Category Archives: Credit markets

Stephen Roach Takes the Fed to the Woodshed

While the Fed appears to be getting nervous about increasing (and long overdue) criticism for its undue coziness with banks, it has for the most part ignored opponents of its aggressive monetary policies. And for good reason. Most of them have been fixated on the risk of inflation, which is not in the cards as long as labor bargaining power remains weak. There are other, more substantial grounds for taking issue with the central bank’s policies. For instance, gooding asset prices widens income and wealth inequality, which in the long term is a damper on growth. Moreover, one can argue that the sustained super-accommodative policy gave the impression that Something Was Being Done, which took the heat off the Administration to push for more spending. Indeed, the IMF recently found that infrastructure spending pays for itself, with each dollar of spending in an economy with high unemployment generating nearly $3 in GDP growth. And a lot of people are uncomfortable for aesthetic or pragmatic reasons. Aesthetically, a lot of investors, even ones that have done well, are deeply uncomfortable with a central bank meddling so much. And many investors and savers are frustrated by their inability to invest at a positive real yield without being forced to take on a lot of risk.

Stephen Roach, former chief economist of Morgan Stanley and later its chairman for Asia, offers a straightforward, sharply-worded critique: just as in the runup to the crisis of 2007-2008, the Fed’s failure to raise rates is leading to an underpricing of financial market risk, or in layspeak, to the blowing of bubbles. He argues that has to end badly.

“Summer” Rerun: So Where, Exactly, Did Lehman’s $130 Billion Go?

Dear readers,

We reinstituting a Naked Capitalism feature, the summer rerun. The last time we reprised an archival NC post (aside from a few more recent ones by Matt Stoller) was a July 9, 2009 post that we published again on December 29, 2011.

Interestingly, picking up again from 2009 serves as a reminder of issues that were hot in the aftermath of the crisis that were not addressed adequately, if at all. Here, we discuss the mystery of the magnitude of Lehman’s losses. We pointed out that they are so large and impossible to explain that there had to be accounting fraud, but the bankruptcy overseer had its own reasons not go to there.

Note that this post was published eights months before Anton Valukus released his report on the Lehman bankruptcy, which described the Repo 105 ruse that allowed Lehman to hide over $50 billion of dodgy assets at quarter end and thus not include them in its financial reports.

Wolf Richter: First Oil, Now US Natural Gas Plunges, “Negative Igniter” for New Debt Crisis

Yves here. Wolf has been keeping a sharp eye out on how shale gas players were junk bond junkies, and how that is going to lead to a painful withdrawal. Here, he focuses on one of the big drivers of the heavy borrowings: the deep involvement of private equity firms, who make money whether or not the companies they invest in do well, by virtue of all the fees they extract. The precipitous drop in natural gas prices is exposing how bad the downside of a dubious can be, at least for the chump fund investors.

It’s hard to imagine an industry that is a worse candidate for private equity than oil and gas exploration and production. The prototypical private equity purchase is a mature company with steady cash flow. Oil and gas development is capital intensive and the cash flows are unpredictable and volatile, because the commodity prices are unpredictable and volatile.

A less obvious issue is that it actually takes a lot of expertise to run these businesses. This is not like buying a retailer or a metal-bender. Now private equity kingpins flatter themselves into believing that experts are just people they hire, but here, the level of expertise required, and the fact that the majors are way bigger than private equity firms means that the private equity buyers don’t know enough to vet whether the guy they hire is really as good as he says he is. Like all outsiders, they are way too likely to be swayed by the sales pitch and personality rather than competence.* And even with all the money that private equity has thrown at energy plays, it’s not clear that New York commands much respect in Houston.

