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Possible Credit Dislocation: Be Warned
The Market Ticker ^ | 10/23/09 | Karl Denninger

Posted on 10/23/2009 12:40:41 PM PDT by FromLori

I have reason to suspect that the "monetary transmission mechanism" is full of rocks (again), and we are about to have another instance of what could colloquially be called "fun." (Yes, that's sarcasm.)

Here's what we know and what I can deduce from it:

JP Morgan's "cash position" was analyzed by a writer who published on SCRIBD, which showed that actual cash held has deteriorated radically. By more than half in the last year. The deterioration is continuing, not slowing.

I am hearing repeated anecdotes from multiple areas that foreclosed property held by banks with multiple full-price offers that include a financing requirement are being sold instead to people with actual cash at radical reductions from that price. This implies that these financing contingencies are regarded as not only potentially no good but factually no good, as if the banks know for a fact that the credit pipeline will (not might), within weeks or months (in the time required to close), disappear. There is no other rational explanation for this behavior.

Citibank's credit-card terms change implies a willingness to accept and even provoke a complete and intentional destruction of their credit card business as a very high probability outcome, given that nobody in their right mind will accept a 30% interest rate who has an alternative. The obvious implication is that only those who can't transfer balances out will remain and if your credit is that impaired there's a good chance you will default - either intentionally or otherwise. This too implies foreknowledge of a near-complete impending freeze in the credit markets.

The change in terms on credit accounts is NOT confined to Citibank. I have received a fax from a customer of Infibank with substantially identical terms, in which both the standard and penalty rate was adjusted to 29.99%. This strongly implies that whatever Citibank smells the problem is not confined to them.

Both of these credit card "adjustment" letters are of course marginal rate changes. That is, they are both based off the PRIME rate. The importance of that is missed by many. Don't be one of them (more on that below.)

I recently received a back channel communication indicating that The Fed is aware that this has been and still is a solvency problem and has so briefed certain members of Congress. This from a source believed reliable, but which cannot be independently confirmed. This data is not conclusive. But - if you are dependent on credit access and these anecdotes are in fact indicative of actual knowledge of an impending lock-up you are at grave financial risk.

Note that "margin" type rates that are based on the PRIME rate could hurt you far worse than you believe. With PRIME at historic lows should any such dislocation spike the prime rate your interest rate could go much higher with little or no notice or ability to do anything about it.

IF this is going to manifest as a dislocation of some sort it will probably occur within the normal closing window for real estate transactions, since the anecdotes related to that have the best-defined "reach", and the discounts being accepted to avoid this risk are massive to the point of denoting near-certainty of this event in the minds of the market participants who are electing to accept these cash-discounted offers.

Therefore, if you are dependent on such credit access I would take immediate action to do whatever is necessary to mitigate, to the extent you are able, the consequences of such a dislocation.

Consider how you survive returning to what essentially amounts to a cash economic posture in your business and personal life.

Note that the indications above are far stronger than what we saw going into last fall before the wheels came off. As a consequence if these actions are those of people with real knowledge (and this is not a guess on their part) I would expect the outcome to be worse than what we saw last fall in terms of economic impact.

Those who are short dollars (synthetically or in the actual market) need to beware - if I am reading this correctly you're about to get a really ugly surprise.

If you want to speculate on this outcome levered bets on radical dollar appreciation look like one of the best choices out there, followed closely by bearish levered bets on commodities. I would not consider such a speculative play that is not characterized by defined risk, as this analysis is based on nothing more than observation of behavior by market participants that all point toward their foreknowledge of an event that might happen in the reasonably-near future and is not, at present, backed up with actual significant credit-spread widening or other objective criteria.


TOPICS: Business/Economy; News/Current Events
KEYWORDS: credit; dislocation; financialcrisis; theskyisfalling; weredoomed
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To: Petronski

Thank you.


21 posted on 10/23/2009 1:23:09 PM PDT by spyone (ridiculum)
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To: WallStreetCapitalist

Good explanation except the part of jp morgan

http://www.scribd.com/doc/21185939/JPM-Miracle-or-Mirage


22 posted on 10/23/2009 1:23:40 PM PDT by FromLori (FromLori)
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To: FromLori

Is he serious? I don’t think the Citicorp credit card letters have gone out to all customers, for starters. Capital One seems upbeat in its outlook. So, maybe this is not as bad as Karl thinks. (Fingers crossed)


23 posted on 10/23/2009 1:27:27 PM PDT by WashingtonSource
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To: FromLori

PING for later reading.


24 posted on 10/23/2009 1:40:33 PM PDT by SatinDoll (NO Foreign Nationals as our President!!)
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To: hoosier hick

Isn’t that where the problem lies? We are told banks are siting on Billions of dollars cash, just not lending it.

So what happened to all those Billions?


