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Monday, August 20, 2007

The Great Unwind Continues Apace

Update: No, Reuters had it wrong. Fannie Mae skips the August Auction. The market is jittery and short term T-Bills yields are collapsing again. Poor Japanese. I don't know how well the Nikkei is going to handle today's US action. Emerging markets may take another whack too, which is hell on a lot of hedge funds. End update.

You can't change market mechanics by cutting the bank discount rate. Commercial paper:

100 basis points = 1%, so the riskiest category of paper continues to become more expensive. Note the previous highs in 2001/2002 - and note that the spikes (red lines only) were discontinuous at about 1 percentage point back then. The discount rate was dropped to 5.75 so it remains to be seen if that will put a cap on this rise. The total outstanding graph will be updated on Wednesday.

If you look at the first table at the link above, A2/P2 nonfinancial was still cheaper than AA Asset Backed at 15 days, so some juggling was still occurring. The entire 1-90 day durations for AA Asset backed and A2/P2 nonfinancial continued at a premium above the discount window rate of 5.75%. In theory one could make quite a bit of money by using that spread, but of course you have to offer collateral to the Fed and if the commercial paper is not paid back you could incur a loss on the deal, so a continuing premium is a commentary on perceived risk.

T-Bill yields show that the Fed's action did create an expectation of more stability past the six month/1 year mark. Compare the 8/16 yields with the 8/17 yields. Prices on the shorter term bills continued to rise after the discount rate drop on Friday.

In the meantime, WalMart is raising money while it can do so cheaply:
Fitch Ratings assigned ratings of 'AA' to Wal-Mart (NYSE:WMT) Stores Inc's new 5.8 pct 500 mln usd senior unsecured notes due 2018 and 6.5 pct 2.25 bln usd senior unsecured notes due 2037.

The proceeds from the issues will be used for general corporate purposes.
Wal-Mart has repurchased about 2.5 bln usd of its common shares in the last six months, and Fitch expects that the company will continue its share repurchase activity in the second half of this year.

However, credit metrics are expected to remain steady at current levels, Fitch said.
That is 2.75 billion WalMart is raising for petty cash or petty share repurchasing cash. 10 vs 30 equates to a 70 basis point cost for the longer term.

But even if you can't change the mechanics of the credit market, you can restore liquidity. Liquidity doesn't protect against higher borrowing costs and lower credit portfolio valuations, but it does restore the ability to move the stuff at repriced values. You need time to do this, so it is essential to protect against a lockup that would force additional defaults (on commercial paper) where the ability to service the debt actually does exist. Thornburg, Luminent and Delta all got some money:
Thornburg Mortgage Inc., forced to stop taking home-loan applications earlier this month because of a cash crunch, said it sold $20.5 billion of mortgage-backed securities as part of a plan to return to ``business as usual.''

The sales will result in a ``capital loss'' of about $930 million this quarter, the Santa Fe, New Mexico-based company said today in a statement.
Luminent Mortgage Capital Inc., an investor in home-loan securities, lined up about $125 million today from Arco Capital Corp. Delta Financial Corp., a subprime residential lender, found investors last week to provide $70 million.
The Dow has been flattish today but I suspect that is because oil and natural gas is falling as a result of Dean's track. Consumers will celebrate; speculators on disaster will mourn. Fannie Mae is selling 3.0 billion of 3 & 6 month benchmark bills on Wednesday.

Update: From The Housing Bubble Blog, reality rolls into the NYC area. The funniest thing about this article is the caption CNNMoney saw fit to run under the headline "The subprime mortgage collapse isn't just threatening the market for low-end homes; it's also afflicting luxury homes, reports Fortune's Jon Birger." I am not sure the individuals discussed in the article would like the implicit characterization:
What could the collapse in the subprime mortgage market possibly have to do with whether Dr. Jeffrey and Madeline Stier get full price for their four-bedroom house in the wealthy New York City suburb of Larchmont?
...six months after the Stiers first listed it for sale at $2.5 million -- a price only slightly above what comparable homes had been selling for -- the house remains unsold. Tired of waiting, the Stiers finally capitulated and recently dropped their asking price to $1.99 million.
The shakeout has already begun, maintains Diane Saatchi, a real estate agent who specializes in multimillion-dollar vacation homes. The head of the East Hampton, N.Y., office of the Corcoran Group, Saatchi says it's no coincidence that several of her sellers agreed to lop hundreds of thousands of dollars off their asking prices the same week that jumbo rates pushed past 7%.

She's now predicting a 20% price decline for all but the most expensive Hamptons homes (the superrich don't care about mortgages). Says Saatchi: "More and more, this feels like a correction."
The rule about not walking the market down is just as true for higher end homes as it is for those possum-infested subprime homes that Bloomberg was worrying about a few weeks ago. In fact, it's even more true, and that's why Thornburg is selling chunks of its holdings at a discount. Maybe we should have a competition for how long a precipitious drop in higher end home prices can be described as "the subprime mess".

The article is excellent and clearly explains the situation, but the refusal to concede that irrational valuations prevailed at the top of the market even more than at the bottom of the market is a bit odd. Everyone knows this occurs. It's occurred before. Bracket compression is a known phenomenon, except, apparently, for those who work at credit ratings firms. The reason why higher end loans are now requiring a downpayment is that the lenders don't want walkaways, and to prevent walkaways, they need to get the buyer to perceive that the buyer, and not just the lender, is losing money on the house if the buyer walks away.

An insider look at this phenomenon (multimedia).

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