Monday, September 17, 2007

Collateral Damage

The first bank run of the 2007 Credit Crisis is now in full swing, as hundreds line outside Britain's Northern Rock branches to withdraw their savings. Some had to wait for as long as 4-5 hours and the BBC reports that around $4 billion was withdrawn Friday and Saturday. The run continues today (Monday), despite BoE's offer of an unlimited line of credit.

If anyone had any remaining illusions as to the nature of the problem facing markets, these are now surely being swept away. The bank in question apparently had a very small exposure to sub-prime loans (though I understand it frequently made loans for up to 125% of house market value), yet it is facing a crisis because it relied on the interbank market for 70%+ of its funding, instead of traditional retail deposits. As the interbank market dried up, Northern Rock simply could not obtain the day to day funds needed to run its business.

And why did the interbank market dry up? Two reasons: (a) Lack of trust and (b) banks needed to keep the extra cash to plug their own holes, which opened up as SIV's imploded and hedge funds needed money for margin calls.

I spoke to a long-time associate in the interbank market in London and asked him for his gut feeling. His take was that we are currently in the eye of the storm - calm, but with more trouble to come. Interestingly, he was the second professional who described the situation in exactly the same way. Another thing he mentioned was that he never expected to see a bank run taking place on London's high street - Podunk, USA maybe... but not London. Ah, the deleterious effects of globalization....

I close with an observation of my own: some think that China and other emerging markets are immune from the Credit Crisis. I, however, view them as another domino which just happens to be standing a few places further down. Their turn will come, too.
_______________________________________________________________
Scary Update: The UK government promised to guarantee all Northern Rock deposits. To the depositors this may seem like a good idea. The scary part is that it may seem like a good idea to several less savory characters, too. Like, for instance, other bankers. Moral hazard, anyone?


22 comments:

  1. It will be interesting to see how the Chinese dictators will react to the eventual bank runs in China. Will they send it the military to remove the mob from the banks? Or will they simply print more money?

    In China, more is at stake than simply the financial system. The political system is fragile - losing trust in the financial system may well cause lose of trust in the political one as well

    ReplyDelete
  2. If capitalism were a tradeable commodity, I would say that its adoption by China is a sign of a bubble.

    ReplyDelete
  3. Dear Hellasious,

    I have learned a great deal from reading all of your prior postings.

    Do you think the Wall Street investment banks going to come clean this week and disclose the mark-to-market value on ALL of their mortgage-backed securities, collateralized debt obligations and credit default swaps?

    Or are they still going to try to pull the wool over the public's eyes (with mark-to-model and mark-to-make-believe)?

    And if they go for the latter, will the market swallow the BS or will they realize that they can't trust Wall Street and hit the SELL button en masse?

    Bernard

    ReplyDelete
  4. Bernard,

    +1

    I could not write the question in a better way. This is la "question du jour".

    This will have a direct impact on the stock market valuations accross the globe. Since most banks around the world will follow up.

    Since I doubt that K. Lewis and other want to share flat with Jeffrey Skilling, I'd bet on rough news.

    ReplyDelete
  5. You can add Brazil, Mexico, Russia, New Zealand, Canada and Australia to the list....

    ReplyDelete
  6. "Will Wall St come clean?"

    Check out FASB 157...at BKUNA, 85% of their option-ARM portfolio clients PAY LESS THAN THE INTEREST each month. BKUNA can come out next quarter and say, we think Hillary will be elected president and pay off the investment condo mortgages for all illegals in Florida, therefore we are taking no impairment on these loans. That would adhere to GAAP standards under FASB 157.

    Think the SEC would step in and not stand for this nonsense? Think again:

    “The SEC’s position lets institutions overseeing bonds backed by subprime and other risky mortgages to keep the assets off their balance sheets and avoid a regulatory requirement to hold more capital in reserve.”

    - Shawn H

    ReplyDelete
  7. One interesting point...Is the absolute 100% bearishness against the U.S. $ right now. It reminds me of the 2000 tech/telecom charade. $200-$240 oil, $1500-$2000-Gold and USDX-40 is being bantered about the message boards. Take a look at Peter Schiff's latest at Europac. His 'cake and eat it too' hypothesis seems to good to be true.

