Credit Crisis Far From Over - Dollar Devaluation in Progress and Will Continue

We could not agree more that this crisis is far from over. The Fed has temporarily stopped the bleeding and is trying to stabilize the patient. But the problem of the huge amount of bad debt to be liquidated still needs to be taken on, and its not just related to subprime mortgages.

What few people recall is that one of the first steps taken to put a bottom in the US Great Depression was the devaluation of the US dollar by approximately fifty percent in terms of the gold standard. The devaluation of the dollar has been underway for several years now, for anyone with an open enough mind to look at the evidence. Did the Treasury devalue the dollar by 50% in 1933 by making bank loans? By taking on additional debt? No. They did it by declaring it to be so, by fiat which means 'let it be done.'

There is little doubt in our minds that dollar devaluation will once again occur by at least fifty percent in terms of real goods. How this translates to the relationship among world currencies is another matter entirely, since they are all fiat at this time. Debtors do not embrace deflation: that is the course of choice for net creditors and exporters, such as Japan in the 1980s. Understanding this is key to grasping the nature of our monetary policy options.

What would be interesting is if the Cold War resumed, not on military terms, but in competitive economic terms. It requires a significant amount of international cooperation to achieve the financial alchemy United States is attempting. Our security we believe is that the US is too big for anyone to allow it to fail, in sort of an assured monetary mutual destruction. We are not so sure this is a valid proposition in which to place our future and our trust.


Credit crisis far from over
By Geoffrey Newman
May 02, 2008

A DERIVATIVES expert who two years ago warned of a potential meltdown in global credit markets has cautioned that the crisis is far from over, and has endorsed recent calls to relax controls on inflation and allow higher prices to help markets trade their way out of their problems.

Longtime critic of derivatives markets, Satyajit Das, says those who believe the US sub-prime loans crisis, and the drought in credit markets it triggered, are nearly over are wrong.

"I think the cycle has some way to run yet," he told a Financial Services Institute of Australasia function in Sydney yesterday. "It's a matter of years, not a matter of months."

In particular, investors in the US stock market, which has climbed off its lows amid a growing mood that the worst of the crunch was over, were being too optimistic, he said.

The author of Traders, Guns & Money warned that many of the problem financial instruments were still hidden and the total amount of debt attached to them largely unknown.

Losses incurred by US banks were certain to rise as $US1 trillion ($1.06 trillion) in sub-prime housing loans was due to reset to higher interest rates in the next two years.

The use of credit card debt -- now totalling $US915 billion -- was cushioning US home owners. But, in an ominous sign, card issuers were rapidly increasing their provisions for bad debts, by as much as 500 per cent in the case of one bank.


The use of sub-prime debt structures was also a feature of other markets, such as private equity, where $US300 billion in loans were due to be refinanced in the next two years.

Mr Das said another $US1-$US5 trillion of assets would have to come back on to US bank balance sheets as a result of defaults on housing and other debts, and it was unclear how the banks could fund them -- issuance of preference shares by US banks was already at a record high. He said losses at financial institutions from the credit crunch were likely to almost double to $US400 billion.

There were also second-round effects to come as the damage done to the real economy from financial sector losses fed back into further bank losses.

Mr Das said there needed to be a massive reduction in debt levels globally or a "nuclear deleveraging" before the crisis could be said to be over. That could be achieved through an economic crash "on the scale of 1929" but allowing inflation to rise would help to avoid that scenario. Higher inflation was a legitimate policy option since it reduced the real value of debt and gave companies and individuals breathing space to reduce their leverage by helping to put a floor under asset prices.

His comments come as some economists urge Australia's Reserve Bank to relax its inflation targeting policy to help avoid a severe economic downturn.

He acknowledged that as inflation rose higher it was more difficult to control it, but noted the global economy was moving into a period of higher inflation anyway. "It could be the lesser of two evils," he said.

"Where are All the Customer's Yachts?" becomes "Where Are All the Customers?"

