stock decline from 42.08 to 37.73 during the time frame in question over a 10% haircut
------------------------------------------------------------------------------
Citi's giant write-downs: What did it know, and when did it know it?
The banking company seems to have taken a looong time in announcing its big news.
By Carol Loomis, Fortune senior editor at large
November 11 2007: 8:59 PM EST
(Fortune) -- Facts coming out in the media, including those in a Fortune article being released with this online posting make it clear that Citigroup delayed for more than a week - from Saturday, October 27th until Sunday, November 4th - in announcing material information about the multi-billion-dollar write-downs it expects to record in this quarter. In the more than a week that passed, there were five trading days - October 29th through November 2nd - in which investors buying and selling Citigroup (Charts, Fortune 500) stock did not know that the write-downs were coming.
Withholding material facts from the investing public makes a company vulnerable to shareholder lawsuits. Securities laws specify that material information must be released on a "rapid and current basis," which is defined as four business days.
On Saturday, November 10th, Fortune sent an email to Citi, asking for a response to the magazine's intention to publish this online article, whose point would be that Citi's delay in announcing its impending write-downs did not conform to the rules concerning material information. The e-mail laid out the chronology and facts that led Fortune to believe that was true.
Does Citi have a capital crisis?
Citi, speaking through Leah Johnson, senior vice president for global corporate affairs, replied on the same day by saying, "We complied with all applicable legal requirements." Citi challenged one fact - we'll get to that. And Johnson made this summation about Citi's estimate that it would record huge write-downs of $8 billion to $11 billion on subprime-related securities in this quarter: "We felt it would be irresponsible to make a public statement about the problem until we had a sufficient level of confidence about the range. As soon as we had that level of confidence, we released the range. Both internal and outside counsel were involved in every step of the process."
It is interesting that even when Citi finally released its range on Sunday, November 4th, it was so wide that it did not suggest a high level of confidence. Speaking to analysts the next day, Gary Crittenden, Citi's chief financial officer, stressed that even the $8 billion to $11 billion range is uncertain because market events could change valuations.
The after-tax effect of the amounts Citi announced would be $5 billion to $7 billion. The lower amount would probably wipe out most of Citi's earnings for this quarter. The higher amount would probably push Citi to a loss.
The controversy here concerns what happened - and didn't - in the 11 days leading up to that Sunday, November 4th bombshell, whose power was magnified by the concurrent news that CEO Charles "Chuck" Prince was resigning. Fortune is aware of what happened on the first few days because of information given it by Citi CFO Crittenden in an interview for the Rubin article mentioned above
Crittenden says that he and other Citi executives met late on Thursday, October 25th to consider downgrades that had recently been issued by ratings agencies and to determine how these changes would affect the value of collateralized debt obligations (CDOs) that Citi held. The Citi group concluded unhappily that significant write-downs would be necessary - a huge blow considering that Citi had announced third-quarter write-downs of CDOs on October 15th and had thought it was past that problem. The group also concluded that it could not determine an estimate for the write-downs until it studied the matter further.
On the next day, Friday, Crittenden told Prince, without specifying any amounts, that significant write-downs would be required. Then, on Saturday, Crittenden and his group bore down on the details and arrived at a range of what the write-downs would be. In response to a Fortune question, Crittenden declined to say what the range was.
Credit crunch, Act 2
But, according to a Wall Street Journal article published a few days ago, Crittenden did tell Prince on that Saturday what the expectation was - "some $10 billion." Fortune included this fact and figure in the e-mail it sent to Citi asking for its response. The answer that came back did not deny that Crittenden relayed that information to Prince.
Citi did, however, say that it was not correct, as the Wall Street Journal reported in the lead of its story, that Crittenden had spoken with Sandy Weill, Citi's former CEO and current senior advisor, on that fateful Saturday, October 27th, to tell him that "Citigroup was facing billions of dollars of new losses." Citi's spokeswoman, Johnson, also said that "We are not aware that anyone spoke to Sandy."
A further fact about either that Saturday, October 27th, or the next day - this is reported in Fortune's Rubin article - is that Chuck Prince called Bob Rubin to tell him about the losses and say that the CEO thought the only "honorable" action for him to take was to resign. Obviously Prince would not have been expecting to take this drastic step if the expected write-downs were not large.
It is just as obvious that Citi, having determined a probable range for the write-downs, could have announced that information on Sunday, October 28th - one week before it did. It is Fortune's conjecture that the company did not make the announcement because of its totally uncertain management situation: Prince was determined to resign because of the new write-downs, and Citi had no person to pop into his place.
