Yves here. While it remains an open question as to whether frenzied efforts to push investors even further out on the risk limb will come to fruition, the fact that so many measures are underway looks like an officially-endorsed rerun of early 2007. If the Fed indeed raises rates in the not-insanely-distant future, getting into subprime and other speculative credits is a quick path to losses. But even if the Fed and other central banks remain super-dovish, risky borrowers can and will go tits up independent of interest rates. Credit risk is not the same as interest rate risk, but the inability to get any return for the latter is producing an extreme underpricing of the former.
By Raúl Ilargi Meijer, editor-in-chief of The Automatic Earth. Originally published at Automatic Earth
A few days ago, I wrote an essay about how ECB head Mario Draghi seeks to redefine the definitions of certain words and terms, like the one that define financial instruments, because he needs to find hundreds of billions in new spending money in Europe without adding to the behemoth existing debt (Germany won’t let him do that). And yes, that is indeed as impossible and meaningless as you think it is. But these are desperate times.
Thing is, I called that essay Draghi To Save Europe With Semantics, and maybe I shouldn’t have, because it’s obviously not the most sexy and catchy title on the planet, but my problem there was, it captures what I was talking about. And it’s all much broader and bigger than that, but then that’s what the article tries to explain.
Moreover, the financial press also catches up. To the fact that semantics and re-defining are the flavor du jour, once again, just like they were in 2005-6-7. When ratings agencies used the confusion about what things actually mean to stamp AAA ratings on everything including your kids’ snot nose tissues and toilet paper. And that is an important development, if you care about preserving some of your remaining wealth. Which I think you’d like to do, so please bear with me.
Three months ago, Tracy Alloway stated the obvious at FT:
Fitch, one of three big rating agencies, this week criticised credit ratings given by its competitors to a securitisation containing a loan secured by the Westin – the latest instance of agencies sparring with each other over so-called structured finance deals. Such deals bundle together a wide variety of loans into bonds that can be sold to large fund managers who use the evaluations of credit rating agencies to help inform their investment decisions.
Typically, these opinions are paid for by the financial firms that create the deals. But, since the financial crisis, regulators have encouraged credit rating agencies to give “unsolicited” opinions on deals that they are not hired to evaluate, as part of an effort to avoid the “ratings shopping” that proliferated before 2008.
However, as the rating agencies trade public barbs amid a resurgence of certain types of structured products, questions are being raised as to whether these unsolicited opinions actually have much effect on investors’ thinking. And are the banks that securitise loans simply taking their deals to the agencies likely to give them the highest ratings?
Translation: nothing has changed. The ratings agencies are too powerful, because the parties that pay them to issue ratings pay them too much to get rid of or even reform.
Which seamlessly takes us to Tracy Alloway today:
Sales of subprime mortgage bonds have withered since the financial crisis, but fresh concerns are arising as issuance of some other types of securitisations surges. Sales of bonds backed by loans used to finance car purchases undertaken by the least creditworthy borrowers have reached pre-crisis levels in the US, prompting a Department of Justice investigation. While losses on subprime auto asset-backed securities (ABS) remained low during the crisis, there are concerns that new specialised lending companies are making riskier loans which are then being bundled into the bonds.
Fitch Ratings has been hired to rate only four of the 29 subprime auto ABS deals sold so far this year, after telling issuers that the vast majority of the bonds did not deserve the triple-A ratings reserved for the highest-quality credits. Fitch – one of the “big three” agencies alongside Moody’s and Standard & Poor’s – warns that a flood of new entrants into the subprime auto lending market are lending to riskier borrowers as they seek to establish a foothold in the market. The creators of such securitisations typically pad the debt with extra cash or introduce other safety features – known as “credit enhancement” – to generate higher ratings on bonds comprised of riskier loans.
“The idea that recent loss history plus credit enhancement ‘heals all wounds’ can be short-sighted,” said Kevin Duignan, global head of securitisation at Fitch. “It’s often last one in, first one out in subprime.” He added: “We believe the risks associated with small lender sustainability are being underestimated by the market and some other rating agencies.”
US sales of commercial mortgage-backed securities, or CMBS, have also staged a recovery with $102bn worth of the deals sold last year – the highest amount since the $231bn issued in 2007, according to Dealogic data. At the same time, some market participants have been warning that the quality of the loans that underpin the bonds – typically secured by shopping malls, office buildings and other commercial properties – has been slipping.
You don’t have to be particularly smart to see here this is going. The floodgates are open, once more, and nothing at all, other than semantics and lip service, has been done to make them more secure. Because that would risk the flow of credit, which is the same as debt, and today gets habitually mistaken for money.
The boys in the banks are at it again, and this time their biggest supporters, if not clients, are central banks and treasury departments. If they can bring down investment requirements for pension funds enough from AAA, and they can at the same time – once again – label mezzanine (aka subprime) tranches of complex instruments ‘AAA’, they got it made. How can you go wrong when you have Mario Draghi himself begging you to to play this game?
