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HomeWhat is Going on with LIBOR?
Posted by Larry Doyle on May 15th, 2009 12:47 PM |
Libor (London Interbank Overnight Rate), the cost of borrowing U.S. dollars in the overnight market, is plummeting. What is driving this move and what does it mean? A number of people in global finance are asking that very question. Let me offer my opinion.
After Lehman failed in September 2008, confidence in banks declined precipitously, counterparty risk soared, and Libor screamed higher as well. 3 month Libor topped out at close to 5%. Historically, Libor is just marginally higher than the Fed Funds rate which is currently between 0-.25%.
Today 3 month Libor is approximately .8%. This move lower is a clear sign of increased confidence in the banking system, isn’t it? In my opinion, this move in rates is a reflection of the following:
1. a realization that global governments will not allow major money center banks to fail.
2. a reflection of the massive increase in dollars in the system associated with all of the liquidity injected via Uncle Sam’s programs.
Has the drop in Libor coincided with an improvement in the credit markets? No. Despite what pundits would tell you, credit spreads remain at elevated levels. In fact, on an inflation adjusted basis, rates are at the highest levels since the early 1980s.
Why aren’t banks lending as much? Lack of confidence in the economy along with enormous embedded losses in their current book of loans. Those losses are real and will be rising. The elusiveness of bank credit is highlighted in a McClatchy article, Businesses Struggle as Bank Loans Remain Elusive, in the Newsworthy section of Sense on Cents.
Thus, if a drop in Libor is not a reflection of improved credit conditions, what does it mean?
In my opinion, it is a precursor to a drop in the value of the dollar. Why?
Very simply, too many greenbacks floating around. A decline in the value of the dollar is inflationary. Both core rates of producer prices and consumer prices reported this week were higher than expected. I’ll be watching.
Maybe a drop in Libor isn’t such a great development after all.
LD
Heavy Losses Raining on Insurance, Roll Out The TARP
Posted by Larry Doyle on May 15th, 2009 8:29 AM |
The fact that a handful of insurance companies are eligible to receive government funding via the TARP is a much bigger event than the benign media reports would indicate. In my opinion, the news reported by Bloomberg, Prudential Said To Be Among Insurers Cleared For TARP, is a clear sign of a much larger storm on the horizon. Why? Let’s get after it.
Not every insurance company has the same business profile. Some are more aggressive in underwriting. Some are more aggressive in their investment portfolio. Some are more aggressive in their product offerings. That said, they’re all members of the same family and if one has the flu, you can rest assured many others are also sick.
On March 12th, in Is My Insurance Insured?, I wrote:
While the government has already taken an 80% stake in AIG, how do the state insurance commissioners deal with entities like Hartford, Met Life, and others with outsized risks and resulting declining capital cushions? Let’s go visit Uncle Sam!! That’s right, if you thought “bailout nation” was already swamped by banks, automotive companies, and Freddie/Fannie, the fun continues: The Next Big Bailout Decision: Insurers.
Fast forward to May 15th and here we are.
Why do the state insurance commissioners have to go to Washington? What about the reserves at the state level? Well, are you sitting down? Those reserves nationwide total only $8 billion.
Can insurers write enough premiums quickly enough to generate sufficient capital to address the losses? That is the $64 billion question. Actually, it will likely be much larger than that. Why?
As consumers are strapped for liquidity and getting credit lines squeezed – if not totally cut by their banks – they will look to tap the cash value of their insurance at an ever greater rate. If consumers were to triple the rate at which they have tapped these lines, the insurance industry would experience a capital drain of approximately $500 billion. Insurance companies will be forced to raise capital via debt or equity offerings, asset sales, or drawdowns of cash and liquidity reserves. The industry has approximately $450-$500 billion in cash and liquidity reserves. “Houston, we’ve got a problem.”
Haven’t insurance companies benefitted from the relaxation of the mark-to-market? No, they do not utilize that form of accounting. Insurance companies typically carry assets at cost or model valuations. If and when the assets suffer a prescribed level of defaults, the losses must then be recognized via a write down in the asset’s value. As losses via defaults and foreclosures across their assets continue to increase, well, that’s why we just saw these insurers “roll out the TARP.”
