Eye on Commodity Prices

There was an interesting "buzz" on Minyanville on Thursday about commodity prices. Here goes from Minyan Peter:

Three things that caught my eye this morning:

• The WSJ reporting that Valero (VLO) is cutting back refining output because of a surplus of supply.
• Oil trading flat/down despite the announcement of a terrorist bombing of a major Iraqi pipeline.
• The CME announced an increase in commodity trading marginrequirements.

While discrete events, all again raise the question of peaking consumer
commodity prices. Two things to keep in mind:

First, commodity price inflation has been cited repeatedly by the Fed as a concern. And given the view of many that the most recent price rises are a function of rampant speculation (versus fundamental demand) I would not underestimate

a) the pressure placed on the CME to increase margin requirements by banking regulators to curtail speculation

b) how stability in commodity prices (let alone price declines) opens up the Fed's ability to drop short term rates further without pummeling the dollar.

Second, while everyone will likely cheer commodity price declines as the savior of the US consumer, asset deflation, whether in housing, commodities or anything else is like Kryptonite to the banking industry. And don't forget, too, how much lending (particularly M&A related) has been done in the past five years in support of commodity related companies - particularly in Asia.

At least to me, commodity price deflation eliminates any notion of decoupling.

Death Spiral Becomes Born-Again Experience

Bloomberg is writing about a Born-Again Experience at Red Kite.

Rising prices for industrial metals and other commodities have pulled thousands of new investors into what were once illiquid markets. Money invested in commodity hedge funds surged 83 percent to about $55 billion in 2007 from $14 billion in 2005, according to estimates by Chicago-based Cole Partners Asset Management. Mutual funds tracking commodity indexes held $125 billion at the end of 2007, compared with $25 billion in 2003, according to Barclays Capital.

"The world is going through the biggest industrial revolution it has ever seen, and it's affecting the largest part of the human population ever," they [Michael Farmer, co-founder of hedge fund Red Kite Metals and his partner, David Lilley] wrote in an e-mail. "This is bringing a combination of millions of new consumers and cheap manufacturing capacity. The implications for raw materials are dramatic, and the world has to learn to value them more highly."

Not everyone agrees that commodity prices will keep rising, especially at a time when economists are predicting a U.S. recession and global slowdown.

"I think where we're really at in the commodity business - - and I've been at this since the 1970s -- is we're overvalued in a number of areas,'' says Don Roose, president of West Des Moines, Iowa-based brokerage U.S. Commodities Inc. "We're nearing a commodity bubble that is very similar to the dot-com bubble.''

Donald Selkin, director of equity research at Joseph Stevens & Co. in New York, says the commodities boom has little to do with supply and demand.

"Massively Misguided"

"The near-record prices that we are seeing come from speculators -- it's massively misguided bullishness," he says. "All economic data we have seen -- durable goods data, economic growth -- are quite negative. It will backfire one day, though I don't expect a market collapse in copper."

Though it also trades aluminum, nickel and tin, Red Kite Metal's main business is copper. It buys the metal from producers in North and South America and sells it to companies that turn the metal into wires and pipes for home and office builders and carmakers. The fund trades copper futures on the LME and buys the physical metal, holding it in warehouses around the world until Farmer and Lilley are ready to sell.

Red Kite moves markets via the huge trades it executes. According to a prospectus sent to potential investors in 2006, Red Kite Metals at that time was borrowing an average of six times its investment pool, which an investor estimated at about $1 billion.

At the March 20 price, that would buy about 750,000 metric tons of copper, or almost four times the combined total metal stockpiles currently held at warehouses registered with the Comex division of the New York Mercantile Exchange, the Shanghai Futures Exchange and the LME.

"If you buy a million tons of copper, that's guaranteed to get the market up," says David Threlkeld, president of metals trading firm Resolved Inc. in Scottsdale, Arizona. Threlkeld was the man who blew the whistle on Tokyo-based Sumitomo Corp.'s illegal effort to corner the copper market in the 1990s.

"RK holds physical stocks of metal as part of its investment strategy," Farmer and Lilley said in a February e-mail. "As a matter of policy, we don't comment on specific positions."

The kings of copper continue to believe that as long as China and India keep building, an investment in the red metal can't lose.

Commodity Speculation

When one points to commodity inventories being at record lows, those inventories do not take into account all the speculative inventories. Red Kite admits being leveraged 6 times. And Red Kite is just one such company. How many more hedge funds are stockpiling metals and/or leveraging futures? In what amounts?

