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“ARM”ageddon As Subprime Financial Dominos Fall

Stock-Markets / Subprime Mortgage Risks Aug 10, 2007 - 12:47 AM GMT

By: Ty_Andros


The dominos have begun to fall, look for it to cascade into the fall as markets reprice the normalization of credit conditions, and CURTAIL the most risky and foolish lending practices. Cov lite, LBO's, private equity and CDO/CMO paper is dead until the deals are priced in a manner that secures lenders interests in a RATIONAL manner, as they should be as they are just SUBPRIME on a gargantuan scale. I love it as volatility is opportunity for the prepared investor. Volatility rose from 1997 till the high in 2000 and the markets did fine. After several weeks of market turmoil it's time to look at the factors that are the catalyst to this market sell off. It's not over by a long shot but some curious things are happening and I want to inform you of them.

Next week Tedbits will be resuming the “Fingers of Instability” series begun last spring. Don't miss it!

For greater insight into our publication, have a look at the Overview of Tedbits . It helps current and potential subscribers understand our mission in serving you. It also gives a broad description of what's unfolding globally and what you can expect from Tedbits as a regular reader.

I have resisted talking about sub prime problems for a long time as so many others were covering the issue. Longtime readers know the term “ARM”ageddon was coined in October 2005 in reference to what is unfolding since early this year by yours truly, Mr. metaphor. It's got a long way to run with the ultimate market resolution slated for the fall of this year at which time it should be fully priced into the market.

The Banking index had a capitulation bottom on Monday, the Federal Reserve in a very detailed statement that included everything but the Kitchen sink was able to preserve their bias against inflation and the market was able to hold, I was amazed as the carnage is still yet to play out. The S&P 500 did a perfect Fibonacci 61.8 % retracements of the February lows to July highs. It's been over 1500 days since the S&P 500 and the Dow have had a 10% correction and this streak as all things in life are destined to end. The yen carry trade went right to its trendline, violated it briefly and went back into the trend channel. Let's take a look at the charts of the action:

S&P 500 - These are weekly charts so the action we see is fairly significant, notice how prices were unable to make new price lows in the S&P, but the internal RSI, MACD and Slow stochastics were? Basically bullish divergences. These oscillators/internals are very oversold. Powerful rallies can be expected, before the sell off resumes, if they don't its crash time. The internals still stink. Its interesting that this chart shows a Fibonacci 62% retracement from the highs and now a Fibonacci 50% retracement from the lows, The battle lines are clearly drawn bulls versus bears. We are with the bears.










In the case of the yen it's a mirror image, Unable to make new price highs, but the internal RSI, MACD and slow stochastic's were able to make new highs, basically bearish divergences on the rally. So the carry trade lives another day. I don't care WHAT anybody says, the carry trade will continue to thrive, it goes through convulsions from time to time and those are great opportunities to enter the trade, but as Greg Weldon's latest piece on Japan outlines deflation is alive and well in the land of the rising sun . They are not foolish enough in Japan to raise rates in the current monetary environment, politicians and the deflationary backdrop tell us this low rate environment is not near an end.






So despite the hysteria in the financial news the market continues to amaze and defy doom and gloomer's everywhere. It is the Crack Up Boom as money anxiously seeks shelter form the monetary authorities debasement. Bonds have risen as interests have fallen over 50 basis points in less then a month. Curiously enough this sell off in the stock markets did not take gold down like previous sell offs have. The baby DID NOT get thrown out with the bathwater. Look at this chart of the S&P 500 it shows a bear market when the S&P 500 is priced in REAL money, but low and behold, a breakout through a several year trendline as gold has solidly broken higher against the paper of the S&P.

However the credit markets are not done meting out their powerful message, they have basically seized up. The pipeline is frozen for good risks and bad. They are repricing risk in a vicious manner and will continue to do so. It's this repricing of risk that will drive the markets lower until the market has priced in the sub prime, private equity and LBO debacle yet to be seen. And the banks and prime brokers will sweat it out until that process has run its course as they are out on the proverbial limb, having made loan commitments they had planned to unload but now must hold until the markets return to normalcy and bonds are able to be sold into the market place. They are balance sheet bombshells as the lending terms are poisonous, and they deserve to be subject to the greed that drove them to agree to these terms and think they could unload them to investors.