Can’t the insurance companies sell their assets to stem the losses? Not easily. Why? Insurance companies have traditionally reached for yield (higher rates of return) by purchasing higher risk assets or writing higher risk insurance. In doing so, the industry has sacrificed the liquidity associated with lower risk assets/products. What are these assets and where do the problems lie?
1. Annuities: this product was aggressively underwritten by insurance companies after the meltdown of the NASDAQ in 2001-2002. A principal protection component was particularly attractive to many investors. That component provided investors downside protection but is now a large source of pain for the industry. In short, investors won, insurance companies lost as the market plummeted.
2. Commercial Real Estate: aside from the banks, insurance companies are the largest underwriters and holders of CRE. Insurance companies not only originated billions in CRE but they were typically the biggest buyers of the subordinate classes of CMBS (commercial mortgage backed securities) deals underwritten by Wall Street banks.
3. Defaults: with default rates on loans (mortgages, corporate, commercial real estate) expected to at least double, likely triple, and in the most credit sensitive sectors potentially quintuple, these losses will quickly burn through established reserves.
As Bloomberg reports:
“If you had some of these companies, the bigger ones like Hartford, go into a spiral, that would just cause another round of panic,” said Robert Haines, a New York-based analyst at CreditSights Inc. “I don’t like the idea of the government getting involved with these companies. You’re making to an extent a deal with the devil, but your options are really limited at this point.”
The problems within the insurance industry are not contained to the firms (Hartford Financial, Prudential, Principal, Allstate, Ameriprise, and Lincoln) that received approval for TARP funds. These institutions are eligible for government funds via TARP because they have bank subsidiaries or have purchased a bank or S&L. What about the insurance companies not in that position? Stay tuned.
Sense on Cents will be monitoring this situation very closely.
LD
For a compilation of posts by Sense on Cents on this topic:
January 12th: Got Insurance? 529 Plans? Financial Aid? Read On…
-an interview with Sean D’Arcy, a longstanding professional within the insurance industry and financial planning space. Sean laid out all the problems.
March 12th: Is My Insurance Insured?
-a review of the fact that policyholders have credit exposure to their insurance carriers.
March 30th: What Is Lincoln Thinkin’?
-a review of Lincoln Financial’s purchase of a small savings and loan in Indiana in order to gain access to government funding.
April 6th: Insurance Companies’ Ignorance Is Definitely Not Bliss!!
-a survey of insurance brokers in which the brokers maintain the insurance companies did not appreciate and understand the degrees of risk embedded in insurance products sold.
April 7th: Uncle Sam To Throw Lifeline To Life Insurers
-a post pointing toward the move made yesterday.
Barney Frank: Twenty Years and Hundreds of Billions Later on Private Profit/Social Loss
Posted by Larry Doyle on May 14th, 2009 3:18 PM |
I find it embarrassing that our country is subjected to the leadership of the likes of Barney Frank. In a 7 minute interview on Bloomberg News this morning, I was initially shocked at Congressman Frank’s selective memory. As I watched the interview further, I got increasingly perturbed and upset that our country is subjected to a Congressional leader with such little appreciation for his own mistakes. From there, thinking that Barney and his colleagues are likely to impose their will and vision upon our economy makes me more concerned about the long term risks for our market and capitalism itself.
I am not blinded by the will of the free market. For a market to remain free, there needs to be strong regulation and real discipline. If the market does not impose the discipline, the government can and should provide guidance, incentives, and if need be hard rules. For the regulation to be effective, though, it is imperative that the regulators themselves are unbiased and unaffiliated within the industry. I would say that both FINRA and the SEC have fallen woefully short on these fronts. I would also say that Congress has fallen woefully short. Against that backdrop, to see none other than Barney Frank trying to make the case for the way forward on compensation reform and municipal insurance is VERY HARD TO SWALLOW.
In regard to compensation reform, I am all for empowering shareholders. I would begin by asking, though, when did shareholders lose the ability to influence compensation? Shareholders should regularly review compensation practices and figures and if they find them problematic, they should voice their opinions and if need be sell their stock.
As Barney was raising the risks embedded in the private profit and social loss model, I wanted to scream and ask him where he was as Franklin Raines was plundering Fannie Mae with Barney’s support on the Hill. Finding religion on these topics after twenty years and hundreds of billions of dollars may appease his constituents, but it does nothing for those who cherish free market capitalism.
