Schedule and Posting and More on Tech Woes

I'm off to Los Angeles Sunday to participate in a first time panel of econbloggers at the Milken Conference. Needless to say, I'm flattered to be in such good company.

As a result, my posting may be a bit lighter next week. If you want to help, please send interesting research, scholarly articles, and news links. Trolling to find suitable material takes a fair bit of effort, so assistance on this front is very much appreciated (and will be rewarded via better posts). I'll be back Friday evening.

As for our problems with Google, we may have declared victory too early. Even though they unlocked the blog so I could post again, they left it in a state which meant that the domain name (www.nakedcapialism.com) could not point to the Blogger address (www.nakedcapitalism.blogspot.com). The term of art is envelope, for those who are versed in such matters. Note this did not affect readers who use RSS. We are having another word with them, but at least things are largely back to normal.

Ed Wright implemented a workaround, but he result was that the blog was down today for an hour at one clip, plus a total of twenty minutes in three outages later. Sincere apologies for the inconvenience and thanks for your patience.

Tech Woes Behind Us

Our recent problems with Google's Blogger hosting service seem to have been resolved. We experienced a bit over an hour of outage while resolving the last of the domain name resolution issues. Thanks for your patience.

Ed Wright
Naked Capitalism - Technical Support

Buffett's and Soros' Feet of Clay

Even great investors have bad days and bad calls. John Authers has a clever piece in the Financial Times on the errors Buffett and Soros have made.

According to a soon-to-be-released book by Vahan Jahigian, Buffett is astute about his picks, natch, but not so hot at selling. He argues that the Sage of Omaha has held on to some stocks that did well for many years but then underperformed.

But is this an indictment? The theorists say that trying to market time or do sector rotation is a way to overtrade and underperform. If Buffett believes his companies are still fundamentally sound, but presently out of favor, that doesn't argue for a sale. One of Buffett's maxims goes something like, "In the short term the market is a popularity contest, in the long term, a weighing machine."

Soros, who as perhaps the first global macro player, certainly the first to do so on the large scale that he did. suffers from a different Achilles heel: his fundamental calls (at least in the period under study) were spot on, but his implementation was wanting. In other words, Soros is a great seer and strategist, but ironically less adept as a trader. But the article suggests that that appearance may reflect this year's particularly treacherous markets.

From the Financial Times:

We all make mistakes, even if our names are Buffett or Soros. But when great investors such as Warren Buffett and George Soros make a mistake, the lessons for the rest of us are so much more interesting.

Both get far more decisions right than wrong. Buffett took over as the world’s richest man this year with a fortune of $62bn, according to Forbes, while Soros managed to pull in $2.9bn as a hedge fund manager last year, according to Alpha. But new books cast light on some mistakes.

Vahan Jahigian’s forthcoming Even Buffett Isn’t Perfect does not quite live up to the iconoclastic promise of its title. He concludes that Buffett is “one of the greatest investors – if not the greatest – of all time”.

But he identifies one recurring problem with Buffett’s approach. He holds on to stocks too long. “Regardless of price,” Buffett once said in a letter, “we have no interest at all in selling any good businesses that Berkshire owns.” He even said he was “very reluctant to sell sub-par businesses” if they were at least producing some cash and had decent labour relations.

For Buffett, his investments are almost like a marriage. Meanwhile, Jahigian prompts him with the old adage, “never marry a stock”. These attitudes can be reconciled because Buffett views all investment decisions as though he is buying a business, rather than simply buying a stock, and takes very large stakes. Once invested, he is married to the business, not merely the stock.

For most of us, it probably does not. If a very good business has become overpriced, we should consider selling it. The emerging discipline of behavioural finance – which uses experimental psychology to explore investment decisions – suggests far more mistakes are made in deciding when to sell a stock than in the much more widely discussed arena of deciding when to buy.

One of Buffett’s great stock picks was Coca-Cola, which he rode all the way up to its brief stint as the world’s largest company by market value, a distinction it reached a little more than a decade ago. But he still holds it, even though Coke has been outperformed by many rivals since then. For Buffett, this might make sense; the rest of us should develop a selling discipline. When a stock has become overpriced, we should sell.

As for Soros’s mistakes, he has been honest enough to tell us about them himself, in real time. His forthcoming book, The New Paradigm for Financial Markets, on the causes of the credit crisis includes an investment diary that started at the beginning of this year. Soros gave his prognosis for 2008 and explained his investment strategy to capitalise on it. He then updated it every few weeks. The timing was fortunate: Soros’s diary took him through until the Bear Stearns fire sale last month.

Soros was the first great “global macro” fund manager, making big asset allocation bets. Most famously, he wagered that sterling would have to devalue in September 1992, forcing the UK government to leave the exchange rate mechanism.

Macro funds did well in the first quarter of this year, making an average of about 10 per cent while many other investors lost serious money. But Soros reveals in his diary that he was only flat for the period.

He failed to make money even though he was exactly correct in the way he called the global markets. In January, he predicted that the credit crisis was severe but that the acute phase would be contained because central banks would provide temporary liquidity – exactly what happened. He also saw a bubble in China. So he started the year betting on the dollar, and US and European stocks, to fall – all correct calls.

How did he fail to make money? Timing was part of it. He was heavily invested in India and China on the theory that the bubble was in its early stages. But Indian stocks fell 20 per cent in a few weeks during January, while the Shanghai Composite is now at half its level from its peak last October.

Then there was Bear Stearns. His overall prediction on US financial services was uncannily correct. But on Friday, March 14, he bought Bear Stearns stock, which closed that day at $54. The Federal Reserve had announced emergency funding and he assumed that Bear would be auctioned off to the highest bidder over the weekend.

Instead, Bear was forced into the arms of JPMorgan for $2 a share. “We forgot to take into account that Bear is disliked by the establishment,” said Soros. “The Fed would ... deal with moral hazard by punishing shareholders.”

Soros could have fared very much worse – his Bear shares were well hedged in the credit market. But by March 20,his fund was “under water for the year”, albeit to a much lesser degree than many others.

There is a belief that times of turbulence are times of greatest opportunity for those who see the big picture. But that perfectly describes George Soros. If even he can fail to make money owing to slight errors in timing and slight misreadings of individual situations, the lesson for the rest of us is sobering.

