Category: credit bubble

Opening Pandora’s box

On Friday Goldman Sachs was charged by the SEC with fraud regarding a real estate structured finance transaction during the height of the credit bubble in 2007. Like any fraud the various players jockey for position and in this case it appears the other players involve John Paulson, ACA and potentially other industry participants. First thought that comes to mind is how this coincides with the upcoming financial reform bill headed by Chris Dodd which goes to a vote in less than two weeks. Second, we really have limited information about the suit although readers of this blog are more than familiar with the underlying fraud that built the greatest credit bubble in history.

Questions we would like to see answered:

1) Was Goldman creating custom products for John Paulson while trading against other clients?

2) Were clients intentionally misled about what was being sold to them in order to reward other clients?

3) Were these and other transactions done at arms length?

4) How did Goldman and other banks emulate Lehman regarding repo transactions via off balance sheet entities at quarter end?

5) Did Paulson get access to other questionable custom Goldman products, specifically Greek CDS? If so, were these products fraudulent?

6) How were these various products assembled and were there known fraudulent activities within raw material? For example, did Goldman know about fraud at the mortgage origination level? Where did these mortgages originate? I mention this because WAMU executives were on Capitol Hill last week admitting to mortgage originations containing fraudulent documentation.

7) Knowing the plethora of global derivative allegations does the blueprint used by JP Morgan on Jefferson County, AL ultimately open Pandora’s box?

8) Since this is a civil suit do we have to rely on the criminal fraud trial beginning next month in Italy to finally receive the juicy details on this sham?

9) The four largest banks in America are also some of the largest mortgage servicing entities so are they privy to mortgage payment information which could or could not be shared with some of the entities creating structured credit?

10) Does Goldman employees’ $1 million contribution to Obama’s campaign coupled with over $344 million in lobbying efforts last year insulate the firm from criminal charges in the USA?

11) Is this material? “Head of allegedly Goldman buyer ACA is married to Goldman deputy general counsel”?

12) How many other derivative dealers have been front running their clients?

My comments: Slowly the details emerge on the greatest fraud perpetrated on the American people. As we discussed on numerous occasions the public wants blood so let’s see if the rule of law still exists in the United States.

Obama/Bernanke science project now on red alert

Over the past few years we’ve chronicled the build and unwind of the greatest credit bubble in history while most market observers continued to embrace the almighty central planners. Time and time again either the Federal Reserve or the US Treasury appeared on the crime scene with extraordinary measures all fraught with precarious unintendid consequences.

First, the countless interventions involving GSEs, money center banks and AIG all had one common denominator: “save the bondholder.” In all cases the US government stepped into various private sector businesses, took a significant equity ownership interest alongside the prior destroyers of capital, and preserved bondholders, consequently crowding out the future investment capacity of remaining and prospective entrepreneurs. For example, AIG is now 79.9% owned by the US taxpayer thanks to over $180 billion in bailout funds, some of which found their way into the hands of multiple Wall Street beneficiaries, namely Goldman Sachs and Deutsche Bank. Fannie Mae and Freddie Mac are categorized as “works in progress” courtesy of ex-Treasury Secretary Hank Paulson’s “conservatorship” scheme while the Obama administration tinkers with alternative strategies. Meanwhile, these propped-up entities are classified as off balance sheet budget items requiring over $100 billion in bailout funds since last fall with projections of another $300 billion before year end!

Second, the money center banks, specifically Citigroup and Bank of America, are ridiculously insolvent yet the Bush/Obama triage unit remains hell bent on emulating the Japanese model of keeping the zombies alive at any cost. Most of the life support was provided by the $700 billion TARP boondoggle.

Third, FDIC debt guarantees enabled additional dead men walking, such as Morgan Stanley, Goldman Sachs, JP Morgan and countless others, the opportunity to sell debt at below-market interest rates in the hope of recapitalizing the murky lenders during the recovery process.