Germany refuses to allow Draghi to buy sovereign bonds and add to the taxpayers’ risk, but what if you can simply shift it all to pension funds by moving the goalposts on what AAA really means?
We went through this 2007-8, and it ended badly, but apparently it’s just too tempting to leave alone. What is there to say? Insanity takes on entirely new proportions. It’s not just doing the same thing time and again, and expecting a different outcome, it’s doing the same thing and pretend it’s something new, because you give it a different name.
So now we get this concerted effort, the central banks are involved, the ratings agencies are too, to just about force pensions funds, the only store of real wealth left on the planet, to put their trillions into opaque and extremely risky instruments. Because Mario Draghi needs to find money, or whatever we should label it.
Mario Draghi is trying to rebuild the market for asset-backed securities in Europe. Global regulators are set to lend him a hand. The International Organization of Securities Commissions will present criteria for marketable ABS to finance ministers from the Group of 20 nations this week, said Chairman Greg Medcraft.
Iosco wants to help create standards that would encourage non-bank investors to buy. A broader ABS market could improve companies’ access to financing and spur growth. That’s the goal behind the European Central Bank’s plan to purchase “simple and transparent” bundled securities with underlying assets including residential mortgages, Draghi said this month. “What we’ve done is develop criteria of what we consider to be simple, transparent and consistent securitization,” Medcraft said. “We’re looking at providing a framework that actually assists the market.”
The European market for ABS, like that in the U.S., was brought close to extinction in the financial panic of 2008, which was fueled in part by banks taking heavy losses on securitized U.S. subprime mortgage debt even though the tranches they held had been considered high quality. It has been slow to recover. Draghi said on Sept. 4 that the ECB will buy senior tranches – the least risky – of simple and transparent packaged securities. “We want to make sure that these ABS are being used to extend credit to the real economy,” he said.
[..] Medcraft said ABS in the right hands is a “fabulous technology.” “You look at the U.S., the auto-loan sector is booming in securitization,” he said. “I think the market is maturing, but it’s about winning back investors. We don’t want to regulate it. We want to provide a nudge.”
“ABS is a fabulous technology”. As we saw in 2008. Absolutely Fabulous. “The auto-loan sector is booming in securitization”, says one of the Three Stooges. And yes, US subprime auto loans are way up. True enough. Whether we should be happy about that is an entirely different story. It’s still subprime, homes or cars. You’re still lending to people with a huge risk that they can’t pay you back. Because they may be fired from their jobs as burger flippers. But yeah, until they are, the numbers look good.
That’s what Draghi’s policy is, going forward: squeeze the money Merkel won’t let him create out of thin air, out of fixed income, by moving the goalposts on definitions and semantics. It’s a poor man’s game played by one of the world’s post eminent central bankers, and all the rest, the ratings agencies and Wall Street banks, just play along. Draghi gives credence to anything they do. He’s a desperate man.
And by the way, the excesses and insanity of cheap credit don’t stop there either.
One year after pulling off the largest bond offering ever, Wall Street debt underwriters are pitching their clients on the possibility of something even bigger.
With investors clamoring for higher-yielding assets and companies on the biggest acquisition spree since 2007, bankers are talking up the ability of credit markets to fund a “mega deal” that Citigroup Inc. says could be backed by $100 billion or more of financing. That’s stoking speculation debt investors stand ready to fund potential takeovers such as a purchase by Anheuser-Busch InBev of rival beermaker SABMiller.
“We are prompting issuers to think outside of the box – in terms of the art of the possible,” said Tom Cassin, co-head of investment-grade finance at JPMorgan, the biggest underwriter of corporate bonds worldwide. “We have got clients that are certainly intrigued by it and interested in it.”
Bankers are pitching the “mega deal” even as investors brace for the 30-year rally in bonds to come to an end. They are telling companies that after fueling $18 trillion in corporate bond sales globally the past six years, including single deals bigger than the gross domestic product of countries from Slovenia to Iceland, appetite isn’t tapering.
Investors have poured about $49.4 billion into mutual funds that buy taxable bonds this year after pulling $20.6 billion in 2013, according to the Investment Company Institute. The added cash has helped shrink the extra yield that investment-grade debt worldwide pays above government securities by 15 basis points to 109 basis points, or 4 basis points from a seven-year low, according to Bank of America Merrill Lynch index data.
I doubt that anyone will have any trouble understanding what this is, and where it goes. The whole shebang is busy re-interpreting and re-defining until there are no more legal barriers for your pension money to be ‘invested’ in subprime loans packaged in ‘securities’ of whatever shape and from. So some trader in the Hamptons can make more wads of cash, through ultra low rates, off of beer brewers buying each other where they would never even have thought of that that at normal interest rates.
This is where our economies are perverted. It’s the final excesses and steps of a broke society. It’s madness to the power of infinity. The only thing that’s certain is that in the end, your money will all be gone. That’s how Mario Draghi ‘saves’ the EU for a few more weeks, and that’s how the big boys of finance squeeze more from what little you have left (which is already much less than you think).
A world headed for nowhere.