It appears that the line about 'Where are all the customer's yachts?' is to be shortened to 'Where are all the customers?'

Once in the dear dead days beyond recall, an out-of-town visitor was being shown the wonders of the New York financial district. When the party arrived at the Battery, one of his guides indicated some handsome ships riding at anchor. "Look, those are the bankers' and brokers' yachts.

'Where are all the customers' yachts?' asked the naïve visitor."

"What in the world should we do, now that 'virtually all investors will withdraw their money?'" - Citigroup

Citigroup Evaluates Options for Old Lane Fund After Investors Pull Money
By Trista Kelley

May 3 (Bloomberg) -- Citigroup Inc., the biggest U.S. bank by assets, said virtually all investors in its Old Lane hedge fund will withdraw their money.

The investors will be allowed to exit the fund as of July 31, the New York-based bank said in a regulatory filing to the Securities and Exchange Commission yesterday. The Wall Street Journal reported today that the clients will pull about $3 billion from Old Lane, citing unidentified people familiar with the fund.

``In April 2008, substantially all unaffiliated investors had notified Old Lane of their intention to redeem their investments,'' Citigroup said. The bank is ``evaluating alternatives for the restructuring of Old Lane.''

Citigroup agreed in April 2007 to pay about $800 million for Old Lane, whose co-founder Vikram Pandit became Citigroup's chief executive officer in December. Citigroup's alternative- investments unit posted a loss in the first quarter, taking a $202 million pretax writedown on Old Lane, the bank said last month.

US Dollar Long Term Chart with Commitments of Traders as of April 29 COB

So far the dollar rally looks like a technical bounce similar to ones we have had in the past when the dollar sets a lower trendline, bounces off it, and then falls back and tests it after a three or four week rally.

The COT report for this week was as of April 29 at the Close of Business. It appears that the Small Speculators are leading the charge higher and are holding a much more significant net long in the dollar than is usual. The Fund are still slightly net short, and the net large traders move negative for the week.

Based on past experience the dollar rally will get a severe test next week, during which time the small specs will get nailed by the funds, unless official intervention is underpinning the dollar, in which case we'd look for the funds to get net long ASAP. They don't often miss that sort of signal.

Its often hard to 'read' the more complex traders positions because they tend to have so many cross market hedges, and the DX is ripe for that because it is merely an artificial basket of currencies.

Still, the Dollar is firmly in a downtrend and must rally quite a bit more to prove that we are seeing a real trend reversal.

S&P cuts Countrywide to "Junk" on Bank of America Default Warning

Countrywide Rating Cut to `Junk' By Standard & Poor's
By David Mildenberg

May 2 (Bloomberg) -- Countrywide Financial Corp.'s credit rating was unexpectedly cut below investment grade by Standard & Poor's Corp., which cited doubt about whether Bank of America Corp. will back the home lender's debt after they merge.

The revision reflects ``the new level of uncertainty as to the ultimate legal status of Countrywide's creditors'' after the lender's sale to Bank of America, Standard & Poor's said in a statement today. Prices on instruments that protect investors from a Countrywide default made their biggest jump in almost four months.

Bank of America, the second-largest U.S. bank by assets, agreed in January to buy Countrywide, the largest U.S. mortgage lender, for about $4 billion after speculation that Countrywide couldn't pay its debts and might go bankrupt. Bondholders have been counting on the merger to put Bank of America's AA credit rating behind Countrywide's $97.2 billion in debt.

``There is no assurance that any such debt would be redeemed, assumed or guaranteed,'' the Charlotte, North Carolina-based bank said in an April 30 regulatory filing, adding that no decision has been reached. Countrywide is based in Calabasas, California.

Just why is Bank of America buying Countrywide Financial, which is not only most likely insolvent, but carrying a huge amount of bad debt liabilities? Its an excellent question, and one which we highlighted early on back on January 11 of this year. Why is Bank of America Buying Countrywide Financial?

