The Market Ticker

Pretty interesting price action yesterday....

Today we got ICSC and Redbook same-store sales data, and both sucked. ICSC came in up 0.1% from a previous down 0.7%, so its still a net-negative.

Redbook came in at -1.1% off a negative 1.0%, which is of course still negative.

The futures are positive this morning; you have to wonder how come. With Chucky (the consumer) at 70% of GDP, how does a slowdown of consumer spending reflected in same-store sales spell good news?

Oh wait - I get it. Just don't report the numbers when they're negative.

Ok.

I wonder how well that will work when earnings have to be reported?

In more signs of credit stress, we have this from AP:

"The American Bankers Association, in its quarterly survey of consumer loans, reported Tuesday that late payments on home equity loans rose to 2.15 percent in the January-to-March quarter. That was up sharply from 1.92 percent in the final quarter of last year and was the highest since the late summer of 2005.

"There are still signs of consumer financial distress, which will continue throughout most of this year as the worst of the housing problem works its way through the economy," said James Chessen, the association's chief economist.

No, you think? But note carefully the unbridled optimism that they think this will all be ok later this year (even if much later.) Uh huh. That's what they said about the spring selling season for housing too - now acknowledged as a flat-out bust.

Then we have this:


That's a very pretty waterfall. And note that this is "AA" credit - you know, high-grade investment stuff. Yeah. By the way, that deterioration wiped out fives years of interest income. Let that one sink in - five years.

The 10 is back down right at 5%. This is being routed as a "big positive". But let's ask the obvious question - why have people been buying treasuries?

Answer: Its a flight to quality. Maybe you can explain how people being spazzed about anything not-US-Treasuries in the credit markets is "good news"?

Then we have the dollar. Bucky isn't doing so good. In fact, Bucky is kinda in trouble, threatening a major support level. Were it not for the Yen Bucky would be in critical care right now; if you look at the Pound, Swiss Franc, Kiwi, Euro, even "funny money" (what we used to call Canadian bucks when I lived less than two miles from the border!) the dollar looks like crap and is at multi-decade lows.

While there will be those who cheer this as it makes exports cheaper (thereby buoying earnings of companies that sell overseas) it is in fact not good at all due to our net import status. See, a weak dollar means that anything bought overseas and brought here gets more expensive due to currency exchange. So when you import raw materials - you pay. When you import goods made overseas - you pay. Etc etc etc. Oh - except for Chinese goods, where they have pegged their currency to the dollar. Of course that pisses off the Congress because it damages our competitiveness in manufacturing (a true charge - for once Congress gets it right!)

What's this all mean? Simple, as far as I can see - don't be buying rallies here. In fact, you might want to consider selling into them.

The pending home sales index (for May) came in down 3.5%, down 13.3% from May 2006. In addition the April number was revised down, which masked the TRUE EXTENT of May's deterioration. In fact, the sales rate now best approaches 2001 levels.

In other words, housing still sucks and there is no indication of a bottom. HELLO!

Year over year sales figures are down everywhere.

New factory orders fell 0.5% as well.

Close to a bottom? Baloney!

The spring selling season can now be said to be a total bust.

The ICSC also said consumer spending is "slow, choppy and uncertain" in their report today, and lowered June sales forecasts. These folks are usually biased strongly to the bullish side on consumer spending and store sales - after all, that's their customer base, so you'd expect some cheerleading. You're not going to find it in today's report!

And oh, by the way, June is the normally the second-best month of the year for retail sales! So if June is bad......

Whistling past the graveyard are we? Maaayyyybbeeeeee! Heh, who's that guy over there in the black robe with a big freaking scythe in his hands?!

That ABX deterioration above isn't limited to the ABX. The CMBX (commercial building construction) and LCDX (financing for corporate buyouts) have both gone parabolic in the last few days. Someone - or a lot of someones - are in trouble in the credit markets.

The intentional hiding of this, along with not marking these assets to the indices, is getting to be more and more serious. The longer this goes on the bigger the haircut when it is finally fessed up to.

In addition, one needs to continue to ask - Where is the SEC? How is it that hedge funds (or anyone else for that matter) are allowed to use as "collateral" for margin trading financial instruments that have their value artificially manipulated through "mark to models", where the model explicitly excludes market data that is KNOWN to the person running the model and valuing the asset? And how does this not make a raw mockery of the margin limits that the SEC has established in an attempt to prevent market meltdowns that were part of the problem in 1929? This sort of thing is ILLEGAL in housing (E.g. intentionally overstating the value of a house to enable you to get an "oversized" mortgage), so how come the same sort of chicanery is not pursued in the securities markets?

Unlike corporate "threatened defaults", which might not materialize at all, these issues are being created by real defaults on real mortgages and real foreclosures! They do not go away nor will they "heal themselves."

Let me be clear - if neither the market (e.g. via the ratings agencies, primary broker/dealers, etc) or the SEC step in and put a stop to this there is a very real risk that this will not be a "small event" but rather a systemic failure. Unlike "possible defaults" on corporate debt the problem here is that the subordinate tranches provided the "insurance" on superior tranches, and that insurance has now been wiped out. As such further losses due to more foreclosures are now going to hit the senior tranches.

And there is no belief - or evidence - that the foreclosure rate is going to ZERO any time soon. None. Zero. Nada. Note that the rate can decrease but that doesn't stop the bleeding - while it slows the RATE of the damage to the senior tranches it DOES NOT REVERSE IT once the insurance is gone!