They flew under the cover of the ratings agencies naiveté concerning the mathematical MODEL's which could turn trash into treasure. Financial alchemy, but lead DID NOT miraculously turn to gold. They are holding TRASH! Their greed for fees in doing bad deals is now BITING THEM IN THE BUT! The big banks and brokerages are NOT YOUR FRIENDS, they are in business to make money for themselves plain and simple, their products designed to serve them NOT YOU! Their foolish Hedgefund clients leveraged to the hilt based on who they know not the whether they had good investment plans. The illiquidity of the instruments they hold is something even the stupidest broker knows to avoid as risk control becomes IMPOSSIBLE. Some will live to see another day; others will perish as a lesson to others.

I love seeing the quant's get it good and hard, as math is a wonderful tool but does not substitute for knowing what underpins the math, CFA's (certified financial analysts) and their firms rule the roost in many parts of the investment world, they are in the highest offices of the prime brokers, private money management and banks. Their customers will suffer for the hubris that math can model everything. The models are failing!

Don't get me wrong there are MANY GREAT hedge funds and alternative investments available, but many are nothing more then WHO YOU KNOW, rather then how good their strategies are. All investors need to learn how to make money no matter which way the markets are headed UP OR DOWN. The hedge fund community now manages over 1.5 Trillion dollars, if investors lose 100 billion of that total it its 6.6 % of the total, hardly the end of the world for the financial system. Main stream stocks lost over 1 trillion dollars in the recent sell off. ALWAYS be careful when investing in LIQUID markets or strategies that invest in them in your portfolios.

There are a number of curious happenings unfolding, notice how the rating agencies stopped downgrading the CDO/CMO sector? Could it be because HUGE money is in these with investment covenants that would require a sale once the label from the ratings agencies changes? YES. The Fed and Treasury no doubt made a call, but they are faced with a conundrum. They have rated 100's of billions of dollars worth of investments sitting in portfolios that really aren't what the ratings agencies imply when they put the investment grades and higher on them. Many of them INSURED by poorly capitalized fixed income insurance operations. Legions of lawyers stand at the gates ready to swoop like the vultures they are.

Billions of dollars of these instruments sit in the accounts of pension funds, insurers, and institutions, the some of the dumbest money on the planet. These investors have an investment RULE book which says exactly how much of each asset class they can hold and how it MUST be rated in order to stay in the investment portfolios they manage, slip below it and they must UNLOAD. This selling process into an over the counter market with very little or no liquidity is the recipe to the market we face. So they DID NOT LOWER THEM to staunch the problem TEMPORARILY.

But the few sales we have seen by hedge funds in retreat show the problem, they are already JUNK only the sticker hasn't been changed yet. Dennis Gartman, of the Gartman Letter , reports that BNP Parabaugh has issued a very straight forward statement concerning its problems: “ The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly, regardless of their quality or credit rating. ” They went on to say that all of their investments were AAA or AA rated -- these quants bought the rating agencies' labels and went no further.

AS predicted in the CRACK UP BOOM the money will be printed to paper it over. Look no further then Germany , where over 8 billion Euros was INJECTED in IKB a large German bank. BNP Paribas, Goldman sachs, Macquarie in Australia , Bear Stearns, expect the list to lengthen. This is only the beginning of the money printing that's going to be required to PAPER over the problem. Part of the selling in the markets is the direct result of MARGIN calls on the highly leveraged CDO/CMO paper. The lending bank calls up the borrower, ie HEDGEFUND and says the collateral has declined in value we need a bigger margin deposit. So since the hedgefund can't sell the CDO/CMO without big losses they sell their most liquid investments, STOCKS, etc. Ipso, facto; dump stocks as we have seen.

There are a number of hurdles to the market directly in front of us. The first one is August 15 th this is the day that redemptions for the hedgefund industry arrives for those that wish to have their money at the end of the quarter. Selling of these assets will resume on that date as FOOLISH investors in these poorly thought out Highly leveraged investment CDO/CMO vehicles hit the EXITS. They will be selling into a market where the value of what they sell can not be readily understood, so the bidders will price in a LOT of extra cushion to make sure they aren't buying a “PIG IN A POKE”.

Look for this market to absolutely convulse in coming weeks as it may prove virtually impossible to liquidate the underlying notes. THERE IS NO WAY TO KNOW THE VALUE OF THEM, there is no market to discover their worth. Many of these holders of CDO/CMO's have purchased credit default insurance over the counter, unfortunately for them in this opaque and completely unregulated market the counter parties quite often are UNKNOWN as the original counter party may have OFF SET his liability in the same over the counter market. It may have been done many times; the weakest link in the chain can spell doom for the purchaser.

The next hurdle is the end of august when the prime brokers and banks close their 3 rd quarter books and we will get to see the real damage to their balance sheets as they will then be in the open for all to see. Compounding the problem is over 500 billion dollars of ARMs resetting in the next year and they can't ROLL into a fixed mortgage as the value of the property PROHIBITS a bank from refinancing the property as the amount owed is in excess value of the property.

