Saturday, March 28, 2009

Jim Chanos: Give Us a Seat at the Table

“New rules of the game” are necessary to restore confidence in the financial system after credit markets seized up and stocks fell the most since the Great Depression, Treasury Secretary Timothy Geithner said yesterday. He proposed requiring hedge funds and private-equity firms to register with the U.S. Securities and Exchange Commission and to disclose information about their holdings.

“The industry has been bracing for the call for regulation and within reasonable bounds accepts it,” Jim Chanos, founder of New York-based Kynikos Associates Ltd. and head of the Coalition of Private Investment Companies, a hedge-fund trade group, said in a Bloomberg Television interview. He stressed that, like banks, hedge funds want to be able to work with the congress on the adjustments in regulation - "give us a seat at the table."

Hedge funds and buyout firms would also fall under the purview of a new regulator that would identify companies deemed “systemically important,” or capable of wreaking havoc on financial markets. Officials would have the authority to seize these firms if they threatened the markets, much as they do now with insolvent banks.

Geithner Essentially Follows Hank Paulson

If Geithner follows through on picking asset managers in coming weeks to run funds that will buy distressed debt, he would succeed where former Treasury Secretary Henry Paulson failed.

After Congress approved the $700 billion financial-rescue fund in October, the Treasury for weeks sought to hire private managers and set up a system of government purchases of the securities. Paulson abandoned that attempt in November. Geithner plans to hire five asset managers by May.

The bailout is mostly in the form of loans and investments that are supposed to be repaid. The Obama and Bush administrations have allocated about $668 billion of the money, according to calculations by Bloomberg.

A further gauge of Fed's initial success could come from a Federal Reserve program providing loans to investors in new securities backed by loans and assets. Officials want to expand the program, the Term Asset-Backed Securities Loan Facility, to include older, devalued securities. Policy makers hailed the TALF’s start last week for catalyzing about $9 billion of deals.

The administration’s plan also includes an initiative to purchase whole loans from banks, which will be overseen by the Federal Deposit Insurance Corp. As with the asset managers for the distressed securities, the Treasury will provide matching capital to investors. The FDIC will offer debt guarantees of up to six times the capital provided.

By employing private investors, the administration is betting it can avoid taking over banks loaded with toxic debt, the strategy advocated by Nobel laureate economist Paul Krugman and ex-Treasury Secretary James Baker. At the same time, Geithner is seeking to address the devalued assets, rather than leave them on balance sheets as authorities in Japan did in the 1990s at the cost of economic stagnation.

New York University Professor Nouriel Roubini projects $3.6 trillion of losses on U.S. loans and securities, including writedowns on $10.84 trillion of securities and losses on a total of $12.37 trillion of unsecuritized loans.

Former Fed Chairman Alan Greenspan said last week that banks will need more than $750 billion in fresh capital, either from the government or private investors. President Barack Obama’s budget for 2010 also included a “placeholder” for an extra $750 billion in rescue funds.

Some Republicans said yesterday they were willing to give Geithner’s approach a chance, while Democratic leaders supported the announcement.

There’s no guarantee that banks will sell to the public- private investment funds, FDIC Chairman Sheila Bair told reporters yesterday on a conference call. She also said that “if we show the program is a success, it may be expanded, Congress may want to provide further support for it.”

Friday, March 20, 2009

Bill Gross on The Consequences of Fed's Treasury Buying

Interview with PIMCO Co-CIO Bill Gross on Bloomberg News: TIPs is the place to go!

Thursday, March 19, 2009

$639m London Hedge Fund Weavering Capital Collapsed

A $639m (£440m) London hedge fund collapsed on Thursday night after the discovery that the main asset of Weavering Capital’s flagship fund was a $637m derivatives trade with an offshore company controlled by the fund’s founder and chief executive.

Weavering Capital called in administrators on Thursday and its Weavering Macro Fixed Income fund was put into liquidation in the Cayman Islands, after claims the trade could not be paid. Weavering froze the fund a week ago after discovering the position and calling in PwC to investigate.

Weavering, which runs small funds including one in Sweden, was set up in 1998 by Magnus Peterson, former head of trading at Swedish bank SEB. It had solid returns of 10-12 percent a year for the past five years.

Also on the board of the UK company were his wife, Amanda, James Stewart, head of research and a frequent TV commentator on economic issues, and Chas Dabhia, chief operating officer, who called in PwC.

The two directors of the Cayman fund were Mr Peterson’s brother and stepfather.

PwC, liquidators of the fund, said there was “considerable uncertainty” over the $637m value listed for the the fund’s main asset not pledged to lenders, a derivative transaction with Weavering Capital Fund Ltd in the British Virgin Islands.

PwC said it had been told the BVI company’s assets were $10m of cash and $40m of private equity positions, although these have not been substantiated. It is unclear who the directors of the BVI company are, but PwC said on Thursday night that Mr Peterson had told them he controlled it.

Matthew Wilde, partner and head of the hedge fund restructuring team at PwC, said he could not comment on who at Weavering put the trade in place, or what it was for.

“Core to the role of the liquidator is to undertake the investigation of who knew what,” he said. He said he had had a “fruitful dialogue” with Mr Peterson, who had been in the office on Thursday.

The problem was discovered after investors tried to withdraw $223m, of which only $90m has been paid so far. In addition to the outstanding $133m payments, the fund reported assets of $506m at the end of February, down from $535m in January.

Paul Clark was appointed joint administrator of the UK management company with Geoff Bouchier, his partner at restructuring specialist MCR, by the board of Weavering.

From Financial Times, March 19, 2009

Chris Whalen on US Banking System Stress and Tim Geithner

Richard Christopher Whalen is Senior Vice President and a Managing Director of Institutional Risk Analytics (IRA) with responsibility for sales, marketing and business development. Chris is a general securities principal and has worked as an investment banker, research analyst and journalist for more than two decades.

Recently, Bloomberg invited Chris to comment on Geithner's Confirmation Hearing. It turns out, Chris would rather see FDIC Chairman Sheila Bair as a current United States Secretary of the Treasury.

