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Economic see-saw

April 23rd, 2008 10:11 AM

The observations below indicate trends and are not a predictor of what rates are going to do in the future. You might tend to agree or disagree with the information on the observations below. This is not Cypress Mortgages opinion nor my own opinion. Many of us look at trends and have established opinions of our own, supplying data to back up that opinion is important and here is some data that supports these observations.

The Economic see-saw: Credit deterioration versus Capital infusion

It seems every day we read about a major bank (and some not so major) reporting millions (and billions) of losses from the growing mortgage mess that is spreading around the globe. It brings back memories of the 1968 hit song Ride my See-Saw by the Moody Blues. The words ring true today: My world is spinning around, everything is lost that I found. People run, come ride with me, lets find another place that's free. FREE is the key word for banks that desperately need to raise capital and are finding they have to give shares away to pique the interest of buyers. Since you cant lend what you don't have banks are lowering the price of stock to levels that dramatically dilute the equity of existing shareholders. Today we saw National City (Cleveland bank) raise $7 billion of capital by selling shares to a private equity fund and a few existing institutional shareholders at $5 per share after closing at $8 per share on Friday. (http://www.prnewswire.com/cgi-bin/stories.pl?ACCT=104&STORY=/www/story/04-21-2008/0004796567&EDATE=) They also cut their dividend to .01 from .21 per share thus avoiding the total disgrace of having to completely eliminate any payout to shareholders. The most amazing piece of news comes from the press release where the CEO stated; We are pleased with the confidence that our investors have expressed in the value underlying National City's franchise and the fundamental strengths of our business model that will help drive a return to profitability. He must be relieved the bank found an investor at any price because it appeared they would be taken over and he might lose his job. The bank managed to lose only $171 million in the first quarter of this year versus a loss of $333 million in the last quarter of 2007. Their business model previously mentioned is what drove the losses as this bank was literally giving away home equity loans to anyone with a dollar of equity in their house. The institutional shareholders are adding to a losing position which violates the #1 rule of investing: NEVER add to a losing position or average down as it always seems to result in bigger losses. Have you ever wondered why the CEO that is responsible for leading a company into massive losses does NOT lose his job? When the average worker makes a mistake they are fired quickly, but the CEO of a big bank is rewarded by existing shareholders with a $7 billion infusion of new capital. Amazing!

Rice riots are growing.

News that corn, wheat and soybean prices have been climbing are now beginning to be seen in higher prices for bread, pizza and other food stuffs but the real story is rice. (http://www.earlywarningwire.com/rice.pdf) Rising demand from India and China and sharp price rises to over $24 per hundredweight have caused many producing nations to curtail exports. A story from Mountain View, California shows that Costco is limiting each customer to one bag of rice. More importantly we are witnessing recent riots in Haiti, Indonesia, Egypt and many African countries where the average person can not afford to purchase their main food staple. (http://nysun.com/news/food-rationing-confronts-breadbasket-world) Economics 101 tells us that price rises are always followed by increases in supply but growers wont be able to switch crops to rice until next year. This mornings UK Independent newspaper makes an important point that cutting exports does nothing except drive prices higher. (http://www.independent.co.uk/news/business/comment/stephen-king/stephen-king-food-protectionism-could-provoke-a-crisis-on-a-par-with-1970s-oil-shocks-812753.html?r=RSS). Finally good news from a speech given by Energy Secretary Bodman on Friday (4/18) on the future of biofuels. (http://www.energy.gov/news/6165.htm) The key quote that might show a change in administration policy: This means moving away gradually from ethanol produced from food stocks like corn. If the government lowers its subsidy to ethanol producers it could have a dramatic effect on the price of corn, wheat and other food stuffs. Food price inflation is painful in the short run but in the long run it will cause massive DEFLATION as consumers are spending more on food & gasoline and less on other items.

The pound is getting heavy

A major decline in the value of the British Pound (versus the dollar) to the $1.80 level. With oil reaching record highs ($117 today) the pound has held above its critical 1.95 level. This morning the Bank of England announced a special liquidity scheme (why did they use that word?) that will provide almost a $100 billion in funds for the now frozen British mortgage market. (http://www.bankofengland.co.uk/markets/money/marketnotice080421.pdf) Similar to the plan announced by the Fed a few weeks ago, the BOE will swap UK Treasury Bills for mortgages held by lenders and banks. Very little attention has been given to the rapidly deteriorating British economy but much like early last year when the experts told us the mortgage mess was confined to subprime we will soon be hearing that the British economy is sinking like the US.

The Fed is slowing running out of Treasury collateral

Every Thursday the Fed releases its H.4.1 report (http://www.federalreserve.gov/releases/h41/Current/h41.pdf) which shows the amount of Treasury holdings has declined to $548 billion. Yes, that is a lot of Treasuries but this amount was over $800 billion a couple of months ago. The Fed is hoping the financial system recovers before its Treasury holdings reach zero as a worldwide panic would be created if the Fed asked the US Treasury to issue new securities for the purpose of loaning them to banks in need of liquidity and capital.

Posted by BRENT ZELT on April 23rd, 2008 10:11 AMPost a Comment (0)