by Calculated Risk on 9/11/2007 11:01:00 AM

From Fed Chairman Ben Bernanke: Global Imbalances: Recent Developments and Prospects. Bernanke provides an update on his "savings glut" explanation of current global imbalances.

... the current pattern of external imbalances--the export of capital from the developing countries to the industrial economies, particularly the United States--may prove counterproductive over the longer term. I noted some reasons for concern in my earlier speech, and they remain relevant today.

First, the United States and other industrial economies face the prospect of aging populations and of workforces that are growing more slowly. These trends enhance the need to save (to support future retirees) and may reduce incentives to invest (because workforces eventually will shrink). If the United States saved more, one likely outcome would be a reduction in the U.S. current account deficit and in the rate at which the country is adding to its liabilities to the rest of the world.

Second, the large U.S. current account deficit cannot persist indefinitely because the ability of the United States to make debt service payments and the willingness of foreigners to hold U.S. assets in their portfolios are both limited. Adjustment must eventually take place, and the process of adjustment will have both real and financial consequences. For example, in the United States, the growth of export-oriented sectors such as manufacturing has been restrained by the shifts in relative prices and foreign demand associated with the U.S. trade deficit. Ultimately, the necessary reduction in the trade and current account deficits will entail shifting resources out of sectors producing nontraded goods and services to those producing tradables. The greater the needed adjustment, the more potentially disruptive and costly these shifts may be. Similarly, external adjustment for China and other surplus countries will involve shifting resources out of the export sector and into industries geared toward meeting domestic consumption needs; that necessary shift, too, will likely be less disruptive if it occurs earlier and thus less rapidly and on a smaller scale.

On the financial side, if U.S. current account deficits were to persist at near their current levels, foreign investors would ultimately become satiated with dollar assets, and financing the deficit at a reasonable cost would become difficult. Earlier reduction of global imbalances would reduce the potential strains associated with financing a large quantity of international liabilities and likely allow a smoother adjustment in financial markets.

Finally, in the longer term, the developing world should be the recipient, not the provider, of financial capital. Because developing countries tend to have high ratios of labor to capital and to be away from the technological frontier, the potential returns to investment in those countries is high. Thus, capital flows toward those countries should benefit both them and the countries providing the capital.

Bernanke didn't offer any clues as to the direction of monetary policy.

by Calculated Risk on 9/11/2007 10:38:00 AM

From the NY Post: Countryslide, Mortgage Lender's Shares Plunge; Seeks 2nd Bailout

Note: You have to enjoy the Post headline. Countrywide is seeking more investments, not a bailout. This story is also on Dow Jones (not as colorful).

Countrywide Financial Corp. is putting together another multi-billion dollar bailout plan as the nation's largest home lender continues to struggle amid the global credit crunch and declines in the housing market ...
...
It's unclear at this point who exactly is involved in the investment, but sources said a group that could include J.P. Morgan and Citigroup as well as several hedge funds has expressed interest in Countrywide.

A final deal could be announced by the end of the month, sources said.
...
"The issues the economy is facing are worse than most people believe," Mozilo said in an interview last Friday with Bloomberg News.

by Anonymous on 9/11/2007 10:15:00 AM

I was so startled by the quote in this morning's WaPo from Congressman Gary Ackerman that I really had to go find his actual statement to the Financial Services Committee. It's a beaut. Ackerman apparently believes that everything the rating agencies have done arose from an intent to defraud, that investors would never have purchased these bonds with more disclosure, and that existing authority to regulate of the SEC is sufficient, but that the problem is the SEC's unwillingness to run right out and make criminal referrals before having studied the matter.

Originators then took these loans – many of which should have been assessed as much riskier than they were – and packaged them into securities to sell to investors. If there had been full disclosure, smart and careful investors would have judged that these mortgage backed bonds carried a disproportionately high level of risk. In an effort to deliberately mislead investors, however, some originators and credit-rating agencies, so-called Nationally Recognized Statistical Rating Organizations (NRSROs), colluded. First, the credit-rating firms would consult, or maybe we should say collaborate, with the originators – receiving high fees, of course – to advise the originators how to design the packaged securities to ensure that the riskiest piece of the product was adequately masked. Then, for another fee, the credit raters would assign overly favorable ratings to these mortgage-backed bonds, giving investors the impression that a neutral, unbiased party with a proven track record of assessing risk thought highly of these volatile products.

