we inherited in half by the end of my first term in office” President Obama setting himself a very ambitious target (24/02/09)

“What other central banks have been doing must be reversed. I am very sceptical about the extent of the Fed’s actions and the way the Bank of England has carved its own little line in Europe. Even the European Central Bank has somewhat bowed to international pressure with its purchase of covered bonds. We must return to independent and sensible monetary policies, otherwise we will be back to where we are now in 10 years’ time” Angela Merkel being uncharacteristically critical towards central banks in Berlin

“What we did with all these bailout billions is that we bought ourselves a rally” Rick ‘Chicago Tea Party’ Santelli

CapitalWhispers

The US budget deficit this year is projected to reach $1.85trillion, that is 13% of the economy. This gigantic -not just in percentage but also in dollar terms- figure, in conjunction with the anything-but-benign macro-economic environment gives President Obama’s pledge Herculean dimensions

What is more -and probably for the first time since the crisis began- Mr Bernanke is shifting his focus to fiscal discipline. The glut of Treasuries issued to fund the deficit are starting to: (1) spook investors (Mr Geithner travelling to China this week to appease the -very serious (in both meanings of the word)- Chinese investors), (2) raise creditworthiness fears -especially since the UK’s outlook has been downgraded to negative and (3) spoils the effort of kick-starting the economy by bringing down the long-end of the yield curve -traders are pushing the 10y+ higher and the curve keeps steepening (not very helpful for mortgages & lending in general)

The past couple of months have produced a spectacular, logic-defying rally that has spilled over almost all asset classes. Credit is rallying ruthlessly, enhanced by the predictable herd capitulation, and now implies defaulkt probabilities in line with historical recession levels (but not fully realised yet – watch this space in the next 12 months). Oil & the basic metals are rallying, aided by a seemingly unstoppable China and macro-indicators showing a distinct improvement from a few months back. In fact oil and dry freights (Baltic Xchange) have doubled from their lows and it feels like the rollercoaster has started again. Equities..the the rally momentum has been almost unprecedented in its smoothness and strength. Many -CW included- have been waiting for the downward correction that never comes (to ride the next wave).

We are increasingly of the view that the rally has nearly exhausted itself (in equities more so, with credit possibly having another 10-20% to go). That said, we believe that revisitng the lows will be rather improbable; instead, we expect a long +-5/10% range-bound market for the next 6-12 months. (Still, when the long overdue correction comes, there should be a brief spike given that so many investors are waiting to jump in).

Keep your ears open, do not follow the herd … and let’s hope that we won’t get overly spooked by the default (personal & corporate) wave that is swelling.

nikosgi

We three loans of Orient are/ Vainly trying to get back to par/ Haircuts rising, forced unwinding/ More sellers than buyers by far

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Oh, par of wonder, par of light/ From par to here was such a fright!/ Seldom trading, cov’nants straining/ Who will save us from our plight?

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A hedge fund was the first to invest/ High recoveries left him impressed/ Long at inception, long protection/ But margin calls made him divest

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Next we were bought by a cash CLO/ An unlikely rescuer, yes, we know./ But firm financing looked entrancing/ Till downgrades then made us go

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Europe’s banks to us then were nice/ Under IAS, who cares about price?/ Assets inflating, but low risk weighting/ Tier one capital should suffice

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To Basel then we made our way/ A committee of wise men had their say/ “This buy-and hold looks uncontrolled -/They’re levered like Fannie Mae!”

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Leverage limits then were imposed/ To liquidity risk they were overexposed/ BWICs singing, prices stinging/ (Proportion cleared undisclosed)

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A hero then arrived from afar/ E’en as we worried for our EBITDA/ The ultimate claimant made repayment/ A buyback by KKR!