Regardless of what China and India are doing, in light of a slowing economy combined with pressure on the CME to do something about speculation, it's quite a leap of arrogance to believe "investment in the red metal can't lose". With enough leverage, anything can lose, even in mostly favorable conditions.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Germany Fears Global Meltdown

Here is an interesting tale of central bankers working deep into the night last weekend, with Bundesbank President Axel Weber repeatedly in touch by telephone and via videoconferencing with Ben Bernanke in an attempt to orchestrate a bailout of Bear Stearns.

The issues are many: What constitutes too big to fail, who should pay the price for bank failures, what to do about the US dollar, and whether there should be a formal statement on the above.

The issues are still not resolved of course. Nor can they be. Too many banks are insolvent both in the US and abroad.

Let's pick up more of the story in Germans Fear Meltdown of Financial System.

Germany and other industrialized nations are desperately trying to brace themselves against the threat of a collapse of the global financial system. The crisis has now taken its toll on the German economy, where the weak dollar is putting jobs in jeopardy and the credit crunch is paralyzing many businesses.

For some time, there has been a tacit agreement among central bankers and the financial ministers of key economies not to allow any bank large enough to jeopardize the system to go under -- no matter what the cost. But, on Sunday, the question arose whether this agreement should be formalized and made public. The central bankers decided against the idea, reasoning that it would practically be an invitation to speculators and large hedge funds to take advantage of this government guarantee.

So, what does apply? Should the state use taxpayer money to help greedy bankers repair the damage caused by their unscrupulous speculation? Should it invest billions to save ailing financial institutions, thereby engendering new risks and side effects? And should the government, to use the words of a Frankfurt investment banker, "treat a drug addict with cocaine"?

How does one explain to honest taxpayers that they should pony up their hard-earned money for a bank like Bear Stearns, whose long-standing CEO forked out $28 million (€18 million) for a 600-square-meter (6,500 square-foot) duplex apartment on New York's Central Park shortly before the collapse of his company? Or that UBS, the crisis-ridden, major Swiss bank, fired three of its senior executives for poor performance only to turn around and pay them roughly 60 million Swiss francs (€38 million/$59.2 million) in golden parachutes?

The central banks and governments of the major industrialized nations are still dodging the answers to these questions.

"I no longer have faith in the ability of the markets to heal themselves," Deutsche Bank CEO Josef Ackermann confessed in a speech delivered last Monday in Frankfurt. Ackermann said that the American example shows that governments and central banks must now play a stronger role.

Even his counterpart at Commerzbank, Klaus-Peter Müller, agreed, saying that the current situation has the potential to develop into "the biggest financial crisis in postwar history" as long as "the markets are allowed to continue operating unchecked." According to Müller, "It would make sense to permit the banks -- retroactively to Jan. 1 -- to account for securities differently by eliminating the daily revaluation requirement." He argues that this would stop the downward spiral on the banks' financial statements.

The German Finance Ministry promptly rejected such calls, saying: "We see no need to become active at the national level." But this assertion is far from the truth. The ministry has become a place of nonstop crisis meetings, the chancellery is kept constantly apprised of the latest developments, and the Federal Financial Supervisory Authority (BaFin) has already set up a task force to address the issue. No one in the government has the slightest doubt that it will intervene the minute another bank begins to falter.

Germany's state-owned banks, which have been especially careless in recent years about investing in American securities backed by subprime loans, are considered greatly at risk. One of them, Bayerische Landesbank, is currently considering writing off €1 billion ($1.54 billion) -- or possibly even more -- in bad debt. In the first two months of 2008 alone, the Bavarian bank's troubled securities portfolio has lost €1 billion in value, and it has fallen even further since. "There could be another billion in losses on top of that," says one banker.

At another state-owned bank, Dusseldorf-based WestLB, €5 billion ($7.7 billions) in government bailout funds are apparently not enough. The bank is already losing its next billion.

If other banks run into trouble, Finance Minister Peer Steinbrück plans to come to their aid with fiscal tools, even if it gets expensive for the government. "Preventing a bank crash," say officials at the finance ministry, "takes precedence over budget consolidation."

US Subprime Market Sinks IKB Bank

Bloomberg is reporting IKB Supervisory Board Denies Fault for Near-Collapse.

The supervisory board of IKB Deutsche Industriebank AG, the first German casualty of the U.S. subprime market collapse, rebuffed shareholder allegations that it could have averted the near-collapse of the German bank.