Turbulence creates risks as well as opportunities. Those of us not called Soros of Buffett should probably leave well alone.

Is Your Salad Bad for the Environment?

There's a good article at the New York Times, "Movable Feast Carries a Pollution Price Tag," on the issue of CO2 emissions resulting from the delivery of foodstuffs around the world.

The article discusses at some length how international fuel tax breaks have facilitated this trade. Let's face it, many foods are low value per unit weight products; they are not the sort that you'd expect to be transported halfway around the world. But subsidies on this scale are hard to unravel.

In the bad old days, people ate what was in season and preserved as much as they could. If we are going to be more environmentally sensitive about what we eat, we'll have to accept less variety in fresh food. And having lived for a few months in the UK in the early 1980s, when they imported far less produce than now, the choices were limited and the quality less than stellar. It will be hard to get people who live in colder climes to go back to the ancien regime.

I'm skeptical that disclosure or regulation will do the trick. Taxes (or in this case, the end of the waiver) would be effective, but as the story notes, you'd need to have near universal cooperation. It would also hit the poor, who often have trouble affording decent produce, the hardest.

From the New York Times:

Cod caught off Norway is shipped to China to be turned into filets, then shipped back to Norway for sale. Argentine lemons fill supermarket shelves on the Citrus Coast of Spain, as local lemons rot on the ground. Half of Europe’s peas are grown and packaged in Kenya/

In the United States, FreshDirect proclaims kiwi season has expanded to “All year!” now that Italy has become the world’s leading supplier of New Zealand’s national fruit, taking over in the Southern Hemisphere’s winter.

Food has moved around the world since Europeans brought tea from China, but never at the speed or in the amounts it has over the last few years. Consumers in not only the richest nations but, increasingly, the developing world expect food whenever they crave it, with no concession to season or geography.....

But the movable feast comes at a cost: pollution — especially carbon dioxide, the main global warming gas — from transporting the food.

Under longstanding trade agreements, fuel for international freight carried by sea and air is not taxed. Now, many economists, environmental advocates and politicians say it is time to make shippers and shoppers pay for the pollution, through taxes or other measures.

“We’re shifting goods around the world in a way that looks really bizarre,” said Paul Watkiss, an Oxford University economist who wrote a recent European Union report on food imports.

He noted that Britain, for example, imports — and exports — 15,000 tons of waffles a year, and similarly exchanges 20 tons of bottled water with Australia. More important, Mr. Watkiss said, “we are not paying the environmental cost of all that travel.”

Europe is poised to change that. This year the European Commission in Brussels announced that all freight-carrying flights into and out of the European Union would be included in the trading bloc’s emissions-trading program by 2012, meaning permits will have to be purchased for the pollution they generate.

The commission is negotiating with the global shipping organization, the International Maritime Organization, over various alternatives to reduce greenhouse gases. If there is no solution by year’s end, sea freight will also be included in Europe’s emissions-trading program, said Barbara Helferrich, a spokeswoman for the European Commission’s Environment Directorate. “We’re really ready to have everyone reduce — or pay in some way,” she said.

The European Union, the world’s leading food importer, has increased imports 20 percent in the last five years. The value of fresh fruit and vegetables imported by the United States, in second place, nearly doubled from 2000 to 2006.

Under a little-known international treaty called the Convention on International Civil Aviation, signed in Chicago in 1944 to help the fledgling airline industry, fuel for international travel and transport of goods, including food, is exempt from taxes, unlike trucks, cars and buses. There is also no tax on fuel used by ocean freighters.

Proponents say ending these breaks could help ensure that producers and consumers pay the environmental cost of increasingly well-traveled food.

The food and transport industries say the issue is more complicated......

Some of those companies say that they are working to limit greenhouse gases produced by their businesses but that the question is how to do it. They oppose regulation and new taxes and, partly in an effort to head them off, are advocating consumer education instead.

Tesco, for instance, is introducing a labeling system that will let consumers assess a product’s carbon footprint.

Some foods that travel long distances may actually have an environmental advantage over local products, like flowers grown in the tropics instead of in energy-hungry European greenhouses...

Some studies have calculated that as little as 3 percent of emissions from the food sector are caused by transportation. But Mr. Watkiss, the Oxford economist, said the percentage was growing rapidly. Moreover, imported foods generate more emissions than generally acknowledged because they require layers of packaging and, in the case of perishable food, refrigeration.

Britain, with its short growing season and powerful supermarket chains, imports 95 percent of its fruit and more than half of its vegetables. Food accounts for 25 percent of truck shipments in Britain, according to the British environmental agency, DEFRA.

Mr. Datson of Tesco acknowledged that there were environmental consequences to the increased distances food travels, but he said his company was merely responding to consumer appetites. “The offer and range has been growing because our customers want things like snap peas year round,” Mr. Datson said. “We don’t see our job as consumer choice editing.”

Global supermarket chains like Tesco and Carrefour, spreading throughout Eastern Europe and Asia, cater to a market for convenience foods, like washed lettuce and cut vegetables. They also help expand the reach of global brands.

Pringles potato chips, for example, are now sold in more than 180 countries, though they are manufactured in only a handful of places, said Kay Puryear, a spokeswoman for Procter & Gamble, which makes Pringles.

Proponents of taxing transportation fuel say it would end such distortions by changing the economic calculus.

“Food is traveling because transport has become so cheap in a world of globalization,” said Frederic Hague, head of Norway’s environmental group Bellona. “If it was just a matter of processing fish cheaper in China, I’d be happy with it traveling there. The problem is pollution.”

The European Union has led the world in proposals to incorporate environmental costs into the price consumers pay for food.

Switzerland, which does not belong to the E.U., already taxes trucks that cross its borders.

In addition to bringing airlines under its emission-trading program, Brussels is also considering a freight charge specifically tied to the environmental toll from food shipping to shift the current calculus that “transporting freight is cheaper than producing goods locally,” the commission said.

The problem is measuring the emissions. The fact that food travels farther does not necessarily mean more energy is used. Some studies have shown that shipping fresh apples, onions and lamb from New Zealand might produce lower emissions than producing the goods in Europe, where — for example — storing apples for months would require refrigeration.

