by Anonymous on 8/10/2007 03:08:00 PM

From Marketwatch, "How effective would Fed rate cut be?":

"It is unwise bordering on imprudent to assume that terrible will not follow bad," Catalano said.

by Anonymous on 8/10/2007 12:04:00 PM

From the New York Times:

Banks that are worried about their own liquidity decided this week to increase their reserves, which they can do by borrowing from other banks. Loans on such rates rose as a result of the added demand. Both the federal funds rate — the rate on loans of reserves between American banks — and the London Interbank Offered Rate leaped sharply yesterday.

The Fed — which conducts monetary policy by focusing on the fed funds rate — was forced to inject money into the system to bring the rate back down to its targeted level. And the E.C.B. lent almost 100 billion euros ($130 billion), to European banks.

If the current panic is just that — unreasoning fear — then such cash infusions may be able to let the new financial system weather the storm. Money can be lent to those owning the dubious securities, obviating the need to sell. As they eventually turn out to be good, the loans can be repaid and all will be happy.

On the other hand, if many of those securities turn out to be as bad as people now fear, some of those loans will not be good, and there may be more financial failures.

by Calculated Risk on 8/10/2007 09:48:00 AM

UPDATE: From Bloomberg: Fed Adds $19 Billion in Funds by Buying Mortgage Debt (Hat tip Napolean)

The Federal Reserve added $19 billion in temporary funds to the banking system through the purchase of mortgage-backed securities to help meet demand for cash amid a rout in bonds backed by home loans to riskier borrowers.

The Fed accepted only mortgage-backed debt as collateral for this morning's weekend repurchase agreement. ...

Fed funds traded above the central bank's target for a second straight day. The Fed's benchmark was 6 percent the last time fed funds opened at today's level.

After the Fed addition today, Treasuries pared their gains. Stocks dropped worldwide on speculation the losses in mortgage debt will hurt economic growth and earnings.

Click on graph for larger image. (hat tip Brian)

From the Federal Reserve:

The Federal Reserve is providing liquidity to facilitate the orderly functioning of financial markets.

The Federal Reserve will provide reserves as necessary through open market operations to promote trading in the federal funds market at rates close to the Federal Open Market Committee's target rate of 5-1/4 percent. In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets. As always, the discount window is available as a source of funding.

See Professor Thoma at Economist's View for an explanation of how this works. Also see Dr. Krugman's comments:

And here’s the truly scary thing about liquidity crises: it’s very hard for policy makers to do anything about them.

by Anonymous on 8/10/2007 07:48:00 AM

The Washington Post reports this morning on the heart-rending situation of upper-middle-class borrowers who are facing the dire situation of being offered a jumbo mortgage interest rate of "more than 7 percent":

Nicholas Schor and Liza Losada-Schor were ready and willing to spend up to $850,000 on a house in Maryland. That was a month ago, when the rate on their mortgage would have been as low as 6.25 percent.

But a sudden shift in the mortgage market means that the couple -- he's a psychiatrist, she's a clinical nurse psychotherapist -- now face a rate of more than 7 percent, reducing their buying power even though they have solid credit. That's because in the past few days, rates on loans for more than $417,000, known as jumbo loans, have shot up.

"I'm sort of surprised that even though we have excellent credit and excellent income and are putting down a 20 percent contribution that the banks aren't able to offer better rates for folks who seem to be a more reliable investment," Schor said.

This is "price rationing," the evil twin of "nonprice rationing," the two components of a thorough-going credit crunch. The Schors may be surprised to discover that the same mechanisms that allowed ample credit to high-risk borrowers also kept the cost of credit to low-risk borrowers artificially low, but those of us in the financial industry do not speak of credit crunches in tones of horror because they are simple predicable, controllable "corrections" that merely tidy up a few regrettable underwriting guidelines and leave the traditionally-creditworthy unscathed.

