According to the Treasury Department, the global demand for US financial assets strengthened in March to a record level, as investors from China to the UK purchased, amongst others, the largest amount of US Treasury bonds since November 2009. Overall, foreign investors were buying equities, notes and bonds in amount of $140.5 billion in March, after a net buying of $47.1 billion in February. It is a clear signal that foreign institutions and investors are returning to the US as the ultimate safe haven. Not surprisingly, China remained the biggest foreign holder of US Treasuries after its holdings rose by $17.7 billion to $895 billion in March. Japan, the second-largest holder, increased its holdings by $16.4 billion to $785 billion in March. Holdings in the UK gained $45.5 billion to $279 billion.
Tuesday, US bonds rallied as Germany announced that it would ban short-selling and naked CDS of EU-16 government bonds, triggering speculations of financial trouble amongst the European financial institutions. Following the news, the euro currency fell as much as 1.9 percent to $1.2162, the lowest level since April 17, 2006. Few FX strategists claim that the euro may fall to $1.16 during the next three months as the sovereign-debt crisis forces the European Central Bank to keep borrowing costs low for a longer than expected period. Another school of thoughts says that as long as the Europeans are banning CDS products, the investors that are negative on PIIGS countries will exercise the other option: shorting the euro currency. According to ZEW, the German investor confidence dropped to 45.8 from 53 in April, the biggest decline since the collapse of Lehman Brothers. Counter-intuitively, the euro has slumped more than 10 percent against the dollar since the announcement of the €750 billion aid package, hence failing to stop speculations that the monetary union could fail.
Monday, China’s stock index recorded the biggest loss since August 2009 on concern government tightening monetary policy will deflate the property market which will ultimately hurt the economic growth. According to Bloomberg, the Shanghai index has lost 22 percent this year, making it the world’s fourth-worst index performer. Prices of reinforcing steel bars used in construction fell 4.7 percent last week, the most in at least eight months. Crude oil fell for a sixth day to $68.56 a barrel, while gold increased 0.8 percent to $1,223.50 an ounce. China is also concerned that the debt crisis facing Europe may delay the global economic recovery.
The recent 50% spike in the CBOE volatility index (VIX) should be a warning sign that investors will have to change their investment strategies as global risk intensifies. The million-dollar question is whether the sovereign crisis will spread outside the EU space. Nowadays, all the investors are focused on Europe’s PIIGS – Portugal, Ireland, Italy, Greece and Spain. What if the fiscal deficit issue will hit the developed countries (i.e., UK, Japan, and USA)? Except America, most of the world’s most advanced economies are facing worrying demographic problems, whereby an increasing number of welfare recipients will depend on a decreasing number of taxpaying contributors. Who will pay for the current rescue packages?
The discussion about China measures to curb the property market is not new, as from the beginning of this year many officials expressed concerns and future measures to tackle it. It may be a good title for the media as to explain the drop on Monday, but where is the efficient market?
As for the last question, I think the countries have a ‘momo trader’ approach: ‘shoot first, ask questions later’.
Maybe a new policy is needed to make sure that the % of child births is sustainable for the long term economic purposes.
Ovidiu,
The China bubble and its monetary policy will drag down the stock market for time to come. Nothing is new, but EU has added more fear, since 20% of its exports goes to Europe.
Toni,
There is one thing regarding China I cannot understand. From what I’ve read in the newspapers, they have agreed to reevaluate their currency and to untie it from the USD.
Why would they do that? Does it make sense economically? (the political perspective is always tricky) I mean … China’s cheap exports have been the key-factor of their sustained economic growth. Why would they make their exports more expensive and, as a result, less attractive?
Ovidiu,
This is the trick. There is plenty of pressure from US, EU & Co. to let the yuan float. There is some upside when its currency strengthens against the other currencies: lower inflation. That will make central bank less hawkish.
Toni,
What are the benefits of complex derivatives like in general ? I still can’t find an answer to that one.
BMM
Bogdan,
There are very useful definitely. A 1:1 ration for synthetic vs. cash makes very much sense. It spreads the risk, it does free-up capital, it cleans-up the banks’ balance-sheet, etc. Similarly, for structured finance deals.
Toni,
Thx … I see now … but what about 1:15 1:20 … what’s that one ?
BMM
Bogdan,
That was a pure gambling scheme.
Toni,
What was the “inflection” point in the US housing market? It would be great if you could explain a bit where or how or due to what, the first cracks started to break …
I looked over the Case-Shiller Home Price Index but that is mostly it …
BMM
Bogdan,
That is right. HPI chart is a very good indicator for what we witnessed so far. It is easy to understand that nothing goes up forever. At one point the speculators’ demand force came to an end. From there, we have seen 4 years of almost continuous slide in home prices.
Toni,
Thank you. Could you please tell me a source (free) where I can watch the HPI chart evolution ?
BMM
Bogdan,
You could get the HPI index from various places. One instance could be:
http://www.fhfa.gov/
It is not the same with the Case-Shiller Home Price Index is it ?
