No Bottom in Sight

From Countrywide's quarterly report, we get this info:

Some 9.3 percent of the loans in Countrywide's mortgage servicing portfolio were delinquent as of March 31, up from 4.9 percent a year earlier. About 4.8 percent were 90 days or more behind in payments, the company said.

Nearly 39 percent of Countrywide's subprime mortgage loans made to borrowers with past credit problems were delinquent, up from 19.6 percent a year earlier. (Yahoo!)

I think the numbers speak for themselves. Who will buy paper that has a 39% non-performing loan status?

The Standard & Poor's/Case-Shiller home price index of 20 cities fell by 12.7 percent in February versus last year, the largest decline since its inception in 2001. Seventeen of the 20 metro areas reported record annual declines. The index dropped 10.7 percent in January and 9.1 percent
in December.

"There is no sign of a bottom in the numbers," David Blitzer, chairman of the index committee at S&P, noting that all 20 metro areas have declined for six straight months.

No sign of a bottom. Credit is contracting, and will continue to contract as the collateral behind the loans continues to shrink. This is a vicious circle that won't be broken until prices stop falling. (Yahoo!)

In other thoughts and speculations, I've been thinking about the dollar. I think this is especially important in the light of Barron's published report that 75% of global institutional "big money" managers believe that the dollar will rebound over the rest of the year. I don't. Here's why: global price inflation is putting increasing pressure on oil-producing countries and other dollar-recyclers to allow their currencies to appreciate against the dollar. Russia, for one, has bought billions of dollars recently. Their dilemma is not whethor or not to allow the Ruble to rise, but by how much. This global pressure on currencies to rise is the same as pressure on the dollar to fall. The dollar is very overvalued because the Fed has lowered rates so much. At the moment, dollar-recycling is propping up the dollar, but this is becoming a losing proposition as price inflation devours GDP growth in dollar-pegging countries.

When the dollar resumes its fall, I believe that Treasury rates will rise behind it. However, the rise in rates will not keep up with the fall.

Still Short!

The market has ignored some really important news lately.

1. Ambac is losing money much faster than anyone thought possible. The have over $500 billion in credit guarantees. This will evaporate by the end of the year.

2. The Japanese bond market just panicked earlier this week. It dropped 5% before trading was halted. Why? Because there was an inflation panic. Is this a preview of the US Treasury market?

3. LIBOR remains near record high spread over Fed Funds.

4. Oil is a hair away from $120.

5. Consumer confidence is at 27 year lows.

6. HELOC and credit card losses are going supernova. These are very potent sources of losses for the credit industry because there's no collateral for cards and collateral for HELOC's will soon be negative.

7. Housing prices have now fallen half of the amount they did during the Great Depression. And there's no end in sight.

8. Employment has shrunk this year and shows no sign of stopping its contraction.

9. The commercial real estate market is immensely overbuilt. Jobs will be lost, and dilution will cause blight in partially filled shopping centers.

10. The VIX is under 20. Wait 'til it goes to 30.

We are seeing the Titannic model on all fronts here. (The Titannic was built with compartments which were watertight below the waterline. However, they were not sealable on top. When the ship hit the iceberg, the water filled up one compartment until it flowed over the top into the next.) The problems that the market has been worried about are already underwater. What the market is not discounting is the spillover losses that occur as the losses spill over into new compartments of the economy. As each new compartment fills up, a tipping point is reached where it starts to spill over into more and more newly flooding compartments. On top of this, Bernanke refuses to close the watertight doors and cut away the dead parts of the economy, instead trying to right the underwater financial sector by flooding the back end of the boat. This just increases greatly the chances that the entire economy will sink.

Interesting side note: I can't be sure, but it seems to me that going back at least to last August that gold has performed best during heightened fears of deflation, and sold off slightly during resurgences of price inflation.

Trades

I cashed in my SBUX put for a 170% gain. I'm tired of waiting for it to leave its $17-$18 range, and I think its downside is limited to $14. Time to take profits and buy other stuff as the VIX was below 20.

