The Troubles in Financials Are Not Over Yet

When I was a investment grade corporate bond manager back in 2002, there were three “false starts” before the recovery began in earnest. The market started rallies in December 2001, August 2002, and October 2002. I remember them vividly, and I behaved like the estimable Doug Kass during that period, buying the dips, and selling the rips.

In this bear market for the financials, we are only through the first leg down. Here is what remains to be reconciled:

• Residential housing prices are still too high by 10-20% across the U.S. on average.
• The same is true of much of commercial real estate.
• The mortgage insurers have not failed yet. Triad Guaranty is close, but at least two of them need to fail.
• There is still too much implicit leverage within the derivative books of the investment banks.
• Too many credit hedge funds and mortgage REITs are left standing.

I have tried to avoid being a pest on issues like these, but the overage of leverage has not been squeezed out yet.

Comments

[TheKingofSw...:]

I agree. How many billions are still to be wrote down from the ticking time bomb of OPTION ARM/neg am loans? People have no idea how many billions of these loans are out there, we're in the 4th/5th inning of this, there will be more blood.

2008 Apr 04 03:40 AM

[helplessobs...:]

30:1 leverage says it all

2008 Apr 04 03:58 PM

[Darrell:]

One has to remember that the debt explosion came about because foreign holders of the dollar were seeking a better return on their dollar holdings. They invested their excess dollars into treasury bills and were getting a negative return on their investment. Various types of sales people convinced them to invest their excess dollars in AAA rated debt securities.

These securities offered an inflation adjusted rate of return. Obviously no one understood these debt securities, as they lost value quickly,

Asset prices bubbled because of an excess dollar supply. Federal Reserve policy makers think they can deal with the problem by printing more money and making it available at low cost to the very institutions that created the debt problem.

The problem is that the process for selling this debt has changed and no longer is there buyers eagerly purchasing them. Also, the perception of the dollar’s value is slowly changing: when one exchanges their goods, services and/ or assets for dollars they are accepting a currency that is declining in value daily.

Investors are now entering into an uncharted financial storm caused by the following events:
1. dollar’s decline in value;
2. the potential difficulty in selling new debt securities;
3. The long unwinding of existing debt securities, with the realization that much of the AAA rated debt may be worthless.

It remains to be seen what the consequence of creating an excess money supply will have on the global economy, but my thesis is that the global economy will, in the end, demand that we put controls on our money supply. Or else.

And this is why I am spending May 08 in Ireland.

2008 Apr 04 04:06 PM

[pickaroonwyo:]

Looking further down the road, foreign investors considering US debt will have one thing to say, "First time, shame on you, second time, shame on me."

2008 Apr 05 07:19 PM