    ReplyDelete
  8. Wall Street come clean and price to market?

    Why on earth would they do that? The Model is now "Mark to What We Need" ...and our friends in DC will let us do as we please. This is so dangerous that words fail me. It lulls everyone into thinking that everything is being managed, that all will be OK. But at some point the problems will become too obvious and the regular people will just have to pay attention.

    Notice how the ripples in the pond are getting bigger and bigger, instead of dying off. Yes, the markets are being stage-managed by the pros, but even they are not gods. Someone important will eventually buckle and ask for his money and then what?

    ReplyDelete
  9. Thanks to all for the feedback about Wall Street coming clean.

    For all this talk among the reformed sinners about the newfound need for "transparency", apparently people on Wall Street may still be bent on pursuing a path of deception and lies.

    As Hellasious said, the whole edifice of debt is based on trust and trust alone (as JP Morgan himself alluded to once). When people finally realize that nothing in the financial world can be trusted, they must default to the most risk averse position--PANIC.

    Bernard

    ReplyDelete
  10. Can someone tell me if this ABCP is rolling over?

    I can't find anything about this on the Internet (which amazes me).

    I read that over $400 billion was scheduled to roll over last week and this week (with the peak hitting today).

    One other question:

    Does anyone know what are the total amount of CDOs outstanding in the world right now?

    I'd really like to know that as well.

    Bernard

    ReplyDelete
  11. Great post as usual and great comments by all...

    Thanks for the reality check....

    I keep forgeting about the Miami condos that I'm so fond of talking about...

    Econolicious

    ReplyDelete
  12. Bernard, re: CDO amounts

    Pls. refer to my post of March 21, 2007 "CDOs By The Numbers". It provides numbers and a reference to SIFMA where you can also get greater detail.

    As for ABCP I believe some demand is coming back to the market because the Fed is expected to cut rates tom. and because those borrowers that can, are providing more info on the underlying collateral to reassure lenders. But no info on amounts, sorry.

    ReplyDelete
  13. Again...I have never seen so many folks on one side of a trade...Long commodities and FX-short USD...This is way beyond the 2000 Tech/Telecom show..This looks and smells like another debacle in the making....

    ReplyDelete
  14. Hi hellasious,

    Would you be able to tell me how to understand this

    http://www.creditflux.com/public/data/leaguetables.htm

    What are the amounts all about? I am getting extremely nervous to-nite.

    ReplyDelete
  15. Francois,

    Whatever that list is, it sure looks like JP Morgan is the hand-down winner of the race. But somehow I suspect that whoever wins this race actually LOSES.

    Thanks to Hellasious for filling me in on the CDOs and ABCP. Looks like there are about $1 trillion in CDOs outstanding right now, as well as $1.2 trillion in ABCP.

    In essence, $2.2 trillion in credit (supposedly AAA-rated) that has been misdirected into funding mortgages, car loans, and credit cards. All for the "benefit" of the US consumer of course.

    Bernard

    ReplyDelete
  16. Looks like hedge funds have borrowed $2 trillion in funds to buy assets (on top of the equity capital they already have from investors).

    This number ranged consistently around $200 billion for a very long time until late 2003.

    Then things changed.

    Here's the link to the chart with the gory details:

    http://www.allaboutalpha.com/blog/2007/04/19/bridgewater-hedge-fund-leverage-now-at-levels-not-seen-since-ltcm/

    I am going to assume that all of that $2 trillion in debt is going to be unwound, which means $2.5 trillion in assets will need to be sold off to pay that off (when the equity capital is factored in).

    Bernard

    ReplyDelete
  17. re: creditflux data

    Synthetic CDOs are not made up of mortgages, bonds, loans or anything like that, but out of CDSs. Fun, eh?

    Morgan invented the whole CDS idea so they have been numero uno for a long time in the field - in this case "long" means around 3-4 years.

    The "league" tables are Wall Street's version of teenager "competitions" about size (you know what I mean). A day does not go by without one of them claiming to be #1 in something...

    Regards

    ReplyDelete
  18. Well, I hope that the UK government is clever enough not to just give money to the banks, but also take some collateral (?) or lend it.

    Giving a blank check to all banks is not wise at all.

    ReplyDelete
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