"We had no chance to recognize the risks and to avoid the life-threatening crisis," Ulrich Hartmann, head of IKB's supervisory board, said today at the annual general meeting in Dusseldorf.

IKB received an emergency bailout last summer after a finance affiliate that invested in mortgage-backed securities couldn't raise funding amid the credit crunch. The German lender has received financial aid of more than 8 billion euros ($12.6 billion) from Germany's development bank KfW Group, the government and the country's banking associations to stave off insolvency and cover writedowns and losses.

"Apparently, there wasn't a soul in the entire bank who had a grasp of risk management," said Hans-Richard Schmitz of the DSW association, which represents German private investors including IKB shareholders. "Shareholders have been left with a shattered bank and no one wants to take responsibility."

IKB has lost about three-quarters of its market value since July 30, when it cut its full-year forecast and received emergency funding less than two weeks after saying the subprime crisis wouldn't affect it. The bank is currently worth 406 million euros. IKB rose 3 cents, or 0.7 percent, to 4.19 euros in Frankfurt trading after dropping 16 percent yesterday.

Chief Executive Officer Guenther Braeunig today called on shareholders to approve a 1.5 billion-euro stock sale that is "vital to continue running the bank."

"IKB should be shut down," said private investor Hans-Wilhelm Voeller at the congress center in Dusseldorf, where IKB is based and more than 1,000 shareholders were in attendance. "Better a miserable ending than misery without end."

Now there's the quote of the month: "Better a miserable ending than misery without end." We need to apply that thinking here in the US instead of attempting to make debt slaves out of homeowners and zombies out of banks.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Dear Citigroup Customer ....

I have a friend "SK" who is a Certified Mortgage Planning Specialist in California. He has clients in existing ARMs with Citigroup. Those ARMs are about to reset and Citigroup has been sending out "Dear Customer" letters warning them of increases in loan rates.

This is where it gets interesting.

Citigroup has been warning customers of higher rates and is offering existing customers fixed rate mortgages at "special rates". The problem with the offer is the rates in question are about to reset lower, not higher. Yes I have proof.

Exhibit A



click on chart for sharper image

The above document shows a letter that was sent out on March 21, 2008. The small red oval says "The rates in this example were current as of 2/27/2008".

Exhibit B



Exhibit B is simply a blowup of a portion of Exhibit A.

Key Points

1) The area at the top states "Projected Loan After Next Reset"
2) The projected rate of 2/27/2008 is 6.303%.

Exhibit C



click on chart for sharper image

Exhibit C states the loan in question is based on one-year LIBOR + 2.25%

Exhibit D



click on chart for sharper image

Exhibit D shows the LIBOR rate as of February 27, 2008.
Let's be generous to Citigroup and call the rate 2.85

Now let's add the index amount from Exhibit C to the base rate from Exhibit D (2.85 + 2.25) to arrive at a projected customer rate for this loan.

My math says 2.85 + 2.25 = 5.1%
Citi's math (from exhibits A and B) says 2.85 +2.25 = 6.303%

LIBOR (and therefore the projected loan rate) is even lower today.

Exhibit E

Exhibit E is from another client of "SK". It is an Email is discussing correspondence between "SK's" client and Citigroup, as well as an actual conference call between "SK", his client, and Citigroup.

Hey "SK",

Sorry for the delay and thank-you for your help with Citi.
The following is a re-cap our March 17th, 2008 correspondence with Citi,:

As a preferred customer of Citi Mortgage, we called to inquire about our options on our 3/1 arm that has a fast approaching anniversary. We received the following information.

Question 1. What happens to our loan on the anniversary? Will it go down?
Answer: It is very unlikely that it will go down. Would you like to refinance?

Question 2. If we refinance should we stick with an arm or go to a fixed mortgage?
Answer: You do not want an arm you want a fixed. We used a 15 yr. fixed as a example;

We were quoted: 15 yr fixed-5.5 with an Apr of 5.65 and a $4400.00 fee.
We asked for a good faith FAX and she said they do not give those.
We said thank you but we are going to shop.

That is when we called you for help.

We did not know if we were tied to the Libor or the Treasury. A call was placed to Citi and after much reluctance, they reveal we were tied to the T-bill with a 2.75 pt. spread and again we received a higher percentage rate quote.

