Friday, February 6, 2009
Henry Blodget Jan 6, 09 3:58 PM
Last year, economist Gary Shilling humiliated the rest of the economic forecasting industry by going 13 for 13.
As promised, here are Gary's predictions for this year:
Every one of our 13 investment strategies for 2008 worked last year. Some of them have been fully exploited so we dropped them from this year's list. But others are only partially achieved in view of our dire outlook that the worst global financial crisis and deepest worldwide recession since the 1930s will continue throughout 2009.
So we've retained 10 of our 2008 strategies this year, some in modified form, and added two new ones.
1. Sell homebuilder stocks and bonds.
2. If you plan to sell your house, second home or investment houses anytime soon, do so yesterday.
3. Sell some housing-related stocks.
4. Sell some consumer discretionary spending companies.
5. Sell most commercial real estate.
6. Sell some commodities.
7. Sell emerging market equities.
8. Sell emerging market debt.
9. Buy the dollar.
10. Sell stocks in general. (S&P 500 to 600)
11. Sell consumer lenders’ equities.
12. Buy, carefully, high-grade bonds.
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By Sarah Mulholland
Feb. 5 (Bloomberg) -- Moody’s Investors Service is reviewing the ratings of $302.6 billion in commercial mortgage-backed securities as real-estate values drop and property owners fall behind on payments.
The review encompasses 52 percent of outstanding U.S. commercial mortgage-backed debt ranked by Moody’s, the New York- based ratings company said today in a statement. The ratings of so-called senior and mezzanine AAA bonds, the top two classes of CMBS accounting for about 72 percent of the securities being reviewed, probably won’t be affected, Moody’s said.
The U.S. recession is crimping consumer spending and hurting business growth, making it harder for commercial property owners to make their payments. Should Moody’s decide to cut the ratings, investors including banks and insurers may need to sell CMBS holdings to maintain required levels of capital.
“Property values declined sharply in 2008, and we anticipate further declines over the next 12 to 24 months,” Moody’s analyst Nick Levidy said in the statement. “Delinquencies on CMBS loans are also on the rise, and we expect the pace to accelerate as macroeconomic pressures take a toll on property cash flows.”
Moody’s said it may downgrade the lowest levels of the securities by an average of four to five levels. Many of the securities are trading at levels that already suggest their ratings were lowered.
The gap, or spread, on commercial mortgage-backed bonds relative to benchmark interest rates has soared in the past year on concern that defaults will rise. Top-rated commercial real estate securities are trading at about 10.3 percentage points more than the swap rate, compared with 1.8 percentage points a year ago, Bank of America Corp. data show. The swap rate is currently 3.154 percent.
“This was already a fait accompli in the market,” said David Castillo, a senior trader of structured-finance bonds at Further Lane Securities in San Francisco.
Sales of the securities plummeted to $12.2 billion last year, compared with a record $237 billion in 2007, according to JPMorgan Chase & Co. data.
To contact the reporter on this story: Sarah Mulholland in New York at email@example.com Last Updated: February 5, 2009 16:09 EST
Here we go. Review, Downgrade, Markdown, Bailout. Yee haw! The banks are insolvent dammit. Nationalize them and get this over with. Ofcourse game theory dictates that uncertainty on one hand makes things worse for the economy and on the other hand makes Treasury debt popular. Right now, the Treasury is focused on raising money for the Fed at cheap rates and therefore they'll try to keep certainty from coming back into the market. For now. At some point Obama has to make an executive decision here and say enough with the uncertainty - the damage that is being caused to "animal spirits" in the economy is unacceptable.
Monday, February 2, 2009
Big Risks for U.S. in Trying to Value Bad Bank Assets
As the Obama administration prepares its strategy to rescue the nation’s banks by buying or guaranteeing troubled assets on their books, it confronts one central problem: How should they be valued?
Not just billions, but hundreds of billions of taxpayer dollars are at stake.
The Treasury secretary, Timothy F. Geithner, is expected to announce details of the new plan within weeks. Administration and Congressional officials say it will give the government flexibility to buy some bad assets and guarantee others in an effort to have a broad impact but still tailor the aid for different institutions.
But getting this right will not be easy. The wild variations on the value of many bad bank assets can be seen by looking at one mortgage-backed bond recently analyzed by a division of Standard & Poor’s, the credit rating agency.
The financial institution that owns the bond calculates the value at 97 cents on the dollar, or a mere 3 percent loss. But S.& P. estimates it is worth 87 cents, based on the current loan-default rate, and could be worth 53 cents under a bleaker situation that contemplates a doubling of defaults. But even that might be optimistic, because the bond traded recently for just 38 cents on the dollar, reflecting the even gloomier outlook of investors.
The bond analyzed by S.& P. is just one of thousands that the government might buy or guarantee should it go forward with setting up a “bad bank” that would acquire $1 trillion or more of toxic assets from banks.
The idea is that, free from the burden of carrying these bad assets, banks would start lending again and bolster the faltering economy. The bad bank set up by the government would, over time, sell the assets and recover some or most of what it had paid.
While the government is considering several approaches to helping the banks, including more capital injections, buying or insuring toxic assets is likely to be a centerpiece. Determining the right price for these assets is crucial to success. Placing too low a value would force institutions selling and others holding similar investments to register crushing losses that could deplete their capital and make it harder for them to increase lending.