BMM
Bogdan,
You can use either one: Case-Shillar or FHFA. The numbers do not differ that much. Read both methodologies and decide which one is relevant for you.
Toni,
Could you please tell me a number for the huge losses of the highly leveraged investment banks until now or lately ?
Bogdan,
The most recent number that I have seen this month is $1.7 trillion.
Toni,
I will ask here in advance regarding the “Economic Stimulus Plan” you are about to bring in. It may sound weird but,if the gov with the $700bn were not worried actually about the banks but about the guy in the real economy who wants to farm or build tractors, why not create a fund with that lump sum and finance directly main stream and by doing so, let the banks who did this fail since bailing out means bailing the equity shareholders that include CEOs, CFOs, internal auditors, financial rocket scientists etc who actually were wrong. Now of course there are the other banks that lent to the troubled banks, together creating the systemic risk , but obviously they did not asses properly the risk to whom they were lending actually, so they should be punished too; it does take two to tango after all, right ? Plus, with the fund and you have no moral hazard issue then, incompetent people out, competent people take over and start all over again and so come back, besides that there were banks who were not involved. With the 700bn bailout banks actually got a nice check from the gov and the same people who benefited in the last years with divy, bonuses etc, now are also nice and shine with the bailout and a lot of them still working the same job. What do you think about the fund or “new bank” like some sort of new or alternative financial system ? Now that will mean gov ownership of this “banks” or fund, but isn’t it the same with the gov buying the stinky assets from the stinky people or the equity infusion through buying stocks ?
BogdanC
BogdanC,
You point is valid. I should paint a larger picture in the near future with a comprehensive article.
I like the idea even though there is a problem: why just 1 bank or fund ? make it 5 20 or 30 by dividing the sum and not place them in NY
NY will remain the ground zero for the financial world, for years to come. In fact I do like less players, as long as Fed is doing a good job.
Toni,
Why is the equity infusion considered better then the liquidity infusion ? It is because at least, the gov joins the stake and the equity shares are punished since the share are diluted, otherwise both the banks who lent and shareholders are receiving the nice check from the gov. Am I missing anything ?
BogdanC
BogdanC,
Very simple. The equity infusion is much safer than the liquidity one. The latter one is just a temporary solution.
Toni,
I forgot to say that $700bn with a conservative leverage 10:1 will mean $700 trillion that =~ about 1/2 US GDP … credit markets would have flown for sure … you could even argue that $700 trillion would be too much … right ?
BogdanC
+ the sum > than the book equity of a lot of the “financial pillars” from nowadays combined
Not all the money went to the troubled financial sector…
BogdanC,
Do you mean $7 trillion? Do not think that the stimulus plan was a huge helicopter spreading cash from the skies.
Toni,
I did not keep up with the bailout … where did all the money go ? Which one was the first ? Tha Paulson plan or the Geithner plan and what’s the main difference between the two ? Thx
Dan
Dan,
The $787 billion stimulus plan was done during George W. Bush & Paulson administration. It covered more than the banking system, It had money for infrastructure, extended unemployment, local agencies, Medicare, etc.. Stay tuned. Two articles from now, I will re-visit this topic.
http://www.mcclatchydc.com/2009/08/09/73212/where-did-that-bank-bailout-go.html
It is good that information flows freely. To tell you the truth, the TARP money was a success, as far as the banking system is concerned. After all the money is paid back and Uncle Sam gets its part of the profits via preferred shares, investing roughly $100 billion to save a $14 trillion economiy, does not sound that bad.
Toni,
Why is not the case of a “Helicopter Ben” issue or something very similar ? From what I understood at least, it was a cash dropping from the skies, just that it did not go out of the system actually. If I remember well the stats, excess reserves at banks at the end of September 2009 were $823 billion. A year ago $2.4 billion, the year before $1.4 billion. Good news out of the bad news, since that money has no velocity, no inflation yet with the hoarding cash issue.
My point is just where are you dropping the $700bn ? Broken banking system with stinky assets or the alternative with a well functioning credit market $7 trillion theoretical credit availability. No inflation if the $1 pumped in real projects will create 1.x$ of wealth.
7 trillion yes … my numbers starts going crazy at 12:30 AM, good night and let me know if I’m wrong.
BogdanC
BogdanC,
You are spot on. It is correct that the stimulus plan did not have any effect on the CPI. Banks generated record profits in 2009, and they were in a comfortable position to pay back the TARP money and book nice EPS numbers.
Toni,
How did they make those profits if they hoarded that much cash ?
BMM
Dan,
As you know after Bear and Lehman collapse the number of main players on Wall Street got smaller. In 2009, the ones that survived got stronger and bigger (i.e., JPM, BoA, Well Fargo) and made a fortune in the plain-vanilla space: FX, IRS. On top of the that, having access to cheap funding via the discount window, their trading desks made good money on the riskier assets too.