But those studies were done in New Zealand, and the food travel debate is inevitably intertwined with economic interests.

Last month, Tony Burke, the Australian minister for agriculture, fisheries and forestry, said that carbon footprinting and labeling food miles — the distance food has traveled — was “nothing more than protectionism.”

Shippers have vigorously fought the idea of levying a transportation fuel tax, noting that if some countries repealed those provisions of the Chicago Convention, it would wreak havoc with global trade, creating an uneven patchwork of fuel taxes.

It would also give countries that kept the exemption a huge trade advantage.

Some European retailers hope voluntary green measures like Tesco’s labeling — set to begin later this year — will slow the momentum for new taxes and regulations.

The company will begin testing the labeling system, starting with products like orange juice and laundry detergent.

Customers may be surprised by what they discover.

Box Fresh Organics, a popular British brand, advertises that 85 percent of its vegetables come from the British Midlands. But in winter, in its standard basket, only the potatoes and carrots are from Britain. The grapes are South African, the fennel is from Spain and the squash is Italian.

Today’s retailers could not survive if they failed to offer such variety, Mr. Moorehouse, the British food consultant, said.

“Unfortunately,” he said, “we’ve educated our customers to expect cheap food, that they can go to the market to get whatever they want, whenever they want it. All year. 24/7.”

Links 4/26/08

Why do whales beach themselves? PhysOrg

Climate 'fix' could deplete ozone BBC

Happy spamiversary! Spam reaches 30 New Scientist

Why Haven't Existing Home Sales Fallen Further? Calculated Risk. A fascinating little post. CR does not see the not-so-bad existing home sales as a predictor of things to come.

Please... No C*#t in the Oval Office Cassandra. Quite a rant.

Could IMF Have Prevented This Crisis? Project Syndicate (hat tip Mark Thoma). Another sighting of the US being compared to a developing country.....

China May Limit Share Sales, Allow Margin Lending, Citic Says Bloomberg

Antidote du jour:

Update on Tech Woes

Loyal readers may know we've had tech misery for the last 24 hours. Ed Wright, who among other things, once ran mission critical trading platforms for a major global bank does not take no for an answer and had us operational, albeit by migrating some of our recent content over.

Google came around only by virtue of a full court press (Felix Salmon and the Milken Institute were on their case) but it appears it was Michael Schrage, brother of Eliot Schrage, who broke the logjam.

It shouldn't require that level of effort to get a screw-up resolved. The inability to get through Google's switchboard (take my word, getting through bureaucracies is one of my long suits, but they had me bested) is, shall we put it, rather revealing.

Ed needs to undo what he did yesterday, but hopefully we will be back to normal later on Saturday. Thanks for your patience and continued support.

Signs of Improvement in the Credit Markets

Various indicators suggest that the tone of the credit market (save the interbank market) is improving:

jck at Alea deems the latest TSLF auction to be a success.

Bloomberg tells us that government bond prices are falling, not just in the US but other major economies, signaling a return of confidence:

Government bonds worldwide are heading for their first monthly loss since June, as rising commodity prices stoke inflation and bankers say the seizure in credit markets is easing.

Yields on Japanese government bonds due in five years today rose the most since 1999 after consumer prices surged 1.2 percent in March from a year earlier. U.S. Treasury notes due in 2010 are poised for their biggest two-week decline since 2001 as traders add to bets the Federal Reserve will stop cutting borrowing costs after its April 30 meeting. European Central Bank President Jean- Claude Trichet said yesterday euro-region interest rates at a four-year high were adequate for curbing price growth.

``Some people seem to be thinking the credit crisis is coming to an end,'' said Ciaran O'Hagan, head of interest-rate research in Paris at Societe Generale SA, France's second-largest bank. ``The market had been expecting rate cuts from the Fed and they've been almost totally priced out, while in euro land, investors are expecting rate hikes.''.....

``There's been quite a shift in bond-market sentiment over the past few weeks,'' said Nick Stamenkovic, a fixed-income strategist at RIA Capital Market Ltd. in Edinburgh. ``The market has become increasingly confident that the worst is over for the financial sector and that the Fed is nearing the end of its easing cycle.''

Some traders anticipate fewer rate reductions into Treasury prices on speculation policy makers are concerned that lower borrowing costs will stoke inflation. Consumer prices in the U.S. rose at a 4 percent annual pace in the 12 months through March.

Demand for fixed-income securities also waned as investor appetite for riskier assets improved. The MSCI Asia Pacific Index of stocks has returned 6.9 percent this month, while the Standard & Poor's 500 Index has advanced 5.1 percent.

The cost of protecting corporate bonds against default fell to the lowest in three months today as the $76 billion of capital banks raised worldwide in April buoyed confidence.....

``The markets are moving from the panic mode of a month or six weeks,'' said Andrew Bell, head of research and strategy at Rensburg Sheppards Plc in London. ``Part of the panic of being really risk-averse in equities was to pile into the short end of the Treasury market.''

Futures contracts on the Chicago Board of Trade show there's a 26 percent chance the Fed will keep the U.S. target rate for overnight bank lending on hold at 2.25 percent on April 30, up from 2 percent a week ago. The balance of the bets are for a quarter-point reduction. The odds of a half-point cut are zero, compared with 28 percent a month ago.

As a result of the improved mood, corporate issuers rushed to the market. From a separate Bloomberg story:

Citigroup Inc. and Merrill Lynch & Co. led $45 billion of U.S. corporate bond offerings, the busiest week on record, as financial companies sold debt at the highest yields since May 2001.

Sales compare with $31.2 billion last week and an average this year of $18 billion, according to data compiled by Bloomberg. Citigroup, the biggest U.S. bank by assets, sold $6 billion of hybrid bonds in the company's largest public debt offering, while New York-based securities firm Merrill Lynch raised $9.55 billion by issuing debt and preferred securities.

Bond offerings soared as investors grew more optimistic financial companies can recover from $309 billion of writedowns and credit losses tied to the collapse of the subprime-mortgage market. Banks and securities firms sold 88 percent of investment-grade debt this week, Bloomberg data show. High-yield bond issuance swelled to the most since November.

``Investors are feeling better about banks being proactive about raising capital,'' said Mike Difley, who helps oversee $21 billion in fixed-income assets as a portfolio manager at American Century Investment Management in Kansas City. ``They're trying to get their house in order.''