Last week Wells Fargo raised the rate on a jumbo mortgages in California to 8% from 6.75%, Jumbos are loans over $417,000, is there any property in California less than $417,000, not many. Even the smallest homes are priced above this figure. Many people that qualified at 6.75% are not qualified at 8%, this is a big problem. I believe they may have to have a EMERGENCY dropping of rates to facilitate the refinancing of the ARM's, don't be surprised if it is up to two full points lower by January when the refi Tsunami really starts to unfold. Just so these people are qualified to roll into a fixed mortgage. MORAL HAZARD writ large.

Take a look at this Schedule of ARM Resets in the next year.

Schedule of ARM Resets

WOW. This must be addressed and the lower home prices fall the bigger the mess, can you say lower interest rates to make these STUCK speculators qualified to roll? Hedge fund HOUSEHOLD's with no bidders for the properties at present prices. The only thing that can save them is the thing that got them into trouble, mispriced interest rates below the rate of inflation . Thank you Alan Greenspan, his legacy is a federal reserve that must follow his prescription of throwing money at the problem. They are cornered.

These numbers look very bad, but keep in mind the Federal Reserve Regularly creates money at a pace of 30 BILLION a week, so you can expect a lot of business to roll into the people who print the money. Expect emergency authorizations to expand Fannies and Freddie loan books so these people can stay in their homes and avoid the debacle to the financial system. THEY WILL PRINT THE MONEY! And give it to Freddie mac and Fannie mae and by extension to the home owners. And who gets the bill? YOU. You insure the risk through Fannie mae and Freddie macs implied guarantees and from the money you hold in the bank as when they print it it is worth equivalently LESS. It's called work outs, and the banks have to do it as well, another reason interest rates MUST fall to bolster the bottom lines of the banks. To cushion the balance sheet bombshells they are holding. It ultimately translates into INFLATION.

Here's a smoke signal for you: Take a look at this chart of the GOLD versus the S&P 500, it clearly shows a breakout higher for the yellow metal. It's why gold HAS NOT sold off. Paper is deflating, and it's setting the stage for the next REFLATION. As long as paper is inflating against the Yellow metal they are OK, but deflation is the one thing they cannot TOLERATE.

This is an interesting chart in that it signals the possible next bull market leg in the Gold market. Gold is looks like its going higher. They will continue to supply ample liquidity wait for the bombshells to emerge and send the treasury/fed firefighters to the scene with checkbooks in hand. This financial fire fighting will be seen in every corner of the globe which holds these TOXIC illiquid BOMBS on bank balance sheets. It's called containment, it's the only thing they can do as too many of the problems are yet to be identified. But every time you see the headline of a bombshell the financials will be knocked down another notch, and financials are the biggest sector of the S&P with over 20% of the market cap. It is clear when you listen to Senator Chris Dodd, chairman of the senate banking committee and Hillary on the campaign trail that the game plan is in place. They UNDERSTAND the nature of the trouble and will do anything to grease their reelection aspirations. As you can expect them to do FOREVER.

FLASH : as we go to press the Fed has added 24 billion dollars worth of EMERGENCY reserves to the financial systems and the ECB has added 95 billion euros to the financial systems in Europe as well overnight. LIBOR ( London inter bank overnight rates) are spiking higher as we speak, short term liquidity is evaporating.

In conclusion : Sell offs don't really end in the nice tidy manner this one appears to have done. Watch that Yen trendline, if it fails to hold: watch out below. Ditto those lows in the S&P. The internals of the stock market STINK STINK STINK. THERE IS A MAJOR REPRICING OF THE FINANCIAL SECTOR UNDERWAY AT THIS TIME! You can expect daily and weekly SURPRISES from hedge funds, prime brokers and their banks from AROUND THE WORLD as they BLOW up in the illiquid markets of the investments they hold. These are only OPPORTUNITIES for the astute and well informed investors.

Many in the main stream press say the Greenspan put is dead and Bernanke has shown he won't bow to the market place. Its way to early to make this statement, HE WILL BOW, it's only a matter of WHEN. The marketplace is his master, not vice versa. When a gun is put to his head and the head of the ASSET BACKED financial system HE WILL DUCK, not die. It is only a matter of self preservation, the most basic of human instincts. The credit markets WILL return, but not on the terms we have seen for the last year, there are too many dollars which MUST find a home. Although BONDS are bombs as the printing press will attack them relentlessly.

