Finance
Fed Monkeys
With few exceptions, the Federal Reserve governors have taken the persona of monkeys: speak no evil see no evil hear no evil. Of course the evil here is inflation. And the few who have been brave enough to even raise the topic in their public events are careful to say 'we must be vigilant!' and 'we see it coming down soon!'. We don't have access to LexisNexis to verify but it seems to us that has been the infrequently mentioned party line for over two years.Yesterday brought a shocking revelation (well, the latest installment): inflation is alive and well. The Labor Dept. released the March PPI (producer price index) data and it was a shocker - so much so that most of the 'major' media outlets picked up the story and fretted over the 1.1% headline increase in the cost of finished goods. The Fed crowd of course were quick to say 'food and energy!' and took solace in the 'core' reading of +0.2%. Lost on both groups?
Intermediate goods: +2.3%, core +1.1%Those are month on month changes, not annual.
Crude Goods: +8.0% core +3.5%
This morning saw March CPI up 0.3% while core posted a 0.2% gain, matching market expectations. Consumer prices rose 4% on a year-over-year basis, same as Feb. Core CPI grew 2.4% on an annual basis. Once again, there are those who are pointing to this release as indicating 'inflation is well contained'. Of note, 6 month treasury bills are yielding 1.45%, 2 year notes are 1.85% and 5 year 2.69%. Only 30 year paper trades over the annual inflation rate (based on y/y CPI) at 4.45%.
We ask: How long before the intermediate and crude components of PPI are passed through into CPI? Asked another way, for how long can companies absorb these increases in inputs (by productivity gains we are told) before their margins begin to erode and consequently, earnings?
It was nice to see that former Reaganite Martin Feldstein wrote yesterday in the WSJ that it was time for the Fed to stop cutting rates or risk further fueling commodity inflation while not helping (and probably hurting) the underlying US economy. We here at Rant Street have been saying this for a few years now but better late than never that someone with clout catches on.
UPS and Inventories Trump Citi
The US equity market has looked a little bit tired the past few days and it appears to be giving in to pressure from an earnings warning from shipper UPS as well as economic data on wholesale inventories. Positive news from Citibank - something one would expect to propel a market that has had nothing but 'credit crunch' on its brain for months has so far failed to stem the red prints.The UPS warning should not have been surprising at all in the light of a slowing economy and very high fuel prices. While noting a rise in shipments in January, business has turned down since with a notable decline in higher value shipping services. Perhaps the need for overnight is not so great, especially in the age of the internet (one also has to wonder the effects of the sagging mortgage industry on overnight/two-day packages).
Citibank is said to be close to a deal with private equity firms to take $12 billion of LBO debt off their books at about 90, roughly 30% of the LBO debt they are carrying. This is a positive not just for Citi who will reduce their cash needs but the market as a whole. We seem to have hit a point now where some people are willing to step up and actually buy paper in which they see value. Citi will take a p/l hit but that is a small price to pay to clean up their balance sheet. If/when this deal is finalized, it could open the floodgates as those with cash begin a rush to purchase before these 'values' are snatched up. Whether this will eventually spill over to the CMO market is a good question but any answer is probably at least three months down the road.
People seemed a bit put off by the February wholesale inventory report today, focusing only on the month/month change. On a seasonally adjusted basis Feb. saw sales fall 0.8% and inventories rise 1.1%. Yet looking at the year on year change, sales are up 12.2% while inventories have risen only 7.4% and the inventory/sales ratio is lower at 1.12 vs 07's 1.17 (the numbers on an unadjusted bases are even more positive). Like the UPS warning, a slippage here is not that surprising in the face of a slowing economy but at this point it does not appear alarming and we prefer to focus on a more current release, the retail sales data for March due out next Monday. Market expectations are for a return to positive territory at +0.1% with some looking (hoping?) for a rise as high as 0.4%.
Insolvent or Illiquid?
This headline just crossed the tape: DJN: *DJ Bear's Schwartz: Bank Run Prompted By Unfounded Rumors. Really. Given the significant suspicions behind the moves by the Fed to have JPM take over BSC (as well as take onto its own books $29B in mortgage related assets) it is time for the Fed, BSC and JPM to answer the simple question: What caused BSC to fail over that weekend? Simultaneous to the announcement of JPM taking over BSC, the Fed announced a new lending facility open to all primary dealers, of which BSC was one.CEO Schwartz would like us to believe that BSC was simply illiquid - that they could not raise funds by repo or credit lines or any other means as the counterparts were refusing their name. If that is so, why was the new Fed facility either (a) not available to BSC and/or (b) not sufficiently large to fund BSC until they were able to re-establish their credit worthiness in the market place, either by audit or additional capital injection?
Or was it the case that upon review, the Fed decided that BSC was not just illiquid but that they were for all intents, insolvent too and that any 'value' in the firm - 'goodwill' and the possible excess of assets over liabilities - could not be quickly realized and were not material in light of the size of BSC's balance sheet and funding requirements. In fact, most commentators when speaking of a valuation on BSC placed most of the value on its real estate and the good will of a few specific subunits. There is likely value, though hard to quantify, in the intellectual property of BSC.