Meredith Whitney on Banking Problems in 2009

A bit of history:

In November of 2007, there were profanity-laced angry calls, hate-spewing e-mails, even wishes for her death. Yet financial analyst Meredith Whitney downgraded Citigroup's stock that caused $369 billion in the U.S. stock market to vanish in one day.

"It is a major call, and it takes guts," Whitney told the press. "This was the intellectually honest thing to do. I think shareholders should get out of the stock," she said. "People have always been afraid to come out with negative calls on Citi because it's a widely held company, and people are intimidated by it."

Fast forward to 2009:

On March 17, sitting in the CNBC studio, Meredith Whitney explains why she thinks that the banks may have even worse problems in 2009 than in 2008.

Wednesday, March 18, 2009

John Paulson Buys a Stake in a Gold Miner

Huge success shorting mortgage backed securities made Hedge Fund Manager John Paulson famous and closely watched. Gold is widely seen as a safe haven for investors in times of financial crisis. Rather than buying gold, Marc Faber recommends and John Paulson buys gold miners. As inflation rises, so can the gold production output, keeping the gold price within certain limits. The rise in the gold production will benefit gold miners.

Mining group Anglo American said on Tuesday it had sold its remaining 11.3 percent stake in South Africa's AngloGold Ashanti for around $1.3 billion (926 million pounds).

The company, which said last month it had scrapped its final dividend and would cut 19,000 jobs in a bid to conserve cash, said in a statement the cash would go towards "general corporate purposes."

Anglo has been gradually cutting back its investment in Ashanti, and now owns no shares in the gold miner.

The latest tranche was sold to investment funds managed by U.S. group Paulson & Co, run by renowned hedge fund manager John Paulson.

Paulson made billions of dollars for himself and clients betting against sub-prime mortgages in 2007.

"We're extremely pleased that someone with John Paulson's track record and reputation has chosen AngloGold Ashanti as one of his investments through which to increase his exposure to the gold market," Ashanti CEO Mark Cutifani said in a statement.

Paulson also owns a 4.1 percent stake in Kinross Gold Corp., making the hedge fund the fourth-largest holder of the gold producer. Paulson is also the second-largest shareholder in chemical-producer Rohm & Haas Co. and has holdings in Cheniere Energy Inc.

Paulson, 53, manages about $30 billion. His Credit Opportunities Fund soared almost sixfold in 2007 on bets that subprime mortgages would plummet. Last year, his flagship fund returned 37 percent, compared with a loss of 19 percent for hedge funds on average.

The firm may have made 311 million pounds ($428 million) since September by betting against the shares of Lloyds Banking Group Plc and HBOS Plc, according to regulatory filings last week.

Gold prices have risen 3.7 percent this year compared with a 15 percent decline in the Standard & Poor’s 500 Index of the largest U.S. companies. Gold futures for April delivery fell $5.30, or 0.6 percent, to $916.70 an ounce at 3:20 p.m. on the New York Mercantile Exchange’s Comex division.

“Hard currency is coming to the fore, as evidenced by the investment choices of some of the world’s most seasoned investors,” AngloGold Ashanti Chief Executive Officer Mark Cutifani said today in an e-mailed statement.

AngloGold’s American depositary receipts, each representing one ordinary share, rose 57 cents, or 1.7 percent, to $34.27 at 3:20 p.m. in New York Stock Exchange trading. The shares have gained 24 percent this year.

AngloGold, the fourth-biggest diversified mining company, dropped 37 pence, or 3.2 percent, to 1,116 pence in London trading.

Anglo, founded in 1917 to mine the world’s biggest gold field, said in 2005 it would give up control of the gold business that helped build the Oppenheimer family’s fortune and concentrate on copper and iron ore.

It has reduced its stake from 51 percent since then, and has also spun off paper and steel units. Anglo said last month it sold 10.4 million AngloGold shares for about $280 million.

AngloGold is reducing contractual commitments to sell gold at fixed prices so as to secure more room to benefit from earning spot-market prices.

The gold producer, whose biggest mines are in South Africa, also is benefiting from declines by the rand because it pays most of its costs in the currency and sells gold for dollars.

Wednesday, March 11, 2009

They Tried to Outsmart Wall Street

I love the Emanuel Derman's book 'My Life as a Quant: Reflections on Physics and Finance'. I would recommend it because of the humbleness and sincerity with which Emanuel Derman wrote it. And now, I can't help it but want people to read 'They Tried to Outsmart Wall Street' by Dennis Overbye, published on March 9, 2009, in the NYT.

Emanuel Derman expected to feel a letdown when he left particle physics for a job on Wall Street in 1985.

After all, for almost 20 years, as a graduate student at Columbia and a postdoctoral fellow at institutions like Oxford and the University of Colorado, he had been a spear carrier in the quest to unify the forces of nature and establish the elusive and Einsteinian “theory of everything,” hobnobbing with Nobel laureates and other distinguished thinkers. How could managing money compare?

But the letdown never happened. Instead he fell in love with a corner of finance that dealt with stock options.

“Options theory is kind of deep in some way. It was very elegant; it had the quality of physics,” Dr. Derman explained recently with a tinge of wistfulness, sitting in his office at Columbia, where he is now a professor of finance and a risk management consultant with Prisma Capital Partners.

Dr. Derman, who spent 17 years at Goldman Sachs and became managing director, was a forerunner of the many physicists and other scientists who have flooded Wall Street in recent years, moving from a world in which a discrepancy of a few percentage points in a measurement can mean a Nobel Prize or unending mockery to a world in which a few percent one way can land you in jail and a few percent the other way can win you your own private Caribbean island.

They are known as “quants” because they do quantitative finance. Seduced by a vision of mathematical elegance underlying some of the messiest of human activities, they apply skills they once hoped to use to untangle string theory or the nervous system to making money.

This flood seems to be continuing, unabated by the ongoing economic collapse in this country and abroad. Last fall students filled a giant classroom at M.I.T. to overflowing for an evening workshop called “So You Want to Be a Quant.” Some quants analyze the stock market. Others churn out the computer models that analyze otherwise unmeasurable risks and profits of arcane deals, or run their own hedge funds and sift through vast universes of data for the slight disparities that can give them an edge.

