WSJ.com: Anatomy of the Morgan Stanley Panic

BUSINESS | NOVEMBER 24, 2008

Anatomy of the Morgan Stanley Panic

Trading Records Tell Tale of How Rivals’ Bearish Bets Pounded Stock in September

By SUSAN PULLIAM, LIZ RAPPAPORT, AARON LUCCHETTI, JENNY STRASBURG and TOM MCGINTY

 

Two days after Lehman Brothers Holdings Inc. sought bankruptcy protection, an explosive rumor spread that another big Wall Street firm, Morgan Stanley, was on the brink of failure. The chatter on trading desks that Sept. 17 was that Deutsche Bank AG had yanked a $25 billion credit line to the firm.

John Mack

That wasn’t true, but it helped trigger a cascade of bearish bets against Morgan Stanley. Chief Executive Officer John Mack complained bitterly that profit-hungry traders were sowing panic. Yet he lacked a critical piece of information: Who exactly was behind those damaging trades?

Trading records reviewed by The Wall Street Journal now provide a partial answer. It turns out that some of the biggest names on Wall Street — Merrill Lynch & Co., Citigroup Inc., Deutsche Bank and UBS AG — were placing large bets against Morgan Stanley, the records indicate. They did so using complicated financial instruments called credit-default swaps, a form of insurance against losses on loans and bonds.

FT.com: Is America’s house price crash at last bottoming out?

FT.com on house prices.

FT: Is America’s house price crash at last bottoming out ?
(Link: http://www.ft.com/cms/s/0/91dd4430-7ea0-11dd-b1af-000077b07658.html)

For Leon Belenky, the low came at the beginning of summer. "Everybody was sitting on the sidelines," says the Florida real estate broker. "They were waiting to see what was going to happen and no one was buying."

But Mr Belenky, a former software consultant who moved from New York in the mid-1990s to deal in beachfront condominiums and other high-end homes, says he recently detected an improvement. That came even before the cautious optimism generated by the government takeover at the weekend of Fannie Mae and Freddie Mac, the two mortgage giants.

He says American buyers seem ready to move back into the market, whereas previously interest was confined to foreigners trying to take advantage of the weak dollar. At Jade Beach, a luxury high-rise development just north of Miami, clients are following through on commitments to buy several units. Mr Belenky had been nervous they might back out. "Although we are still seeing some turbulence on Wall Street, I think the worst is already behind us," he says.

Brad Setser: Quaint

Quaint

Posted on Wednesday, August 13th, 2008 by bsetser

The Economist – in the course of its analysis of the Fed’s response to the credit crisis — noted that only a few years ago the Fed got rid of its Agency holdings because it didn’t want its asset purchases to distort the allocation of credit in the US economy.

“Politicians have asked the Fed to favour certain industries or keep interest rates low almost from its birth. In 1921 the Fed rejected requests from Congress to buy long-term agricultural debt. In the 1940s and again in the 1960s, under pressure from the Treasury, it bought bonds to hold down long-term interest rates. In the 1970s, at the behest of Congress, it bought the debt of federal agencies such as Fannie Mae and Freddie Mac.

A 2002 staff study pointed out the risks of favouring particular assets or borrowers: it could result in too much investment in preferred sectors and too little in others, drag the Fed into arguments about fiscal policy and compromise its monetary policy. In recent decades the Fed largely extracted itself from anything resembling credit allocation. The last of its Fannie bonds matured in 2003.”

Obviously, the Fed has shed its inhibitions here over the past year — though helping the banks avoid forced sales of their existing assets into an illiquid market arguably has less impact on the allocation of future credit than buying securities other than Treasuries when times are good. still, there are concerns that the Fed is now shaping the allocation of credit in the US economy. The Economist writes:

“The central bank is lending to private companies on an unprecedented scale and is thus making decisions it long sought to avoid about the allocation of credit. It is also acquiring new powers of oversight. Politicians could chafe at the Fed’s power: why, they might ask, should unelected officials choose who benefits from taxpayers’ money? And they might press the central bank to pursue political ends—such as propping up favoured borrowers—that interfere with monetary policy ….

That brings up an interesting question: If Americans are uncomfortable having the Fed shape the allocation of credit in the US economy, shouldn’t they be equally uncomfortable when foreign central banks — notable China’s central bank — shape the allocation of credit in the US economy through their asset purchases?

Brad Setser: the June US trade data

The June US trade data

Posted on Tuesday, August 12th, 2008 by bsetser

In July, China posted rather impressive export growth — all things considered. US imports from China in July aren’t known, but US imports from China were only up 2.9% y/y in June. During the first half of the year, US imports from China are only up 4.2%. The US hasn’t been driving Chinese export growth — Europe has.

And in June, US exports were up 21.1% y.y ($164.4b v $135.7b). Non-petrol good exports were up 17.7% y/y — so it wasn’t all driven by higher prices on the United States (small) petroleum exports. Real goods exports were up 11% in June, and 9.6% for the first half of the year. And real non-oil goods imports aren’t growing. Real non-petrol goods imports in June 2008 were 2.7% lower than in June 2007 — and for h1, real non-petrol goods imports are down by a bit less than 1%.

Exports of corn, beans (and other oilseeds) and wheat are up 90% in nominal terms, rising from $13.6b in the first half of 2007 to $25.9b in the first half of 2008. It isn’t all just higher prices — real exports of foods, feeds and beverages are up 10%. The United States’ financial capital should be grateful it is linked in a currency union to the agricultural Midwest; think where the dollar would be if the US only exported repackaged residential mortgages. Quips about flyover country should stop …

Ben Bernanke: Reducing Systemic Risk

Ben Bernanke: Jackson Hole Symposium Speech

Chairman Ben S. Bernanke
At the Federal Reserve Bank of Kansas City’s Annual Economic Symposium, Jackson Hole, Wyoming
August 22, 2008
Reducing Systemic Risk

In choosing the topic for this year’s symposium–maintaining stability in a changing financial system–the Federal Reserve Bank of Kansas City staff is, once again, right on target. Although we have seen improved functioning in some markets, the financial storm that reached gale force some weeks before our last meeting here in Jackson Hole has not yet subsided, and its effects on the broader economy are becoming apparent in the form of softening economic activity and rising unemployment. Add to this mix a jump in inflation, in part the product of a global commodity boom, and the result has been one of the most challenging economic and policy environments in memory.

The Federal Reserve’s response to this crisis has consisted of three key elements. First, we eased monetary policy substantially, particularly after indications of economic weakness proliferated around the turn of the year. In easing rapidly and proactively, we sought to offset, at least in part, the tightening of credit conditions associated with the crisis and thus to mitigate the effects on the broader economy. By cushioning the first-round economic impact of the financial stress, we hoped also to minimize the risks of a so-called adverse feedback loop in which economic weakness exacerbates financial stress, which, in turn, further damages economic prospects.

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