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Friday, February 29, 2008 10:36 PM

Free Fall In Munis, Worst Month Since 2003

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Bloomberg is reporting Munis Have Worst Month Since 2003.

U.S. municipal bonds are headed for their worst month in more than four years after collapsing demand for securities with rates set at periodic auctions sent debt costs for state taxpayers and hospitals as high as 20 percent.

The $330 billion auction-rate market froze after dealers stopped purchasing the bonds when buyers failed to bid. Their lack of support has spread to the broader tax-exempt market, sending yields soaring. Borrowers from California to New York City plan to convert the securities to longer-term debt, raising concern that a flood of bonds will overwhelm already sparse demand from banks and hedge funds.

"We're going to get smashed with new-issue volume from all these auction-rate bonds" that are being converted, said Brian Battle, a trader and vice president at Performance Trust Capital Partners in Chicago.

"Every alternative we turn to is worse than it was a year ago," said Roger Anderson, executive director of the New Jersey Educational Facilities Financing Authority, which sells bonds for colleges in the state.
Professor Bennet Sedacca on Minyanville had this to say about Munis today.
My firm has avoided municipal bonds for years now. The above Bloomberg article, an excellent piece by Jeremy Cooke shows why.

This is not a back slapping exercise, it is an exercise in just how bad a 'credit unwind' can get. I expect that many municipal bond portfolios will now get marked down in a big way. Net asset values of all sorts of municipal mutual funds, both closed end and open end will likely get smashed. How badly? It depends on the quality but I am guessing anywhere from 5-20%.

All sorts of 'bid lists' are hitting Wall Street, but not much as trading as folks are appalled at the bids compared their values on their statements. But I will say this. My firm has been waiting on this and I am now getting interested in the municipal market as an opportunistic trade. I am not quite sure at what level as markets tend to overshoot on the upside and downside, so we will now monitor this market for signs of extreme fear and pessimism to enter the market for my firm's investors and our fund.
Here is followup commentary from Sedacca a bit later in the day.

Muni Market in Disarray

As a follow up to the couple of pieces I wrote on munis, the Shoe has officially dropped... like an anvil.

Sources are telling me that the municipal bond market has all but seized up. Bid list after bid list surface, but nothing trades. The reality is that the bids are 10-15 points under statement values.

I have also heard of a few muni arb funds liquidating and shutting down (these funds mainly buy munis and short govies when the spread is wide). Well, it will get wider, and wider, and wider, until the margin clerk arrives.

If I owned a muni fund, I would not trust the nav, particularly in closed end levered funds. Be careful, folks. And don't panic...
With that, let's take a look at a list of closed end muni funds compiled by professor Kevin Depew. Click on any chart to see a sharper image.

Blackrock Long Term Municipal Advantage Trust

Blackrock Long Term Muni Yield Quality Fund II

Blackrock Strategic Muni

Eaton Vance Insured Municipal Bond Fund

Nuveen Prem Muni Fund

A forced unwind in leverage is now underway, with fingers pointed in the wrong direction (see Hedge Funds Blame Wall Street Instead Of Themselves). Anyone over-leveraged in anything right now should be scared half to death.

Mike "Mish" Shedlock
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1:04 PM

Ambac Deal Hits Snag, MBIA writing "Very Little" New Business

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CNBC is reporting Ambac Deal Hits Snag Regarding Raters' Capital Demands.

CNBC's Charlie Gasparino did not take to the air at the appointed 3:30 p.m. EDT to declare an impending deal to bail out Ambac. Breaking news? Broken record news might be more like it.

Intoned Charlie at 7:42 a.m. this very morning:

"The bailout of troubled bond insurer Ambac has hit a significant snag, after rating agencies demanded more capital from the consortium of banks involved in the bailout effort, CNBC has learned.

People close to the deal are confident that it will still happen, because the banks and the rating agencies are aware that, if it collapses, there will be a huge decline in the stock market."

So apparently, the rescue deal (whichever one we are talking about now) hit snags. But guess what? It might still happen, so let's revisit just how often he's oversold this story.
Dow Jones Had This Take
Ambac Financial Group Inc. (ABK) hit a "significant snag" Wednesday in its restructuring effort, CNBC's Charlie Gasparino reported Friday.

