Credit Crunch Continues.
The Wall Street Journal is today reporting that Wells Fargo, a major mortgage lender, is raising the interest it charges on prime jumbo home mortgages by a whopping 1.125%.
The Cerberus deal to buy Chrysler went through today, but they were unable to sell the corporate debt to fund the deal at prices that they were willing to pay (so the bank bridge loans, intended to be temporary, continue in force). It was this news of problems in the financing for the Cerberus deal that triggered last Thursday’s sell-off in the US stock market, the second largest down day in the last 4 years in a week that was the worst for the stock market in at least 4 years.
Standard & Poor’s today lowered its outlook on brokerage Bear Stearns to negative:
Bear Stearns Cos., the manager of two hedge funds that collapsed last month, had its credit-rating outlook cut to negative by Standard & Poor's on concern declining prices for mortgage-backed securities will reduce earnings. . . .
The failure of the Bear Stearns funds, which invested in mortgage-related bonds, triggered a flight from the riskiest debt that spurred some lenders to balk at financing leverage buyouts and dried up credit lines for some U.S. mortgage providers. Shares of Bear Stearns, the second-largest underwriter of mortgage-backed bonds, have lost more than  percent this year.
Among the problems for Bear Stearns are lawsuits alleging that the brokerage misled investors to induce them to stay in the hedge funds when problems first became public.
CNBC reporters have been discussing the difficulty of finding money for new deals, though most deals previously in the works are still going through.
In a flight to quality, investors in the last two weeks are buying Treasury notes, which has led to those interest rates moving sharply lower. Usually, this leads to lower mortgage interest rates, but mortgage interest rates are going higher because of the difficulty of repackaging those loans and selling them as mortgage-backed securities. This would tend to lengthen the current slump in the housing market, which most analysts are now saying should probably last at least through 2008.
On Wells Fargo’s huge jump in interest rates on jumbo home mortgages, the Wall Street Journal reports:
Lenders broaden clampdown on risky mortgages
Tightening standards could worsen slump in the housing market.
Jittery home-mortgage lenders are cutting off credit or raising interest rates for a growing portion of Americans, extending well beyond the market for subprime loans for people with the weakest credit records.
This worsening credit crunch threatens to put further pressure on the housing market, where prices are flat to declining in much of the country.
Lenders say they are being forced to raise interest rates and stop offering certain loans because mortgage-bond investors have lost their appetite for a broad range of mortgages considered risky. That includes those dubbed Alt-A, a category between prime and subprime that often involves borrowers who don't fully document their income or assets, or those buying investment properties. Notably, American Home Mortgage Investment Corp., which stopped making loans earlier this week, said late yesterday it would cease most operations, slashing its work force to about 750 from more than 7,000.
"It is with great sadness that American Home has had to take this action," Chief Executive Michael Strauss said in a statement. "Unfortunately, the market conditions in both the secondary mortgage market as well as the national real estate market have deteriorated to the point that we have no realistic alternative."
Lenders are tightening standards and "raising rates like crazy," said Melissa Cohn, chief executive of Manhattan Mortgage, a New York mortgage broker. She said Wells Fargo & Co. is charging 8% for a prime jumbo 30-year fixed-rate loan that carried a 6 7/8% rate late last week. (Jumbo loans are those too large to be sold to government-sponsored mortgage investors Fannie Mae and Freddie Mac.) A Wells spokesman said rates are lower on loans made directly by the bank than on those through brokers.
The market for mortgage-backed securities is "very panicked," Michael Perry, chief executive of IndyMac Bancorp Inc., another big lender, said in a message on the lender's Web site yesterday. . . .
Alt-A loans accounted for about 13% of U.S. home loans granted last year, according to Inside Mortgage Finance, and subprime loans about 20%. Industry executives have said subprime lending is likely to shrink by more than 50% this year, and now much of the Alt-A market is vanishing too.
This credit squeeze "will further crimp the effective demand for housing, and will make the late summer home-sales season even worse than the dismal spring season," said Thomas Lawler, a housing economist in Vienna, Va. . . .
Several dozen lenders have gone out of business in the past six months, and others are teetering. Shares of Accredited Home Lenders Holding Co. fell 35% yesterday on the Nasdaq Stock Market after auditors said its "financial and operational viability" is uncertain if a pending merger isn't completed.
I’ll have more thoughts on Federal Reserve policy in a later post.
CNBC's Jim Cramer Goes Ballistic: "WE HAVE ARMAGEDDON!"
On CNBC at 2:46pm ET, Jim Cramer is screaming about the Fed right now: "WE HAVE ARMAGEDDON!"
UPDATE (2:56pm): While I was writing a very long post suggesting in a quiet and indirect way that I can't understand why the Fed is not providing credit to the market, Jim Cramer on CNBC's "Stop Trading" segment started screaming with a passion that I've never seen even from him. He screamed over and over that the Fed has "NO IDEA" what's going on, and added that its behavior is "SHAMEFUL."
Cramer said that the Fed should "open the window" and cut rates "TODAY"!
