ECB Member Say’s Taking Rates to ZIRP and Buying Commercial Paper is Open For Discussion

Put your rates where your mouth is

April 9 (Bloomberg) — European Central Bank council member Ewald Nowotny said cutting the benchmark rate below 1 percent is still open for debate and it would be “sensible” for the bank to buy corporate debt.

“It’s my personal opinion that the benchmark rate should not go below 1 percent, but this is a point that’s open for discussion,” Nowotny, who heads Austria’s central bank, said in a telephone interview from Vienna late yesterday. The purchase of commercial paper and corporate bonds is “a sensible and efficient measure,” Nowotny said, adding it may not be introduced immediately because it would take time to prepare.

The comments suggest the ECB council is split over the best way forward amid signs the euro-region economy is slipping deeper into recession. While Germany’s Axel Weber has signaled he’s opposed to buying corporate debt and doesn’t want to take the benchmark rate below 1 percent, Greece’s George Provopoulos this week indicated both remain options.

The euro dropped more than half a cent to $1.3268 after Nowonty’s comments were published. The ECB’s key rate is currently at 1.25 percent.

“All the Governing Council so far appears to have agreed upon is that there could be a 25 basis point cut in May,” said Julian Callow, chief European economist at Barclays Capital in London. “They have clearly not yet determined whether that would then mark the low for the refinancing rate or not.”

New Measures

The ECB this month cut the rate by a quarter point, less than economists forecast, and delayed a decision on new tools until May. The Federal Reserve, Bank of Japan and Bank of England are already pumping money into their economies by buying government and corporate debt.

“If you’re aiming at intensifying credit supply, measures which focus directly on credit supply are of interest,” Nowotny said. “For example the purchase of commercial paper, corporate bonds and similar things.”

Still, he said this would “take longer to prepare” than offering banks longer-term loans to ease credit tensions. The ECB currently lends banks as much as they want at the prevailing benchmark rate for up to six months.

Lengthening maturities is “the best option” as far as speed of implementation is concerned, Nowonty said. “That means going beyond the current six months to an extension of, for example, 12 months. That’s something that can be implemented immediately and takes effect promptly.”

‘Need for Speed’

The comments are “helpfully transparent on the evolution of unconventional policy measures,” said Ken Wattret, an economist at BNP Paribas in London. “In short, if there’s a need for speed, then repo maturity extensions are the best option.”

Longer loans pose some complications. Banks may not take up the offer unless the ECB signals rate cuts are at an end, and securing cheap money for a year may distort efforts to raise borrowing costs once an economic recovery sets in.

“I would happily accept this problem if indeed the economic recovery comes faster than expected,” Nowotny said. “I think our task is currently to fight the worst economic slump in the post-War period with all available tools. If an improvement becomes apparent, I’d be happy about it.”

The Organization for Economic Cooperation and Development predicts the euro-region economy will shrink 4.1 percent this year. By comparison, the ECB on March 5 projected a 2.7 percent contraction.

Legitimate Pessimism

While Nowotny said the OECD’s forecast is a “pessimistic assessment,” he added: “Regrettably, I’m aware that pessimism in the past was often legitimate.”

He expects inflation to remain below the ECB’s 2 percent limit “over the medium term,” giving the bank room to keep interest rates at historically low levels for some time.

“In a situation like the current one” an expansionary monetary policy “is absolutely necessary,” Nowotny said. “If the recovery is very weak we have to continue to follow an expansive path with both monetary and fiscal policy.”

Weber said March 10 that 1 percent would be his “bottom line” for the ECB’s benchmark rate, while Provopoulos in an April 6 interview said he doesn’t consider 1 percent to be “a threshold.” The Greek Central Bank later issued a statement saying the remark was “inaccurate” and that Provopoulos’s view was the benchmark “could go down from the present level, although in a very measured way.”

When asked about the debate on the council, Nowotny said: “You can’t say we’re divided, rather it’s a discussion we will have. In the past, the decisions in the Governing Council were always consensual. I don’t expect that this will change in the future.”

Pack your bags

Rush Limbaugh said thanks to the state of New York’s new tax, dubbed the, ‘Millionaire Tax,’ he’s leaving the big apple, and he’s not coming back.

In an interview with FOX Business Network anchor Neil Cavuto, Limbaugh spoke out against the new tax and said he expects other New Yorkers will leave the city as well.