At issue is a disparity between how much money a bank consortium is willing to invest in the troubled bond insurer and how much capital cushion ratings agencies require to maintain the company's rating given a structure that would separate the municipal bond insurance from the collateralized debt obligations.

The consortium banks and Ambac are devising a new proposal to present to the ratings agencies, Gasparino said, "citing people close to the deal."

He added that talks are ongoing and the deal is not dead.
Translation: The Deal Is Dead Or Irrelevant

This is just one of several significant "snag" that await the monolines. Even if Ambac is funded with "sufficient capital" to meet the non-existent requirements of Moody's, Fitch, and the S&P (See MBIA Maintains Highest Rating, Pfizer Cut), the one certainty is that still more funding will will be required down the road.

After all, who wants to buy insurance from Ambac or MBIA with the CDO cloud hanging over their heads, when insurance could instead be bought from Warren Buffett instead?

Little New Business

Bloomberg is reporting MBIA Writing `Very Little' New Business Amid Scrutiny.
MBIA Inc. is writing "very little'' new bond insurance business as borrowers balk at buying a guarantee from a money-losing company without stable AAA credit ratings.

MBIA, whose ratings were under scrutiny by Moody's Investors Service and Standard & Poor's for more than three months, said losses on mortgage-backed securities will probably increase this year and expand beyond subprime mortgages.

"The demand for our product is the lowest it has been, and we are writing very little new business," the company said in a filing today with the U.S. Securities and Exchange Commission.

Credit-default swaps tied to MBIA's debt jumped 106 basis points to 705 basis points, according to London-based CMA Datavision, a signal of eroding investor confidence in the company's creditworthiness. Contracts on its insurance unit, which investors and banks have been using to hedge against the risk the company loses its top ratings, rose 77 basis points to 505, CMA prices show.
It's Time To End The Pretending

While Moody's, Fitch, and the S&P all pretend that the guarantees of the monolines are worth something, the CDS market and the insurance buyers believe otherwise. Has there ever been an AAA rated company in history with swaps trading over 700?

Wishin' and Hopin' and Pretendin' will not turn a cow chip into a gold eagle. And the longer the ratings agencies live in Bizarro World, the more instability there will be in the system. It's time to end the pretending.

Mike "Mish" Shedlock
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11:47 AM

Hedge Funds Blame Wall Street Instead Of Themselves

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As strange as it may sound, Hedge Funds Blame Wall Street For Lending Crackdown.

Peloton Partners LLP, the London- based hedge-fund manager being forced to liquidate a $1.8 billion asset-backed fund, said it's a victim of the lending drought on Wall Street.

"Credit providers have been severely tightening terms without regard to the creditworthiness or track record of individual firms, which has compounded our difficulties and made it impossible to meet margin calls," Peloton co-founders Ron Beller and Geoff Grant said in a letter yesterday to clients.
My Comment: That is the spin. The truth is hedge funds over leveraged into debt instruments they did not understand, pushing risk premiums to all time lows. The herding behavior of hundreds of hedge funds all paying the same game had to end, yet every one of them thought they would be the ones to be able to get out. This is what happens when liquidity dries up. Every one of them is stuck. Those with the most leverage will go bankrupt.
Peloton joins Thornburg Mortgage Inc. and Sailfish Capital Partners LLC on the growing list of funds and companies that have had to sell securities or shut down after banks restricted how much they could borrow, or demanded more collateral as values of securities backed by mortgages slumped. The world's biggest financial institutions are cutting off lines of credit to hedge funds after at least $163 billion of asset writedowns and market losses.