A conference call was then made between you, a Citi loan officer and myself. Again they were quoting a percentage rate higher than 4.75 which it should have been on that day. We then asked for a supervisor and we were transfer to another loan officer of the same level. When asked if he was a supervisor, he said "no" and another request was made for a supervisor and they hung up on us.

We are seriously questioning Citi Mortgage's ethical practices.
Thank you for your help. We do appreciate doing business with you.

Let's look at Q&A #1 again.

Question 1. What happens to our loan on the anniversary? Will it go down?
Answer: It is very unlikely that it will go down. Would you like to refinance?

By the way the existing rate on the loan in the Email above is 6.00%. That rate is based on the one-year treasury rate plus an index of 2.75. On March 17, the one-year T-Bill rate was 1.53 as quoted during the conference call. Let's do the math. 1.53 + 2.75 = 4.28 (rounded to the nearest higher 1/8 would be 4.375). Citigroup told the client the new rate would be above 6.00%

The above conversation, in conjunction with the documented hard evidence above, suggests a pattern deceit by Citigroup. I am wondering how many Citigroup customers have refinanced to a higher rate and payment based on inaccurate rate quotes from Citigroup mortgage specialists.

I am not a lawyer. I do not know if any of this violates truth in lending laws, fair lending practices laws, or any other laws. However, I do know this is a mess, and if I was a customer of Citigroup I would be questioning whether or not I could believe anything they say.

In the sake of fairness, if Citigroup has a different explanation for the above examples, I will post it.

Addendum 3:

Inquiring minds may wish to read Operational Risk – Improper Disclosure By Citigroup Mortgage. The article discusses a potentially serious breach of fiduciary responsibility by Citigroup, possible RESPA violations, potential violations of Reg. Z, and likely violations of internal procedures.

Addendum 2:

Anyone who feels aggrieved by the actions of Citigroup may contact http://www.consumergripes.net/

This addendum is not associated with Addendum 1 posted previously.

Addendum 1:

I received an Email from a lawyer who writes:

I am a lawyer. And, you don’t need to be a lawyer to KNOW fraud when you see it, and I’d say that what you describe – deliberately misquoting rates, etc. is fraud (there are two types of fraud – fraud in fact and fraud in the inducement, but we don’t have to get in to that, and you may well know the difference (and I suspect you do)).

Most law is “common sense” and if something screams “fraud” it most likely is – under whatever particular law – whether statutory law or common law.

If Citi KNOWS the rate is going lower, but says “it is most likely to go higher” and doesn’t give a straight answer, and is stupid enough to have third party witnesses listen to the misrepresentations and/or put them in writing and or have them recorded (and I assume Citi records a lot of stuff by law or company policy), then they deserve to be sued by a lot people.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Liquidity Battle Moves To Different Universe

Bloomberg is reporting Fed May Emerge From Crisis With More Influence at SEC Expense.

America's financial system faces its biggest overhaul since the Great Depression as officials weigh lessons from the credit-market rout and the near collapse of Bear Stearns Cos.

Federal Reserve policy makers are redefining which companies are vital to the flow of credit, an area once the sole domain of commercial banks, and which institutions pose risks to the entire economy if they fail. Treasury Secretary Henry Paulson said in a speech yesterday that the Fed should broaden its oversight to include Wall Street investment firms, now regulated by the Securities and Exchange Commission.

"This is tectonic," said Ralph Ferrara, a former general counsel at the SEC, and now a partner at Dewey & LeBoeuf LLP in Washington. "We no longer want to have a balkanized response to a national crisis." The SEC will be so diminished that it "will be given a nice view of the Potomac from whatever floor of the comprehensive financial services regulator they are given," said Ferrara.

"Because of financial innovation, we have lots of these financial firms that started to look like banks," said Mark Gertler, a New York University professor and visiting scholar at the New York Fed. "Any institution that may need to go to the discount window directly or indirectly ought to be under the supervisory control of the Fed."

Legislators are already considering a new regulatory structure. House Financial Services Chairman Barney Frank said last week Congress should consider creating an agency to monitor market risk or give that authority to the Fed. The Massachusetts Democrat also said he will seek less duplication. Currently, there are five separate regulators of banks, thrifts, and credit unions.

Lovely. Let's give the most guilty party in creating the mess, more power to make an even bigger mess. Not to be outdone, the Bank of England and the ECB join the battle.

BOE and ECB Join Liquidity Battle

Things are so bad that the BOE Will Take Revolutionary Action.