Still others have opened an academic front, using complexity theory or artificial intelligence to better understand the behavior of humans in markets. In December the physics Web site, where physicists post their papers, added a section for papers on finance. Submissions on subjects like “the superstatistics of labor productivity” and “stochastic volatility models” have been streaming in.

Quants occupy a revealing niche in modern capitalism. They make a lot of money but not as much as the traders who tease them and treat them like geeks. Until recently they rarely made partner at places like Goldman Sachs. In some quarters they get blamed for the current breakdown — “All I can say is, beware of geeks bearing formulas,” Warren Buffett said on “The Charlie Rose Show” last fall. Even the quants tend to agree that what they do is not quite science.

As Dr. Derman put it in his book “My Life as a Quant: Reflections on Physics and Finance,” “In physics there may one day be a Theory of Everything; in finance and the social sciences, you’re lucky if there is a usable theory of anything.”

Asked to compare her work to physics, one quant, who requested anonymity because her company had not given her permission to talk to reporters, termed the market “a wild beast” that cannot be controlled, and then added: “It’s not like building a bridge. If you’re right more than half the time you’re winning the game.” There are a thousand physicists on Wall Street, she estimated, and many, she said, talk nostalgically about science. “They sold their souls to the devil,” she said, adding, “I haven’t met many quants who said they were in finance because they were in love with finance.”

The Physics of Money

Physicists began to follow the jobs from academia to Wall Street in the late 1970s, when the post-Sputnik boom in science spending had tapered off and the college teaching ranks had been filled with graduates from the 1960s. The result, as Dr. Derman said, was a pipeline with no jobs at the end. Things got even worse after the cold war ended and Congress canceled the Superconducting Supercollider, which would have been the world’s biggest particle accelerator, in 1993.

They arrived on Wall Street in the midst of a financial revolution. Among other things, galloping inflation had made finances more complicated and risky, and it required increasingly sophisticated mathematical expertise to parse even simple investments like bonds. Enter the quant.

“Bonds have a price and a stream of payments — a lot of numbers,” said Dr. Derman, whose first job was to write a computer program to calculate the prices of bond options. The first time he tried to show it off, the screen froze, but his boss was fascinated anyway by the graphical user interface, a novelty on Wall Street at the time.

Stock options, however, were where this revolution was to have its greatest, and paradigmatic, success. In the 1970s the late Fischer Black of Goldman Sachs, Myron S. Scholes of Stanford and Robert C. Merton of Harvard had figured out how to price and hedge these options in a way that seemed to guarantee profits. The so-called Black-Scholes model has been the quants’ gold standard ever since.

In the old days, Dr. Derman explained, if you thought a stock was going to go up, an option was a good deal. But with Black-Scholes, it doesn’t matter where the stock is going. Assuming that the price of the stock fluctuates randomly from day to day, the model provides a prescription for you to still win by buying and selling the underlying stock and its bonds.

“If you’re a trading desk,” Dr. Derman explained, “you don’t care if it goes up or down; you still have a recipe.”

The Black-Scholes equation resembles the kinds of differential equations physicists use to represent heat diffusion and other random processes in nature. Except, instead of molecules or atoms bouncing around randomly, it is the price of the underlying stock.

The price of a stock option, Dr. Derman explained, can be interpreted as a prediction by the market about how much bounce, or volatility, stock prices will have in the future.

But it gets more complicated than that. For example, markets are not perfectly efficient — prices do not always adjust to right level and people are not perfectly rational. Indeed, Dr. Derman said, the idea of a “right level” is “a bit of a fiction.” As a result, prices do not fluctuate according to Brownian motion. Rather, he said: “Markets tend to drift upward or cascade down. You get slow rises and dramatic falls.”

One consequence of this is something called the “volatility smile,” in which options that benefit from market drops cost more than options that benefit from market rises.

Another consequence is that when you need financial models the most — on days like Black Monday in 1987 when the Dow dropped 20 percent — they might break down. The risks of relying on simple models are heightened by investors’ desire to increase their leverage by playing with borrowed money. In that case one bad bet can doom a hedge fund. Dr. Merton and Dr. Scholes won the Nobel in economic science in 1997 for the stock options model. Only a year later Long Term Capital Management, a highly leveraged hedge fund whose directors included the two Nobelists, collapsed and had to be bailed out to the tune of $3.65 billion by a group of banks.

Afterward, a Merrill Lynch memorandum noted that the financial models “may provide a greater sense of security than warranted; therefore reliance on these models should be limited.”

That was a lesson apparently not learned.

Respect for Nerds

Given the state of the world, you might ask whether quants have any idea at all what they are doing.

Comparing quants to the scientists who had built the atomic bomb and therefore had a duty to warn the world of its dangers, a group of Wall Streeters and academics, led by Mike Brown, a former chairman of Nasdaq and chief financial officer of Microsoft, published a critique of modern finance on the Web site last fall calling on scientists to reinvent economics.

Lee Smolin, a physicist at the Perimeter Institute for Theoretical Physics in Waterloo, Ontario, who was one of the authors, said, “What is amazing to me as I learn about this is how flimsy was the theoretical basis of the claims that derivatives and other complex financial instruments reduced risk, when their use in fact brought on instabilities.”

But it is not so easy to get new ideas into the economic literature, many quants complain. J. Doyne Farmer, a physicist and professor at the Santa Fe Institute, and the founder and former chief scientist of the Prediction Company, said he was shocked when he started reading finance literature at how backward it was, comparing it to Middle-Ages theories of fire. “They were talking about phlogiston — not the right metaphor,” Dr. Farmer said.

One of the most outspoken critics is Nassim Nicholas Taleb, a former trader and now a professor at New York University. He got a rock-star reception at the World Economic Forum in Davos this winter. In his best-selling book “The Black Swan” (Random House, 2007), Dr. Taleb, who made a fortune trading currency on Black Monday, argues that finance and history are dominated by rare and unpredictable events.

“Every trader will tell you that every risk manager is a fraud,” he said, and options traders used to get along fine before Black-Scholes. “We never had any respect for nerds.”