Just because the Fed didn't engineer this credit crunch, as Fed Chairs Volcker and Greenspan did in 1987, doeesn't mean that the Fed shouldn't provide the liquidity needed to ease the pressure on defaulting homeowners and on financial institutions that are getting killed from the drying up of corporate credit.
BTW, when Cramer started his tirade against the Fed the Dow was down about 100 points, which was less than 1%.
S&P 500 has Second Worst Day Since Early 2003.--
According to final figures on Friday, the S&P 500 ended down 2.66%, edging out last Thursday's 2.64% drop for the second worst day in the S&P 500 since early 2003. The NASDAQ was down 2.51%; the Dow was down "only" 2.09%.
That means that for the year the S&P 500 is up only 1%, while the NASDAQ is up 4%, and the Dow is up 5.7%.
Looking back, the pattern of big down days over the last two weeks happens more often near market bottoms than market tops. In the past, when such a pattern has occurred after big runups in the market, sometimes it signals a temporary top (1987). Sometimes it signals a buying opportunity in an up market (1998).
Some commentators on TV have pushed for Fed Chair Bernanke to take a page from Greenspan's response to a similar mini-crisis in 1998, meeting with experts to assess the problems and assuring the markets that liquidity would be available if needed. As it now stands, the Fed still has an official slight bias toward fighting inflation by leaning toward tightening, though in action it is neutral. Most expect the Fed at least to go neutral officially next week, perhaps to a stated bias toward easing, though to do essentially nothing significant about interest rates in response to the spreading credit crunch.
What Credit Crunch?--
Today the New York Stock Exchange had its biggest volume day ever, trading 2.8 billion shares.
As the US Stock market neared the end of another big down day (down 2.8%, 387 points on the Dow), here are some of the headlines on the stories at Yahoo Finance:
Dow Plunges [Over] 300 on Mortgage Concerns
Wall Street fell sharply again Thursday after a French bank said it was freezing three funds that invested in U.S. subprime mortgages because it was unable to properly value their assets. . . .
A move by the European Central Bank to provide more cash to money markets intensified Wall Street's angst. Although the bank's loan of more than $130 billion in overnight funds to banks at a low rate of 4 percent was intended to calm investors, Wall Street saw it as confirmation of the credit markets' problems. It was the ECB's biggest injection ever [according to CNBC reporters, twice as big as after 9/11].
The Federal Reserve added a larger-than-normal $24 billion in temporary reserves to the U.S. banking system.
The ECB's injection of money into the system is an unprecedented move, said Joseph V. Battipaglia, chief investment officer at Ryan Beck & Co., adding that it shows that problems in subprime lending are, in fact, spilling into the general economy.
"This is a mini-panic," he said. "All the things that had been denied up until this point are unraveling. On top of this, retail sales were mediocre, which shows that indeed, the housing collapse is affecting the consumer."
BNP Paribas Freezes Security Funds
A major French bank, BNP Paribas, announced Thursday that it was suspending three of its asset-backed securities funds, saying it could no longer value them accurately because of problems in the U.S. subprime mortgage market. . . .
The bank, France's largest bank by market value, said it was suspending three funds worth a total of 2 billion euros ($2.75 billion): Parvest Dynamic ABS, BNP Paribas ABS Euribor and BNP Paribas ABS Eonia. All funds combined at BNP Paribas Investment Partners are worth more than 350 billion euros ($482.79 billion).
"The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating," BNP Paribas SA said in a statement.
"The situation is such that it is no longer possible to value fairly the underlying U.S. ABS assets in the three above-mentioned funds" and "therefore unable to calculate a reliable net asset value, NAV, for the funds," the company said. . . .
This week WestLB Mellon Asset Management, the asset management joint venture of German state bank WestLB AG and The Bank of New York Mellon Corp., suspended redemptions from its asset-backed securities ABS Fund, which is part of the West LB Mellon Compass Fund.
WestLB AG denied speculation on Thursday that it is facing a fund liquidity problem.
Other companies, including Union Investment Asset Management, a German mutual fund manager, and Frankfurt Trust, a unit of BHF-Bank, have also halted redemptions.
ECB Moves to Add Liquidity to Market
The European Central Bank loaned nearly 95 billion euros ($130.81 billion) in overnight funds to banks at a bargain rate of 4 percent on Thursday, putting more cash into a global financial system jolted by the collapse of the U.S. subprime mortgage market.
Analysts and economists were surprised by the move, with some seeing it as evidence that the problems in subprime lending are spilling into the general economy and others as a case of the European Central Bank stepping in where the U.S. Federal Reserve Bank has not. . . .
"Today's events show that either the Fed committed a large policy error on Tuesday, or that both the Fed and the ECB are themselves more in the dark on the problems that lie underneath the surface than are investors in the financial markets," Tony Crescenzi of Miller Tabak said in a research note.
"While the Fed and the ECB may not have the providence to see all problems that exist, it should at the very least have a greater sense about conditions in the markets it controls — the money market and the credit markets more generally — and of conditions in the banking system."
The Fed met Tuesday to discuss monetary policy and announced after the meeting that inflation, not credit problems, remained its major concern.
