Tuesday, August 26, 2008

Banks In Trouble and the FDIC

Looks like the FDIC is working on a new business plan. Apparently, closing small banks one at a time is inefficient, slow, and probably not adequate given this unofficial list of problem banks. In truth, it is probable that a big bank or two (or three) is being lined up for failure, and Sheila Bair realizes that they don't have the money.

So what will the enterprising FDIC do? Why, borrow money from the treasury, if it gets its way:
WSJ.com: "Federal Deposit Insurance Corp. Chairman Sheila Bair said Tuesday her agency might have to borrow money from the Treasury Department to see it through an expected wave of bank failures.

Ms. Bair said the borrowing could be needed to cover short-term cash-flow pressures caused by reimbursing depositors immediately after the failure of a bank. The borrowed money would be repaid once the assets of that failed bank are sold.

The last time the FDIC borrowed funds from Treasury came at the tail end of the savings-and-loan crisis in the early 1990s after thousands of banks were shuttered."
The NYT tells us that she is certainly expecting the banking crisis to get worse. They mention that 117 banks are on the troubled list, with assets just under $78 billion.

Do you know that $78B / 117 = $666 million per bank on average? If that isn't an obvious sign of what's to come, I don't know what is.

LEH Rearranges The Furniture

I would love to see LEH sell off their mortgage assets to a new company. It would cause a giant mark-to-market, if the investors were truly arms-length:
Bloomberg.com: Worldwide: "Lehman Brothers Holdings Inc. may set up a company funded by outside investors to buy some of its mortgage assets, aiming to dispel concern the firm faces crippling losses, people familiar with the discussions said.

Investors in the new venture would also manage the holdings, which are linked to commercial real estate, the people said, declining to be identified because the proposal hasn't been made public and no decision has been made about how to proceed. The New York-based firm had about $40 billion in commercial-mortgage assets as of May."
My read is that LEH is just about out of options and time. This smells of desperation to me.

Two of my favorite blogs

If you are looking for folks who nailed the housing meltdown well before it was making headlines, then you need to follow thehousingbubbleblog and calculatedrisk. Although there are many good blogs who contributed, these were the two that made it clearest to me that something was amiss.

CalculatedRisk is especially good at spin-free data, like today's Case-Shiller numbers. While a bunch of headlines were trumpeting expectations-beating performance, CR shows the raw data (and the data are not pretty). Even though the number beat expectations by 1.9%, the market seemed to have taken this as a positive.

Frankly, I think that the worst drop in the history of Case-Shiller is terrible news for the solvency of many banks, and beating the expectation by less than the error in the measurement is not cause to run out and buy madly. But that's just me.

As for The Housing Bubble Blog: Ben Jones has a knack for finding regional anecdotes. After reading for a while, you will get a sense of where most of the country is in the meltdown. Ttoday for example:
“Take Holiday. Energized by furious flipping, the median home sales price peaked at $130,000 in early 2006. By the first half of this year, the median price had hunkered down at $75,000. That’s a drop of 42 percent, one of the county’s worst.”

‘It became investor heaven. Now it’s turned into investor hell,’ said Greg Armstrong, president of the West Pasco Board of Realtors. ‘People didn’t want to be left out, but they got burned instead.’
Areas that are not as far along in the meltdown will not have local stories like the above, so it is good information to see what might be coming down the pike.

Monday, August 25, 2008

Dismissing a Rumor

A Korean regulator dismissed dismissed Friday's rumor about he Korean Development Bank buying Lehman.
Korean regulator reportedly warns against buying Lehman: "South Korea's financial regulator on Monday warned the Korean Development Bank should take a cautious approach to buying an overseas bank, following KDB's expression of interest in Lehman Brothers 'In principle, taking over a global investment bank can become an opportunity to raise the capability of the [Korean] investment banking business,' Jun Kwang-woo was quoting as saying by the Financial Times. 'But at the same time, as the risks are also big, KDB should take a cautious approach.'"
Translation: It ain't gonna happen. No how, no way.
So who unwound their position during the rumor pop?

Friday, August 22, 2008

The Law of Unintended Consequences

Freddie and Fannie are now learning the law of unintended consequences. The recent legislation by Congress to backstop these government sponsored enterprises is now interfering with their ability to raise money in the private markets. After all, who would be foolish enough to provide them with more capital when the government now has the right to step in and wipe out stockholders?
Freddie Hunts for Cash - WSJ.com:
"But that effort is running up against what may be an insurmountable hurdle: Many investors fear any money they invest now in Freddie or its main rival, Fannie Mae, will be lost later if the U.S. Treasury bails out the companies through a purchase of equity in them. Investors believe such a purchase would likely involve terms that would wipe out the value of previously issued shares."
Moody's saw fit to pile on this morning too:
Moody's cut the firms' preferred stock ratings to Baa3 from A1 and their bank financial strength ratings to D+ from B-.

