AsI usually do, I wrote this today for posting tomorrow. Events arerunning ahead fast, however, and I think it is more timely to post ittoday.
On March 15 I posted what has turned out to be a prophetic entry titled "Well, What Do You Want It To Be?" ,which followed the various stages in securitizing and derivativizing asimple home mortgage up to the fourth degree (CDO, CDS, hybrids, fundedvs. unfunded, etc). By that stage the resulting structured instrumentis completely unrecognizable vs. the original mortgage and isimpossible to price without a long list of assumptions about futuredefault rates, the shape of the yield curve, volatilities, etc. Thevarious institutional owners, mutual funds among them, relied on daily,weekly or monthly indicative valuations from their broker-dealers whowere more than happy to oblige by concocting essentially fictitiousquotes, since no one was selling, anyway. But the real price is alwaysrevealed when you finally have to sell and then the firm quote you mayget could be... -95, i.e. no bid - 95 offered. A completely worthlessquote that cannot be used to price anything, let alone sell.
BNP-Paribas,the largest bank in France and one of the largest in the world, tookthe highly unusual and severe step of stopping the calculation of NAV'sand suspending redemptions for three of its mutual funds that held suchmortgage-related instruments because, and I quote: ``Thecomplete evaporation of liquidity in certain market segments of theU.S. securitization market has made it impossible to value certainassets fairly regardless of their quality or credit rating''.
Let's translate, though it is quite straightforward for an official release:
a)The complete evaporation of liquidity = No one wants to buy, there are no bids.
b) Impossible to value = Brokers/dealers aren't even giving us official indications - too scared of their implied legal obligations.
c) Regardless of their quality or credit rating = Those AA or AAA ratings are on paper only. God knows what they really are.
There are also several highly disturbing facts:
Here's aquestion to ask the SEC, NASD and, of course, the OCC (Comptroller ofthe Currency: Ensuring a Safe and Sound National Banking System For AllAmericans): Do you have any ideawhatsoever what the real exposure is to the hedge funds of theinstitutions you are charged with overseeing? Especially thoselarge deposit-taking institutions (aka banks) that also act as primebrokers (soup to nuts package deal to hedge funds, from transactionservices all the way to margin lending). Because if liquidity has evaporated, what's the collateral ultimately backing those savings and checking accounts worth?
..................................
...and as I finished writing this the ECB had to intervene in the interbank euro money market to provide 90 billion euro at 4%(normal amts. are around 5 billion) because banks started to denylending to one another, pushing O/N rates to 4.7% - if they could getany, that is. This being an area I know very well, I cannot emphasizeenough how concerning this is. The ECB became the lender of last resort,a role that central banks hope to never have to play because it meansthe financial system has seized up. Likewise, dollar O/N LIBOR ratesshot up to 6% from 5.37% yesterday and this is for the biggest,strongest banks like BofA and Barclays. The Fed just did a 14 day repoto add liquidity at 5.25% - no news on the amt. yet. (just in $15billion).
If the banks are nervous about lending money O/N (justone day) to one another, what do you think they are doing with theirhedge fund customers? Calling in margin loans (yen included)? Biggerhaircuts on the collateral? Higher interest rates? Pressuring them toreduce debit balances by selling positions? All of the above?
On March 15 I posted what has turned out to be a prophetic entry titled "Well, What Do You Want It To Be?" ,which followed the various stages in securitizing and derivativizing asimple home mortgage up to the fourth degree (CDO, CDS, hybrids, fundedvs. unfunded, etc). By that stage the resulting structured instrumentis completely unrecognizable vs. the original mortgage and isimpossible to price without a long list of assumptions about futuredefault rates, the shape of the yield curve, volatilities, etc. Thevarious institutional owners, mutual funds among them, relied on daily,weekly or monthly indicative valuations from their broker-dealers whowere more than happy to oblige by concocting essentially fictitiousquotes, since no one was selling, anyway. But the real price is alwaysrevealed when you finally have to sell and then the firm quote you mayget could be... -95, i.e. no bid - 95 offered. A completely worthlessquote that cannot be used to price anything, let alone sell.
BNP-Paribas,the largest bank in France and one of the largest in the world, tookthe highly unusual and severe step of stopping the calculation of NAV'sand suspending redemptions for three of its mutual funds that held suchmortgage-related instruments because, and I quote: ``Thecomplete evaporation of liquidity in certain market segments of theU.S. securitization market has made it impossible to value certainassets fairly regardless of their quality or credit rating''.
Let's translate, though it is quite straightforward for an official release:
a)The complete evaporation of liquidity = No one wants to buy, there are no bids.
b) Impossible to value = Brokers/dealers aren't even giving us official indications - too scared of their implied legal obligations.
c) Regardless of their quality or credit rating = Those AA or AAA ratings are on paper only. God knows what they really are.
There are also several highly disturbing facts:
- These are plain vanilla mutual fundsfrom a highly reputable bank, not some high-roller leveraged hedgefund. Supposedly ho-hum, safe and with daily pricing and redemptionprivileges. They are designed for the conservative middle-classinvesting public who are putting money away pour les enfants, or towards a house down-payment.
- The amounts involved are quite large: as of July 27 the three portfolios together amounted to $2.8 billion.
- The structured bonds in question are rated AA or better.
Here's aquestion to ask the SEC, NASD and, of course, the OCC (Comptroller ofthe Currency: Ensuring a Safe and Sound National Banking System For AllAmericans): Do you have any ideawhatsoever what the real exposure is to the hedge funds of theinstitutions you are charged with overseeing? Especially thoselarge deposit-taking institutions (aka banks) that also act as primebrokers (soup to nuts package deal to hedge funds, from transactionservices all the way to margin lending). Because if liquidity has evaporated, what's the collateral ultimately backing those savings and checking accounts worth?
..................................
...and as I finished writing this the ECB had to intervene in the interbank euro money market to provide 90 billion euro at 4%(normal amts. are around 5 billion) because banks started to denylending to one another, pushing O/N rates to 4.7% - if they could getany, that is. This being an area I know very well, I cannot emphasizeenough how concerning this is. The ECB became the lender of last resort,a role that central banks hope to never have to play because it meansthe financial system has seized up. Likewise, dollar O/N LIBOR ratesshot up to 6% from 5.37% yesterday and this is for the biggest,strongest banks like BofA and Barclays. The Fed just did a 14 day repoto add liquidity at 5.25% - no news on the amt. yet. (just in $15billion).
If the banks are nervous about lending money O/N (justone day) to one another, what do you think they are doing with theirhedge fund customers? Calling in margin loans (yen included)? Biggerhaircuts on the collateral? Higher interest rates? Pressuring them toreduce debit balances by selling positions? All of the above?
