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Five Things You Need to Know: Ghost in the Machine Slowly Grinding to a Halt; Housing Slump Contained to Only Those Things Affected by Housing Slump; Jai Guru Containment; Speaking of Increasing Loss Provisions; Major Statistical Errors in Economics


What you need to know (and what it means)!


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Ghost in the Machine Slowly Grinding to a Halt

The market for collateralized debt obligations is slowly grinding to a halt, according to Bloomberg, threatening one of Wall Street's sacred cash cows - (read: $8.6 bln in annual underwriting fees) - and reducing the availability of credit for everyone from major Wall Street buyout firms to homeowners themselves.

  • Sales of collateralized debt obligations (CDOs), which are used to pool bonds, loans and their derivatives into new debt, fell to $9.1 billion in July, down from $42 billion in June, analysts at JPMorgan Chase (JPM) said, according to Bloomberg.
  • What's behind the declining appetite for CDOs?
  • The near collapse of two Bear Stearns (BSC) hedge funds, for one. The downgrade of 75 CDOs by the ratings agency S&P, for two. And concern about growing losses due to rising homeowner mortgage defaults, for three. Those are just for starters.
  • OK, so what are we really talking about here with these so-called CDOs?
  • CDOs were created in 1987 by bankers at Drexel Burnham Lambert.
  • Wait a minute.
  • Did you say Drexel Burnham Lambert?
  • Isn't that the same firm that was driven into bankruptcy in 1990 due to illegal trading in junk bonds driven by Drexel employee Michael Milken?
  • And did you say they were created in 1987?
  • The same year the market crashed?
  • And wasn't the 1980s known as the "Decade of Greed"?
  • Yes, yes, yes, yes and yes.
  • So let's see if we got this right.
  • Today, in 2007, the market for securities that were created in the "Decade of Greed" by a firm that was only a short time later forced into bankruptcy due to illegal trading in high-risk bonds is grinding to a halt?

2. Housing Slump Contained to Only Those Things Affected by Housing Slump

Countrywide Financial (CFC), the biggest U.S. mortgage lender, reported its third straight decline in quarterly profit due to increases in late loan payments.

  • Countrywide this morning reported that second-quarter net income fell 33% and revenue fell 15%.
  • The company also reduced its forecast for earnings for this year.
  • Why the grim forecast?
  • The company said profit was hurt by impairment charges on securities backed by
    prime home-equity loans.
  • Well, of course they said that. This subprime mess is going to continue to hurt for awhile. Even Bernanke said so last week.
  • No, sorry. Read that bullet point again: The company said profit was hurt by impairment charges on securities backed by prime home-equity loans.
  • Countrywide Chairman and Chief Executive Angelo Mozilo said "delinquencies and defaults continued to rise across all mortgage product categories."
  • The company also noted it has set aside $293 mln for loan losses in the quarter, more than triple the level a year earlier, blaming a loan-loss provision of $181 mln on prime home-equity loans, the Wall Street Journal said.

3. Jai Guru Containment

Contained. Contained. Contained. It's out there like a new mantra. But where does it come from? Is it herding behavior? Or perhaps it's an organized propaganda campaign from a group we'll call the Containers. Whatever it is, it's really starting to freak us out a little bit.

  • Look at it! Here's the word from the Containers... and this is just in the past 30 days.
    - The market shrugged off comments by U.S. Treasury Secretary Henry Paulson, who said on CNBC television on Monday that problems in the subprime mortgage loan sector could be CONTAINED. - Reuters, Khaleej Times, July 24, 2007
    - Lehman Brothers Holdings Chief Financial Officer Christopher O'Meara told investors on a June 12 conference call that "we continue to believe that subprime market challenges are and will continue to be reasonably CONTAINED." - Charlotte Observer, Bloomberg News, July 24, 2007
    - The U.S. Treasury Department Friday said the recent woes in the subprime mortgage market appear to be CONTAINED. - Reuters, July 20, 2007
    - Fed's Poole: "Subprime woes look CONTAINED." - Yahoo News, Reuters, July 20, 2007
    - "The subprime problem appears to be CONTAINED,'' said Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York. - Bloomberg, July 17, 2007
    - Chicago Fed study sees subprime woes CONTAINED. - Reuters, June 28, 2007
    - Freddie Mac says subprime rout "severe but CONTAINED." - Bloomberg, June 26, 2007

4. Speaking of Increasing Loss Provisions

In Number Three today we saw where Countrywide more than tripled the amount it is setting aside for loan losses in the second quarter. Similarly, American Express (AXP) yesterday said it was raising its provisions for credit card losses in the US by 85%.

  • On the bright side, American Express reported that record spending had fueled a 12% jump in profit.
  • But the company raised its provisions for losses in its United States card business by 85%, to $640 million, and its total loss provisions by 36% to $993 million.
  • Moreover, the percent of credit card loans written off on an annualized basis rose to 4.1% in the second quarter from 3.8% a year earlier.
  • So why the increase?
  • In the conference call, acting CFO Dan Henry noted, "The increase in lending provision was driven by higher loan volumes and increased past-due and write-off rates relative to the lower year-ago levels that benefited from the impact of the 4Q05 U.S. bankruptcy legislation."
  • Overall, Henry in the conference call maintained the company is not seeing a deterioration in credit quality among its customers.

5. Major Statistical Errors in Economics

While preparing for tomorrow's release of Existing-Home Sales and Thursday's release of New Home Sales, we were taking a look at
the most recent New Home Sales figures from the US Department of Housing and Urban Development when we came across this:

"These statistics are estimated from sample surveys. They are subject to sampling variability as well as nonsampling error including bias and variance from response, nonreporting, and undercoverage. Estimated average relative standard errors of the preliminary data are shown in the tables."

What does that mean? Well, in the case of May's New Home Sales, which were reported down 1.6% from April, but with an error of +/- 10.8%, it basically means May sales could be anywhere from down 9.2% to up 12.4%. So, in other words, who knows!

After doing some careful research, Minyanville has learned that statistical errors in economics reporting are actually far more common than one might think. Below are some of the more shocking errors in economics statistics.

Minyanville Flashback: Major Statistical Errors in Economics

400,000 BCE:
Homo sapien 1 crushes skull of Homo sapien 2 with boulder after economic release mistakenly shows dramatic 100% decline in expected fish output. Homo sapien 1 later learns the error was related to an unexpected increase in dinosaur population shortly before being eaten by a dinosaur.

June 21, 1979: President Jimmy Carter signs Congressional bill mandating a 68% tax increase on The Man after a statistical error in the US Census Bureau Report incorrectly showed The Man's share of total US wealth had risen to 99% of GDP from its actual reading of 98% of GDP.

November 18, 1983: All beige books in Kansas City, MO libraries are burned after local television news station anchor mistakenly reports economists believe "beige books" indicate pending recession. It was later learned that the reporter meant believe the Fed's Beige Book report indicates a pending recession, not all beige books.

February 9, 1998: Stock market rallies 23% after then-Federal Reserve Chairman Alan Greenspan inadvertently substitutes Crazy Eddie Discount Electronics ad for interest rate testimony and promises to slash short-term Fed Funds rate to crazy, never-before-seen rates of 90 days same as cash.

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