Sunday, November 4, 2007

October Updates (November topics on your right)

This is an update on things I was blogging about in October. If you would prefer not to read this you can go directly to new pieces (and rants) that are filed under November on your right.

1. More news about subprime and the overall credit saga:

An article in yesterday’s WSJ Online Edition here discusses the issues homeowners face when trying to renegotiate their loan with a lender today. The main thrust of the article is that people are told that unless they are in default (a certain number of payments behind) they cannot help them. In other words, if you want to negotiate a better rate, first go into default. Anyone who has been following my take on this issue knows this comes as no surprise. You can find my rant about it here and in various other October posts. This post is more recent and deals with the response from some in Congress.

Things are getting a bit edgy, with people now talking about outstanding credit default swaps of $45 Trillion dollars and other possible credit market nightmares. At issue with these insurance policies on debt is whether any counter parties have actually reserved adequately in the event some corporate debt starts to go bad and there are calls for payment. This gets to the big question – is the credit problem limited to housing or did lenders make the same mistakes in other areas too? Also this week – rating agencies under scrutiny. I think that will become a bigger story, especially if the credit situation gets any worse. I wrote a piece about the rating agencies and the banking system in October that is posted here.

Speaking of credit, I have read a lot of discussion about whether the FED rate cut this week was justified, and there are lots of people on both sides of that issue. I posted my opinion on it last week here (I seem to have offended some sensibilities with the title – oh well).

In related developments, the Standard & Poor’s/Case-Shiller home price index report was recently released. You can get the WSJ Online Edition take on it here, but it was decidedly negative. Some commentators thought there could be a glimmer of hope as some of the numbers seemed to be deteriorating at a slightly slower pace. I’m not as optimistic as that. Here is a portion of the explanation of how data is used in this report to measure prices:

“When a specific home is eventually resold, the new sale price is matched to the home’s first sale price. These two price points for a specific home are called a “sale pair.” The difference in the sale pair is measured and recorded. All available sale pairs within the geographic market being measured are then aggregated into one index. Sales pairs are carefully screened for any data points that would distort the index such as foreclosures, non-arms length transactions, and suspected data errors where the order of magnitude of the change is substantially different from others in the region.


The indices are designed to measure the change in the price of homes that have not undergone significant changes in quality. Sales pairs are assigned weights to account for fluctuations in price that can be attributed to factors like extensive home remodeling, adding a home addition, or extreme neglect. For example, the indices assign smaller weights to sales pairs with large change in sales price relative to the community around them. The assumption is that this change is due to remodeling or neglect. Sales pairs are also weighted based on time intervals between sales. Sales pairs with longer time intervals are given less weight than sales pairs with shorter intervals to account for the probability of physical changes.”
Click here for the report.

Looks to me like the data could easily hide unusually high foreclosure rates and neglect, and there may be some of that now. The overall market could be worse than expected.

2. More to come on Citi and the SIVs:

From The WSJ Online Edition here:

“The SEC is reviewing how Citigroup accounted for certain off-balance-sheet transactions that are at the heart of a banking-industry rescue plan, according to people familiar with the matter. The review is looking at whether Citigroup appropriately accounted for $80 billion in structured investment vehicles, or SIVs, these people said.”

The article does not go on to say whether there is any suspicion they are not properly accounted for, but with the SEC coming in to take a peek one has to wonder. Last month I addressed some potential accounting issues relating to the M-LEC here and here.

I also had a post up here a while back with info about Citigroup but took it down because I did not want to be seen as expressing an opinion on a particular stock. Given recent events (the rapid decline in Citi’s stock price and more news about off-balance sheet entities) I decided to put just the part that follows reagarding disclosure of off-balance sheet items back:

“As mentioned above, the Company may, along with other financial institutions, provide liquidity facilities, such as commercial paper backstop lines of credit to the VIEs. The Company may be a party to derivative contracts with VIEs, may provide loss enhancement in the form of letters of credit and other guarantees to the VIEs, may be the investment manager, and may also have an ownership interest in certain VIEs. Although actual losses are not expected to be material, the Company’s maximum exposure to loss as a result of its involvement with VIEs that are not consolidated was $117 billion and $109 billion at June 30, 2007 and December 31, 2006, respectively. For this purpose, maximum exposure is considered to be the notional amounts of credit lines, guarantees, other credit support, and liquidity facilities, the notional amounts of credit default swaps and certain total return swaps, and the amount invested where Citigroup has an ownership interest in the VIEs. In addition, the Company may be party to other derivative contracts with VIEs.” Pg 67 of the Citigroup 2007 2Q 10Q available here.

Regarding that last sentence, does that mean the potential exposure is more than $117 billion? I know the “notional amount” is always looked at as some extreme, but these are extreme times, no? What is the potential exposure? If anyone can figure a probability of loss magnitude from reading the foregoing disclosure please let me know.

3. There was a very interesting piece on the Laffer Curve and republican politics titled “Tax Evasion, The great lie of supply-side economics”, wherein James Surowiecki discusses the fallacy of the current Republican mantra - tax cuts increase tax revenue. I have written about this here last month and it is one reason for writing the November piece titled Classless Warfare that you can find here. I recommend Surowiecki’s New Yorker article that can be found here.

4. Finally, the jobs report. This came in reporting surprising strength in new job creation. Unfortunately, as reported by Floyd Norris of The New York Times here it appears that 103,000 of the 166,000 new jobs are statistical creations based on a birth/death rate (of businesses) methodology adopted by The US Department of Labor Bureau of Labor Statistics. You can find that report here. The jobs picture may actually be worse than reported – surprise. Love those statistics.

So far in November I have posted two pieces. “America On Sale” is about the recent rate cut by the FED, and “Classless Warfare” is a rant that addresses some of the coverage of poverty in The United States and the fairness of the graduated tax system. Links to those posts are on your right.

I hope my first month’s attempt at this has provoked some thought. For a few minutes of cuteness, check out John's blog here. Please feel free to leave comments.

Mark Palermo
© 2007

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