Finally, the Federal Reserve – under fearless leader Ben Bernanke – has assured the American people that his science project, a.k.a. Shadow Banking II, will revitalize the private sector credit machine since over 60% of all US lending the past decade took place in the toxic off balance sheet world (Shadow Banking I). Predictably, his reliance on the same incompetent rating agencies and questionable collateral never comes up when presenting his plan. One simple question comes to mind regarding the Fed’s current balance sheet vs. several years ago: “How will the Fed remove all of this temporary liquidity when the balance sheet two years ago was primarily short term T-bills vs. longer-term structured finance instruments today?” Of course the answer is they won’t be able to remove any of it without creating hyperinflation.

In summary, the US government, in cahoots with the privately-owned Federal Reserve, intervened in an unprecedented fashion in order to preserve the US dollar fiat monetary system. It took conservatorship of Fannie and Freddie, the Bear Stearns bailout, TARP, FDIC guaranteed debt, and a plethora of “temporary” Federal Reserve credit facilities as well as permanent government credit backstops totaling $12.7 trillion to prevent the mother of all bank runs.

Until now the economic and investment minyans have applauded the work of Alan Greenspan’s worthy successor, but what lies ahead should make any supporter of central planning awfully concerned. Ladies and gentlemen, the dollar reserve currency system is now teetering on the edge thanks to the latest decisions by the Obama/Bernanke administration. Instead of allowing bank receivership or worthy bankruptcy law to remove the misallocated private sector debt in our lopsided system, team Obama has created additional bailouts resulting in a projected record budget deficit of $2.2 trillion for 2009 (an unprecedented 20% of GDP). This year alone sends over $1 trillion to the Wall Street dealers who created the fiasco with no mention whatsoever of the epic fraud from various participants, some now on the Obama team roster (Rubin, Geithner, et al.). The $1 trillion happens to be roughly 8 years of productivity in this country so expect government handouts to crowd out potentially thousands of new businesses and related jobs. (Despite the current government-created economic drought, the public sector parasite must be well-fed.) On cue, team Obama – literally televised daily – continues to tell the American people not to worry since his recent stimulus plan will create thousands of new government jobs similar to FDR’s New Deal.

By 2011 some economists project another several trillion in borrowing needs, taking the national debt above $15 trillion with an economy contracting by another 10%. This begs the question: “Who will lend us money to operate the USS of A?” Clearly scientist-in-chief Bernanke is now in the final phase of his lab experiment since earlier test results have all been negative. Showing signs of desperation, beginning in December of last year Bernanke discussed the possibility of extraordinary measures by the Fed, specifically buying mortgage-backed securities and longer-term Treasuries in hopes of controlling the long end of the yield curve. Germany tried this in the ’20s and we all know how that ended up. Since Bernanke’s trial balloon in December, the 10-year Treasury yield has climbed from 2.28% to over 3.45% as of Friday’s close. Subsequent to the December speech Bernanke has implemented his quantitative easing experiment as the Fed announced in March it would buy $750 billion in mortgage-backed securities and $300 billion in Treasury notes and bonds. $113 billion has been committed to buying Treasuries year-to-date. Not only has the yield spiked on the 10-year, but the US dollar index has declined by approximately 11%! Note to Bernanke: your experiment is an unmitigated disaster; please refrain from any more of this economic insanity! (Fortunately, Dr. Ron Paul has now garnered momentum in his quest to strip Mr. Bernanke of these insidious actions.)

It is said the road to hell is paved with good intentions. In this case, the perpetrators of the crime of the century are simply motivated by saving their own bacon.

Bearing Credit Bubble Index finishes 2008 down 55%

Indices, year-to-date:

  • BCBI: -55.26%
  • S&P 500: -38.49%
  • Nasdaq 100: -41.89%

Sub-indices, year-to-date:

  • Government-sponsored enterprises: -97.95%
  • Subprime lenders: -79.93%
  • Credit insurance: -77.99%
  • Brokers: -73.17%
  • Non-bank financial: -53.97%
  • Banks: -52.65%
  • Homebuilders: -16.49%

Bearing Credit Bubble Index down 54.4% year-to-date through November

Indices, year-to-date:
  • BCBI: -54.41%
  • S&P 500: -38.96%
  • Nasdaq 100: -43.13%

Sub-indices, year-to-date:

  • Government-sponsored enterprises: -96.79%
  • Subprime lenders: -79.94%
  • Credit insurance: -79.11%
  • Brokers: -74.03%
  • Non-bank financial: -52.13%
  • Banks: -50.07%
  • Homebuilders: -22.83%

