Great Moments in Public Relations
Posted by Eddy Elfenbein on February 25th, 2008 at 10:51 am

“I’m fairly confident that we’re not going to do anything stupid. We have a history of not doing anything stupid.” Angelo Mozilo, CEO of Countrywide Financial

Countrywide Financial (CFC) had a rough 2007 with the stock being down by 78% and all. So what should a company do? Celebrate, of course!

Countrywide Financial Corp., the nation’s largest mortgage lender by loan volume, will host about 30 representatives of smaller mortgage banks for three nights next week at the Ritz-Carlton Bachelor Gulch ski resort in Avon. At one of the country’s most-glamorous skiing spots, a regular room on a weekday starts at $750.
The first items on the agenda for guests arriving Monday evening are cocktails and ski fittings. Next is dinner at the Spago restaurant, whose menu includes Kobe steak with wasabi potato puree for $105. (For the budget-minded, pan-roasted buffalo filet with Kabocha pumpkin flan is $54.)

Since July, Countrywide has laid off 11,000 people. The company has now said that the ski trip is off.

Junk-Grade Fed?
Posted by Eddy Elfenbein on February 25th, 2008 at 10:06 am

Here’s an interesting editorial today from the New York Sun:

What caught our eye in the markets last week was the verdict by Grant’s Interest Rate Observer that, by its lights, the Federal Reserve Bank of New York was no longer a “presumptive triple-A” credit but rather one of “mid-grade junk” quality. This news didn’t exactly rock the financial world, as Grant’s is no kind of formal rating agency, even it if does have as elite and savvy a readership as any market newsletter could want. It wouldn’t surprise us, though, were people — including some in Congress — soon to sit up and take notice of a worrying set of facts.
Grant’s was reacting to the sudden appearance on the Federal Reserve’s balance sheet of $60 billion in lending under the new Term Auction Facility. The New York Fed’s share of that $60 billion is no less than $44.9 billion. The TAF is a credit facility. Its purpose is to lend to banks under stress in the sub-prime credit crisis. The banks front collateral against which the Fed advances money. “The rub,” Grant’s writes, “is the quality of the collateral.” It quotes a Financial Times interview with one financial strategist, Christopher Wood, as saying that banks “are increasingly giving the Fed the garbage collateral nobody else wants.”
The New York Fed doesn’t seem overly concerned about all this. When our Julie Satow called over to the fortress on Liberty Sreet a spokesman said the bank took the downgrading by Grant’s to be a form of humor. “Reserve banks operate under well-established guidelines regarding margining and collateral,” the spokesman said. However that may be, the Fed’s Web site invites would-be borrowers to submit collateral of decidedly low quality. Against this dubious stuff, the Fed stands ready to lend on highly generous terms — as much as 90 cents on the dollar against “private label” mortgage-backed securities. Unless we have been misreading the papers these past six months, the Fed is alone in assigning that much value to that particular class of mortgage asset.
It’s a little-noted irony that the Federal Reserve, the supposed conscience of the American banking system, is itself an exceedingly highly leveraged institution. At the latest weekly tallying up, $881 billion in assets rested on just $38.5 billion in capital, As for the New York branch office, $312 billion in assets (including those $44.9 billion in TAF credits) were balanced on a little less than $10 billion in capital. The scant showing of capital was of no especial concern when the Fed owned nothing but Treasury securities. But now that it’s in the business of lending against what may well be mongrel mortgages, that extreme leverage introduces real risks. As Grant’s points out, it’s not so farfetched to imagine the Fed itself needing a bailout one of these days. We wonder how a headline on the order of “Fed insolvency fears” would play in the already skittish world currency markets.
* * *
Why not let an independent auditor check up on the value of the collateral that the Fed is so willingly taking aboard? It would not be lost on such an auditor that the New York Fed is, as they say on Wall Street, a kind of “hidden asset story.” It carries slightly more than $4 billion of gold on its balance sheet at the early 1970s price of $42.22 an ounce. At today’s prices, that works out to more than $90 billion. On that basis, as the editor of Grants, James Grant, sketched it for us, “the hometown central bank would be in the clover, credit-wise.” He goes on to say that “the Fed is unlikely to acknowledge the great bull market in gold bullion for the obvious reason that it, itself, is largely the author of it.” Or, to put it another way, if the salvation of the Fed is all the gold it has in its basement, what does that tell us about the monetary system on which the rest of the world is relying?

After Hours: The Carter Family – Are You Lonesome Tonight
Posted by Eddy Elfenbein on February 22nd, 2008 at 5:14 pm

Hacking For Profits
Posted by Eddy Elfenbein on February 22nd, 2008 at 11:26 am

Here’s a strange story. In October, Oleksandr Dorozhko hacked into IMS Health’s computers to get inside information which he used to load up on puts on the company’s stock. He made a killing, about $300,000 off a $41,000 investment.
The SEC tried to block him from taking his profits. A judge has ruled that what he did may be illegal but it’s not insider trading. Dorozhko may face more charges, but for now, he can keep his cash.

The SEC argues that deception was involved in hacking into the computer system, which was designed to allow access only to authorized persons.
That view drew scorn from Charles Ross, Dorozhko’s lawyer, at the appellate court hearing Wednesday. “They want you to believe there is a deception of a computer,” he said. “All there is is a high-tech lock pick.”

The Phillips Curve
Posted by Eddy Elfenbein on February 21st, 2008 at 11:11 am

I’m not much of a believer in the Phillips Curve, the trade-off between employment and inflation, but with all the stagflation talk, it’s worth taking a look.