Thursday, August 21, 2008

Auction Rate Securities Penalties

Strange days in New York state: Their AG has reached a deal with three investment banks for malfeasance in the way ARS were sold:
Merrill, Goldman, Deutsche in deal with regulators: : "New York Attorney General Andrew Cuomo said regulators have reached settlements with Merrill Lynch & Co., Goldman Sachs Group Inc. and Deutsche Bank over their roles in selling risky auction-rate securities to investors.

Under the agreement, Cuomo said, Merrill Lynch will buy back roughly $10 billion to $12 billion of the investments from investors by Jan. 2 and pay a fine of $125 million.

Deutsche Bank, which must buy back about $1 billion of auction-rate securities, has been fined $15 million. Goldman Sachs has $22.5 billion of the securities to buy back, and was fined $1.5 billion.

'This has been a great day of progress,' Cuomo said during a conference call.

Cuomo and other regulators previously reached $42 billion worth of settlements with five major Wall Street banks, including Citigroup Inc. and Switzerland's UBS AG. The attorney general threatened earlier Thursday to sue Merrill Lynch if an agreement was not reached by the end of the day."
DB only pays a penalty of $14M (= wrist slap) for selling $1B of securites, but Goldman pays $1.5B for selling $22.5B of ARS? Remind me: Why does Goldman have a good reputation for negotiation?

Credit Cards Manufacturer Slowdown

In a concrete sign of slower issuance of credit cards: JDSU, who manufacturers the optical films for credit cards blamed its bad quarter in part on reduced orders for coatings.

Tech Trader Daily - Barron’s Online : An Indicator Of Consumer Credit Slump:
"It’s not often a fiber optic company tells you a lot in a direct way about the health of consumer spending. However, I had a fascinating discussion last night with Kevin Kennedy, the CEO of JDSU (JDSU), the $2.4 billion (market cap) maker of lasers and other components used in communications equipment. Part of the company’s business, the “Advanced Optical Division,” consists of coatings used on credit cards. That business, which is 13% of sales, was down about 6% in its fiscal Q4, the company last night reported, contributing to the company missing sales and profit estimates.

Kennedy noted that one of the three largest credit card issuers, a customer of JDSU’s, substantially reduced its issuance of new cards in the June quarter. JDSU has material share in the market for card coatings, so with card delinquencies and charge-offs on the rise, this is yet another meaningful indicator that credit card companies are pulling in their horns, lending less. Just one of the surprising economic tidbits you find from a tech company."

Wednesday, August 20, 2008

Another day, another FRE/FNM bombshell

This morning's Fannie/Freddie fiasco centers on whether the twin monsters will be able to roll over $200B worth of debt. Bloomberg's piece raises (yet again) the spectre of treasury intervention, despite all denials from Paulson et al:
Fannie Mae and Freddie Mac's success in repaying $223 billion of bonds due by the end of the quarter may determine whether they can avoid a federal bailout.

Rising borrowing costs and evidence that demand for their debt was waning last month led Treasury Secretary Henry Paulson to seek the authority to pump unlimited amounts of capital in Fannie and Freddie in an emergency. Their interest costs are again increasing amid concern that credit losses are depleting the capital of the beleaguered mortgage-finance companies.

Rolling over the debt "is the single most important factor to their ability to remain liquid," said Moshe Orenbuch, an analyst at Credit Suisse in New York. "So far, they've been able to do that."

"This whole backstop mechanism was set up so the actual need for it could be avoided," said Mahesh Swaminathan, a mortgage strategist for Credit Suisse in New York. ``The market is testing the Treasury's resolve."

New Capital

The companies, responsible for 42 percent of the U.S. home loan market, need as much as $15 billion each in fresh capital to reserve against losses on mortgages and related securities that they either own or guarantee, Paul Miller, an analyst with Friedman Billings Ramsey & Co. in Arlington, Virginia, said.

The Treasury will probably be forced to buy as much as $30 billion of preferred shares in both Fannie and Freddie by the end of next month, according to Bill Gross, who manages the world's biggest bond fund at Pacific Investment Management Co.
I find it both hilarious and sad that the treasury asked for a blank check while claiming that they had no intention of using it. Perhaps those tactics were required in order to get congress to vote for it while holding their nose.
Initial optimism that Paulson's proposal would bolster confidence in the companies has vanished on concern that the deteriorating housing market may force a bailout, a move that would likely wipe out common shareholders and potentially some preferred stockholders, Miller said.
It's time to face facts: The Paulson plan is only a stopgap to kick the problem into the next administration. Who knows? Maybe he'll still pull it off. However, there was no actual "solution" to the problem: The initial loss of confidence requires more than money, it requires serious housecleaning.