Biggest losers in November:

  • Credit insurance: -33.50%
  • Banks: -24.21%
  • Brokers: -18.45%

Bearing Credit Bubble Index hits 10-year low in October

Indices, year-to-date:

  • BCBI: -46.86%
  • S&P 500: -34.03%
  • Nasdaq 100: -35.98%

Sub-indices, year-to-date:

  • Government-sponsored enterprises: -97.32%
  • Subprime lenders: -77.66%
  • Credit insurance: -68.59%
  • Brokers: -68.16%
  • Non-bank financial: -45.61%
  • Banks: -34.13%
  • Homebuilders: -16.31%

Bearing Credit Bubble Index hits 8 1/2-year low in September

The mother of all margin calls

On credit expansions:

This new money [inflation] is never evenly distributed, but instead gets funneled into whatever narrow area happens to capture the public’s fascination. As prices and valuations soar, greater doses of credit are required to keep the game going. Either more marginal borrowers are drawn in at ever more precarious levels or greater leverage must be applied to existing borrowers. This is what ultimately doomed the housing bubble. In the end, nearly anyone who could fog a mirror was getting an invitation to join the party.

The trouble with pyramid schemes is that they’re not designed to go in reverse. Eventually, the number of willing dupes is exhausted. The same people who panicked late to get into the game are just as likely to panic when the music stops. The longer the music plays, the more leveraged and unstable the inverted credit pyramid becomes. As the late economist Hyman Minsky observed, “stability is unstable.”
~ Kevin Duffy, “It’s a Mad, Mad, Mad, Mad World,” May 22, 2007

The financial establishment and power elite have known all along that their asset inflation scheme was not designed to work in reverse. The consequences for them (as opposed to the rest of us who bear most of the costs) would be too terrifying to face. Despite 13 months of massive government intervention, D-Day has arrived. The mother of all margin calls is finally upon us.

Credit markets enter crisis mode

Last weekend’s bailout of Fannie and Freddie came as no surprise due to multiple years of excess mortgage credit creation hitting a wall in 2007. The downturn in home values in 2006 led to the demise of toxic lenders such as New Century and Countrywide Financial setting the stage for one last surge in GSE balance sheets in 2007-2008 as the remainder of mortgage freeways became jammed. No-homeowner-left-behind DC mantra continued to receive media support as marginal homeowners and McMansion dwellers pleaded for additional rate cuts or forbearance.

Initial intervention

Unprecedented credit facilities and other types of government intervention by central planners have proven to be inadequate for several reasons. As articulated numerous times (specifically here and here), we presented our case of a failed monetary system collapsing at epic speed. From the chronic denial by Hanky Pank and Bernanke last summer to the most recent assurance that Fannie and Freddie now have Paulson’s bazooka to fight the mortgage monster, has it become obvious that the central planners are in reactive/desperation mode and the inferno continues to rage as Paulson reaches for one more bucket of water?

Paradox of deleveraging

Eventually global central bankers providing ongoing credit lines to banks and brokers in return for suspect asset-backed collateral will come to the realization that this is a solvency issue. Additional collateral damage from rising unemployment, declining home prices and minimal wage growth all but guarantee the worst credit cycle since the Great Depression. Since this credit bubble evolved from the inception of credit default swaps it seems appropriate that we come back to square one. Players of all shapes and sizes wrote default insurance on a wide array of debt instruments which drove additional issuance as swaps hit multi year lows and debt issuance hit all time highs in 2006. Of course this changed last year when AAA-rated structured finance securities imploded and the confidence game ended. Shock waves went out to bond insurers, investment banks, banks, insurance companies, hedge funds and others who built faulty models based on asset inflation. Declining collateral coupled with unprecedented leverage of 40-1 has led to the inevitable unwind of planet leverage.