Dr. Taleb has waged war against one element of modern economics in particular: the assumption that price fluctuations follow the familiar bell curve that describes, say, IQ scores or heights in a population, with a mean change and increasingly rare chances of larger or smaller ones, according to so-called Gaussian statistics named for the German mathematician Friedrich Gauss.

But many systems in nature, and finance, appear to be better described by the fractal statistics popularized by Benoit Mandelbrot of IBM, which look the same at every scale. An example is the 80-20 rule that 20 percent of the people do 80 percent of the work, or have 80 percent of the money. Within the blessed 20 percent the same rule applies, and so on. As a result the odds of game-changing outliers like Bill Gates’s fortune or a Black Monday are actually much greater than the quant models predict, rendering quants useless or even dangerous, Dr. Taleb said.

“I think physicists should go back to the physics department and leave Wall Street alone,” he said.

When Dr. Taleb asked someone to come up and debate him at a meeting of risk managers in Boston not too long ago, all he got was silence. Recalling the moment, Dr. Taleb grumbled, “Nobody will argue with me.”

Dr. Derman, who likes to say it is the models that are simple, not the world, maintains they can be a useful guide to thinking as long as you do not confuse them with real science — an approach Dr. Taleb scorned as “schizophrenic.”

Dr. Derman said, “Nobody ever took these models as playing chess with God.”

Do some people take the models too seriously? “Not the smart people,” he said.

Quants say that they should not be blamed for the actions of traders. They say they have been in the forefront of pointing out the shortcomings OF modern economics.

“I regard quants to be the good guys,” said Eric R. Weinstein, a mathematical physicist who runs the Natron Group, a hedge fund in Manhattan. “We did try to warn people,” he said. “This is a crisis caused by business decisions. This isn’t the result of pointy-headed guys from fancy schools who didn’t understand volatility or correlation.”

Nigel Goldenfeld, a physics professor at the University of Illinois and founder of NumeriX, which sells investment software, compared the financial meltdown to the Challenger space shuttle explosion, saying it was a failure of management and communication.

Prisoners of Wall Street

By their activities, quants admit that despite their misgivings they have at least given cover to some of the wilder schemes of their bosses, allowing traders to conduct business in a quasi-scientific language and take risks they did not understand.

Dr. Goldenfeld of Illinois said that when he posted scholarly articles, some of which were critical of financial models, on his company’s Web site, salespeople told him to take them down. The argument, he explained, was that “it made our company look bad to be associating with Jeremiahs saying that the models were all wrong.”

Dr. Goldenfeld took them down. In business, he explained, unlike in science, the customers are always right.

Quants, in short, are part of the system. “They get paid, a Faustian bargain everybody makes,” said Satyajit Das, a former trader and financial consultant in Australia, who likes to refer to them as “prisoners of Wall Street.”

“What do we use models for?” Mr. Das asked rhetorically. “Making money,” he answered. “That’s not what science is about.”

The recent debacle has only increased the hunger for scientists on Wall Street, according to Andrew Lo, an M.I.T. professor of financial engineering who organized the workshop there, with a panel of veteran quants.

The problem is not that there are too many physicists on Wall Street, he said, but that there are not enough. A graduate, he told the young recruits, can make $75,000 to $250,000 a year as a quant but can also be fired if things go sour. He said an investment banker had told him that Wall Street was not looking for Ph.D.’s, but what he called “P.S.D.s — poor, smart and a deep desire to get rich.”

He ended his presentation with a joke that has been told around M.I.T. for a long time, but seemed newly relevant; “What do you call a nerd in 10 years? Boss.”

Joseph Stiglitz on US Economy Reaction to Obama's Recovery Program

Some people thought that Barack Obama's election would turn everything around for America. Because it has not, even after the passage of a huge stimulus bill, the presentation of a new program to deal with the underlying housing problem, and several plans to stabilise the financial system, some are even beginning to blame Obama and his team.

Obama, however, inherited an economy in free fall, and could not possibly have turned things around in the short time since his inauguration. President Bush seemed like a deer caught in the headlights – paralysed, unable to do almost anything – for months before he left office. It is a relief that the US finally has a president who can act, and what he has been doing will make a big difference.

Unfortunately, what he is doing is not enough. The stimulus package appears big – more than 2% of GDP per year – but one third of it goes to tax cuts. And, with Americans facing a debt overhang, rapidly increasing unemployment (and the worst unemployment compensation system among major industrial countries), and falling asset prices, they are likely to save much of the tax cut.

Almost half of the stimulus simply offsets the contractionary effect of cutbacks at the state level. America's 50 states must maintain balanced budgets. The total shortfalls were estimated at $150bn a few months ago; now the number must be much larger – indeed, California alone faces a shortfall of $40bn.

Household savings are finally beginning to rise, which is good for the long-run health of household finances, but disastrous for economic growth. Meanwhile, investment and exports are plummeting as well. America's automatic stabilisers – the progressivity of our tax systems, the strength of our welfare system – have been greatly weakened, but they will provide some stimulus, as the expected fiscal deficit soars to 10% of GDP.

In short, the stimulus will strengthen America's economy, but it is probably not enough to restore robust growth. This is bad news for the rest of the world, too, for a strong global recovery requires a strong American economy.

The real failings in the Obama recovery program, however, lie not in the stimulus package but in its efforts to revive financial markets. America's failures provide important lessons to countries around the world, which are or will be facing increasing problems with their banks:

• Delaying bank restructuring is costly, in terms of both the eventual bailout costs and the damage to the overall economy in the interim.

• Governments do not like to admit the full costs of the problem, so they give the banking system just enough to survive, but not enough to return it to health.

• Confidence is important, but it must rest on sound fundamentals. Policies must not be based on the fiction that good loans were made, and that the business acumen of financial market leaders and regulators will be validated once confidence is restored.

• Bankers can be expected to act in their self-interest on the basis of incentives. Perverse incentives fuelled excessive risk-taking, and banks that are near collapse but are too big to fail will engage in even more of it. Knowing that the government will pick up the pieces if necessary, they will postpone resolving mortgages and pay out billions in bonuses and dividends.