So let's talk about what can happen here IF we don't get a near-immediate regulatory (or market) correction of this situation.

• Primary broker/dealers have been allowing these hedge funds to use "marked to model" rated CDOs/CLOs/RMBSs as collateral for margin debt.
• These hedge funds now are taking big losses, but by not selling the CDOs, they're not recognizing the loss. Their "model" still says these issues are worth 100% of their face. However, all of the insurance that made this debt "senior" has been destroyed by actual defaults - that insurance is gone and cannot be replaced.
• NOW the hedge fund gets redemptions. They suspend them (as some are now doing!) - which they can do - for a short while. Typically 30-90 days. They hope (pray?) that the ABX recovers. But.... foreclosures don't stop - even if they slow down, it doesn't matter, because the insurance is already wiped out, so now we're talking about the rate of additional deterioration, not the possibility of recovering value. Each additional foreclosure impacts the coupon payments on the next tranche, depressing its market price and threatening the others further up the chain.
• When their lockup period expires they are forced to honor the redemption requests. This forces selling of assets in order to pay the redemptions.

Now the Hedgies and their primary Broker/Dealers are in bit of a pickle. If they sell the "best" assets first, they destroy the remaining margin collateral and generate an immediate margin call. If they sell the crappy assets first they mark them all to market and generate an immediate margin call. Either way, a margin call is generated and the CDOs must be sold - to SOMEONE - in order to meet the redemption request.

That's bad, but that's the risk of being a hedgie. Its part of the game and is no big deal. Hedgies blow up all the time and while the investors in them lose money (sometimes all of their money) that's the risk you take for the potential outsized returns. This is not where the systemic risk lies, although you will hear people moan about it.

The actual big deal is what happens next.

Once the margin calls start, the primary broker/dealers are forced to recognize that the "collateral" is not worth what they said it was. This means that not only did Sir Hedgie lose his money, he also lost huge amounts of the broker/dealer's money!

In the Bear Stearns case, it appears that one hedge fund lost $1.6 billion worth of Bear's money before the margin call went out.

That is about 7-8% of Bear's Market Capitalization - on one fund!

But there are hundreds of similar funds, and they all have been marking to the same flawed models!

This not only can, it WILL bankrupt primary broker/dealers. If not directly, it will force downgrades of those primary broker/dealers to junk status, which will make their operations unprofitable.

The spillover effect of such an event is likely to be beyond anything we have seen in the financial markets since the 1929 crash.

How is this avoided?

The market, or the regulators, need to force the margin calls NOW. They need to either re-work the models to include the ACTUAL market conditions in housing OR they need to just flat-out BAN the use of any illiquid and not-publicly-quoted asset as collateral for margin debt.

Either move forces the markdown and thus the inevitable margin calls. We get a handle on these losses, the hedgies that made the bad bets blow up, and the primary broker/dealers, while hurt (and some, like Bear, might be severely hurt), are not killed.

IF THIS CHARADE GOES ON MUCH LONGER THE RISK OF A FULL-ON SYSTEMIC MELTDOWN INCREASES PRECIPITOUSLY. LOOK AGAIN AT THAT "AA" TRANCHE ABOVE.

THAT IS VERY HIGH GRADE DEBT, AND IT HAS HAD FIVE YEARS OF ITS INCOME WIPED OUT IN ONE DAY! IT IS ALSO WHAT THE DOW JONES AND S&P CHARTS MAY LOOK LIKE SOON IF THIS IS NOT ADDRESSED.

Oh, in the last hour the homebuilder stocks all went in the toilet. Nobody seems to want to be long over the 4th in them. I wonder why? :-)

Right near the close a story hit the wires that some of the investors in Bear's Hedgie Fund that blew up are planning to sue. Apparently they were told not to sell last fall (when redemptions were possible without a significant loss) due to the impending IPO that Bear planned to dump all the toxic crap on unsuspecting retail bagholders. They believed it, stayed in, and of course now have lost big. That's going to be interesting! This is - at this point - unconfirmed. So far.

You guys buying the market here - be careful. Your wallet may regret that decision in the coming weeks and months, and that pain may come a lot sooner than you'd think.

In any event here is something you ought to think about this Independence Day - consider doing what you can to get out of debt, at least any debt that is tied to a floating interest rate. This means you pay off your credit cards and if you can't pay them in full every month cut them up!

Why?

Because if this scenario comes to pass the only option available to the Fed will be to defend the dollar, lest we wind up with a Depression. This will mean precipitously higher real interest rates and credit card companies will defend their earnings by raising rates even higher as more and more of their customers default. If you are carrying a balance, you are at risk of financial ruin in this environment.

While your risk with a fixed-rate mortgage is that your house may decline in price, if you do not sell you have a higher carrying cost but no instantaneous capital loss. But you face severe, perhaps even critical damage to your financial future should your credit card interest rates double.

They just may.

Yes, even if that means they'd be near or even - perhaps - above 30%.

ICSC up 0.1% (from -0.7%, which is still negative)
Redbook -1.1%, from previous -1.0%.

Guess what? Two sequentially bad numbers.

NO MENTION OF EITHER FROM CNBC ON THE NUMBER RELEASES EITHER LAST WEEK OR THIS WEEK.