“It’s not just income taxes that are pressuring people there — property taxes, even though home values have declined the property taxes haven’t — people have been fleeing the Northeast, including New York and moving to the Southern states many of them with no state income tax,” Limbaugh said. “North Carolina’s getting a lot of Yankees moving in, Florida is, and so forth — I think it’s already happened.”

Limbaugh said he’s been audited by the state every year for the past 12 years and is fed up, calling the state’s new tax the “tipping point,” prompting him to move all work operations outside of the state.

The tax plan, which is designed to expire after three years, would affect those earning more than $300,000 per year, raising their tax rate to 7.85%. Taxpayers earning more than $500,000 per year would be taxed at a rate of 8.97%. Government officials argue the tax will help to close the state’s budget gaps, but Limbaugh argues it won’t work. He thinks New York will be forced to make the tax permanent.

“They’ll be forced to raise taxes again…the government sector does everything the opposite of what the private sector does to compete and they drive out their best customers,” Limbaugh said. “This is, I think, ridiculous to assume that this is going to raise a lot of revenue and it’s going to be temporary.”

While he praised House Republicans’ alternative budget, Limbaugh argued that the elected Republican leadership has yet to take a firm stance against proposed tax increases at both the state and federal level.

“The elected Republican leadership hasn’t yet decided to speak out,” Limbaugh said. “We’re going to have to let some of this stuff happen — let it fail and let some of it not work and that will then inspire others to start speaking up.”

Banks and brokerage firms just can’t catch a break…so sorry

By AARON LUCCHETTI

Morgan Stanley isn’t in crisis mode anymore, but the Wall Street firm is still struggling to dig out of a slump.

Adding to woes from real-estate and other basic businesses: The recent rebound in its bond prices, generally thought of as a positive, will actually hurt the company’s bottom line.

Because of the accounting treatment on some bonds issued by Morgan Stanley before the financial crisis erupted, the New York company is expected to take a hit of $1.2 billion to $1.7 billion on the bonds when it reports quarterly results later this month, according to people familiar with the situation.

That is somewhat higher than the $500 million to $1 billion mark that many analysts are predicting Morgan would take from the bond-price move.

The bonds, valued at about $29 billion recently, rallied as Morgan Stanley distanced itself from fears last fall that it was in dire straits. However, the gains forced the firm to increase the paper value of bonds it owes to investors. Since Morgan Stanley adjusts its marks on these bonds as if they were being bought back on the open market, the more expensive liability flows to its bottom line, hurting earnings.

While the hit reverses some of the gains Morgan Stanley got last year from the same securities, it could plunge the company into the red for the second quarter in a row. That hasn’t happened in the 23 years since the firm went public.

Analysts expect a seven-cent per share loss, down from a $1.45-a-share gain a year earlier. On Wednesday, two more analysts published reports predicting Morgan would lose money in the first quarter; its shares dropped 2.7%, or 63 cents, to $22.69, but they are still up 41% on the year.

A Morgan spokeswoman declined to comment on the company’s earnings.

Ugly first-quarter results also would show how hard it is for Morgan Stanley to escape bets it made on real estate and leveraged loans when times were good. Write-downs on those assets are expected to total at least $1 billion in the latest quarter, casting a long shadow over Chairman and Chief Executive John Mack’s continuing push to shed risky businesses and focus more on trading for the firm’s clients.

Taking fewer chances with trading also might have cost Morgan Stanley business in the first quarter, according to some analysts. And like other securities firms, Morgan Stanley still is dogged by a dismal climate for investment banking and asset management.

The strains help explain why Mr. Mack is in no hurry to pay back the $10 billion in capital Morgan Stanley received from the federal government as part of the Troubled Asset Relief Program.

In February, Mr. Mack told shareholders that the company’s “intent is to pay it off as soon as it is feasible.” On March 27, though, the CEO struck a different tone in a White House meeting, saying in an interview with The Wall Street Journal shortly afterward that a quick payback, while possible, would “undercut the purpose” of TARP.

The first-quarter results, due the week of April 20, aren’t expected to plunge Mr. Mack back into anything like the scramble he faced last September to shore up confidence in the firm. Since then, Morgan Stanley has sold a stake to Mitsubishi UFJ Financial Group Inc. and struck a joint-venture brokerage deal with Citigroup Inc., which could lift earnings in the long run.

For now, though, Morgan Stanley’s real-estate bets remain a daunting liability. In contrast, Goldman Sachs Group Inc., which has less real-estate exposure and is the only other major securities firm to survive 2008 as a stand-alone company, is expected to post roughly a 50% decline in per-share profit when it reports first-quarter results Tuesday.