• Socialising losses while privatising gains is more worrisome than the consequences of nationalising banks. American taxpayers are getting an increasingly bad deal. In the first round of cash infusions, they got about $0.67 in assets for every dollar they gave (though the assets were almost surely overvalued, and quickly fell in value). But in the recent cash infusions, it is estimated that Americans are getting $0.25, or less, for every dollar. Bad terms mean a large national debt in the future. One reason we may be getting bad terms is that if we got fair value for our money, we would by now be the dominant shareholder in at least one of the major banks.

• Don't confuse saving bankers and shareholders with saving banks. America could have saved its banks, but let the shareholders go, for far less than it has spent.

• Trickle-down economics almost never works. Throwing money at banks hasn't helped homeowners: foreclosures continue to increase. Letting AIG fail might have hurt some systemically important institutions, but dealing with that would have been better than to gamble upwards of $150bn and hope that some of it might stick where it is important.

• Lack of transparency got the US financial system into this trouble. Lack of transparency will not get it out. The Obama administration is promising to pick up losses to persuade hedge funds and other private investors to buy out banks' bad assets. But this will not establish "market prices," as the administration claims. With the government bearing losses, these are distorted prices. Bank losses have already occurred, and their gains must now come at taxpayers' expense. Bringing in hedge funds as third parties will simply increase the cost.

• Better to be forward looking, focusing on reducing the risk of new loans and ensuring that funds create new lending capacity, than backward looking. Bygone are bygones. As a point of reference, $700bn provided to a new bank, leveraged 10 to 1, could have financed $7tn of new loans.

The era of believing that something can be created out of nothing should be over. Short-sighted responses by politicians – who hope to get by with a deal that is small enough to please taxpayers and large enough to please the banks – will only prolong the problem. An impasse is looming. More money will be needed, but Americans are in no mood to provide it – certainly not on the terms that have been seen so far. The well of money may be running dry, and so, too, may be America's legendary optimism and hope.

From Guardian, March 8, 2009

Diminishing Appeal of U.S. Treasuries

Another week of U.S. Treasury note auctions diminished the appeal of U.S. debt securities on March 10 as investors ventured back into the stock market, pushing the Dow Jones industrial average up to its strongest close of the year.

The U.S. Treasury kicked off a fresh week of note sales totaling $63.0 billion with its $34.0 billion auction of new three-year notes. The auction had a bid-to-cover ratio of 2.26, which was well below the prior ratio of 2.67 and also below 2.42, the average ratio of the last 10 auctions. Bid-to-cover ratios measure interest in note auctions by comparing the number of bids with the amount of notes sold. A ratio exceeding 2.0 indicates a successful auction.

The auction drew healthy demand from indirect bidders, which include foreign central banks, who took 40.3% of competitive bids. The notes paid 1.489% at the high yield, at which point 10.54% were allotted. The securities had a median yield of 1.419%. In comparison, the outstanding three-year issue had closed on March 9 at a yield of just 1.384%.

Mounting U.S. government debt needed to bolster the U.S. financial system has diminished the appeal of U.S. Treasuries, which have typically been considered a safe-haven bet. That, combined with an optimistic memo from Citigroup's chief executive, Vikram Pandit, seemed to coax investors back into U.S. equities.

Prices fell on U.S. Treasuries, lifting yields on securities across the maturity spectrum. The benchmark 10-year Treasury note's yield cracked 3.0%, ending at 3.01%, compared with 2.89% late March 9. The 30-year Treasury bond's yield rose to 3.73% late March 10, from 3.59% previously. The iShares 10-20 Year Treasury Bond ETF (TLH), which tracks the prices on long-dated government debt, lost $1.21, or 1.1%, to close March 10's trading session at $112.35.

The yield on the two-year Treasury note rose to 1.04% late March 10 and the iShares 1-3 Year Treasury Bond ETF (SHY) shed 5 cents, or 0.1%, to close at $83.84.

On March 11, the U.S. government auctions $18.0 billion in reopened 10-year Treasury notes. On March 12 - $11.0 billion in reopened 30-year bonds.

Friday, March 6, 2009

As home crisis deepens, Obama, Democrats bow to banks on housing rescue

By Tom Eley, published on World Socialist Web Site, March 5, 2009

On Wednesday, the Obama administration released guidelines on its plan to stem the collapse of the housing market with its "Making Home Affordable" initiative, or Homeowner Affordability and Stability Plan (HASP). The plan claims to offer "assistance to as many as 7 to 9 million homeowners."

Part of the program, costing $75 billion, pertains to private lenders, providing funds to them if they agree to renegotiate home loans. A separate $200 billion component will make funds available to Fannie Mae and Freddie Mac, the two federally-backed mortgage lending giants, so that they can modify a share of the home loans they control.

The newly-announced guidelines pertaining to private lenders make clear that the program's primary aim is not to assist homeowners, but to further prop up the banks. The plan does not reduce the grossly overvalued debt homeowners owe banks. It will not affect homeowners "underwater" by more than 5 percent—that is, those who owe more than 5 percent more than their homes' current market value.

Not surprisingly, the plan immediately won the vocal support of the major banks, including Citigroup, JPMorgan Chase, Bank of America, and Wells Fargo.

Hurdles have been thrown up to prevent easy access to the program. In order to qualify, homeowners must submit an "affidavit of financial hardship," in addition to payroll documents, tax forms, and extensive information about other debts and assets in order to prove that they have made "every possible effort" to pay their mortgages. Some participating households will be required to seek debt counseling through government-approved "community organizations," funded by HASP.

The Treasury will assist banks in reducing monthly payments to 31 percent of loan recipients' income through reductions in interest rates or extensions to loan periods. Banks will receive a cash handout of up to $4,000 over three years for every mortgage they modify. Mortgage securities investors could also receive $1,500 per modified loan.

Significantly, only in cases where monthly payment reductions prove less costly to banks than forcing homeowners into foreclosure will lenders have to participate. That is, only under conditions where it is financially beneficial to them, will they be "required" to alter mortgage terms.

Separately, on Tuesday House Democrats agreed to change language in new housing legislation that would have given bankruptcy judges wide latitude to alter payment conditions for homeowners in foreclosure. Previously, Obama indicated that this would be the primary means to compel bank cooperation in the otherwise voluntary HASP program.