Make no mistake, government was a large part of the problem then which makes me leery to think that it can be an effective part of the solution now.
To also hear Barney offer his opinion on the relative value of municipal debt versus corporate debt made me want to change the channel. The link to Barney’s Bloomberg interview is provided below. Let me know if you were able to stomach it before changing the channel.
Barney Frank, September 25, 2003 on the topic of sub-prime lending:
“I want to roll the dice…”
LD
Economic Update: Jobless Claims and Producer Prices
Posted by Larry Doyle on May 14th, 2009 10:42 AM |
Economic data released this morning included Initial Jobless Claims and Producer Price Index. Let’s dive right in!!
Initial Jobless Claims rose to 637k from last week’s reading of 601k, which was revised to 605k. The expectations for this week’s claims figure was 611k so the reading is disappointing as far as looking for stabilization within labor.
I am not surprised, though, for a few reasons:
1. we know there are going to be layoffs coming in the automotive industry. In fact, a large percentage of the increased unemployment filings came from states with heavy automotive exposure, especially Illinois.
2. as I reported in last Friday’s May Unemployment Report:
The fact that temporary government workers are factored into overall employment, in my opinion, is stretching the integrity of the report.
Thus, I am not surprised to see this week’s claims report higher than expected and I expect subsequent revisions to show higher claims as well.
In regard to the Producer Price Index, it was reported as an increase of .3% and without the volatile food and energy components as an increase of a mere .1%. No big deal, right? Well, it’s no big deal as long as you don’t eat. For those of us who actually look to consume food on a regular basis, this report is very troubling. Why?
Prices of food products rose 1.5%!! Including a rise of 43.7% for eggs, 5.2% for vegetables, 4.5% for beef, and 2.5% for pork.
Sense on Cents did receive very interesting color the other day about the state of produce in California. A reader shared:
The cost of food is on the rise faster than you can eat.
Now the feds have cut off water to the central valley and fields are not being farmed. I do not about you but ya might want to watch the price of a head of lettuce in NYC go through the roof.
Additionally, I was surprised to see a rise in prices for cars of .2% and light trucks of 1.1%. Despite the fact that car and truck sales are at depressed levels, the auto companies are in such desperate straits that they need to squeeze revenue wherever possible. That said, the asking prices of these vehicles may have risen, but who pays asking?
Please share insights on these fronts or any others from your local economies so we all can more effectively navigate the economic landscape!!
LD
Economic Data and News Below The Radar
Posted by Larry Doyle on May 13th, 2009 8:27 PM |
While navigating the economic landscape, I picked up a few items below the radar:
1. projected issuance of U.S. Treasury bills, notes, and bonds for calendar 2009 will be $2 trillion. To put that in perspective, that figure exceeds the issuance for 2006, 2007, and 2008…..COMBINED.
2. seven senior executives at GM sold all of their stock in the company. With the price of GM in the $1.25-$1.50 range, this sale is a clear indication that the company will either file for bankruptcy or massively dilute existing shareholders in a restructuring.
3. 1st quarter tax revenues in 47 states declined on average by 12.6% year over year with expectations of steeper declines going forward. Increased taxes and declining services are on their way. I also mentioned to my better half, I expect states to pass legislation promoting “sins” in an attempt to generate revenue.
4. our economy is experiencing the highest inflation adjusted level of interest rates since the ’80s. These rates along with anemic consumer demand are squeezing company bottom lines. As a result, companies are aggressively cutting expenses while revenue opportunities are diminishing.
5. the IMF has indicated that European banks should undergo stress tests much like our domestic banks.
6. the GAO (General Accounting Office) issued a scathing report highlighting how deficient the SEC is in terms of equipment, systems, staffing, and execution. No surprise, but very disheartening.
7. I have added a link which I think readers will find quite informative. Subsidyscope, launched by the Pew Charitable Trust, will track federal subsidies across industries. In the Uncle Sam economy, this link should prove to be invaluable.
LD
If Shipping Is Up, What About Rail Activity?
