Liquidity Liquidity Everywhere

[rowdyroddypiper]

" The (data) miners on strike?"



I've actually been listening to the Mekons Fear and Whiskey on a steady loop for the past three months so miner strikes abound.



Anyway, call me a cynic or a fool or what have you but I'm just not scared yet.  I mean is there a reasonable estimate for how much loss we think is baked into the US sub-prime market?  Is it $100bn., $200bn., something higher?  These definitely sound like really big numbers and they are, but insurance payouts from 9/11 and Katrina were also really big and also expected to trigger extreme financial difficulty.  I think at the end of the day, a couple of guys got torpedoed and everyone else went along their merry way albeit at a lower pace.  There are definitely going to be some portfolios that are over exposed and are going to get croaked, but for a majority of the owners of this stuff it's just going to prove to be noise. 



I can see the argument that a reduction in the personal balance sheet triggers a slowdown in consumption which cascades into a whole bunch of other shit, but a lot of men smarter and more hardworking than I am have bled out predicting the death of the American consumer. 



"Sure, structured finance is in the crapper, but why would the Fed want to bring that back, with all the implications of losing control of the credit creation process"



Very good point.  Maybe they are getting bored with inflation as their arch-nemesis and need to move onto something more.....evil.

[Martingale]

what are the typical syndrome of 70s and 80s? I was mainly play mud clay those days. By the way, RRP, have you changed scenary or just took a long vocation?

[AndyM]

[i]I can see the argument that a reduction in the personal balance sheet triggers a slowdown in consumption which cascades into a whole bunch of other shit, but a lot of men smarter and more hardworking than I am have bled out predicting the death of the American consumer.[/i] 



Very true. Many people, myself included, have been banging the drum (unprofitably) for the demise of the US consumer for some considerable time. Many have been stopped out, or become convinced that the US consumer is some sort of juggernaut, or at least a Timex...takes a licking and keeps on ticking.



However, in the immortal words of Herb Stein, if something cannot continue, it will stop. With the housing mkt looking tapped out, perhaps now is the time to revisit the possibility that gravity still operates in the financial sphere.



Re the absolute size of subprime losses, I see this as irrelevant to the big picture. How big was the Russia default? How big was LTCM? Doesn't really matter. What matters is where the linkages and fault lines are.



What's important going forward is the quantity and price that the marginal lender will charge to the marginal borrower, and this is only secondarily a function of capital adequacy and primarily a function of animal spirits. And while $200bn may not be a lot of money (relative to what?), its a hell of a lot of money compared to what the lenders stood to make on the deals, which is perhaps the relevant comparison when assessing how quickly they'll put their hands back into their pockets.



Also, its extremely implausible that subprime is some sort of rogue outlier. Credit quality of new issues deteriorates over the course of the cycle, and we've just had a super cycle. Subprime has been a particularly graphic example of how this can play out, but I see it as merely a symptom of something much larger.



This stylised fact has been known for some time, and is a standard feature of credit cycles.



"The history of business cycles shows that the stage of prosperity in general is marked by an ever-increasing inefficiency. In the field of secirity investment, the buying public, swayed by overoptimism, seeks more and more after securities of higher yield, and investment bankers, under the stress of competition, issue securities of higher yield, greater risk, and poorer quality" - George Edwards, Harvard Business review, 1933



...to which one may add, in this cycle, "at ever tighter spreads". There's no way to ringfence subprime; all classes of credit will have gone through the same process.

[Johnny]

yeah, what AndyM said. Smiley

[sfca]

Predicting an increasing probability of a recession was and is correct.  However, good analysts get punished for being good analysts.  For example, diving into the data and looking at the personal savings rate going negative in the last two years was one of many red flags that recession forecasts were based upon.  But then the BEA just waved it all away with their annual revisions and now we have a happy positive saving rate for those years.  Like magic!  And those rates were revised up with other indicators that analysts were looking at that previously pointed to recession.  It greatly complicates economic forecasting when the numbers cannot be trusted, as Larry Meyer points out in his book on the Fed.

[Energetic]

[i]Re the absolute size of subprime losses, I see this as irrelevant to the big picture. How big was the Russia default? How big was LTCM? Doesn't really matter. What matters is where the linkages and fault lines are.[/i]



I disagree. Size matters, except maybe for the very short term. In the presence of sufficient stimuli the linkages will be relinked and fault lines will be patched up.



[i]What's important going forward is the quantity and price that the marginal lender will charge to the marginal borrower, and this is only secondarily a function of capital adequacy and primarily a function of animal spirits.[/i]



That's right. But these marginals will become different entities. The end result may not be too different.

[rowdyroddypiper]

"Re the absolute size of subprime losses, I see this as irrelevant to the big picture. How big was the Russia default? How big was LTCM? Doesn't really matter. What matters is where the linkages and fault lines are."



Agreed.  But I don't think LTCM and Russian debt defaults set off a period of prolonged darkness.  To get my position out as concisely as possible; I think we're in a spot of trouble but we're likely to come through this with bumps and bruises like before, rather than hooked to a respirator. 



People have been declaring credit dead since at least the time of this 18th century german wood carving.  As you've said it's cyclical and we are heading into the tightening phase.  I don't think this is a terrible thing and I don't feel it portends economic doom.  The thing that amazes me about subprime at this point is not the number of defaults but the number of wholly unqualified borrowers that are still holding on.  Maybe once all the rate resets hit we'll have a problem, but I'm a glass half full guy if you couldn't tell.

[AndyM]

[i]To get my position out as concisely as possible; I think we're in a spot of trouble but we're likely to come through this with bumps and bruises like before, rather than hooked to a respirator.[/i] 



You're probably right, but what turns bumps and bruises into severed limbs is leverage, and there's no shortage of that around.

[kr]

If you want to point to size, then losses on subprime are not really the place to start... Stalled CP volume is well more than that - which I state without checking b/c I know the central banks have pumped out well over 200bn trying to get a little more fiber in the system.



I also believe animal spirits in the form of expectations are on the move and just like you're not supposed to fight the Fed, I would not fight the negative consumer sentiment and positive inflation expectations that start to take hold in this environment. And what is going on in the banks - as many here can attest to - is a bit worrying. Right now it is manageable, but if it took another jump up I think somebody would get carted od teh bund oday.

[rowdyroddypiper]

Right, it's somewhere between 200bn and 1.7Tn.  However, I'm not viewing stalled CP as the canary in the coal mine.  There was/is a lot of concern about how liquid this stuff actually is.  People knew that one or two of these things would hit some problems rolling, they just didn't expect all of them to.  That's a liquidity problem, not necessarily a problem with the structure or collateral.  Now when your main function is to provide liquid investment and you hit a liquidity problem, it may be time to sharpen your pencil and see if your product makes any sense, but I don't think people are going to get torched on this going forward.



What's got you freaked out about banks?  I have a long list so just trying to narrow it down.  In CP space, this is definitely a case of them biting off more than they bargained for inre: liquidity provision.  In generally just doing business as a banker, the fact that the risk managers seem to have wrested the steering wheel from the bankers has me a little concerned.  There's quite a bit of outrageous marking going on.  I mean how do you get put back 15 points on a loan with a 2 duration?