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"Troubles are a lot like people -- they grow bigger if you nurse them" (author unknown).
I think it is way too early to claim that the worst is over for the mortgage-backed securities market. Thursday's disclosure from Thornburg Mortgage (TMA, news, msgs) that it was forced to pay $300 million in new margin calls is the first warning bell of what might be another spiral of write downs -- and thus more dilution to come -- in the financial sector.
The Thornburg situation is significant for several reasons. During the "go-go" days of the subprime boom, Thornburg represented the gold standard of conservative underwriting standards for the whole sector. It kept only the highest-quality assets on the balance sheet, and thus when the whole subprime sector caught a fever last summer, TMA was widely believed to be a "thriving oasis" in the subprime desert.
But when the commercial paper market effectively shut down back in August, Thornburg's share prices tumbled from the high $20s into the teens in a matter of days. Being a contrarian investor myself, I sensed fear and thus opportunity, and after carefully studying their balance sheet, I started a position. But to my surprise, Thornburg's share price kept declining daily. So assuming that their portfolio was of high enough quality to sustain some short term losses, I bought more.
Long story short, it was one expensive lesson, and I won't repeat it again.
A lesson from a costly mistake
Thornburg not only turned out to be one of my two largest losers during the last Strategy Lab contest but also taught me a valuable lesson -- in the event of the severe dislocation in financial markets, asset quality is significantly less important than steady and ample access to liquidity. Because of their heavy reliance on short-term financing in a form of commercial paper, Thornburg was forced to sell some of their best assets at a huge discount to meet margin calls, which triggered more write downs and thus more margin calls.After huge write downs and liquidity injections last fall, things seemed to have gotten much better for the troubled lender. It actually managed to report a profit in the most recent quarter and has even paid a dividend again. The stock has rallied strongly just like the rest of the financial sector. Unfortunately, as the most recent announcement from TMA and UBS confirms, it looks like we might be in for another round of the same troubles.
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I know there have been a number of reports in the media stating that conditions have improved markedly for the battered financial sector, but I question this logic for a number of reasons. First, it is true that rate cuts from the Ben Bernanke Fed theoretically increase the value of assets on the balance sheet and thus help the financial sector. These rates cuts also usually lead to lower mortgage rates, but not today because of inflation. Mortgage rates actually hit a multimonth high last week, according to Bankrate.com.
If the Fed can't read the writing on the wall, I think someone needs to spell it out: "No more rate cuts!" I think that Fed is either asleep at the wheel or they are just playing some of kind of silly game that I do not understand. We keep hearing a story from Fed officials that inflation is not really an issue, and the headline inflation number excluding food and energy does not matter.
What? We are talking about 4%-plus inflation. This kind of hands-off attitude toward price stability from the head of a central bank of a developed country is simply incomprehensible and irresponsible.
Blame lax monetary policy
The truth of the matter is simple -- inflation is always driven by excess liquidity and thus is always a pure monetary phenomenon. Blaming high inflation on high oil and food prices is a very convenient cover up for populist politicians, but the truth is much simpler: The housing bubble and the oil bubble are a direct result of lax monetary policy. Period.All the explanations about the impact of the rising demand from China are simply overblown. The world has plenty of spare oil production, and even the most recent OPEC moves were to cut production -- case closed.
Continued: We will pay for the Fed rate cuts
(Editor's note: Due to problems with his portfolio, The Amateur's trades were not originally posted with this journal. They were submitted Sunday evening to take effect with Monday's open.)
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