The Fed Is Worryingly Laughable

I can't believe it, but MarketWatch is reporting Fed might accept foreign collateral: Kohn.

"The Federal Reserve is actively considering creation of a lending facility that would accept "very safe" foreign collateral from "sound" global banks in case of a widespread liquidity crisis, Fed Vice Chairman Donald Kohn said Thursday."

I feel like walking up to Bernanke's front door and taking a sh$t on his welcome mat! This is lunacy.

By the way those are your tax dollars getting flushed away from reckless and unnecessary policies.

"A new global discount window is "under active study," Kohn said. "It is possible that over time, major central banks could perhaps agree to accept a common pool of very safe collateral, facilitating the liquidity management of global banks," he said, stipulating that such loans only be made to sound institutions."

If those assets are so safe, then why is this window needed?

""Market functioning remains far from normal," Kohn said, pointing in particular to large spreads between overnight bank rates such as Libor and other short-term rates. Such large spreads indicate that markets still are in shock."

Well this point they have right, FRB Commercial Paper Rates and Outstanding:

Spreads on ABS still have not budged much, but saw a small easing 2 weeks ago and CP outstanding are at near three year lows. These "temporary" windows have achieved very little.

Moral Hazard

I know this phrase has been beaten on us in the past couple of months like Ike on Tina, but it can't be stressed enough. I can't help reflect on the signal the Fed is sending to commercial and investment banks around the globe;

Take advantage of our zombified nonfinance savvy consumers with idiotic schemes that make no long term sense and we'll back you up with low interest rates to fuel the bubble and bail out your toxic unwanted investments after they start to deteriorate in exchange for widely liquid ones at the taxpayers expense and then finally go cheat on your wife and buy a Bentley with that ridiculous stock option bonus you got.

Well maybe not those exact words, but close. The point is the Fed's policy is growth at any expense it seems.

"Permanent access to the Fed's balance sheet at attractive rates would distort markets without well-designed and well-executed supervision. On the other hand, everyone in the markets knows that the Fed will step in with funds in an emergency, so in some sense the markets have been irredeemably distorted already.

Kohn suggested that the term auction facility, which was created in December and expanded in early May, should be retained on a permanent basis after the crisis is over. The TAF allows banks to bid to borrow funds from the Fed's discount window for 28 days."

I think everyone knew going in this that "temporary" was never intended. A look at the spreads and outstandings prove that the windows aren't working and that this credit crisis is far from over.

"The biggest question is: What to do about the broker-dealers and investment banks that, since the run on Bear Stearns, have now been given unprecedented access to the Fed's lending facilities? Should that access be continued on a permanent basis? Or should it be provided only in emergencies?

Kohn had no simple answer to that question: "Unquestionably, regulation needs to respond to what we have learned," he said. "Whether broader regulatory changes for broker-dealers are necessary is a difficult question that deserves further study.""

One thing we've all learned (most likely already known) is that regulation is always a few large steps behind financial innovation. The legislative process is too slow and not as smart and furthermore they only care when "crises" emerge.

What to do?

It amazes me that the most logical and simple solution is never given the light of day;

Dramatically increase required reserves for commercial banks!

This would hinder the ability of any institution to excessively lever their balance sheets, which would reduce malinvestment because money is more scarce. Point for me, nailgun to the heads of every congressman, economist, and most certainly every Fed board member.

2008 Q1 Corporate Profits

I've been waiting for this release for quite some time now, Preliminary Corporate Profits from Q1 2008:

I'd like to take a moment to move past the featured headline, which adjusts for inventory and capital consumption, and strip that, and then feature inventory and capital consumption each separately. Trust me, you will be glad to see the details.

First,

Pure profits have fallen below 2006 levels, but why?







Second,

Inventory is building, we saw this in the April Durable Goods numbers.







Lastly,

Companies have almost completely stripped out capital investment input, which distorts profits had investment been closer to historical investment.

My assumption from these data is that business activity has declined dramatically, thus the rise in inventory and plummet in capital investment.

It is important to look at the year over year numbers and get past the headlines, otherwise you would miss trends like these and only see an increase in corporate profits from last quarter, which is misleading to what is actually occurring.

Twilight in the Desert

Matthew Simmons author of Twilight in the Desert had a guest spot on CNBC's Squak Box this morning, in which peak oil was the discussion.

(click on the image to watch)

Contrarian Industry Fishing

It wasn't too long ago I was proclaiming that The Market is Overvalued in which I warned that prices are now too high considering the way earnings have been reported, that is "better than expected", yet an ignorant reason to cheer.

That doesn't mean the investor should roll over and play dead though, opportunities always present themselves to a keen eye. Case in point the property and casualty insurance industry is trading at an aggregate P/E of 4!

Case Study

One particular company that caught my eye is Odyssey Re Holdings Corp. (ORH); a brief and general overview:

from YahooFinance!

(click on image for clearer picture)

Some interesting points to make:

1. The P/E is 3.51
2. The cash position is larger than the market cap
3. The P/B is 0.90
4. The ROCE is 30.53% to go along with phat margins
5. Debt/Equity ratio is 0.174 and cash exceeds debt by a factor of almost 5
6. Dividend yield of 0.70%

Investing based off of those rather generic valuations might be enough to prove profitable in the long run based strictly from a contrarian approach, but there's more than meets the eye; from the Odyssey Re Holdings Corp. Q1 2008 Earnings Call Transcript with regards to the competitive environment:

"perhaps a contrast to what other people have said, I think that today we would be more akin to the let's say 95-96 period. I think there is a likelihood that we will see things deteriorate much more significantly from this point because there still is considerable downward price pressure, meaning that there is excess capacity and there is hunger of business in the market place. So, I think that the short-term prospects are of concern in terms of how much worse things can get and in particular in the casualty lines which as you know were, that is the place where usually the most long-term damage gets created. So, that is of concern I think. It will take some time for it to turn around, because it's no as though anyone out there is recognizing negative results at this point in time. So, I think there is more to go in the soft market, I don't think we are at a trough."

If 183.5% earnings growth (yoy) and 35.8% revenue growth (yoy) is tough, than I'm really looking forward to when a new hard market begins. There is an abundance of competition, which from the sounds of it, is being priced out by larger competitors with stronger balance sheets. Speaking of balance sheets, ORH mentions investment in credit default swaps, indicating since quarters end has taken mark to market losses of $72 million.

"Market value and their liquidity may vary dramatically, either up or down in short periods and their ultimate value will therefore only be known upon their disposition."

They seem to have a long term focus with regards to holding to maturity, so this may not be a serious issue, however:

"As of March 31, 2008 the carrying value of CDS portfolio was $239 million, with the notional amount of $4.1 billion. The average term to maturity was 3.3 years."

A major impairment in the future could have a devastating effect, but more information will need to be known with regards to what the CDS's are associated with to determine if that is realistic or not.

More importantly going forward I'll have more to be said on this industry, which from the looks of it has a bumpy road in the future and ORH in particular as the valuation metrics are certainly attractive and their balance sheet is strong.

April Durable Goods

April Durable Goods numbers were reported today from the US Census Bureau:

"New Orders

New orders for manufactured durable goods in April decreased $1.0 billion or 0.5 percent to $214.4 billion, the U.S. Census Bureau announced today. This was the third decrease in four months and followed a 0.3 percent March decrease. Excluding transportation, new orders increased 2.5 percent. Excluding defense, new orders decreased 0.3 percent.

Unfilled Orders

Unfilled orders for manufactured durable goods in April, up twenty-six of the last twenty-seven months, increased $7.6 billion or 1.0 percent to $804.5 billion. This was at the highest level since the series was first stated on a NAICS basis in 1992 and followed a 1.3 percent March increase.

Inventories

Inventories of manufactured durable goods in April, up nine of the last ten months, increased $1.7 billion or 0.5 percent to $328.6 billion. This was also at the highest level since the series was first stated on a NAICS basis in 1992 and followed a 1.0 percent March increase."

Inventories have been stacking up consistently, which signals that cancellations must be rising, though not reported (as fas I could find) or companies are just running at overcapacity. Inventories are already at their highest levels since 1992 and if they keep on growing (my assumption uses a growth rate of 1/2%) than for the year end 2008 inventories will look like:

It's hard to predict whether corporations will continue to pretend no problem exists and keep on building inventories. However eventually some level of recognition will have to be accepted, at which point lay offs are likely.

The increase in unfilled orders interests me particularly so from a Description of the Survey I found:

"Unfilled orders include orders (as defined above) that have not been reflected as shipments. Generally, unfilled orders at the end of the reporting period are equal to unfilled orders at the beginning of the period plus net new orders received less net shipments."

Unfilled orders are also at their highest levels (since inception of tracking), which is normally a good thing indicating that order volume is high. There is a lot of uncertainty going forward though, cautious thinkers might wonder if those orders will be filled going forward, or if they might be canceled and sit on the sidelines as inventory, further exacerbating the already excess inventory existing.

The Prediction

Back in March I questioned how PPI could keep on coming in hot without translating into CPI in The 36 Chambers of Inflation. Well, look forward to higher CPI in the future as Dow Chemical bumps prices up to 20 percent. That is a massive increase and with such a big name as Dow raising prices, look for others to now find justification and follow suit.

Getting back to durable goods, with inventory and unfilled orders running at their highest levels since 1992 with plenty of uncertainty in the future and companies now beginning to pass rising costs along, I would not expect economic releases in the future to be rosy in any way shape or form. Orders will decrease going forward.