The previous high for U.S. corporate bond sales was in the week ended June 22, 2007, when $42.1 billion of debt was issued, Bloomberg data show.

Note that this development is a bit of a mixed bag, since the bond issues were skewed towards the desperate riskier issuers.

The Vix and , which many see as a proxy for market risk generally, also fell, and as did options implied volatility in financials, per VIX and More:

Just yesterday, in Financials Struggle to Establish Momentum, I expressed some concern that the recent relatively weak performance of the financial sector (XLF) did not bode well for any sustainable bull moves. Perhaps the sector overheard me, as today the XLF is up 2% in an otherwise flat market as I type this.

While the price action is ultimately what matters most, there is more to the story than just the prices of the financial stocks. In particular, I am watching the implied volatility of XLF, the financial sector’s bellwether ETF. As depicted in the chart below, the implied volatility (which has a significant fear and anxiety component in it) for XLF is approaching levels not seen since the first week in November.

I consider option traders to be a fairly savvy bunch; if they think that the risk premium in the financial sector is lower than any time in the past six months, I am going to listen – and watch to see what happens to the price.

The Financial Ninja, who pointed to the post above, is not convinced, as his post title, "Bulltards Grow Complacent: VIX Drops", makes clear (click to enlarge):



The text says:

Yesterday’s New Home Sales data should have DESTROYED the argument that there won’t be a recession or that it will be short and shallow. I know, I know, equities didn’t seem to mind. Wait for it. Looks like the Bulltards really want to tag 1400 on the S&P 500. Volatility (VIX) has fallen to COMPLACENCY levels (in this credit crisis environment).

Love those charts, even though they make no sense to me.....

Costly Navy Ship Screw-Up Illustrates How Not to Innovate

The New York Times has one of those "your tax dollars at work" stories in the form of "Costly Lesson on How Not to Build a Navy Ship."

The article recounts how the Navy set out to build a new type of vessel, "littoral combat ships," which would become the first line of defense in asymmetric warfare, which is military speak for "low tech can blow up our big ticket toys."

The littoral combat ships were to be fast and adaptable:

To Navy planners, a ship designed for coastal combat could neutralize hostile submarines, surface warships, mines and terrorist speedboats, clearing the way for other combat ships to operate in offshore waters and support combat ashore....

The Navy also wanted ships that could travel fast, better than 40 knots. And they needed to be easily outfitted with different weapons and surveillance systems. A removable package of mine-sweeping equipment, for instance, could be replaced with a package of special-operations gear used by a Seal team.

Um, what led to the need for the rethink on ship was the attack on the Cole, which was launched not by terrorist speedboats, but a rubber dingy. Never mind.

But Donald Rumsfeld's vision of "transformational warfare," of which these ships were an example, turned out to be another example of Bush Administration faith-based policies:

“The littoral combat ship is an imaginative answer to emerging military requirements, but it has the most fouled-up acquisition strategy I have ever seen in a major military program,” said Loren Thompson, a military analyst at the Lexington Institute, a policy research center.

Where did they screw up? The story gives tons of particulars, and is fascinating appalling reading, but they can be boiled down to one major mistake: the Navy tried innovating on all axes at once. That effectively meant that everyone was making things up as they went along. To illustrate:

In their haste to get the ships into the water, the Navy and contractors redesigned and built them at the same time — akin to building an office tower while reworking the blueprints. To meet its deadline, Lockheed abandoned the normal sequence of shipbuilding steps: instead of largely finishing sections and then assembling the ship, much of the work was left to be done after the ship was welded together. That slowed construction and vastly drove up costs.

“It’s not good to be building as you’re designing,” said Vice Adm. Paul E. Sullivan, commander of the Navy branch that supervises shipbuilding.

So how was the Navy trying to do things differently? Consider:

1. Completely new design. This wasn't simply a new ship, this was a new type of ship, adapted from commercial high speed ferries. And the Navy fell into the same bad behaviors of clients for major new custom software: not being clear about what it wanted, changing requirements as the project was underway.

2. Innovating on methods. The Navy decided to build this never-before-anything-like-it littoral was going to be launched in record time:

The first model was to be delivered no more than six years after conceptual planning began, half the normal time. Construction was to take two years, instead of the usual four or five.

But worse was that this innovation was supposed to achieve the impossible:

The Navy first publicly declared its intention to build the ship on Nov. 1, 2001. In those days, the Pentagon’s defining procurement mantra was “Faster, Better, Cheaper.” From the first, the coastal ships’ defining characteristic was speed.

Have you every heard of the project triangle? Draw a triangle. At each apex, write one of these three words: Good, Fast, Cheap. The rule of the project triangle is you can have only one leg at most. You can have Good-Fast, Fast-Cheap, or Cheap-Good. You can't have all three. But the Navy clearly hoped to create the military program equivalent of cold fusion.

3. Inexperienced contractor. Bad enough to try something almost destined to fail as 1 and 2 together. But who did the Navy choose? Lockheed, which the Times tells us "had virtually no shipbuilding experience." Yes, they did hire a naval architect "and two shipyards." I can't believe the Times repeated the latter as bolstering Lockheed's credentials. Where other than a shipyard could they possibly have built a ship? In an car factory?

But do read the piece. It's yet another example of how at its core, this Administration valued staying faithful to its ideology, no matter what the cost, over achieving tangible improvements.

Links 4/25/08

Human line 'nearly split in two' BBC and Humans nearly wiped out 70,000 years ago, study says CNN. Note the difference in emphasis.

Does economics make you selfish? Greg Mankiw. The evidence can be read that way.....

The cost of a lifeline: Humbled financial groups brace for more regulation Gillian Tett and Krishna Guha, Financial Times. The piece provides a good overview, and also makes clear how hard it will be to achieve meaningful reform in the absence of an uncontrolled meltdown (say a credit default swaps crisis) that would blow away the impediments to a major overhaul.

Mark Hulbert: Contrarian analysis no longer as bullish on gold Marketwatch

Study Shows Suicide Rates Significantly Higher Among Veterinarians PhysOrg

Antidote du jour:



Adapting to the state’s growing role in global equity markets Brad Setser

The case for 2-1/4 James Hamilton, Econbrowser. Hamilton is right, of course, but will the Fed lister?

