Housing Doom

Canada’s market for asset-backed commercial paper remains just as illiquid as it was the day it seized up nearly 17 months ago but the lawyers and financial advisors trying to rescue it have already billed noteholders for nearly $200-million. [1]

First off, don’t mess with their parents …

Doomers should appreciate that those events of a couple of years ago were occurring a lazy afternoon’s drive from Plattsburgh New York, in a part of the world that supplies America’s Middle Atlantic States with much of their hydro-electricity, not to mention some really good jazz. Quebecers get into some different things from their neighbors. One of them is Socialism. The mind boggles at the prospect of what would happen if governments were ever to lose a significant amount of the pension money set aside for the province’s civil servents.

The Caisse de Depot et Placement du Quebec "manages the funds contributed to the Québec Pension Plan." Which is to say, it handles Quebec’s share of the monies for Canada’s version of "social security." Neat, eh? Caisse was also the proud inventor (and a big-time investor in) Canada’s innovative Asset-Backed Commercial Paper (ABCP) market, the same stuff that froze solid in mid-August 2007, heralding the start of the world-wide credit crunch & global financial crisis. How big is the Caisse? [2]

The Caisse is not only Canada’s biggest pension fund, but is also the heavyweight of Quebec finance. The fight that played out between the board and the politicians offers a look at what the government thinks about the institution, which holds Quebec pensions and is also a major investor in Canada’s biggest companies, as it tries to navigate the global financial crisis. As of Dec. 31, 2007, it held $155-billion in net assets.

Canadian business pundit Diane Francis has some tough questions [3] for the company’s management (this is a selection):

• Has the Caisse been hurt, its trades held in limbo or unexecuted; or its assets tied up in bankruptcy as a result of the demise of Lehman Brothers?
• On ABCP valuation being too low: The writedown in December 2007 was 25% but since then writedown charges for others have been higher so is the Caisse going to match these higher writedowns this year?
• How does the Caisse and Ontario Teachers compare in terms of overhead? In return over their own benchmarks?

This story feels like it’s going to turn into a real circus, with either Flaherty or his Coalition successor as Federal Finance Minister likely to get called soon for further assistance when the real extent of the company’s losses become public. We may well be about to test Canada’s reputation as the world’s leader in banking stability.

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Big hat to to Tim for finding this YouTube.[1]

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"We believe that in 2009 we will need to see Canadian banks stem loan and asset growth, to control their balance sheets better." [1]

If I recall correctly, a Fleet Street publisher was once asked to describe the most boring imaginable newspaper story. He replied it would be coverage of The Bank Act, or anything about Canada. Well, we’re combining both this morning. Not long ago our Finance Minster was positively gloating [2] about the dullness of our financial services industry. However behind closed doors the grownups were quietly freaking, even while Canadians continued to live in a Fool’s Paradise.[3]

Although Doomers were expected to forget by now, Flaherty sneaked down the chimney on Xmas eve with a C$1.3 billion down payment on a complete bailout of the Montreal Accord on ABCP, and in the process knocked his Nov 13th braggadocio into a cocked hat.  Our country’s commercial paper market is now dead as a private enterprise, so today’s meeting is an exercise in fantasy. Canadian banks can’t lend until governments inject the money directly. It’s the same here as it is in every other Western country, and for exactly the same reasons.  Wake up and smell the socialism, Jim.

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Oops! wrong again …" [Canada's central banker Mark Carney] has a good empathy for the folks that are in this thing," Mr. Hunter said. "It was clear that he was working to get this done, and he clearly understood that, sure, we could survive this, but we didn’t want to." [8]

On Oct 7th the Fed announced [1] a new Funding Facility (CPFF) for the US commercial paper market, and late last week Japan’s central bank initiated an aggressive program to buy CP to stimulate their economy.[2]

Meanwhile, after more than 16 months, Canada’s Asset-Backed Commercial Paper (ABCP) market remains as frozen as Narnia in The Lion, The Witch & The Wardrobe or, well, Canada.  A job for Paulson’s Bazooka? No, Flaherty’s Flyswatter.

SUGGESTION: Housing Doom post "Sorry, Charlie! Subprime Mortgages Like Subfresh Fish Seize Up Debt" (Aug 22, 2007) has links to a number of stories from near the start of this issue, including Calculated Risk’s classic "Coventree Fails to Sell Asset-Backed Commercial Paper" (August 13, 2007) (don’t miss the comments!)