The legislation was waylaid last week after conservative Blue Dog Democrats and free market New Democrats, backed behind the scenes by the Obama White House, raised objections. They were responding to a fierce campaign waged by the finance industry against any legislation that would have granted bankruptcy judges new powers to rewrite mortgage contracts.

Should it pass both houses of Congress, the new legislation may well make it more difficult for homeowners to seek redress from the courts. To avoid judicial proceedings, banks would be able to present evidence indicating that they offered adjustments to payment plans. Homeowners would have to prove to a judge, with paper evidence, that they first tried to adjust their mortgages by appealing to the banks.

The change would also water down from the earlier version judges' ability to lower the principal (the outstanding balance on home loans) and would force homeowners who have gone through bankruptcy courts to hand over profits from the future sale of their home to the lender.

Democratic House Majority Leader Steny Hoyer explained that motivating the change was the fear that homeowners could take advantage of the banks. "The concern is that we want to ensure that those people who get relief have tried other avenues," he said.

An Associated Press article pointed out the financial industry's power in altering the legislation. "The changes bring the legislation closer in line to what President Barack Obama's administration has sought and what the banking lobby finds acceptable," the article notes. The Washington Post added that "the financial services industry, which has lobbied against the bill, fought for all [the new] provisions."

Democratic Representative Brad Miller, of North Carolina, was quoted by the AP as saying that the finance industry has "been giving it everything they've got. They still have remarkable influence." Democrat Representative Maxine Waters was more blunt. "These guys rule this place," she said.

New statistics on the housing market underscore the ineffectual character of the measures. On Tuesday, the consumer credit tracking firm TransUnion released data showing a surge in the number of Americans falling behind on their mortgage payments. Households missing at least two consecutive payments rose to 4.58 percent during the fourth quarter of 2008, up from 2.99 percent a year earlier.

According to Moody's about 27 percent of homeowners, or 14 million out of 52 million households, are underwater, owing more than their houses are worth. A survey by First American CoreLogic, the research wing of a major real estate and home title firm, has found that the number of underwater homeowners is likely to increase markedly in the coming months. If home values should fall by the relatively modest figure of 5 percent, another 2.16 million homes would go underwater, according to the report. Housing values have already fallen by 26 percent since 2006 as measured by Standard & Poor's/Case-Shiller index.

Especially hard hit are the states of Arizona, California, Florida, Georgia, Michigan, Nevada, and Ohio. They combine for 62 percent of underwater homeowners, but only 41 percent of mortgages. However, the study anticipates that underwater home loans will mount in other states that have so far been resistant to collapsing home prices.

The foreclosure crisis, which touched off the global financial crisis, is now being pushed forward by layoffs. On Wednesday, ADP Employer Services released data showing that nearly 700,000 private sector jobs were lost in the US in February, and revised January job losses upward to 614,000 from 522,000.

Chinese Central Bank Governor Zhou Xiaochuan Pledges Fast, Forceful Policies for China Growth

By Li Yanping and Luo Jun, published on, March 6, 2009

Chinese central bank Governor Zhou Xiaochuan pledged fast and forceful policies to restore confidence and prevent the global financial crisis from deepening the nation’s economic slump.

“If we act slowly and less decisively, we’re likely to see what happened in other countries: a slide in confidence,” Zhou said at briefing in Beijing. The central bank has “ample room” to fine-tune monetary policy after a record surge in lending in January, he said.

The central banker said he saw “signs of stabilization and recovery” in the world’s third-biggest economy, echoing Premier Wen Jiabao’s confidence that the nation’s 8 percent growth target for 2009 remains within reach. Collapsing exports because of the global recession have dragged growth to the weakest pace in seven years and cost the jobs of 20 million migrant workers.

“This isn’t the time to be cautious with the measures you roll out, it’s time to overdo it,” said Dariusz Kowalczyk, chief investment strategist at SJS Markets Ltd. in Hong Kong. “The outlook for the global economy has deteriorated dramatically.”

The Shanghai Composite Index closed 1.3 percent lower on concern that the global recession is deepening. The yuan was little changed against the dollar as of 4:48 p.m. in Shanghai.

Premier Wen restated the 8 percent target in an annual speech to China’s parliament yesterday, the equivalent of a U.S. State of the Union address.

Slump in Confidence

Fast and forceful policies are preferable to “prevent confidence slumping during the financial crisis,” Zhou said.

China’s confidence contrasts with U.S. Treasury Secretary Timothy Geithner’s warning yesterday that his nation’s recession is deepening as it starts a $787 billion stimulus program of public works.

China’s official manufacturing index rose for a third month in February, from a record low in November. Initial public offerings of shares may resume, the nation’s securities regulator said today. Wen has cited growth in power output and consumption, loans and retail sales as positive signs.

Chinese banks doled out a record 1.62 trillion yuan ($237 billion) of loans in January and more than 800 billion yuan last month, Liu Mingkang, chairman of the China Banking Regulatory Commission, said in Beijing yesterday. The regulator plans to conduct spot checks of bank loan books to “ensure quality of growth,” Liu said.

Lending Quotas

Loans and money supply may have grown too quickly, Zhou said, after China cut interest rates, scrapped quotas limiting lending and pressed banks to support a 4 trillion yuan stimulus package. The jump in lending exceeded the central bank’s expectations, he said.

The government will study the results of its existing stimulus package before deciding whether to take any new measures, Zhang Ping, head of the National Development and Reform Commission, said in Beijing today.

The People’s Bank of China cut interest rates five times in the final four months of last year, including the biggest single reduction since the 1997-98 Asian financial crisis, leaving the benchmark one-year lending rate at 5.31 percent. There have been no cuts in 2009.

China needs “stable and relatively fast growth” to create jobs, boost incomes and ensure social stability, Premier Wen said yesterday.

Not everyone is convinced that China will meet its 8 percent goal.

Lower Growth Forecasts

The 6.8 percent gain in the fourth quarter was down from 9 percent for all of 2008 and 13 percent for 2007. The International Monetary Fund forecasts the economy will grow 6.7 percent in 2009, the least in almost two decades.