Ambac Claims "No Liquidity Issues, Ratings Solid"

It's predictable that embattled Ambac CEO Michael Callen would claim that all is well at the bond insurer in the face of considerable evidence to the contrary in the form of first quarter net loss of $1.66 billion, which wiped out last month's highly dilutive capital raise of $1.5 billion. Ambac had to triple its common shares last go-round to raise money that was now clearly inadequate to strengthen its balance sheet, as the rating agencies demanded.

Consider further: there is no new business for the monoliines. They've sworn off the securitized credit market, and with rating agencies re-doing their grading scales for municipalities, that low-risk credit arbitrage is gone.

It gets even better: Goldman predicts that Ambac and MBIA each need to raise $3.4 billion more in capital. How, pray tell, and at what cost?

Despite these rather uncomfortable facts, Callen asserts that the ratings are "solid'. Fitch doesn't think so and already downgraded Ambac to AA. Rating agency Egan Jones doesn't think so and has been a long-time critic of the bond guarantors. The credit default swaps market doesn't think so. Even New York State insurance superintendent Eric Dinallo has doubts.

And the last time I recall a company saying its liquidity was fine was Bear, and at least at the time of its crunch, Bear's long-term prospects looked better than Ambacs' do (there is still ample debate as to whether Bear was insolvent or not: the answer in most cases depends on one's view of the credit default swaps market).

While Lehman made similar assertions, they took some steps to assuage worries, like securing bigger bank credit lines. And Lehman was in the fortunate position of having its crisis of confidence at the time of the Bear failure. The Fed simply was not gong to let two institutions go into crisis in such close succession if there was anything it could do to prevent it.

But the old dynamic still prevails: despite widespread skepticism about the Moody's and S&P AAA ratings on MBIA and Ambac, the two rating agencies will continue to be loath to downgrade until the evidence becomes overwhelming. So the monolines will limp along until it becomes impossible not to put them out of their misery.

So take this Bloomberg story with a handful of salt:

Ambac Financial Group Inc., the bond insurer struggling to hold on to its AAA credit rating, has no liquidity issues and the majority of its portfolio is performing well, interim Chief Executive Officer Michael Callen said.

The company's credit ratings ``are solid,'' Callen said in a Bloomberg Television interview from New York today.

The world's second-largest bond insurer, has been ``very aggressive'' in addressing its losses and will likely exceed ratings companies' capital targets by May, Callen said. Ambac in March sold $1.5 billion in stock and equity units after more than $5 billion of charges on its guarantees of mortgage-liked debt.

Ambac and larger competitor MBIA Inc. may need to raise more capital, New York Insurance Department Superintendent Eric Dinallo said in a Bloomberg Television interview earlier today.

``It's not time for a victory lap,'' Dinallo said. ``Mortgage losses and defaults will drive whether capital is ultimately OK.''

Goldman Sachs Group Inc. analyst James Fotheringham estimates New York-based Ambac and Armonk, New York-based MBIA may need to raise $3.4 billion each to fill capital shortfalls.....

Ambac's March stock offering was enough to persuade Moody's Investors Service and Standard & Poor's to take the AAA bond insurer rating off review, averting a downgrade that would have crippled the company's ability to guarantee bonds. It also removed the broader threat of losses for the $524 billion of municipal and asset-backed debt the company insures.

Bond insurers have posted record losses after expanding from guarantees on municipal bonds that rarely default to insuring securities tied to mortgages that are now going delinquent at the highest rate since 1985. Ambac's new business slumped 87 percent last quarter after ratings companies threatened to strip the insurer of its AAA status.

Credit Suisse Takes Bigger Than Expected Writedown

Credit Suisse, which heretofore looked somewhat immune to credit market problems, has joined its peers in having a loss-making quarter. A Sf5.3 billion writedown on leveraged loans and mortgage instruments was the proximate cause.

Note the quarterly deficit was more than three times the consensus estimate. The CEO was also loath to declare the debt crisis to be in remission.

From Bloomberg:

Credit Suisse Group, Switzerland's second-biggest bank, reported a first-quarter loss that exceeded estimates on writedowns linked to deteriorating credit markets.

The net loss, the bank's first in almost five years, totaled 2.15 billion Swiss francs ($2.1 billion), compared with a 2.73 billion-franc profit a year earlier, Zurich-based Credit Suisse said in a statement today. The median estimate of 14 analysts surveyed by Bloomberg News was for a 594 million-franc loss.

Chief Executive Officer Brady Dougan said the results were ``clearly unsatisfactory'' after 5.3 billion francs of markdowns on leveraged loans and mortgage-related securities.....

The writedowns at the securities unit included collateralized debt obligations that the bank said last month were intentionally mispriced by a ``a small group'' of traders. The bank had writedowns of 2.66 billion francs on CDOs, 1.68 billion francs on leveraged finance and 848 million francs on commercial mortgage-backed securities.

Profit at the wealth management unit fell 13 percent to 860 million francs, while earnings rose 3 percent to 464 million francs at the corporate and retail banking division...

On a number of occasions ``people had seen the light at the end of the tunnel and it's been a train coming down the tracks,'' Dougan said today. ``Things have stabilized a bit in April. While we're certainly hopeful that things will improve from here, we're not counting on it.''

"This bear growls on"

In a post at the Telegraph, Ambrose Evans-Pritchard reviews the case for why the credit markets might be on the mend and finds it wanting. While some of his arguments are familiar, the part I found interesting was his belief (contrary to Wolfgang Munchau at the Financial Times' piece "Pessimism about the eurozone is misplaced") that neither Europe's banks nor its economy will fare well: "Far from being the shock absorber, Europe may prove to be the accelerator of this post-bubble denouement."

Confirming part of Evans-Pritchard's thesis, a particularly well connected source (he reported that the Fed and Treasury were working on a quasi-nationalization plan for banks back in January) reiterated that the European banks are in at least as bad shape as their US counterparts (this is based on contact with both European regulators and senior bank executives).

From the Telegraph:

No bear wants to be a perma-pessimist, ever waiting for the sky to fall.