Posted by Larry Doyle on May 13th, 2009 3:26 PM |
I just reported in my prior post that the Baltic Dry Index (measuring global shipping activity) is rising and has risen close to 45% over the course of the last month. This is clearly a sign of increased economic activity and a turn in both our domestic and global economy, correct? Clearly the rise in the BDI must be correlated with a rise in rail activity here in the United States as we get our goods and commodities to port. Let’s jump on the rails and go for a ride navigating this part of our economic landscape.
Uh-oh!! It is not widely broadcast but rail activity is not only down year over year (no surprise there) but the pace of decline is quickening. The theory behind the green shoots is promoted by analysts as a slowing in the pace of economic decline. How did they miss this data? Are they not looking or not reporting?
Let’s review. The Heard on the Street column in the WSJ reports, Risk In Market’s One Track Mind.
In reviewing this piece, I was particularly struck that the pace of decline in rail activity from the 1st quarter 2009 to this point in the 2nd quarter is QUICKENING.
As the WSJ highlights:
The slump in weekly rail traffic reflects sluggish industrial activity and consumption. Shipments of industrial products are down almost a third in the past year, while raw materials like coal, metals and crops also show steep drops. The pace of decline has picked up relative to the first quarter’s 16% fall, according to Credit Suisse analyst Chris Ceraso.
In commodities, while crude oil and copper have been on a tear, prices for lumber and natural gas remain depressed. Lumber is exposed to construction and has been in a bear market since 2004, so it might be regarded as a special case. Still, there is little sign of a rebound.
The fact that rail traffic is declining at a quickening pace is inconsistent with other analysts promoting that our economy is turning. This same trend is occurring in trucking as well.
That light in the economic tunnel? It may not be daylight. Based on this report, it may not be a train either. Perhaps it is merely a reflection of overly optimistic analysts and pundits who are trying to sell you something. Ask them what they think about rail traffic.
LD
Let’s Get Some Chinese: A Review of Economic Activity in China
Posted by Larry Doyle on May 13th, 2009 11:59 AM |
China’s stock market closed today at the highest level since August ’08. Is that an indication that China is ready to resume its economic expansion and can literally pull the global economy right along with it? Well, let’s check out a number of items on the menu:
1. The Baltic Dry Index has rebounded over the last few weeks. The BDI is extremely volatile. It plummeted approximately 95% from its high in early 2008, rebounded strongly earlier this year only to suffer a setback in March as our equity market started to regain its legs. The recent rebound in the BDI is again credited to increased shipping activity of commodities into China. Prices of commodities (copper, oil, iron ore) have been very highly correlated with the BDI as a result.
So far, so good . . . let’s try some more items on the menu.
2. How about Chinese lending activity? Is the well directed Chinese stimulus precipitating an increase in activity by non-governmental borrowers? The FT reports, China Cuts Lending Amid Asset Bubble Fears.
I will give those in charge of China’s fiscal stimulus and government programs credit. As this article highlights, these authorities have real concerns about inflation and irresponsible lending practices.
The FT reports:
Chinese bank lending slowed dramatically in April because of fears that loan growth in the first quarter had been excessive and could pave the way for loans of deteriorating quality, so possibly creating a new round of asset bubbles.
That led to fears among regulators that money was being funnelled illegally into the stock market and handed out to state-sponsored stimulus projects of dubious commercial value that could become non-performing assets.
Some regulators also worried about the potential for rampant inflation. Those fears were somewhat eased by price measurements released on Monday showing China remained in deflationary territory in April for the third consecutive month.
Wow! Can you imagine if a regulator in our country had the integrity to voice concerns about government funds being utilized illegally or fraudulently?
This item did not taste so good in regard to leading the global economy to greener pastures, but I commend the Chinese for addressing potential pitfalls in their programs.
3. Away from the government stimulus, the Chinese economy remains largely dependent on exports. Let’s take a taste! Again, our friends at the FT provide some spice, Slide In Chinese Exports Will Hit Growth Strategy:
The FT reports,
Chinese exports fell steeply in April for a sixth month in succession, suggesting that the worst might not be over for the world’s third largest economy.
The total value of Chinese exports fell 22.6 per cent to $91.9bn (£60.2bn) last month compared with the same month a year earlier – a faster rate of decline than the 17.1 per cent year-on-year drop in March.
