by Calculated Risk on 10/09/2008 11:16:00 AM

“What we have learned from this whole exercise over the last few years is that it is not wise for a small country to try to take a leading role in international banking.”
Geir Haarde, Prime Minister of Iceland

Update from Reuters: Iceland PM asks public not to take out lots of cash

"I want to emphasise ... that people remain calm and understand that the transaction system is fully functioning and deposits are safe," Haarde said.

"I also ask the public not to withdraw large sums of money from the banks. It will make things more difficult."

From The Times: Iceland seizes Kaupthing as meltdown continues

Crisis-hit Iceland has taken control of Kaupthing, its biggest bank, and suspended trading on its stock exchange for two days.

With the nationalisation of Kaupthing, the Icelandic Government now has control of all three of the country's big banks — Kaupthing, Landsbanki and Glitnir ...

The OMX Nordic Exchange Iceland said it will not re-open until Monday, due to “unusual market conditions." Meanwhile trading in the Icelandic crown ground to a halt.

by Anonymous on 10/09/2008 09:52:00 AM

I will have you know I had a cup of coffee this morning. For the first time in about a month. I am sure that any of you long-term caffeine addicts who have ever had to quit cold turkey for an extended period of time will understand why this fact demands celebration. For me, for the rest of my days, "PPI" will no longer mean Producer Price Index--who cares about that?--but Proton Pump Inhibitor, which is a wonder drug.

At any rate, while I still lack the key qualities of a decent blogger--energy, wit, intelligence, stamina, the attention span God gave a rutabaga--I wanted you to know that I'm still here and in the process of crawling out from under a nasty bout of weather. Who knows but what I might even have something actually relevant to say in the near future? Bear with me, forgive my absence, and I'll try to ease myself back in to regular blogging.

To all of you who have sent messages and inquiries to me and to CR, let me say that your kindness and warmth has meant a great deal. The Pig and I are grateful. (OK, well, mostly me, but the Pig tries to be grateful.)

Now, back to the TED Spread . . .

by Calculated Risk on 10/09/2008 09:05:00 AM

Here is the TED Spread from Bloomberg. The TED spread hit a record 4.13 this morning. This is far above the highs reached during the previous waves of the credit crisis.

Note: the TED spread is the difference between the LIBOR interest rate and the three month T-bill. Usually the TED spread is less than 0.5%. The higher the spread, the greater the perceived credit risks (compared to "risk free" treasuries).

From Bloomberg: Libor Dollar Rate Jumps to Highest in Year; Credit Stays Frozen

The cost of borrowing in dollars for three months in London soared to the highest level this year as coordinated interest-rate reductions worldwide failed to revive lending among banks for any longer than a day.
...
The London interbank offered rate, or Libor, for three-month loans rose to 4.75 percent today, the highest level since Dec. 28. The Libor-OIS spread, a measure of cash scarcity, widened to a record.

The credit markets are still in severe distress.

by Calculated Risk on 10/09/2008 12:45:00 AM

From the NY Times: U.S. May Take Ownership Stake in Banks

Having tried without success to unlock frozen credit markets, the Treasury Department is considering taking ownership stakes in many United States banks to try to restore confidence in the financial system ...

Treasury officials say the just-passed $700 billion bailout bill gives them the authority to inject cash directly into banks that request it. Such a move would quickly strengthen banks’ balance sheets and, officials hope, persuade them to resume lending. In return, the law gives the Treasury the right to take ownership positions in banks, including healthy ones.

The proposal resembles one announced on Wednesday in Britain.

This would essentially be the plan supported by most economists.

by Calculated Risk on 10/08/2008 08:34:00 PM

From my brother:

"Politics is the art of looking for trouble, finding it everywhere,
diagnosing it incorrectly, and applying the wrong remedies."
Groucho Marx

And unrelated from the Daily Show (15 seconds):

by Calculated Risk on 10/08/2008 06:55:00 PM

There has been some more discussion today that the Emergency Economic Stabilization Act (EESA) allows for a UK type recapitalization plan (see Krugman: To do, not to do). The UK plan is more along the lines recommended by most economists, and many economists are looking for any hint that the TARP might become a recapitalization plan.

