by Anonymous on 9/19/2007 11:30:00 AM

To supplement our regular reporting on MMI (Muddled Metaphor Index), we present our inaugural post on Mountain-Molehill Befuddlement Syndrome. MMBS is characterized by an inability to resist making a front-page story out of anything with 1) "mortgage-backed security" in it plus 2) one quote from some hedge fund guy (whose position is disclosed only in dollars, not in, like, who's getting shorted in the swap market). It's probably incurable, but we fight the good fight here anyway. Call us Quixotic.

Karen Johnson of the Wall Street Journal has a bad case of MMBS:

When fruit-spread purveyor J.M. Smucker Co. started buying mortgage-backed securities in 2004, they seemed like a safe way to diversify some of its investments.

Now, however, that asset class is in a bit of a jam.
Shares of banks and brokerages have fallen sharply since the markets cooled for commercial paper and other securitized debt that might hold mortgage-backed loans. But they aren't the only players with home-loan-related holdings.

In recent years, Smucker joined the ranks of other nonfinancial companies such as Garmin Ltd., Microsoft Corp., Netflix Inc. and Sun Microsystems Inc. by investing in what had been viewed as relatively safe investments that produced slightly better returns than cash and government bonds -- and could be sold quickly if needed. Many of these companies are cash-rich, looking for a secure place to park their millions. And none are expected to cash out any time soon.

The issue for investors is how these companies determine the "fair" value of their mortgage-backed securities in the current environment, and whether they are telling the whole story about how easily these assets can be liquidated -- and for how much.

"It concerns me from the standpoint of transparency, whether the cash stated on the balance sheet is a true representation of the cash available to the company," said Jeffrey Diecidue, a hedge-fund manager at UCA LLC in Short Hills, N.J., who has less than $100 million in assets.

Oh, man, this is just not sounding good. Jelly makers hiding the sticky details of MBS holdings. According to some guy who runs a little bitty hedge fund in "Short Hills."

You might as well get off the edge of your seats here, folks.

The amount of mortgage-backed securities owned by nonfinancial companies as a proportion of their total assets is low, and some, like Smucker, say they invest in only highly rated loans. But in the current environment, just saying investments have high credit ratings gives investors little comfort. As the traditionally staid commercial-paper market has shown recently, even triple-A-rated debt can be backed by subprime loans, causing investors to balk, prices to fall and trading to seize up.

At the end of July, Smucker had $41.5 million in mortgage-backed debt classified as noncurrent marketable securities available for sale, which are assets the company intends to sell for cash if it is needed for future operations. While that debt is just 1.2% of Smucker's total assets, it makes up 22% of the company's total marketable securities and 100% of its noncurrent marketable securities.

Hoooo-eee. $41.5 million. 1.2% of assets. You get bonus points here if you know that "noncurrent" in this context has nothing to do with performance. And double-extra bonus points if you have any idea why the metric of percent of noncurrent marketable securities means anything important, useful, or sinister. If you enjoyed the slide from "investors in Smuckers, Inc." to "investors in MBS," vis-a-vis who is balking about what, you win the whole PBJ.

Other companies with mortgage-backed securities, including Biomet Inc., Microsoft, Novell Inc., Netflix and Sun Microsystems, declined to comment. Semiconductor maker LSI Corp. didn't respond to requests for comment.

John Olson, chief financial officer of memory-chip maker Xilinx Inc., said the company buys only diverse high-grade securities and no collateralized debt obligations, or CDOs, which are debt pools that can carry triple-A ratings while still being backed entirely by subprime debt. "Fortunately, our treasurer was smart enough to know that CDOs aren't always what they say they are," he said. Mortgage-backed securities make up $24.3 million, or 2.5%, of Xilinx's $963.8 million in short-term investments.

Still, complicated investments have hurt other companies in the past. In 1994, for instance, Procter & Gamble Co. sustained heavy losses from derivatives on its balance sheet and sued its financial adviser, Bankers Trust, for selling these complex contracts to the consumer-products company.

So, the CFO guy says, we aren't holding the complicated ones and we aren't holding derivatives of the complicated ones. Therefore the very next paragraph says . . . "still."

For the moment, investors will pretty much have to take companies at their word when they say such mortgage-backed financial instruments are liquid and their stated fair-value estimates are based on market prices. Most nonfinancial companies classify their mortgage-backed securities investments as available for sale, meaning they aren't required to record changes in fair value on the income statement, which is followed closely by investors and analysts.

