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I’m
never comfortable with the idea of “yelling ‘fire’ in a
crowded theater.” But
Jim Cramer already did as much late this afternoon on CNBC.
His “we’re in Armageddon” tirade was made moments after Bear
Stearns’ CFO Samuel Molinaro offered a disconcerting assessment
of market conditions during the company’s hastily called
conference call: “I’ve been out here for 22 years, and this is
as bad as I’ve seen it in the fixed-income markets.” A
highly-aroused Mr. Cramer, volunteering to speak on behalf of Wall
Street, called for the Fed to aggressively cut rates and “open
the discount window.”
The
Credit Market has dislocated,
liquidity has evaporated, and our academically-inclined new Fed
chairman is in store for a historically challenging real world
first test. Wall Street has been conditioned over the years to
expect “bailouts.” Only months on the job, Alan Greenspan
stepped up and assured the markets that the Fed was ready to add
liquidity after the ’87 stock market crash. The Greenspan Fed
acted aggressively during the LTCM crisis and, later, Dr.
(“Helicopter”) Bernanke played an instrumental role in the Fed
talking the risk markets higher in late 2002. To be sure, Fed
“re-liquefactions” played a conspicuous role in fostering ever
greater and more unwieldy Bubbles - and this will remain in the
back of FOMC members’ minds. The Bernanke Fed today would likely
prefer to maintain a “hands off” approach for as long as
possible – which has already been too long for an acutely
fragile “Wall Street.”
And
let’s not forget the (unsung hero) GSE “backstop bid.” The
GSE’s ballooned their balance sheets $150bn to absorb
speculative de-leveraging during the 1994 de-leveraging and bond
market rout – about double 1993’s at the time record asset
expansion. GSE balance sheets (chiefly holdings of mortgages and
MBS) ballooned $305bn during tumultuous 1998, $317bn during 1999,
$238bn in 2000, and $344bn during liquidity challenged 2001.
Agency balance sheets mustered growth of $37bn last year.
Importantly, the GSE’s are definitely in no position these days
to aggressively create marketplace liquidity by expanding their
(money-like) liabilities to aggressively purchase MBS - in the
process stabilizing market prices (especially for the leveraged
speculators). Wall Street must all of the sudden feel short of
friends.
Appearing
this evening with Larry Kudlow, Larry Lindsey called upon Fannie
and Freddie to loosen lending standards to help ameliorate the
rapidly accelerating Mortgage Credit Crunch. I was immediately
reminded of how Washington nurtured the $200bn (or so) S&L
bailout from what should have been resolved years earlier at a
fraction of the cost to taxpayers. The GSE tab is today running
out of control. Keep in mind that Fannie and Freddie already have
combined “Books of Business” (MBS holdings and guarantees) of
almost $4.0 TN supported (in the best case) by stockholders’
equity in the neighborhood of $60bn (current financial statements
not available!). The thinly-capitalized Federal Home Loan Bank
System has another $1.0 TN of assets. Before all is said and done,
taxpayer GSE exposure will likely reach the trillions – to add
to other untenable ballooning federal contingent liabilities.
This
week, the unfolding financial crisis reached a problematic stage
on several fronts. For one, illiquidity hit the gigantic “AAA”
market for “private-label mortgage-backed securities.” The
booming market for non-agency MBS has played an instrumental role
in ensuring abundant cheap mortgage Credit – on the one hand
filling the liquidity void created by the constrained GSEs
(balance sheets) and, on the other, providing virtually unlimited
inexpensive “jumbo” mortgage finance to inflate upper-end
housing Bubbles in California and the most desirable locations and
neighborhoods across the country.
While
the sub prime implosion was a major marketplace development, in
reality only a small segment of the mortgage marketplace was
actually impacted by significantly tighter Credit conditions.
Today, we are in the throes of a dramatic, broad-based and
momentous tightening of mortgage Credit. Importantly, key players
and sectors throughout the mortgage risk intermediation process
are increasingly impaired and now in full retreat. This includes
entities such as the mortgage insurers, MGIC’s and Radian’s
faltering C-BASS securitization unit, REITs such as failed
American Home Mortgage and others, hedge funds such those that
failed at Bears Stearns and many more, the broker/dealer community
and the expansive mortgage derivatives market generally. There is
also the issue of exposed mutual funds, money market funds,
pension funds and the banking system in general. Just like NASDAQ
went to unimaginable extremes than then doubled during a fateful
“blow-off” – total mortgage Credit doubled subsequent to the
Greenspan Fed’s reckless post-tech Bubble “reflation.” Risky
mortgage exposure now permeates the (global) system and is highly
susceptible to “Ponzi Finance” dynamics.