Mortgage delinquencies, defaults spreading: AIG
"The market's in a panic mode because the subprime crisis is spreading into other areas of the economy," said Bill Hackney, a managing partner of Atlanta Capital Management. . . .
'WHISTLING IN THE DARK'
"Problems in July have gone beyond the subprime market," said Bill Bergman, an analyst with Morningstar. "Maybe not AIG, but some of these lenders have been whistling in the dark."
Expressing a different view a few days ago, Ben Stein argued against any significant spread in the “subprime mess.” I found most of his arguments unpersuasive (including his assertion that US subprime woes had “no connection” to other developed or developing stock markets).
But Stein made one excellent point:
Ben Stein: "How Not to Ruin Your Life"
What about the supposed drying up of loans for mergers and acquisitions by private equity firms? Well, here's a good, simple test of just how valid that explanation is for stock market moves: The majority of private equity takeovers are financed with junk debt.
If there really were a major shortage of funds for these deals, the interest rate on the junk would skyrocket. Instead, while the rate has risen by about 150 basis points in the past month, the spread between junk and investment grade is now about 290 basis points, according to leading junk analyst Martin Fridson.
This is a lot lower than the year-end average of the spread from 2002 to 2006, and far below the almost 800 basis point spread during a true interest-rate crunch like the one after the tech meltdown in 2000-2002.
So that's phony, too. Interest rates have risen, but not anything like what they've done in real crises.
Hedge Funds in Trouble.—
According to the Wall Street Journal, two Goldman Sachs hedge funds are having trouble. The first of these revelations on Thursday seemed to trigger an acceleration of the market slide that began in Europe.
Apparently, the computer models that had proved so successful over the last few years caused large trading losses in the last three weeks.
Unfortunately, WSJ’s stories are not open to non-subscribers.
Blind to Trend, 'Quant' Funds Pay Heavy Price
Computers don't always work.
That was the lesson so far this month for many so-called quant hedge funds, whose trading is dictated by complex computer programs.
The markets' volatility of the past few weeks has taken a toll on many widely known funds for sophisticated investors, notably a once-highflying hedge fund at Wall Street's Goldman Sachs Group Inc.
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.
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.
Just before the close yesterday (Wednesday), Goldman Sachs denied rumors that it was about to announce problems with one or more quantitative hedge funds. The Dow, which had tanked about a hundred points in a few minutes on the rumor, rebounded about a hundred points on the denial issued about 10 minutes before Wednesday's close.
Hedge Funds Are Beginning to Disclose Recent Losses.--
Among the many hedge funds disclosing recent losses is the main one run by Renaissance Technologies. Jim Simons, the spectacularly successful hedge fund manager of Renaissance, just reported that his main hedge fund has lost 8.7% so far in August. Nonetheless, in a letter to investors, he claims that "The culprit is not our Basic System" of investing (no online link yet). (According to Wikipedia, Simons’s personal compensation was $1.7 billion in 2006 and $1.5 billion in 2005.)
Hedge funds that severely restrict withdrawals may not be subject to severe challenges in the next few weeks, but others that don't routinely restrict substantial redemptions from investors may be selling parts of their portfolios — both to deleverage their investments and to raise cash to pay investors.
For the last few months, I have been developing and forward testing some statistical models to predict daily moves in the US stock market, ETFs, and some no-load, no-fee mutual funds. I noticed that in late July, my models ceased predicting moves in both the stock market and in commodities. I then completely redid the models, which have performed well in August, but they are much less consistently correct than they were in the May to mid-July period. Things have changed from the way they were from mid-2003 to mid-2007.
Federal Reserve Intervenes a Third Time Today.--
For the third time today, the Federal Reserve has intervened to provide liquidity to banks at its discount window. After the second intervention, CNBC reported that the size of the Fed’s two interventions was larger than in any day since September 2001. The third intervention was a very small addition ($3 billion) to the other two ($35 billion).
What the Fed bought was mortgage-backed securities, the market for which has dried up. According to CNBC news reports, the Federal Reserve was forced to act because US banks have been reluctant to lend short-term money to each other. As banks refuse to cooperate in the usual way because of the spreading credit crunch, the possibility of major problems over the next few months accelerates.
UPDATE: On further investigation, it is unclear whether news reports of the Federal Reserve buying mortgage-backed securities are in error.
From reading the Fed's website, I think that the Fed may have merely accepted such securities as collateral for three-day loans.
2D UPDATE: Two of the expert talking heads on CNBC are now saying that the Fed did not buy mortgage-backed securities today. Rather, according to them, the Fed accepted the CDOs as collateral. The two experts then disputed whether the Fed had effectively provided a price for these securities that are not being publicly traded. It would appear from the Fed's margin requirements for collateral that an implicit minimum price would have been set by the Fed's acceptance of them.
If so, I would hope that banks, hedge funds, and public corporations would mark their investments to market as quickly as possible so that the capital markets can adjust to this latest estimate of value, even if it is flawed. As this credit crunch is playing out, almost every day for nearly a month, we hear of new problems surfacing in new places. As some VC commenters have noted, we don't want a long-term refusal to mark assets to market, as occurred when the Japanese real estate market collapsed in 1990.