Why are Chinese exports falling? Well, please review our first post this morning which highlighted that domestic retail sales here fell by .4% after a decline of over 1% last month. If American consumers aren’t buying, Chinese producers aren’t exporting.
4. LD, it is only a matter of time, though, before the American consumer returns to his old ways of spending and the Chinese exporters will be happy, right? Let’s go for the fortune cookie and see what it says: U.S. Lawmakers In Threat To Raise Tariffs On China.
Congress is raising this threat given rising unemployment here at home and concerns that China manipulates its currency. Will this tariff fly? Perhaps.
The FT reports:
a group of lawmakers from manufacturing-dominated states are determined to give it another try and some analysts think the US recession could help build support this time. The charge in the Senate will be led by Debbie Stabenow, a Democrat from Michigan, and Jim Bunning, a Republican from Kentucky. In the House, it will be pushed by Tim Ryan, a Democrat from Ohio, and Tim Murphy, a Republican from Pennsylvania.
Whether these tariffs are the right maneuver or not, increased protectionsist measures are not one way streets. If we are looking to grow our own economy without being dependent on the American consumer, we will need global trade lines to be open.
So, what did you think of our sampler?
To me it was more sour than sweet. In my opinion, our future/fortune remains decidedly mixed at best.
LD
For more in depth BDI analysis, check out Baltic Dry Index and Commodity Graphs
Economic Update: Housing and Retail Sales
Posted by Larry Doyle on May 13th, 2009 8:39 AM |
Ultimately, all economic roads lead back to the housing market. The breakdown in the integrity of housing finance led us into this economic mess and any self-respecting economist (or financial commentator) will tell you that a healthy housing market will lead us out. Let’s check the patient.
The Fed has supported housing by effectively “overpaying” for refinancings. Mortgage rates relative to rates on U.S. government debt are at 17 year narrows. This development is great for homeowners who can and have refinanced. However, the pool of eligible homeowners is finite and seems to have run its course for now as recent data indicates that refinancing filings have declined while purchase activity has been unchanged. This data is reflected in the U.S. MBA Mortgage Applications Index Fell 8.6% Last Week, as reported by Bloomberg.
How about new supply of homes coming onto the market? Well, certainly home building has come to a virtual standstill with over a year’s worth of homes currently on the market. As new housing starts occur this supply can be gradually absorbed. Thus, we once again are back to the concept of needing time for the patient to heal. However, are we subject to another bout of housing sickness to hit our economy? I believe we are. Why? Two reasons:
1. government programs forestalled but did not eliminate a number of “sick” mortgages. These mortgages would likely have defaulted with banks forcing foreclosures a few months ago.
2. a large supply of adjustable rate mortgages will soon reset to a considerably higher rate leading to payment problems for homeowners and likely foreclsoures. Data indicating increased rates of delinquency (late payments) clearly points to increased foreclosures.
In fact, foreclosure filings just hit a record level of 342k as reported by RealtyTrac which monitors this data nationwide. Foreclosure activity also seems to be spreading from California, Florida, Nevada, and Arizona to other parts of the country. In fact, Idaho has recently had a surge in foreclosure activity as the unemployment rate in and around Boise has spiked.
What about home prices? The declines in home prices have certainly sparked renewed interest in prospective homebuyers. Will they enter the market at this stage? Data indicates prospective buyers continue to be patient as Bloomberg reports, Home Prices In U.S. Drop Most On Record In Quarter.
When may consumers feel confident enough to enter into the market and purchase a home? The largest factor in that decision is consumer’s confidence in their employment situation. In my opinion, with the rate of unemployment nationwide likely to hit double digits by year end, housing will remain under pressure.
On a separate economic note, the retail sales figures for April were just released and declined .4%, and excluding auto sales, declined by .5%. The market expected April retail sales to be unchanged. This report is a clear indication the economy remains on life support. Not surprising to me, March retail sales were revised even lower from a decline of 1.1% to a decline of 1.3%.
With all due respect to credible journalists, analysts, and financial commentators, I personally do not see enough green shoots in the midst of reviewing the entire economic landscape.
The equity markets are moving sharply lower on this news.
LD
P.S. Sense on Cents welcomes feedback. Let us know what you are seeing in your local economies.