"More hedge funds will blow up this year than ever before," said Michael Hennessy, who helps oversee $10 billion of hedge fund investments at Morgan Creek Capital Management in Chapel Hill, North Carolina. "Financing is much harder to get. The bubble has burst."
My Comment: I expect 30-50% of all hedge funds in existence today will not be in business a few years down the road. Increasing risk aversion of investors over time, 20% fees, and illiquidity will all play a major role.
The price of top-rated Alt-A securities, which rank above subprime, dropped 10 percent to 15 percent this month, according to Thornburg Mortgage, the Santa Fe, New Mexico-based finance company which yesterday said it may sell securities to meet further margin calls, after burning through cash.
My Comment: I reported on "Top Rated" Alt-A securities in Evidence of "Walking Away" In WaMu Mortgage Pool. If you have not seen the chart, take a look. It's pretty stunning. 92.6% of a Washington Mutual Alt-A pool of recent vintage was rated AAA. Yet 15% of the whole pool is in foreclosure or REO after a mere 8 months!
"Risk managers everywhere are revisiting how collateral is being priced so you're seeing margin calls," said Kenneth Hackel, managing director of fixed-income strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut. "As risk appetites decline, the price of assets that are used as collateral decline."
My Comment: For many hedge funds and companies, this re-evaluation is too late. There is simply no bid now for many credit derivatives people are stuck in.
UBS needs to reduce its balance sheet from 2.3 trillion francs ($2.2 trillion) to less than 1.7 trillion francs, and reducing ties to hedge funds is a likely lever, Van Steenis wrote in an e-mail today.

An increase in margin calls may drive prices even lower, RBS's Hackel said.

"I feel like so many shoes have already dropped, the shoe store should be empty by now," he said. "I'd like to think we're pretty close to the end of the game, but I can't say that with any degree of confidence."
My Comment: Most shoes are in mid-air, not even close to the ground. Commercial real estate is just starting to implode, unemployment is just starting to rise, people are just starting to walk away, and the equity markets have just started to fall.

Furthermore, China is overheating, commodity herding is rampant, and a blowup of the Yen carry trade has not yet gained traction. Those are shoes still waiting to drop, as is an unwinding of $50 trillion in credit default swaps, Lord only knows how many of which are marked to market.

It's not realistic to think that the biggest credit boom in history, a boom that took over 20 years to build, a boom that went exponential over the last seven years, can be corrected in a 10% pullback in the S&P from all time highs. Time and price are the key. We are a long, long way away on both fronts. The shoes that people think have already hit ground are still in mid-air and falling, with still more shoes still in the store to be dropped.

Mike "Mish" Shedlock
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3:02 AM

Keeping Down With The Joneses

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Less than a year ago it was a struggle to keep up with the Joneses. Now the Joneses are not spending. The new struggle is to keep down with the Joneses. This theme is discussed in Consumers cut back on small pleasures.

Such small luxuries seemed almost necessities in happier economic times. But no more for lots of folks, including those and other USA TODAY readers who described how they've changed their habits.

The murky financial outlook and recession fears are factors. Another driver: fear of being out of step with a cultural mind-set that increasingly says less is more. If your best friend and next-door neighbors are cutting back on little luxuries, shouldn't you be, too?

"For years, we had the opposite. It was all about keeping up with the Joneses. Now, the Joneses are starting to cut back," says Ellie Kay, author of 12 personal finance books.

"There's a sense that prices are rising — and will continue to rise — but wages will not," says Ken Goldstein, economist at The Conference Board. "This is squeezing household budgets whether they're $200 per week or $200,000 per year. Folks are looking closely at anything they don't have to purchase now."

"The new status isn't how much you've got, but your ability to show what you don't spend," says futurist Watts Wacker, who advises businesses on trends.

"This is a seminal moment. It's not a fad that will die out when the economy picks up."

Trends guru Faith Popcorn puts it this way: "It's cooler not to spend."
Borrowers Abandon Mortgages

The Wall Street Journal is reporting Borrowers Abandon Mortgages as Prices Drop.
As home prices plummet, growing numbers of borrowers are winding up owing more on their homes than the homes are worth, raising concerns that a new group of homeowners -- those who can afford to pay their mortgages but have decided not to -- are starting to walk away from their homes.

In the Phoenix area, where home prices were off 15% in the fourth-quarter when compared with a year ago, accountant Steven Ulrich says several of his clients have recently said they plan to walk away. One client's home is now worth $100,000 less than the mortgage and the other is $60,000 underwater.

"It surprised me," said Mr. Ulrich, who works at The Focus Group in Scottsdale. "I'd never had people doing that before, if they had to it was something they were forced into. But these people are choosing it as a strategy, and I think it's going to be happening a lot more."

