Wednesday, August 8, 2007

Sticker Shock At The Risk Emporium

As Mr. Treasury Secretary Hank Paulson so elegantly understated it, risk is being "re-priced".

The blinds are down, the "Grand Sale" sign is gone and shopkeepers are hastily re-arranging their window displays. Suppliers are calling daily, even hourly, with higher quotes and they can hardly keep up with changing all the price tags. Customers, used to rock bottom prices, walk away shaking their heads in disgust vowing to look for cheaper merchandise elsewhere, only to discover that the same thing is happening everywhere. What's more, several previously abundant products have been pulled from the shelves completely and dozens of smaller stores have closed for good, having gone from riches to rags literally within days.

The big stores are still in business, but their owners are not feeling too chipper, either. They know that when prices go up so fast and so much, customers simply can't adjust. Sticker shock is bad news for business and it does not matter if your are selling pizzas or mezzanine loans.

Back to the financial community.. As risk gets re-priced banks and brokers (particularly) have to mark their own portfolios to market and that hurts, though there are dozens of tricks to mask and ease the pain. But their real risk exposure is elsewhere: it resides in their major customers' balance sheets, those hedge and private equity funds that borrowed so heavily to speculate in overvalued, risky assets from stocks and CDO's to real estate in Romania. (Are you familiar with the term "prime broker"? If not, you should be.) The risk connection is direct, even if a few domino drops away.

The game could be sustained for as long as no one wanted their money back. But everyone now knows that risk is being re-priced at the Risk Emporium - and who wants to get stuck inside? Get the money out first, ask questions later, because there is an infinite amount of time but a finite amount of money, despite all the nonsense about liquidity. This is where and when things get nasty: withdrawal requests combined with margin calls can bring down leveraged funds within days, even hours. Funds can stop redemptions, but all this means is that customers will most definitely get wiped out, because margin calls have priority.

If this sounds alarmist, it is. Because in talking yesterday with a long-time friend in the business he said: "Those guys at Goldman and Morgan, they are smart, they'll figure it out - it will be OK". How does it go? Denial, hope, anger, capitulation, apathy... I am alarmed because we are now clearly past the "denial" stage and in full "hope" mode. Even Mr. Paulson acknowledges the problem, but "we have a strong economy", etc. We can see this in the way markets are acting: the "hopefuls" are looking for bottoms, just 5% off the top.

In speaking with a broker whose observations I highly respect, she had this to say: "This time around it won't be the little guy who gets stuck. It will be the supposedly "smart" money, the hedge funds and the big-time individual speculators... unless of course the little guy is somehow convinced to jump back in, right now". Now, that would be a shame, wouldn't it?


  1. How could the little guy jump right in, right now? From your earlier posts and from the statistics you quote, it seems that most little guys are broke, drowning in debt.

    This is getting interested. I think we are not only witnessing a financial crisis, but also on ideological paradigm shift. The neo-liberal paradigm of free markets etc has run its course, mostly due to resource depletion world wide. Now, as you have pointed out, we need another economical paradigm, one with more substantial foundation and smaller requirements for material inputs.

    Very, very interesting times. Simpler, harder, but hopefully happier ways of life coming.

  2. Thanks for your comments mane,

    I agree with you, it will be almost impossible for the small guy to truly jump in in great enough numbers to bail out the big boys - as is usually the case - because they are tapped out.

    Great economic upheavals bring about paradigm shifts. Keynesian economics and the social state were "born" during the Great Depression and if this debt bubble bursts hard enough I think we will be headed for something new. Hopefully it will be along the lines of sustainable development. The other option is too scary to ponder.


  3. Democrats would unload junk mortgages onto Fannie and Freddie

    By Andrew Ward and Stephanie Kirchgaessner
    Financial Times, London
    Tuesday, August 7, 2007

    WASHINGTON -- Influential Democratic senators on Tuesday called for Fannie Mae and Freddie Mac, the government-sponsored mortgage companies, to be given a bigger role in efforts to stabilise the troubled US mortgage market.

    Chris Dodd, chairman of the Senate Banking Committee, and Chuck Schumer, chairman of the Senate subcommittee on housing, supported the lifting of investment caps on the companies.

    Hillary Clinton, the New York senator and Democratic presidential frontrunner, also urged expansion of the mortgage groups.

    The comments added to growing hope among investors that Fannie and Freddie would be freed to buy more mortgages from struggling lenders, easing the crisis in the subprime sector.

    Federal regulators are understood to be reviewing the portfolio caps imposed on Fannie and Freddie last year after a probe found flaws in their accounting, corporate governance, and risk management practices.

    "It may be appropriate, consistent with safe and sound practices as determined by the regulator, to ease the temporary regulatory cap on Fannie and Freddie’s mortgage portfolio," said Mr Dodd.

    Such a move would "allow Fannie Mae and Freddie Mac to provide needed stability to the secondary mortgage market," said Mr Schumer.

    Mrs Clinton proposed expansion of the groups among measures to tackle weaknesses in the mortgage market and  support homeowners. She vowed to clamp down on "unfair lending practices" and create a $1 billion federal fund to help homeowners avoid foreclosure.

    Mrs Clinton said fixing the mortgage crisis would be among the priorities of Democratic lawmakers when Congress returns.

    "We need to put an end to fly-by-night mortgage brokers peddling loans to unqualified applicants based on inflated appraisals," she said. "We need to help those facing the pain of foreclosure. We need to secure the market place and put reforms in place right now."

    The remarks added to the populist economic rhetoric that has become a theme of the Democratic presidential campaign as candidates respond to concern about economic insecurity among middle-class Americans.

    Steve O'Connor, senior vice president for public policy at the Mortgage Bankers Association, said there were signs that Democratic lawmakers could favour a bailout of homeowners, but that such a proposal would be mired in difficulties.

    "You have to think of whom you are bailing out, and are you really helping who you intend to help?" he said. "A lot of loans going bad are held by speculators. You can argue that you shouldn't be bailing out speculators."

    One banking lobbyist in Washington said the idea of a bailout had been rejected because of its cost. He predicted disagreement among Democrats because Rep. Barney Frank, chairman of the House Financial Services Committee, would support a measure assigning liability on some of the big trading houses, whereas Mr Dodd, his Senate counterpart, would not.


  4. The following is a quote from regarding the new pension law that takes effect on January 1, 2008.......

    "To boost 401(k) participation and protect procrastinators from themselves, the new law encourages companies to automatically enroll workers in their 401(k) plan. Although employees can choose to opt out, most probably won't -- turning the inertia associated with retirement savings to their advantage. The Employee Benefit Research Institute estimates that automatic enrollment would increase 401(k) participation from about 66% of eligible workers today to more than 90%."

    This may the be the vehicle by which the 'little guy' jumps in............