As one private equity insider wrote in June, ironically just before oil priced peaked:

New York’s Benjamin Lawsky Forces Resignation of CEO of Mortgage Servicer Ocwen Over Wrongful Foreclosures, Shoddy Records and Systems

New York State Superintendent of Financial Services Benjamin Lawsky has forced the resignation of the chairman and CEO of a mortgage servicer, Ocwen over a range of borrower abuses in violation of a previous settlement agreement, including wrongful foreclosures, excessive fees, robosigning, sending out back-dated letters, and maintaining inaccurate records. Lawsky slapped the servicer with other penalties, including $150 million of payments to homeowners and homeowner-assistance program, being subject to extensive oversight by a monitor, changes to the board, and being required to give past and present borrowers access to loan files for free. The latter will prove to be fertile ground for private lawsuits. In addition, the ex-chairman William Erbey, was ordered to quit his chairman post at four related companies over conflicts of interest.

The Ocwen consent order shows Lawksy yet again making good use of his office while other financial services industry regulators are too captured or craven to enforce the law. Unlike other bank settlements, investors saw the Ocwen consent order as serious punishment. Ocwen’s stock price had already fallen by over 60% this year as a result of this probe and unfavorable findings by the national mortgage settlement monitor, Joseph Smith. Ocwen’s shares closed down another 27% on Monday. And that hurts Erbey. From the Wall Street Journal:

Combatting Eurozone Deflation: QE for the People

Yves here. This post describes why having the ECB give money directly to citizens would do a better job of fighting Eurozone deflation than the US version. The author starts from the premise that QE worked in the US, when there is ample reason to believe it worked only for financial institutions and a small portion of the population. Here, the ECB would engage in what amounts to a fiscal operation, which also would have dome more to stimulate the economy than the Fed’s QEs.

Christie Allies Offer Dubious Defenses for Payments Made to His Wife’s Firm

Increasingly defensive responses from the Christie administration and friendly media outlets show that David Sirota’s relentless reporting on pension fund improprieties is starting to draw blood.

The New York Times ran a story last week that recapped (and cited) the Sirota’s reporting on a new Garden State impropriety: that of Christie’s wife, Mary Pat, being hired by hedge fund Angelo Gordon after the firm had been told by the state to liquidate a $150 million custom fund. That should be uncontroversial except Angelo Gordon has failed to sell a portion of the fund after three years, meaning it is still generating fees from New Jersey even as Christie’s wife works there. This relationship looks to run afoul of New Jersey’s strict pay-to-play rules, which state officials from “being involved” in “any official manner” in which they have direct or indirect personal or financial interest.

The Newark Star Ledger also wrote up the story, with the addendum that Tom Bruno, chairman of the state’s largest pension fund, called for an ethics investigation.

The day after the Times story appeared in print, the Newark Star Ledger in an editorial tried to depict the accounts as off base. The timing of the response, coming so quickly on the heels of the Times’ account, strongly suggests that it was planted. An all-too-consistent feature of the rebuttals to Sirota’s charges is that they play fast and loose with facts. The bone of contention is that the state is still paying fees to Angelo Gordon, when by all normal standards payments should have ceased years ago.

Michael Pettis: Is China Really Turning Away from the Dollar?

Yves here. This important post by Michael Pettis addresses whether the efforts of the Chinese to diversify their foreign investments away from the dollar will be a negative for the US. Pettis is skeptical of that thesis, and some of his reasons are intriguing. Like quite a few experts, he doubts that China’s role in sponsoring an infrastructure bank will be a game changer, and he also points out, as we have regularly, that the Chinese cannot deploy their foreign exchange reserves domestically without driving the renminbi to the moon (via selling foreign currencies to buy RMB), which is the last thing they want to have happen. A more surprising, but well argued thesis is that reduced Chinese purchases of US bonds would be a net plus for the US.

Get a cup of coffee. This is a meaty, important article.

What are the Odds of a Commodities-Led Global Financial Crisis?

Yves here. While the odds of commodities-triggered 2008 style meltdown is still not the most likely outcome, recall that that pessimists like yours truly assessed the likelihood of Seriously Bad Things Happening as of early 2008 at 20-30%, which I then saw as dangerously high. In other words, tail risks are bigger than they appear.