The Bank of England is poised to take revolutionary action to find a “resolution” to the problems faced by British banks unable to sell or refinance portfolios of mortgage-backed debt, Mervyn King, the governor, signalled on Wednesday.

Mr King also suggested that the Bank was becoming more open to interest rate cuts. His comments came as Hank Paulson, US Treasury secretary, offered strong support for the Federal Reserve’s handling of the Bear Stearns crisis.

In a statement to the British parliament, Mr King said the Bank of England’s existing lending against mortgage-backed securities was “a useful bridge to a longer-term solution”, but can “be only a temporary measure”.

He said a longer-term resolution was needed to deal with the “fragility” of financial markets and to relieve the “overhang on banks’ balance sheets of assets in which markets have closed”.

Mr King was not specific about the mechanisms that might be used. But possibilities are understood to include the purchase or the swapping of asset-backed securities for liquid assets or cash – ideas that have been discussed with other central banks, as the FT reported last week.

To ensure taxpayers were not left with banks’ bad debts, Mr King insisted that the government would have to be insured against any credit losses. Insisting that the big problem in the UK was liquidity, not irresponsible lending, he added: “The banks neither need nor want the taxpayer to insure them against these losses.”

[My comment: Excuse me but insured by who? Ambac? MBIA? Northern Rock?]

Meanwhile, Jean-Claude Trichet, European Central Bank president, told the European parliament that the ECB was committed to easing financial market tensions, but the rescue of banks facing solvency difficulties would be “in a different universe” and require taxpayers’ money.

A Different Universe

Now there's an interesting admission by Trichet: Easing financial tensions will be in a different universe requiring taxpayer money. Meanwhile, the Bank Of England wants guarantees from the tooth fairy that taxpayers will not be at risk. And back in the US, Congress is investigating into how the Fed and the Treasury department handled Bear Stearns while looking into giving the Fed more still power to wreak havoc.

Does anyone else want to join this mad hatters tea party? There seems to be plenty of room at the table for Japan.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Fed Drains Again: 9 Straight POMOs

Every day I hear from someone how the Fed is "printing". My typical reaction is to ask for proof. I never see any. I just looked again. I still don't see any. Oh sure, people point to various Fed sponsored facilities like these as printing.

Recap Of Fed Sponsored Facilities

• The TAF (Term Auction Facility) failed to restore liquidity.
• The TSLF (Term Securities Lending Facility) failed to restore liquidity. See The Fed's Swap Meet for more on the TSLF.
• The PDCF (Primary Dealer Credit Facility) will be the next "facility" to fail. See Fed Fails To Halt Debt Meltdown for more on the PDCF.

However, none of the above is printing. Others point to rate cuts, but rates cuts sure are not printing. Still others point to the $30 billion (now $29 billion) guarantee of the JP Morgan take under of Bear Stearns as printing. However, as bad or illegal as that idea may have been (see Debate Over Bear Stearns: Hussman vs. Mauldin) that is not printing either.

Perhaps one can argue they expect the Fed to start printing, or the Fed will have to start printing once the crappy collateral the Fed is taking for the above swaps and bailouts heads south, but until that happens, let's not say the Fed is printing when in fact they are doing the opposite, at least on a permanent basis.

The last 9 Permanent Open Market Operations, all this month, have been "draining" actions (the opposite of printing). A "printing" action is an Outright Purchase. A "draining" action is an Outright Sale.

Permanent Operations

Operation Date: 03/26/2008
Operation Type: Outright Bill Sale
Release Time:   10:45 AM
Close Time:   11:10 AM
Settlement Date: 03/27/2008
Maturity/Call Date Range: 05/01/2008 - 05/15/2008
Total Par Amt Accepted (mlns) : $9,000
Total Par Amt Submitted (mlns) : $30,285

Operation Date: 03/25/2008
Operation Type: Outright Bill Sale
Release Time:   10:30 AM
Close Time:   10:55 AM
Settlement Date:03/26/2008
Maturity/Call Date Range: 05/22/2008 - 06/12/2008
Total Par Amt Accepted (mlns) : $11,999
Total Par Amt Submitted (mlns) : $41,194

Operation Date: 03/24/2008
Operation Type: Outright Coupon Sale
Release Time:  10:45 AM
Close Time:   11:10 AM
Settlement Date:03/25/2008
Maturity/Call Date Range: 06/30/2011 - 09/30/2011
Total Par Amt Accepted (mlns) : $5,001
Total Par Amt Submitted (mlns) :$12,289