We would have preferred to see Wall Street handle the demise of BSC on its own, perhaps with some strong arming by the Fed and Treasury department as happened with LTCM. Had the 'crisis' continued another few days it is likely some solution could have been found, perhaps involving group ownership through a holding company by a large number of banks and brokers thus limiting individual risk while preventing the wholesale liquidation of the assets of BSC.
However, the Fed did what it clearly thought was most prudent at that moment in time. But they have not answered the important question of illiquidity or insolvency. If BSC was simply illiquid then the Fed has gone well out of bounds by picking a winner and loser and forcing the sale of BSC to JPM while offering cash flow to others. The American people and the financial markets in particular, need to know the real answer.
The Fed In Space
On Monday there were a few comments from Treasury Secretary Paulson in regards new regulatory proposals and the potential for increased powers at the Federal Reserve bank. This one in particular:DJN: *DJ Paulson: Fed Should Go Wherever `It Thinks It Needs To Go`got us to thinking.....
queue music...
CDOs...
the final frontier...
these are the voyages of the Starship Fed...
our open-ended mission: To explore strange new structured products
To seek out hidden risk and astronomical losses
To bodly go wherever the fuck we think we need to go!
starring....
Hank Paulson as Capt. Kirk
Ben Berspankme as Spock
Jim Cramer as Dr. McCoy
and an assortment of red shirts from Wall St.
The Doomsday Machine
special guest Alan Schwartz as Commodore Matt Decker
...scene opens on the heavily damaged BSC...
[Kirk] Matt. It's Jim Kirk.
[McCoy] Commodore? Commodore Decker?
[Kirk] Matt? Matt.
[Decker] Kirk. It's Jim Kirk.
[Kirk] What happened to your bank, Matt?
[Decker] My bank ... Attacked! That -- That thing.
[Kirk] What was it?
[Decker] That --
[Kirk] Answer me! What was it? What happened, Matt?
[McCoy] Jim, give him a minute. He's in a state of shock.
[Scotty] Ready with the duplicate log, sir.
[Kirk]Go.
[Matt Decker] CEO's Log -- Feddate 4202.1.
Exceptionally heavy market interference
still prevents our contacting Fedfleet
to inform them of the destroyed CDO tranches we have encountered.
We are now funding CDO L-374.
Risk Management Officer Masada reports the equity tranche is breaking up.
We are going to investigate.
(pause)
The equity tranche. Only two tranches left now.
[Kirk] Scotty, beam the microSD to Spock.
I want a complete report of what happened
when they tried to fund that CDO.
[Decker] We tried to contact Fedfleet.
Uh, no one heard. No one!
We couldn't fund.
[Kirk] What happened to your crew?
[Decker] I had to cut their pay.
We -- We were dead.
No liquidity, our repos useless.
I stayed behind, the last man.
The CEO, the last man in the bank.
That's what you're supposed to do, isn't it?
And then it hit again
and the, uh, credity facility went out.
They were down there, and I'm -- I'm up here.
[Kirk] What hit? What attacked you?
[Decker] They say there's no devil,Jim, but there is.
Right out of hell, I saw it.
[Kirk] Matt, where's your staff?
[Decker] Funding the third trache.
[Kirk] There is no third tranche.
[Decker] Don't you think I know that?
There was, but not anymore.
They called me. They begged me for liquidity,
400 of them! I couldn't. I -- I couldn't.
[Scotty] Captain, Washburn has our report.
[Kirk] Go.
[Scotty] We made a complete check on structured products and CPDO's.
As far as we can tell, something crashed through the debt covenants
and knocked out the credit facilities.
Somehow the liquidity in the short term lines has been deactivated.
[Kirk] Deactivated?
Scotty, could some kind of general liquidity dampening field do that,
and would the same type of thing account for the heavy market interference?
[Scotty] Aye, that all adds up.
[Kirk] What thing could do all that?
[Decker] If you'd seen it, you'd know.
The whole thing must be a weapon.
[Kirk] What does it look like?
[Decker] Well, it's -- it's miles long,
with a maw that could swallow a dozen boutique investment banks.
It destroys collateral and balance sheets, rips them into pieces.
[Kirk] What is it, a commercial bank? Or is it a government agency --
[Decker] Both or neither. I don't know.
[Kirk] Matt, your log stated
that the fourth tranche was breaking up.
You went in to investigate.
[Decker] We saw this thing hovering over the debt,
slicing out chunks with a force beam.
[Kirk] What kind of a beam?
[Decker] Pure anti-liquidity. Absolutely pure.
[Beep Beep]
[Kirk] Kirk here.
[Spock] Spock here, Captain.
Unable to raise Fedfleet Command
due to heavy market interference.
Attempting to remedy.
[Kirk] What about the BSC's tapes?
She was attacked by what appears to be essentially ... a robot,
an automated weapon of immense size and power.
Its apparent function is to smash investment banks to rubble
and then digest the assets for profit.
It is, therefore, self-sustaining
as long as there are investment banks for it to feed on.
[Kirk] A robot weapon that purposely destroys entire financial systems. Why?
[Spock] Unknown, Captain.