That situation changed during the following week, as plans developed for Sir Winfried Bischoff to become interim CEO and for Rubin to take over as chairman. Rubin did not agree to accept that post until Friday, November 2nd. His assent very probably cleared the way for the bombshell two days later.
But a wish by Citi to make its announcements in an orderly and packaged way, if that was the case, would not seem to excuse it from the need to release material financial news in a "rapid and current" manner.
------------------------------------------------------------------------------
Citi's giant write-downs: What did it know, and when did it know it?
The banking company seems to have taken a looong time in announcing its big news.
By Carol Loomis, Fortune senior editor at large
November 11 2007: 8:59 PM EST
(Fortune) -- Facts coming out in the media, including those in a Fortune article being released with this online posting make it clear that Citigroup delayed for more than a week - from Saturday, October 27th until Sunday, November 4th - in announcing material information about the multi-billion-dollar write-downs it expects to record in this quarter. In the more than a week that passed, there were five trading days - October 29th through November 2nd - in which investors buying and selling Citigroup (Charts, Fortune 500) stock did not know that the write-downs were coming.
Withholding material facts from the investing public makes a company vulnerable to shareholder lawsuits. Securities laws specify that material information must be released on a "rapid and current basis," which is defined as four business days.
On Saturday, November 10th, Fortune sent an email to Citi, asking for a response to the magazine's intention to publish this online article, whose point would be that Citi's delay in announcing its impending write-downs did not conform to the rules concerning material information. The e-mail laid out the chronology and facts that led Fortune to believe that was true.
Does Citi have a capital crisis?
Citi, speaking through Leah Johnson, senior vice president for global corporate affairs, replied on the same day by saying, "We complied with all applicable legal requirements." Citi challenged one fact - we'll get to that. And Johnson made this summation about Citi's estimate that it would record huge write-downs of $8 billion to $11 billion on subprime-related securities in this quarter: "We felt it would be irresponsible to make a public statement about the problem until we had a sufficient level of confidence about the range. As soon as we had that level of confidence, we released the range. Both internal and outside counsel were involved in every step of the process."
It is interesting that even when Citi finally released its range on Sunday, November 4th, it was so wide that it did not suggest a high level of confidence. Speaking to analysts the next day, Gary Crittenden, Citi's chief financial officer, stressed that even the $8 billion to $11 billion range is uncertain because market events could change valuations.
The after-tax effect of the amounts Citi announced would be $5 billion to $7 billion. The lower amount would probably wipe out most of Citi's earnings for this quarter. The higher amount would probably push Citi to a loss.
The controversy here concerns what happened - and didn't - in the 11 days leading up to that Sunday, November 4th bombshell, whose power was magnified by the concurrent news that CEO Charles "Chuck" Prince was resigning. Fortune is aware of what happened on the first few days because of information given it by Citi CFO Crittenden in an interview for the Rubin article mentioned above
Crittenden says that he and other Citi executives met late on Thursday, October 25th to consider downgrades that had recently been issued by ratings agencies and to determine how these changes would affect the value of collateralized debt obligations (CDOs) that Citi held. The Citi group concluded unhappily that significant write-downs would be necessary - a huge blow considering that Citi had announced third-quarter write-downs of CDOs on October 15th and had thought it was past that problem. The group also concluded that it could not determine an estimate for the write-downs until it studied the matter further.
On the next day, Friday, Crittenden told Prince, without specifying any amounts, that significant write-downs would be required. Then, on Saturday, Crittenden and his group bore down on the details and arrived at a range of what the write-downs would be. In response to a Fortune question, Crittenden declined to say what the range was.
Credit crunch, Act 2
But, according to a Wall Street Journal article published a few days ago, Crittenden did tell Prince on that Saturday what the expectation was - "some $10 billion." Fortune included this fact and figure in the e-mail it sent to Citi asking for its response. The answer that came back did not deny that Crittenden relayed that information to Prince.
Citi did, however, say that it was not correct, as the Wall Street Journal reported in the lead of its story, that Crittenden had spoken with Sandy Weill, Citi's former CEO and current senior advisor, on that fateful Saturday, October 27th, to tell him that "Citigroup was facing billions of dollars of new losses." Citi's spokeswoman, Johnson, also said that "We are not aware that anyone spoke to Sandy."
A further fact about either that Saturday, October 27th, or the next day - this is reported in Fortune's Rubin article - is that Chuck Prince called Bob Rubin to tell him about the losses and say that the CEO thought the only "honorable" action for him to take was to resign. Obviously Prince would not have been expecting to take this drastic step if the expected write-downs were not large.
