Tuesday, March 18, 2008

The Fed, Finally Gets a Grip...for $30 Billion



The Fed is finally getting a grip, and it's only costing $30 billion!

That's right: the U.S. sub-prime crisis, a wave that has been gathering strength and growing in dimension for at least a year, swept away Bear Stearns in a single weekend, forcing the biggest government intervention in history.

And while investors speculate there will be other, even bigger players disappearing shortly, we here at NotMakingThisUp suspect the worst of the liquidity crisis is past, or at least well-discounted by investors, here in the United States.

We believe nervous sights should, instead, be set on China, where the fallout of the greatest bubble of all time, the China Bubble, may be coming to a head.

By "China Bubble" we do not mean to imply that China's rise to power isn't real, and that the country has not become a great economic engine for the entire world, supplanting the United States.

But the fact of the matter is investors know far less about the true health of banks and brokerage firms in China than they ever did about Bear Stearns.

And if, as Warren Buffett says, a falling tide lets you see who has been swimming naked, our guess is that the vast majority of those naked swimmers will be found to have been incorporated in China.

Not Delaware.

Regardless of how the impending China Bust unfolds, we republish here last summer's imagining of what was going on behind the closed doors of Ben Bernanke's dithering Fed, which at the time seemed more concerned about sentences in press releases than about the rapidly unravelling sub-prime crisis.

The price of that dithering? $30 billion, as of Sunday night.

***

Monday, July 02, 2007

When Phil was Up-Looking ‘Un-Restrained,’ and other Tales from the Federal Reserve

The credit derivatives market is imploding.


There is no overstating the issue: it’s imploding as you read this.A phenomenon that was supposed to have been contained inside the definitional boundaries of “sub-prime” mortgages is spreading across all classes of debt, now that the formerly gluttonous consumers of dubious paper have reached their limit.

Stuffed to the proverbial gills, the former buyers have pushed away the scrap-filled mortgage plate on the table before them and are refusing offers of all sorts of paper, sub-prime or not.

Thus we read about the suspension of debt offerings by not just highly leveraged buyouts such as U.S. Foodservice and Myers Industries, but also proper corporate debt-issuers, such as steel giant Mittal's newest acquisition, Arcelor.

Even companies you’ve never heard of are having a hard time accessing capital.

One such is Magnum Coal, a West Virginia company about which we have no facts to report owing to the fact that the company has the least informative corporate website in the industry, hands down.

What we do know is that Magnum is a large Central Appalachian coal producer, and while Central Appalachian coal is wonderfully low in sulfur and high in BTUs, it also tends to be found underground. Thus, Magnum's key asset is only recovered by union workers toiling in dangerous environments.

The company recently delayed a third-of-a-billion junk bond deal.

Another lesser-known victim of the credit seize-up is Catalyst Paper, a Canadian company whose business has been in something of a down-cycle lately—last quarter’s $14 million (Canadian) EBITDA being less than the $18 million of interest expense reported on page 22 of a very lengthy press release.

Catalyst recently pulled a fifth-of-a-billion junk bond deal.

What happened in sub-prime has most indisputably not stayed in sub-prime.

Of course, nobody wants to shout ‘fire’ in a crowded movie theater, least of all the Federal Reserve Board, which, like Hitler in his bunker, appears to believe it is still in control of the forces unleashed by Alan Greenspan’s free-money policy of some years back, which triggered the whole you-too-can-afford-this-house mortgage mess now showing up on the balance sheets of major Wall Street brokerage houses.

Nevertheless, you might expect a bit more of a reaction out of the Federal Reserve Board than merely eliminating the word “elevated” from its interest rate policy statement.

Yes, while the Chinese call on natural resources takes commodities to new highs, and Russian oligarchs and Middle East sheiks bid up all manner of assets, both hard and soft, leaving U.S. consumers fully employed but tightly squeezed, the members of the Fed are literally tinkering with adjectives.

Herewith my reconstruction of the dialogue among Fed policy bigs as they prepared their most recent missive to the outside world:


Chairman: “Last month we said ‘economic growth was moderating.’ We have a motion before us to replace ‘moderating’ with ‘slowing.’ The motion has been seconded. The floor is open for discussion.”

1st Board Member: “Why ‘slowing'? Why not ‘moderating.’? I liked ‘moderating.’”

2nd Board Member: “I prefer‘slowing.’ We haven’t used it in a while.”

1st Board Member: “Well I don’t care for it. How about ‘restrained’?”