April Existing Home Sales

May 23rd brought us April Existing Home Sales Commentary and Existing Home Sales Data:

The Data

April sales were -1% from March and -17.5% year over year:

The truly disheartening caution about this data is that home sales in the West, the region hit very hard with home price depreciation saw an increase in sales:

"Today's data also reflects something I have not seen over the past two years: several markets seeing a substantial rise - to the tune of 20 percent or better - in home sales on a year-over-year basis. The notables include Detroit, Ft. Myers, Las Vegas, Orange County, Riverside, San Diego, and Sacramento. These are also the markets that have experience substantial price declines - to the tune of 20 percent of more. Improved affordability conditions have enticed buyers to pick up properties on the cheap.

Measurable sales declines were in the regions where things were holding up well just last year. Seattle and Portland in the Pacific Northwest, Charlotte and Raleigh in the Carolinas, Salt Lake City, and the Texas markets have seen sales decline. Home prices in these regions are still moving up."

You might ask why is that disheartening for buyers to come in the market where prices have fallen? The answer lies in the inventory situation:

"Inventory rose to the second highest level ever with 4.55 million homes listed for sale - which is an increase of 10.5 percent from the prior month (or by 434,000 units). In the latest month, the inventory represents 11.2 months supply at the current sales pace. Part of the rise is due to the normal seasonal increase from March to April. More new inventory reached the market over these two months than during any other month. Irrespective, the high inventory levels are uncomfortable. It is also a signal to many home sellers to be more realistic about pricing to attract buyers. Unless you have immaculate, unique home features, don't even bother listing if you are not going to concede on prices in today's market."

A warning that must be respected. The US median home price dropped 8% year over year with the West leading the way with a decrease in home prices of 16.7%. Reconsider The April Housing Starts Anomoly when I warned:

"The NAR will release existing home sales in 9 days from now and I'm sure the inventory picture isn't going to justify this expansion from the home builders. Remember, this is an inventory problem, the longer excess inventory persists, the longer home prices will continue to plummet. If you remember housing inventory has between 9.8 and 12 months of excess housing levels."

The NAR is now reporting 11.2 months of inventory levels at current sales, which is 31.8% larger on a year over year basis. Home builders are digging themselves a hole larger than necessary. If housing starts and permits don't continue to fall and stagnate this inventory picture is going to continue running like a decapitated chicken.

To Get a Little Off Track...

A little weekend humor. Next up, existing home sales.

America's Energy Crisis - A Satire

I couldn't draw you a more exact metaphor for America's energy abuse and addiction myself...go buy another Escalade.

An Ode to the Ignoramous (congress)

There is quite a bit of hype around the word "crisis" in the world we live in today. This is a ridiculous tactic aimed at increasing ratings. In fact, labeling our food and energy troubles as a crisis is self reinforcing, creating more panic than is necessary. Enter our "wonderful" legislature, which wields this fear to pass silly bills for farmers. Consider why the Farm Bill, in Part and in Full, Wins Passage:

"Thursday’s vote in the House was on all 673 pages, which also embrace subsidies for farmers, food stamps, land conservation and various other items too attractive for most lawmakers to shun."

This is complete garbage! This bill is for $307 billion in subsidies to an industry that is accumulating record profits.

"The glitch “shows that they can even screw up spending the taxpayers’ money unwisely,” the president’s spokeswoman, Dana Perino, said on Thursday."

Right on Dana! The glitch referred to is 34 pages of the bill left out when sent to Bush last week for approval...nice work jerk offs! Let's take A look at farm bill programs:

"A breakdown of the bill:

--Food stamps and other domestic nutrition programs such as emergency food assistance: just over 66 percent, about $200 billion.

--Subsidies for rice, cotton, corn, soybeans, wheat and other crops: 14 percent, around $43 billion.

--Conservation programs to set aside or protect environmentally sensitive farmland: 9 percent, about $27 billion.

--Crop insurance to help farmers protect against losses: 8 percent, about $23 billion."

I'm not even going to bring up the $200 billion food stamp issue, that's a separate and more complicated demon. Now consider 2008 Farm Income:

"In 2008, net farm income is forecast to be $92.3 billion, up $3.6 billion from 2007 and over $30 billion above its average for the previous 10 years."

What's the deal with subsidies

Now there's a sector that needs subsidies (explicit sarcasm). If only there were a congressman who understood the real use of subsidies. They are not for mature, profitable sectors, but for competitively disadvantaged "infant industries" that are vital to the aggregate health of an economy. This was the case for our agriculture sector many many decades ago, but times have changed and so should regulation.

The same should be true for for China and India, which provide oil subsidies so the massive demand for oil and gasoline by their citizens can be supplied. Consider Oil price fundamentals:

"with Asia and the Middle East accounting for 60% of the increase in petroleum use between 2003 and 2006. North America and Europe contributed only 1/5 of the growth."

"Particularly dramatic in this growth has been China, whose petroleum consumption between 1990 and 2006 increased at a 7.2% annual compound rate."

With such high amounts of growth in oil demand in these parts of the world, there is quite a bit of justification in the run up of oil prices recently, of which speculation has played a role. The point is this rapid pace of demand can't be satisfied by supply and these subsidies Chinese and Indian governments supporting are only aggravating the problem more, leading to higher prices from artificial demand. Regardless, indeed Peak Oil is Scary!

Commercial Real Estate Delinquencies Rise

Whoo Ha readers the Federal Reserve released Charge Off and Delinquency Rates yesterday, let's take a gander:

Appropriately so, I'll start with a chart showing commercial real estate and just look at that swing. Delinquencies have increased by an interval of 0.73% units from Q4 2007 and 2.45% since the low in Q1 2006. I've been creating carpal tunnel syndrome for myself writing about this coming phenomenon warning that Commercial Retail Space Unfolding and CMBS are Next to Tumble as The Real Estate Epic Turns Another Page.

And how is this affecting banks you might wonder?

That's how! What's really sad is that this problem is only beginning, more and larger write offs are coming as retailers cut back, close down, lay off, etc. because the consumer is taking a vacation into a strange land called reality. This is a bitter world where home equity lines and credit cards used for needless consumer goods actually have consequences to your finances from their abuse.

All the meanwhile, single family home loan and credit card loan delinquencies and charge offs are rising as well. Going forward I'll keep an eye on these and report back as Alt-A and Option ARM loan delinquencies begin to have a serious impact from resets, and these are the ones the Fed will have to lower rates to close to zero to avoid because they were originated with higher rates. See The Great Real Estate Debate to find out more.

The Ill Fated Airlines

Can you believe it, two thought provoking interviews on CNBC two days in a row?! You'd think one of those machines programming that mockery of the business world put down his pom-poms long enough to have a thought of his own to program something intellectual, or maybe it was just coincidence.

To the left is former CEO of Southwest Airlines Herb Kelleher, discussing the state of airlines (click on video to watch).

He speaks with stunning clarity on airline troubles for a CEO who is just stepping down. The part near the end that interests me the most is his comments on the discussion he had with an airline analyst; "major airline failure is imminent".

Now I take the opinion of some schmuck analyst about as seriously as I take a celebrity at rehab, but considering airlines have long been dying from a case of government cock knocking (which Kelleher briefly explains), rising oil prices and fear of terrorism among other things, there could be some truth to that. Also, consider some of the airlines that filed bust recently:

• ATA Airlines
• Skybus
• Aloha Air

From an investors stand point, this is potentially excellent news long run. The weak competitors will be weeded out and pricing pressures in the industry will relax allowing the airlines with better reputations and stronger balance sheets to emerge victorious. Now thats just an observational forecast, but somewhat plausible nonetheless.

Among The Herd, A Voice Of Reason

Early Innings for Housing

Whitney Tilson of T2 Partners is the first I've heard to publicly come out on national television and talk about the deferred issues of Home Equity Lines of Credit (HELOC), ARM's and ALT-A mortgages, bravo!

Interested parties will consider my painfully long take on The Great Real Estate Debate to learn more about this issue and how sub prime was only the beginning. He also has an excellent philosophy on investing, value/contrarian style.

The Market is Overvalued

I know Barry Ritholtz already did an excellent job covering this topic in S&P500 Profits Ex 3 Oil Cos = Awful, but I must rehash as this is an important issue. Consider the following data:

S & P 500 Month End Data

• P/E 20.94
• Dividend Yield 2.06%

Dow Jones Industrial Average Data

• P/E 15.58 (including negatives)
• P/B 3.54
• Dividend Yield 2.51%
• P/CF 8.31

Now consider what Ritholtz covered from Bloomberg Oil Producers Mask Decade's Worst S&P 500 Profit Drop:

"Energy companies made up almost half the income growth reported by S&P 500 companies in the first three months of 2008 as oil prices surged past $100 per barrel."

Guess what, Exxon (XOM) and Chevron (CVX) are included in both indexes. Especially with regards to the DJIA, this index is most likely understating its P/E because of these two companies masking earnings.

Another, bearish observation, is that in screening through companies across many industries, they all share one common characteristic; insufficient cash to debt. This is less true for the largest companies, but the mid caps and small caps seem to be very levered in their cash flows.

Let's use an example, Chesapeake Energy Corp. (CHK), YahooFinance!

Market Cap 30B
P/E 32.16

Click on the image to the right to get a clearer picture. These are the key statistics for this company. Pay close attention to the debt of $12.25B and cash of only $1M, well under capitalized. Yet Mr. Market is rewarding this irrational riskiness sending the stock continually higher:








This doesn't represent the market as a whole, but it gives you an idea of the kind of over valuation and excessive leverage that is out there now.