It is just as obvious that Citi, having determined a probable range for the write-downs, could have announced that information on Sunday, October 28th - one week before it did. It is Fortune's conjecture that the company did not make the announcement because of its totally uncertain management situation: Prince was determined to resign because of the new write-downs, and Citi had no person to pop into his place.
That situation changed during the following week, as plans developed for Sir Winfried Bischoff to become interim CEO and for Rubin to take over as chairman. Rubin did not agree to accept that post until Friday, November 2nd. His assent very probably cleared the way for the bombshell two days later.
But a wish by Citi to make its announcements in an orderly and packaged way, if that was the case, would not seem to excuse it from the need to release material financial news in a "rapid and current" manner.
china can't find a bid yet....4.48% haircut
getting interesting
can follow the action here
http://www.sse.com.cn/sseportal/en_us/ps/home.shtml
getting interesting
can follow the action here
http://www.sse.com.cn/sseportal/en_us/ps/home.shtml
uh oh big yen spike just now
:monsters-
here's wealth destruction in real time romo :missingte
http://finance.yahoo.com/intlindices?e=asia
well some quotes are lagged not real time
:monsters-
here's wealth destruction in real time romo :missingte
http://finance.yahoo.com/intlindices?e=asia
well some quotes are lagged not real time
well looks like yen buying has subsided after some consolidation still find it comical how dependent world markets are on yen currency movements
think that'll about do it for the asia markets tonight 3-4% haircut with a possible rebound of some sort before the night is out....although china down 5% now i suppose
sleep tight bullies
think that'll about do it for the asia markets tonight 3-4% haircut with a possible rebound of some sort before the night is out....although china down 5% now i suppose
sleep tight bullies
:monsters- getting comical on the banking front
honestly i'd think this article was written by onion or something
--------------------------------------------------------------------------------
Citigroup, Banks Reach Agreement on `Super SIV,' Person Says
By Elizabeth Hester and Bradley Keoun
<!-- WARNING: #foreach: $wnstory.ATTS: null at /bb/data/web/templates/webmacro_en/20601087.wm:266.2 --> <!-- WARNING: #foreach: $wnstory.ATTS: null at /bb/data/web/templates/webmacro_en/20601087.wm:280.19 --> Nov. 12 (Bloomberg) -- Citigroup Inc., Bank of America Corp. and JPMorgan
Chase & Co., the three largest U.S. banks, reached an agreement on the structure of an $80 billion fund to help unfreeze the market for short-term
debt, a person familiar with the talks said yesterday.
Bankers working on the deal met at Bank of America's offices in New York
on Nov. 9 and settled on a simpler plan than initially proposed last month, according to the person, who declined to be named because the agreement
isn't public. Under the original plan brokered by Treasury Security Henry Paulson, the fund would buy some of the $320 billion in assets held by so-called structured-investment vehicles, known as SIVs.
A term sheet may be ready in as few as two weeks, once ratings
companies evaluate the super-SIV and the banks obtain tax and legal opinions, the person said. The plan still has to win the confidence of investors, who may remain leery of assets whose market value has tumbled, said Graham Fisher & Co. managing director Josh Rosner.
``The whole thing is flawed,'' said Rosner, whose New York- based firm analyzes structured finance and real estate investments. ``As opposed to recognizing losses, we're trying to roll those losses into the future, regardless of the sanity or safety and soundness of doing that.''
Citigroup spokeswoman Danielle Romero-Apsilos and JPMorgan spokesman Brian Marchiony declined to comment. Both firms are based in New York. Scott Silvestri, a spokesman for Charlotte, North Carolina-based Bank of America, said he had no immediate comment. The New York Times reported yesterday that the banks had reached the agreement.
Borrow Short, Buy Long
SIVs borrow in the short-term commercial paper market to invest in longer-dated securities ranging from mortgage bonds to bank debt. SIV assets have dwindled by at least $75 billion since July as the companies struggled to raise short-term debt, according to data compiled by Bloomberg.
The net asset value of SIVs has fallen to 71 percent of initial capital from 102 percent in June, Moody's Investors Service said last week. Net asset value measures the difference between SIV assets and liabilities, expressed as a percentage of its capital.
Paulson told reporters in Washington on Nov. 9 that he expected the SIV
fund to be in place by the end of the year.
``I'm saying that from the postings I get,'' he said.
JPMorgan Chief Executive Officer Jamie Dimon said two days earlier that the
banks were working to meet that goal. Credit strategists including Vishwanath Tirupattur at Morgan Stanley and Christian Stracke at CreditSights Inc. in London have said they're skeptical banks will be able to convince SIV debt holders to participate in the fund.