This week I bought:

• SPY Sept 111 put for 1.07
• C Jun 20 put for 0.44
• ABX Jan'09 60 call for 1.28

The SPY put is a play on the VIX going back over 30 during the next six months. The C put is a play on C's funding plans breaking down over the next two months. Plan: sell if C drops below $20. Finally, the ABX call is the best way to play another drop in the dollar. I will try to remember to sell this if it triples, the way I should have sold the 70 call at $4.50 when gold topped $1000. It's now at $0.65. Ouch.

One of the things I've been thinking about is the massive amounts of equity that the financial companies are raising. My question is, Will the funding go according to plan? Capital raising by financial companies has received unquestioningly positive spin from the media, as well as being reported as a sure thing. However, I predict that sometime over the next couple of months, some of this funding will fall through. Suddenly, money that was reported as already raised will disappear.

Agriculture Inflation

Especially scary is the trend of high prices working their way into the fundamentals. As one example, I read in Jim Jubak’s MSN money article a couple of weeks ago that Pakistan was growing much less wheat this year than last year. How is that possible? Doesn’t the market force of higher prices encourage higher production? No, not necessarily. In this case, the increased demand for fertilizer worldwide (leading to higher fertilizer prices) together with a lack of access to credit and futures markets (for Pakastani farmers) has contributed to a lessening of supply (at least in Pakistan).

Trade + Citigroup

Trade: closed DCR at $3.99 yesterday for 28% gain. The nav has dropped below $2.50, and the termination trigger has been activated. However, the shares won't be redeemed until the end of the quarter. With the dollar plumbing all-time lows against the Euro, I think it would be greedy to try for more.

On to Citigroup. I am so tempted to short more now. It's up 8% on $15 billion in writedowns. On top of that, their debt ratings are under pressure of downgrades.
The losses are spreading from subprime throughout the whole company, encompassing leveraged loans, commercial real estate, and auction rate securities.
Here's a prime example of why the writedowns aren't over:

I was particularly interested by one component of the $13 billion in write-downs: $1.5 billion on auction-rate securities. Citi had $11 billion of these animals in February, but by the end of March, after write-downs and sales, it had brought its exposure down to $6.5 billion. Let's say that it managed to sell $3 billion at or around par, and that it wrote down the remaining $8 billion by $1.5 billion. That would mean that Citi is valuing its unsold ARS portfolio at just 81 cents on the dollar. - Felix Salmon

Let's look at excerpts from another story:

April 18 (Bloomberg) -- ``To have subpoenas and the threat of criminal investigations raised suggests that somebody has made up their mind that there really are abuses there,'' said Donald Langevoort, a former Securities and Exchange Commission attorney.
...
Citigroup Inc., the biggest underwriter of municipal auction debt from 2000 to 2007, this week predicted the market will ``cease to exist."

From the first article, we learn that Citi has $6.5 billion in Auction Rate Securities still on the books. From the second article, we learn that these are not assets, but liabilities. Although the author of the first article suggests that $6.5 billion includes a 20% writedown, they have only written client's accounts by 5%. I see at least another few billion in writedowns here.

Another large source of writedowns for the second quarter will come from leveraged buyout loans. Citi just sold $12 billion worth yesterday. From what I remember, they sold at about a 10% discount. However, Citi gave the buyers a free put option worth another 10% of the price by agreeing to cover the first 20% of losses. In addition, the buyers got to pick and choose what they wanted. What this means is that although Citi has been boasting about reducing it's exposure to fictitious capital, it's just been concentrating the risk in a smaller dollar amount of exposure. Although the exposure to LBO loans is $12 billion smaller, the risk of losses is not much smaller at all.

Brilliant!

Sometimes an analysis or thought comes along that is just so brilliant that it astounds you with its clarity and simplicity. The following from Liz Capo McCormick is just such a quote:

April 14 (Bloomberg) -- The dollar isn't the only casualty of the Federal
Reserve's rescue of seized-up credit markets. Bond traders are finding there is nothing special about Treasuries anymore, now that the Fed accepts substitutes for government securities as collateral -- having concluded it wasn't enough to reduce the benchmark interest rate for overnight bank loans six times since September.

Although I was already considering how to play a coming drastic decline in Treasuries, this explains it better than I ever could have. Now that it's out there in the mainstream, I'm going to have to take some drastic and swift action. I believe that the best way to play this is to buy TLT leap puts. I think I'll try to buy on for '09, and one for '10. Because of monetary restraints in the options account, I will probably look at an $80 strike for the '10 put, and then see what I can get for '09, even if I have to settle for a lower one.

