February 10 – 15, 2008

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February 10, 2008

I should be nervous, I suppose. After all tomorrow will be the first time that I will be authoring an Afternoon Briefing, a standard product, produced every day at the Markets Group “desk” of the Federal Reserve Bank of NY.  Blah, blah, blah . . .   I’m a little more concerned about whether or not a particular bit of news will be a headline in the front page of Section C of tomorrow’s edition of the Wall Street Journal (WSJ).  I received a “heads up” from a market contact late last week that caused me to send an internal e-mail around stating that JPMC and Goldman Sachs may decide to leave the Government-Backed Student Loan market because of problems with Auction Rate Securities (ARS).  ARS, it’s not like it’s a $320 billion market, oh wait, it is like that, and student loans make up a fairly sizeable portion of outstanding ARS securities.

February 11, 2008

 No headlines in today’s WSJ about Auction Rate Securities. There was mention of some difficulty in the ARS market that was buried very deep in a fairly long article about generic credit woes.  Two explanations immediately came to my mind: either the WSJ reporter is trying hard not to disrupt fragile market sentiment or the reporter has no idea how the ARS market works.  Good chance it’s the latter since reporters don’t encourage sensationalism, do they?

Work this morning starts off in a surprisingly routine manner, same old, same old.  Sure conditions are a little stressed in the financial markets, but they basically have been since August ’07.  A major European stock index is down about 1.00 % and there’s news that the big French bank Societe Generale (Soc Gen) is biting the bullet and planning to issue a “rights offering” with a stock purchase price that’s about a 40 percent discount from the current share price.  Hmmm…maybe the rights offering and the associated big price concession is the market’s way of extracting a pound of flesh from Soc Gen for the sins of Jerome Kerviel, who was charged with causing huge trading losses for the bank that were revealed last month. The Soc Gen news attracts relatively little interest, however. Of more import is an article that states that AIG’s auditors are uncomfortable with AIG’s accounting treatment of certain credit default swap, or “CDS” transactions.  The article further suggests that AIG needs to write-off another $3 – $4 billion of subprime exposure.  Following the article’s publication, the market’s reaction suggests there’s more to come since AIG’s stock price declines 12 percent on the day. AIG’s market capitalization is probably close to $150 billion, so 12% of that, means the market value of AIG is down $18 billion – like I said, another day at the office. Of more immediate interest is the continued widening of credit indices.  They rose another 6 percent or so this morning.  Who knew, credit indices rise during a credit crisis?!

            The big news for me was NOT posting my first Afternoon Briefing, although one word alone may be adequate to capture the range of emotions I felt in posting this document to FRBNY’s internal website … Yawn!  No, the big news is that there were numerous failed auctions of auction rate securities, or “ARS” today, all of them being of the student loan variety.  ARS are long term securities whose interest rates reset at predetermined intervals (e.g. weekly, monthly) via an auction process.  The auction reset process is kind of cool, and it’s a Dutch auction (single price) which should make unsophisticated investors comfortable since all “winners” receive the same interest rate as the highest bid that “clears” the auction.  What should make unsophisticated investors uncomfortable is the fact that ARS have no underlying liquidity support.  If investors want “out”, they have to hope that other investors want “in” otherwise they have to wait to cash out of their investment in the ARS product.  ARS dealers typically take down small amounts in ARS auctions to enhance liquidity in the product so that retail investors can get their money out when they want; but if they don’t, and demand is insufficient to clear an auction, then the auction “fails” and investor redemption requests are not honored, i.e. the investor can’t get immediate access to their money.  That is what is happening in student-loan ARS and there should be a real headline in the WSJ tomorrow.

February 12, 2008

There was a headline in today’s WSJ – Section C – entitled: Student Loan Issues Under Stress, but very little was mentioned about the dynamics of the ARS market that is causing all this stress.  So I’m thinking another case of “irresponsible journalism” or maybe the reporter just doesn’t get it?’  Hard to know, of course.  Fall-out from the failed auctions doesn’t seem so bad in the morning from talking to a couple of muni traders.  Big news this morning was Warren Buffet appearing on CNBC saying that he’s willing to “help out” the muni bond insurers by reinsuring the municipal part of their financial guarantee book.  The CNBC reporters are all just in love with Mr. Buffett who has this “nice, rich uncle” aura about him. Trouble is his offer won’t “help” the struggling financial guarantors at all, in fact, acceptance would probably wound, or even kill, them, but it would make Mr. Buffett’s company millions of dollars. You don’t become a billionaire by accident.  Fair enough, but the equity market appears to be rallying on this specific news, at one point it’s up 1.5%!  Of course the buying is not indiscriminate and on average, financial guarantor shares are down 12% on the day.

            Like I previously mentioned, I’m supposed to be spending my time writing a daily product known as the ‘Afternoon Briefing’ which will be posted on the Federal Reserve intranet to keep us central bankers informed of latest developments.  These briefings frequently contain “juicy tid-bits” of information as we have access to a lot inside info from primary dealers.  Today, however, I don’t get to spend too much time preparing the pm briefing because my boss’s boss asked me to edit a document. It’s a speech that some poor Fed official has to read before Congress about the situation / financial stress facing monoline insurers.  The speech covers municipal bonds, and since that’s my Specialty Market coverage area, they asked me to take a look.  Pretty cool, eh? The speech was pretty good from a big picture perspective but it glossed over some problems that are evident in the municipal bond market: including loss of investor confidence contagion following financial guarantor downgrades.