Tipping Point

Over the next 6 months roughly $500 billion in corporate borrowings come due with fewer and fewer possible creditors. Lehman Brothers is ready to join the equity holders of Bear Stearns and GSEs into the dustbin of history as credit default swaps soar and CEO Dick Fuld waves the white flag. AIG, though, remains the bigger tell in our opinion. Markets are screaming “game over” as credit default insurance on AIG surpasses 640 basis points, exceeding the March highs. How will this $1 trillion asset behemoth survive if the market refuses to finance $20 billion in additional debt later this month? Or do we turn to Merrill Lynch, who over the last 4 quarters destroyed 17 years of earnings? CEO John Thain has raised capital and sold assets yet his balance sheet has witnessed growth in Level 2 assets of some $280 billion the past 12 months while equity has declined from roughly $38 billion to less than $32 billion. Today we are inundated in bailout requests for both Ford and GM as automakers go to DC with a $50 billon hat in hand.

Central bankers’ end game

The heavy lifting has been completed by the Bernanke clan as 85% of the Fed balance sheet has now been lent out to casino dealers on Wall Street leaving Paulson with another challenge. Since his announcement in July of supporting Fannie and Freddie with additional taxpayer dollars, many asked the question of moral hazard. Will the Lehman Brothers demise force the government to remain on the sidelines when future financial institutions incur a bank run? Have we finally left the denial stage and accepted the fact that over $3 trillion in shadow banking system asset problems are dead ahead leaving central planners impotent? Or is Bernanke of the opinion that most of the shadow banking system was nothing more than speculation so it should fail along with housing speculators? At the end of the day we envision a credit contraction for the ages resulting in an L-shaped recession lasting several years.

Bearing Credit Bubble Index -1.57% in August to 8 1/2 year low

Indices, year-to-date:

  • BCBI: -35.03%
  • S&P 500: -12.64%
  • Nasdaq 100: -10.19%

Sub-indices, year-to-date:

  • Government-sponsored enterprises: -83.99%
  • Subprime lenders: -76.87%
  • Credit insurance: -49.51%
  • Brokers: -36.47%
  • Banks: -24.03%
  • Non-bank financial: -22.60%
  • Homebuilders: +10.58%

Credit market update

Since massive intervention beginning 12 months ago we take a glance at modern central banking’s unintended consequences:

Mortgage Market

  • 30 year conforming mortgage rates have increased by 75 basis points, jumbos 175 basis points
  • Mortgage loan applications are down 34% year over year
  • Prime mortgages for less than $417,000 had a delinquency rate of 2.44% in May, up 77% from last year. Prime jumbo loans over $417,000 had a 4.03% delinquency rate in May, up 263% from last year
  • Approximately 15% of all subprime mortgages and 7% of all Alt-A mortgages are in delinquency
  • Almost one-third of U.S. homeowners who bought in the last five years now owe more on their mortgages
  • Fannie and Freddie now comprise approximately 80% of the $12 trillion residential mortgage market
  • Difference between yields on Fannie/Freddie MBS and borrowing rates adjusted for prepayment risk increased from 10 basis points in Jan ’08 to 65 basis points this week
  • Private securitizations reached just $131 billion (1st half ’08) down sharply from $1 trillion in the same period last year
  • Fannie’s current-coupon 30-year fixed-rate bonds currently yield 6.02 percent, 212 basis points more than Treasuries, 26 basis points from the 22-year high of 238 basis points reached March 6, 2008
  • 75 percent of U.S. banks surveyed indicated they tightened standards on prime mortgage loans, up from 60 percent in the previous survey, the Federal Reserve
  • 80.7% of survey respondents said they were tightening standards on commercial real estate loans up from 78.6% a quarter earlier and the highest on record.

Credit Market

  • 66.6% of lenders said they were tightening standards on credit card borrowers up from 32.4% a quarter earlier and the highest since the Fed began collecting data in 1996. 67.4% are making it tougher to get other consumer loans, up from 44.4% and another record.
  • Federal Reserve has now lent approximately 2/3 of their balance sheet to broker dealers/banks
  • Interbank lending still problematic as Libor remains elevated
  • Spread between 10-year Baa-rated bonds — the lowest investment grade rating — and U.S. Treasurys increased to 326 basis points
  • Foresight Analytics estimates that land- and construction-loan delinquencies reached 8% in the second quarter for commercial banks, up from 7.1% in the first quarter and 2.3% in the year-earlier period
  • Estimated $700 billion in HELOCs on bank balance sheets and based on foreclosure/delinquency 25% should default leading to $175 billion in write offs

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