Trade: short DCR. I got this idea from Barron's. Here's the reasoning. It seems that a lot of amateurs have been betting on a decline in crude oil. Their favorite vehicle, according to Barron's, is DCR. This ETF goes up when crude goes down. Here's the opportunity: it's trading at 108% of NAV. This is a no brainer to short! On top of that, Barron's reported that DCR together with UCR will be closed and paid out at NAV if oil closes over $111 for three days straight. Not only is this thing selling for more than double its intrinsic value, it comes with a free option on the NAV with a strike price that is out of the money less than the the NAV.

Inflation Comes to Japan

As I have suspected, inflation is coming to Japan.

April 11 (Bloomberg) -- Japan's wholesale prices rose at the fastest pace since 1981, pushed by higher fuel and food costs, highlighting concern inflation may accelerate even as the economy slows.

Producer prices climbed 3.9 percent in March from a year earlier, after a revised 3.6 percent increase in February, the Bank of Japan said in Tokyo today.

This is a trend to jump onto and which will continue. It is still in the infancy stage, but the pressure is building. When it becomes great enough, Japan will have to raise interest rates. The "quantitative easing" of earlier this decade is bearing fruit, and the fruit will be an uncontrollable price inflation. Remember, Japan must import almost all its energy supplies. The question is: How do I play this? I could buy the Yen against the dollar, hoping that speculators pile into the Yen if interest rates move up. However, holding Yen leaves me vulnerable to the currencies depreciation. Gold keeps looking better and better.

Mish Explains Fed Discussions

Mish explains:

The Fed is now considering borrowing from the Treasury (US taxpayers). Were the Fed to have to do this to remain whole, i.e., have the Treasury underwrite the Fed's balance sheet, the US central bank would be de facto insolvent, having insufficient assets to carry out its mandate.

The perceived invincibility of the Fed's ability to reflate is now clearly in question. The Fed's own discussions prove it.

This leads me to predict that we will suffer a collapse of the dollar later this year. At that point, the government will be forced to stabilize the dollar. The time to make this trade is after there is yet another flight to safety manifested in US Treasuries. When this happens, it will be time to buy TLT puts. As the flight to safety unwinds, Treasury yields will skyrocket, as will gold.

Let's look at what's happening with the Fed a little more closely. Let's start with the question: How does the Fed print money? Answer: the Fed prints Federal Reserve Notes and gives them to banks in exchange for interest plus collateral. This collateral is usually US Treasuries. However, the banks are out of Treasuries because they are insolvent. So the Fed let banks swap MBS for Treasuries. However, since the Fed is already in discussions about what to do when these swaps fail to reflate the banks, we can assume that the Fed is looking ahead for a reason, and that reason is that they will fail. Looking at it this way, the Fed is just a clearing house for swapping one type of IOU's for another. The Fed takes Treasury IOU's or CDO IOU's or MBS IOU's and gives its own: Federal Reserve Notes. However, the government gave the Fed the legal authority to force any debtor to accept it's IOU's. In other words, if the Fed is insolvent (and it is just a matter of time before it is, as their own discussions betray), then the dollar is worthless.

Quando Es Mi Diner?

Univision Draws Down $700 Million of its Bank Line

April 8 (Bloomberg) — Univision Communications Inc., the largest U.S. Spanish language broadcaster, drew $700 million from its bank credit line to repay maturing debt after selling its music division for less than planned.

The company, which has a $750 million credit line, will use $250 million to pay off bank debt maturing in 2009 and the remainder for general corporate purposes, said spokeswoman Stephanie Pillersdorf. Bond and loan prices fell as investors grew concerned that the company was increasing its debt load.

Wow! Who knew 2009 was coming up so fast? They may speak Spanish at Univision, but they’re not stupid. They’re turning their credit into cash while they still have the chance! I give the banks three months to start pulling credit lines, then another 6 months for junk bonds to show 10%+ default rates.

Economic Theory (notebook scribbles edition)

Here's the question I came up with while reading Ludvig Von Mises' "'The Causes of the Economic Crisis' and Other Essays Before and After the Great Depression": When central banks print notes to sterilize inflows of foreign money, why is there such a delay between printing money and price inflation/monetary depreciation? In addition, credit growth pushes down interest rates. Why? Increase of supply... but then doesn't inflation cause higher rates?