We bought up the usual suspicions, including a generous heaping of Fed pressure on BAC to consummate the deal, as CFC was clearly wobbly and most likely to fail after Bear Stearns.

We think that the pressure alone however would not have been enough to compel BAC to swallow something as ugly as CFC, even with a currency (BAC stock) that was likely inflated. And even with some big egos on the line, the ugliness that is the creation of Angelo M. is a significant pill to swallow, although we never like to attribute to complex motives when sheer arrogant stupidity might suffice.

We extended the hypothesis on March 14 in a story about the derivatives counterparty exposure which JPM had to Bear Stearns. If you look at the second chart in that story (reproduced below) you will see that BAC is number three on the derivatives over-leveraged hit parade. Bear Stearns: the Smoking Guns

And quite recently we put up a story about the losses at Countrywide, which are bad and getting rather ugly even by today's backstopped standards. Women and Children in Boats - Cannot Last Much Longer

Today we had the distinct pleasure of reading an analysis by one of our new and favorite commentators, Mr. Mortgage. His review of the CountryWide Financial acquisition by BAC is devastating, and sure to send a tingle up the spine of any BAC shareholder. BofA Getting Cold-Feet over Countrywide ‘Purchase’ - Too Many Toxins!

Mr. Mortgage gives BAC a piece of advice that had to occur to every swinging financial appendage in the market when the details of the JPM - Bear deal was disclosed. Ken Lewis had to feel a little shrunken at that point, with Jamie Dimon having achieved a deal with Ben that was significantly better by any standards based on the information at hand.

My advice is to BofA is to call Bernenke and say “the US can’t handle the largest mortgage servicer going down so you must back-stop $38.7 billion and we will back-stop $1 billion. If it was good enough for Chase and Bear, shouldn’t it be good enough for us? We were your first shill darn-it!”

Bloomberg has an interesting story today in which Bank of America suggests it might not provide any backing to Countrywide's debt as part of this acquisition. Nice legal trick if you can pull it off. This disclosure has caused Countrywide to be cut to 'junk' today by Standard & Poors.

May 2 (Bloomberg) -- Bank of America Corp., the second- biggest U.S. bank, said it may not guarantee $38.1 billion of Countrywide Financial Corp.'s debt after taking over the mortgage lender, increasing the likelihood of a default.

``There is no assurance that any such debt would be redeemed, assumed or guaranteed,'' the bank said in an April 30 regulatory filing, adding that no decision has been reached. Investors had grown more optimistic the bank would back Countrywide debt, and Standard & Poor's said this week it may raise Countrywide's rating to match Bank of America's.

Prices on instruments that protect investors from a Countrywide default made their biggest jump since March 10. Bank of America agreed in January to buy the largest U.S. mortgage lender for $4 billion amid speculation that the worst housing market since the Great Depression would bankrupt Countrywide. Bondholders are counting on the merger to put Bank of America's AA credit rating behind Countrywide's $97.2 billion of debt.

Countrywide's $1 billion of 6.25 percent notes due in 2016 fell 2.5 cents to 89.5 cents on the dollar at 12:24 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt yields 8 percent, or 4.2 percentage points more than similar-maturity Treasuries, Trace data show. The debt fell to about half that price in January before Bank of America announced the purchase of Calabasas, California-based Countrywide.

We still think this whole deal hinges on Countrywide's debt assets, which are sure to be significantly impaired, similarly to that of Bear Stearns. As you see, the estimates of losses in the many tens of billions are far too much for BAC to just absorb, especially since the Fed has established the moral hazard precedent of stepping in and taking the big losses.

Let's keep an eye on this one. Nice trick if Bank of America can proceed with this acquisition and just keep the loan marketing and servicing infrastructure and repudiate the debt, either by default or wrapping it in a package for Bernanke's Fed, aka 'you' in another moral hazard milestone in socializing bank losses while privatizing their huge speculative profits.