Krugman points us to Justin Fox at Time: Treasury prepares for a TARP-and-switch. And it's a good thing, too

Did anybody else notice that when Hank Paulson was describing in his press conference today what the Emergency Economic Stabilization Act enables Treasury to do, the first thing he listed was "to inject capital into financial institutions"?

Here is Paulson's prepared statement:

Specifically, the EESA empowers Treasury to use up to $700 billion to inject capital into financial institutions, to purchase or insure mortgage assets, and to purchase any other troubled assets that the Treasury and the Federal Reserve deem necessary to promote financial market stability.
emphasis added

Paulson clarified this somewhat in the Q&A (transcript from CQ Politics)

QUESTION: The EESA program, do you think it will help -- the purchasing program, troubled asset relief program, will it help much to rebuild the capital base of the financial institutions?

PAULSON: Yes. Yes, that is -- that’s what’s -- what’s critical. There is -- capital has been reluctant to come into certain financial institutions, because a lack of visibility, in terms of the uncertainty, in terms of the value of -- of some of these assets.

So the -- the -- the prime motivation is to lead to the recapitalization and the stronger capitalization of the -- of the industry.

That seems to imply that the institutions will be better able to raise capital after the TARP buys the dodgy assets - as opposed to suggesting the TARP will inject capital into the institutions.

And another question:

QUESTION: Mr. Secretary ... Is it conceivable ... that the Treasury might have to take far more far-reaching measures and, in particular, might that include the U.S. do some sort of recapitalization of its banking system?

PAULSON: Yes, I’m not going to speculate on all the things we -- we may have to do. I would simply say we have a broad range of authorities and tools in the -- in the TARP. And so we -- we’ve emphasized the purchase of the liquid assets, but we have a broad range of authorities. And I’m confident we have the authorities we need to -- to work with going forward here.

And that comment is ambiguous.

Here is a comment from Rep. Barney Frank (hat tip Brian):

In implementing the powers provided for in the Emergency Economic Stabilization Act of 2008, it is the intent of Congress that Treasury should use Troubled Asset Relief Program (TARP) resources to fund capital infusion and asset purchase approaches alone or in conjunction with each other to enable financial institutions to begin providing credit again, and to do so in ways that minimize the burden on taxpayers and have maximum economic recovery impact. Where the legislation speaks of ``assets'', that term is intended to include capital instruments of an institution such as common and preferred stock, subordinated and senior debt, and equity rights.
emphasis added

Maybe people are seeing what they want to see, but it'd be nice if the TARP was more oriented towards increasing capital.

by Calculated Risk on 10/08/2008 04:51:00 PM

From the Fed: Board authorizes Federal Reserve Bank of New York to borrow securities from certain regulated U.S. insurance subsidiaries of AIG

The Federal Reserve Board has authorized the Federal Reserve Bank of New York to borrow securities from certain regulated U.S. insurance subsidiaries of the American International Group (AIG), under section 13(3) of the Federal Reserve Act.

Under this program, the New York Fed will borrow up to $37.8 billion in investment-grade, fixed-income securities from AIG in return for cash collateral. These securities were previously lent by AIG’s insurance company subsidiaries to third parties.

As expected, drawdowns to date under the existing $85 billion New York Fed loan facility have been used, in part, to settle transactions with counterparties returning these third-party securities to AIG. This new program will allow AIG to replenish liquidity used in settling those transactions, while providing enhanced credit protection to the New York Fed and U.S. taxpayers in the form of a security interest in these securities.

by Calculated Risk on 10/08/2008 02:35:00 PM

From Reuters: US' Paulson to discuss G7 financial coordination

The Bush administration said U.S. Treasury Secretary Henry Paulson at a news conference on Wednesday will discuss coordinated actions by wealthy industrialized countries to ease financial system stress.
...
The news conference is scheduled for 3 p.m.

Here is the CNBC feed.

And a live feed from C-SPAN. (updated: C-Span2)

by Calculated Risk on 10/08/2008 12:14:00 PM

When I started this blog (Jan 2005), I was concerned about excessive speculation in housing and extremely loose lending practices. It appeared that housing starts and new home sales would fall significantly. I forecast record foreclosures and significant declines in home prices. Many of us wondered who the eventual bagholders would be for all the bad loans. I was also concerned about the extent of equity extraction from homes (the home ATM), and I believed that the coming housing bust would lead the economy into a recession.