Doomers may wonder why I am constantly harping on this relatively trivial farce, but it’s more important than it looks. Because ABCP was the first market to freeze in the world-wide credit crunch, any way that we manage to extricate ourselves from the grip of illiquidity will serve as a powerful precedent as the larger bits of the world financial system try to come unstuck. A handy rule of thumb for putting Canadian events into American context is that many of the Canadian parameters (population, GDP, etc.) run at about 1/10th the heft of their American counterparts. Canada’s ABCP sector is nominally valued at C$32 billion, and it’s very comparable (including in how it seized up) to the $300 billion US Auction-Rate Securities (ARS) business. You could almost say that we’re a beta-test site for some of the Fed facilities and Treasury’s TARP.

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Making use of my hard-fought-for, trusty (if slightly rusty) DND MILSPEC estimation skills, plus info from two new stories, [1] [2] I hereby declare that the (initial) taxpayer cost of the bailout agreed yesterday for the nominal C$32 billion (C$200+ billion leveraged in reality) Montreal Accord / Crawford Committee / Asset Backed Commercial Paper / Largest Bankruptcy in Canadian History™ deal (aka "Big P bailout") was precisely $8 billion (Canadian) with the breakdown as follows:

• Quebec — C$3 billion: (see [2]) Charest’s election is safely over, so it’s now politically possible to do this. PQ opposition isn’t going to be too happy, though. Poetic justice given that The Caisse’s financial engineers came up with this bright idea in the first place.
• Ottawa — C$3 billion: Harper certainly isn’t going to put in less than QC!
• Ontario — C$1 billion: Coventree breaking is what froze ABCP in mid-August 2007. The world-wide financial firestorm was touched off by a spark on Bay Street.  Anything less than 7-figures would look chintzy.
• Alberta — C$1 billion: Oil industry, mining and mineral companies here (and in BC, etc.) were really hurt by their short-term financing freezing. Besides, they can’t lag behind ON in the rescue.

The C$8 billion figure would be the bare minimum to assure the foreign banks with Big P investments that they now have governments on the hook for the inevitable losses as they materialize over the next while, up to a total likely in the $100+ billion range. The initial Big P taxpayer shakedown is then about twice the size of the one for the Big 3 (less than I previously feared), but both are clearly just the first installments of massive taxpayer subsidies to legacy industry and offshore bankers.  Only in Canada, you say?

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The comments came a day after the federal government, Quebec and Ontario agreed to an eleventh hour request from a committee spearheading the restructuring to put up nearly $10-billion to meet potential margin calls on the assets underlying the frozen notes. [3]

"Justice Colin Campbell said it wouldn’t be appropriate for him to make such an order. He tried to calm the waters, noting that he didn’t interpret Mr. Howard’s comments to be a threat." [4]– but see below [this added about 5:15PM Pacific Time Friday]

Canada’s "Big P" ABCP bailout is about 3 times bigger than the "Big 3" bailout. Why are we doing this without a public debate?

There’s no nice way to say this. Yesterday a few of the big boys put a gun to Jim Flaherty’s head.[1]

Dec. 18 (Bloomberg) — Deutsche Bank AG, Citigroup Inc. and other banks backing a plan to convert C$32 billion ($27 billion) of insolvent Canadian commercial paper said they will walk away from the deal unless it’s completed tomorrow.

The non-Canadian banks, which include Bank of America Corp. and HSBC Holdings Plc, agreed last year not to demand collateral tied to the paper while holders worked out a restructuring. Peter Howard, who represents the banks, told an Ontario judge today that his clients won’t extend the accord past tomorrow.

Now the Canadian government has announced [2] that they, Alberta, Ontario and Quebec will be putting in enough money to make the ABCP restructuring a done deal by Monday. We’re talking about a close to C$10 billion bailout getting dragged out of the Tories, although the size of Ottawa’s share will probably not be made public for a long time.

There are lots of stories coming out on different aspects of this dramatic plot-twist, and I’ll try to get back to them soon.  It is likely to have a strong influence on the struggle between Harper and The Coalition which is scheduled to resume in the New Year.  As well, since the freeze of ABCP assets marks the starting point for the world credit crisis, a successful resolution of the problem would serve as a precedent for later parts of the crunch.  Contrariwise, if this falls apart over the weekend, it will be a strong indication that the world financial services industry is in even worse shape than we thought.

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The reputation of Professor Scott Nelson’s recent article on The Panic of 1873 (links and discussion at this Doom post; further discussion here [1] ) continues to expand.

Click the Pic to go to this slightly garbled account.[2] Environmentalism journalist Kaushik Das Gupta provides an interesting summary of Nelson’s theory for his Indian audience. He’s using this cover from a 1873 Harper’s issue, which represents President U.S. Grant rescuing "America" from the end result of that era’s housing bubble: "I am glad you are unhurt. Houses in this street have been on false bases for long time." Clearly our expectations for President-elect Obama are similar.