So, sunk in a deep armchair with an optimistic bottle of Rioja (Baron De Ley Reserva), I have tried to tot up reasons why the great credit smash-up of 2007-2008 may now be safely over, heralding sunlit uplands once again.

1) Ben Bernanke has carried out the most dramatic rescue since the creation of the US Federal Reserve. His emergency rate cuts - 125 basis points over eight days in January - was a "game changer", as they say in London’s American Quarter, Canary Wharf.

By cutting rates from 5.25pc to 2.25pc since September, the Fed has averted 're-set Armaggedon' on the Greenspan mortgages – those floating rate 'teasers' taken out in 2005 to 2007. Payments will barely jump at all for most subprimers. Big difference.

The cuts are heavenly manna for the banks. These miscreants can now play the "steepening yield curve", using their monopoly privileges to borrow cheaply from the US Government and lend back expensively to the same US Government on long-dated bonds. This is the time-honoured method for rebuilding balance sheets. It works wonders. Even better (from the banks point of view), few people are aware of this massive bail-out.

2) Bernanke has accepted 'bus tickets' as collateral. The broker dealers (Bear Stearns, et al) can take their waste to the Fed’s Discount window, putting a floor under the entire shadow banking and $516 trillion derivatives nexus. Meanwhile, Fannie Mae and Freddie Mac have been armed with nuclear weapons to win the credit war. De facto, if not de jure, the mortgage industry has been nationalized. Big difference.

3) The Bank of England has woken up. Better late than never. As Professor Charles Goodhart (LSE and ex rate-setter) put it: "When you’re in a crisis, you deal with the crisis. Moral hazard comes when times are easier." Quite.

4) A dodgy one, this: China grew at 10.6pc in the first quarter. The BRICS - Brazil, Russia, India, China - are holding up. (If you ignore their galloping inflation, which you can’t, of course: current inflation merely means a future squeeze.) Actually, scrap point 4. It’s rubbish.

Still 1, 2,and 3, matter a great deal. Yet, I cannot really believe the tale of salvation. The Greenspan credit bubble and Europe’s EMU bubble (Club Med, Ireland, and ERM-fixers in Denmark and Eastern Europe) have together infused so much poison into the Atlantic economy that it will require a brutal purge - like chelating heavy metals from the brain.

America, of course, is already in recession – although the cascade of defaults, business closures, and job losses has barely begun.

Japan is in recession too, according to Goldman Sachs. It is still the world’s second biggest economy by far, lest we forget.

Britain, Ireland, Spain, Italy, and New Zealand, are tipping into housing slumps and demand implosions of varying severity.

Ontario and Quebec have stalled. Canada’s growth is the weakest in fifteen years, hence the half point cut by the Bank of Canada yesterday.

Australia is on borrowed time, whatever the price of coal and iron ore. Household debt is 175pc of disposable income, up in La La Land with England, Ireland, Denmark, and the Dutch. The wholesale funding market for mortgages that underpins this nonsense remains frozen.

Together these countries and regions make up roughly 45pc of the global economy, and over half global demand. My hunch is that this bloc will be sliding towards full-blown deflation within a year as the commodity bubble pops and job losses set off a self-feeding downward spiral.

The alleged parallel with the oil spike of the early 1970s is a snare. Debt leverage has been more reckless this time. It must contract more viciously. Inflation is less sticky (going down) in the Anglo-Saxon world, if not flexless Europe, where stagflation awaits.

If you think that core Europe - Greater Germany, Benelux, and the Scandies (France is faltering) - can somehow tough it out as the rest of the OECD’s industrial family hurtles into a brick wall, read the IMF’s “Regional Economic Outlook: Europe”, published this week.

The Fund has cut its eurozone growth forecast to 1.4pc this year, and 1.2pc next – with perma-slump pencilled in for Italy. This puts it at daggers drawn with the European Central Bank, the fervent apostle of decoupling.

Europe will suffer 40pc of the entire $940bn global losses stemming from the credit crunch. Euro banks alone will lose $123bn (compared to $144bn for the US). "Loss recognition will need to catch up," said the IMF.

"Liquidity remains seriously impaired. Lenders are tightening credit standards, particularly for loans to enterprises," it said.

"The deteriorating economic outlook could weaken European and corporate balance sheets appreciably," it said.

On it goes, more or less dire, if you adjust for the IMF’s softly-softly style.

The report contains a grim chapter on what may happen along the vast arch of over-heating silliness from the Baltics to the Black Sea, funded by Austrian, Swedish, German, Belgian, and Italian banks.

"Europe’s emerging economies are susceptible to financial shocks, which could make the situation dramatically worse," said Michael Deppler, the Fund’s Europe chief.

Last year, private credit grew 62pc in Bulgaria, 60.4pc in Romania, 55.2pc in Kazakhstan, 45pc across the Baltics. Need one say more?

Current account deficits have reached 22.9pc in Latvia, 21.4pc in Bulgaria, 16.5pc in Serbia, 16pc in Estonia, 14.5pc in Romania and 13.3pc in Lithuania. The gap has been plugged by foreign loans. These are no longer forth-coming. Spreads have ballooned by over 500 basis points.

"Banking systems that are heavily dependent on foreign borrowing to support credit growth could face a sudden shortfall," said the IMF.

Woe betide the creditors. Loans to the old Soviet bloc account for 23pc of the entire asset base of the Austrian banking system, and 10pc of the Swedish and Belgian systems.

As Europe’s drama slowly unfolds, the ECB is sticking defiantly to its orthodox line. The IMF suggests looking beyond the current food and oil spike (inflation is at a post-EMU high of 3.6pc), and preparing "some easing of the policy stance".

Axel Weber, the German Bundesbank chief and leader of the Uber-hawks, will have none of it. "I do not share the vision of the IMF," he said, tartly.

One notes that the Bundesbank was quieter when Germany was in the dumps and needed lower interest rates. It acquiesced in roaring money supply growth as inflation fuelled bubbles in the Latin Bloc – the cause of their current distress. Such is the hypocrisy of EMU. Beware the pious incantations by Mr Weber, a German nationalist in Euro-clothing. (I will return to the theme of Mr Weber in another blog.)

The ECB’s "error" will become clear over the next year as the house price crash across Club Med and Ireland combines in a lethal brew with the East Bloc credit deflation.