Some financial advisers are even encouraging homeowners who are upside down to consider foreclosure, which they see as a purely financial decision with limited negative consequences. YouWalkAway.com, a Web site started in January that offers foreclosure counseling to homeowners, advises that borrowers who default on one mortgage can typically get another mortgage between two and four years after a foreclosure. Then, "before you know it, you will have this behind you and a fresh start!" the site says.
Facing Default, Some Walk Out on New Homes

A similar article in the New York Times is Facing Default, Some Walk Out on New Homes.
When Raymond Zulueta went into default on his mortgage last year, he did what a lot of people do. He worried. “I was terrified,” said Mr. Zulueta, who services automated teller machines for an armored car company in the San Francisco area.

Then in January he learned about a new company in San Diego called You Walk Away that does just what its name says. For $995, it helps people walk away from their homes, ceding them to the banks in foreclosure.

Last week he moved into a three-bedroom rental home for $1,200 a month, less than half the cost of his mortgage. The old house is now the lender’s problem. “They took the negativity out of my life,” Mr. Zulueta said of You Walk Away. “I was stressing over nothing.”

In recent months top executives from Bank of America, JPMorgan Chase and Wachovia have all described a new willingness by borrowers to walk away from mortgages.

Carrie Newhouse, a real estate agent who also works as a loss mitigation consultant for mortgage lenders in Minneapolis-St. Paul, said she saw many homeowners who looked at foreclosure as a first option, preferable to dealing with their lender. “I’ve had people say to me, ‘My house isn’t worth what I owe, why should I continue to make payments on it?’ ” Mrs. Newhouse said.

The same sorts of loans that drove the real estate boom now change the nature of foreclosure, giving borrowers incentives to walk away, said Todd Sinai, an associate professor of real estate at the Wharton School of Business at the University of Pennsylvania.

“There’s a whole lot of people who would’ve been stuck as renters without these exotic loan products,” Professor Sinai said. “Now it’s like they can do their renting from the bank, and if house values go up, they become the owner. If they go down, you have the choice to give the house back to the bank. You aren’t any worse off than renting, and you got a chance to do extremely well. If it’s heads I win, tails the bank loses, it’s worth the gamble.”
50 Ways To Leave Your Mortgage

You just slip out the back, Jack
Make a new plan, Stan
You don't need to be coy, Roy
Just get yourself free
Hop on the bus, Gus
You don't need to discuss much
Just drop off the key, Lee
And get yourself free

Mike "Mish" Shedlock
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Thursday, February 28, 2008 12:38 PM

Fallacy of Inflation Targeting

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Ben Bernanke is in favor of inflation targeting at 2% a year. Considering he means prices, he sure is a long ways off, at least as measured by the CPI or PPI.

But let's assume the Fed could magically meet that target. Inquiring minds might be wondering how that would look graphically. Let's take a look.

Inflation Targeting at 2% a Year

click on chart for sharper image.

The above chart is thanks to Minyan Charles who writes:

Hey Mish,

I have been pondering this whole "inflation-targeting" approach by the Fed. Their stated goal is around 2.0% year over year, correct? So, I did the graph I included which confirmed my suspicion that a constant percentage increase is indeed an exponential growth curve (who says bacterial growth is irrelevant for finances!). If the mandate is price stability, why would you shoot for an exponential growth situation? (And that is if you're doing your job well and hitting the target!)

Does stability really mean ever more increasing prices?!? When you combine this with the stagnant growth in wages over the last 30 years, it is easy to see why the middle class has been so squeezed. Why would deflation be so horrible, besides dispersing some wealth back to the have-nots? And did the Fed really kill inflation in the 1980s? Or did they just change the statistical reporting mechanisms?


Minyan Charles
Charles, thanks for that chart.
Let's see how the model actually stands the test of time.

CPI In Actual Practice

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

Note what happened once Nixon closed the gold window. Greenspan has maintained the Fed has approximated the gold standard in practice. The above chart proves otherwise.

Inflationistas Need Not Apply

No doubt inflationistas will be crowing about the above chart. Why shouldn't they? Then again Inquiring minds may wish to consider this progression.
Fallacy of Inflation Targeting

The reason banks (and government) want inflation targets is that inflation is beneficial to those with first access to money: banks, government, and the wealthy. By the time access to credit filters down to everyone, the economy is poised to reverse. This happens time and time again in every cycle. The current housing bust is the latest example.

