The Ghost of Ace Greenberg
March 26, 2023 -Weekly Comment
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$3.2 Billion Move by Bear Stearns to Rescue Fund – NYT
By Julie Creswell and Vikas Bajaj
- June 23, 2007
Bear Stearns Companies, the investment bank, pledged up to $3.2 billion in loans yesterday to bail out one of its hedge funds that was collapsing because of bad bets on subprime mortgages.
It is the biggest rescue of a hedge fund since 1998 when more than a dozen lenders provided $3.6 billion to save Long-Term Capital Management.
The crisis this week from the near collapse of two hedge funds managed by Bear Stearns stems directly from the slumping housing market and the fallout from loose lending practices that showered money on people with weak, or subprime, credit, leaving many of them struggling to stay in their homes.
Bear Stearns averted a meltdown this time, but if delinquencies and defaults on subprime loans surge, Wall Street firms, hedge funds and pension funds could be left holding billions of dollars in bonds and securities backed by loans that are quickly losing their value.
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We know how this turned out. This time around, SVB depositors were saved, but CS AT1 bondholders weren’t. The last hike prior to the GFC was June 2006 to 5.25%, the first ease was Sept 2007 to 4.75%, one-and-a-quarter years later. Below is a chart of SPX over the two-year time frame of March 2006 to March 2008. In March 2008, Bear essentially failed and was bought by JPM with Fed backed financing. Sound familiar? Now the SNB financed the UBS purchase of CS. In September 2008 Fannie and Freddie were nationalized, and shortly thereafter Lehman filed for bankruptcy. [thanks MB for bringing up CS/BS comparison].
The core problem is that long-dated crappy assets can’t be funded at current high short rates. The crappy assets were accumulated during the long period of zero to negative rates. That issue doesn’t go away when a stronger institution marries a weaker one. In the 1980s Savings and Loan crisis, the Resolution Trust Corp was created. It took the bad assets and slashed the prices, which then went into stronger hands. Assets need to be written down. Does relatively high inflation change that equation? Maybe. Typically, the CB cuts and the positive curve allows everyone to build-back capital relatively quickly. Current inflation will drag the process out. In an inverted curve, the value of assets becomes questionable, and the holders of these assets try to fudge the values. “First gradually, then suddenly”, as desperation sets in. Unsurprisingly we’re getting articles like this:
Is corporate malfeasance on the rise? The Wall Street Journal reports today that an indicator of potential earnings manipulation developed by Indiana University accounting professor Messod D. Beneish is registering at its most elevated levels since the late 1970s. The so-called M-Score, which tracks eight balance sheet and P&L metrics including changes in accounts receivable, depreciation expense and timing of accruals, signaled red flags at Enron and Wirecard prior to those firms becoming embroiled in accounting scandals.
from Almost Daily Grants. March 24, 2023 [link to more info on M-Score at bottom]
From this week’s Credit Bubble Bulletin:
SVB, no doubt about it, was up to its eyeballs in idiosyncratic risk. Yet the unfolding banking crisis is systemic. Years of loose “money” was systemic. Gorging on risky loans and mispriced securities – systemic. There was a protracted period of extraordinary system-wide excess. Crazy everywhere.
Lending will now tighten, Credit growth will slow, and the downside of the Credit Cycle will surely unleash economic stagnation and major loan quality issues. Understandably, focus is now on the small and medium sized banks with their big exposures to vulnerable real estate loans. Compounding U.S. risks is the harsh reality that finance and economies are fragile globally.
Powell clearly emphasized that tighter credit is coming, not necessarily through rate hikes, but through a combination of regulation and counter-party risk dynamics.
Below is a chart of the 2yr yield now, which topped on 3/8/23 at 5.07% (SVB failure 3/10), and the 2y yield in the GFC, which topped in 2006 at 5.28, but made another move higher to peak at 5.10% on June 12, 2007, just before the article at top was published.
From the behavior of the 2yr yield this time around, it appears as if the market is taking current issues more seriously. We’ve dropped 130 bps in yield in 2s in two-and-a-half weeks. It took 3 months in 2007.
I have also added a chart of the first-to-fifth ED calendar spread. Currently, the lowest one-year SOFR calendar is June’23/June’24 at -145 (current 1st to 5th). Sept’23/Sept’24 is -127. In Sept 2007 the ED calendar was -142. In December the low was -158. What is also interesting is that by mid-March 2008 the 5th ED contract reached 98.10. (Remember, first Fed ease was Sept 2007. SPX heaved a sigh of relief and made a brief new high. It didn’t last). On Friday. SFRM4 settled 9684 and SFRU4 at 9705.5. The highest SFR contract at Friday’s settle was SFRH’25 at 9715.5. For a more accurate comparison, 26 bps should be subtracted from SFR contracts, so SFRU4, for example, would be more like 9680. If the current situation unfolds like 2007/08, there’s more room to run in reds; SOFR red pack settled Friday just under 9705.
This week we’ll have several Fed speakers. So far they are hewing to the anti-inflation fighting message despite liquidity problems.
03/27 17:00 Fed’s Jefferson Discusses Monetary Policy
03/28 10:00 Fed’s Barr Appears Before Senate Banking Panel
03/29 08:05 NY Fed Head of Supervision Dianne Dobbeck Speaks to Bankers
03/29 10:00 Fed’s Barr Appears Before the House Financial Services Panel
03/30 12:45 Fed’s Barkin Speaks at Virginia Council of CEOs Event
03/30 12:45 Fed’s Collins Speaks at NABE in Washington
03/31 15:05 Fed’s Williams Speaks at Housatonic Community College
03/31 16:00 Fed’s Waller Discusses the Phillips Curve
03/31 17:45 Fed’s Cook Discusses US Economy and Monetary Policy
Auctions of 2, 5, 7 year notes begins Monday
Fed’s favored inflation measure released Friday:
PCE prices yoy expected 5.1% from 5.4%. Core yoy expected 4.7% from 4.7 last.
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Ace Greenberg was CEO of Bear from 1978 to 1993 and Chairman of the Board from 1985 to 2001. In 1998, when Long Term Capital Management failed, Bear, then under CEO Jimmy Cayne, famously refused to participate in the LTCM bailout. When Bear’s problems occurred, other banks weren’t inclined to help out.
| 3/17/2023 | 3/24/2023 | chg | ||
| UST 2Y | 383.1 | 377.7 | -5.4 | wi 372.5 |
| UST 5Y | 346.1 | 341.0 | -5.1 | wi 340.0 |
| UST 10Y | 339.1 | 338.0 | -1.1 | |
| UST 30Y | 359.7 | 364.3 | 4.6 | |
| GERM 2Y | 238.7 | 239.2 | 0.5 | |
| GERM 10Y | 210.7 | 212.9 | 2.2 | |
| JPN 30Y | 128.7 | 132.3 | 3.6 | |
| CHINA 10Y | 286.6 | 287.0 | 0.4 | |
| SOFR M3/M4 | -109.5 | -145.0 | -35.5 | |
| SOFR M4/M5 | -24.5 | -31.0 | -6.5 | |
| SOFR M5/M6 | -1.0 | 4.5 | 5.5 | |
| EUR | 106.65 | 107.62 | 0.97 | |
| CRUDE (CLK3) | 66.93 | 69.26 | 2.33 | |
| SPX | 3916.64 | 3970.99 | 54.35 | 1.4% |
| VIX | 25.51 | 21.74 | -3.77 | |
https://www.thebalancemoney.com/2007-financial-crisis-overview-3306138
https://www.grantspub.com/resources/commentary.cfm
https://en.wikipedia.org/wiki/Beneish_M-score