Instead, changes in fair value of such securities are recorded on the balance sheet in "other comprehensive income," which affects shareholders' equity but is less of a focus for Wall Street. Those disclosures will begin to change next year, when a new accounting rule kicks in for U.S. companies. This rule, which will first be required of companies with financial years beginning after Nov. 15, calls for companies to provide more information about financial instruments for which they apply fair, or market, values.

For investors like Mr. Diecidue, the rule can't come soon enough.

"The current market volatility in connection with these asset-backed securities presents a conundrum to the investors, because it's harder to know the true book value of a company," he says, referring to the measure of a company's assets minus its liabilities.

Well, you know, if you're worried about it, you could get out the back of the envelope and write down 100% of Smuckers' MBS holdings, which would reduce assets by 1.2%. Then you could go back to worrying about somebody who has substantial enough MBS holdings to get your knickers in a twist over.

Or maybe you could ferret out some "news" about corporate balance sheets that is somewhat less mortgage-obsessed? Nah . . .

by Calculated Risk on 9/19/2007 09:54:00 AM

The NY Times is no longer charging for TimesSelect, and their archives are available free back to 1987.

We have ended TimesSelect. All of our Op-Ed and news columns are now available free of charge. Additionally, The New York Times Archive is available free back to 1987.

The NY Times archive is a great resource.

Also, economist Paul Krugman has started his own blog: The Conscience of a Liberal.

by Calculated Risk on 9/19/2007 09:21:00 AM

The Census Bureau reports on housing Permits, Starts and Completions.

Seasonally adjusted permits fell sharply:

Privately-owned housing units authorized by building permits in August were at a seasonally adjusted annual rate of 1,307,000. This is 5.9 percent below the revised July rate of 1,389,000 and is 24.5 percent below the revised August 2006 estimate of 1,731,000.

Starts declined:

Privately-owned housing starts in August were at a seasonally adjusted annual rate of 1,331,000. This is 2.6 percent below the revised July estimate of 1,367,000 and is 19.1 percent below the revised August 2006 rate of 1,646,000.

And Completions declined slightly:

Privately-owned housing completions in August were at a seasonally adjusted annual rate of 1,523,000. This is 0.2 percent below the revised July estimate of 1,526,000 and is 19.0 percent below the revised August 2006 rate of 1,881,000.

Click on graph for larger image.

Here is a graph of starts and completions. Completions follow starts by about 6 to 7 months.

My forecast is for starts to fall to around the 1.1 million units per year level; a substantial decline from the current level. Goldman Sachs' forecast is for 1.1 million units, and UCLA is for 1.0 million units.

Even with the declines in permits and starts, this report shows builders are still starting too many projects. Starts will probably fall much further incoming months.

by Calculated Risk on 9/18/2007 08:29:00 PM

Update: From the Financial Times: Bank acts boldly to avert recession risk (hat tip Steve)

David Rosenberg, chief economist at Merrill Lynch, said it was hard to combat a deflating credit and asset bubble. He said that while markets soared when the Fed cut rates by 50 basis points in January 2001, they soon fell back.

The S&P 500 closed at 1,276.05 on January 2nd, 2001. The Fed cut rates 50bps on Jan 3rd. The S&P 500 closed at 1,347.56, up 5.6% for the day. Then the market started to sell off, falling almost 20% by March. Rosenberg is correct (doesn't mean history will repeat).

Bloomberg video has several interviews concerning the Fed rate cuts. Here is PIMCO's Bill Gross:

Click image for video.

Gross of Pimco Sees 3.75% as `Destination' for Fed Rate September 18 (Bloomberg) -- Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co., talks with Bloomberg's Michael McKee from Newport Beach, California, about today's decision by the Federal Reserve to lower its benchmark interest rate by a half point to 4.75 percent, the first cut by the central bank in four years. (Source: Bloomberg)

by Calculated Risk on 9/18/2007 04:26:00 PM

The reactions to the Fed funds rate cut are extremely varied - from relief to outrage. Here are a couple excerpts from the WSJ: Economists React: ‘One and Done’?

The FOMC makes it sound like “one and done” as it cuts both the Fed funds and discount rate by 50 basis points but continues to note inflation risks… As of this writing, we no longer look for the Fed to cut rates in October but that position, like the Fed’s, remains data dependent. –Drew Matus, Lehman Brothers

And outrage:

Today’s irresponsible 50 basis point reduction is really just the hair of the dog that bit us and is a tacit admission that our economy is addicted to cheap money… A Fed bailout in the form of rate cuts will neither prevent the recession nor keep house prices from collapsing. It may slow the process down a few quarters, but it will cost us dearly. –Peter Schiff, Euro Pacific Capital