Debt Market Distress Spreads

[question everything]

SEPTEMBER 26, 2008

Debt Market Distress Spreads
By LIZ RAPPAPORT and ANUSHA SHRIVASTAVA

Short-term money markets remained in turmoil, heightening the likelihood the credit pullback may harm the broader economy. Inside markets that are hidden to most Americans -- the overnight Treasury repo market, the short-term commercial-paper markets and the floating-rate municipal bond markets -- action was unfolding that will soon affect how companies meet payroll, pay vendors and make investments.

These markets allow companies with ample reserves to squeeze out a few extra dollars by investing the cash in securities with life spans of just days or weeks. All that cash helps keep the economy lubricated by distributing money to other firms that need short-term loans to buy inventory or meet payroll.

Some distressing signs emerged Thursday from one of the most important of these marketplaces, the commercial-paper market, where companies borrow money for periods of just a day to up to a year. The market contracted by $61 billion in the week ended Sept. 24, its largest decline since August 2007, when investors fled over some of the first warning signs of the subprime-mortgage crisis. In the latest week, banks and other financial companies accounted for most of the decline, as they took $50.3 billion of paper off the market.

(snip)

These changes already are having effects on a host of companies that are constantly managing their cash positions. Payroll processor Paychex Inc. transmits billions of payroll payments each day for 500,000 U.S. businesses. Last week, Paychex's chief financial officer, John Morphy, moved some of his working cash out of short-term municipal bonds and some money-market funds and into discount notes issued by government-backed Fannie Mae and Freddie Mac, called agency discount notes... The changes also have come to Stanley Works, the New Britain, Conn., toolmaker. The company has cut its reliance on commercial paper, replacing it with long-term debt that costs nearly twice as much.

(snip)

There is so much mistrust in the markets that banks and funds aren't extending credit to customers even for a few hours during the day, as they usually do. Instead, lenders are waiting until the last possible moment to release funds, creating a logjam at day's end when they wire money to branches, subsidiaries or other accounts. The backup of cash transfers has led the Federal Reserve to keep its money-transmission system open late, said a Fed spokesman. All these worries will come to a head as the Sept. 30 payday approaches, which also is the end of the quarterly financial-reporting period for many companies.

(snip)



http://online.wsj.com/article/SB122235083012475109.html?mod=testMod (subscription)

[lapfog_1]

1. Crap... I hope I get to cash my next paycheck...

This is serious. I don't get one until Oct 3.

[orwell]

2. Don't worry...

...a lot of newly minted "financial experts" in the highly economically literate American body politic are willing to let the whole thing burn to the ground to punish the "greedy bankers".

Burn our own house down...That'll teach 'em.

[wtmusic]

4. Maybe you can explain how the US financial system will

"burn to the ground" when we have a 2.5% foreclosure rate (the rate during the Depression toppped 50%).

Banks want to make money too, and they can't without lending money. So Sept 30 will come and go without the sky falling, and Henny Penny Paulsen will have even a harder time selling his handout.

We almost had a run on WaMU yesterday, but the depositors couldn't run as fast as Morgan Stanley did to buy it up. :D

[ProfessorGAC]

5. Nicely Stated

The free marketeers and hyper-dereg crowd is looking to create cover for the obvious failures in their philosophy by overstating the situation and riding to the "rescue".

I'd suggest the solution lies not in a quick action to bail-out, but in systemic change to get the train back on the rails. And trains can come off the rails without it being a catastrophe.
The Professor

[Neshanic]

7. The best post yet on this.

[orwell]

6. The run on WaMu has been going on for some time...

...that is why they were closed.

Comparing the current situation to the Great Depression is apples to oranges. The global financial system was far simpler then. There wasn't a quadrillion dollars of derivative products floating around. There were stocks, bonds, and savings.

The amount of leverage was far different. The US was an ascendant nation with vast untapped resources, not a flailing global superpower armed to the teeth with nuclear weapons and a broken political dialog with the ability to take down the world's financial system as it turns out the lights.

A 2.5% foreclosure rate is devastating with the quantity of leverage in this system. Bank capital is at 1/16 of it's assets. It doesn't take a genius to see how very low foreclosure rates can completely wipe a bank's core capital in a short amount of time.

JP Morgan is making a calculated bet which may turn out to be good for Morgan's shareholders. He is picking up an existing branch network and deposit base on the cheap. The WaMu shareholders are of course wiped out. It is unclear what will happen to the bondholders but early reports indicate that they may take it on the chin as well. Morgan will also float a 10 billion dollar offering partly to pay for the purchase.

Any way you look at it, investment capital is going up in smoke rapidly. Because of the domino effect in today's highly flawed, highly interconnected capital markets, small brush fires can far more easily turn into mammoth fire storms.

The question is are we all willing to take that chance.

I don't like this plan. I also don't trust the market to "work it out". There are better ideas out there, such as Nouriel Roubini's, and I hope that they get a fair hearing. But doing nothing is not an option here.

