Cold Feet and Sea Bass

Fear of risk is sending investors into retreat as cold feet become the factor.

The widening fallout in the U.S. mortgage industry has reminded investors of a risk they had forgotten: the fear of risk itself. Corporations are paying higher interest rates on their bonds, some private-equity firms are having trouble raising money to close big purchases, and the stock market has lost 7 percent of its value in less than two weeks — all mainly because of an exodus from risk.

“I would characterize it as a loss of excessive risk appetite," said Ian Lyngen, an interest-rate strategist at RBS Greenwich Capital. "There is a lot more apprehension about layering on riskier assets."

The meltdown of this comparatively small segment of the U.S. economy is contributing to a much bigger and broader issue: Lenders around the world are growing scared to lend.

"It is making people pull in their tolerance for risk," said Doug Sandler, Wachovia’s chief equity strategist. But Sandler thinks investors had been way too eager take on risk without enough compensation.

“We have the strongest global economy I’ve seen in my business lifetime today,” Treasury Secretary Henry Paulson — the former CEO of Goldman Sachs — told reporters in Beijing yesterday.

“There has been a change in attitude,” said Eric Thorne, investment strategist at Bryn Mawr Trust. “We were in a situation a couple of weeks ago where there wasn’t much that investors were worried about. It’s more a psychological impact of the lending environment in general.”

Two mortgage insurers said this week a $1 billion partnership created to invest in mortgage debt may now be worthless for that very reason.

The partnership — C-Bass LLC — insists nothing fundamental has changed and the credit quality in its portfolio remains intact. The only problem, it claims, is that it cannot come up with the cash to repay the skittish lenders who have demanded their money back.

"It’s just a broader fear," said Grubb & Ellis’s Bach. "That credit disruption has spread to the point where people are reluctant to make loans. What started in subprime mortgage has sort of transferred into other kinds of debt right now."

Key Ideas

• Loss of excessive risk appetite
• Lenders around the world are growing scared to lend
• There has been a change in attitude

Oddly enough this change in risk appetite is occurring in what Paulson claims is "the strongest global economy I’ve seen in my business lifetime today". Then again if things can't get any better, they only have one way to go don't they? Certainly liquidity is not going to get any better than it was early this year when senseless leveraged buyouts could be funded with ease. It's also interesting that there are record numbers of foreclosures in the strongest global economy ever.

With those rising foreclosures, attitudes of consumers about consumption are changing as well. In spite of solid growth in the 2ns quarter, consumer spending is weakening.

Consumer spending grew just 1.3 percent in the second quarter, a dramatic falloff from the first quarter's 3.7 percent and the 3.4 percent growth in 2006.

Capital spending rose a lackluster 2.3 percent in the second quarter, a performance that looks good only in comparison to the anemic 0.3 percent growth in the first quarter or the decline of 4.9 percent in the last quarter of 2006.

Capital outlays were "on the weak side," said Merrill Lynch's Rosenberg, and, despite the higher-than-expected GDP reading, "we still believe that the weak handoff into the third quarter remains intact."

Rosenberg expects a sluggish 1.7 percent growth rate in the third quarter.

C-Bass Liquidity Problems

The Wall Street Journal is reporting a liquidity crisis for sea bass. Oops that's C-Bass not sea bass. Thankfully there's still plenty of water for our friend there on the left.

On the other hand C-Bass is liquidity challenged and flopping around like a wet fish on dry land hoping to find water as the following statements show:

C-BASS LLC, an affiliate of MGIC Investment Corporation (MTG) and Radian Group Inc. (RDN) today issued the following statement in response to the announcements made last night by MGIC and Radian regarding the liquidity challenges faced by C-BASS.

While nothing fundamentally has changed at C-BASS, like many other firms in the industry, the current severe state of disruption in the credit markets has caused C-BASS to be subject to an unprecedented amount of margin calls from our lenders. The frequency and magnitude of these calls have adversely affected our liquidity. To address this, C-BASS is in advanced discussions with a number of investors to provide increased liquidity and is exploring all options to mitigate the liquidity risk in this difficult market.

At the beginning of 2007, we had $302 million of liquidity, representing greater than 30% of our capital of $926 million. During the first 6 months of 2007, a very tumultuous time in the subprime mortgage market, C-BASS' disciplined liquidity strategy enabled the company to meet $290 million in lender margin calls. During the first 24 days of July alone, C-BASS met an additional $260 million of margin calls, representing greater than a 20% decline in the lender's value. We believe that nothing justifies this substantial amount of margin calls received in such a short period of time, particularly as there has been no change in the underlying fundamentals of our portfolio.

"There has been no change in the underlying fundamentals of our portfolio."

That statement seems laughable at first glance but it's possible. Let's see if this slight revision expresses the idea: "The underlying fundamentals of our portfolio were god awful from the beginning and they are still god awful today. What has changed is the willingness of lenders to slosh water on our gills. Liquidity is drying up and that is affecting our stock price."

MTG
(click on charts for a crisper image)



RDN



C-Blass claims a "disciplined liquidity strategy" enabled them to meet a total of $556 million in lender margin calls.

Two questions:

• Is it possible to repeatedly have disciplined margin calls?
• How much more discipline can C-Bass take?

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/