A bit later: I forgot to add an important nuance. Obama is not actually reprising Grant’s role, that job goes to Hu Jintao. The new American President is actually replaying Benjamin Disraeli.

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Yet surely I’m not the only person to ask the obvious question: How different, really, is Mr. Madoff’s tale from the story of the investment industry as a whole? [4]

[NOTE: this post originally didn't have a letters-of-fire quote, and then that one dropped in our laps.  Thanks Paul ]

It’s beginning to look like the Madoff Ponzi was something of an open secret. Perhaps (and this is pure speculation) the more sophisticated investors then saw their risk as purely political, with the strength of their investment depending on Madoff’s nearly unassailable person. This would be analogous to the strength of Fannie’s and Freddie’s common stock after the Democratic Party gains in the November 2006 mid-term elections. That party was perceived as a source of support for the big GSEs, so in spite of their obvious intrinsic problems, shareholder confidence was boosted by their political ally’s success.

The morality play aspect of the affair already seems to be burning off a bit ("Madoff" no longer invariably appears somewhere on Google News Business’ front page). We’d better remember that morality as such rarely enters into capitalistic calculus. The starkest fact about this event is its sheer size. We can presume the initial $50 billion damage estimate was probably low. Quite simply, we’re looking at a fraud that’s too big to fail.

If the lame-duck Bush and the President-elect Obama teams let nature take its course, the unwinding of the Madoff Ponzi will strike each’s community of core supporters (but especially Obama’s) with a financial force to compare with the 1755 Lisbon Earthquake. That’s obviously unthinkable. Considering that relief is readily achievable through the TARP (all it requires is a Guinness World Record scale demonstration of nose-holding, but we are speaking about politicians here) it’s hard to imagine a scenario where help, indeed full restitution, would not be forthcoming. The most likely playing out of this little farce will be reports that CIPC will work to give the victims some of their money back, with the entire making-whole resources being laundered through CIPC over an extended period of time. The investors will be quietly assured early in the game that "the fix is in," though, if only to inspire confidence.

The idea that Treasury will be monetizing $50+ billion in fradulent conveyance resulting from a simple Ponzi is going to take some getting used to. But when you think about it, they’ve already bailed out a half-dozen situations over the last year or so that would appear to differ only in the complexity of the deals and structures that ran out of cash when the RE bubble burst. Who’s to know if at their foundations these bailed-out cinders weren’t just as much exercises in paying off early investors with the late investors’ inputs?

Of course the Mother of All Ponzis is fractional reserve banking, but that one looks like it’s going to hold up for a while yet This week’s Reuters report [1] has foreign central banks buying a very large $26.384 billion net of Treasury Debt. This is the 2nd largest weekly treasuries move ever recorded, behind only the truly astonishing $43.93 billion net buy reported on Oct 1, 2008. The report was, as usual, based on the weekly update from the NY Fed’s H.4.1 table site.[2] Here is Doom’s updated CSV version of the agencies and treasuries foreign central bank holdings data set.[3]

Meanwhile the cenbanks sold a significant amount, $15.2 billion, of Agency Debt in the week. Although overshadowed by the other number, this move just breaks the Agencies Top 10 list at #10. Still, combined with the huge buy of treasuries, cenbanks’ net holdings of US obligations rose by a robust $11.184 billion.

When you put those two moves together, you’ll see that the graphs for Treasury versus Agency debt are continuing to diverge.  Treasuries are still climbing a wall, while agencies are steadily retreating at a slightly faster rate than they were advancing a year ago.  Journalists are starting to write of a "bubble" forming in treasuries, and the acceleration of the yellow line’s upward arc would certainly suggest that such a conclusion is supportable.

UPDATE: The NYT’s Floyd Norris has an analysis [5] of foreign investors (cenbanks & others) buying treasuries and selling agencies in October.  He coverage intersects some of the issues here.  In particular, he has an updated version of something similar the 12-month-trailing graph that Brad Setlzer’s colleagues worked out at the Council on Foreign Relations and which Doom mentioned on October 27.  The Norris piece started off:

AS foreign investors pour cash into United States securities, particularly short-term Treasury bills, they are pulling it out of the higher-yielding bonds issued by the government supported-entities Fannie Mae and Freddie Mac.

The moves appear to indicate that even after the government bailout of the two agencies, there is some lingering doubt that the government would actually stand behind their debts if their situation grew much worse.

Once more the huge absolute difference between the agencies dump and the treasuries gorge is pushing twist’s ratio graphs strongly downwards.