Diminishing Access
An SIV needs the approval of three-quarters of its senior debt holders before it can sell assets to the fund, analysts say. The structure for the super-SIV that the banks agreed to Nov. 9 may lower that requirement, according to the person briefed on the discussions. The fund may also impose fees of as much as 100 basis points, or 1 percentage point, the person said.
SIVs, pioneered by Citigroup in the 1980s, sold commercial paper to fund purchases of assets including collateralized-debt obligations that have slid in value as mortgage defaults rose. The companies' access to funding slumped as the asset-backed commercial paper market shrank for 12 straight weeks.
The creation of the new fund, known as the master liquidity enhancement conduit, or M-LEC :missingte , preceded the resignations of Citigroup CEO Charles Prince and his counterpart at Merrill Lynch & Co., Stan O'Neal. Both were forced to step down after their companies disclosed at least $19 billion of writedowns, mostly from bonds linked to subprime mortgages.
Citigroup's SIVs
Citigroup took action on Nov. 5 to shore up its SIVs. The New York-based bank provided $7.6 billion of emergency financing to the seven SIVs it runs after they were unable to repay maturing debt.
Moody's said Nov. 7 that it downgraded or placed on review for a downgrade the credit ratings on debt sold by 16 SIVs that manage $33 billion.
honestly i'd think this article was written by onion or something
--------------------------------------------------------------------------------
Citigroup, Banks Reach Agreement on `Super SIV,' Person Says
By Elizabeth Hester and Bradley Keoun
<!-- WARNING: #foreach: $wnstory.ATTS: null at /bb/data/web/templates/webmacro_en/20601087.wm:266.2 --> <!-- WARNING: #foreach: $wnstory.ATTS: null at /bb/data/web/templates/webmacro_en/20601087.wm:280.19 --> Nov. 12 (Bloomberg) -- Citigroup Inc., Bank of America Corp. and JPMorgan
Chase & Co., the three largest U.S. banks, reached an agreement on the structure of an $80 billion fund to help unfreeze the market for short-term
debt, a person familiar with the talks said yesterday.
Bankers working on the deal met at Bank of America's offices in New York
on Nov. 9 and settled on a simpler plan than initially proposed last month, according to the person, who declined to be named because the agreement
isn't public. Under the original plan brokered by Treasury Security Henry Paulson, the fund would buy some of the $320 billion in assets held by so-called structured-investment vehicles, known as SIVs.
A term sheet may be ready in as few as two weeks, once ratings
companies evaluate the super-SIV and the banks obtain tax and legal opinions, the person said. The plan still has to win the confidence of investors, who may remain leery of assets whose market value has tumbled, said Graham Fisher & Co. managing director Josh Rosner.
``The whole thing is flawed,'' said Rosner, whose New York- based firm analyzes structured finance and real estate investments. ``As opposed to recognizing losses, we're trying to roll those losses into the future, regardless of the sanity or safety and soundness of doing that.''
Citigroup spokeswoman Danielle Romero-Apsilos and JPMorgan spokesman Brian Marchiony declined to comment. Both firms are based in New York. Scott Silvestri, a spokesman for Charlotte, North Carolina-based Bank of America, said he had no immediate comment. The New York Times reported yesterday that the banks had reached the agreement.
Borrow Short, Buy Long
SIVs borrow in the short-term commercial paper market to invest in longer-dated securities ranging from mortgage bonds to bank debt. SIV assets have dwindled by at least $75 billion since July as the companies struggled to raise short-term debt, according to data compiled by Bloomberg.
The net asset value of SIVs has fallen to 71 percent of initial capital from 102 percent in June, Moody's Investors Service said last week. Net asset value measures the difference between SIV assets and liabilities, expressed as a percentage of its capital.
Paulson told reporters in Washington on Nov. 9 that he expected the SIV
fund to be in place by the end of the year.
``I'm saying that from the postings I get,'' he said.
JPMorgan Chief Executive Officer Jamie Dimon said two days earlier that the
banks were working to meet that goal. Credit strategists including Vishwanath Tirupattur at Morgan Stanley and Christian Stracke at CreditSights Inc. in London have said they're skeptical banks will be able to convince SIV debt holders to participate in the fund.
Diminishing Access
An SIV needs the approval of three-quarters of its senior debt holders before it can sell assets to the fund, analysts say. The structure for the super-SIV that the banks agreed to Nov. 9 may lower that requirement, according to the person briefed on the discussions. The fund may also impose fees of as much as 100 basis points, or 1 percentage point, the person said.