For this company in particular, they will need to maintain outstanding cash flows or else they will be in danger of defaulting on debt, have to liquidate assets, or raise more capital diluting shareholders. Any way you look at it, the fundamental risk is great. The return on equity is below market averages despite the positive levering effect debt has on it, which indicates that this company is not very profitable, but no matter the Beta is only 0.76, which suggests CHK is less risky, unless you knew that Efficient Market Hypothesis is completely whacked. That is a simplified evaluation, but it can go a long way.

The point I'm getting at is to be careful and remember some simple concepts from the Graham & Dodd school and the contrarian school:

• Margin of safety - when investing in marketable securities this is the most sacred concept. A cushion between the market price and the intrinsic value (estimated actual value of the company) can provide safety from unforeseeable shocks and provide greater returns when the market catches on to the pricing mistake.
  
• Low P/E, P/B, P/CF and P/D stocks consistently outperform their higher valued peers. If you don't believe me just check out Contrarian Investment Strategies in the Next Generation for proof.
  

The market has been unjustifiably bullish since April, ignoring scores of negative data, only observing what they want to observe without identifying the underlying fundamentals. Just a word of caution going forward, earnings are not keeping up with prices, an adjustment is likely.

Commercial Retail Space Unfolding

Before you begin reading this post it might be wise to familiarize yourself as The Real Estate Epic Turns Another Page to see why CMBS are Next to Tumble. This is my continuing research into the commercial real estate picture, in which I believe is headed for a big downturn as a result of a burdened consumer, a tight lending environment and an overcapacity of commercial real estate properties, especially retail. So, now consider why Retail properties dressed for distress:

"The credit crisis has made the cost of new loans expensive or impossible for commercial real estate buyers and developers. That could leave some with short-term debt scrambling for loans to complete their projects or hold onto new ones.

"There's a lot of broken projects out there," Simon, who heads Simon Property Group, said during a recent conference call.

Soaring gasoline and food prices and the U.S. housing crisis have forced the U.S. consumer to cut other spending and retailers to reel in expansion plans. Those who own shopping centers are likely to feel a double punch: less demand for space and falling prices of their centers due to higher financing costs for buyers."

And yet as you'll see, new projects continue to carry on, regardless of cost and consequences. The falling demand is of particular importance. Refer back to CMBS are Next to Tumble and see just how wide the spread between retail property and demand for it is; the supply keeps growing while demand keeps falling.

"So far, commercial real estate has seen vacancies rise mildly and loan default rates have generally been low. But the sector lags the general economy, and many investors and other experts believe the sector will see prices fall about 15 percent to 20 percent from their highs of last year."

Here is part I of the problem which addresses commercial mortgage backed securities (CMBS):

This will be like residential (RMBS) redux, where investors are holding overvalued securities which are bound to decline in value because the property they represent will be falling in value. Now the 15-20% decline seems somewhat fathomable considering the excess inventory, but it is hard to give economist predictions too much weight considering how often they are off the mark. However, if there is some accuracy in the prediction, then CMBS will have a long way to fall and write downs will be triggered once again, punishing financial institutions. It appears this problem will take longer to unfold because it is largely dependent on the consumer, who is slowly finding out that they are far too much in debt and are learning that some discretion in spending as energy prices inflate is necessary.

"The report, obtained by Reuters, forecasts the overall retail real estate vacancy rate will rise 1.4 percentage points this year to 11.1 percent, after a 0.9 percentage-point increase last year."

"While demand slows, the supply of new shopping centers is expected to continue to grow, albeit at a slower pace. Marcus & Millichap forecasts about 131 million square feet of new shopping centers should be completed this year, down from 145 million square feet in 2007."

Now part II, the scenario of employment effects, where builders will have to recognize the overcapacity and new construction slows, so lay offs will be inevitable. Again, this will take time to come to fruition, but to continue to expand shopping space in a time of falling demand and growing vacancies is ridiculous! Builders are setting themselves up for a much harder and more sudden shock.

"Real estate experts said they do not expect to see an overall fallout in retail real estate. But new construction and shopping centers that were either a part of a new residential development or were built to support one may not fare well. Properties in once-hot residential markets of southwest Florida; the California's Inland Empire areas, such as Riverside and San Bernardino; Phoenix; and Las Vegas are of particular concern.

"In some of those markets, what you saw were properties that were built to service a consumer base that never materialized," Haber said."

This problem will gain more exposure as conditions continue to worsen and it will unfold as follows;

"Those securities, such as commercial mortgage-backed bonds, first felt the pain because they're most liquid, meaning they can be bought and sold quickly. Loans follow, and finally properties themselves."

As vacancies rise, so will defaults from the property owners on their loans as a result of lower rents revenues, followed by a slowdown in building and increases in construction lay offs and finally frosted with commercial property value price declines.

Capital Raising, Shareholders Lose

Bernanke urged banks to raise more capital which I outlined in Deciphering Fed Speak. The effort is necessary, but a voice of reason emerged to counter the diluting actions of banks asking Capital: how much is enough?

"Bill Blain at KNG Securities provides the counter-argument:

NO NO NO! There is only one thing worse than a bank that is short of capital - and that’s one that has too much! Capital strapped banks are careful and cautious, and look after their shareholders. Banks with too much capital do silly things like lend to people who can’t possibly pay back or they go and buy Dutch banks for absolutely no perceivably good reason.

Short-term, banks have to continue the deleverage process, and yes they do need to raise capital selectively. And those guilty of hubris - come on down Fred, Chuck, Stan, Marcel, and Jimmy - pay the price. Some banks will/have be forced into rights issues. But to make a virtue of raising capital is not a good thing - it’s bad bad bad! Running efficient banks well on the right amount of capital is the path of virtue. Running fat lazy banks on the amount of capital a regulator tells to you to have is not."

Now I agree completely with Blain's claim, diluting shareholders to have cushy capital so as to make ill advised decisions again in the future is self defeating.

Consider another scenario though, one in which reserves and lending provisions are revised entirely. Yes I am referring to the fractional reserve banking system and its fallacies. Banks are able to lend entirely too much at your deposits risk (10% reserve requirement, banks may lend 10 times this much). Significantly raise reserve requirements and I assure you, risky lenders will quiet down, but more importantly shocks to the system will be less frequent and devastating.

The April Housing Starts Anomoly

"Good news" leaked today from the census bureau with new residential housing starts up and of course the usual suspects (market cheerleaders and a%$mongers) hailed the data as a sign of relief, and of course in the eyes of the enthusiasts, signaled a bottom in the housing market. In financial markets, enthusiasm that ignores the big picture should be considered the worst kind of ignorance. Not to mention that we've been in the bottom for months now from their perspective.

For the more enlightened reader, go to Naked Capitalism and Mish's Global Economic Trend Analysis and learn about the eye of the hurricane, W comes to mind.

So here is the April Construction Data:

"Building Permits

Privately-owned housing units authorized by building permits in April were at a seasonally adjusted annual rate of 978,000. This is 4.9 percent (±1.2%) above the revised March rate of 932,000, but is 34.3 percent (±1.4%) below the revised April 2007 estimate of 1,489,000.

Single-family authorizations in April were at a rate of 646,000; this is 4.0 percent (±1.4%) above the March figure of 621,000.
Authorizations of units in buildings with five units or more were at a rate of 294,000 in April.

Housing Starts

Privately-owned housing starts in April were at a seasonally adjusted annual rate of 1,032,000. This is 8.2 percent (±14.5%)* above the revised March estimate of 954,000, but is 30.6 percent (±6.7%) below the revised April 2007 rate of 1,487,000.

Single-family housing starts in April were at a rate of 692,000; this is 1.7 percent (±11.7%)* below the March figure of 704,000. The April rate for units in buildings with five units or more was 326,000.

Housing Completions

Privately-owned housing completions in April were at a seasonally adjusted annual rate of 1,000,000. This is 16.0 percent (±8.4%) below the revised March estimate of 1,190,000 and is 34.9 percent (±5.9%) below the revised April 2007 rate of 1,535,000.

Single-family housing completions in April were at a rate of 792,000; this is 13.0 percent (±8.9%) below the March figure of 910,000.
The April rate for units in buildings with five units or more was 181,000. "

I thought last month home builders were finally starting to realize the Housing Pain, but these swine just don't want this situation to end, but to instead continue limping on one gangrene leg instead.

The NAR will release existing home sales in 9 days from now and I'm sure the inventory picture isn't going to justify this expansion from the home builders. Remember, this is an inventory problem, the longer excess inventory persists, the longer home prices will continue to plummet. If you remember housing inventory has between 9.8 and 12 months of excess housing levels.

I bet Kudlow is preaching Goldilocks with a trumpet in the background somewhere in front of an American flag.

Efficient Market Hypothesis: Getting Past the Data

I am a skeptical market researcher, and as such I am not a proponent of the Efficient Market Hypothesis and It's Critics, a report by Burton G. Malkiel, author of A Random Walk Down Wall Street.

First, a definition

"Markets can be efficient in this sense even if they sometimes make errors in valuation, as was certainly true during the 1999-early 2000 internet bubble. Markets can be efficient even if many market participants are quite irrational. Markets can be efficient even if stock prices exhibit greater volatility than can apparently be explained by fundamentals such as earnings and dividends. Many of us economists who believe in efficiency do so because we view markets as amazingly successful devices for reflecting new information rapidly and, for the most part, accurately. Above all, we believe that financial markets are efficient because they don’t allow investors to earn above-average risk-adjusted returns."

"What I do not argue is that the market pricing is always perfect. Nor do I deny that psychological factors influence securities prices. But I am convinced that Benjamin Graham (1965) was correct in suggesting that while the stock market in the short run may be a voting mechanism, in the long run it is a weighing mechanism. True value will win out in the end."