Maybe this is the same problem in different words. Let's construct a timeline to get a more detailed view of what's actually happening. First, foreign money comes in. Then the central bank buys said foreign exchange by printing money (notes) or extending credit. At this point, let's assume interest rates may be either high or low. If real interest rates are high, money/credit will go into savings, lowering rates. If rates are low, money goes to buying assets or goods, raising prices. Only after rates have been driven lower do rates rise on the back of price inflation, usually with the help of the central bank pushing rates lower. (Obviously, this whole scenario assumes a substantial increase in a nation's money/credit supply.)

On top of that, as rates stay low, the savings flow reverses and pours more money into goods/assets, further increasing prices.

hmmmm... gotta think about this...

Pro - credit expansion/printing always seems to lower rates...
Pro - as rates go lower with the help of what Mises calls "forced savings" (exporters saving a portion of the money they get from exchanging foreign currency at the CB) the currency devalues, creating a more favorable exchange rate for exporters and the boom takes off.

how does forex depreciation jive w. rising rates? - maybe an example would help - how 'bout China...? - Ususally, by the time rates start to rise, it's because the boom has imploded. The first Asian crisis, for example.

shit - don't know if this works... what about pressure from dollar devaluation on all pegged currencies? Can't leave that out of the mix.

Problem solved: if the money's been pegged to dollar, it can rise against the dollar and still fall against goods. Actually this isn't a problem as long as the peg remains.

Next question: Does reflexivity play a role in the process?

How do market manipulations/distortions/sentiment change "fundamentals"?

- Printing money should cause interest rates to rise, however, if the printing goes into savings, it will bring rates down. (Ex.: forex comes into country, central bank buys with printed money, exporter buys govt bonds with money = govt bond yields down, prices up.) This would be an (eventually) self-defeating vicious circle. However, the issue is more complicated because CB's often engage in setting interest rates as well as forex rates. This puts further pressure on lowering rates.

- But this isn't truly "reflexive" in the sense of a self-reinforcing market disruption because lower rates lower the money value. Wait! - it does, because (when the money value falls against foreign money) then more forex comes into the country. - On top of that, more credit is available within the country as credit availability raises collateral values (and banks feel more comfortable lending money).

This seems completely illogical and counterintuitive. The reason it's true, however, is because the depreciation of the money is hidden by the rise in asset prices. While it takes years for inflation to trickle down into consumer goods, interest rates drop quickly. Also there is additional demand for the money from foreign speculators who wish to take advantage of rising collateral values. This further confuses the issue by creating demand for money with a declining interest rate.

That's all for now. Most of this probably doesn't make sense. However, it's a more grammatically correct rendering of my recent notebook brainstorming. Perhaps someday I will distill something valuable out of it.

Confirmation

That the stock market is at Insane Valuations:

Think the market is in the doldrums? You wouldn't know it by its price, given by the vaunted P/E ratio, the most basic stock valuation metric. The Dow's P/E is now just a hair under 54. A reader writes in more about this:
Yes, it is due to failing earnings. As you know, P/E is the actual price of a stock since it is normalized to an otherwise arbitrary share price. Generally any index P/E over 25 is considered a flashing warning light. Some perspective:
In 1929 the Dow P/E was 32.6
In 1932 it was 5.6 which is the lowest ever recorded
In 1966 the Dow P/E was 24.1
In 1982 the Dow was the same price as 1966 but with a P/E of only 7
In 1987 the Dow P/E crashed from 18.3 to 13.4
In 1999 the Dow P/E spiked to 44.2

WaMu

I'm always suspicious when a company announces a deal, but gives no details. Now the details of the WaMu deal come out. Among the highlights: existing shareholder equity will be diluted by 50%. The new shares were sold at $8.75, a 33% discount to yesterday's close. The dividend will be cut by 93%. The dividend on the preferred stock was not disclosed.

What's Going On Here

A bunch of different things are happening today.

First, WaMu announces that it will dilute shareholder equity and earnings by 50% to raise $5 billion. Voila! Stock up 24%. I will short more at the close today, if there's anything left to short.