SIVs, pioneered by Citigroup in the 1980s, sold commercial paper to fund purchases of assets including collateralized-debt obligations that have slid in value as mortgage defaults rose. The companies' access to funding slumped as the asset-backed commercial paper market shrank for 12 straight weeks.
The creation of the new fund, known as the master liquidity enhancement conduit, or M-LEC :missingte , preceded the resignations of Citigroup CEO Charles Prince and his counterpart at Merrill Lynch & Co., Stan O'Neal. Both were forced to step down after their companies disclosed at least $19 billion of writedowns, mostly from bonds linked to subprime mortgages.
Citigroup's SIVs
Citigroup took action on Nov. 5 to shore up its SIVs. The New York-based bank provided $7.6 billion of emergency financing to the seven SIVs it runs after they were unable to repay maturing debt.
Moody's said Nov. 7 that it downgraded or placed on review for a downgrade the credit ratings on debt sold by 16 SIVs that manage $33 billion.
Pretty good article
Money is Also Destroyed
by Michael Nystrom, MBA
July 20, 2007
If money can be created from thin air, the opposite is also true: it can be destroyed as well. Usually it is the Federal Reserve System that does the creating, but the destruction comes by other means. Bear Stearns’ hedge fund investors have found this out the hard way. Two of its funds recently went belly up, taking 100% of investors’ capital with them. One of the funds, the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage fund, reported $638 million of investor capital in the first quarter. Today nothing remains.
How can money so quickly and effectively be destroyed? To understand this, we have to understand how the money was created in the first place. According to news reports, the underlying securities in the hedge fund in question were subprime mortgages.
Mr. Jones Takes out a Sub Prime Loan
Let’s say it’s 2003, and Mr. Jones, who has less than stellar credit wants to buy a house. He goes to the bank to get a mortgage. The conventional wisdom is that the bank loans him money so he can buy the house. In reality, Mr. Jones is actually borrowing the money from himself, -- or rather against his own future earnings. The bank simply facilitates the real estate transaction between him and the house seller. It does this by writing a note that says ‘we’ve loaned Mr. Jones X dollars and he’s promised to pay us the money back over 30 years. We are holding his house as collateral until the money is paid back.’ This note is called the mortgage, and it becomes the bank’s asset. Under Federal Reserve rules, it can use this asset to create the money to pay the seller of the house.
In reality, the bank has no money, and the mortgage has value only because of Mr. Jones’s promise to pay back the money. As long as Mr. Jones’s promise is good, the mortgage will retain its value and the bank can sell it to another investor – for example a hedge fund.
The Hedge Fund Buys Mr. Jones’s Mortgage
The hedge fund bought thousands of mortgages like Mr. Jones’s, with the hope of collecting a steady stream of income as borrowers paid off their mortgages. That sounded like a good idea, and a solid bet. People traditionally are very good about paying their mortgages back. No one, after all, wants to lose their home. In fact, it sounded like great idea – so great in fact, that Bear Stearns took the $638 million of its investors money, borrowed $10 billion more, (yes, that is a b) and put it all into subprime mortgages.
Mr. Jones Defaults
As it turned out, Mr. Jones, and many more like him were unable to keep their promises to pay the money back. Maybe Mr. Jones lost his job in this terrible economy; maybe he got sick and couldn’t work; maybe he didn’t understand that his mortgage payment was going to jump to something he couldn’t afford; maybe he thought he could sell the house for more money, and never expected to hold on to it this long; maybe he just wasn’t a good credit risk to begin with.
Whatever the reason, Mr. Jones and millions like him had to break their promises about paying back the loans. In the end they’ll just give their keys back to the bank and say, “Thanks, but no thanks. I can’t afford it.”
The banks in turn will say, “Don’t give us the keys. We sold your mortgage a long time ago. We don’t even know who owns your mortgage now, and frankly we don’t care.”
Until now, his debt was an asset of the fund, and was being used as collateral against loans ten times its value. But the moment that Mr. Jones gave up on the idea of home ownership, the value of his mortgage simply disappeared. The paper asset, which derived its value from Mr. Jones’s promise, was destroyed. This had a cascading effect, since Mr. Jones’s mortgage was being used as collateral to borrow money to buy even more subprime mortgages, many of which were also defaulting. Assets purchased on borrowed money were now worthless. Only the debts remained, and suddenly there was more debt than the original amount that investors had put into the fund. These original funds would be needed repay the debts incurred by the fund. Nothing is left to return to investors. This is the process by which money is destroyed.