The fallacy of the argument

The definition itself is a contradiction, but before I explain my thesis is simple; all of these empirical studies based on econometric models beyond my abilities yield the equivalent of the triumph of data over common sense. It is contradictory to proclaim that the market is effective and accurate in reflecting new information rapidly when such large mispricings and irrationalities exist.

At the core of EMH, this means investors and traders alike cannot earn above-average risk-adjusted returns. The basic theory is you cannot earn higher returns without an adverse increase in risk. I must disagree.

My disagreement comes over the definition of risk, most popularly defined as Beta from the Capital Asset Pricing Model, which measures risk in volatility of a stock price. This measure is econometrically easily calculated and is widely accepted. Yet it ignores many important risks like a companies financial strength, earning power, debt, macroeconomic fundamentals and scores of other considerations. It is only logical that Beta is a weak risk measure.

On a final note on risk and earning abnormal returns, what about these guys:

Warren Buffett, Peter Lynch, John Templeton, John Neff, Bill Miller (excuse his recent performance)

Dremman's counter argument

So far I haven't read any mention of David Dremman in this report, kind of odd to me since this was written in the past few years that this guy wouldn't mention Dremman's arguments, which are well documented even in mainstream media and blasts EMH proponents and yet the charade continues.

One of his excellent arguments against EMH was in the data used to support it in the first place when mutual fund managers were researched in the early seventies. This excerpt from Contrarian Investment Strategies in the Next Generation about statistical significance;

"the researchers showed it was not possible at a 95% confidence level to say a portfolio up more than 90% over ten years was better managed then another portfolio down 3%. It was also noted that "given a reasonable level of annual outperformance and variablity (volatility), it takes about 70 years of quarterly data to achieve statistical significance at the 95% confidence level."

The point here is the acceptance of a theory based on a study that used weak tools and is still accepted today. Another point to concede from Dremman;

"It is an enormous leap of faith from these simple findings to the conclusion that the market correctly interprets all information, no matter how complex, almost instantaneously."

That is just good common sense, the investors greatest asset. Finally try to remember Why Market Cheerleding is so Prevalent? where I noted the analysts disincentive to perform, hardly efficient. Remember the following bullet points make no impact on the bonus of an analyst.

• Accuracy of profit estimates.
• Accuracy of performance estimates

Question the Accounting

Forget the notion of traditional fundamental metrics, this assumption in Malkiel's argument is somewhat correct. Remember that piece of paper represents a company with underlying components that can be evaluated and used in analysis. As I mentioned in my attack on the use of Beta in defining risk, risk can be better defined through the financials of a company, after all that is what their managers asses.

Furthermore, analysts interpret these numbers in different ways using different strategies, hence information is extracted and acted upon (or not acted upon) very differently. For example, there are those like myself, who do not trust GAAP and reformulate and filter though the components of earnings, and then there exists those who look at sales and the bottom line as printed. That information is interpreted in completely different ways and is in no form efficient.

To get slightly off topic, check out an article I wrote at Ezine Articles on the assessment of earning power and valuation; The Concept of Residual Earnings

Conclusion

There are piles of points I am skipping over, but for the sake of time I will sum my argument. EMH is a simple hypothesis based on data. It is easily defined and conveniently packaged in a display of data that bares little resemblance to reality that investors don't have to think too hard about (after all, isn't it easier to just accept and go along). I repeat my earlier claim, just like financial innovation, EMH is the triumph of data over common sense.

Deciphering Fed Speak

Anyone who has ever listened to a Fed hearing knows exactly what this title refers to, especially those who observed the Greenspan era. Yesterday Bernanke was quoted as saying Crisis Not Over; Prices Worry Others. I am not an affluent Fed speaker, but I will attempt to translate on what this really means from citing the article and then outline why:

"Conditions in financial markets are still far from normal," Bernanke said. "Ultimately, market participants themselves must address the fundamental sources of financial strains. This process is likely to take some time."

Bernanke has a plethora of information at his fingertips and the minds of many top economists in his midst. In my interpretation, this comment is his controlled way of saying there exists a big problem outside of the realm of the Fed. Indeed, he nonchalantly tips his hat that eventually the Fed will run out of ammo via TAF, TSLF and PDCF, in their imaginative discount window operations and financial institutions will be left on the front lines, credit frozen. If you are having a hard time gripping this comment, just look at the already lacking effectiveness of these windows in the first place by viewing Commercial Paper Outstanding: Asset Backed securities continue to fall in demand.


Reuters left out some crucial info in their article, so I went straight to the speech Bernanke gave on Liquidity Provisions:

"A number of securitization markets remain moribund, risk spreads--although off their recent peaks--generally remain quite elevated, and pressures in short-term funding markets persist. Spreads of term dollar Libor over comparable-maturity overnight index swap rates have receded some from their recent peaks but remain abnormally high.⁴ Funding pressures have also been evident in the strong participation at recent TAF auctions even after the recent expansions in auction sizes, and, of late, depository institutions have borrowed significant amounts under the primary credit program for terms of up to 90 days."

Bernanke's speech, which foretells more hardship, for a long uncertain period of time, went largely unnoticed and markets cheered and rallied the Dow 66 points up as CPI numbers came in less than expected and oil hit record highs at $127 a barrel. Now there's a conundrum!

Stay tuned for more on this conundrum, which is directly related to expectations and the Efficient Market Theory (EMH), of which I will dissent from.

First Marblehead Q3 08 - Adding Order to Chaos

I discussed The Higher Education Dilemma back in April, and mentioned (FMD) and their short term troubles with a frozen ARS market and the TERI bankruptcy. FMD released First Marblehead Corp F3Q08 10-Q earnings on May 8th and the First Marblehead Corp F3Q08 Earnings Transcript. This is a break down of the transcript and quarterly report:

Student Lending Going Forward

"Demand for all types of student loans is extremely high, but capital to fund loans is scarce leading to a mismatch between demand and supply. While capital for many types of lending is limit, we believe the issue for student lending is acute."

I stick to my initial opinion from the education dilemma post; If FMD can maintain enough capital and sustain adequate cash flows, they will emerge more dominant when securitization markets unfreeze. Higher education demand is not going to fade and capital will have to be provided to meet that demand.

Changes in FMD's Operations

"As a result of this environment capital for new loans is both scarce and if available expensive, without a liquid securitization market to monetize both Federal and private student loans, lenders are forced to retain these assets on their balance sheets."

Bank of America has terminated all new underwriting of student loans for the year and RBS has terminated some of its agreements with FMD, and Chase might possibly be next. (BOA) constituted 15% of 2007 revenue and Chase 29% of 2007 revenue, and RBS accounted for approximately 4% of revenues.

FMD is currently working on gaining regulatory approval for a capital infusion equal to 25% of shareholders equity, approximately $150 million, including $59.8 million secured in December 2007'.

They have also wisely cut their work force in half:

"In total over the past five months a cost reduction of 60% on an annualized basis. This was a necessary decision taken to preserve cash and to align expenses with revenue in light of the challenges we face. The level of cost reduction is targeted with design to generate positive cash."

Furthermore, the cash dividend was eliminated until further notice.

The Securitization Markets

"We did not complete a securitization transaction during our second fiscal quarter, and we are uncertain about our ability to complete a securitization in the current fiscal year. We expect our securitization volumes to materially decrease in fiscal 2008 compared to fiscal 2007, and we expect pricing terms substantially less favorable than in the past. In the near-term, we also expect investors to have limited or no demand for subordinate tranches of asset-backed securities in securitization transactions that we facilitate."

The auction rate securities market has deteriorated since 2007;

"Since that time, the auction rate market has failed, with very little, if any, trading occurring on regularly scheduled auctions and many believe the impairment could well be permanent.

Five trusts facilitated by the company include some component of auction rate securities. In these transactions, the auction rate classes are now trading at the maximum rate on their current rating. Generally, the maximum rate is LIBOR plus 150 basis points for securities rated AA minus or better and LIBOR plus 250 basis points for securities rated less that AA minus. The maximum rate could increase if the ratings decrease."

Unfortunately FMD has found its trusts partially backed by Ambac. For more on why any guaranteed by Ambac is harmful, please see Ambac Surprises With Huge Losses, Bond Insurers Revisited.

"On January 18, 2008, Fitch Ratings downgraded the insurance financial strength rating of Ambac Assurance Corporation, which has provided credit enhancement in several securitizations that we have facilitated, to AA, Credit Watch Negative. In addition, Standard & Poor's and Moody's placed Ambac's AAA rating on CreditWatch Negative in January 2008. Fitch Ratings downgraded, and Standard & Poor's and Moody's placed on watch for possible downgrade, forty one classes of student loan asset-backed notes which have credit enhancement provided by Ambac. These notes were issued by three securitization trusts facilitated by us. These rating agency actions could reduce demand for future securitizations that we structure, result in further write-downs of our service receivables, or reduce revenues that we derive in connection with future transactions."

If (most likely when) these downgrades occur, expect FMD to be hit with more write downs.

TERI and the Aftershocks from it's Bankruptcy

"TERI is the exclusive third-party provider of borrower default guarantees for our clients' private label loans. In addition, we have entered into an agreement to provide various services for TERI and received fees from TERI for services performed of $83.5 million, or 32% of total revenue, for the first six months of fiscal 2008"

The bankruptcy pronouncement of TERI has increased the nerves for potential clients and current clients of FMD. Since TERI is the student loan default guarantor for the securitizations, there is now a credibility issue that will effect new business and client relationships with FMD. The bankruptcy resulted in a large write down of the estimated services receivable of $315 million, the majority of which is attributable to TERI's filing at about $220 Million.

