Bankruptcy Originator
Yesterday, I read the following headline on Bloomberg: “Countrywide Falls as Schumer Seeks Probe of Advances.” And I smiled.
Not because I enjoy Countrywide's misery, but because a couple of paragraphs into the article, Sen. Chuck Schumer expressed concern that Countrywide had borrowed a huge amount of money from the Federal Home Loan Banks which it had little ability to repay. Apparently Senator Schumer does not read this newsletter, because on November 5, we already knew what was going on:
The Missing Link: the Federal Home Loan Banks
There has been a massive surge in the liabilities of the Federal Home Loan Banks in the past month. This Depression-era agency, bigger and badder than Fannie Mae and Freddie Mac, has taken a ton of CDOs ($150bn or so) on its books in the third quarter (through September 30), and in all probability its liabilities increased even more rapidly in October. Taxpayers have already footed the bill for some of the CDO debacle through blatant depreciation of the dollar, but they will pay more when the government is faced with the price of insuring FHLB debt, which currently stands at approximately $1.15 trillion. According to the FHLB financials (see http://www.fhlb-of.com/specialinterest/financialframe.html), FHLB consolidated obligations have increased by 21 percent in the previous nine months.
There was a conspicuous absence of bankruptcies among the biggest (presumably the most exposed) mortgage originators, and a surge in notes outstanding from the FHLBs. Put two and two together, and it does not take a rocket scientist very long to surmise that the mortgage industry is getting bailed out by the federal government in a massive way, through the Federal Home Loan Bank system. Countrywide was fingered for borrowing $37 billion, but FHLB notes outstanding [all this stuff is online somewhere or other – see http://www.fhlb-of.com/issuance/debt_outstanding.html] has soared. In the first ten months of this year, discount notes have risen from a previous $158bn outstanding to $328bn outstanding. That's a $170 billion – 110% -- increase. And we still have two months left in the year. That rate of increase is unprecedented: the period 1997-2003, which encompassed a deep bear market and 9/11, took six years for the FHLB's liabilities to go up 100 percent nominally (even then, it closer to 80 percent adjusted for inflation).
This $170 billion bailout of the mortgage industry presumably is not included in accounting for the federal deficit, but it's a liability that needs to be repaid. A lot of “too big to fail” institutions have been mining this piggy bank in the past several months. It is all well and good that Sen. Schumer noticed this when he did, but it's too late, and the difference will come out of the value of the dollar. The UK received enormous flak for its bailout of Northern Rock (about $50 billion), but that pales compared to this. The derivatives market is $516 trillion, and the United States will go bankrupt at a blinding rate if it believes it can bail out everybody who made stupid bets in credit derivatives markets. At this rate, the FHLBs will have taken on $200 billion (in mostly bad debt) before the year is out. This is yet another reason why I am bearish on the dollar in the medium term.
Remember: Capitalism is for poor people. Socialism is for rich capitalists hit by speed bumps.
Citigroup's Desperation
Citigroup managed to secure effective junk bond financing on Monday from the Abu Dhabi Investment Authority. They basically sold Abu Dhabi a $7.5 billion convertible bond – at 11 percent interest – due for mandatory conversion between 2010 and 2011. This marks Dhimmigroup's second major bailout by a Gulf petrosheik (Saudi Prince al-Walid bin Talal bailed out Citigroup first in the early 1990's), and Gulf royalty now owns 10 percent of the bank. Effectively, ADIA bought Citigroup shares at something like $23/share, based on the four-year yield premium their convertible received over Citigroup's current 7 percent dividend yield and subsequent conversion into Citigroup stock.