Of course, it could have something to do with that $850,000 house:

"With a rate increase from 6.75 percent to 7.5 percent, the buyer's buying power just dropped by 10 percent," said Frank Borges LLosa, a broker at FranklyRealty.com. "That $600,000 buyer will now have to look at buying a $550,000 place or paying 10 percent more per month for the same house versus last week."

That's what happened with the Schors. They recently bid $675,000 for a six-bedroom house in Olney, instead of the higher amount they originally thought they would spend. They are still hoping they can find a mortgage lender that will offer a better rate.

It is possible, however, that the lender will be just as spooked by the appraisal of the $675,000 house as the $850,000 house. There's a lot of price froth yet to evaporate in Olney, Maryland.

I don't particularly want to pick on the Schors--I'm sure they're nice people and decent credit risks--but theirs is the story I think of frequently when I hear clamoring to raise the conforming loan limit. I don't hear too many folks asking how Fannie and Freddie can afford to shave 100 bps off the Schors' interest rate when the private jumbo market cannot.

by Anonymous on 8/10/2007 07:04:00 AM

Via Clyde, from Financial Times:

Borrowers of alt-A mortgages may be of higher caliber than their subprime counterparts, but that hierarchy doesn’t necessarily hold for the bonds backed by the two types of loans. In fact, some alt-A securities are trading in line with comparable subprime-backed bonds, according to several market participants.

“We’ve historically been very wary of alt-A because of the decreased levels of subordination in the transactions,” said a buyside source. “We are much bigger believers in subprime.” . . .

Despite what may be higher credit fundamentals of alt-A mortgages, securitizations of the loans are more vulnerable to losses in underlying collateral. That’s because rating agencies have not required as much credit enhancement on the transactions as they have for subprime deals, according to a research report by JPMorgan Chase.

For now, alt-A borrowers are defaulting more slowly than subprime mortgage borrowers, as evidenced by their lower delinquency rates. JPMorgan found that 60+ day delinquencies averaged 7% for a sample of alt-A loans originated in 2H06 versus just under 13% for the ABX deals of the same vintage.

But some investors are opting for subprime securities because of their higher yields and credit protection relative to alt-A. Increasingly valued as interest only investments, subprime-backed bonds purchased at low enough dollar prices may generate superior returns, the investors say.

While subrime delinquencies outnumber those on alt-A mortgages, a fair number of alt-A bonds rated A2 and lower and originated in the second half of 2006 have loss coverage ratios of less than 1 assuming a 30% severity, according to JPMorgan. That compares with an average 1.31 loss coverage ratio for BBB rated subprime bonds underlying the ABX 07-1 index and 1.15 for BBB- bonds, assuming 40% severity. . . .

Key predictors of alt-A securities’ performance are borrower FICO scores, percent of limited or absent documentation loans, exposure to risky geographies – mainly California and Florida – and the loan-to-value ratios of the underlying collateral.

Subordination levels relative to expected losses suggest that most AA and A-rated alt-A bonds are behaving like single-Bs, according to JPMorgan, which tested roughly 30 deals late last month.

by Calculated Risk on 8/10/2007 02:19:00 AM

Paul Krugman writes in the NYTimes: Very Scary Things

Note: the NY Post is reporting that these columns will be free in the near future. Excerpts are from Economist's View.

What’s been happening in financial markets over the past few days is something that truly scares monetary economists: liquidity has dried up. That is, markets in ... financial instruments backed by home mortgages ... have shut down because there are no buyers.

This could turn out to be nothing more than a brief scare. At worst, however, it could cause a chain reaction of debt defaults.
...
When liquidity dries up ... it can produce a chain reaction of defaults. Financial institution A can’t sell its mortgage-backed securities, so it can’t raise enough cash to make the payment it owes to institution B, which then doesn’t have the cash to pay institution C ...

And here’s the truly scary thing about liquidity crises: it’s very hard for policy makers to do anything about them.