What about the houses, you ask? Yes, they have some value, but not nearly as much as when they were first purchased. Again, it was not the houses that had the value, it was Mr. Jones promise to pay a steady stream of high interest income over 30 years that was valuable to investors.
American Dream, Up in Smoke
Not only is the money gone, but so are the dreams of those millions of homeowners. The decision to purchase a home is not made lightly, and is usually accompanied by great hope and optimism. Defaults are the opposite. As the collective mood of millions of people like Mr. Jones, (not to mention the investors in the hedge funds who also lost everything) shifts from exuberance and optimism to negativity and pessimism, it is reflected in the larger economy as financial losses. This is a major aspect of the Wave Principle, which predicts tough times ahead.
Inflation and Deflation
The Federal Reserve System has systematically inflated the money supply since 1987, causing tremendous inflation. Along the way, money has also been destroyed, most memorably during the dot.com collapse of 2000-2003. This process of destruction is part of the reason why the economy has not experienced true hyperinflation.
In fact, a key point here is that the Fed is not really creating money, but credit. In truth, money is a physical commodity. Credit is simply the ability to buy something. Today credit functions as money, so it is difficult to tell the difference, but this was not, and will not always be the case.
If the Fed had actually printed bills (rather than made electronic book entries) for each dollar it created, those dollars would still be circulating in the economy and inflation would be much higher. As it is, the Fed can create credit, and those closest to the source of that credit creation – banks and government contractors – reap the greatest benefits. As the credit works its way through the system, it 1) causes general inflation, and 2) finds its way into weaker, less experienced hands – the likes of Mr. Jones and his subprime mortgage, or the average investor chasing internet stocks. In these weak hands, it can easily be manipulated to destruction.
Through this process of destruction, runaway money supply growth can be controlled. But if the destruction process gets out of hand, it is possible that we could see the reverse of what we have seen over the past twenty years – a prolonged period of sustained deflation. This could happen if people’s preference for assets over debt shifts along with the social mood. Recall that the value of paper assets is only as good as the promise standing behind them. Bear Stearns promise to investors rested on the promises of millions of people like Mr. Jones to continue paying their mortgages. Its not that they didn’t want to pay; economic conditions and the way the mortgages were written made sure that they couldn’t. If people like Mr. Jones become unwilling or unable to borrow, and if hedge fund investors who lost everything become to skittish about borrowing, the Fed will have a more difficult time increasing the money supply, since all credit creation today comes via debt creation.
The most recent issue of the Elliott Wave Financial Forecast, which remains a steadfast proponent of deflation, (available here, sign in required) made this observation earlier this month:
In his most recent testimony before Congress, Chairman Bernanke reiterated that inflation is the Fed’s foremost concern. For the time being, the Fed is holding interest rates steady. If it can hold the line, and allow the market to continue on its destructive path, inflation can be contained. The risk is that the destruction gets out of hand, and becomes full blown deflation.
Money is Also Destroyed
by Michael Nystrom, MBA
July 20, 2007
If money can be created from thin air, the opposite is also true: it can be destroyed as well. Usually it is the Federal Reserve System that does the creating, but the destruction comes by other means. Bear Stearns’ hedge fund investors have found this out the hard way. Two of its funds recently went belly up, taking 100% of investors’ capital with them. One of the funds, the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage fund, reported $638 million of investor capital in the first quarter. Today nothing remains.
How can money so quickly and effectively be destroyed? To understand this, we have to understand how the money was created in the first place. According to news reports, the underlying securities in the hedge fund in question were subprime mortgages.
Mr. Jones Takes out a Sub Prime Loan
Let’s say it’s 2003, and Mr. Jones, who has less than stellar credit wants to buy a house. He goes to the bank to get a mortgage. The conventional wisdom is that the bank loans him money so he can buy the house. In reality, Mr. Jones is actually borrowing the money from himself, -- or rather against his own future earnings. The bank simply facilitates the real estate transaction between him and the house seller. It does this by writing a note that says ‘we’ve loaned Mr. Jones X dollars and he’s promised to pay us the money back over 30 years. We are holding his house as collateral until the money is paid back.’ This note is called the mortgage, and it becomes the bank’s asset. Under Federal Reserve rules, it can use this asset to create the money to pay the seller of the house.
In reality, the bank has no money, and the mortgage has value only because of Mr. Jones’s promise to pay back the money. As long as Mr. Jones’s promise is good, the mortgage will retain its value and the bank can sell it to another investor – for example a hedge fund.