The AP put some color on the upcoming capital raising that needs to occur:
Freddie has said it is committed to raising $5.5 billion to help shore up its troubled balance sheet -- that is nearly twice the size of Freddie's current market capitalization of about $2.84 billion.

Fannie's market capitalization is about $6.58 billion. Friedman, Billings & Ramsey Co. analyst Paul Miller estimates Fannie needs to raise between $5 billion and $10 billion in new capital.

But the prospect of government help has been one of the greatest hang-ups in efforts to raise capital from other investors.

Fannie and Freddie could raise those funds through non-governmental investors, but the cost would likely be severe in terms of interest or dividend payouts depending on the structure of the capital raise and in terms of dilution to current shareholders, analysts said.

"The cost of capital of this nature is just staggering," said Ladenburg Thalmann Inc. analyst Richard Bove. Fannie and Freddie could likely raise capital, but it would cost them so much during the current downturn in the credit market that it is unattractive, Bove said.

At a certain price, though, analysts said the companies would find investors. It is just a matter of what costs and stock dilution investors are willing to incur.
I predict that current investors are going to be unpleased with the results.

Tuesday, August 19, 2008

Large U.S. bank collapsing: report

In the morning news, inflation is raging at the producer level and housing starts continue to tank.

Again, the headlines are hiding some significant developments, one of which is that an Ex-IMF economist sees large U.S. bank collapsing:
: "Kenneth Rogoff, the former chief economist of the International Monetary Fund, reportedly said Tuesday that a large U.S. bank will collapse in the next few months. 'We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks,' Rogoff told a conference in Singapore, according to a Reuters report."
It is important that investors abroad keep faith in the American banks, since foreign investment plays such a large role in our current financial system. God help us if that unwinds quickly.

Monday, August 18, 2008

Merrill, Wachovia in Danger of Failing

Most of the headlines this morning are about tough times at Lehman. As a consequence, others are getting lost in the shuffle:
Merrill, Wachovia in Danger of Failing: "The amount of cash written off Merrill Lynch and Wachovia's balance sheets since the onset of the credit crisis still far outweighs the amount of cash they have raised, suggesting the need for fresh capital injections."
As has been mentioned on this blog, John Thain is in definite need of Pinocchio nose-elongation surgery.

Saturday, August 9, 2008

Gone Hiking

It's time for me to trade views of the Rockies for those of my computer.
I'll be back on the 17th.

Friday, August 8, 2008

The Citi Snowball

Looks like the Citi settlement is going to cause a snowballing effect:

UBS to buy back stricken debt securities:
Swiss bank UBS has agreed to buy back $19.4 billion of debt securities whose value collapsed during the global financial crisis, and to pay $150 million in fines to settle charges that it misled investors, a Massachusetts official said on Friday.

Hedge Fund Exit Stampede

One interesting aspect of the current stampede out of hedge funds is the comparison to LTCM (Long-Term Capital Management), which was the first great hedge fund meltdown requiring Fed intervention. LTCM was thought to be large threat to the financial system in 1998, but now it looks like small potatoes:
Greenwich, Connecticut-based LTCM leveraged $2.3 billion of capital into holdings of about $125 billion before its collapse, which roiled financial markets and led to a bailout organized by the Federal Reserve. The company lost $4.6 billion and received a $3.5 billion bailout from 14 lenders in 1998.

July ranks among the worst months of performance for hedge funds. Chicago-based Hedge Fund Research Inc.'s Weighted Composite Index, based on data from more than 2,000 funds, fell 2.4 percent in the month and is down 3.5 percent year-to-date, which would be the worst annual performance since at least 1990.

A mere $125 billion? Pfft. Definitely small potatoes.

Wednesday, August 6, 2008

AIG Bad News, and More Bad News

AIG posted a $5+B dollar 2Q loss yesterday, and that is the bad news.

The "more bad news" is that there's more on the horizon. As one example: AIG listed about $21B of CMBS (Commercial Mortgage-Backed Securities). Of their CMBS investments, 24% were 2007 vintage; 32% were in either New York or California.

The CMBX spread since June 30th, the closing date of AIG's report, has already risen from 750 to 1000 bps. (An increase of the spread implies a decrease in the value of the mortgages.)

That's $21B that didn't even make the article in Bloomberg. Things like their $460B notional value credit default swaps, of which CDO exposure composes $80B, grabbed most of the column space.

However, as the chart above shows: More losses are already baked into the cake.

Tuesday, August 5, 2008

CDO Issuance and Merrill Sale

I spent some time looking at the recent Merrill announcement in detail. Let's combine a few data: First, from a terrific series in the Financial Times

Notice that the bulk of the CDO issuance is 2006 and beyond. Now let's look at the exact phrasing of the Merrill announcement:
On a pro forma basis, this sale will reduce Merrill Lynch’s aggregate U.S. super senior ABS CDO long exposures from $19.9 billion at June 27, 2008, to $8.8 billion, the majority of which comprises older vintage collateral – 2005 and earlier.