Operation Date: 03/20/2008
Operation Type: Outright Coupon Sale
Release Time:  10:44 AM
Close Time:    11:05 AM
Settlement Date:03/24/2008
Maturity/Call Date Range:02/15/2011 - 05/31/2011
Total Par Amt Accepted (mlns) : $4,957
Total Par Amt Submitted (mlns) :$9,884

Operation Date: 03/19/2008
Operation Type: Outright Bill Sale
Release Time:   10:18 AM
Close Time:   10:45 AM
Settlement Date: 03/20/2008
Maturity/Call Date Range: 06/12/2008 - 07/31/2008
Total Par Amt Accepted (mlns) : $14,999
Total Par Amt Submitted (mlns) : $53,672

Operation Date: 03/17/2008
Operation Type: Outright Coupon Sale
Release Time:  10:55 AM
Close Time:  11:30 AM
Settlement Date: 03/18/2008
Maturity/Call Date Range: 09/30/2009 - 01/31/2010
Total Par Amt Accepted (mlns) : $5,000
Total Par Amt Submitted (mlns) : $13,015

Operation Date: 03/17/2008
Operation Type: Outright Bill Sale
Release Time:   10:04 AM
Close Time:    10:30 AM
Settlement Date: 03/18/2008
Maturity/Call Date Range: 08/07/2008 - 09/11/2008
Total Par Amt Accepted (mlns) : $17,999
Total Par Amt Submitted (mlns) : $56,605

Operation Date: 03/12/2008
Operation Type: Outright Bill Sale
Release Time:   10:45 AM
Close Time:    11:15 AM
Settlement Date: 03/13/2008
Maturity/Call Date Range:05/08/2008 - 06/05/2008
Total Par Amt Accepted (mlns) : $15,001
Total Par Amt Submitted (mlns) : $57,065

Operation Date: 03/07/2008
Operation Type: Outright Bill Sale
Release Time:  10:31 AM
Close Time:   11:15 AM
Settlement Date: 03/10/2008
Maturity/Call Date Range: 05/08/2008 - 06/05/2008
Total Par Amt Accepted (mlns) : $10,000
Total Par Amt Submitted (mlns) : $52,595

Of course the Fed conducts temporary open market operations as well. On that score, a repo is a temporary injection of cash and a reverse repo is a draining action. "Temporary" is typically overnight to 28 days while "Permanent" is months or longer.

Every time there is a huge repo the conspiracy crowd goes gaga because they forget to include expiring repos. Here is a table of Temporary Open Market Operations.

I am not going to add it all up even though some meticulously keep track of such changes. Instead I am going to point to a chart of base money supply.

Base Money As Of 2008-03-12



click on chart for sharper image
The above chart courtesy of the St. Louis Fed

Someone wake me up when the Fed starts printing to a significant degree. In the meantime let's not say the Fed is printing when it is perfectly clear the Fed is printing at close to a 0% rate.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Citigroup Freezes HELOCs

Here is an interesting article on QueerCents about Citibank Freezing Home Equity Lines of Credit. Nina writes...

“Remember that credit is money.” – Benjamin Franklin

As many readers know, I’m a proponent of keeping an untapped home equity line of credit (HELOC) at my disposal for major emergencies. This isn’t my emergency fund. It’s what I call my catastrophe fund.

I’ve always believed that keeping a HELOC readily available is the best insurance policy and the back-up plan for if / when the emergency fund runs empty. Think about it… being able to tap this money could buy us time in the event of job loss or illness. And time is money.

Immediately after we bought the house, our mortgage broker had us refinance and get a line of credit from Citibank for $168,000. We have never used it.

I list all the financial details to support my belief that we’re responsible borrowers. The HELOC is there strictly as a backup plan. For a catastrophe. Period. End of story. But with that said, I’ve always looked at that line of credit as my money. Money I could access at any time.

So it came as a surprise yesterday when we got the letter from Citibank about our $168,000 line of credit: "We have determined that home values in your area, including your home value, have significantly declined. As a result of this decline, your home’s value no longer supports the current credit limit for your home equity line of credit. Therefore, we are reducing the credit limit for your home equity line of credit, effective March 18, 2008, to $10,000. Our reduction of your credit limit is authorized by your line of credit agreement, federal law and regulatory guidelines."