The Hedge Fund Buys Mr. Jones’s Mortgage
The hedge fund bought thousands of mortgages like Mr. Jones’s, with the hope of collecting a steady stream of income as borrowers paid off their mortgages. That sounded like a good idea, and a solid bet. People traditionally are very good about paying their mortgages back. No one, after all, wants to lose their home. In fact, it sounded like great idea – so great in fact, that Bear Stearns took the $638 million of its investors money, borrowed $10 billion more, (yes, that is a b) and put it all into subprime mortgages.
Mr. Jones Defaults
As it turned out, Mr. Jones, and many more like him were unable to keep their promises to pay the money back. Maybe Mr. Jones lost his job in this terrible economy; maybe he got sick and couldn’t work; maybe he didn’t understand that his mortgage payment was going to jump to something he couldn’t afford; maybe he thought he could sell the house for more money, and never expected to hold on to it this long; maybe he just wasn’t a good credit risk to begin with.
Whatever the reason, Mr. Jones and millions like him had to break their promises about paying back the loans. In the end they’ll just give their keys back to the bank and say, “Thanks, but no thanks. I can’t afford it.”
The banks in turn will say, “Don’t give us the keys. We sold your mortgage a long time ago. We don’t even know who owns your mortgage now, and frankly we don’t care.”
Until now, his debt was an asset of the fund, and was being used as collateral against loans ten times its value. But the moment that Mr. Jones gave up on the idea of home ownership, the value of his mortgage simply disappeared. The paper asset, which derived its value from Mr. Jones’s promise, was destroyed. This had a cascading effect, since Mr. Jones’s mortgage was being used as collateral to borrow money to buy even more subprime mortgages, many of which were also defaulting. Assets purchased on borrowed money were now worthless. Only the debts remained, and suddenly there was more debt than the original amount that investors had put into the fund. These original funds would be needed repay the debts incurred by the fund. Nothing is left to return to investors. This is the process by which money is destroyed.
What about the houses, you ask? Yes, they have some value, but not nearly as much as when they were first purchased. Again, it was not the houses that had the value, it was Mr. Jones promise to pay a steady stream of high interest income over 30 years that was valuable to investors.
American Dream, Up in Smoke
Not only is the money gone, but so are the dreams of those millions of homeowners. The decision to purchase a home is not made lightly, and is usually accompanied by great hope and optimism. Defaults are the opposite. As the collective mood of millions of people like Mr. Jones, (not to mention the investors in the hedge funds who also lost everything) shifts from exuberance and optimism to negativity and pessimism, it is reflected in the larger economy as financial losses. This is a major aspect of the Wave Principle, which predicts tough times ahead.
Inflation and Deflation
The Federal Reserve System has systematically inflated the money supply since 1987, causing tremendous inflation. Along the way, money has also been destroyed, most memorably during the dot.com collapse of 2000-2003. This process of destruction is part of the reason why the economy has not experienced true hyperinflation.
In fact, a key point here is that the Fed is not really creating money, but credit. In truth, money is a physical commodity. Credit is simply the ability to buy something. Today credit functions as money, so it is difficult to tell the difference, but this was not, and will not always be the case.
If the Fed had actually printed bills (rather than made electronic book entries) for each dollar it created, those dollars would still be circulating in the economy and inflation would be much higher. As it is, the Fed can create credit, and those closest to the source of that credit creation – banks and government contractors – reap the greatest benefits. As the credit works its way through the system, it 1) causes general inflation, and 2) finds its way into weaker, less experienced hands – the likes of Mr. Jones and his subprime mortgage, or the average investor chasing internet stocks. In these weak hands, it can easily be manipulated to destruction.
Through this process of destruction, runaway money supply growth can be controlled. But if the destruction process gets out of hand, it is possible that we could see the reverse of what we have seen over the past twenty years – a prolonged period of sustained deflation. This could happen if people’s preference for assets over debt shifts along with the social mood. Recall that the value of paper assets is only as good as the promise standing behind them. Bear Stearns promise to investors rested on the promises of millions of people like Mr. Jones to continue paying their mortgages. Its not that they didn’t want to pay; economic conditions and the way the mortgages were written made sure that they couldn’t. If people like Mr. Jones become unwilling or unable to borrow, and if hedge fund investors who lost everything become to skittish about borrowing, the Fed will have a more difficult time increasing the money supply, since all credit creation today comes via debt creation.
The most recent issue of the Elliott Wave Financial Forecast, which remains a steadfast proponent of deflation, (available here, sign in required) made this observation earlier this month:
“When Merrill Lynch announced that it planned to sell the securities in [the Bear Stearns hedge fund] on the open market, Bloomberg reported that the “threat is sending shudders across Wall Street.” Why? “A sale would give banks, brokerages and investors the one thing they want to avoid: a real price on the bonds in the fund that could serve as a benchmark.” Later that day, Merrill decided against an open market sale. Retuters described the episode this way: “If word of the exact nature of the losses became public, it would have forced many other funds to revalue their holding and perhaps lose money, setting off a domino effect that could rattle markets globally.”