Economist Kowalczyk sees a 6 percent expansion this year and warns that surging unemployment may undermine social stability if the government fails to do more to boost growth.

China’s exports may have fallen 20 percent in February from a year earlier, the 21st Century Business Herald newspaper reported today, citing an unidentified trade official. Imports may have also fallen 20 percent last month, it said.

The nation’s trade surplus for February may be $7 billion, the newspaper reported. That would be less than a fifth of the size of January’s surplus.

“China’s economic conditions may appear less dismal than its Asian peers, but the government’s growth target of eight percent seems too optimistic,” said Sherman Chan, a Sydney- based economist at Moody’s Economy.Com.

Thursday, March 5, 2009

The difference between two- and 10-year yields widens

Julian Robertson's 2003 estimated net worth was over $400 million, and in 2008 it was estimated at $1.8 billion. Robertson is thought to have shorted the sub-prime. Having long warned of a coming credit crisis, Robertson's bet may have paid off handsomely: his current wealth is estimated by some to exceed $3 billion (

Recently, Julian Robertson was on CNBC and suggested that buying puts on treasuries was a good trade. Bill Gross from Pimco agreed and said that he sees interest rates going to seven percent. Some experts predict the rates reaching 18 percent.

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TBT - ProShares UltraShort 20+ Year Treasures
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We do see the widening of the gap between two- and 10-year yields.

By Wes Goodman of, March 5, 2009

Treasuries were little changed after two days of losses on speculation the government will announce plans to sell $60 billion of notes and bonds next week, raising record amounts to fund efforts to snap the U.S. recession.

Notes slid initially after China said it will “significantly increase” investment to counter a slowdown in the world’s third-biggest economy, eroding demand for the relative safety of government debt. A measure of corporate bond risk in Asia and the Pacific fell and the region’s stocks gained as investors sought higher-yielding assets.

“The U.S. government has to borrow a huge amount of money,” said Satoshi Okumoto, general manager in Tokyo at Fukoku Mutual Life Insurance Co., which has $58.1 billion in assets. “If China’s economy recovers quickly, people will expect the world economy to recover, so that’s bad news for the bond market.” He sold Treasuries last week.

The 10-year note yield rose one basis point to 2.98 percent as of 7:27 a.m. in London, according to BGCantor Market Data. The price of the 2.75 percent security due in February 2019 fell 3/32, or 94 cents per $1,000 face amount, to 98.

Yields, which fell to a record low of 2.034 percent on Dec. 18, averaged 4.64 percent for the past decade.

Spread Widens

The difference between two- and 10-year yields widened to 2.06 percentage points, the most since November, from as little as 1.25 percentage points late last year. The growing spread shows investors are demanding extra to hold long-term maturities because of concern the government will be selling more of them.

The cost of protecting bonds in Asia from default fell after Premier Wen Jiabao reiterated China’s 2009 growth target of 8 percent in a report to the National People’s Congress in Beijing today.

Markit iTraxx’s Asia index of credit-default swaps on the debt of 50 investment-grade borrowers outside Japan fell 25 basis points to 4.35 percentage points, according to Barclays Capital. A basis point is 0.01 percentage point.

Credit-default swaps are contracts that pay the buyer face value in exchange for the underlying securities if a borrower fails to adhere to its debt agreements. Traders use them to speculate on changes in credit quality. An increase in the price suggests deteriorating investor perceptions of credit quality and a decrease indicates improvement.

MSCI’s Asia Pacific Index of regional shares rose 0.5 percent, gaining for a second day.

Record Sale

The U.S. will probably announce today that it will sell a record $33 billion of three-year notes on March 10, $17 billion of 10-year debt the following day and $10 billion of 30-year bonds on March 12, according to Wrightson ICAP LLC, a research unit of the world’s largest inter-dealer broker. The auctions follow $94 billion of note sales last week.

President Barack Obama’s administration is seeking congressional approval for a budget of $3.55 trillion for the fiscal year beginning in October. His spending plans for the year that ends Sept. 30 would result in a record $1.75 trillion deficit.

The government is relying on overseas investors to help fund aimed at turning around an economy that “deteriorated further” in the past two months, according to the Federal Reserve’s regional business survey.

China is the largest foreign holder of Treasuries, with $696.2 billion, followed by Japan, with $578.3 billion.

“Foreign investors will not be able to absorb that kind of supply,” said Mark MacQueen, who helps oversee $7 billion as co-founder of Sage Advisory Services Ltd. in Austin, Texas. “We can’t expect them to buy more than they bought last year, so rates will have to trend higher,” he said yesterday.

Notes recouped some losses on speculation government reports today and tomorrow will show the U.S. labor market is deteriorating.

More Jobless

The number of people receiving jobless benefits rose to a record 5.16 million, according to the median estimate in a Bloomberg News survey of economists before the Labor Department releases the figures today. The U.S. lost jobs for a 14th month in February, a separate survey showed before the Labor report tomorrow.

U.S. 10-year yields will fall below 2 percent as the economic figures weaken, said Mike Turner, the head of strategy and allocation in Edinburgh at Aberdeen Asset Management PLC.

A Bloomberg survey of economists projects the yield will drop to 2.64 percent by June 30, with the most recent forecasts given the heaviest weightings.

Deflation Risk

“Deflation remains a predominant risk,” Turner wrote in a February report that Aberdeen, the Scottish fund company overseeing $158.4 billion, distributed today. Deflation, a general drop in prices, is good for bonds because it enhances the value of their fixed payments.

U.S. consumer prices were unchanged in the 12 months ended Jan. 31, the Labor Department said Feb. 20, which shows bond investors aren’t losing anything to inflation.

Yields indicate inflation forecasts rose this year.

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices climbed to 94 basis points from 9 basis points on Dec. 31. The figure has averaged 2 percentage points over the past two years.

Treasuries handed investors a loss of 3.6 percent in the first two months of 2009, the steepest decline since dropping 4.8 percent between May 2003 and the end of July 2003, according to Merrill Lynch & Co.’s U.S. Treasury Master index. Treasuries gained almost 14 percent in 2008, the best return in 13 years.