Reduced to $10,000!? Hello!? Please don’t f-ck with my house in Newport Beach…

Of course, I’m calling them today to dispute it. Why? Because unlike the Phoenix property, I believe I can prove our home has retained its value and hasn’t declined. But Newport hasn’t declined with any significance and if we compare current comps in our zip code, we can prove to the lender that our home has retained its value. Or so that’s my plan. I’m going to fight this one and I’ll write a follow up post about my success or failure with regards to the dispute.

Misconceptions vs. Reality

There are many amazing misconceptions in this story but let's start at the top.

Ben Franklin is wrong. Credit is not money. Credit is credit. Nina in fact proves why credit is not money. Credit lines can be withdrawn while cash in the bank (below the FDIC limit) is cash in the bank.

Above the FDIC limit cash in the bank may soon not be cash in the bank. For more on this idea please see Treasuries Safer Than Cash and Yield Curve Twilight Zone. Anyone above the FDIC limit at any bank needs to take action now.

For a quick look at the idea that credit is money and homes are safe credit please consider WaMu Alt-A Pool Revisited.

Since May of 2007, on a credit pool rated 92.6% AAA, 22.69% is now 60 days delinquent or worse, with 11.62% in foreclosure and 3.56% already in REO status. Clearly credit is not cash. Although that is just one pool, not necessarily representative of overall market conditions, but with that kind of action going on it's no wonder banks are cutting back credit lines.

Declining Housing Markets

As far as overall conditions go, let's consider the Case-Shiller Housing Index from my post Chicago Area Foreclosures On Record Pace.

Chicago is one of the cities that Calculated Risk plots. Let's take at his latest chart from Real Case-Shiller House Price Index.



click on chart for larger image

Note the decline in the composite 10 and composite 20 market areas. The chart is inflation adjusted which arguably makes the chart look a bit worse, but the reality is home prices are declining in all major markets.

Furthermore, housing has not yet bottomed. Please see Housing - The Worst Is Yet To Come and When Will Housing Bottom? for details. For an updated look at Florida, ground zero of the housing bubble bust, please read Grown Men Are Crying In Florida. It's a pretty shocking composite.

"It's My Money"

Anyone making a statement "I’ve always looked at that line of credit as my money." should not be advising anyone on money matters. Borrowed money is not one's money. Once borrowed, the amount is debt owed to the lending institution or person making the loan.

Nina is calling Citigroup to dispute. Good luck. Nina writes "When we bought our home three years ago, we put $300,000 down on the $1,100,000 purchase price. .... One reason why we bought in Newport is because we believed that property values would retain their value over time".

I have a message for Nina:

Wake Up!

It is highly likely that you are underwater on your house or soon will be. California is getting hammered. Anyone depending on "comps" is likely hearing what they want to hear. If by some miracle, your area is a pocket of strength it likely will not be soon. Home prices have dramatically outstripped affordability and have only one way to go and that is down.

You can believe in the tooth fairy just as you can believe in your house, but that does not make it real.

Look at this from Citigroup's point of view.

• You have decreasing home equity, most likely no equity.
• California is in decline with a long way to go before houses can be considered affordable.
• The US is in recession.
• People are losing jobs.
• You do not know the difference between money and credit.
• You do not understand the difference between your money and someone else's money.
• You spent $55,000 trying to "make a baby" (mentioned in the article).
• You are about to adopt a child instead (also mentioned in the article).
• Your cash went down and your expenses are clearly going to rise as a result of the last two points.

The frightening thing to Citigroup and other lenders has to be the cavalier attitude of people who still do not see the freight train coming their way. Yes, you want the cash for "emergencies" but should an emergency arise (such as a huge loss in income) that forces you to sell your home after you deplete a $168,000 equity line, Citigroup would be on the hook for it.

Most importantly, the "E" in HELOC stands for equity, (it is likely that you have none or far less than you think) and the "C" in HELOC stands for credit as opposed to your money.

I suggest Citigroup is acting quite reasonably.

Corporations Tapping Equity Lines

Ironically, one reason lending institutions are looking to reduce credit lines elsewhere is corporations are in a mad scramble to tap their lines.

Please consider Porsche, Sprint Unsettle Banks With Rush for Credit.

Citigroup Inc., JPMorgan Chase & Co. and the rest of the banking industry face a new drain on their capital.

Borrowers from Sprint Nextel Corp. to Porsche Automobil Holding SE to MGIC Investment Corp. are drawing on credit lines. JPMorgan analysts say it's the start of a trend that may force banks to raise as much as $40 billion to keep an adequate cushion against potential losses.