Inflation Targeting and Price Stability Questions
  • Why should inflation be targeted at 2% and not 1% or 3%?
  • Why should any inflation be targeted at all?
  • Even if it was smart to target prices, can prices really be measured it accurately?
  • What do central banks do to overcome lag effects of monetary tightening and loosening?
  • Is this just blind faith "we know neutral when we see it"?
I addressed the above questions in Inflation Monster Captured. Inquiring minds may wish to take a look. If you have not yet seen it, there is a cute video from the ECB in the above link.

What it all boils down to however, is inflation targeting is nothing more than Fed sponsored theft to the detriment of those who obtain access to credit late in the cycle.

More importantly, the Fed can only succeed when attitudes allow the Fed to succeed. For more on attitudes please see Credit Lines Dry Up, Homeowners In Withdrawal.

Here is the pertinent snip:
Attitudes are like pendulums. Momentum carries both pendulums and attitudes to extremes. The pendulum of consumer recklessness has now reversed, having recently reached a secular peak. It will not stop at equilibrium on the way down. Instead, momentum will progress to a point of complete exhaustion marked by cautious saving instead of reckless spending.
For still more on attitudes please see "Social Mood Darkens", point 5 of Professor Depew's "Five Things" on How It's Gonna End.

According to Professor Depew, "Social mood drives social action, not the other way around. Cautious people cause home prices to plunge. Cautious businessmen cause credit to tighten. Fearful people suddenly view debt as harmful, not helpful."

In the final analysis the Fed undershoots, overshoots, and blows serial bubbles. It matters not whether this is by accident or design. The end result is the same: wealth concentration in the hands of the banks and the wealthy, fear sponsored government fascism, and the impoverishment of the middle class. For these reasons the Fed should be abolished.

Note that the inflation cycle ends when consumers are no longer willing or able to borrow, and banks are no longer willing or able to lend. The preponderance of data suggests that is precisely where we are now. The last time this happened the US was facing the great depression. There are now safety nets that may prevent a similar occurrence now, then again perhaps not. The real question is whether or not one is prepared.

Mike "Mish" Shedlock
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8:54 AM

New Rules At Fannie Mae Rules Combat Appraisal Fraud

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Before we get to "New Rules" let's recap some recent news on Fannie Mae. There is a lot on news to digest. Let' start with Fannie Posts $3.6 Billion Loss in Fourth Quarter.

Fannie Mae said Wednesday that it lost $3.6 billion during the fourth quarter as credit conditions took a large toll on the government-sponsored enterprise. The quarterly loss pushed Fannie to a $2.1 billion loss, or $2.63/share, for the full year.

Earnings woes at the largest GSE were driven primarily by mark-to-market activity on derivatives holdings, leading to $3.2 billion in write-downs; Fannie also absorbed a $2 billion charge in building its credit loss reserves and an additional $600 million in impairment losses on mortgages and investments it moved into its held-for-sale portfolio.
Systemic Risk At Fannie Mae

Fannie Mae and Freddie Mack derivatives are a ticking time bomb. Untangling derivatives took Fannie years and clearly Fannie is still struggling with their hedge book as it is.

Fannie Rewarded For Poor Performance

In spite of the above, Fannie, Freddie Portfolio Caps Lifted.
Fannie Mae and Freddie Mac, the two largest financiers for the U.S. mortgage market, will see their portfolio growth caps removed as of March 1, 2008.

According to a statement released Wednesday by the Office of Federal Housing Enterprise Oversight, which regulates both GSEs and had imposed the portfolio restrictions in response to massive accounting errors, the move comes as “recognition of the progress being made by both companies, as indicated by the timely release of their 2007 audited financial statements.”

Lockhart also signaled that it may ease capital requirements at the GSEs. A current Consent Order requires Fannie and Freddie to maintain a capital level at least 30 percent above the statutory minimum, the result of financial and operational uncertainties associated with past accounting problems.

OFHEO will likely look to gradually decrease the 30 percent requirement in the months ahead, Lockhart said.

Shares in Fannie and Freddie surged on the announcement. Fannie Mae shares were up 10 percent to $29.68 in heavy trading on the New York Stock Exchange Wednesday morning, while Freddie Mac saw its shares jump 7.5 percent to $27.10.
Fannie clearly can't handle what it has already but what does OFEEO do? Eliminate lending caps, and consider easing capital requirements.

