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2 Subprime fallout: Save Our
Souls By Julian Delasantellis
Call it karma, Karl Jung's synchronicity,
serendipity, or just plain old bad dumb luck, but
it is interesting that the US stock market chose
to throw in a 5% price decline in the week that
Rupert Murdoch's Fox Business cable channel, the
unabashedly rightwing rah rah towel-snapping boobs
over bonds alternative to General Electric's CNBC
and Bloomberg TV, debuted in 30 million US homes.
In contrast to the rest of the financial
media, which correctly
placed
the blame for this latest market falloff,
culminating in Friday's 367-point, 2.6% fall in
the US Dow Jones Industrial Average, on continuing
and ever-deepening concern over the credit quality
effects of the US subprime crisis, Fox Business
rounded up the usual keffiyeh-clad suspects and
was alone among the financial media in placing at
least part of the blame for the selloff on market
nervousness over the terror bombings that greeted
former premier Benazir Bhutto's return to Pakistan
the previous day.
In a time of significant
crisis in the markets, when investors are in
desperate need of real, unbiased actionable
information, Fox Business will probably keep its
viewers from changing the channel to CNBC or
Bloomberg with the usual Murdoch media strategy of
increasing the diaphanousness quotient of their
female on-air talent's attire. (Surely, Fox
Business' Liz Claman and Nicole Petallides must
have by now discerned the purpose of the bowls of
ice cubes on their dressing room tables.)
For the rest of us, dealing with the
challenges posed by the current financial markets'
travails may prove somewhat more problematic.
To paraphrase Henry II, "subprimes,
subprimes; will no one rid me of these damned
subprimes?" That's proving to be much easier said
than done. For the third time since March, we are
in the midst of a significant market selloff, a
sharp and painful expansion of what the markets
call "risk aversion".
The first time was
in early March, followed soon by HSBC bank's
reporting that its earnings would be negatively
affected by problems at its American Household
Finance mortgage unit, the signature event that
brought the subprime mortgage crisis front and
center to the market's attention. That caused a 7%
decline in the US Dow Jones Index, 8.5% in
Germany's XETRA DAX index and a 9.7% decline in
Japan's Nikkei 225 index.
Strong world
economic growth drove the subprimes from the
market's concern in spring and early summer, but
by mid-July, growing realization of just how
extensive, and how widespread the subprime losses
were going to be led to the big equity market
calamities of August, with both the Dow Jones and
the DAX falling over 11%, the Nikkei 16.5%. (I
wrote about the internal market dynamics of the
August selloffs in my October 2 ATol article, No such thing as a sure
thing.)
August's market carnage
and investor losses had the US Federal Reserve and
other world central banks saddling up and riding
to the rescue of their large investment banks and
other speculative interests, with market
interventions and, in the case of the Fed,
interest rate cuts.
This settled things
down a while; the Dow Jones and the S&P 500
reached all-time record highs in the first week in
October, the DAX nearly so. Until last week the
markets seemed to be confident that the world's
economic regulators could, with more rate cuts and
prudent oversight of the institutions endangered
by the crisis, stay at least somewhat ahead of the
whole subprime mess.
Last week the
sentiment turned; it no longer seemed that the
central banks were staying ahead of the crisis;
the fear was that the crisis was going to catch
up, run over and flatten them.
In a
fitting upbraid to those who think that by the
sheer force of their intellect or will they are
able to tame markets, the proximate cause of last
week's turmoil was an attempt to save them. I've
written before that one of the biggest problems in
the current subprime crisis is the fact that those
investors outside of the financial institutions
that waded into the subprime swamp have no real
idea just how bad things are, just how much
subprime and subprime-related exposure that those
now caught in the swamp are hiding under water and
away from view. (The Economist magazine reports
that banks suspected of having the most exposure
to the specific subprime-related debt called
"structured investment vehicles" (SIVs), are now
being termed by the markets as being "SIV
positive", as if the SIVs were deadly communicable
viruses, which, in actuality, may be closer to the
truth than the wags either realized or intended.)
Three of the most bounteous of American
finance capital's heavy hitters, Citigroup, JP
Morgan/Chase and Bank of America, floated an idea
over the weekend of October 13-14 to establish,
within the neighborhood of US$100 billion (a very
nice neighborhood indeed) of these banks' funds,
something called "the Master-Liquidity Enhancement
Conduit", or M-LEC - commonly called "the
superfund".
In simplest terms, what the
big hitters were hoping was that when investors
dealt with these institutions after the
establishment of the M-LEC, no longer would the
big institutions be tinged with the pervading
aroma of feculent subprime carrion that currently
permeates much of American finance. The idea was
that the M-LEC would buy the questionable
(although not the worst) of the subprime SIVs,
taking them off the bank's balance sheets, and, in
so doing, restoring confidence in the big banks.
But if it was going to be this easy to
solve the subprime mess it probably would have
been done by now, and, as the markets realized
this, the selling of last week set in. (This
selling was matched in Asia on Monday, where
stocks plunged, led by Japan's benchmark Nikkei
225 stock index losing 3.20% and the Korea
Composite Stock Price Index shedding 3.8% in early
trade. Stocks were also down in Australia, Hong
Kong, Indonesia, the Philippines and Taiwan.)
If the big banks really wanted to get the
SIVs off their books, they would not have needed
to set up a $100 billion M-LEC to do it; all they
would have to do is exactly the same thing that
widows and orphans do when they want to sell 100
shares of AT&T; call up their brokers and have
them put in a sell order.
But this is
exactly what the big banks do not want to do, for
they do not want to accept the fire-sale or worse
prices for the distressed SIVs that the market is
now willing to give them. Since the SIVs trade in
the secondary market so infrequently, the big
banks had been valuing them on their books not in
relation to their recent sales, their "comps" in
real-estate lingo, but instead according to a
series of complicated proprietary mathematical
model formulations that allowed the banks to carry
them on their books at valuations far higher than
what today's nervous markets are willing to pay
for them. (I wrote about the inherent dishonesties
involved in marked-to-model pricing in my July 3
ATol article, Of termites and index
mania.)
So, if the M-LEC is
going to take the bad SIVs off the big banks'
hands, at what price will these transactions be
made? The big banks don't want to take the market
prices; they'd be overjoyed to get the
marked-to-model prices. The free market won't give
them the latter; it was the sneaking suspicion
that the banks were going to force marked-to-model
pricing down the throats of the M-LEC, which after
all would be the big banks' creation, that turned
the markets against the M-LEC concept by late last
week.
Inherent in the idea of the M-LEC is
the hope that, eventually, the big banks which
created it would be able to take off its training
wheels and let it stand alone as a profit-making
entity. The market sees this as unlikely; if at
birth the M-LEC is to be saddled with the dead
weight of its creators' previous greed-soaked
imprudence and impropriety, then it's not
surprising that, by the end of the week, the
market looked around and saw that the general
situation was far worse than it previously
thought.
As far as the markets are
concerned, it's best to not have any problems,
it's somewhat worse but acceptable to have a
problem but then to come up with a workable
solution. If you have a problem and it is then
seen that your solution is nothing more than
blather-sodden balderdash, then, in terms of
inspiring and maintaining confidence, that's the
worst situation of all. No wonder
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