25 posted on 10/23/2009 1:41:19 PM PDT by Freddd (CNN is not credible.)
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To: demsux

And a lot that should have been foreclosed on, haven’t been. Simply living in them free, for now.


26 posted on 10/23/2009 1:43:51 PM PDT by Freddd (CNN is not credible.)
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To: FromLori
Citibank's credit-card terms change implies a willingness to accept and even provoke a complete and intentional destruction of their credit card business as a very high probability outcome, given that nobody in their right mind will accept a 30% interest rate who has an alternative. The obvious implication is that only those who can't transfer balances out will remain and if your credit is that impaired there's a good chance you will default - either intentionally or otherwise. This too implies foreknowledge of a near-complete impending freeze in the credit markets.

I called this week - we have a stellar rating and the rate is still going up - the operator blamed it on the govt...though couldnt cite anything specific. Fortunately, we pay off our balance each month in full.... but will be cancelling soon

27 posted on 10/23/2009 1:50:31 PM PDT by Revelation 911 (How many 100's of 1000's of our servicemen died so we would never bow to a king?" -freeper pnh102)
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To: FromLori

Holy Smokes!

This is magnitudes worse than anything else.

Got FRNs under the mattress?


28 posted on 10/23/2009 2:22:38 PM PDT by OpusatFR (Tagline not State Approved.)
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To: FromLori

I understand what the author of the article is stating about J.P. Morgan, I just think he doesn’t fully comprehend the banking industry.

Repurchasing agreements were a major source of liquidity for the markets (which he acknowledges) and the fact that it has been largely runoff has caused the M-multipliers to drop (which is why the Federal Reserve is printing so much money but it hasn’t yet led to inflation - the printing has yet to exceed the amount of money created through the debt markets and activities such as repurchase agreements).

When Lehman Brothers failed, counterparty risk became the prime concern of most investors and institutions. When trust fails, the repurchase market is going to fail even most cases when the collateral covers the full 100% of the “loan” because a receivership would still cause issues and most people, rationally, don’t want to deal with those problems. As a result of the credit market freeze, I currently utilize ZERO repurchase agreements, maintain cash in 30-day T-Bills only or FDIC insured bank accounts at regional banks with excessive tangible equity ratios, and we don’t even lend out our securities, as we did in the past, to short sellers because we want fully custody, paid for in cash, in a third-party custodian in the off-chance that another brokerage fails. This is a rational response for me and those who have an investment in my companies.

Ten years from now, history will show that J.P. Morgan Chase used this time, and very cheap government money, to put together a collection of businesses that will make it one of the most profitable firms in history. The analysis of the cash problem isn’t indicative of a problem in its cash flow, it merely represents the reality that the auction rate securities business, repurchase agreements, and a host of other commonly used financial instruments and securities, have yet to return to the level they were before the crisis (and it’s not certain that they ever will). JPM is still solvent. It’s a non-issue.

The only banks I liked better were Wells Fargo at any price below $15 per share and USB at the same valuation. In the interest of full discloure: We own a lot of these two banks and some JPM but it is a much, much smaller position.

Feel free to disagree with me. If you do, there’s nothing more American than shorting the stock or selling put options on it =) I’m happy to take people’s money.


29 posted on 10/23/2009 2:31:34 PM PDT by WallStreetCapitalist
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To: Leisler

If they had to liquidate today, you are absolutely correct, they would be bankrupt regardless of what the government says.

The paradox here is that by pretending, for the sake of the country, that they are solvent, in as little as 12-36 months, the profits generated every day that passes will be enough to plug the capital hole on the balance sheets, making up for the losses.

In other words, it’s like a teenager who has trashed his parent’s house. If the parents show up and lay down the law, there will be consequences. If, instead, they go spend the night at a hotel, show up the next morning like nothing happened and the house is put back together, the problem is solved (well ... the house problem is solved - you still won’t trust the teenager, or bank, because you know they’re prone to misbehaving).

Every day, more dollars are getting pored back into the balance sheets. It is merely a matter of time before the capital has been replaced and all is well with the world. Except for the dollar, which I maintain cannot stand the assault of $9+ trillion in deficits over the coming decade.


30 posted on 10/23/2009 2:35:45 PM PDT by WallStreetCapitalist
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To: WallStreetCapitalist

Clarification:

USB = US Bancorp

Not UBS = Union Bank of Switzerland, which is lucky it’s still functioning because it is a MESS. I’ve never seen such horrific capital losses.


31 posted on 10/23/2009 2:39:03 PM PDT by WallStreetCapitalist
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To: WallStreetCapitalist
With respect to your point 4), Denninger is saying the dollar would APPRECIATE rapidly in value if this credit “dislocation” was to occur.
32 posted on 10/23/2009 2:39:35 PM PDT by swamp40
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To: demsux

Banks are getting back more than they can handle.
Now “holding on to” often means, the houses are vacant, but the lender has not transfered title. This defers associated costs, insurance, HOA dues, and taxes are still the responsibility of the debtor.