This blog was a daily dose of doom and gloom!

Here was how former Fed Chairman Paul Volcker described the situation in Feb 2005:

"Under the placid surface, at least the way I see it, there are really disturbing trends: huge imbalances, disequilibria, risks – call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot.
...
We are buying a lot of housing at rising prices, but home ownership has become a vehicle for borrowing as much as a source of financial security."

I'm frequently asked if I'm more concerned today than I was in 2005. There are reasons for concern: the credit markets have seized up, many financial institutions are insolvent, consumer spending and investment in commercial real estate is starting to decline, export growth appears to be slowing, the unemployment rate is rising ... and the economy is clearly in a recession.

There are huge and scary downside risks today, but I'm actually more sanguine now than I was in 2005. If you think back to 2005, we were standing at the precipice, and there was no where to go but over the cliff.

Here is a look at some of the data. Where would you rather be?

Click on graph for larger image in new window.

Housing starts have collapsed by more than half since 2005. This decline seemed obvious and inevitable in 2005, and now most of the adjustment has already happened.

Which was better for the economy looking forward? To be standing at the edge (in 2005) or to be much nearer the bottom in 2008?

Here is a similar graph for new home sales. Just like for housing starts, new home sales have collapsed by more than half since 2005.

The good news is starts of single family homes built for sale have fallen below new home sales, and new home inventory is declining (although existing home inventory is still near record levels). Once again the bulk of the adjustment is now behind us.

The third graph shows price-to-income using the Case-Shiller national index through Q2 2008.

Although I believe there are more price declines ahead (and therefore more homeowners with negative equity and more foreclosures), prices are much more reasonable today than in 2005.

The price adjustments were inevitable, and progress is being made.

The fourth graph shows Mortgage Equity Withdrawal (MEW) or the Home ATM. It was scary in 2004, 2005 and even in 2006 as homeowners supplemented their income by using the equity in their homes. This amounted to around 9% of disposable personal income in some quarters.

It was obvious this had to stop and now it has. The decline in MEW will impact consumer spending, but this was a necessary step towards fixing household balance sheets.

And the final graph shows the trade deficit as a percent of GDP. The trade deficit peaked in 2005 too, and would have fallen even faster except for the huge increase in oil prices.

Now that oil prices are falling, this adjustment in the trade deficit will probably accelerate. The trade deficit doesn't need to fall to zero, but 5% or 6% of GDP was unsustainable.

It's easy to get caught up in the day to day financial crisis and recession news - and this blog will continue to bring you the doom and gloom of the worsening recession. But it's important to remember that even though the adjustment process is painful, progress is being made.

Here is something to ponder from the Seattle Times in 1990: Experts: Bank Crisis Risks Turning Recession Into Depression (hat tip John)

People are starting to make nervous jokes about pulling their money out of shaky U.S. banks and stashing it under their mattresses instead.

But the banking crisis is no joke.

It is real - so real it risks turning the emerging recession into the biggest economic nightmare since the Great Depression of the 1930s.

``My own view of this tends to be apocalyptic - that we are on the threshold of a '30s-like experience,'' said David Cates, chairman of Ferguson & Co., bank consultants based in Dallas.

``The banking system is under tremendous strain. Should it begin to unravel, recession could easily become an economic disaster,'' said a recent editorial in Business Week magazine.

The financial crisis is worse today than in 1990, and there are many problems ahead (like less consumer spending and business investment), but I believe progress is being made.

by Calculated Risk on 10/08/2008 10:00:00 AM

From the NAR: Pending Home Sales up Strongly

The Pending Home Sales Index, a forward-looking indicator based on contracts signed in August, jumped 7.4 percent to 93.4 from an upwardly revised reading of 87.0 in July, and is 8.8 percent higher than August 2007 when it stood at 85.8. The index is at the highest level since June 2007 when it stood at 101.4.

Existing home sales are reported at the close of escrow, pending home sales are reported when contracts are signed. The Pending Home Sales index leads existing home sales by about 45 days, so this suggests existing home sales in October will be up somewhat.

This is data before the most recent credit crunch in September.

For some graphs comparing existing home sales to pending home sales, see: Do Existing Home Sales track Pending Home Sales? The answer is yes - they do track pretty well.