The market is in a GIANT finger of instability, and its behavior will set the stage for the next round of REFLATION. The Global boom will continue. Deflation is rearing its ugly head, you can expect the dollar holders worldwide to step forward and buy the FIRE sale after it runs down the most foolish investors. Sam Zell and others who sold the highs are standing by to buy the lows. Sovereign wealth funds also stand at the ready as saviors, what delicious irony. LOL. Note to regular readers, The “FINGERS OF INSTABILITY” series (see archives at ) will return next week as we detail the unfolding turmoil and public servant foolishness. Don't miss it.

If you enjoyed this edition of Tedbits then subscribe – it's free , and we ask you to send it to a friend and visit our archives for additional insights from previous editions, lively thoughts, and our guest commentaries. Tedbits is a weekly publication that comes out on Thursdays or Fridays.

By Ty Andros
Copyright © 2007 Ty Andros

Tedbits is authored by Theodore "Ty" Andros , and is registered with TraderView, a registered CTA (Commodity Trading Advisor) and Global Asset Advisors (Introducing Broker). TraderView is a managed futures and alternative investment boutique. Mr. Andros began his commodity career in the early 1980's and became a managed futures specialist beginning in 1985. Mr. Andros duties include marketing, sales, and portfolio selection and monitoring, customer relations and all aspects required in building a successful managed futures and alternative investment brokerage service. Mr. Andros attended the University of San Di ego , and the University of Miami , majoring in Marketing, Economics and Business Administration. He began his career as a broker in 1983, and has worked his way to the creation of TraderView. Mr. Andros is active in Economic analysis and brings this information and analysis to his clients on a regular basis, creating investment portfolios designed to capture these unfolding opportunities as the emerge. Ty prides himself on his personal preparation for the markets as they unfold and his ability to take this information and build professionally managed portfolios. Developing a loyal clientele.

Disclaimer - This report may include information obtained from sources believed to be reliable and accurate as of the date of this publication, but no independent verification has been made to ensure its accuracy or completeness.  Opinions expressed are subject to change without notice.  This report is not a request to engage in any transaction involving the purchase or sale of futures contracts or options on futures.  There is a substantial risk of loss associated with trading futures, foreign exchange, and options on futures. This letter is not intended as investment advice, and its use in any respect is entirely the responsibility of the user. Past performance is never a guarantee of future results.

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t gorman
11 Aug 07, 04:25
Fed manufactures bubbles

Bernanke has admitted the the Federal Reserve engineered the Great Depression with currency and interest rate manipulation. What's different now? The Fed, a private institution of bankers, was given the authority by Congress to regulate unfair lending practices.

The Fed is supposed to smooth out economic cycles and keep inflation in check. We have just has a historic run-up in real estate prices with some shady loan products. What happened FED? We don't really know much about the Federal Reserve. It's not Federal and there are no reserves. There's the unregulated inflationary printing of currency. Which is ironic given the presumed mission of the Fed.

Who are the major stockholders in the big banks represented and administered by the Fed? The Fed does not even report how much money it's printing now.

There's central banks running the finance show in other countries too. How much money in interest do these central banks make printing money with no backing and then loaning it out especially to the governments themselves that should be printing interest free money. The Fed and other central banks in Europe and Japan are creating these boom/bust cycles and someone is making a killing timing these manipulated crashes too. Welcome to the latest engineered bubble finance crash. Ban the central banks!

S Jacobs
12 Aug 07, 22:59
How to Save Our Financial Soul

As a former member of one of the regulated US commodity exchanges, I full well know the benefit of a robust clearing house to clear and settle all trades, collectively guaranteeing the integrity of all transactions. For decades I have warned about the explosive growth of the off balance sheet derivatives whose performance is "guaranteed" only by the supposed offsetting credits & debits to each liability, with no centralized audit mechanism.

If not too late, the answer to halt any firm to firm cascading "1929-type" default is an international clearing house for all MUST BE REGISTERED derivative trading firm brokers & principals wherein x% of all net transactions must be set aside to guarantee performance. Offsetting transactions that are extraneous, eminating from non-members, will not be netted against gross positions, for lack of any measure of financial substance and integrity to these non-member transactions, whether derivative insurance or outright offsetting credits & debits.

Furthermore, It is high time that the Leo Wanta US$4.5 trillion settlement be fulfilled , and the Royals' gold returned post haste! To ignore the performance of same is to insure the continuance of the corrupt financial fiat fallacy that is soon due re the US$27.5 trillion borrowings against Wanta's original exact same amount, as the history books will soon be filled with evidence of same. No doubt, much of the money used to attempt to stabilize this past week comes from the Wanta settlement.

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