Essentially, the originators and credit raters shoved enough pigs and laying hens in with the beef herd that investors expecting prime ribs on their silver platter and money in their pocket ended up with pork ribs on their paper plate and egg on their face. The credit-rating firms were double-dipping; profiting first from helping to put these shady securities together, and then collecting fees for deliberately rating these risky products at a higher value than they were worth. It’s like hiring a judge to advise you as to how to commit an act and then paying him to decide whether you have committed a crime. My strong view is that NRSROs conspired with financial institutions to fool investors by packaging and rating securitizations in a manner that was deliberately aimed at misleading them. This is the accounting firm telling shareholder companies how to fool their investors and then getting hired as independent auditors.

That's not the free market at work. That's fraud. Fraud is a crime, not a correction.

What I find, perhaps, to be most perplexing of all is that Congress already identified problems stemming from NRSROs and passed legislation seeking to increase statutory authority to oversee the credit-rating agency industry. In the 109th Congress, the Credit Rating Agency Reform Act of 2006 was passed by the House and Senate, and was signed into law by President Bush almost exactly one year ago. This legislation granted the Securities Exchange Commission much greater authority to regulate and supervise NRSROs. To my knowledge, and as the current financial debacle makes clear, the SEC has not acted to either discipline those NRSROs that were involved in these types of practices, or to make certain that these insidious practices are thwarted in the future. The SEC simply is continuing to examine the credit-rating industry, a study that has been ongoing since before the Credit Rating Agency Reform Act became law last year.

Here's a conclusion for the SEC: you're more than a few days late and more than few billion dollars short.

The SEC has all the tools it needs to act swiftly and appropriately, but it has failed to do so. Unless the SEC demonstrates to investors, quickly and convincingly, that they intend to clean up the mess that the banks and credit-rating agencies have created, Congressional action will be necessary. This Committee and this Congress will not be passive spectators as banks and credit-rating agencies use their control of information to fool investors into believing that a pig is a cow and a rotten egg is a calf.”

I can understand why there is a problem with the rating agencies combining consulting and rating roles, just as there is a problem with accounting firms combining consulting and auditing roles. Perhaps naively, though, I wonder why we think there is always such a bright line between the two. If the rating agencies publish their methodologies and due diligence criteria, in the name of full disclosure to investors, isn't this necessarily information that issuers can use to change their practices so that their securities achieve the highest ratings? Is that in and of itself a problem, or is it only a problem if the ratings criteria are faulty? And if they are, is it necessarily because of fraudulent intent? We're all rightly impatient with too much of this "mistakes were made" line, but are we really going to hold rating agencies to the standard of either perfect prediction of credit loss or jail time?

by Anonymous on 9/11/2007 08:52:00 AM

The Washington Post does a drive-by look at subprime-related litigation. There may not be much new here, although it does make you wonder what all those market participants who were paying big bucks for legal counsel when they built these securities and originated these loans are now thinking about how worth it that was. As far as I can tell, the securities lawyers who blessed the original securitization deal documents are now intimating that they, too, relied on the rating agencies' representations. I'm not interested in defending the rating agencies, but I will predict that it won't be long before they are blamed for autism, teen pregnancy and the price of an iPhone.

This part, however, merits our attention:

"Essentially, the originators and credit raters shoved enough pigs and laying hens in with the beef herd that investors expecting prime ribs on their silver platter and money in their pocket ended up with pork ribs on their paper plate and egg on their face," Rep. Gary L. Ackerman (D-N.Y.) said in an opening statement during a Financial Services Committee hearing last week.

Bear in mind that the original idea for the Muddled Metaphor Index arose from the insight that when normally articulate people start speaking in tongues, you know you have a crisis on your hands. You can debate the extent to which members of Congress are normally articulate these days, but I don't think you can escape the conclusion that Congress hasn't got the first idea what to do about this, or whom to do what about, or when to do what to whom. I do expect the Beef Producers Council to sue for defamation.

by Calculated Risk on 9/11/2007 01:50:00 AM

From the WSJ: KKR Buyout Terms May Set the Standard

KKR ... agreed to make several concessions to bankers ... largely at the margins. That assured that market attention will remain focused on the $26.4 billion First Data leveraged buyout as the first and most important in a string of coming deals valued at about $400 billion.

First Data "is the canary in the coal mine. If it gets done, then another $350 billion is doable," says the co-head of private equity at one major Wall Street firm. "But if not, then the whole market may plunge, and the rest of the capital markets will react badly."

... KKR reached an agreement with its bankers to introduce one covenant ...on First Data debt ... Under the covenant, First Data ... must maintain a certain ratio of earnings before interest payments, depreciation, tax and amortization to its amount of senior debt ... people familiar with the matter say the ratio is modest.

... KKR declined to agree to increase fees to the banks to enable them to cut their losses on financing the $24 billion in debt. And more importantly for investors, KKR declined to agree to an increased interest rate on the loans. The concessions were sufficiently toothless, said one banker, to describe them as offering the banks "sleeves on the vest."