Defaults and Extended Life of Receivables

"During the second quarter of fiscal 2008...we increased the assumed net default rate from 5.81% to 7.68% on average for the portfolio."
"This increase in the net default rate assumptions resulted in a decrease in the estimated fair value of our residuals receivable of $36.2 million"
"Net defaults are calculated by reducing gross defaults by the amount of recoveries received on previously defaulted loans. During the second quarter of fiscal 2008, we increased our assumed average gross default rate from 9.68% to 14.76%. During the second quarter of fiscal 2008, we also increased, from 40% to 48%, the percentage of defaulted loans that we expect to recover."

"The result was an increase in the assumed average prepayment rate over the life of the trusts from 8% to 8.4%. This change in the prepayment rate assumption resulted in a decrease in the estimated fair value of our residuals receivable of $46.6 million"

Pay close attention to the recovery rate and refer to the graph below to get an idea of the long run return from the trusts.

Change of Strategy and Liquidity

"We are in the process of developing alternatives to the loan guaranty and loan origination services that TERI has historically provided to our clients. We are attempting to secure an alternative guarantor for our program loans, and we are developing in parallel a private label loan program that would not require a guaranty from a third party."


"We expect the private label loan program under development to generally have more selective underwriting criteria, higher borrower pricing than prior TERI-guaranteed programs and a greater portion of immediate-repayment loans, or loans for which payment of principal and interest begins shortly after final disbursement, and interest-only loans, or loans for which payment of interest begins shortly after disbursement but payment of principal is deferred during enrollment. Development of the program is not complete, and we are uncertain whether former, current or prospective clients will be interested in the program or whether we will secure an alternative guarantor on acceptable terms or at all . We are also uncertain whether Union Federal will be able to participate in the private label loan program currently under development due to its current lack of balance sheet capacity."

The risk to FMD is if it has to incur another write down in the near future. The cost reductions and GSCP capital infusions will be welcome guests. The announcement of a new guarantor or origination strategy should win them some support, but ultimately they will need the ARS market to open up so short term capital sufficiency is the ultimate concern here.

Banks are Trapped

There have been many comments in the media, especially CNBC, and especially by Punk Ziegel analyst Richard Bove, that banks will recover and perform well by year end. This statement is a stretch. Unfortunately Banks Fear Demand for Corporate Loans.

"With the economy struggling, some corporations are starting to tap so-called revolving lines of credit and other forms of backstop financing. If others rush to do the same, the banks might have to lend hundreds of billions of dollars at a time their own finances are stretched, forcing them to raise money to cover the loans.

It is unlikely companies will reach for the emergency loans en masse, since such financing typically is used only as a last resort. Still, the worry is that the demand for cash might be greater than banks expect.

The potential exposure is enormous. Collectively, banks have pledged to lend companies more than $1 trillion. And because most of those loans have not been made yet, and many perhaps never will be, the banks have not accounted for them on their balance sheets."

The author of the article is correct, the likelihood of a sudden demand for credit lines is small, but a slow drawn out process of tapping into these capital sources is likely. The demand will undoubtedly force banks to have to either sell more assets, raise more capital (shareholder dilution or more debt issuance at high rates), or simply revoke their agreements. This last possibility could be devastating, seriously hurting the reputations of many banks if this outcome were to occur.

This draining of excess capital at banks and tightening in lending is having an impact in areas where it matters most, small business. Fed governor Frederick Mishkin testified before the senate on April 16 on Small Business Lending and Entrepreneurship:

"Small businesses are critical to the health of the U.S. economy. They employ more than half of private-sector workers, generated well over half of net new jobs annually over the past decade, and create more than half of nonfarm business gross domestic product. Moreover, larger firms often begin as smaller firms that prosper and grow. If small businesses are to continue to provide major benefits to the economy, their access to credit is clearly a high priority.

Of particular importance for small businesses, however, are the facts that these spreads jumped significantly both on loans originated by smaller U.S. banks and on smaller commercial loans--that is, those loans below $100,000.

Despite tighter credit standards and loan terms, growth in the dollar amount of commercial loans at U.S. banks was quite well maintained in the first quarter of 2008. Particularly noteworthy from the point of view of small businesses is the fact that after growing almost 20 percent in the fourth quarter of 2007, commercial loans at small banks continued to expand at a rate of almost 12 percent in this year's first quarter.³ Thus, although slowing somewhat, commercial loan growth has held up in recent months even though banks' terms have tightened and economic growth has slowed, the latter driving down the demand for small business and other commercial loans. On balance, this suggests that credit is generally available, albeit at a higher cost."

Growth in lending is slowing, and it will continue to slow, especially for the reasons mentioned in the NY Times piece and as more write-downs come.

"On the demand side, the NFIB survey's results are quite pessimistic. For example, the survey's index of small business optimism has dropped to its lowest level since the monthly surveys began in 1986, as the net percentage of borrowers that believe it is a good time to expand their business has fallen to the bottom of its range over the past two decades.

Perhaps one of the most important concerns about the future prospects for small business access to credit is that many small businesses use real estate assets to secure their loans. For example, data from our 2003 Survey of Small Business Finances (SSBF) indicate that 45 percent of the total dollar amount of small business loans outstanding in 2003 was collateralized by some type of real estate asset.⁶ About 37 percent was collateralized by business real estate assets, and 15 percent was secured with "personal" real estate.⁷ Looking forward, continuing declines in the value of their real estate assets clearly have the potential to substantially affect the ability of those small businesses to borrow. Indeed, anecdotal stories to this effect have already appeared in the press.

Similarly, declines in the value of real estate assets held by banks and other lenders could affect their willingness and ability to supply loans, as real estate losses use up capital that could otherwise be used for making new loans. Indeed, there are reasons to believe that these forces are currently at work not only at large banks, where the initial problems were observed, but across the full size spectrum of banking organizations. As noted previously, more stringent loan terms are already in place. In addition, banks across all size groups, including community banks, have recently experienced a sharp deterioration in credit quality, mostly within loans secured by real estate. Moreover, if banks continue to place on their balance sheets some assets that they had expected instead to place in conduits or otherwise sell to investors, the move could crowd out loans to small businesses and other borrowers."

I'm not the only one who realizes that the CMBS Are Next to Tumble, even Governor Mishkin sees this. Who knows what concoction the Fed has brewing to try and halt this one.

Sound Central Banking and the Contradiction of Greenspan

Greenspan is an enigma! If you don't believe me then follow his comments over the past month:

From an April 9th Bloomberg article Volcker Stands Tall, Greenspan Keeps Shrinking:

"Greenspan is desperate to deflect the blame for a credit crisis he called ``the most wrenching'' in 50 years"

I'd take my shots at Greenspan, but Bloomberg's Caroline Baum already said it too well:

"Greenspan's curriculum vitae includes two asset bubbles (one in Internet and technology stocks in the late 1990s, another in residential real estate), a pair of banking crises, a boatload of fraudulent lending he chose to ignore, and a household savings rate of zero."

She also does a wonderful job in reiterating the accomplishments of Volker:

"Volcker is content to let his record speak for itself: He inherited inflation of almost 15 percent and bequeathed a rate of 4 percent to posterity. It took two recessions to get there, but he did the heavy lifting on inflation."

Volcker is truly admirable, and might I add he started his studies under the assumption of the Austrian economic thought.

So where then did Greenspan's train of thought shift to after his shocking prediction? Consider Secondary Sources: Greenspan, Globalization, Regulation and Food Prices:

"Former Federal Reserve Chairman Alan Greenspan tells Bloomberg that we’re in a “pale” recession. “Greenspan said that continued stagnation for the rest of this year may be the best the U.S. can hope for and might even be the most likely outcome. ‘That’s certainly the most benevolent scenario,’ he said. ‘It’s not all that far from being the most probable.’ … ‘We’re in a recession,’ he said. ‘But this is an awfully pale recession at the moment. The declines in employment have not been as big as you’d expect to see.’ … ‘Until there are stabilized prices of homes, and I think they have a good way to go down, you still have prospective losses’ for financial companies and investors. ‘It’s too soon to tell’ if the worst of the credit crunch is over, he added.”

In just a month's time, that is a dramatic change in predictions. Now the final conundrum where Greenspan Says Worst of Credit Crisis is Over:

"Former Federal Reserve Chairman Alan Greenspan said on Thursday that the worst of the credit crisis is over, according to sources who attended a speech he delivered in New York."

Erase all credibility from this man, if his past actions haven't already persuaded you otherwise. In one month's time all risk of "the most wrenching'' credit crisis in 50yrs just simply disappears? Deception comes to mind; either that or complete incompetence.

Jerry Grantham of the Financial Week sends an excellent message out in Paging Paul Volcker:

"Mr. Volcker inherited about as big a mess as we have today. He worked out what he had to do and did it with unusual lack of concern about what Congress thought of the necessary pain involved and the number of enemies he might make.

A lot has changed since then. The idea that occasional economic setbacks might benefit the system in the long run was one of the first ideas to disappear. Yet if you prop up weak sisters who would otherwise fail, and in failing present their more efficient competitors with extra growth, you must surely weaken the system. Desperation pricing from weak firms that simply should not exist can weaken the profitability of a whole industry, as it has for the airlines. The average efficiency of most industries is reduced, with at least some effects on our global competitiveness. With a slightly lower average return on equity, the ability to reinvest drops so that, in this world of moral hazard where recessions are few and mild, GDP growth is a little less than it might have been.

