Sunday, August 26, 2007

Liquidity, "A Well Run Dry"

There is a massive call to redeem mortgage CDO’s and there are few buyers. Let’s face it; almost everything is suspect that was written up to the third week in June when Bear Stearns “Roman Candled” into the ground. So if there is some good stuff out there, most investors wouldn’t know how to even recognize it. Even if it was a good deal, liquidity for a security means willing buyers. Finding any buyers seems to be a problem now.

Notice the issue here is not the mortgage itself; you just can’t lay your hands on the individual notes written on each home. The mortgages have been grouped and abstracted into an asset that can’t be broken down, its all or nothing. This new security is full of covenants and restrictions. How do you get clear title to a foreclosure when you’re not sure who really owns it? Purchasing a CDO is kind of like buying a dozen eggs and you notice that 6 are broken. The store owner won’t let you switch the broken ones with some from another container.

Over at Country Wide, the problem is a little different. It’s a catch 22 situation. They can write the paper, but in order to write more loans, they have to sell the loan for cash to some investor in order to have cash to write another loan. In the past, these loans went out the door and were packaged and sliced up for consumption, no questions asked. Now the real estate paper is a hot potato. This stuff is the new Monopoly money. You bought it, keep it and good luck!

Then we have the Yen carry trade that has been going on for years. The Japanese stock market crashed in 1990 and the banks literally went under. To save the banks, they dropped the interest rate to zero and invested in U.S. Treasury bills, which over the last 17 years, have made them whole again. Lately there have been rumors that their banks have been investing in hedge funds of all things (more bang for the buck). There are indications that the carry trade has dried up even though the interest rate spread between BOJ and the U.S. is about 5%. I guess that the futures trading for the Yen to Dollar now has the meanness of a rabid dog. You could say there is a Yen to go home.

Bloomberg on Friday mentioned that worldwide, governments have added 400 billion dollars of liquidity to the markets. If money is water, then this financial crisis is a pretty thirsty critter! Our current situation revolves around the fact that real estate instruments are no longer highly fungible. A majority of financial issues trade on faith. If it can’t be exchanged freely between everyone, then there is a problem. Some of the holders of these CDO’s have no real cash for the next hand of poker. That’s no problem, the discount window is open. Bernanke is catering the event, and you thought there was no Free Lunch!


Anonymous said...

enstulohHello Jim, this is Anon 5:08. I have another novice question today. I noticed that the NYSE volume is 80000000 at 11:04 AM CST this morning, I`ve never seen it above 40000000 in the very short time that I`ve been following this. Is there anything to read of how high the volume is in a particular trading session? Why would they be trading close to twice as much volume as I have ever seen it today?

Jim in San Marcos said...

Hi Anon

I checked todays volume and it was around 2.5 billion shares. No big move for the exits yet.

I don't really follow the volume much and I suppose I should, but if things start to happen volume would definitely jump up as would the size of the blocks of stocks traded

Anonymous said...

As a broker in Phoenix, I have noticed that the lenders are keeping the foreclosure properties on the market at high prices. It makes me believe no one really wants to know how much is going to be lost.

Anonymous said...


Jim in San Marcos said...

Annon 5:54

The thing that is being missed here, is that the lender, the entity who holds the note, in 99% of the cases, is no where near the property. Deutche Bank in Germany, Chase in New York, and other centrally located offices manage these foreclosures.

So the bank in your town managing each foreclosure, could care less what happens, they get a management fee for keeping an eye on the property. They have absolutely no interest in selling it. You tell them what you want them to do for $200 a month and they send you the bills due on the property.

Another point of issue, when does the loan holder have actual title to the property? In some states that can be over a year. So things are not going to move very smoothly

Jim in San Marcos said...

Anon 4:36

They could print more money, but the problem the Fed is running into is that no one wants to borrow money.

When the Fed prints money, they have to buy something, like a new road, a military tank, or even pay social security payments.

This stuff that they have been pulling at the discount window so far, is a loan item, technically they are not printing money but that could be argued.

Anonymous said...

Hello Jim, If you were an average American with a blue collar job and had all your debts paid off except the house, plus you had about $100,000 in T-bills, What would you invest in, after looking at what is happening right now? Would you pay the house off? (which would be possible, plus a little left over) Invest in gold? Foreign currencies? Buy some blue chip stocks? Or maybe just sit tight for a little bit and see what unfolds? I won`t hold you to anything, I`m just looking for some ideas. Thanks

Jim in San Marcos said...

Hi Anon 6:59

I think that sitting tight would be the best thing to do. There will be opportunity coming up, but you have to wait. I see rental real estate (not condos, but detached houses) as a good investment if the market goes to hell. It might take a couple of years to get there, but everyone that is fully invested today, probably won't have the funds in the future to take advantage of the real estate collapse.

Here is a Link to a post of mine from May 29th last year that goes into more detail.

Anonymous said...

Thanks for the link Jim, VERY much appreciated! My gut was telling me to sit tight, but it is good to hear it from someone with more experience than I have.

Anonymous said...

Jim, I went back and read your "The Pop and Drop Monetary Implosion" post, it was great. I also read the comment to it, and I have to say that I don`t care if you`re not a perfect speller, just keep bringing on these uncommonly good post. We have TONS of people who can spell perfectly with the advent of spellchecker, but few with common sense.