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While hedge funds watched…/ While hedge funds watched their stocks by night/ All falling to the ground/ An agent from their broker rang:/ “These haircuts are unsound”/ “Be scared,” said he, for mighty dread/ Had seized their troubled mind/ “Redemptions too are on their way/ For you and all your kind”

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“But, sir!” they said, “this is not fair/ Just look at this report!/ Our fund has only profits made/ We’ve not been long, we’re short”

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“That’s no excuse,” the broker said,/ “At this unhappy time/ The credit crunch affects much more/ Than banks which hold subprime”/ “Your leverage is way too high/ For your liquidity/ Besides, we need to recalc VaR/ Given volatility”

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The fund then had no other choice/ But to exit its position/ And the thing that really drove them mad/ Was the need to pay commission

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From that day on, redemptions soared/ Just as the chap had warned/ Performance mattered even less/ The asset class was scorned

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The lesson of this sorry tale/ Of asset allocation?/ That prior performance may not stop/ Your fund’s annihilation

Good King Wenceslas/ Ben Bernanke last looked out/ On the Feast of Stephen/ Credit markets lay in rout/ Deep and crisp and even/ Paulson called up late that night/ “The markets are so cruel!/ Goldman’s profit’s down again:/ my bailouts need more fuel”/ “GS!” said Ben, “that’s no surprise/ Their funding model’s shattered/ Now had it been dear JPM/ It really would have mattered”/ “But Ben!” growled Hank, his usual croak/ O’erlaid with suppressed fury,/ “The world is going up in smoke/ You can’t play judge and jury!”/ “But Hank!” said Ben, “I’ve no resource/ To save the market’s debtors/ TSLF, PDCF -/ I’m running out of letters!/ The brokers’ model always stank/ Of insecurity:/ More repo funding than a bank/ In short maturity!”

…

“But Ben,” said Hank, “you do forget/ Just how their model’s altered/ They’re guaranteed with public debt/ We cannot let them falter/ When Lehman failed, we thought the TARP/ Would bring stability/ But Libor’s steady rise demands/ A new facility”

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Ben furrowed then his wrinkled pate/ How could they fund a bailout?/ They’d need Congressional debate/ The funds from TARP had run out/ “Why don’t banks just start to lend?/ We’ve given them our support/ Maybe we should just suspend/ The ban on selling short”

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“Now Ben,” rasped Hank, “that wouldn’t work/ They’re overlent already/ With undrawn lines they went berserk/ It’s worse than Fannie and Freddie/ Six trillion still could be drawn down/ How awful that would be!/ The average spread would make them drown:/ Just twenty-four bp!/ With that, I fear, they’ll never lend/ We need to find more dollars/ And yet the Treasury just can’t spend/ According to the scholars”

…

“But wait!” said Ben, “I’ve got a plan/ That may be our salvation/ The US cannot be Japan/ That way just lies deflation/ If you can only keep your nerve,/ We’ll clear up all this mess/ We’ll make the Federal Reserve/ A giant printing press!”

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“Yes”, cried Hank, in great delight,/ “We’d bring down credit spreads/ The old refrain once more is right:/ ‘Never fight the Fed!’”

Hello and apologies for the sparsity of new comments, but capitalwhispers is travelling at the moment. I was planning to write something about the Great Depression and the New ‘New Deal’ but I decided instead to share some gossip and market colour from Greece. It helps, as it puts things into perspective.

1. First some couleur local on the global financial crisis. Greeks, after pioneering philosophy, democracy etc, were among the first to withdraw their savings from Greek Banks, threatening the system with serial bank runs. This is a puzzle to me, since:

• the Greek Banks are relatively underexposed to ‘toxic’ (sic) assets and are generally well capitalised
• the state is a protectionist one (it rushed to guarantee -following Ireland- local deposits up to EUR 100k)
• Greeks complain that they have no money

In the end, these ‘runs’ fizzled out to the following typically melodramatic pattern: Mr Papadopoulos went to the cashier, demanded that all his savings are withdrawn immediately and when he was presented with a pile of bank notes, said: ‘Oh, so you have my money after all; ok, you can keep it’

Nevertheless, the local banks are facing an uphill struggle, primarlily due to exposure to the Balcans as well as to a rather inflated local housing market and a heavily geared population. In response, Greece has adopted UK-like support measures (recapitalization, interbank lending, deposits and bank refinancing guarantees)

2. Then some more sombre news on the shipping markes. The last years were good years for shipping. Actually, good is nowhere near where they were. In the scale of booms this was a supernova.

