Hallelujah, praise Paulson I see the light!
A plan backed by the US Treasury (aka Goldman Sachs) is being kicked around to rescue banks from losses on mortgage securities. This plan is being put into place "in order to persuade investors (that's you sucker) to pour more money into the troubled credit market."
Yay – we're saved! Of course by saved I mean that the bankers have come up with a way to rip us off and save themselves – but if CNBC says we're saved then I guess it must be true. Indications that this fund will be in the range of $80-$100Bn in order to buy up "troubled" assets in the hopes of restoring faith in commercial paper (which is backed by "troubled" assets), sales of which have fallen off a cliff this past quarter. Companies depend on commercial paper to finance day-to-day expenses like payroll and rent.
What exactly is off a cliff you may wonder? Well in Q1 of this year, structured investment vehicles (SIVs) were up at $1.2Tn. Last month, just $900Bn worth of notes were left outstanding as investors ran, not walked away from corporate debt. How many months in a row can we be short $300Bn before someone has to cut back their spending (or, even worse, buybacks)?
I mentioned on Wednesday that there is AT LEAST $200Bn in unrecoverable junk on the books that hasn't hit the fan yet and the fact that the banks are rushing in with a $100Bn bailout this early in the game either means I'm right or I'm horribly wrong and it's a little closer to my worst-case $1.5Tn mark. As investors continue to withdraw their funds, the SIVs need to sell off the assets that back them. That would be the homes that are on their books as being worth $500K but aren't selling at $350K all across the country (remember Darla?).
Why are the banks rushing in to help? Because Mr. Potter and Co have made $15,000,000,000,000 in loans to US homeowners and they back their own assets with those homes "valued" at $500,000 and it would be very unpleasant for them, due to what little is left of banking regulations, if someone notices that no one is willing to pay that price anymore.
Of this $15Tn worth of overpriced assets, $1.5Tn is in the category of "sub-prime" and an average of 20% of those loans are in imminent danger of default. Over the next 12 months, another $600Bn worth of those loans "adjust" from the "teaser rates" as low as 1% all the way up to the "regular rates" of around 8%. If you had a $400,000 home you had put a 10% deposit on you would be paying a neat-o $1,157.90 a month (plus taxes, utilities, etc). Once the rates kick up to 8%, that payment jumps to $2,641.55 a month. Many people went into these deals under the impression that they could refinance before the rate lock wore off but those people no longer qualify for loans because the loose lending policies that gave them the sub-prime loan have disappeared, along with over 100 of the companies that used to originate them.
This means the average American homeowner, who has a family income of $48,000 and a take-home pay of about $32,000, has to come up with an extra $15,000 a year to stay in a house with a $360K mortgage. Even if you assume their mortgage is only $200,000, the rate increase for a sub-prime adjustment from 1 to 8% would cost them close to $10,000 a year (payment moves from $643,28 to $1,467.53 a month). How many of the 3.5M sub-prime homeowners will be able to afford this? Even at $250,000 per home, that's still $875Bn worth of homes in serious jeopardy – no wonder the banks are rushing in with $100bn – that could be how much they need EACH QUARTER for the next 2 years!
Obviously (begin sarcasm font) this is a reason to celebrate as more money is thrown onto this economic fire sale! The energy markets love it and are immediately putting their hands out, driving oil up to $85 in European trading this morning. If the banks are willing to do ANYTHING to stave off a crisis, then money must be thrown around like mad and the commodity brokers are in a perfect position to grab a lot of that cash as the banks can't afford to say no to them – otherwise people might get the impression that things aren't as great as they're telling us.
Can the banks really be that desperate? Well Citibank, for example, already pre-announced today's awful earnings (but they beat lowered expectaitons, as it wasn't as bad as they warned us last week – fantastic manipulation fellahs!), down 57% from last year as they wrote down $1.35Bn of virtual portfolio value (getting a tax break for doing so) as well as taking a straight $1.56Bn loss on subprime loans. The bank also lost $636M in "fixed-income trading losses" and took another $2.98Bn hit on "increased consumer credit costs." Despite ALL that, the company still made $2.38M – think about that when they tell you they can't waive your ATM fee!