Some of the things that favor worse outcomes than one might otherwise anticipate is investor irrationality, or what one might politely call herd behavior. For instance, a major news story today was how investors are dumping emerging markets assets willy nilly, when many are not exposed to much if any blowback from lower commodity prices and quite a few are seen as net beneficiaries. The offset is that central banks have been conditioned to break glass and overreact when banks start looking wobbly. But the Fed may be slow to get the memo, since it sees recent data (the last jobs reports and retail sales data) as strong, and is also predisposed to see its medicine as working even though it is really working only for those at the top of the food chain.

Note that this report is from Monday in Australia, and look how much oil prices have dropped since then. WTI is now at $54.28 per Bloomberg.

Did Wall Street Need to Win the Derivatives Budget Fight to Hedge Against Oil Plunge?

Conventional wisdom among banking experts is that Wall Street’s successful fight last week to get a pet provision into the must-pass budget bill (or in political junkies’ shorthand, Cromnibus) as more a demonstration of power and a test for gutting Dodd Frank than a fight that mattered to them. But the provision they got in, which was to undo a portion of Dodd Frank that barred them from having taxpayer-backstopped deposits fund derivative positions, may prove to be more important than it seemed as the collateral damage from the 40% fall in oil prices hits investors and intermediaries.

Ilargi: Will the Oil Collapse Kill Energy Junk Bonds?

Yves here. Some ahead-of-the-curve analysts have warned of the magnitude of energy debt, mainly junk bonds issued to fund shale gas projects, that are now at risk thanks to plunging oil prices whacking the entire energy complex.

We’ve heard over the last few weeks sunny proclamations of how many shale players have lower cost structure than commonly thought and could ride out weak prices. The supposedly super bearish Bank of America report published earlier in the week called for oil prices to drop to a scary-sounding $50 a barrel. But the document sees that aa a short-term phenomenon. As supply and demand equilibrates (shorthand for “of course some people will drive more, and a lot of wells will get shut down”), it anticipates that oil prices will rebound to $80 to $90 a barrel in the second half of 2015.

The problem with conventional wisdom, even pessimistic-looking conventional wisdom, is that the noose of a lot of borrowings is likely to change the decision-making process of those producers.

Yanis Varoufakis: Ten Questions on the Eurozone, with Ten Answers

Yves here. Yanis Varoufakis’ discussion today focuses on hot-button issues in the Eurozone, which isn’t getting the attention it warrants in the US press right now, given the competition from so many stories closer to home, such as the oil price collapse to sustained protests over police brutality to the CIA torture report.

Admittedly, while a crisis looks inevitable, with Germany committed to incompatible goals (continuing to be export-driven but not lending to its trade partners), the Troika has made kicking the can down the road into such an art form so as to have dulled the interest of most Eurozone watchers. But there’s been a bit of a wake-up call with the possibility that Greek prime minister Antonis Samaras’ gambit of calling for a presidential snap election (which is a vote within the legislature) will fail, leading to general elections. A general election is widely expected to produce a victory for the leftist party Syriza, which is opposed to more bailouts, and one is scheduled to be wrapped up within the next couple of months. Syriza wants the debts restructured and also wants to be allowed to deficit spend, which in an economy so slack, would reduce debt to GDP ratio over time (the austerians keep ignoring the results of their failed experiments: when you cut government spending, the economy shrinks disproportionately. As a result, this misguided method for putting finances on a sounder footing makes matters worse as government debt to GDP ratios rise as a direct result of spending cuts).

As much as the Syriza leader, Alexis Tsipras, has spoken against bailouts, even if he comes into power, it’s not clear that he has the resolve to bluff the Troika successfully. International lenders will rely on the notion that Tsipras can’t afford to threaten a default, since that could trigger bank runs and potentially rescues via depositor bail-ins and are likely to push back hard. But the spike up in Greek government bond yields and the near 12% plunge in the Greek stock market yesterday says investors are plenty worried about the possibility of brinksmanship, and the tail risk that Greece might actually default and print drachmas to fund its government budget, which would be grounds for kicking it out of the Eurozone.