The
process of transforming risky mortgage loans into coveted
perceived safe and liquid (“money”-like) Credit instruments
has broken down on several fronts. Not only is the risk
intermediation community impaired, marketplace confidence and
trust in the quality, safety, and liquidity of mortgage (and
mortgage-related) securities is being shattered. There are
apparently serious problems developing throughout the massive
marketplace for (“repo”) financing MBS. And it is precisely
the market for financing the top-rated mortgage securitizations
– where the perceived risk was minimal – where I suspect the
greatest abuses of leverage occurred. The marketplace is now
experiencing forced de-leveraging and a liquidity Dislocation -
with major systemic ramifications.
I
mostly downplayed the marketplace liquidity and economic impact of
the housing downturn last fall and the sub prime implosion this
past February. For the system as a whole, the Credit spigot
remained wide open. My view of current developments is markedly
different. I cannot this evening overstate the dire ramifications
for the unfolding Credit Market Dislocation. There is today
serious risk of U.S. financial markets - distorted by years of
accumulated leverage and derivative-related risk distortions - of
“seizing up.” A system so highly leveraged is acutely
vulnerable to speculative de-leveraging and a catastrophic
“run” from risk markets. At the same time, the Bubble Economy
and inflated asset markets – by their nature – require
uninterrupted abundant liquidity. The backdrop could not be more
conducive to a historic crisis, yet most maintain unwavering
confidence that underlying fundamentals are sound.
I
am this evening unclear how the enormous ongoing demand for new
California mortgage Credit will be financed going forward. With
the market having lost all appetite for “jumbo” MBS, mortgages
must now be priced generally in accordance with the standards of
increasingly cautious loan officers willing to live with these
loans on their banks’ balance sheets (a radical departure from
pricing set by originators selling loans immediately in an
overheated MBS market). And, let there be no doubt, the
prospective Credit tightening will hit grossly inflated and highly
susceptible “Golden State” housing prices hard – a scenario
that will force lenders to incorporate significantly higher Credit
losses into their loan pricing terms (perhaps Cramer was speaking
to CA homeowners when he jingled house keys in front of the camera
during Wednesday’s show and suggested it was perfectly rational
to mail your keys to the bank). Furthermore, I expect the pricing
and availability of Credit required to refinance millions of
rate-reset mortgages in California and elsewhere to turn
prohibitive for many. And the home equity well is about to run dry
– from a combination of sharply tightened Credit conditions and
accelerating home price declines.
A
severe tightening in mortgage Credit is in itself sufficient to
pierce a vulnerable U.S. Bubble Economy. But there is as well an
abruptly brutal tightening in corporate Credit. The junk bond
market has basically closed for business. The leveraged loan
marketplace is in turmoil and scores of debt deals have been
pulled. And, more ominously, the previously booming ABS and CDO
markets have slowed to a crawl. Perhaps not immediately, but it
will not be long before the economy succumbs to recession.
Credit
Market Dislocation now dictates the assumption that Federal
Reserve liquidity assurances and rates cuts are on the near
horizon. And while they will likely incite the expected knee jerk
response in the equities market, I don’t expect they will have
much lasting effect on our impaired Credit system. Current issues
are much more complex and serious than ’87, ’98, 2000, or
2002. The dilemma today is that confidence in “Wall Street
finance” has been shattered. The manic Bubble in Credit
insurance, derivatives, and guarantees is bursting. The manic
Bubble in leveraged speculation is in serious jeopardy. The
currency markets are a derivative accident in waiting. Fed rates
cuts risk a dollar dislocation and/or a further destabilizing (for
spreads) Treasury melt-up.
A
focal point of my Macro Credit Analysis has for some time been the
grave risks posed to markets and economies commanded by the
seductive elixir of speculative liquidity. I have compared the
current backdrop to that of 1929. For too long our Bubble Economy
and Bubble Asset Markets have luxuriated in liquidity created in
the process of leveraging speculative securities positions...
(especially in the Credit market). We are now witnessing how
abruptly euphoric boom-time liquidity abundance can transform to a
liquidity crisis.
I
apologize for appearing overly dramatic. But this evening I have
nagging feelings that for me recall the disturbing emotions
following the terrible 9/11 tragedy. I know the world has changed
and changed for the worse – yet I recognize that I don’t know
how and to what extent. I fear for our markets, our economy, our
currency and our system. I received an email this week on my
Bloomberg that said something to the effect, “You all must be
happy in Dallas.” I can tell you we’re instead sickened by
what has transpired during the late-stages of this senseless
Credit and speculative orgy. The Great Credit Bubble has been
pierced, and there will now be a very, very heavy price to pay.
And, as always, I hope I am proved absolutely wrong. END |