This data is from 2000 to the present. The X-axis is the unemployment rate and the Y-axis is the trailing 12-month core CPI. The arrow points to the data from January and December.
All the data I used is from the government so consider it at your own risk. Actually, I’m rather surprised by how well the curve holds up, meaning the dots seem to run diagonally from lower right to upper left. (Well, sort of…the R-squared is 0.3734.) If we’re in stagflation, then this relationship should breakdown and the dots would start drifting to the upper right. So far, that isn’t happening.
At least, not yet.

How Does Inflation Impact Stock Prices?
Posted by Eddy Elfenbein on February 20th, 2008 at 1:41 pm

Since the market is digesting a troubling inflation report today, I wanted to look at how inflation impacts the market. I took the inflation-adjusted monthly market returns from 1925 to 2005 (thanks to my Ibbotson Yearbook), resorted them by inflation rate and look at the cumulative return by rate of inflation.
As you might expect, high inflation is bad for equity prices. In fact, the only thing worse for stocks is deflation, which is really, really bad for stocks. Here’s my chart:

Stock returns do very poorly when deflation runs over 5.6% (data points 0 to 68). After that, stocks do quite well up to an inflation rate of 3.1% (data point 490). They then slow down a bit but still climb up to an inflation rate of 5% (data point 698).
Now the trouble starts. Above 5%, stocks flat line up to an inflation rate of 12% (remember, I’m looking at the inflation-adjusted returns). After 12%, things get very ugly and stock returns plunge.
So inflation isn’t good for stocks, but the troubling numbers we’re seeing are still a long way from being a major problem.

Housing Indexes
Posted by Eddy Elfenbein on February 20th, 2008 at 12:59 pm

Calculated Risk has a great post looking at the differences in housing price indexes. As an admitted indexaholic (my name is Eddy, and I’m…), I’m afraid I have to resign myself to the fact that it’s basically impossible to come up with one simple index of house prices.
The Case-Shiller Index has a monthly gauge of prices in 20 major markets. There’s also a quarterly national index. Calculated Risk writes, “OFHEO covers more geographical territory, OFHEO is limited to GSE loans, OFHEO uses both appraisals and sales (Case-Shiller only uses sales), and some technical differences on adjusting for the time span between sales.”
The numbers from Case Shiller have been much gloomier recently. The reason is that lower-priced and non-GSE homes have fallen faster, which is probably because the lending standards were questionable.
As long as home prices were rising, all the lending problems were invisible. Now that prices are falling, the problems are accelerating. The difficulty we’re having is that we’re not exactly sure what home prices, in aggregate, are doing.

Obamanomics
Posted by Eddy Elfenbein on February 20th, 2008 at 12:04 pm

Now that it’s very likely he could become president, what does Barack Obama want for his economic policy? I’m not sure if this is real policy or just pandering.

Mr Obama’s plan would lower the corporate tax rate for companies that met criteria including maintaining their headquarters in the US, maintaining or increasing their US workforce relative to their overseas workforce, holding a neutral position in union drives among their employees and providing decent healthcare.
The lowered rate would be paid for by the abolition of tax breaks that encourage companies to shift jobs overseas. “In the last year alone, 93 plants have closed in Ohio,” Mr Obama said. “And yet, year after year, politicians in Washington sign trade agreements that are riddled with perks for big corporations but have absolutely no protections for American workers.”
Mr Obama’s plan met instant scepticism from otherwise sympathetic Democratic economists who said it would require a large regulatory apparatus to put into practice. They also said that companies could “game the system” by spinning off overseas subsidiaries in order to reduce the offshore-onshore workforce ratio.
They questioned whether it was necessary to provide incentives for employers to provide health insurance since Mr Obama’s healthcare plan would already mandate them to do so. Finally, Mr Obama has already tied up the estimated $10bn (€6.8bn, £5.1bn) in revenues that would be saved from abolishing tax incentives for multinational companies that retain their profits overseas.
“I would say that this plan is borderline unimplementable,” said a Democratic economist in Washington. “It is also puzzling. Normally presidential candidates only come up with plans that are unrealistic when they are losing. But Obama is now the favourite.”

Defaulting Before the Resets
Posted by Eddy Elfenbein on February 20th, 2008 at 10:23 am

One of the big fears over the housing mess is that borrowers would default once their mortgages reset. It turns out, this is happening before the reset:

Defaults for subprime loans issued in 2007 – none of which have reset yet – hit 11.2 percent in November. That represents perhaps 300,000 households, and is twice the default rate that 2006 loans had 10 months after being issued, according to Friedman, Billings Ramsey analyst Michael Youngblood.
Defaults are spiking well before resets come into play thanks to the lax lending environment of the past few years. Many borrowers were approved for mortgages that they had little chance of affording, even at the low-interest teaser rates .
“I was rather shocked by the characteristics of the 2007 loans,” said Youngblood.
Hybrid ARMs start with very affordable fixed-rate terms of two or three years. After that, rates can jump three percentage points or more, and then re-adjust even higher every six months to a year. On a $200,000 mortgage, a reset could add nearly $400 to the monthly mortgage payment.

Today’s Inflation Report
Posted by Eddy Elfenbein on February 20th, 2008 at 9:55 am

Today’s report on consumer prices shows that inflation is a still a problem. The headline rate was 0.4% and the core rate was 0.3%. Both were 0.1% above expectations.

Over the last four years, the headline CPI Index has grown at a 3.3% rate. The Fed Funds rate is currently targeted at 3%.
To put the resurgence of inflation into some perspective, here’s a look at the four-year trailing rate of the core CPI.

The line is clearly moving in the wrong direction, but we’ve seen a lot worse.