What’s worse, those who took on unjustified risk live to prosper and reinforce the existing agency problems. These problems were big enough already: stock options, for example, that encourage risks by rewarding upside success and not punishing failure. If you win, you take some of the shareholders’ company, and if you lose, you lose nothing. In fact, if you lose, you rewrite your options at depressed or crisis prices, just as some financial companies are doing as we write. Similarly some hedge funds and private equity firms can take a level of leverage that might guarantee failure in the long run, but with asymmetrical returns they pocket gains and sidestep the worst impacts of a potential terminal loss. To maintain a healthy respect for risk taking, it is surely necessary to punish egregious overreaching or spectacular misjudgment with the spectacular penalties they deserve and used to get but get no longer."

The defense of bailouts is that the alternative is ugly. But surely the penalties for excessive risk taking, issuing flaky paper, passing it on—often in its entirety—to others, and not even understanding the consequences of the low-grade paper that you yourself issue should be ugly. “Yes, of course, we would like to punish the excessive risk takers,” goes the line, but we can’t do it without hurting the innocent economy. But we will never know what can be absorbed if the penalties are always removed by a bailout. In more traditional times, say, from 1945 to 1985, the economy could absorb substantial punishment from recessions and still grow faster than it has done in the last 10 years. So in a crisis à la Bear Stearns, we now transfer pain from risk takers to innocent taxpayers. Worse, even the routine treatment for the bubble-breaking disease does the same. By raising the slope of the yield curve, the Fed deliberately benefits bankers and hedge funds that borrow short and invest long and punishes pensioners and others who are trying to make a safe but still reasonable return at the short end.

Yes, this is a real credit crisis, substantially the worst since the Depression, so it now invites unusual responses, and what we have is a series of harried and hasty responses, perhaps even panicky, but we can at least understand the urgency. The real incompetence here goes back over 20 years: the refusal to deal with investment bubbles as they form, combined with willingness, even eagerness, to rush to the rescue when they break. It’s almost as if neither Mr. Greenspan nor his successor, Ben Bernanke, allows himself to see the bubbles."

My sentiment exactly, well done!

Just Charge It!

Isn't it ironic that just last week the Fed announced they will start accepting ABS's of auto and credit card loans? It's as if they knew something was coming. You would think that ironic too if you saw how Consumer borrowing 'Unexpectantly' Surges in March:

"Consumer borrowing rose in March at the fastest pace in four months, more than double the increase of the previous month, in what was seen as a sign of rising economic stress.

The Federal Reserve reported Wednesday that consumers increased their borrowing at an annual rate of 7.2 percent, compared with a 3.1 percent rate of increase in February.

The gain was much larger than economists had been expecting and reflected strong borrowing on credit cards and also in the category that includes auto loans. The increase in consumer debt totaled $15.3 billion at an annual rate in March, much bigger than the $6 billion increase that economists had been expecting.

Economists said consumers were being forced to make greater use of their credit cards during hard economic times when they are being battered by job losses, soaring gasoline prices and higher food costs.

"This represents distressed borrowing. Consumers need cash and they have turned back to their credit cards to fill the void left by lost jobs and weaker incomes," said Mark Zandi, chief economist at Moody's Economy.com.

Borrowing on credit cards was up at an annual rate of 7.9 percent, compared to a 5 percent gain in February, while borrowing in the category that includes auto loans jumped by 6.8 percent, compared to a 2 percent increase in February.

The overall growth in debt of 7.2 percent at an annual rate was the biggest gain since an increase of 8.25 percent last November.

Consumers have been moving to put more of their purchases on their credit cards as banks have tightened lending standards for home equity loans in response to the deepening credit crisis.

The Fed's measure of consumer borrowing, which does not include any debt secured by real estate such as mortgages or home equity loans, stood at a record $2.558 trillion in March."

Higher credit card use in November makes sense because of the holiday season, but for there to be such a large increase in March must signify consumers are strapped for cash.

Back in April I discussed The Leverage Factor and determined consumer compensation was overstated, most likely due to the skewing of income and compensation packages from top tier income earners, you know the Lloyd Blankfein's of the world. It's sadly logical that consumers would have to turn to higher credit card indebtedness at steeper interest rates (Usually) to help pay for the most basic fundamentals of Maslow's hierarchy, especially as home equity loans are less available.

Breaking development: as I drove into work this morning from the quiet suburb of Brunswick, Ohio, I noticed $3.75 on the sign at the gas pump (gulp!).

But don't worry, the recession isn't here and it's not going to happen.

CMBS are Next to Tumble

I have mentioned it several times, but please realize that when The Real Estate Epic Turns Another Page a whole new dimension will be added to this gobbledegook of a mess. Remember:

"Property values of commercial real estate are declining. A Moody's index of commercial real-estate values fell 1.5% in December from the previous month. It was the fourth steepest monthly decline in the seven-year history of the index, which nearly doubled from the end of 2000 through October.

Moody's expects a peak-to-trough decline of 15% to 20% in commercial real-estate values, returning prices to where they stood about four years ago. Goldman Sachs Group Inc. analysts have projected a drop of as much as 26%."

Since then the index has climbed back up, according to the Moody's Commercial Property Real Estate Price Index:

"April 22, 2008 update: The latest results of the Moodys/REAL CPPI show an increase of 2% in February for the all properties national index."

The index has nearly doubled since 2001. It's hard to justify the bounce back in commercial real estate prices when looking at this index. However, pay attention As A Weaker Office Market Looms Landlords Bargain.

"Just months ago, the Manhattan office market was so red-hot that it was easy for a major landlord to ignore a small company seeking a modest amount of space.

But when Richard M. Warshauer, a commercial real estate broker in Manhattan, made an offer recently for 3,500 square feet of space near Grand Central Terminal, it took only two hours for the landlord’s agent to respond. A week later, they had a deal.

“The alacrity with which they shepherded this process was very unusual,” said Mr. Warshauer, a senior managing director at GVA Williams. “I just found the response time amazing.”"

"The standard signs of a weakening market — rising vacancies and lower rents — are expected to take several more months to materialize, industry leaders said. Rents typically fall when tenants start subletting large blocks of their space, because they are usually willing to take a loss. But at present, financial services firms are not rushing to dump excess space on the sublease market. And asking rents have actually risen slightly, according to some brokerage firms.

“While we certainly believe there will be sublease space coming to market, we are having a hard time getting the firms that have announced layoffs to commit to us what, if any, space they will be subleasing,” said Mary Ann Tighe, the regional chief executive for CB Richard Ellis."

The demand is disappearing and job losses are climbing. Consider the data from the MIT Center for Real Estate Transaction Based INdex (TBI):

"Results for the 1st quarter of 2008 show a 2.1% capital return for the properties sold in the NCREIF database. The demand-side index continued to fall, by 4.6 percent, which is the third straight quarterly drop, for a cumulative decline of more than 14 percent versus the mid-2007 peak. However, the supply side of the market raised its reservation prices by 9.2 percent in the first quarter."

The data is subject to revision at the end of 2008, but I wouldn't get your hopes up. Consider the supply and demand charts for office and retail indexes:

Eventually, prices will be forced to adjust. Companies are downsizing as the economy weakens, and profits are falling. There is going to be adjustment and if you refer back to my original article referenced above and look at the huge increase in construction spending, then the bubble is easy to spot. Check out the cool chart I found from the NY Times article I quoted. After that look at the headlines so far in May and ask yourself what the job reports are going to look like at the end of the month.






















JPMorgan sees Bear clients returning, job cuts

Medtronic to cut about 1,100 jobs

UBS axes 5,500 jobs as it sells down subprime

Linens files for Chapter 11, to close 120 stores

Sun Micro cutting up to 2,500 jobs

Home Depot to close 15 stores, curb openings

First Marblehead cuts more than half of work force

Peak Oil is Scary!

Peak Oil

Sorry folks, after I made you suffer my novel of a post The Great Real Estate Debate, this post isn't going to be any brighter. Before I get into today's incredibly scary headline, consider the meaning of peak oil. In simple terms it is the out pacing of oil demand and consumption vs supply and production. This does not necessarily imply that supply will disappear, but will thin out.

It is important that you familiarize yourselves with this subject and a good reference is Peak Oil: Life After The Oil Crash, from which I borrowed the graph on the left, so simple that even our government could understand.

Now onto the very scary headline of the day: "Super-Spike" Could Lift Oil to $200: Golman .

""We believe the current energy crisis may be coming to a head, as a lack of adequate supply growth is becoming apparent," Goldman said in the note made available to Reuters on Tuesday.

Oil hit a new record near $121 a barrel on Tuesday, continuing an advance which has seen it double over the past 12 months.

"The possibility of $150-$200 per barrel seems increasingly likely over the next 6-24 months, though predicting the ultimate peak in oil prices as well as the remaining duration of the upcycle remains a major uncertainty," Goldman said.

Goldman, which was one of the first to point to a triple digit oil price more than two years ago, said it believed the market was approaching the crunch in the "super-spike".

The "super-spike" theory argues that a lack of adequate supply growth along with price-insulated demand growth in non-OECD countries will lead to a dramatic and continuous rise in oil prices that will ultimately lead to a sharp correction in oil demand."

Start Biting Your Nails Now

Ouch! Now I just know some of you more seasoned readers out there who lived through the oil scare in the 70's and 80's are most likely thinking this is just another scam or short term disruption. Well, the future isn't set in stone, but there are some very key facts in place that makes this a world of a difference from that point in time:

• The population keeps growing, leading to higher demand, especially in the U.S. where nothing exceeds like more excess.
  
