S&P Story Follow-Up

August 12, 2011

Mike raised an excellent and common point in the comment section on the last post.

He objected to my “free pass”, so to speak, for the rating agencies on the MBS mess.  He felt, as many do, that they had an obligation to identify the bubble, and warn the public.

Maybe so.

What Mike and others are demanding is that S+P abandon their tradition of using statistics and balance sheets, and base their ratings on subjective opinion instead.  In a sense, that’s what they did by lowering the long-term rating for the United States’ debt to AA+.  As they said in their commentary when they issued that rating downgrade, they do not doubt the ability to pay, just the willingness.

With a bubble like the housing market experienced, the problem was more one of future ability to pay, especially for the class of loans called “alt-A”.  Those loans to people with FICO scores north of 700 (definitely NOT subprime) have turned out to be worse than subprime on hundreds of deals. Those alt-A deal losses were initially modeled to be less than a quarter the severity and frequency of subprimes.

That said, my response to Mike’s comment follows the break.

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S&P Story

August 11, 2011

You probably think I’m going to write the umpteenth story about the recent downgrade of long-term US Treasuries.  If that’s what you want, I’m sorry to disappoint.

Instead, I’m going to tell you about the danger of being blinded by your own cleverness, especially when your smartest people fall in love with a model.

Back in 2002, I had a large holding of Corning stock, or glass works, as I had called it since first buying stock in it back in the 1970′s.  In 2002, the yammering crowd called it an Internet stock, or a fiber optic company.

I knew it was much more than that.

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amREIT NIrvana !!

August 9, 2011

It doesn’t get any better than this.

The long end of the curve is rallying like crazy, so new capital (and reinvested mortgage principal) won’t get quite as fat a spread, but low repo rates for the next eight quarters is simply amazing.

The FOMC sez:

The Committee currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013

On top of that, the bond market rally will result in surprise increases in book value this quarter.  That should make the nervous nellies that have been dumping amREITs feel safe getting back into the pool.

The only cloud that could ruin this silver lining is a liquidity crisis.  That won’t come from mortgage land, but could come from CDS land.  If it does happen, we could experience a disruption in the repo market.

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Downgrades and Liquidation

August 8, 2011

Though most holders of US Treasuries won’t be under pressure (yet) to reallocate their bond holdings, for a number of them a second ratings downgrade will change that.

This morning the suggestion is out that Moody’s will likely downgrade US Treasuries if the Bush tax cuts don’t expire as scheduled at the end of next year.  I can’t picture the House majority going along with that, so insurance companies and pension funds who have ratings-based guidelines for their portfolio will have to start thinking about repositioning for a second downgrade.

Most who don’t know the bond market will probably think that action would result in selling pressure on Treasuries.

Au contraire, mon ami.

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Death of the Yield Curve?

August 7, 2011

When Alan Greenspan ran rates to near zero in preparation for Y2K, he kicked off a wave of financial asset speculation.

Not satisfied with that object lesson, he repeated the monetary stimulus (doubled down) after the 9/11 attacks, thus making sure we could all go shopping whether we had the income to support the new debt or not.

As much as modern economic historians would like to blame the debt overhang problem on families or government, the reality is that debt growth from the late 90′s until the collapse of 2008 was by far fastest and largest among financial companies.  Luckily for them, their position as the dominant “industry” in the S&P 500 and their position as the largest contributor to both parties in the national government pretty much set us all up to be the life preservers for the banks and brokerages.

Unfortunately, when you’re just an ordinary Joe trying to swim to shore after the ship capsizes, you are likely to drown if you are being used as a life preserver by the 240 pound bankers.

All of which brings me to the actual difference this time that may allow the yield curve recession predictor to fail.

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Getting the Sign Wrong

August 7, 2011

I’m going to show my age here, but that’s OK.

In my very first consulting assignment with a professional trader, I came in to rescue a project that had been started by an academic who was pursuing a PhD in Computer Science.  Unfortunately, that meant there was already a computer and a partially-completed bunch of software that didn’t quite run on that computer.

The software was written in APL (favorite of the theoretical computer science set at the time), and the computer was IBM’s earliest attempt at creating a PC.  It was the model 5100, for those who want to place this story in the context of useless technological history.

The punch line of this story is that I wrote the rest of the program exactly as specified, but when it produced the results for the commodity trader who hired me, it was telling him to buy when he should be selling, and vice-versa.

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Recessions and Yield Curves

August 7, 2011

NOT déjà vu.

If we are going into another round of recession, we aren’t going the same way as before.

In the late 90s, I was part of a group of cyber-buds who debated markets, economic theory and policy in a stimulating endless argument.  A few of them (George Ure, Tom Drake, Rick Ackerman) have carried the tradition to this day, adding their voices to the tree frog chorus of economic thought on the web.

Just to be clear, I love tree frogs and their nighttime racket.

I have my Tree Frog Beer T-shirt from freshman year in college, much the worse for wear, but you can still recognize the all-knowing face of the Checkered Demon.  For those who know and appreciate the greatness of the Demon and S.Clay’s other characters, you might want to stop by and donate to help him with uncovered medical expenses.

But, I digress.  What I really came to do today was to talk about yield curves predicting recessions. Read the rest of this entry »


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