Secondly, the crack-up-boom is the play of the day today. How can anything else be expected? The Fed has pledged 40% of the collateral backing their notes for dubious MBS. As commodities are hoarded as a protection against further dollar devaluation, there is a lack of supply of commodities relative to the dollar supply. This lack of supply remains firmly in commodities' favor even as the Fed decreases money supply.

Which leads right into number 3. This is the Fed's recent campaign of selling off Treasuries to offset their monetization of MBS for insolvent banks. In my opinion, this is very bearish for equities. It is meant to combat the crack-up-boom, but will probably squash equities instead. This is just my best guess of what's going on.

Housing Prices

According to Bloomberg, some homes are not even worth foreclosing on. The banks just let people stay for free.

April 4 (Bloomberg) -- Banks are so overwhelmed by the U.S. housing crisis they've started to look the other way when homeowners stop paying their mortgages.

This tells me that the official foreclosure numbers, housing prices, housing inventory, etc., are all better than they should be.

Also, with 80,000 jobs lost in March. Bloomberg reports that is even worse than it seems at first glance.

The loss of jobs in February was revised to 76,000 from 63,000.

Workers' average hourly wages were 3.6 percent higher than a year earlier, the smallest increase since March 2006.

Gains in government jobs prevented a deeper drop in payrolls last month as private employers cut 98,000 workers, the fourth straight monthly decline.

With tax revenues eroding rapidly, the government will soon be shedding jobs, not adding them. I believe that we are now clearly in recession. It's obvious that the recession has now finally spread from the financial sector to the broad economy.

But don't worry anyone, economic growth will bounce back in the second half of the year! (smirk).

Too much happening

And not enought time to blog. But here's a trade I did today. I bought MCGC on Tuesday, but sold it today. It was up two cents. The reason I sold it was that I had a chance to read the analyst report that was responsible for tanking the stock on Tuesday. The analyst predicted that the dividend would be cut 25%. I decided to investigate for myself. I started by checking the payout ratio, in terms of earnings (123%) and, more importantly, in terms of operating cash flow (210%). Next, I checked the debt to equity ratio, which is 0.9. Digging through the analyst report some more, I discovered that MCGC recently had a $200 million credit line pulled.

Conclusion: I believe that the dividend is unsustainable unless the company is able to grow. Without the credit line, the company will have to cut back on the dividend by at least 20% if they want to have any cash to do any future deals.

Agflation

I do not have time to devote sufficient praise to this brilliant article. So, I've copied it in its entirety below:

Agflation will change the course of history

BY MATEIN KHALID (At Home)2 April 2008

WHILE consumers, savers and financiers in the Gulf fret about the current inflation surge and rightly attribute it to the dollar peg, offplan madness and the property speculation bubble, the prices of cement and steel, rent spirals, wage spikes, the money supply, 30 per cent bank credit growth and the tooth fairy, I am convinced that the Middle East’s next macroeconomic demon will be a spectacular rise in food prices.

Agflation will define the future of the region to a far greater degree than illusory hopes for a GCC monetary union, Arab League diplomatic platitudes or demographic time bombs everywhere from Iran to the Maghreb. Yet myriad forces define the supply and demand equations of agflation. As in crude oil, iron ore, nickel and steel, Chinese demand has surged for soyabeans, where the Middle Kingdom already accounts for
26 per cent of global consumption. The world’s inventories of grain, corn and edible oil are at historic lows and, just like gold and crude oil in 2003,
spectacular bull markets in soft commodities have been ignited. Political
chicanery has been the DNA of agflation in modern times. The Iraq war and $100 crude oil forced the Bush White House and the EU to anoint biofuels as the path to energy independence from Arab oil. As US corn, protected by price subsidies and mandation, monopolised arable land, soybean and cotton production will plunge.

Agflation will change international politics, redefine economic models and trigger regime changes across the emerging markets. Far more than crude oil or even bullion, price rises in the supermarket trigger mass consumer
inflation psychology. So central bankers at the Fed, the ECB, the Bank of Japan, RBI, PBOC and SAMA will be powerless to prevent food prices from accelerating the embryonic global inflation nightmare. Global warming, the destruction of the rain forest, carbon emissions and black swan (rare high impact events with fat statistical tail) events like Mad cow’s disease, avian flu and Australian droughts will make agflation as compelling a global issue, at Davos or the UN, as climate change.