33 posted on 10/23/2009 2:53:36 PM PDT by moehoward
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To: swamp40

Thanks for catching that!

I personally think that five to ten years from now, cash is trash. The combination of $9,000,000,000,000 in projected deficits combined with the fact that the United States cannot maintain its reserve currency status with China and the European Union offering more attractive terms for many nations as we ruin our balance sheet is an assault the USD simply cannot take.

This isn’t a tragedy for individual investors. There are dozens of ways you can make obscene amounts of money off a declining dollar - from foreign real estate investments to holding stocks in other countries in the native currency with no hedging to issuing 30-year fixed-rate bonds (if you own a business that is large enough, which isn’t feasible for most people), to buying equity to multi-nationals such as KO, GE, JNJ, etc., which I mentioned earlier, a falling dollar can make you very, very rich if you are positioned to take advantage of it.

My philosophy is, and has been, there are always intelligent things to do. Whether you believe the dollar will increase, the dollar will decrease, or we’ll trade in the greenback for seashells, it doesn’t matter. You can structure your life and finances in a way that you are flexible, with resources to take advantage of whatever comes our way. It’s why capitalism works and why I love it.

If I were retired, I’d buy a Best Western or some other real estate holding in Canada, keep the money invested in Canadian currency in their banks (their debt as a percentage of GDP has drastically declined over the past 10 years), and then if and when the dollar fell, ship the money back to the states to live on as needed, enjoying extreme gains in real purchasing power. If the dollar appreciated, I could take more of my dollars and pour them into additional real estate holdings in Canada, using the power of the dollar as a “discount” on my acquisition price. Either way, I’d be protected.

Note: I’m not actually advocating someone do this, I’m merely pointing out that it is a practical application of my philosophy.


34 posted on 10/23/2009 2:56:14 PM PDT by WallStreetCapitalist
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To: WallStreetCapitalist

I have a friend who manages his family money. Very very wealth, multi jet family, yachts, in the financial papers. Anyways I asked him what he has been doing this last year with his part of the money and he said buying farms, mineral rights in western Canada.


35 posted on 10/23/2009 3:10:24 PM PDT by Leisler (It's going to be a hard, long winter)
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To: thefoundersrock

canned beans...lots of ‘em.


36 posted on 10/23/2009 3:58:21 PM PDT by usshadley (Orwell was an Optimist)
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To: hoosier hick; FromLori
I am hearing repeated anecdotes from multiple areas that foreclosed property held by banks with multiple full-price offers that include a financing requirement are being sold instead to people with actual cash at radical reductions from that price. This implies that these financing contingencies are regarded as not only potentially no good but factually no good, as if the banks know for a fact that the credit pipeline will (not might), within weeks or months (in the time required to close), disappear. There is no other rational explanation for this behavior.

I would interpret this differently. This looks like the banks are desparate for cash NOW, rather than a moneymaking stream of cash flows (as they may not be in business to benefit from a long-term mortgage).....

If Bank A holds a property and gets multiple full-priced offers that are to be financed by Banks B or C, then it should not care about future income stream. At closing, Bank A would be paid in full. This is telling me that Bank A is not even confident that the buyer will be able to close. This is about taking cash today vs taking a promise of cash in 30 days or so.

37 posted on 10/23/2009 4:31:41 PM PDT by Cooter
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To: FromLori
Citibank's credit-card terms change implies a willingness to accept and even provoke a complete and intentional destruction of their credit card business

I got my letter raising my rate from 5.99% to 29%. I couldn't close the account quickly enough. I seldom used the account and I have sterling credit.

Their loss.

The only question in my mind was, "What was all that consumer credit card legislation Congress passed?"

Don't bother asking me to open a new account when things are better, Citi. I no longer trust your judgment.

38 posted on 10/23/2009 4:36:53 PM PDT by Glenn (Free Venezuela!)
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To: Cooter

They did just announce a new stress test again today so that could very well be part of it too maybe they are worried they will not have adequate funds to cover? Though we all know what a joke that test was but maybe some who aren’t in on obamas payoff will get taken out otherwise.

http://rawstory.com/news/afp/Fed_to_widen_stress_tests_for_banks_10232009.html


39 posted on 10/23/2009 4:37:47 PM PDT by FromLori (FromLori)
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To: Glenn

That was the joke of it all fooling the masses they gave them plenty of time in that legislation so they could get their rates up the jokes on the people once again. The responsible are being made to pay for the irresponsible the legislators do not expect their meal tickets the banks who gave them so much campaign cash to foot the bill.


40 posted on 10/23/2009 4:40:57 PM PDT by FromLori (FromLori)
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