What Citibank doesn't tell you, however, is that this does NOT include $80Bn in "off balance sheet" assets that are backed by mortgages and other questionable securities. Should the bank be forced to "adjust" those and move them onto their books… well, we've seen a lot of other mortgage lenders who were lucky to get 50 cents on the dollar for these assets. So shhhhhhhhhhhhhhhhhh! Let's not talk about that and enjoy the rally as we celebrate another $100Bn being tossed into commodities (houses are commodities) at the ultimate expense of the American people to cover the excesses of the financial community while they celebrated the 9/11 crisis by making record amounts of loans at record margins, transferring over 5% of the nation's wealth to the top 1/10th of 1% (6,000) of our citizens in just 5 years. Mission accomplished guys – now, can we have our country back? No? Well, I just thought I'd ask…
According to the WSJ: "The plan (to bail out SIV's) means that some banks now stand to profit from the problems their industry helped create. Citigroup, J.P. Morgan and Bank of America, for example, will be paid fees for providing the financial backstop to the fund. In addition, the broker-dealer arms of the banks could be paid for helping the new structure raise capital. Bank of America highlighted the opportunity to generate fees in discussions leading up to the final plans, people familiar with the matter said."
So yay, I guess – everything will be great because we're going to keep pretending that assets the banks helped people overpay for were really worth, and are STILL worth what they claim they are and they are going to support this nonsense by buying the assets from each other since no real people will do so anymore. The rising tide of one asset class (housing) should lift all commodity ships (just look at oil and gold go) and stocks, being a commodity, are hardly likely to be left behind – as long as everyone on the planet buys into this BS we should be in great shape!
Ordinarily, I'd see this as a huge shorting opportunity but I've learned to switch off my brain once the markets are in session and just go with the flow, there' s no room for worrying in this investing environment. No one in Asia seemed worried as the Hang Seng jumped another 702 points and the Shanghai Composite gained 2.2% to finish at 6,030, up over 100% for the year! The China rally was led by defense contractors as President Hu Jintao said at the opening of the 17th Communist Party Congress that "China was committed to making its military more modern." This is such a great plan we have, sending THOUSANDS of BILLIONS of dollars out of the country during the past decade to pay for oil and goods that used to be manufactured at home in order to help non-NATO countries build up their military (as well as to purchase strategic global assets) – BRILLIANT!
On the bright side, it gives our own military complex someone to fight (or, at least, someone to remain at code orange about) for another decade so we'll have to take another look at our own defense contractors, who probably have a lot room to grow as well. Another great thing about a military build-up is that it uses a lot of gas. The US army uses more oil and gas than all but 3 other entire countries on this planet so that's killing two birds with one nuke!
Japan's Nomura Holdings is taking a $621M loss and is quitting the US mortgage market after 2 previous quarters where they had also taken $620M in losses. This left them with $119M of residential mortgages total so that's 90% of their virtual portfolio that had to be written off. Kind of puts the 10% "worst-case" estimate by the Treasury into perspective doesn't it. Fortunately, Nomura only employs 1,300 people in the US and is laying off just 30% of them. The TOTAL revenues generated from mortgage underwriting by the company between 2002 and 2006 were $108M, the problem with leverage is the lever cuts both ways sometimes – something the US banks mentioned above are trying very hard to avoid!
Europe is flat ahead of our open which looks fairly positive as of 8:30. Airbus is finally delivering A380s and that's helping out as is Northern Rock's claim that they are "working with a number of potentially interested parties about a variety of potential transactions." Gee, that is potentially great! (see, I can play this game). The ECB is making some noise about inflation concerns but we know that's a crock as these guys just don't know how to measure "CORE" inflation, which clearly shows that prices are under control (that would be the sarcasm font again).
At home, it should be party time in the financial sector as we swallow today's dose of snake oil, so let's be very concerned if it's not. Oil running up to $85 will NOT be great news for the refiners but will be bad news for the guy we sold SU $100 puts to so I'm generally pleased with the mix.
Happy Trading and I are keeping our eyes on the Nasdaq and it will be interesting to see how the SOX react to Samsung's decision to increase global chip capacity by another 7% (it's already up 7% this year). Semiconductors are themselves a commodity and we really want to see the Nasdaq take off for this rally to have legs:
Get set for a wild week, we'll run down earnings and economic indicators in tonight's post but, for now, we need to see how the markets digest this latest BS news as we wait to see how the sentiment is going.
Have a great week!
– Phil