Wolf Richter: Treasury Warns of Leveraged Loan Risk

Yves here. Wolf provides a detailed and informative account of a new report by the Office of Financial Research on the risk of leveraged loans. The big finding is they don’t like what they are seeing. And on top of that, part of their nervousness results from the fact that the ultimate holders of leveraged loans are typically part of the shadow banking system, such as ETFs, and thus beyond the reach of bank regulators.

Because these loans were issued at remarkably low interest rates, they aren’t a source of stress. But as their credit quality decays (recall quite a few were made in the energy sector) and/or interest rates rise (the Fed is making noises again), investors in mutual funds and ETFs will show mark to market losses that could well be hefty. Any bank with large amounts of unsold inventory would also be exposed; query whether regulators will let them fudge by moving them to “hold to maturity” portfolios.

Oh, and what is the biggest source of leveraged loans? Private equity funds when they acquire or add more gearing to portfolio companies.

Yanis Varoufakis: Burst Greek Bubbles, Spooked Fund Managers – A Cause for Restrained Celebration

Yves here. Varoufakis describes a classic case of the old investing adage, “Little pigs get fed, big pigs get slaughtered.” In this case, the big pigs decided to ride what was clearly only a momentum trade on Greek sovereign debt, since anyone with an operating brain cell could tell that Greece was not getting better any time soon, and limited German tolerance for bailouts meant that some sort of restructuring was inevitable. The concern that the Greek bubble will be pricked sooner than expected looks to have wrong-footed some big name investors.

Ilargi: Oil Shock – More Than A Quantum Of Fragility

Yves here. We’ve written that the sudden decline in the price of oil has the potential to deliver some nasty financial shocks, given that shale companies and even the majors have been financing exploration and development with debt.

But while concerns about fragility are well warranted, we wanted to make sure a mention made in this article is not treated with undue alarm. It points out that the BIS is concerned that an unprecedented portion of CDOs are now made of leveraged loans.

The problem is that the term “CDO” has been used inconsistently in the financial media. The CDO that you learned to hate in the wake of the crisis and blew up AIG, monoline insurers, and did a lot of damage to big banks were more formally called “asset backed securities CDOs” or “ABS CDOs” But that was too much of a mouthful, so they were referred to as “CDOs” in the press. There were two periods when that type of CDO existed, the late 1990s, and from the mid 2000 to mid-2007. Ina both cases, that market was a Ponzi, used to make the unwanted parts of subprime securitizatons saleable by making them into financial sausage, with some better assets thrown in, and then re-tranched again. The Ponzi part came about from the fact that these CDOs also had unsaleable parts, which were either put into first generation CDO sausage (CDOs allowed a certain portion of CDOs to be included) or sold into CDO squareds (which were hard to sell).

But the more mainstream type of CDO was one made of credit defaults swaps on corporate credits. That was the original CDO done in the famed JP Morgan Bisto deal in the mid-1990s. Indeed, when I first started researching subprime (ABS) CDOs, and just called them “CDOs” some experts assumed I meant the corporate loan type, since that was prevalent. During the crisis, possibly to make sure no one confused these CDOs with the ones that were blowing up, they were increasingly called CLOs, or “collatearlized loan obligations.” They were also legitimately less risky than the subprime CDOs, since their value didn’t suddenly collapse when a certain level of loan losses was breached.

The cause for pause is that CLOs, which are indeed a type of CDOs have traditionally been made mainly or entirely of investment grade credits. It now appears that junk credits predominate. While their structures and diversification will keep ABS CDO-type total wipeouts from happening, they could still deliver some nasty surprises.

The ECB’s Balance Sheet and Draghi’s Confidence Game

Yves here. This post provides a high level summary and assessment of the ECB’s post-crisis conduct. Among other things, it demonstrates that the ECB makes the Fed look good. Some readers will take issue with the fact that Mody treats QE as a reasonable policy, when the experimental policy has goosed asset markets without doing much for the real economy. It has hurt savers by flattening the yield curve and reducing yields on longer-term investments and many economists believe it has exacerbated income inequality, which is increasingly seen as a drag on growth. However, the hair shirt of the Masstricht treaty rules out fiscal stimulus, and most economists accept the view that monetary stimulus is better than standing pat.