“In this quarter, the tide is in favor of Goldman Sachs and against Morgan Stanley,” said Roger Freeman, a Barclays analyst. Goldman has more exposure to stocks, which rallied at the end of the quarter. Morgan Stanley is likely to suffer from its “heavy concentration” in real estate, Mr. Freeman said.

The Barclays analyst predicts a first-quarter net loss of $1.4 billion at Morgan Stanley, including the hit from the firm’s bonds. Morgan Stanley is more affected by changes in prices of its structured notes than other firms because it was a large issuer of those bonds, which give buyers an investment in stocks, commodities or other assets along with a Morgan Stanley debt instrument.

Volatility in the bonds’ pricing and yields resulted in a gain of more than $2 billion in the fourth quarter, even as Morgan Stanley was fending off speculation that it might collapse.

The first-quarter loss on the bonds “is a relatively high-quality problem to have,” Banc of America Securities-Merrill Lynch analyst Guy Moszkowski wrote in a recent note to clients. Diminished concerns about Morgan Stanley’s bonds eventually should help lower the firm’s borrowing costs and help its trading business.

According to people familiar with the situation, Morgan Stanley is likely to mark down the value of its real-estate investments by a smaller amount than the bond adjustment.

In the fourth quarter, the commercial real-estate fund in Morgan Stanley’s investment-management division, called MSREF VI International, wrote down the value of its investments as much as 60%, according to a letter reviewed by the Journal.

In June 2007, Morgan Stanley billed the venture as “the largest ever real-estate fund.” It includes more than 20 office buildings in Germany.

Meanwhile, investment banking, while somewhat better than in 2008 partly because of an improved performance in the merger-advisory business by Morgan Stanley, still is likely to be down 16% in revenue from last year’s first quarter, estimates Brad Hintz, an analyst with Bernstein Research.

March has seen rapid deterioration… Maybe the AIG rumor of eating losses for the banks was true

March was notoriously a tough month for banks. After a supposedly good January and February, something went wrong and business deteriorated.

We have this on the authority of JP Morgan Chase CEO Jamie Dimon.

Exactly what went wrong is a bit of a mystery, however. The stock market rallied hard, bonds gained 3.3% and the commercial real estate mortgage market improved as well. At first glance it looks like March should have been a good month for banks. What happened?

New data about hedge fund performance may provide a clue. The Hennessee Hedge Fund Index, which attempts to measure the performance of hedge funds across a variety of strategies, gained just 1.4% in March, badly underperforming the broader markets. Since the proprietary trading operations inside banks follow hedge fund strategies, its safe to assume that they also badly underperformed.

“Most hedge funds were caught with tight net exposures and were unable to participate in the rally,” Charles Gradante, co-founder of New York-based Hennessee Group, is quoted as saying in this Investment News story. “Managers were also hurt as the sectors they have been heavily short, such as financials, consumer discretionary and materials, were the sectors that rallied the strongest.”

In other words, the trading performance at banks may have been hurt by the rally in financial stocks.

If they are priced correctly then I’m assuming many assume much, much more people will be driven into foreclosure

The study out of Harvard and Princeton arguing against the official story line about firesales underpricing toxic assets is now coming under fire from those who think the authors are too pessimistic about asset values.

Megan McArdle at the Atlantic’s Business blog raises two objections.

* If toxic assets aren’t underpriced, we’re all in “big, big, BIG trouble.”
* The market prices for toxic assets don’t reflect reasonable expectations of cash flows.

Her first objection isn’t really so much an argument as a lament. The correct response is simply: Yes. We are in big trouble. Some of our big money center banks are insolvent. But just because something is very bad news doesn’t mean it isn’t true.

The second objection is more substantive. We hear a different version of it all the time: real estate isn’t going to zero, so therefore securities backed by real estate can’t go to zero. This makes sense only if you don’t really understand how complex the collateralized debt market got during the boom years. Because once you understand this, it’s pretty obvious that even though most mortgages will continue to perform, lots of real-estate based assets held by banks can go to zero.

How To Make An Asset Backed Security

Let’s ilustrate this with an example of an asset backed security built on home loans. (We’re borrowing the example from the excellent Acrued Interest blog.) These weren’t exotic credit products. In fact, for most of the years building up to the crash, HEL ABS (as they were known in the business) was the dominant credit product. In 2005, something like $400 billion were issued. At the time, JP Morgan Chase was urging clients to buy this stuff by saying the pricing was “cheap” because of “irrational fears” over a housing bubble.