How much value, based on how many broken promises, has already been lost but not yet revealed? As long as financial prices rise (as they have continued to recently) no one is interested in such questions. But in the end, an ever inflating money supply is simply unsustainable. Money must also be destroyed to maintain equilibrium.
In his most recent testimony before Congress, Chairman Bernanke reiterated that inflation is the Fed’s foremost concern. For the time being, the Fed is holding interest rates steady. If it can hold the line, and allow the market to continue on its destructive path, inflation can be contained. The risk is that the destruction gets out of hand, and becomes full blown deflation.
ope:
strange day yen carry trade unwinding strongly and US markets up for now
yen up 2% or more vs. most currencies
first time i've seen this before :think2:
think we roll over before the day is out on equities
yeah DAW etrade has some toxic shit on the books
yen up 2% or more vs. most currencies
first time i've seen this before :think2:
think we roll over before the day is out on equities
yeah DAW etrade has some toxic shit on the books
Hopefully saved a few people.Steam, I dont have any trade with etfc for Im already short some subprime related stocks.
etrade doesnt look like they are going to make it.
in the on deck circle: countrywide.
the market needs to knock that one out of its misery.
bidu and google looking very shaky going into the final couple hours today.
etrade doesnt look like they are going to make it.
in the on deck circle: countrywide.
the market needs to knock that one out of its misery.
bidu and google looking very shaky going into the final couple hours today.
E*Trade Going Out Of Business?
11.12.07, 12:38 PM ET
Is it going from bad to Chapter 11 for E*Trade Financial?
On Monday, shares plunged 54.5%, or $4.68, to $3.91 in midday trading, after a Citi Investment Research analyst said the online brokerage could face bankruptcy. Late Friday, E*Trade (nasdaq: ETFC - news - people ) warned investors that its write-downs will be larger-than-expected in the fourth quarter.
The company said the rapid devaluation of mortgage-related securities, has reduced the value of its $3.0 billion asset-backed securities portfolio. "Management believes the additional deterioration observed since September 30 will likely result in write downs that exceed the previous expectations," the company said. "Actual securities-related losses will depend on future market developments, including the potential for future downgrades by rating agencies."
Given the great uncertainty in the credit markets, E*Trade's management said it will no longer provide earnings expectations for the rest of the year.
The gloomy announcement comes roughly two months after the firm said it would exit its troubled wholesale mortgage business.
While most people know E*Trade as an online stock brokerage firm, the company also operated a large mortgage business--with a home loan portfolio of $30 billion. And like other mortgage players, the turmoil in the housing markets has battered its home-loan business in recent months. The pressure on the mortgage market, which is expected to last until 2009, has forced E*Trade to alter its business strategy, Chief Executive Officer Mitchell Caplan said in a conference call back in September.
http://www.forbes.com/markets/econo...pdate-markets-equity-cx_er_1112markets24.html
11.12.07, 12:38 PM ET
Is it going from bad to Chapter 11 for E*Trade Financial?
On Monday, shares plunged 54.5%, or $4.68, to $3.91 in midday trading, after a Citi Investment Research analyst said the online brokerage could face bankruptcy. Late Friday, E*Trade (nasdaq: ETFC - news - people ) warned investors that its write-downs will be larger-than-expected in the fourth quarter.
The company said the rapid devaluation of mortgage-related securities, has reduced the value of its $3.0 billion asset-backed securities portfolio. "Management believes the additional deterioration observed since September 30 will likely result in write downs that exceed the previous expectations," the company said. "Actual securities-related losses will depend on future market developments, including the potential for future downgrades by rating agencies."
Given the great uncertainty in the credit markets, E*Trade's management said it will no longer provide earnings expectations for the rest of the year.
The gloomy announcement comes roughly two months after the firm said it would exit its troubled wholesale mortgage business.
While most people know E*Trade as an online stock brokerage firm, the company also operated a large mortgage business--with a home loan portfolio of $30 billion. And like other mortgage players, the turmoil in the housing markets has battered its home-loan business in recent months. The pressure on the mortgage market, which is expected to last until 2009, has forced E*Trade to alter its business strategy, Chief Executive Officer Mitchell Caplan said in a conference call back in September.
http://www.forbes.com/markets/econo...pdate-markets-equity-cx_er_1112markets24.html