• China and India are growing at close to 10% in GDP, have larger populations than the U.S., and are demanding cars, building factories, and simply just consuming a lot of oil.
  
• The U.S. military is burning through oil more than anyone in the world, with the Department of Defense using 350,000 b/d in 2004.

Finally, it never hurts to consult old angry white guys who manage billions of dollars in the commodities markets with George Soros:



We're F'd!

The Great Real Estate Debate

I'm pulling in the heavy hitters for this one, as there have been some great discussions of real estate losses. Before I get started here, hat tips must go out to, Mish's Global Economic Trend Analysis, and Tom Brown's bankstocks.com. Brace yourselves, this post is going into extra innings. My inspiration for this post is Tom Brown's opinion that Sub-Prime Mortgage Losses: Not Destined to Send World Into Abyss After All:

"Of the $600 billion or so of subprime mortgages originated in 2006 (again, by the lights of what have gone on with ABX bonds), $282 billion have already been repaid, while realized losses have come to just . . . $12 billion.

We’ll start at the beginning. First, take the $600 billion in subprime loans originated in 2006 and put them into three imaginary piles: 1) loans that have been paid down, 2) loans that have already resulted in losses, and 3) balances still outstanding.

OK? We already know what the losses are on 1 and 2. They are, respectively, $0 and (as I’ve already mentioned) $12 billion.

So the question as to ultimate losses on the 2006 vintage comes down to what happens to 3, the $306 billion in balances outstanding. And actually, we have a pretty good idea what will happen to a big portion of those loans, as well. Of the $306 billion, $100 billion is delinquent by 60 days or more. As any subprime-mortgage banker will tell you, once a loan gets past 60 days past due it’s pretty much doomed these days. So we’ll assume that fully 93% of those delinquent loans go into foreclosure (a much higher rate than is typical, but hardly uncommon recently) and generate a loss severity of 45% (compared to last year's rate of 35%). Estimated losses from past-due 2006 outstanding balances, therefore: $42 billion.

That leaves the $206 billion of outstanding balances that are still performing. Obviously, some of those are destined to default, as well. The question that has the financial markets transfixed is: how many?

To get an answer, I looked at which lenders originated the remaining performing loans, where the properties are located, and other relevant factors, and extrapolated past performance into the future. I came up with an estimate that 26% of remaining loans now current will eventually default, which will in turn lead to (again, assuming a 93% roll rate into repossession and 45% severity) $23 billion in losses. The other, 74% of the remaining outstanding balances will sooner or later pay down. The losses from those loans will of course be zero.

So. Let’s add up all the actual and estimated losses and see how the numbers shake out. Here goes:

Realized 2006-vintage subprime losses to date: $12 billion

Estimated future losses on outstanding balances 60 days or more past due: $42 billion

Estimated losses on outstanding balances still current: $23 billion.

Add those three numbers up, and you get $77 billion in cumulative realized losses on the 2006 vintage. "

Brown makes an excellent argument with facts to back it up, but it still left me wondering. His assessment of subprime is correct, but its only a piece of the puzzle.

For the rest I had to turn to the one and only Mish who took a Closer Look at the ARM's reset problem, and as Mish would phrase it, inquiring minds would be savvy to study this article closely:

"3-1 ARMs Analysis

Based on the above table, 3-1 treasury based ARMs initiated in 2005-2006 would likely reset lower. I stress likely because initial rates on any given day may be based on the above caveat on day to day conditions, lender specific conditions, etc.

3-1 LIBOR based ARMs initiated in 2005-2006 would also likely reset lower and again with the same caveat repeated about day to day conditions, lender specific conditions, etc.

In general, loans originated in 2005-2006 simply do not appear to be a problem. In fact, the reset of 3-1 ARMs from those years may provide economic stimulus. This statement may not apply in every case but it should be true for many, if not most cases.

3-1 ARMs prior to 2005 have already reset. So those problems, whatever they were, have already been faced.

5-1 ARMs Analysis

5-1 ARMs analysis is more difficult. However, we can say that the above charts clearly show that loans originated in 2003-2004 are more likely to be problematic than loans originated in 2005-2006.

Here is an analysis from my Certified Mortgage Planning Specialist friend:

"Most of the 5/1 ARM’s I reviewed that originated in 2003 had start rates between 4% and 5.125%. This makes it hard to lump them all together to state they will in aggregate reset higher or lower. Some of this will depend on points paid to reduce the original interest rate. Many of these loans will reset marginally higher than they were before. However, the situation is far better now than it was even a few short months ago where it appeared virtually every loan in this group would reset much higher."

While likely to be net negative to the borrower, 5-1 ARM adjustments from 2003-2004 are not likely to be the end of the world. Some may even benefit. Looking ahead, adjustments on 5-1 arms for 2005-2006 are likely to be consumer friendly based on the above tables. However, 5-1 ARMs from 2005-2006 will not reset until 2010-2011. Those loans are simply not today's problem.

Principal Payments Needs To Be Factored In

There is still one more issue to address, and that is higher payments when the interest only period ends. For example, a 5-year ARM loan typically goes from interest only payments to interest + principal amortized over 25 years on the first rate reset. Likewise a 3-year ARM loan typically goes from interest only payments to interest + principal amortized over 27 years on the first rate reset. Some ARMs have a 10 year interest only period which postpones this particular problem.

Many of those in 3-Year ARMs with principal and interest payments will see their total mortgage payment drop. This is especially likely for loans originated in July of 2005 or later. However, those paying interest only for three years may see their total payments rise.

For others, especially those in 5-year ARMs, there could be payment shock even if the interest rate drops. Once again, it will be the 2003-2004 loans that will prove to be more problematic.


Poof!

The Fed vaporized much of the ARM reset problem in 2008-2009 by slashing interest rates. This is especially true for those in 3-1 ARMs. It is highly likely the Fed's panic rate cuts in early 2008 were made with this in mind.

Looking ahead, and assuming rates stay low, those in 3-1 ARMs originated in 2006 are likely to see significant resets lower. This would be economically stimulative as long as other conditions are stable.

Unfortunately, other conditions will not be stable. I believe unemployment is going to soar, commercial real estate is going to plunge, and the stock market is likely to keep heading south. Given rampant overcapacity everywhere, I see no economic force to create jobs. All of this is going to further pressure housing prices and the economy in general.

Look Ahead to 2010-2011

Looking ahead to 2010-2011 I see a different set of problems.

Those problems are Alt-A and Pay Option ARMS. And that is where the liar loans (no-doc loans) are hidden. Liar loans are likely to blow up long before we get to 2011. I discussed a particular Alt-A pool in WaMu Alt-A Pool Revisited and WaMu Alt-A Pool Deteriorates Further.

The pool discussed above originated in May 2007, and was 92.6% rated AAA. The most recent update shows the pool is already 25.3% 60 day delinquent or worse, 13.35% in foreclosure, and 4.44% REO (Real Estate Owned). The problem is easy to spot: only 11.27% of the pool had full doc. The rest of the pool was liar loans. The pool may not be representative a representative sample of Alt-A pools. However, it does illustrate the type of problems one would expect to see with liar loans. And those problems are both big and growing.

Pay Option ARMs (POAs) pose additional problems. The first problem is that over 80% of POA mortgagees only make the minimum payment. Given that minimum payments typically do not cover interest owed, the loan balance increases every month. This is called negative amortization, and it has been going on for years. Negative amortization is compounded by falling home prices. At some point, typically 110-125% of the mortgage, an enormous gotcha kicks in. That gotcha requires a fully indexed fully amortized principal and interest payment, amortized over the remaining years.

People who could only afford the minimum payment will be forced to pay principal, plus interest, on top of a loan balance that has been growing monthly. Good luck on lenders getting all their money back on those loans.

The second problem in regards to POAs is that a huge portion of these loans originated if the least affordable, biggest bubble areas, like Florida, California, Las Vegas, etc. From a lender's perspective that hugely increases the likelihood of default as well as the size of the problem should default occur."

Phew! This is not a battle of who was right or wrong, in fact both are right (in my opinion), but Brown misses the big picture. He only (correctly) analyzes the subprime problem, but in fact this was only the first wave as Mish illustrates with option ARM's and ALT-A's, which were originated at higher interest rates.

The self reinforcing dilemma

The low interest rates have prevented many resets from forcing unprecedented foreclosures, but are straining consumers through exploding commodity prices, and producers have yet to pass those costs along. Still massive levels of housing inventory will will continue The Housing Pain where Rosy Predictions are Misguided. The effects of housing price declines will further exacerbate the problem down the road in 2010 and 2011. Though not evident yet, still as The Real Estate Epic Turns Another Page down the road, things will just get worse, especially in unemployment. Be aware that consumers carry plenty of HELOC's and CES's, second lien. Consumer sentiment is low!

The Fed is going to be faced with a mighty dilemma. Their balance sheet is growing, not in size, but in risk. In fact, this is a key point to make, in order to support their recent facilities (TAF, TSLF, PDCF) they will need to grow their balance sheet. The only way to support that is by taking interest rates to zero and printing after they run out of assets. Whats worse, is these facilities have done little to actually ease the markets when Looking Into the Eye of the Fed, so the Fed is potentially risking theirs and America's reputation (whats left of it) for programs that have proven ineffective outside the realm of saving Bear Stearns depositors.

Tom Brown Revisited

I had to revisit Brown's follow up article Better Outlook for Sub-Prime 2006 Performance: Problem Simply Not Rolled Into 2007:

the typical 30-year mortgage doesn’t last anything like 30 years. Rather, people sell their houses and move--and pay off their loans with the proceeds from the sales, then take out new loans to finance their new houses. Or, if they’re subprime, they might raise their FICO scores and refinance the existing property on better terms.