Germany will not be immune from the blow-back. It has funded a good chunk of Club Med’s foreign debts: Spain ($362bn), Italy ($275bn), Greece ($129bn), Greece ($98bn), and - honorary Club Med - Ireland ($123bn).

Far from being the shock absorber, Europe may prove to be the accelerator of this post-bubble denouement.

Once you add Europe to the Anglo-Saxon and Japanese sick list, you reach 60pc of world GDP, and two thirds world demand.

This leaves the global boom on tenuously narrow ground. Who is going to buy all those exports from China? Who is going to keep pushing commodity prices into the stratosphere? This bear growls on.

First, Let's Kill All the Servicers

As the housing/mortgage crisis has progressed, homeowner advocates and legislator have to get mortgage servicers to offer more loan modifications to struggling borrowers. Even though this housing recession has a far higher proportion of borrowers seriously underwater than past downturns, the logic of loss mitigation is still valid. It's still better for the bank to keep the homeowner in place, even at a reduced payment, than foreclose (although in some communities where home valued have plummeted, the banks seem content for the moment not to take action against defaulting debtors).

Some observers have taken the view that it's impractical for banks to negotiate on a case-by-case basis (gee, that's how they used to make loans and do workouts before they decided to go for efficiency at the expense of quality). And that may be a valid objection: serivcers are factories. Even by some affordable housing experts report that they are unable to do one-offs.

Another impediment is that securitized transactions often limit the ability of the servicer to do loan modifications (although no one seems to have good estimates on how often that is operative).

Last year's Treasury sponsored Hope Now Alliance was a cosmetic rescue program to address those issue, offering a "one-size-fits-few" template that was anticipated to offer servicers a legally defensible ground for making mods. However, few have happened.

Now legislators are considering another approach: require servicers to attempt loss mitigation before foreclosing. From Credit Slips:
I

n my prior post on mortgage servicing, I talked about the potential of mortgage servicers to be harmful barriers between homeowners and investors, both of whom may want to negotiate a loan modification. Recognizing such a problem raises the question of a solution. U.S. Representative Maxine Waters recently introduced legislation that would profoundly alter the duties of mortgage servicers. The bill, HR 5679, The Foreclosure Prevention and Sound Mortgage Servicing Act of 2008, would prohibit the initiation of a foreclosure if the mortagee or servicer has failed to engage in "reasonable loss mitigation activities." The bill lays out exactly what counts as loss mitigation and offers up non-binding guidance on standards of affordability for loss mitigation. Servicers would have to report data on their loss mitigation activities, disaggregated by the type of mitigation activity (separately accounting for things like modifications, deeds in lieu of foreclosure, or repayment plans).

The bill also takes aim at the communication problems between servicers and homeowners. The bill requires services to provide a toll-free number that provides borrowers with direct access to a person with the information and authority to fully resolve issues related to loss mitigation and specifies that such a person must be physically located in the United States. Servicers are also required to forward borrower's information to HUD-certified housing counselors whenever a borrower is 60 days or more overdue.

In the hearing last week on the bill (which you can watch as an archived webcast), Chairwoman Waters kept returning to a fundamental point--mortgage servicing is an unregulated industry. The witness testimony was essentially unanimous that mortgage servicing has a tremendous impact on American families and on the resolution of the current crisis. Of course, the debate was over whether this regulation was the right approach. The bill hasn't gotten much publicity yet, but I encourage readers who are interested in the foreclosure crisis to take a look and post their feedback.

Mind you, I skimmed the text only quickly, but several thing stood out. This bill is clearly thought out, and is tough. Not only do the servicers have reporting obligations as discussed, but there are explicit requirements regarding communication with the borrower. For instance:

`(2) INCOME USED IN DETERMINING AFFORDABILITY- In making a determination of affordability for purposes of this subsection, a mortgagee or servicer shall use the income information furnished by the borrower at the time of loan origination, except that the borrower or mortgagor may elect to provide the mortgagee or servicer with current information and, if so provided, such current income information shall be used for purposes of determining affordability. The mortgagee or servicer shall advise the borrower or mortgagor of any right under this paragraph to provide current income information. If current income information is used, all sources of income shall be verified by tax returns, payroll receipts, bank records, or other third-party verification; the best and most appropriate documentation shall be used....

`(4) WRITTEN NOTIFICATION OF AFFORDABILITY CALCULATION- The mortgagee or servicer shall notify the borrower or mortgagor in writing of the results of the determination of affordability under this subsection and the income on which the determination was based. Such written notice shall be provided by mail not later than 7 business days after such action is taken or as part of the written notice required under subsection (c)(1), whichever is earlier.

The bill also permits servicers to recover "reasonable fees" (although they are subject to review) and applies to any "federally related mortgage loan that is secured by a lien on the principal residence of the borrower or mortgagor" that defaults after the bill is enacted.

My initial reaction is schadenfreude: the industry has brought this sort upon themselves. If it can't figure out a way to do mods despite the mounting pressure to do so (and in cases where a mod might be possible, lose/lose to borrower and investor for failure to do so), it will be imposed on them, and as this bill delineates, in a way that offers them little wriggle room. My second is that it won't be passed; there appears to be no Senate version of this bill. My third is that that's a shame, the credible threat of the passage of a measure like this would light a fire under servicers (although that might only be to mobilize lobbying against it).

But to the more serious question: is this bill a good idea? Given the track record so far, it may be that servicers need something this confining to force them to act, and to give them cover with their investors to do so. Mods, however, typically favor certain tranches over others, so this might produce some sharp repricings.

Moreover, even if the team at the servicer has the best of intentions, it has to start with the mit plan from the income records at the time of the loan. With no docs, low docs, and generally lousy standards, that information is generally terrible. And while the debtor can provide current information, it isn't clear they will be forthcoming. Servicers aren't particularly well liked or trusted in borrower land.

But as much as I have little sympathy for companies that made a lot of money during the gravy days of the housing bubble and now plead poverty as an excuse for inaction, this bill would an industry under stress to the wall. It will have to incur the costs of notification and reporting for all defaulting borrowers, but will be able to collect fees only out of continuing cash flow from the borrower or a foreclosure sale. Most of these activities (setting up a call center, creating methods, forms, and supporting systems for borrower communication and regulatory reporting) have high fixed and low variable costs. It will be hard to determine the right fee levels up front (and you can't readily go back if you got it wrong). And its quite possible the fees will look disproportionate, even if they are costed properly.