So let’s say our imaginary bank, CitiMorganAmerica, decides it wants to sell HEL ABS built from mortgages with $100 million face value. One of the first things it does is cut this up into tranches to reflect the risk and price points of various customers. For simplicities sake, we’ll just pretend that there are only three tranches. (In reality, there could be dozens of tranches).

* Senior: 5.75% coupon, $80 million
* Mezzanine: 6.50% coupon, $15 million
* Subordinate: 8.00% coupon, $5 million

The reason the lower tranches get bigger coupons is that they are riskier. They only receive interest payments after the tranche above them have received all interst payments they are due. Each tranche below senior receives principal payments only when the tranche above them has been full paid off. Any short fall hits the lowest level first.

Here’s where things start to get scary. If just 5% of the mortgages in that HEL ABS default, the subordinate tranche is worth zero. We’re just about at 5% national default rate for all mortgages right now. Default rates on more recent mortgages are even higher. Fortunately, the ratings agencies were pretty good about this level of stuff so the Mezz and Sub investors knew they were getting riskier products, and only the senior deal would be rated AAA.

How To Make A CDO

Now lets see what happens when we build a CDO on these types of deals. CitiMorgan America takes $1 billion and buys the Mezz and Sub tranches of 50 HEL ABS deals that are built just like this. It slices up the CDO just like it did the earlier deal.

* Senior: 5.45% coupon, $800 million
* Mezz: 6.00% coupon, $120 million
* Sub: 8.00% coupon, $40 million
* Equity: $40 million

These pay out just like the ABS, a waterfall filling up each bucket before anything gets paid to the next level down. The top tranche of this CDO can be rated AAA even though it is built out of already subordinated debt. You see, even though it is technically subordinated debt, there are so many underlying mortgages spread out across the country that the odds of systemic defaults materially affecting the cash flow would have been viewed very remote. After all, what are the odds that defaults will suddenly tick up all around the country?

How To Lose Your Shirt

See the problem? Here you have $1 billion of assets that can be devastated by a small increase in the default rate. If defaults climb to just 5% for the underlying mortgages, the cash flows will drop 25% as the portion of the CDO built from the Sub HEL ABS stops paying. Everything but the senior portion of the CDO gets wiped out.

If the losses on the mortgages rise to just 10%–high defaults from those bubble years from 2005, lower than expected recovery rates from foreclosures on houses with falling values, cram downs–even the most senior piece will lose 30% of its value.

In short, structured debt can rapidly decline in value even though the underlying assets don’t decline as much. The benchmark index of the market for securities backed by home loans shows that the AAA tranches for deals made in 2007 are valued at about 23% of their original value. The lower tranches show losses greater than 97%. Some of this may no doubt reflect a bit of irrational fear and illiquidity. But claiming the overwhelming majority of these losses aren’t real is just wishful thinking.

Plans are developing

2009: The FCC Finally Makes A Broadband Plan
Now the real test: shaking off lobbyist influence…
08:54AM Wednesday Apr 08 2009 by Karl Bode
tags: legal · fcc · business · legislation · net-neutrality
According to an FCC announcement, the FCC will finally start developing a national broadband strategy this week, after more than a decade of assuming we didn’t need one. That assumption resulted in the United States’ mediocre global showing when it comes to speed, penetration, competition and price, with Americans paying more, for less — than more than a dozen developed countries.

Since any useful plan would increase competition and therefore reduce revenues, carriers are lobbying against substantive changes or tough rules of any kind. The FCC’s new broadband plan is expected to take about a year to complete, and will explore all options — including a government subsidized broadband network, network neutrality protections, improved broadband mapping, and a higher standard (than 768kbps) for what we consider broadband.

Developing a working, useful plan may be the easy part. After (and while) it’s being cooked up it will run through a gauntlet of K-Street telecom lobbyists — some of the best in any business. That’s where the real test occurs.

As we’ve noted, the problem with getting a real broadband plan in place certainly hasn’t been a shortage of ideas — we’ve seen an endless flood of industry round tables at which a myriad of techno-celebrities and Ivy League pundits offer their insight into the best possible course of action. The problem has been that telecom lobbyists have such a tight grip on DC, truly consumer-friendly policy never survives the incubation period.

It’s not clear the “new” FCC will be any less beholden to carrier lobbyists. One thing you can be sure of, if lobbyists are running this show, you’ll see the FCC very quickly throw their wholesale support behind a program called Connected Nation, which consumer advocates argue is little more than a sophisticated con cooked up by the nation’s largest carriers, and dressed up as a real national broadband policy.