[wtmusic]

8. A bank run that goes on for some time is an oxymoron

and doing nothing is always an option, though we may disagree on the value of that option.

What we will see go up in smoke is the "quadrillion dollars" of hyperinflated, overleveraged derivatives which should have been torched long ago. It will create great investment opportunities for companies like JP Morgan and BofA which for the most part didn't participate in the subprime scam. The people who lose savings because of banking failures have poor regulation to thank, and are rightly entitled to FDIC payouts. The FDIC may need bolstering.

There is still growth and there is still value in American equity. The markets are not crashing but correcting, which is good - the financial equivalent of a underbrush fire among redwoods which returns nutrients to the soil.

[orwell]

9. With the WaMu purchase, JP Morgan...

...now has over 10% of the deposits in America. Is that healthy? You don't see a problem here?

If you don't think the markets are crashing you are concentrating on a very narrow universe. The global credit markets are locking up.

Of course the derivatives primarily represent crap. That isn't the argument. The argument is that balance sheets and the associated asset leverage has been built on that crap. You can't allow the pile of crap to go up in smoke, no matter how worthy you or I think that option may be. If we are to de-leverage safely it must be done in a controlled manner. The largely semantic argument about doing nothing being an option strikes me as the most toxic form of Libertarianism. To paraphrase a famous economist, "In the long run we are all dead."

I have been expecting the current scenario for most of my 28 year trading life. I don't owe any money. I own my house outright. I am in far better position to weather this than most. That being said, I am also a realist. What we are staring into is not "the financial equivalent of a underbrush fire among redwoods which returns nutrients to the soil." We are looking at a full blown firestorm that would affect a significant quantity of the world's population - possibly for a generation. Handled incorrectly this could make Japan's 10 year slowdown look like a cakewalk. And the world's poor will be the most severely impacted. That is not just me talking, that is the opinion of the bulk of sane economists.

As far as growth, I long ago gave up on government statistics as little more that political fairy tales. It is unclear what is going on. That is part of the problem.

http://www.shadowstats.com/

There was value in Lehman equity...or so the markets told us.
There was value in Freddie and Fannie equity...or so the markets told us.
There was value in Bear Sterns equity...or so the markets told us.

Right up until the last second, the markets told us there was value, and the markets were wrong. Markets get things catastrophically wrong all the time.

Unlike John McCain or the Cato Institute I am not willing to play dice with people's lives. There is no need to. I do not trust the markets to work this out. I have been around too long. I have witnessed the extraordinary madness of crowds.

[wtmusic]

10. Do you have a link to the sane economists

you refer to? (Greenspan and Bernanke don't count; they got us into this mess).

I admit I'm not a financial expert, but frankly I don't see how the global credit markets can "lock up". It would be suicide for a bank to refuse to lend anyone money - completely contrary to their own interests. And you are asking me to believe that all banks will commit suicide?

I also don't trust someone to saddle my kids with a trillion dollars in debt because they fucked up.

[orwell]

12. Here you go.

Both of these guys were warning about this for awhile so they are not Johnny-come-latelys to this problem.

http://www.hussmanfunds.com/wmc/wmc080922.htm

http://www.rgemonitor.com/blog/roubini

Here is a more simplistic synopsis of Roubini's thoughts:

http://money.cnn.com/2008/09/24/news/economy/Roubini_on_bailout/?postversion=2008092411

Here is the letter, from a group of economists that Senator Shelby has been touting on the hill. Notice that even though they do not agree with the Bush/Paulson plan they agree that something has to be done:

http://faculty.chicagogsb.edu/john.cochrane/research/Papers/mortgage_protest.htm

I completely understand your concerns about the debt. I share them. I have been railing against Federal Budget mismanagement for decades, many times talking to myself while people laughed at me. But I also realize that we are at the tipping point here. I actually would prefer the world to deflate for awhile. I think it would do us good. I would like to return to a sound money policy. But I also realize that to do so with a thermonuclear explosion in the financial system will not bring this about.

Sorry to come off as so strident or opinionated. Most who know me would think I would relish these Aholes getting their comeuppance. Unfortunately, there is a bigger issue here that requires some very calm, reasoned, yet decisive action. This isn't going to go away on its own.

Good luck - and thanks for engaging in a civil conversation - and actually giving a shit!

[wtmusic]

13. Thanks.

In your opinion do you believe this can't wait until after 9/30?

[aquart]

3. Tax and spend translates to Pay as you go. Bush didn't.

First budget line to cut is that wasteful, expensive war. Both of them. Pakistan is getting ready for civil war, we don't want to be there for it.

[Eurobabe]

11. I used to work on one of the largest REPO desks in the USA

Alot of the monies we placed overnight were in MBS (mortgage-backed securities) One time, the brokerage firm (I think it was Merrill Lynch) fucked up the overnight collateral and gave our client MBS instead of treasuries as was specified in their TRI-PARTY REPO agreement.

Heads rolled.

Could you imagine that kind of fuck up on a 250mil trade THESE days?