3rd Board Member: “Why ‘restrained’?”

1st Board Member: “Because we’ve never used ‘restrained’ and I’ve always wanted to use ‘restrained.’ (He lapses into a reverie, as if quoting from a book.) ‘She restrained herself as his strong hands grasped her heaving shoulders—’”

Chairman, interrupting: “Er, that’s fine, thank you. But I don’t care for ‘restrained.’ The markets might worry. They might think that we think that something is restraining growth that needs to be un-restrained.”

3rd Board Member: “Mr. Chairman, forgive my impertinance, but, is ‘un-restrained’ a proper word?”

Chairman, a bit testily: "Well I believe so. I'm almost certain... I recall we used it during the Barings crisis of '94..."

2nd Board Member: “I’ll look it up.”

4th Board Member, quite grumpy: “Jesus God, what are we doing here? Can’t we just say ‘The economy is okay and if things change we’ll let you know’?”

Chairman, calmly patronizing: “Please settle down. The discussion will continue while the word ‘un-restrained’ is being looked up.”

3rd Board Member: “Is ‘being looked up’ proper English?”

1st Board Member: “I think that depends on whether ‘up’ is being used as an adverb or preposition.”

4th Board Member: “This is absurd.” (He rises from the table, refills his coffee cup from a pot on the credenza, and stares out the window at the traffic on Pennsylvania Avenue.)

3rd Board Member: "Shouldn’t we really say, ‘being up-looked’?”

5th Board Member: “Frankly, I thought the proper usage was ‘Up which it is being looked’.”

4th Board Member, turning sharply away from the window: “How about ‘up yours, Charlie’?”

Chairman, banging his gavel: “Please! We will have none of that. Now, where were we?”

5th Board Member: “Phil was looking up ‘un-restrained.’”

3rd Board Member: “I’d prefer ‘Phil was up-looking ‘un-restrained.’”

4th Board Member: “How about ‘Phil was up-looking your big hairy nose’?”

Chairman, sharply: “Ladies and Gentlemen, I will not have this type of disrespectful behavior. The secretary will strike the previous remarks from the record.”

Secretary, reading from note-pad: “Starting where? Starting with ‘How about Phil was up-looking’? Or starting with ‘big hairy nose’?”

Chairman, stroking his beard: “Hmmm...where to begin the striking of the records. That is a conundrum. I recall a similar situation during the Asian crisis of '98. Do I have a motion?”

3rd Board Member: “Mr. Chairman, I move that we start with ‘How about Phil was up-looking.’”

Chairman: “Excellent! Is there a second?”

4th Board Member: “I move we all stick needles in our eyes, because that would be more fun than I’m having right now.”

5th Board Member, looking harshly at the 4th Board Member: “I second the previous motion, that we start with 'How about Phil was up-looking.'”

Chairman: “Moved and seconded.” He puts down his glasses and looks around the table. "Is there discussion?”

2nd Board Member: “Mr. Chairman, before we discuss that motion, I’d like to report that the term ‘un-restrained’ is not proper English.”

Chairman, startled: “Is that right? Are you sure?”

2nd Board Member: "Quite sure."

4th Board Member: “Oh puh-leeze. I've had enough of this...” He is getting something out of his briefcase. It is a small, metallic object. The security guard at the door eyes him nervously.

Chairman, somewhat preoccupied: “Well then, all those in favor of starting the striking of the records at ‘How about Phil was up-looking,’ say ‘aye.’

A chorus of ‘ayes’ is heard.

Chairman: “All opposed?”

A gunshot rings out. The 4th Board Member slumps across the table. The security guard rushes over and checks for a pulse, then somberly shakes his head.

3rd Board Member: “Mr. Chairman, I note the presence of a dead body on the table. Would you like a motion to remove the body?”

Chairman, somberly: “First let me express my shock and surprise—(He pauses and clears his throat, amid solemn murmurs and nods around the table)—that the term ‘un-restrained’ is not proper English.”

Other Board Members: “Hear, hear.”

Chairman, more brightly: “As for starting the striking of the records at ‘How about Phil was up-looking,’ the secretary will note five in favor, none opposed, and a dead guy on the table.”

END


Jeff Matthews
I Am Not Up-Making This

© 2007, 2008 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

12 comments:

Question said...

Jeff,

A buyout at $2! Was this priced at $2 to ensure that credit default swaps were not triggered?

theodore said...