But inflated values would bail out the companies, their shareholders and executives at the expense of taxpayers, who would swallow the losses if the government could not recoup what it had paid.
Some critics of the plan warn that the government should not buy the assets, because banks will try to get too high a price and leave taxpayers holding the bag.
“To date, the banks have stuck their heads in the sand,” said Lynn E. Turner, a former chief accountant for the Securities and Exchange Commission, “and demanded that they be paid the price of good apples for bad apples.”
But many believe that, given the depth of the problem and the fact that it keeps getting worse, the government has little choice.
Finance experts from Wall Street and academia are advising the administration on other options. To sidestep the thorny valuation problem, some have suggested that the bad bank acquire only assets that have already been marked down significantly and guarantee other assets, but officials would have just as difficult a task in determining how much to charge for insuring risky assets.
Economists predict that the cost of the program will most likely exceed the $350 billion remaining in the $700 billion Troubled Assets Relief Program that Congress approved in October.
They say the Obama administration may need upwards of $1 trillion in additional aid for banks — on top of the more than $800 billion the administration is seeking in an economic stimulus measure moving through Congress.
Many in Washington question whether the rescue has achieved its goal of stabilizing the financial markets. A report by the Government Accountability Office on Friday concluded that whether the bailout program had been effective might never be known.
“While the package helped avoid a financial collapse, many are frustrated by the results — and rightfully so,” President Obama said in hisweekly address on Saturday. “Too often taxpayer dollars have been spent without transparency or accountability. Banks have been extended a hand, but homeowners, students, and small businesses that need loans have been left to fend on their own.”
Mr. Obama and many lawmakers have expressed anger that banks that received the first batch of aid money do not appear to have increased their lending significantly, even as some firms have spent billions on bonuses, corporate jets and other perks. In two weeks the House will hold a hearing to ask chief executives of the eight largest banks about their spending controls.
As early as this week, the Treasury Department may impose new limits on the executive pay of companies receiving financial assistance. The Oversight Panel created by Congress to monitor the program is also expected to publish a report this week looking at whether the government paid too much to the large banks that they have provided with assistance.
A frequent refrain in Washington and on Wall Street is that there are no current market prices for toxic securities. But people who buy and sell these investments say that is a simplistic reading of the problem. They say most kinds of securities can be valued and are being traded, but trading has slowed as sellers and buyers disagree about what that the price should be.
The value of these securities is based on the future cash flow they provide to investors. To determine that, traders have to make assumptions about the housing market and the economy: How high will the unemployment rate go in the coming years? How many borrowers will default? What will homes be worth?
The Standard & Poor’s group, Market, Credit and Risk Strategies, which operates independently from the company’s credit ratings business, has been studying troubled securities for investors and banks. The bond that is trading at 38 cents provides a vivid illustration of the dilemma in valuing these assets.
The bond is backed by 9,000 second mortgages used by borrowers who put down little or no money to buy homes. Nearly a quarter of the loans are delinquent, and losses on defaulted mortgages are averaging 40 percent. The security once had a top rating, triple-A.
Michael G. Thompson, a managing director at the S.& P. group, says his computer models can easily calculate what the bond is worth under different situations. “This is not rocket science, this is straight bond math,” he said. But determining what the future holds is much harder. “We are not masters of the universe who can predict the macroeconomic environment,” he added
Some would-be buyers of these assets fear that a deep recession could drive up default rates and push down home prices much further. They also worry that a cataclysm like the failure of a big bank could send prices tumbling again, just as the collapse of Lehman Brothersdid in September. Others see no reason to bid up prices because those who need to sell are desperate.
Big banks and other owners of mortgage investments have argued that the low market prices reflect fire sales. Many have classified such securities as level-three assets, for which accounting rules allow them to determine values using computer models rather than the marketplace. Mr. Thompson estimates that at the end of September financial firms had $600 billion in such hard-to-value assets.
But critics like Mr. Turner say that the banks’ accounting for these assets cannot be trusted because they have an incentive to use optimistic assumptions.
Policy makers have found such arrangements appealing because they do not require upfront payments and they can be customized for each bank, Douglas J. Elliott, a fellow at the Brookings Institution, wrote in a recent paper.
Still, government guarantees need to be based on sound valuations, Mr. Elliott and others say. If the government underestimates the risks of default, taxpayers could eventually lose tens of billions of dollars. The cost of insuring such assets in the private market is often several times greater than the price the government is charging banks.
Whatever approach the Obama administration takes, investors and policy makers say it should provide more and clearer information about the health of banks and the risks that the government is taking.
Many analysts do not trust what they are told about the quality of the securities and loans held by banks and other financial firms. Most banks provide only a very general description of their holdings, because they consider the information privileged.
But the government, using its power as a big investor, could compel the banks to divulge more specific data, without giving away the names of individual bonds or loans, analysts said. The market could then do its own analysis on what the assets are worth.
“At least it would give the government one objective measure of the value of these assets,” said Anthony Lembke, co-head of investments at MKP Capital Management, a hedge fund firm that is a big investor in mortgages. “In the absence of transparency and clarity, investors are going to assume a value that will be conservative and then add a risk premium.”