            So I suggest some edits to the document and then meet with a bank examiner to discuss structured municipal products in general.  Once again, all in a day’s work, well maybe half a day’s work because I still have to write my second ever PM Briefing.  However, when I get back to my desk I find out from my muni contacts that two large dealers just let municipal ARS auctions fail.  This is the first time a municipal ARS auction has failed.  Numerous individual investors will not be able to liquidate their investments – the outcome of which remains to be seen. This means there will likely be a much more ominous story in tomorrow’s WSJ, probably with a lead-in paragraph on Page 1.  That should have the effect of pouring sand in a gas tank of a market that was starting to cough anyway.

            Needless to say, I needed a decent amount of help to finish the Briefing, which seemed to read pretty well with the help.  I feel bad for the Federal Reserve official that has to testify on Thursday.  Maybe I should pity myself, because I may have to edit that document again tomorrow AND write another PM Briefing!

February 13, 2008

There was a Page 1 headline in the WSJ today, but curiously a headline did not appear in Bond Buyer until 5:30 in the afternoon.  The WSJ article was pretty subdued but a Bloomberg article mentioning a 20% penalty interest rate paid by a municipality garnered a lot of attention.  As I feared, the saga intensified today with more failed ARS auctions.  I had to write a couple of paragraphs for both the Morning and Afternoon Calls, which are companion products to the Briefings, and are literally given over the phone.  After the PM Call at 1:30, I fielded a question from a BoG staffer and then had about 15 of my peers ask me questions about ARS.  However I am not allowed to go to today’s 4 pm briefing with President Geithner because it’s my turn to learn how to become proficient in writing the PM Briefing.  Grrrr!! My boss told me that at the meeting, the President asked why there wasn’t more fall-out from the failed auctions. This was a chance for me to shine, since I could then ask my dealer contacts these questions and then report the “inside scoop” back to the President.  The most intelligent replies I received expected an increase in “liquidity hoarding” from investors who are being temporarily frozen in the ARS market. This will translate to reduced demand for term commercial paper and perhaps selling of equities to generate cash. This hypothesis sounds very interesting but it soon may no longer be a hypothetical exercise because the incidence of failed ARS auctions is increasing and readily observable fall-out is likely coming.

            More headlines tomorrow – no doubt.  Maybe even a story that understands the issue.  Oh yes, I did speak to the BoG official and he changed a sentence or two in his speech.  Cool!  It could be worse, I could be the one giving the speech.

February 14, 2008   –  Happy Valentine’s Day!

So on Valentine’s Day I left the house just before 7 am and I’ll return around 7:30 pm.  Yesterday I worked until 9 pm so, so I’ll take the 7:30 arrival time.  I’m exhausted, OK I admit it…the PM Briefing is wearing on me.

            A Bloomberg news article quoted someone from BofA who estimated that $20 billion of ARS failed auctions occurred on Wednesday.  Today was the first time there were articles in the WSJ about the systemic ARS failed auctions.  It doesn’t rain but it pours…there were about 5 ARS articles in the paper.   People know all about it now anyway…and it’s a freaking mess!  From another perspective, I shouldn’t be complaining at all.  A lot of people are going to lose their jobs on Wall Street.  The ARS market has about $320 billion in outstanding securities and it looks like that market is going to shrink to near zero.  How many people are employed in a $320 billion market and how many will have jobs in six months?  I’m pretty sure I’ll still be working.

            NY State Insurance Commissioner Eric Dinallo testified before Congress today along with the President of AMBAC, a large monoline insurer.  Mr. Dinallo suggested that it might be helpful to split the guarantor insurers into two:  a “good insurer” to provide sound coverage to municipalities and a “bad insurer” to provide not so sound coverage to structured finance exposures. I don’t know how that scheme will look to a reader on paper, but to me it’s a non-starter absent a huge equity raise, as the bad insurer will probably be insolvent at inception.  There’s a good chance that none of this apparent to Mr. Dinallo, however.

            Moody’s downgraded their rating of another financial guarantor, FGIC, from ‘AAA’ to ‘A3’.  They are all but done as an ongoing entity.  Perhaps when the dust settles they will have some capital left.  They probably won’t have too many employees left who remember how to write profitable business in any case.  Adjustments, we make adjustments. !:-0  As I’m ready to leave, I hear that the worsening trend is accelerating in ARS.  My contact thinks an additional $20 billion of auctions failed today.  In retrospect, these ARS securities were just a bad idea.  The issuer wants a long term obligation – the investor wants short term and there is no sophisticated financial intermediary to step in between them and provide liquidity for a fee.  Yikes!  I’m sure it seemed like the thing to do at the time though.

11:00 pm         Despite my “early” arrival home, Valentine’s Day was a little sad.   Wonder why?  Perhaps it has something to do with finding myself lying awake in the middle of the night noting that pretty much everything sucks around me.  Why do I work so hard and everything looks so bad?  

February 15, 2008 

            After all my talk of how many hours I’ve been working recently, I took a half day this morning to go to the dentist.  Apparently, after the morning call, there were many questions about ARS and people were looking for me and I wasn’t there.  In this week’s edition of the am call: Slacker goes to the Dentist! I did manage to send an email out by the end of the day summarizing the week’s developments and, in terms of celebrity sightings, I spoke to an Undersecretary of the Treasury and with FRBNY President Geithner. Can’t say that I was surprised to see that the municipal ARS market remains f****d.


  1. Really fascinating inside account of what was going on this week. The honest (and exhausted) tone drives it home. Looking forward to reading more!

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