Mainland Chinese stocks are in a bubble, but I would venture to say that small-caps in HK are the cheapest they've been since 2004.

Mainland banks have their own problems, but mortgages are about ten percent of GDP in China versus 55%+ in the US & UK, so the risk of a spillover is arguably a lot lower.

Lyon Jewett said...

From the front lines, I can attest to mortgage rates dropping significantly since Friday.

30yr fixed conforming rates are at 5.625% today with no points, down from 6.25% last week.

The 5/1 Jumbo ARM is now 5.875% with no points, down from 7% last week. 30yr Jumbo fixed at 6.50% down from 7.50%.

The Feds $400 billion plus injection into the banking system seems to be having the desired effect- narrowing the treasury/MBS spread which had ballooned to over 2.50%.

whydibuy said...

I'm surprised that none of these talking head pundits are mentioning the cresting and now deflating of the Shanghi stock market bubble. After peaking at 6000 its now below 3700.00. Thats quite a drop. But as Jim Stack warned back in late '06, it was growing parabolicly into a bubble. And like all bubbles, it will come down steep when it bursts. Like it is now. Even thought he was a bit early in his call. He warned of a building bubble when the shanghi was at 4800 and it consequently continued to rise on up to 6000 . For some reason, pundits don't even mention it as a contributing factor in the ongoing weakness in the US market. Markets do tend to move togather so it may well be a drag on the US for a while as it deflates.

Sean said...

The Shanghai bubble isn't being discussed because it simply doesn't affect the rest of the world. Chinese capital controls mean that it is a purely local mainland phenomenon.

The same companies listed in HK and Shanghai are trading at huge premiums in Shanghai. For the kind of growth you'd expect from companies in a 10% GDP-growth economy, the HK PE-multiples simply aren't that bad.

The Inscrutable Chicken said...

Have I missed something or did Jeff Matthews finally make something up?

tony.yick said...

I'm sorry but this Jeff Matthews guy sounds like an idiot when he says investors know much less about the true health of Chinese brokerage firms and banks than they do about Bear Stearns before the collapse. Jeff, which investor are you referring to who had information on Bear Stearns prior to their collapse? Probably the stupidest statement I've heard all year...

buckeye1 said...

Last time I checked, the Fed had injected a helluva lot more than $30 billion into this market. In fact, they have depleted over half their available capital thus far, and opening the discount window to brokers is going to cause further balance sheet degredation. Can you buy CDS on the Fed?

Phillip Charles said...

Is it just me or are those TD Waterhouse commercials with Sam Waterston the metaphorical equilvalent of fingernails on a chalkboard?

Tahoe Kid said...

Isn't $30 billion just the amount the Fed has backstopped JPM in the Bear Stearns rescue? The numbers for subprime are well north of that. Regarding a previous post about purchasing CDS on the Fed, while the Fed has committed a significant portion (50% by some estimates)of its balance sheet to the credit markets so far, they still own the most powerful tool of all-the printing press. And for those still convinced there is little to worry about in China: While US investment banks expose their very dirty laundry and struggle to trade at book value, CITIC Securities has trades at 13 times book even after dropping more the 30% YTD. Even me, being of very little brain, can see the arb there.

dblwyo said...

That's three head-hurting arguments in one post - a record ? China, Bear/market collapse and derivatives, on which you were clearly prescient though not the earliest.
Recent troubles (not Tibet) have exposed serious fragilities in Chinese socio-political system, challenges in extending coastal development to the interior and massive on-going infrastructure investment requirements. They are indeed "rising" BUT that rise will not be a smooth path. Jim Jubak has several recent columns and five-year track record of tracking some of these which I recommend. Also recommended is Greg Chow's "China Transformed" just refreshed with a 2nd ed.

dblwyo said...

On the BSC thingee two observations. First BSC made have had the assets to survive but, to the best of my awareness, cover it's bets. Mr. Market called the markers and collected the vig here, as was overdue. Lesson - don't be a gambling addict.
What the Fed did was fix a systemic threat to the entire financial system when you take into account their extraordinary extension of the discount facilities to other financials plus what they accept as collateral. IMHO that threat has found a treatment but not a fix.
We're now going to have to work thru de-leveraging AND the Housing bubble over-hang for years. With a core economy that was slowing anyway and will now longer have synthetic debt and MEW to hold up spending, especially by consumers. That's going to be painful but at least it's now possible where a week ago the Wings of the Angel of Death brushed us. Almost literally.