The market's reaction to this piece of information was incredibly bullish. The Nikkei, which had been down 250 points, blasted off to plus-150 in a matter of minutes. I didn't see what there was to be bullish about: on the contrary, the ADIA deal implied that Citigroup is about 20 percent overvalued! I guess the market forgot about “the SWF put” (the idea that foreign piles of dollar bills in Abu Dhabi, Saudi Arabia, Singapore, China et al. will be blindly plowing their money into US assets after Americans get out of them). Now, one major Mideastern investment firm has done its part to refill the punch bowl, and continue the unsustainable recycling of American trade deficits into exporters' bank accounts, back into United States assets. As far as foreign investors are concerned, this is a losers' game.
It does mean Citigroup won't go bankrupt. It also means, however, that Citigroup was certainly on the ropes before the deal, and is probably still teetering close to the edge; Meredith Whitney, the ICBC analyst whose downgrade sparked a run on Citigroup stock, said that Citigroup needed to come up with $30 billion over the next two quarters.
In any case, other foreign investors will not be nearly so eager to jump into US assets. Three-month Treasuries are probably yielding negative real interest rates at the moment, unless the bond market is pricing in a significant rebound in the devastated value of the dollar (also known as 'reducing the rate of inflation') as the economy slows down. I think current bond yields are reflective of a panicked exit from equities much more than anything else; we'll see. There is no way I am ready to reinvest in the US dollar. Feeble rebounds can always happen, but the dollar's value is the same as it was in 1997, and–with the usual caveats that 1) economic history only rhymes, it never repeats; and 2) I'm usually wrong--the US economic outlook is much worse now than it was in 1997 for every reason imaginable.
The Citigroup investment was also probably a reaction to HSBC's rejection of the SuperSiv, the $80 billion behemoth which Paulson and Bernanke have tried (and thus far, failed) to foist onto large pools of capital. HSBC chose to take two huge, troubled SIVs ($45 billion capitalization) onto its balance sheet and assume public liability for them. They will have billions in future writedowns, but at least they are being big boys about it.
In the meantime, Morgan Stanley, Bear Stearns, Barclays, Royal Bank of Scotland, and a host of German banks still have plenty of dirty laundry. The Japanese banks probably do too, but they could hide it indefinitely.
Currency Politics
Nicolas Sarkozy, Jean-Claude Trichet, Jean-Claude Juncker, and Peter Mandelson have formed a united front demanding that China revalue the yuan upwards. Eurozone politicians are not willing to shoulder the burden of the Chinese export bubble. Spreads of French, Italian, Spanish, Greek, and Belgian bonds over German bonds widened extremely sharply over the past week, in a panicked lurch eerily reminiscent of AAA CMBS bonds' spreads over Treasuries. The implication is that the bond markets are probably beginning to price in the possibility of a “fat tail” event in the form of a split in the EU. Italy, which is particularly dependent on exports and suffering from huge public debts (which it can't inflate away as long as Brussels is running its currency policy), is seen as especially likely to bail out of the eurozone if the euro continues to appreciate.
And if the euro continues to appreciate, the GBP sterling would theoretically become another “reserve currency” candidate. As I have said before, I think the UK economy is an imminent train wreck even more so than ours, and its political system, already one of the most profligate in the eurozone, will only accentuate a UK recession. Fundamentally, I still see a gigantic “inflation glut” all over the world. The United States residential sector soaked it up for several years, but that's over. The falling dollar has caused the Asian export bubble to roll over into Europe, which is now facing massive political pressures to push the export glut elsewhere; but there is no other currency union up to the job. Every country faced with the choice of recession or inflation has chosen inflation. As a result, the global economy is increasingly staring into a liquidity trap of its own making. Which is why, in defiance of the bond market, I remain resolutely bullish on gold. I am a disciple of the commodities markets, and the those markets—plummeting base metals, stratospheric but deflating oil prices, relatively high gold prices—augur stagflation.
That's all for this week. As always, if you have any questions, comments or concerns, please e-mail me at alex.forshaw@gmail.com, and check our forex blog, http://cartmanist.wordpress.com, for more frequent updates.
Thanks again for reading,
Alex Forshaw,
Editor in Chief
http://www.bestwaytoinvest.com
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