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Old Doom friend Rodrigue Tremblay is back with another thoughtful article. Doomers will enjoy his perspective as he tries to make sense of the latest moves taken by America’s central bank.

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A Most Desperate Move by the Fed

by Rodrigue Tremblay

"In a crisis, discount and discount heavily."
Walter Bagehot (1826-1877), British economist

"I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a monied aristocracy that has set the government at defiance. The issuing power (of money) should be taken away from the banks and restored to the people to whom it properly belongs."
Thomas Jefferson (1743-1826), 3rd U.S. President.

"By this means [printing money] government may secretly and unobserved, confiscate the wealth of the people, and not one man in a million will detect the theft."
John Maynard Keynes (1883-1946), British economist

Last Tuesday, December 16 (2008), the Bernanke Fed took the most unusual step of lowering the overnight inter-bank lending rate, the federal funds rate, to a level never reached before, i.e. zero percent with an upside limit of 0.25 percent. It also announced that it will buy “large quantities of” mortgage-backed securities and is considering doing the same thing with Treasury bonds of longer maturities, in order to lower the entire yield curve. What it did not say explicitly is that the Fed is ready to debase the U.S. dollar to artificially low levels in order to reflate the U.S. economy. What the Fed wants is to trigger monetary inflation and change deflation expectations at all costs through large-scale debt monetisation and thus floating excess debts in a sea of newly created money.

Overall, what the Fed has done, in effect, is to announce that it is suspending the normal functioning of private credit and capital markets, according to supply and demand, and has decided to micro-manage such failing markets for the foreseeable future, that is to say as long as deflationary pressures, in its own view, persist in the U.S. economy. The Fed is also taking big chunks of ownership in large private U.S. banks in order to recapitalize them and to let them deleverage themselves in an orderly way.

People may want to know why the Fed went to that “socialist” extreme and what will be the financial and economic intended and unintended consequences?

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Canada’s Conservative government is in talks on proposed loan guarantees to prevent the failure of a hard-fought-for rescue plan for C$32 billion ($26.5 billion) worth of asset-backed commercial paper, Finance Minister Jim Flaherty said on Wednesday.

UPDATE Dec 19th 2008: Looks like the bailout is going through.  See the new Doom post "Ground Zero Canada: Ottawa to Detoxify Original World Seed-Crisis by Monday — OR ELSE"

This story  may be way down the page from the possible auto industry bailout, but where GM, Ford and Chrysler are presently looking for roughly C$3 billion to tide them over the next while, the size of those loan guarantees is about 3 times as much.[1]

The investor committee overseeing the planned restructuring of the nonbank ABCP, which froze up last year when the credit crunch erupted, said last week it is seeking outside funding for such new measures as an additional C$9.5 billion in margin facilities in the form of backstop arrangements and an initial moratorium on collateral calls.

But Canadians need not worry their pretty heads about that "facility," since it will probably never be needed.[2] Clearly nobody up here ever heard of "Paulson’s Bazooka"

Let’s put ideology aside and just look at the numbers. What will it cost the governments to do it? At the most, $9.5-billion, assuming they are actually called to put up the capital in a future emergency and it’s a total loss. But some very, very smart people who have been through the structure (and who are not investors in ABCP who are conflicted by their desire to get the deal done) say there’s a very low risk of that.

Doomers will remember the National Post just setting us straight on how hairy the situation is.  A year ago The Artful Dodger himself revealed that leverage has expanded that nominal C$32 billion into at least C$200 billion of the world’s scuzziest structured deals.  Yup, if the money’s there, the collateral calls will follow.  Which, of course, is why the government is being pressured to put almost ten billion loonies in harm’s way on this.

Somehow, I don’t think Jim Flaherty (or Ignatieff’s replacement for him, neither) is going to be presenting a balanced budget any time soon.

UPDATE: this [3] just in. The Admission Creep has just begun.

Flaherty also said he would discuss with "certain governments" the issue of asset-backed commercial paper (ABCP) and might have more to say later in the day.

But he said potential government guarantees to restructure the non-bank asset-backed commercial paper market, which has been damaged by the credit crisis, would be less than the $10-billion figure that has been floated.

UPDATE Thursday Morning: Now we know Jim’s got a sense of humour.[4] The Federal contribution won’t be nearly C$10 billion after he gets finished shaking down the Provinces.

Finance Minister Jim Flaherty has formally asked Alberta, Ontario and Quebec to contribute toward a government-backed $9.5-billion standby facility that would clinch a deal in the 16-month restructuring of wonky commercial paper.

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