Unfortunately though, physics kicked in. Sir Isaac Newton was among the first to formulate the rules of gravity, i.e. what goes up must come down (he was followed by Justin Timberlake who expanded the theorems on the horizontal plane, postulating that ‘what goes around must come around’). The supernova years were feeding on -sounds familiar?- cheap credit and the insatiable appetite from a developing China (and others) for raw materials (iron ore ) and food (grains). This translated to:

• Shipbuilders in the Far East were booked to capacity for decades to come
• Ships were changing hands while at the dock being built (something like buying a new flat off the plans, paying the deposit and selling on for profit prior to completion)
• Second-hand ships were at times more expensive than ones being built, since the demand for their services was so great and the supply limited

Unfortunately, gravity is brutal and inescapable. The global financial crisis, i.e. the credit crunch which led to a liquidity crunch which caused a confidence drain and a hard-landing (?) in a recessionary landscape, brewed a perfect storm in shipping. The BIFFEX index (a benchmark index for ocean freight futures) dropped 10fold from 11,500 to 1,500. Now that is scary. The results?

• Banks have closed their lending books and no credit is available 
• New-buildings are being abandoned (with the ‘owner’ foregoing deposits) with chain reaction to steel suppliers and builders workforce
• Sales have ground to a halt

I heard of the story of a shipowner who has chartered one of his vessels for free (the charterer pays crew, fuel and insurance – the freight is thrown in for free) to avoid docking it. Extreme times ask for extreme measures..

The reason why these developments are a concern for us all is that transporters are the canary that gives the early warning to the rest of the economy. China has stopped imports of steel for 6 months, so shippers are tumbling since they largely operate with term contracts and they are out of cargoes to carry. It doesn’t stop there though. Chinese factories close, workers get laid off, China’s growth rate decelerates, imports/exports slow down, everyone feels the consequencecs. We move to Australia then where miners feel the pain of smaller demand that causes base metal prices to plummet (check Rio Tinto shares); further factories close and so on. A recession avalanche at its early stages..

3. Finally some lighter news to leave you with a smile. A new phenomenon in Greece is the emergence of the supermarket Robin Hood. A vigilante gang robs food from supermarkets (not money) and distributes it to the people. This is not a joke, It is happening -of course they don’t wear green tights and there is no romantic sub-plot, but you get the picture.  The best story we heard lately.

Before I bid you good night, I leave you with the following:

Ben Bernanke, thought Milton Friedman was right to blame the Federal Reserve for its role in the Great Depression, stating on Nov. 8, 2002: “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

Good Luck!

•nikosgi

House of Politics

I never liked politics much. They never liked me much either. We have respected each other, though, and managed to get by in life -so far- without drama. So, I will be careful in phrasing my comment for today so as not to disrupt the status quo. That means that I will just state some facts and you -dear reader- can reach your own conclusions. Here we go:

• The sanctioning of the ‘bailout’ plan is already considered a given in the markets
• So even without going back to why the plan is essential to ensure continuity of life as we know it, it has to pass soon so that a catastrophic confidence crisis is avoided
• Hank Paulson wants the plan
• Ben Bernanke wants the plan 
• GW Bush wants the plan
• GW Bush is the President of the USA
• GW Bush asked the Senate & the House to expedite their ruminations and reach a speedy conclusion, sanctioning the plan
• GW Bush is Republican
• Republicans are blamed for the state of the economy
• Elections are in a few weeks
• The House Democrats, the Senate Democrats & the Senate Republicans pretty much are ready to sign-off the ‘bailout’ plan
• There is an increasing number of House Republicans who are not happy with the plan and have not agreed to anything yet

…Come on!

Anyway, we think this is just flirting in some kinky, political kinda way. It is going to be signed, it is going to be signed tomorrow or before the Monday open (probably the latter since all events tend to happen over the w/e lately) and then..

THEN WHAT?

Don’t know about you, but I hope for some healthy profit come sign-off and then…the news, economic indicators, analysts, interviewees etc etc will start talking about the slowdown in growth (recession?), credit troubles in consumers, housing, corporate earning blues and so on. Few more dollars available to tackle these issues, so they might print some (stagflation anybody?) or they might not.

We’ll soon find out.

•nikosgi