“We’re buckling underneath this supply,” said Theodore Ake, head of U.S. Treasury trading in New York at Mizuho Securities USA Inc., one of 16 primary dealers that trade with the Federal Reserve. “Right now the camel’s back is cracking. Rates should be lower, but there’s a massive deficit that we are going to have to fund,” he said yesterday.

Tuesday, March 3, 2009

David Karsbøl predicts 2009 will hit all economic lows

David Karsbøl, Chief economist and Head of Strategy at Saxo Bank, made predictions on the 2009 in the Saxo Bank press release of December 17, 2008.

Crude trading at $25. S&P 500 falls 50% to 500. China’s GDP growth falls to zero. EURUSD falls to 0.95. Italy to leave the ERM. If Saxo Bank’s 10 outrageous claims for the year ahead transpire, economic conditions will worsen dramatically in 2009. “The good thing is, overall, we predict 2009 will be a turning point because it can’t get much worse” says chief economist David Karsbøl.

The Copenhagen-based online trading and investment specialist's predictions are compiled as part of the 2009 Outlook and thought exercise, and are an annual attempt to predict ‘black swan’ sightings in the global markets, and this year present a dismal view. Black swan events are high impact, rare occurrences that are beyond the realm of normal expectations.

Saxo Bank’s Outrageous Claims for 2009:

1) There will be severe social unrest in Iran as lower oil prices mean that the government will not be able to uphold the supply of basic necessities.
2) Crude will trade at $25 as demand slows due to the worst global economic contraction since the great Depression.
3) S&P will hit 500 in 2009 because of falling earnings, vaporizing housing equity and increased cost of funds in the corporate sector.
4) The EU is likely to crack down on excessive government budget deficits in several member states, and Italy could live up to previous threats and leave the ERM completely.
5) The AUDJPY will drop to 40. The decline in the commodities markets will affect the Australian economy.
6) EURUSD will fall to 0.95 and then go to 1.30 as European bank balances are under tremendous pressure because of exposure to the faltering Eastern European markets and intra-European economic tensions.
7) Chinese GDP growth drops to zero. The export driven sectors in the Chinese economy will be hurt significantly by the free-fall economic activity in the Global Trade and especially of the US.
8) Pre-In's First Out. Several of the Eastern European currencies currently pegged or semi-pegged to the EUR will be under increasing pressure due to capital outflows in 2009.
9) Reuters/ Jefferies CRB Index to drop to 30% to 150. The Commodity bubble is bursting, with speculative excesses so large they have skewed the demand and supply statistics.
10) 2009 will see the first Asian currencies to be pegged to CNY. Asian economies will increasingly look towards China to find new trade partners and scale down their hitherto US-centric agenda.

David Karsbøl, Head of Strategy at Saxo Bank, comments:

“It is not even outrageous to call this the worst economic crisis ever. We have, regrettably, been rather precise in almost all predictions from last year. What used to be outrageous now seems to be the norm”, says Karsbøl.

“In a year when markets and economies have fluctuated more widely than ever before nothing seems out of the ordinary or impossible. We believe that 2009 will be equally unpredictable and therefore have made ten outrageous predictions largely focusing and what might happen to global indices and currencies. The good thing is, overall, we predict 2009 will be a turning point because it can’t get much worse” says Karsbøl.

"In 2008 the S&P 500 has fallen well over 25% below its 1182 high of 2007, world oil prices got close to the predicted high of $175, and UK growth has turned negative. Who knows which of our 2009 forecasts will prove to be right but judging by previous years some of them most certainly will," he adds.

Warren Buffett: "The [US] economy will be in shambles throughout 2009 – and probably well beyond."

Berkshire Hathaway lost $10.9bn, out of which $4.61bn pre-tax losses on derivatives.

By Richard Tyler, Telegraph, 28 February 2009

Billionaire Warren Buffett, the Sage of Omaha, has recorded his worst financial performance since taking over famed US investment group Berkshire Hathaway in 1965.

The group's net worth dropped by $10.9bn (£7.6bn) in the final quarter of 2008 to end the year at $109.2bn.

His investments and broad mix of insurance, utility, manufacturing and services businesses barely broke even, with quarterly net income sinking 96pc to $117m.

In his annual letter to shareholders, released yesterday, Mr Buffett pointed the finger at $4.61bn of pre-tax losses booked on falls in the market value of 251 derivative contracts that he had personally approved. These included 15-20 year bets that the FTSE 100 and S&P 500 would recover all their recent losses.

Mr Buffett described derivatives as "dangerous", but he remained convinced that they were a good bet. "I believe each contract we own was mispriced at inception, sometimes dramatically so. If we lose money on our derivatives, it will be my fault," he wrote.

Nineteen of top 20 stocks in Berkshire's US portfolio, valued at $51.9bn, fell last year. Coca-Cola, its top holding, dropped 26pc and American Express plunged 64pc.

Mr Buffett, 78, said he would maintain Berkshire's "Gibraltar-like financial position" during 2009 by retaining "huge amounts of excess liquidity, near-term obligations that are modest and dozens of sources of earnings".

But he offered a gloomy outlook, saying: "The [US] economy will be in shambles throughout 2009 – and probably well beyond."

He also upped his attack of the US government's bail-out of his insurance and banking rivals. "Though Berkshire's credit is pristine – we are one of only seven AAA corporations in the country – our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing," he wrote. "At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one."

He said he would continue to buy shares and bonds from companies. "Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down," he quipped. However, he hinted that his focus this year would be in snapping up companies at bargain prices that had the potential for solid earnings growth in the future. "We like buying underpriced securities, but we like buying fairly-priced operating businesses even more," he wrote.

Despite his near-mythical status, Mr Buffett readily admitted that he was fallible. "During 2008 I did some dumb things in investments," he said, pointing to his decision to increase the fund's stake in oil and gas giant ConocoPhillips at peak prices as he did not anticipate the dramatic fall in energy prices in the second half of the year. It cost Berkshire shareholders several billion dollars.

Berkshire Class A shares closed on Friday at $78,600 (£55,138) and have fallen 44pc since the end of February 2008. Over the last 44 years, the value of Berkshire's net assets has rocketed from $19 to $70,530 a share, a growth rate of 20.3pc compounded annually.