Companies are scrambling for cash at one of the worst times for the financial services industry. The world's biggest firms have taken $195 billion in writedowns and losses on securities tied to subprime mortgages, and the 10 biggest U.S. banks have the lowest capital levels in at least 17 years, according to Credit Suisse Group. The tapping of credit lines may be enough to grind new lending to a halt, said David Goldman, a senior portfolio strategist at London-based hedge fund Asteri Capital.

Banks had more than $1.4 trillion in untapped loan commitments as of September, the most since data became available in 1989, according to the Shared National Credit survey by four U.S. regulators including the Federal Reserve and Office of the Comptroller of the Currency.

New York-based Citigroup had $471 billion at yearend, more than any other U.S. bank, according to regulatory filings. Charlotte, North Carolina-based Bank of America disclosed $406 billion of undrawn loan agreements and New York-based JPMorgan had $251 billion. Merrill Lynch & Co. had $59.3 billion.

The added demand from borrowers comes as banks rein in lending to everyone from hedge funds to homeowners in an attempt to preserve capital. A mortgage fund run by David Rubenstein's Carlyle Group collapsed after creditors withdrew financing and Peloton Partners LLP liquidated a fund after demands from banks to repay loans. Leveraged buyouts have slowed to a trickle.

Borrowers will be more inclined to tap credit lines as banks tighten their lending standards, according to Kevin Murphy, a money manager who oversees investment-grade and emerging-market bonds at Boston-based Putnam Investments, which has $65 billion in fixed-income assets.

"It's a vicious cycle," he said. "The more that they tighten the lending standards, the more there will be certain stresses in the financial market. Any sort of unfunded commitments they've put out are likely to be called on."

Sprint, which lost $29.5 billion last quarter, borrowed $2.5 billion in February from a $6 billion credit line arranged by JPMorgan and Citigroup, according to a regulatory filing. Sprint has $1.25 billion in bonds due in November and $400 million of commercial paper.

"If they are short of capital at some point, banks may stop offering credit to borrowers that would normally qualify for a loan," said Anil Kashyap, a professor at the University of Chicago Graduate School of Business, and a former economist for the Federal Reserve. "That's the definition of a credit crunch."

Nina may (or may not be) a good credit risk. I actually suspect she is. But plenty of so called good credit risks will no longer be good credit risks should an emergency arise.

The prudent person needs to have a cash cushion of their own as opposed to a credit line should an unfortunate situation such as the loss of a job happen. Given that unemployment is extremely likely to soar, a sad day of reckoning is coming for the "credit generation".

Those who lose their job and have little or no savings are in for a rude awakening: Cash is not trash but credit sure is.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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WaMu Alt-A Pool Revisited

About a month ago, in Evidence of "Walking Away" In WaMu Mortgage Pool, I wrote about a particular Washington Mutual (WM) Alt-A mortgage pool "affectionately" known as WMALT 2007-0C1 .

Many inquiring minds have been asking for an update of this pool. I am pleased to present a new screen shot of the same Alt-A pool. Once again, thanks go to "CS" for the screen shot.

New chart of WMALT 2007-0C1



click on chart for sharper image

The pool data just keeps getting uglier and uglier.

Month      REO     60+

10-2007   0.00%   11.53%
11-2007   0.04%   13.30%
12-2007   0.64%   16.83%
01-2008   1.83%   19.32%
02-2008   3.56%   22.69%

60 day delinquencies or greater has been rising at a nice steady pace of 2.5% to 3.5% or so every month since August 2007. The Real Estate Owned (REO) number is now a whopping 3.56% of the pool.

Inquiring minds may be asking about lines 7 and 8 as well as the GEO lines at the bottom of the screen shot.

• Line 7 is the sum of lines 3 through 6 (anything 60 days late or greater plus all previous foreclosures and REOs)
• Line 8 is the sum of lines 4 through 6 (anything 90 days late or greater plus all previous foreclosures and REOs).
• The GEO lines (geographic distribution) show this pool is 48% California and 14% Florida.

Cesspool Bottom Line

22.69% of a pool that was 92.6% rated AAA is 60 days delinquent or worse. 3.56% of that pool is REO. That's an amazing performance for an AAA pool whose issue date was May, 2007. At the current rate of progression it would not be surprising to see 30% of this pool get to REO status.

Repeating what I said last month....

Washington Mutual was the underwriter. If you bought a slice of this cesspool from WaMu, are you going to buy their next offering?

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