I think Brown is correct, but I don't think this logic would apply in the case of rapidly falling home prices, where negative equity doesn't cover your home in the case of a sale and refinancing proves much more difficult; walking away occurs instead.

I hate predicting doom and gloom (even though it's like soap opera for econodorks like myself), but a realist I must be.

Say On Pay

Today for the first time ever shareholders of Aflac (NYSE:AFL) will vote on executive compensation. This is an enlightening theory in concept, however you cannot eat that proverbial cake just yet. For starters, members of the board still have final say, so regardless of the shareholders vote management may still conceivably get paid like Bill Clinton on a university campus speech.

In order for such a grandiose system to fully function properly there must exist certain conditions:

• The members of the board of directors should be compiled of outsiders, that is management board members and other insiders should be kept to a minimum to prevent biases and scratching of each others backs.
  
• The majority of shareholders are institutional investors. As you learned in A Sea of Funds fund managers are no strangers to lofty compensation packages themselves.
  
• Say for pay might push the wrong kind of agenda for management incentive to perform. Short term earnings are already a strong emphasis in managements assessment of priorities. The result could end up being schemes to make earnings so management could earn that pay.
  
• In any case, shareholder votes would actually have to count as the deciding factor! Board members have final say, but this is contradictory to the concept of say for pay.
  

All in all, the board should decide on executive compensation, but an unbiased board of outside members with long term interests.

Buffett's Derivative Losses

On Friday the world learned that Berkshire Net Was Off 64% on Derivatives and Insurance:

Results suffered from $991 million of after-tax losses tied mainly to contracts designed to make money if junk bond stay out of default and stock indexes rise. Buffett had warned in his annual letter to shareholders in February that derivatives could make quarterly results volatile.

This is no surprise, after all When Buffett Speaks...You Listen!:

"Two aspects of our derivative contracts are particularly important. First, in all cases we hold the money, which means that we have no counterparty risk.

Second, accounting rules for our derivative contracts differ from those applying to our investment portfolio. In that portfolio, changes in value are applied to the net worth shown on Berkshire’s balance sheet, but do not affect earnings unless we sell (or write down) a holding. Changes in the value of a derivative contract, however, must be applied each quarter to earnings.

Thus, our derivative positions will sometimes cause large swings in reported earnings, even though Charlie and I might believe the intrinsic value of these positions has changed little. He and I will not be bothered by these swings – even though they could easily amount to $1 billion or more in a quarter – and we hope you won’t be either. You will recall that in our catastrophe insurance business, we are always ready to trade increased volatility in reported earnings in the short run for greater gains in net worth in the long run. That is our philosophy in derivatives as well."

In the Reuters article Warren :

"financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

You're most likely thinking this is a contradictory statement because Buffett holds 94 contracts himself worth approximately $40 billion.

Buffett's Brilliance

Pay careful attention to three concepts behind Buffett's derivative holdings:

1. He carries no counter party risk, and instead receives cash up front.
   
2. Buffett warns of wild swings in quarterly earnings as a result of mark to market accounting principles. To understand why this is just noise...
3. Buffett indicates these mark to market changes do not reflect changes in the intrinsic value of the derivative contracts he holds.
   

The Mistake of Interventionism

Continuing right where I left off in Looking Into the Eye of the Fed where I questioned Fed policy (rightly so), NY Times columnist Floyd Norris is Determining Who Rides the Lifeboat, a query who should be bailed out. A nice excerpt from the article from which Floyd borrowed from economist Hyman Minsky:

"If the institutions responsible for the lender-of-last resort function stand aside and allow market forces to operate, then the decline in asset values relative to current output prices will be larger than with intervention; investment and debt financed consumption will fall by larger amounts; and the decline in income, employment and profits will be greater.” In other words, without government bailouts, there can be a downward spiral."

It is this kind of logic that must be applauded. Why try and oppose what market forces are gravitating towards, this force is natural and necessary. The policies of the Fed only help to reinforce the agonizing length of time required to escape this mess. The deleveraging and unwinding of credit, housing prices and tightening of lending standards among our financial institutions is a fine dose of reality, but the Fed wants to hyper-extend these factors before these adjustments have abated themselves, leading us back into another speculative boom, hardly a stable policy. Please consider:

Capitalism defined:

"An economic system based on a free market, open competition, profit motive and private ownership of the means of production. Capitalism encourages private investment and business, compared to a government-controlled economy. Investors in these private companies (i.e. shareholders) also own the firms and are known as capitalists." - Investopedia

If I may elaborate,

Shamitalism Defined:

"An economic system based on deceiving the masses on the idea of a free market, rising inequality, government bailouts, masked inflation, expansion of government authority and power, high deficits and excessive leverage with a vague concept of disclosure. Shamitalism encourages private investment and business, with the help of artificially low interest rates, so powerful bankers can profit from booms at the crest and the middle class can bust at the trough. (see also reverse Robin Hood Theory)"

Also see Common Sense Financials = Disclosure to understand why regulation failed, leaving trillions of dollars managed by our "shadow banking system" completely unchecked, a large proponent of the mess we're in.

Looking Into the Eye of the Fed

Correction from previous post

In Bernanke: The Man, The Magician I reflected upon the increase of the MZM despite massive issuance of Fed balance sheet treasuries. One crucial point I left out was the flood into money market funds since the end of 2007, which increases MZM, in this case dramatically.

A Reflection of Fed Policy

The destruction of the Fed balance sheet with its Term Auction/Securities Lending Facilities is a sad necessity for the situation our economy has weaseled itself into. Without the claiming of Bear Stearns assets in the "temporary" 28 day window, Bear would have seen a massive run and its depositors would have been wiped out. This would have a contagion effect and other runs of similar magnitude would have been highly likely to occur. This is the "sad necessity", sad because it puts the Fed's already lacking policy credibility at even more risk with a balance sheet credibility, in which taxpayers take a risk with as well. This hasn't solved the problem and the Fed's balance sheet can only go so far before it runs out of treasuries to lend out in exchange for land fills of crappy derivatives.

The above scenario isn't terrible, however the Fed exacerbated the problem with the usual suspect ~ interest rate easing. What the Fed should have discovered was this was as useful as an a%*hole on their elbow! Needless to say, it has not been very useful. Instead of figuring out that their easy money policy isn't lowering risk premiums on spreads of commercial paper, financial and non financial, they continued easing. Just look at the daily commercial paper rates discount spread (excluding nonfinancial paper) courtesy of the FRB website. It's still historically high. Easing interest rates is not solving the problem, but instead is just creating all new dilemmas.

Monetary Easing Is Elevating Economic Woes

Ignore the statistical releases, they bear little real relevance in this economy. The Fed's reliance on CPI to gauge inflation is wrong! This is aside from the already flawed metrics used to calculate CPI, which in reality is much higher. We've seen the PPI creep up and up in past months without a corresponding translation into the CPI. Corporate earnings for Q1 of 2008 will be significantly lower then the already low Q4 2007 earnings. But that doesn't stop markets from Investing on Hope still, where better than expected results translates into positive news, regardless of where those numbers are relative to a year ago. Headline CPI will translate into the CPI, corporations will not eat up their margins forever and consumers are being pummeled by food and energy, a serious threat. Eventually, more price inflation will ensue as corporations pass their woes along to the consumer.

Bernanke Is A Slave to Bankers and Markets

Rather than halt easing any further, rates were slashed another 1/4 point yesterday, a worthless maneuver as we've seen it did nothing to alleviate spreads. Worse, this policy only works to weaken the dollar which fuels the food and energy bubble further. Much praise goes out to FOMC member Fisher in his consistent stance against easing.

Weren't the new discount window policies enacted because traditional interest rate policy proved ineffective? Yet Ben continues to swing his interest rate swords, decapitating the masses of American consumers, who remain loyal spenders as they reach further down into their pockets. This loyalty will eventually be forced to break.

In every move the Fed has been in line with expectations for easing policy. I believe that some level of transparency is good for the markets to have with regards to Fed actions to keep volatility from getting out of control, however big Ben has swayed with the masses too consistently with little justification.

The Fed Is Under capitalized

financial institutions have been in a capital raising friendzy and the Fed has played a large role in that. In fact today the Fed explained the Recent Decline In Nonborrowed Reserves:

"By definition, nonborrowed reserves are equal to total reserves minus borrowed reserves. Borrowed reserves are equal to credit extended through the Federal Reserve's regular discount window programs as well as credit extended through the TAF. To maintain a level of total reserves consistent with the Federal Open Market Committee's target federal funds rate, increases in borrowed reserves must generally be met by a commensurate decrease in nonborrowed reserves, which is accomplished through a reduction in the Federal Reserve's holdings of securities and other assets. The negative level of nonborrowed reserves is an arithmetic result of the fact that TAF borrowings are larger than total reserves."

This is a scary thought! They are under capitalized and now have enough sh!^#y paper cluttered on their balance sheet to fill all the latrines of the land, waste management will be busy. What will be the Fed's actions when more write downs come as housing prices continue to plummet and commercial real estate unwinds, forcing more hedge funds and private equity firms to implode?

I can only think of one scenario, one in which answers the question of why the Fed once again lowered interest rates and the answer is clear as day; cut rates. Prepare for more price inflation. This is why they didn't just pause and why they all of a sudden failed to give adequate disclosure of their stance in the battle between inflation and growth. They just don't have a clue!