1. Only "super senior" tranches were included. "Senior" and lesser tranches are omitted. They might have a trillion dollars in exposure, but we'd never know from this release.

2. The majority of $8.8B of continued exposure (which might be 50.0001%) is pre-2005. If the ratio of the original $20B of exposure was in the ratio of the Financial Times graph, then the part that got sold off was post-2005 by a wide majority.

3. Until there are realistic valuations of Tier 3 items and an elimination of off-balance sheet items, a safe assumption would be to assume that Merrill's 22¢ on the dollar sale (really 5.5¢, since they financed the buyers) is an upper bound for seller-financed deals.

When sellers have highly asymmetric information about an item for sale, intelligent buyers should demand a discount. I cannot think of a better example of this than MER common stock. God only knows what other crap is waiting for recognition on the books.

Monday, August 4, 2008

Credit Card Securitization

It appears that we have a horse race. I would guess that commercial real estate is going to be the next headline-grabbing meltdown, Credit Cards are going to give us a run for the money.

From Bloomberg: Citigroup Posts Loss on Credit-Card Securitizations

"The biggest U.S. credit-card lender lost $176 million in the second quarter packaging card loans into securities, the company said in an Aug. 1 regulatory filing. The New York-based bank completed fewer deals and was forced to mark down its own $9 billion stockpile of the debt instruments and other stakes the company amassed while selling them to investors.

Led by Chief Executive Officer Vikram Pandit, 51, Citigroup manages about $202 billion of credit-card loans worldwide, about $111 billion of which have been turned into securities and sold, according to the filing. Delinquencies on the securitized portion have jumped by 16 percent since the end of last year to $2.16 billion as of June 30, Citigroup said. The firm's results may portend similar losses for rivals.

Banks and other card issuers ``are predicting higher net charge-off rates across the credit-card industry,'' said Meghan Crowe, a Fitch Ratings analyst who tracks credit-card issuers including American Express Co., Capital One Financial Corp. and Advanta Corp. ``Things have been worse than anticipated.''"

Saturday, August 2, 2008

S&P Introduces "Ridiculous" rating

Just when you thought it was safe to back into the water: S&P was fully aware of the
undeserved CDO ratings

In one email message, an S&P analyst called a mortgage or structured finance deal "ridiculous" and wrote "we should not be rating it."

In another email, an S&P manager said ratings agencies were helping to create an "even bigger monster -- the CDO (collateralized debt obligation) market. Let's hope we are all wealthy and retired by the time this house of card falters."

I don't know what S&Ps penalty should be, but it should be large.

As an aside: PR departments throughout the US know that if you have to drop a bomb, do it for the Saturday papers, which has the least readership in the news cycle. If all goes well, somebody else's bomb drops for the Sunday papers, so that everyone forgets your bad news.

Friday, August 1, 2008

Paulson vs Greenspan

I don't know how it's even possible to be an average guy who believes everything he reads. Just yesterday, I was filled with happy economic fervor as Hank Paulson helped us reject pessimism in the economy:

Paulson says housing remains biggest threat

Paulson predicted in a speech to a Washington audience that the economy will continue growing at a moderate pace for the rest of this year, despite housing slump-induced problems.
... Paulson said he expected foreclosures and the level of unsold homes would likely remain "substantially elevated this year and next and home prices are likely to decline further on a national basis."

Nevertheless, he predicted that the bulk of the housing slump would be over in months, instead of years.

Great! We only have a few months until this whole housing-induced economic nightmare is over. So I was whistling among the flowers with Disney birds swirling around my head when this article started raining on my parade:

"'Fannie and Freddie are a major accident waiting to happen,' Greenspan said. He said that they are an 'unstable structure' and should not continue to exist as quasi public/private entities. He suggested that Fannie and Freddie should be nationalized and then broken up into a group of smaller entities, which could be sold back into the market.

Greenspan also said the U.S. is on the brink of recession, and a key factor that could tip the economy is the slowing growth in the world economy. He also made a rather disturbing comment about the current financial crises.

'We've had huge amounts of liquidity engendered by central banks, and it's getting increasingly evident that this is a once-in-a-century type of phenomenon. It is not the standard liquidity crisis we've seen in the past. It's verging on the issue of solvency,' he said."

So on the one hand, I have Paulson telling me this whole mess is going be behind us Real Soon Now, and then Greenspan tells me to go out and nationalize Fannie and Freddie, and implied that the shareholders are going to be zeroed out.

I can only conclude that Greenspan rejected Paulson's rejection of pessimism.