Toni,
Consumer up today … BSE is going way down so as major exchanges … Do you think investors are pricing in this sharp changes in credit market conditions that can have a much more profound impact on business activity later ? If I recall right, the US economy entered into a recession in the end of 2007, ~five months after the early signs of damage in credit markets while developed economies started to suffer after 2Q of 2008. I guess it is a fact/lesson that there is a lag between turbulence in credit markets and growth, in the mean time economic indicators may still remain in positive territory. It is not the same level of credit turbulence but is this one of the important things on traders’ minds now ?
BogdanC
BogdanC,
Investors are now pricing in the beginning of the EU banking crisis. However, the LIBOR is still way under post-Lehman days. The lagging effect is obvious and it could push down the US GDP growth into the 2% area and possibly EU back into recession.
Toni,
I appreciate that one.
Far from the topic, how close or far are the 2 scenes from the NYSE reality ?
http://www.youtube.com/watch?v=zvICN8DNMpY
http://www.youtube.com/watch?v=TbIRedOqDwE
I know it’s a movie but I was just wondering …
Dan
Dan,
First of all the movie is about a brokerage firm. NYSE is the world’s biggest exchange. There are two completely different business models. As far as the action in the movie, there is plenty of real stuff, but as you can imagine, it is just a movie that has to entertain people.
Toni,
aham … my mistake. I meant brokerage life on Wall Street or US in general etc. Is that possible “becoming an employee of this firm, you will make your first million within 3 years” ?
Dan
Dan,
Theoretically, for a trader the sky is the limit. Practically, on the long run 95% of the proprietary traders does not make it in the businesse. So, get real! You have to be damn good to make a good living. However, I happen to know few people that were able to take home mid five figures at the end of the month.
Toni,
Sorry but I lost track with the bailouts … liquidity was Paulson and equity injection was Gaithner or ?
This was the main difference between the 2 plans ? (liq vs equity) ?
Anton
Can you be more precise? What do you mean by two plans? What do you mean by equity injection?
It was one big stimulus plan that covered everything. Today, I will publish an article on that.
Toni,
Besides AIG, who were the other insurers who took the hit with providing CDS insurance to whoever wanted ?
Raul
Raul,
We call them: Monoline Insurance. Besides AIG, you could find Ambac, FGIC, MBIA and few others.
Toni,
Why Fortis went under ? did they do CDS insurances also or ?
Raul
Raul,
Even though they had a large insurance presence in EU, they did not operate in the bond insurance space. Most of the losses came from their EU correlation desk and the US structured credit desk.
Toni,
I see … thx … is it correct to assume that AIG, FGIC and MBIA are the 3 top losers with the CDS insurances ?
Raul
Raul,
Throw Ambac in the mix too.
Toni,
thx … what about RBS ? what did they do ? CDS too I suppose.
Raul
Raul,
After a very costly GBP10 billion acquisition of a portion of ABN Amro, RBS took in excess of GBP6 billion of writedowns. As a result, RBS got into a heavy liquidity shortage. Its stock fell like a stone. Eventually, the UK government stepped in.
Toni,
Thx. Did AIG bear such a systemic risk that it really had to be saved ? too big too fail issue right ? From what I read they insured everybody but none when setting capital aside … how is that possible ? ohh yeah and AAA rating on top of that
Raul
Raul,
AIG was the world’s biggest insurance conglomerate. The cashed the CDS premium for years never imagining that those bonds they insured would go under. I recall paying 20 bps for a Super Senior AAA HG CDO bond. Nobody cared to doubt that. Quite the opposite: many people that issued CDO bonds considered a waste of money buying CDS protection on SS AAA tranches…
Toni,
Thx now I got it. Were their losses high due to CDSs ?
Your next topic the ESP sounds great … meanwhile you could think also about the one dedicated to the fall of Lehman. THX
Raul
Raul,
I am sure they had trading losses on CDS. However, those would not be part of the writedowns.
Toni,
I cannot find where you explain how GS did get away from the subprime implosion. They did hedge I remember you were saying but could you please input that again ? I really appreciate.
Raul
Raul,
GS was the first Wall Street that recognized the crisis and bought protection via AB CDS, ABX HE indeces and other derivatives.
Toni,
Why are so many folks using the excuse that EMH is to blame ? From what I read on EMH it states that the prices reflect all known information that impacts their value. Nowhere the hypothesis says or implies that the market price is always right …
Moreover, the fact that yields on subprime securities were high even though they were investment grade implies that the market was somehow correctly suspicious about their quality, risk-reward ratio etc
What’s your call ?
BogdanC
BogdanC,
As I said before, this EMH topic does require a dedicated subject. All I can say now is that price is not always right, and there are scores of examples around. First thing that pops-up is the dotcom bubble, with plenty of triple-digit stocks that have never generated profits. Another one is the subprime crisis, and I remember AA CDO tranches trading at L+40. The list can go on for ever.
Toni,
Thanks. I’m looking forward for that one.
Hopefully, I would do it before the World Cup starts.
Toni,
Could you please provide more examples from within the subprime meltdown ? It would be interesting to see some “irrational” stuff …
Raul
Raul,
I believe I could do that in a separate article. I have so many examples from 2007…
Toni,
That would be great … I would really appreciate