Plus there's a big cash flow problem: the costs are incurred up front, the fees recovered over time. And servicers are already having big time cash flow problems. I have been told that servicers, which in most cases are part of large banks, are hemorrhaging cash. Notes from a conversation with informed parties:

The servicer has guaranteed to pay whatever interest is promised to the investors for at least 90 days after default. Some agreements also require them to pay principal during that period. Even after the 90 days, the servicer has to continue to pay real estate taxes and insurance. The servicer can use any late payment or other penalties from the borrower to offset these costs.

The idea was that if you were good at collecting and efficient at serciving, the overcollateralization would give you enough of a cushion. But they assumed 5% loss rates, not 20%.

And the cash flow drain is worse in prime or mixed pools than in subprime pools. The defaults relative to assumptions are far worse there.

As we noted, the banks will probably dodge this bullet. But a measure like this is an indicator of how sentiment about regulation is changing, Expect to see more tough-minded proposals, some of which will stick.

Derivatives Predict Further Increase in Libor

Despite the cheery tone in the press of late and the claims by quite a few senior banking executives that the credit crisis is on the mend, the money markets remain unconvinced.

As we pointed out in a post yesterday, the results of the Fed's latest Term Auction Facility auction were disappointing, leading the writer, David Kotok of Cumberland Advisors, to predict that the Fed will not only cut rates a further 25 basis points, but also increase the size of the TAF yet again.

Today, a Bloomberg story discusses the poor results of the TAF auction, and points up two other signs it depicts as troubling. The Libor-overnight index swap spread has increased dramatically since January, although it is still below its early December high just before the Fed announced the creation of the term auction facility. Open interest in Eurodollar swap futures has also fallen, which is an indicator of deleveraging.

From Bloomberg:

Interest-rate derivatives are signaling that the rate banks charge for loans in dollars in London may rise further as financial institutions remain reluctant to lend.

The difference between the rate of three-month loans in London relative to the overnight index swap rate, known as the Libor-OIS spread, is 88 basis points, just below the year high of 90 basis points reached on April 21.

The London interbank offered rate, or Libor, for dollar climbed to a seven-week high amid speculation the global credit crunch prompted lenders to manipulate the rate to prevent their borrowing costs from escalating. The British Bankers' Association said last week it will speed up a review of the process by which money-market rates are set daily and ban any member providing misleading quotes.

``The correction in Libor has not completely happened,'' said Bulent Baygun, head of interest-rate strategy in New York at BNP Paribas Securities Corp., a unit of France's largest bank. ``Given the dynamics that have persisted in the past few weeks, it looks like there could be a little bit more room for an increase.''

Three-month Libor for dollars has advanced 20 basis points to 2.92 percent since April 16.

The three-month Libor-OIS spread was as narrow as 24 basis points on Jan. 24 and reached as high as 106 basis points on Dec. 4. A basis point is 0.01 of a percentage point. The OIS rate signals what traders' expect the overnight federal funds rate to average over the time period of the swap....

Use of Eurodollar futures, which are based on predictions for Libor rates, as a bet on expected changes in Fed interest- rate policy has waned amid the questions regarding Libor rates, according to Credit Suisse Securities USA LLC, one of the 20 primary dealers that trade directly with the Fed.

Eurodollar futures open interest, or the total number of futures contracts that have not been closed, liquidated, or delivered, declined by 21 percent since the end of January, according to CME Group data. It fell 4.7 percent for the week ended April 18, after the BBA announced it was monitoring banks involved in the Libor process, from the end of the prior week.

``Libor uncertainty has led to a large-scale deleveraging in the Eurodollar complex,'' wrote Dominic Konstam, head of interest-rate strategy at Credit Suisse, in a note published on April 18. ``Over the past week, the decline in open interest has been dramatic as the problems with Libor have become more publicized.''

Eurodollar futures, which trade in price terms, settle to three-month dollar Libor at expiration.

Links 4/24/08

Human brain appears 'hard-wired' for hierarchy PhysOrg

Green reaper's grave new world Sydney Morning Herald

Mortgage approvals slump nearly 50% to decade low Times Online

Debt Collection Done From India Appeals to U.S. Agencies New York Times

Sam's Club, Costco Ration Rice Amid Hoarding Worries Wall Street Journal

Dirty Economic Indicator of the Month Barry Ritholtz

Antidote du jour:

Bondholders "Lucky" to Recover 10% in Defaults

Bloomberg reports that the rating agency Fitch predicts that recoveries on corporate bonds that default will be far lower than in previous downturns, due to the deterioration in lending standards. The estimate is grim;

Rather than receiving the historical average recovery of 42 cents on the dollar in a default, owners of a third of high- yield, high-risk bonds rated B+ or lower may get no more than 10 cents, according to New York-based Fitch Ratings. About 22 percent are likely to get 11 cents to 30 cents.

Note that there is, understandably, forecasts as to how bad the defaults will get:

Moody's anticipates defaults will quadruple to 5.9 percent in 12 months. That assumes a ``mild'' recession. Judging by the amount of distressed debt, investors expect an 8 percent default rate, said Martin Fridson, head of high-yield research firm FridsonVision LLC in New York.

Fed Continues to Treat Symptoms, Not Disease (TAF/Derivatives Edition)

In a bit of synchronicity, two items, focusing on different aspects of our continuing credit woes, illustrate how the Fed is acting like the drunk looking under a streetlamp for his keys, because the light is good there, rather than where he lost them. The central bank's version of this behavior is to continue to focus on the most superficial aspects of the crisis, even though those measures have not produced any lasting success (indeed, some have backfired) rather than go after root causes. In the initial phases, this response would be reasonable; you need to stabilize the patient before you operate, but at this juncture, the Fed's disinclination to address obvious causes of instability is mystifying.

Let's look at the two faces of this coin. The first is market commentary, "TAF results are disconcerting," from David Kotok of Cumberland Advisors. Note that Kotok by predisposition is more optimistic about the future than yours truly, and is well plugged into the Fed, so a note of this sort signals real concern: