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Wednesday, 27 February 2008

Did Mr Bernanke's Speech To Congress Mislead The People?

Did Mr Bernanke's Speech To Congress Mislead The People?

Mr Bernanke went to congress to deliver the semi annual Monetary Policy Report today. For those of us who have the stomach to read the text of his speech it can offer some deeper insight into how the Fed is thinking.

Here is a link to the text: Bernanke speech

To help you along, I am going to reproduce some of it here and spell out what is required for the Fed Chairman wish-list to happen. Here is that first paragraph again:

"The U.S. economy has weakened considerably since last July, when the Federal Reserve Board submitted its previous Monetary Policy Report to the Congress. Substantial strains have emerged in financial markets here and abroad, and housing-related activity has continued to contract. Also, further increases in the prices of crude oil and some other commodities have eroded the real incomes of U.S. households and added to business costs. Overall economic activity held up reasonably well into the autumn despite these adverse developments, but it decelerated sharply in the fourth quarter. Moreover, the outlook for 2008 has become less favorable since last summer, and considerable downside risks to economic activity have emerged."

Now, I am going to be a little cheeky here. How many of you actually read the speech BB gave to congress? Yes, that one in the link above.

Well done if you did....but did you re-read the paragraph above too?

I wouldn't be surprised if it was only me. It's what I do, check things out, read the small print. The paragraph above is from the actual report, the very first paragraph of part 1.

Yes, you guessed it, I have no intention of seeking deeper insight today. I found something much darker to discuss.

Now please bear with me, here is the first paragraph BB actually delivered after his introduction:

"The economic situation has become distinctly less favorable since the time of our July report. Strains in financial markets, which first became evident late last summer, have persisted; and pressures on bank capital and the continued poor functioning of markets for securitized credit have led to tighter credit conditions for many households and businesses. The growth of real gross domestic product (GDP) held up well through the third quarter despite the financial turmoil, but it has since slowed sharply. Labor market conditions have similarly softened, as job creation has slowed and the unemployment rate--at 4.9 percent in January--has moved up somewhat."

Here is a list of words missing in BBs' first paragraph of his speech but are actually part of the first paragraph of the Monetary Policy Report to the Congress. I will show the phrase from the report first and then what BB actually said,

"The U.S. economy has weakened considerably since last July", replaced with "The economic situation has become distinctly less favorable since the time of our July report"

"Substantial strains have emerged in financial markets here and abroad" replaced with "Strains in financial markets, which first became evident late last summer"

"housing-related activity has continued to contract" replaced with "have led to tighter credit conditions for many households"

"but it decelerated sharply in the fourth quarter" replaced with "but it has since slowed sharply"

"Moreover, the outlook for 2008 has become less favorable since last summer, and considerable downside risks to economic activity have emerged." Replaced with a silence.

At first glance you may wonder why I think this is important? It looks roughly the same you might say. Well these are the days of market expectations, of political and economic spin and propaganda.

I will go further. These are the days of deceit and lies. Has Ben Bernanke sat in front of Congress and misled the People?

This is serious, this is an attempt to make the problems sound less urgent than the Federal Reserves' own report. Some areas of concern in the report are not present in the speech. Is this a deceit driven for political ends?

Shame should be heaped upon on the members of the committee on Financial Services at The US House of Representatives. They either knew of the deceit put before them or didn't even bother to read the actual report and therefore showed their ignorance. These so called representatives are nothing of the sort. Fifteen minutes of television coverage and a 2 minute close up are all they seek.

American citizens who read this article might want to think about the usefulness of such individuals.

This is shocking in the extreme. Every wire report I have seen carried BBs speech, not the actual report. Remember, this was the first paragraph, it sets the tone for the hearing, it gets the markets to react.

I am not going to go through the full texts here, it would take a much larger article. So, I'll leave you with the first part of the respective second paragraphs, again the actual report first and the speech second.

"The turmoil in financial markets that emerged last summer was triggered by a sharp increase in delinquencies and defaults on subprime mortgages. That increase substantially impaired the functioning of the secondary markets for subprime and non-traditional residential mortgages, which in turn contributed to a reduction in the availability of such mortgages to households."

"Many of the challenges now facing our economy stem from the continuing contraction of the U.S. housing market. In 2006, after a multiyear boom in residential construction and house prices, the housing market reversed course. Housing starts and sales of new homes are now less than half of their respective peaks, and house prices have flattened or declined in most areas. Changes in the availability of mortgage credit amplified the swings in the housing market."

You see what I mean? The report is realistic and identifies the areas of concern with clarity. The speech obscures the realism, using up tempo words such as boom. Where it is impossible to deny downside, the speech rewords the report to soften the meaning and context, "substantially impaired" becomes "changes in the availability of mortgage credit".

Ben Bernanke has wandered into the prison block showers and slipped it to the USA as it bent down to pick up the soap.

And he did it on Bloomberg.

No snippets today but for FTSE followers an update to RBS. Last week RBS denied rumours that it would seek funding. Today RBS confirmed it placed 50 million shares priced at 400p. The placing was rumoured to be with a Qatari Govt backed investment fund. How did the share react?

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Right into the resistance pointed out last week at a premium to the placing. Spin indeed.

Sunday, 24 February 2008

The Weekly Report 25th February 2008

The Collection Agency - Weekly Report

25th February 2008

Welcome to the weekly report. The turmoil in credit markets continues and attention moves to CDS, the Federal Reserve gets worried about its credibility and the US markets get a boost 15 minutes from the end of Fridays close. We finish with a quick recap of some stocks we looked at last week and look around to see if anything else catches our eye.

Firstly an update to the continuing and widening collapse of the Municipal Bond prices as the failures in the auction rate bond (ARB) markets grow. Last week I mentioned 3 market makers who had stopped supporting ARB with their own capital to support prices. That list has grown, in addition to Citi, Goldman Sachs and Lehman Bros you can now add UBS, Morgan Stanley and Merrill Lynch. Without wanting to labour the point that's 6 of the biggest Investment Brokers / Banks that are effectively saying either the Muni bond market is toxic or they do not have the capital to support the Muni market. I firmly believe it is the latter.

I want to show you one chart that supports my assertion. It's from the Fed:

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Colin Twiggs of Incredible Charts produced the chart, which saved me having to do it. You have seen this chart in my previously written articles. Clearly the situation has deteriorated at a rapid pace and is much more serious than the credit scare last August. US banks have no reserves; they are for all intents and purposes, broke. In fact they are beyond broke and as I suggested last year banks are now sub-prime. 150% of the reserves at depository institutions are borrowed. That can only mean one thing, the banks have "lost" 1.5 times their original non borrowed reserves. Not only have they lost what they had, they went on and lost half as much again. If you or I did that, we would be bankrupted and probably arrested for attempting to defraud the lender.

Notice the amount of total reserves (yellow line) is roughly equal and appears cyclical to the Federal Reserve TAF lending programme. The Fed is no longer the "lender of last resort" it has become the de-facto Bank of the USA.

I am amazed that so little attention has been paid to this state of affairs. The Northern Rock debacle, one overstretched bank in the UK, has had all the headlines, yet with the WHOLE banking industry in the US insolvent you hardly see it mentioned.

Now, I am not going to give you advice on what to do about your cash on deposit and I don't want you to think I am being overly bearish but…….I have called this whole fiat credit collapse correctly from the beginning. No, I don't want a pat on the back. I just want to read the next line carefully.

If I had money in a US bank today, I would be worried. So worried I would withdraw the cash before new regulations are passed restricting account activity. I know it sounds alarmist but then the first warnings always do.

This week saw talk of problems becoming apparent in the Credit Default Swap markets, a leveraged, counterparty insurance and re-insurance scheme designed to protect a buyer of debt against a default event using a third party who sells the protection.

For some of us, this is old news and signs of trouble have been around for sometime. Spreads on corporate debt have widened significantly of late. The Markit iTraxx Europe Index (yes Europe, you didn't think it was just the USA having problems did you?) composed of the prices of CDS for 125 investment graded companies saw spreads widen to 135 basis points, up from 91bp just 2 weeks ago. The higher the spread, the more perceived risk is seen in the markets. Get this, investors in this market are getting compensated for possible default rates up to 5.5 times higher than the highest recorded levels in the past 50 years.

Maybe I'm wrong to point out rising risk, maybe it's just over reaction and the spreads will fall back. Then again it is the market telling you about risk, not me.

The Federal Reserve seems to have a problem. It is becoming clear that even members of the committee are worried about the direction of Fed policy. The concern seems to be rooted in very economic soul of the committee members. Those that believe interest rates should go no lower or, indeed rise, are becoming more vocal. The latest to speak out was Dallas Fed President Richard Fisher. Although he has attracted a reputation for speaking "off message" thanks to the 8th innings remarks about interest rate rises, he has since then been a very clear and concise speaker. After voting against the latest cut in FFR (9-1) he has been explaining why he is worried.

Mr Fisher is no career economist, he is not from the Bernanke school. It may well explain why he feels strongly about the current situation. From the Dallas Morning News here is a quick run through his roots:

"Even more intriguing than Mr. Fisher's lonely vote at the Fed is the path this globe-trotter, self-made man and failed politician took to get there.
After his birth in Los Angeles to a father who had emigrated from Australia and a Norwegian mother who grew up in South Africa, Mr. Fisher moved with his parents to Mexico City, where he grew up speaking Spanish at school and playing on a youth baseball team coached by Norman Borlaug, the future Nobel Peace Prize winner.

Soon afterward, the family fell on hard times and moved back to the U.S., to Miami. Mr. Fisher, then about 11, remembers going with his mother to a pawn shop there, where she sold her engagement ring for cash to buy clothes for her children.

In another shift in fate, the boy won a scholarship to a private military academy.

Years later, after studying at England's Oxford University and collecting a degree from Harvard, as well as a Stanford University MBA, he would become a wealthy fund manager - moving between the financial world and government service in a career distinguished by intellectual curiosity and an independent streak."

I fully suspect Mr Fisher does not rely on computer models of the economy to get his "feel" for how things are going, unlike the Fed committee chairman. This guy has been there and done it, successfully too, unlike Greenspan.

Mr Fisher understands poverty, he lived it. He knows the effects it has and the struggles it causes. He is genuinely afraid of price inflation devaluing the money in peoples' pockets. Another snippet from the Dallas Morning News tells us all we need to know about Mr Fisher:

"There's a photo of Mr. Fisher with current Fed Chairman Ben Bernanke, and a portrait of former Fed Chairman Paul Volcker, one of Mr. Fisher's heroes."

Mr Fisher understands a simple rule, if you lower interest rates you ignite $ devaluation. Do this during a period of commodity bullishness and the basics become more expensive. It also raises what the Fed calls inflation expectations. Simply put that means if people perceive that prices are going to rise, they demand more money for their labour. True monetary inflation then follows. (NB, this is mainstream thinking, not mine - I see a different outcome.)

I suspect what is really worrying Mr Fisher is that despite repeated large cuts in the FFR, real interest rates for consumers, especially those hurting right now, have not fallen. Indeed the rates at Freddie and Fannie, for instance, have been rising of late. Why administer a medicine that has no effect on the illness?

His latest remarks in a speech at Fort Worth seem to be alluding to such:

'We're trying to bridge the gap, between what most people believe will be two quarters of 'anemia' in the economy, and prevent that turning into a recession, but not at the same time 'stir those dreadful embers of inflation.'

He went on to mention that the fallout from the credit markets cannot happen without some pain and that pain cannot be removed by the Federal Reserve.

With Bernanke talking of a "consensus committee" my bet is that although only Fisher voted against a cut at the last meeting, many of the committee share his reservations on current Fed policy. As the last Fed minutes pointed out:

"When prospects for growth had improved, a reversal of a portion of the recent (rate)-easing actions, possibly even a rapid reversal, might be appropriate,"

That should be taken as a warning by anyone intending to borrow at current low rates. You do not want to be on the wrong side of a 1% rise in FFR.

A funny thing happened on the way to the market close on Friday. The markets took off with about 40 minutes of the session left, tagging on around 250 points.

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The reason touted around appears to be this announcement:

"US BONDS/INSURANCE: CNBC is cited saying a bailout at bond insurer AMBAC may be reported Mon. or Tues; this news is aiding stocks."

I saw this happen, I was trading at the time and had closed out a long (I don't hold Index trades over weekends). The sell side of the Dow futures went away on holiday, resulting in trades on the buy side leap-frogging higher. A shame I didn't hang on a little longer but that's trading. It looks to me as though the market believes, or wants to believe the bail-out is good news. I have a couple of worries on that score.

Firstly, since when are bail-outs "good" news?

Secondly, another announcement on Friday hasn't been picked up on and it's much more important:

"NEW YORK (AP) - Moody's downgraded the financial strength rating of Channel Reinsurance Ltd., imperilling a pillar of credit safety for bond insurer MBIA Inc. Moody's cut its financial strength rating on Channel Re to "Aa3" from "Aaa." The new rating implies Channel Re's balance sheet is "high-grade," whereas the previous rating implied "maximum safety."

Channel Re was created in 2004 to provide "reinsurance" to MBIA, a bond insurer based in Armonk, N.Y. MBIA is Channel's only customer.

MBIA writes insurance policies that promise to repay bondholders when bond issuers default. MBIA, which insures $670 billion in debt, buys reinsurance for a little more than $70 billion of the bonds it insures.

Reinsurance essentially means buying an insurance policy to protect an insurance policy, or shifting some of the risk and some of the premiums to another insurer. Channel Re reinsures just under half of MBIA's ceded debt, implying the company guarantees more than $35 billion in bonds.

Moody's said Channel Re has "significant exposure" to risky mortgage investments. The company was too willing to accept risks from MBIA, Moody's said. Collateralized-debt obligations, or pools of different kinds of debt often layered with risky mortgage loans, constitute 12 percent of Channel's insured debt, Moody's said.

Moody's estimates Channel Re needs $1.3 billion in cash available to pay claims to maintain the top-notch rating. The company has access to $930 million, Moody's said.

When an insurer is downgraded, much of the debt the company insured is downgraded too because a bulwark protecting the debt from default is less sturdy. A downgrade of one of MBIA's reinsurers could leave MBIA itself more vulnerable to a downgrade.

Channel Re is owned by MBIA, RenaissanceRe Holdings Ltd., PartnerRe Ltd. and Koch Industries Inc."

Yes, notice that last line. MBIA is now suffering from the same threat of possible default on its insurance as the rest of the market is suffering from the possible default of MBIA but MBIA part owns the re-insurer! Oh the deliciousness of it all.

Short term the markets may well have gone up on the Ambac rumour. In the longer term disclosures like that from Moody's will kill it.

Finally an update to the companies we looked at last week.


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I have drawn in a tentative support line.

From this article at Livecharts "If it's February then it must be the bank sector reporting season" an update to some UK shares:

Barclays Daily:

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As I suspected Barclays pleased the markets and broke out of the wedge. I am watching for a retest of the upper wedge line and a possible attempt to take out the January high.

HBOS continues to drift sideways within its wedge as does HSBC within its down channel.

Lloy Daily.

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As I said in the original article, I was surprised LLoyds didn't look more bullish. It looks bullish now.

RBS Daily:

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Possibly a rise on general sentiment, I did get the feeling last week that the market believed RBS rather than the analyst talk of raising new funds etc. It appears poised for a breakout but be warned it could just as easily reverse. Worth watching as results are announced this week.

FTSE Daily

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As mentioned last week 6002 is resistance with 5861 as support. I have removed the upper triangle line, leaving the rising support line. I am watching for a move either through the mentioned resistance or support.

One last point, keep an eye on UBS. The FT reports that HSH Nordbank, a German bank that is the worlds biggest provider of shipping finance, has filed lawsuit on UBS claiming it was mis-sold CDO's to the tune of E500m - apparently "lost" in an SIV called North Street 4. If this suit gets legs many other Investment Bank CEOs might start sweating too.

Have a good week.


In answer to Richards point, I found this chart (click on image for larger size):

What me, worry?

You can clearly see the current situation dwarfs even the near past events. 1987 and 2001 look like blips. As for the 30's - well I have always said that the impending credit collapse and its deflation will make that decade look "sweet" in comparison.