See Economist's View for more excerpts.

by Calculated Risk on 8/09/2007 08:40:00 PM

Countrywide Financial Corporation (CFC) filed their 10-Q today with the SEC. Since CFC is the largest mortgage lender in the U.S. it is worth reading their outlook. Here are a few recommended sections:

Outlook

Near the end of the second quarter and shortly thereafter, market demand for the securities that we create in our loan securitization activities was negatively affected by investor concern about credit quality and demand for higher yields. As a result of these changes, we expect in the short term to retain more loans in our portfolio of loans held for investment or to hold additional loan or security inventory until market conditions improve.

Similarly, during the third quarter, funding liquidity to mortgage companies became constrained. We believe we have adequate funding liquidity to accommodate these marketplace changes in the near term; however, the secondary market and funding liquidity situation is rapidly evolving and the potential impact on the Company is unknown. Continuation of these conditions or further deterioration could result in further reductions in the Company’s funding volume. Our strategy of retaining a larger portion of loans or securities may impact our gain on sale margins in the short-term.

Prospective Trends

We believe the current environment of rapidly changing and evolving markets will provide increasing challenges for the financial services sector, including Countrywide. Specifically, in the near term, we may experience:

· Continued pressure on housing values and mortgage origination volumes

· Increasing delinquencies and foreclosures

· Continued disruptions in the secondary mortgage and debt capital markets and

· More restrictive legislative and regulatory environments.

Under Risk Factors, CFC has added a new risk:

Debt and secondary mortgage market conditions could have a material adverse impact on our earnings and financial condition

We have significant financing needs that we meet through the capital markets, including the debt and secondary mortgage markets. These markets are currently experiencing unprecedented disruptions, which could have an adverse impact on the Company’s earnings and financial condition, particularly in the short term.

Current conditions in the debt markets include reduced liquidity and increased credit risk premiums for certain market participants. These conditions, which increase the cost and reduce the availability of debt, may continue or worsen in the future. The Company attempts to mitigate the impact of debt market disruptions by obtaining adequate committed and uncommitted facilities from a variety of reliable sources. There can be no assurance, however, that the Company will be successful in these efforts, that such facilities will be adequate or that the cost of debt will allow us to operate at profitable levels. The Company’s cost of debt is also dependent on its maintaining investment-grade credit ratings. Since the Company is highly dependent on the availability of credit to finance its operations, disruptions in the debt markets or a reduction in our credit ratings, could have an adverse impact on our earnings and financial condition, particularly in the short term.

The secondary mortgage markets are also currently experiencing unprecedented disruptions resulting from reduced investor demand for mortgage loans and mortgage-backed securities and increased investor yield requirements for those loans and securities. These conditions may continue or worsen in the future. In light of current conditions, we expect to retain a larger portion of mortgage loans and mortgage-backed securities than we would in other environments. While our capital and liquidity positions are currently strong and we believe we have sufficient capacity to hold additional mortgage loans and mortgage backed securities until investor demand improves and yield requirements moderate, our capacity to retain mortgage loans and mortgage backed securities is not unlimited. As a result, a prolonged period of secondary market illiquidity may reduce our loan production volumes and could have an adverse impact on our future earnings and financial condition.

by Calculated Risk on 8/09/2007 05:15:00 PM

From MarketWatch: S&P: 76 ratings on 19 U.S. cash-flow, hybrid CDOs may be cut (hat tip Gary)

Standard & Poor's Ratings Services on Thursday placed ratings on 76 tranches from 19 U.S. cash-flow and hybrid collateralized debt obligation transactions on creditwatch with negative implications. The affected tranches have a total issuance amount of $2.16 billion, the agency said.

It seems the pace of the Negative Watch or downgrade stories is picking up.

by Calculated Risk on 8/09/2007 03:03:00 PM

From MarketWatch: Big liquidation triggers hedge fund turmoil (hat tip barely and Gort)

The liquidation of a big hedge fund or investment bank trading portfolio is causing havoc in some parts of the hedge fund business, according to managers and investors.

Black Mesa Capital, a hedge fund firm that uses computer models to track down investment ideas, has told investors that at least one very large hedge fund or investment bank is liquidating "massive" trading portfolios, according to a letter the Santa Fe, NM-based firm sent to investors on Wednesday.

That's causing disruptions and triggering big losses among other so-called market-neutral hedge funds, Black Mesa said in its letter, a copy of which was obtained by MarketWatch on Thursday.

"Clearly, something is amiss in the markets that few in our strategy, if anyone, have experienced before," Black Mesa's managers Dave DeMers and Jonathan Spring wrote. DeMers declined to comment on Thursday.

The firm's hedge fund, which has about $1.9 billion in long positions and $1.9 billion in short positions, is down roughly 7.5% this month through Aug. 7. It could be down as much as 10% since then, Black Mesa noted.

From the WSJ: Blind to Trend, 'Quant' Funds Pay Heavy Price

Global Alpha, Goldman's widely known internal hedge fund, is now down about 16% for the year after a choppy July, when its performance fell about 8%, according to people briefed on the matter. The fund, based in New York, manages about $9 billion.

The fund's traders in recent days have been selling certain risky positions, according to these people. Early this week, those moves sparked widespread rumors on Wall Street that the entire fund might be shut down. A Goldman spokesman has said the rumors are "categorically untrue."

Campbell & Co., an $11 billion hedge fund that trades in the futures market as well as in stocks and bonds and is completely driven by such computer programs, was down 10% to 12% by the end of July.

From the WSJ: Second Goldman Hedge Fund Moves to Sell Some Positions

A second Goldman Sachs Group Inc. hedge fund has hit a rocky patch and has sold down some of its positions, according to a person familiar with the matter.

Goldman's North American Equity Opportunities hedge fund had $767 million under management earlier this year. The Fund was down over 15% this year, through July 27, according to investors and was down more than 11% in July alone. It is not known how much the fund has sold in recent days.
...
Tykhe Capital, a New York hedge-fund firm that manages about $1.8 billion, has suffered losses of about 20% so far in August, and is moving quickly to trim its investment positions, according to an investor in the firm briefed by Tykhe executives. The selling by Tykhe and a range of similar hedge funds is putting pressure on the holdings of a number of funds.

by Calculated Risk on 8/09/2007 12:02:00 PM

Quote added (hat tip dis):

So, today the monetary base in the North Atlantic economies is 7% higher than it was yesterday--an annualized growth rate of 2100% per year.

This is indeed a significant liquidity event...
Professor DeLong, August 9, 2007

From the WSJ: Fed Enters Market To Tamp Down Rate

The scramble for liquidity in Europe spilled over into the U.S. The federal funds rate, the rate at which banks make overnight loans to each other, was between 5.375% and 5.5% in early trading in New York, analysts said, well above the Federal Reserve's 5.25% target.

The Fed, in an effort to get the funds rate back down and meet the spike in demand for cash, lent $24 billion through its open market operations. It did so through two operations: A 14 day "repo," the name for an operation that adds reserves to the banking system and alleviates upward pressure on rates, and an additional $12 billion through an overnight repo. It is common for the Fed to do the two types of operations, but analysts said the amount added was relatively high, exceeding what it would have injected to cover expiring repos.

From the WSJ: ECB Injects €94.8 Billion To Ease Jittery Markets

Mounting fears that the U.S. subprime crisis is spreading to Europe prompted the European Central Bank to loan €94.841 billion ($130.2 billion) in emergency funds to European banks this morning, the first time it has taken this type of action since just after the terrorist attacks of Sept. 11, 2001.

Concern that European banks face growing losses on investments linked to U.S. mortgages shot the euro zone's overnight borrowing rates to 4.7% today, their highest since October 2001 and well above the ECB's benchmark financing rate of 4%.

From Bloomberg: Bank of Canada Says It Will `Provide Liquidity' to Aid Markets

The Bank of Canada said it will ``provide liquidity'' to support financial markets, the same day the European Central Bank lent money to ease a credit crunch that started with the U.S. subprime mortgage collapse.

The Ottawa-based central bank will ``support the stability of the Canadian financial system and the continued functioning of financial markets,'' ...