Inflation in Dubai is as visceral as “stickershock” in Spinneys and Carrefour as in the price surge in white hot developments like the DIFC or Business Bay. Inflation psychology aside, agflation hits the poor like a financial neutron bomb and encourages hoarding behaviour that make price spirals
a self fulfilling prophecy. As agflation accelerates, countries with farmland
like Russia, Argentina, Ukraine, Australia and Brazil will possess a new
currency of geopolitical power. While soybean and corn are as supply elastic in the short run as black gold, making price rises inevitable. Chinese pork prices, half the CPI for a staple diet for more than a billion people, surged and sparked worker riots and wage rise demands even in the high growth coastal provinces. The surge in the price of beef and tofu in Indonesia led to protests and compelled a cabinet minister to warn of potential social unrest similar to 1965, the fabled year of living dangerously when General Suharto overthrew President Sukarno and the Indonesian military massacred 500,000 suspected communists. Australia’s drought, Brazil’s bad harvests, Russia and Ukraine’s export restrictions and soaring global demand has lead to epic rises in the price of wheat. The surging price of kerosene, cooking oil and flour were instrumental in bringing down Pakistani President Musharraf’s PML-Q, the ostensible king’s party now reduced to a pitiful toothless dictator party. Indonesia’s sovereign creditworthiness is at stake because of agflation since Jakarta spends a third of its budget on fuel/and electricity subsidies.

Egypt is most at risk in the Arab world by the nightmare of agflation. Bread has been subsidised by the rulers of Egypt for millennia from Pharonic times down to the government of President Mubarak. Basic food prices have surged on strikes, bringing factories and universities to a halt. After all, “IMF bread riots” preceded the violence and unrest in the early 1990’s that culminated in the assassination of Anwar Sadat at a military parade to commemorate the 1973 October War. Even though the Egyptian government subsidises sugar, rice, oil and bread, food price surges are more of a threat to regime stability than Dr Zawahiri’s Al Qaeda terrorists. Bread queues turn violent, a recurrent theme in Egyptian history from Ramses II to the Mamluk sultans, from the Ottoman pasha rule to Lord Cromer’s British viceroyalty, from King Farouk to Nasser, Sadat to Mubarak.

The price of rice is the most accurate gauge of social stability for almost three billion Asians. Since Egypt, India and Vietnam banned exports to
bring down local prices, the global price of rice has skyrocketed. If India
restricts Basmati rice exports, a worldwide panic is inevitable. I believe Thai
rice will prove a far bigger money maker for investors than Saudi sour crude. As rice prices double, the poor of Southeast Asia will go ballistic, threatening the government of countries like the Philippines, Burma and Vietnam. With water scarce, low investment in agriculture and dependence on imported food is a disaster for the Arab world.

As hedge funds speculate in coffee, the incomes of Brazilian farmers and Coorgi yuppies surge and the price of a Starbucks cappuccino became an inflation indicator in Ibn Batuta Mall. Stock exchange rumours swirl that Nestle and Kraft Food (owners of the Maxwell House brand) have not hedged their wholesale prices for robusta and arabica beans. I grew up
in a world where the CRB, the world’s commodities index, correlated perfectly with global economic growth. The correlation, unfortunately, has broken down as the world flirts with recession even as food prices skyrocket. This is the stagflation and supply shock scenario, as in the 1970’s.

Agflation concerns UAE economic policymakers. The UAE economy minister is considering food price reserves to combat inflation. This was also the message of the government’s decision to freeze 18 basic foodstuff prices on 2007 levels. Will the UAE government follow rent caps with price freezes at private supermarkets? Food subsidies could even compensate for the decision by GCC central banks not to revalue their currency or drop the dollar peg, the symbol of the Gulf’s Washington security and diplomatic umbrella. Agflation, I am convinced, will be world history’s next game changer, an ominous sword of Damocles over the poorest citizens of the global village.

Matein Khalid is a Dubai-based investment banker and economic analyst

Brilliant! This shows the unintended consequences of the food to energy corn ethanol program. It also shows that just as the US is dependent on the Arabian Gulf for oil, so is the gulf dependent on "Russia, Argentina, Ukraine, Australia and Brazil" for their food supply. Fascinating.