Does anyone remember the mission of the GSEs? It was to help make housing affordable. Has it come close to that mission? Clearly not. Make funds available to any idiot who can fog a mirror and the exact opposite will happen, which of course it did.

Fannie Mae and Freddie Mac, both should be eliminated for failing their mission. Instead, in the alternate Bizarro Universe we must be in, their loan limits will increase and capital requirements lowered. The market cheered as if this was good news. It wasn't. It increases the chance of a huge taxpayer bailout down the road.

Ironically, these caps removal are not going to solve their intended short term mission of increasing liquidity in mortgages, especially in regards to refis. Most loans originated in the past few years are now under water. Fannie Mae will not be refinancing those loans. In addition, Fannie has increased down payment requirements and has restrictions in high risk areas (essentially the entire state of California for starters) so there are still huge roadblocks still in place that are affecting the housing markets. Will some new loans get approved? Yes, enough to unjam the roadblock? No.

New Rules Prohibit In-House Appraisers

In an attempt to reduce appraisal fraud, Fannie Mae working with New York Attorney General Andrew Cuomo, is about to tighten the reins on appraisals. Bloomberg has the story in Fannie Proposes Ban on Lenders' In-House Appraisers.

Fannie Mae, the biggest source of financing for U.S. home loans, told lenders it will probably ban their use of appraisals by in-house employees or those arranged by brokers.

Fannie Mae distributed the proposal, a response to New York Attorney General Andrew Cuomo's yearlong mortgage probe, to lenders in a "talking points" memo this week, according to a person familiar with the document. The memo was published on American Banker's Web site yesterday.

"It would be a monumental change because it would require a shift in the way that the lending industry does business," said Jonathan Miller, chief executive officer of Manhattan-based appraisal company Miller Samuel Inc. and a longtime proponent of creating a firewall between residential appraisers and mortgage originators. "I think it would be tremendous."

The restrictions would apply to loans acquired after Sept. 1, according to the memo. Fannie also told lenders that an independent appraisal clearinghouse likely would be established.

`Laughable' Practice

About three quarters of residential mortgage appraisals are arranged through brokers who only get paid if a loan closes, Miller said today in a phone interview. He called the practice "laughable" because it creates a financial incentive for mortgage brokers to push appraisers toward higher valuations. Higher appraisals also mean more homeowners qualify to refinance their homes and take cash out, he said.
Gravy Train Of Appraisal Fraud Slows

I welcome this development. It will slow down, but not put an end to the fraudulent practice of deliberately appraising as high as necessary to get the deal done. Not only will Fannie refuse to accept in house appraisals, independents who deliberately appraise high run the risk of being banned by Fannie Mae.

Tanta on Calculated Risk's Blog has more analysis of this situation. Inquiring minds may wish to take a look. This is a very significant, and welcome change in the way GSEs will do business.

Mike "Mish" Shedlock
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Wednesday, February 27, 2008 9:19 AM

Quarterly Banking Profile Is Bleak

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I have been talking about the possibility of a huge wave of bank failures for a long time. Recent references include Citigroup VIEs Raise Question Of Solvency, and Wave of Bank Failures is Coming.

Even the Fed is in on the act. Please consider FDIC Adds Staff as Bank Failures Loom.

The Federal Deposit Insurance Corp. is taking steps to brace for an increase in failed financial institutions as the nation's housing and credit markets continue to worsen.

The FDIC is looking to bring back 25 retirees from its division of resolutions and receiverships. Many of these agency veterans likely worked for the FDIC during the late 1980s and early 1990s, when more than 1,000 financial institutions failed amid the savings-and-loan crisis.

"Regulators are bracing for well over 100 bank failures in the next 12 to 24 months, with concentrations in Rust Belt states like Michigan and Ohio, and the states that are suffering severe housing-market problems like California, Florida, and Georgia," said Jaret Seiberg, Washington policy analyst for financial-services firm Stanford Group.
Quarterly Banking Profile

The Fourth Quarter FDIC Banking Profile is looking mighty bleak.
Here are the highlights:
Quarterly Net Income Declines to a 16-Year Low

Fourth-quarter net income of $5.8 billion was the lowest amount reported by the industry since the fourth quarter of 1991, when earnings totaled $3.2 billion. It was $29.4 billion (83.5 percent) less than insured institutions earned in the fourth quarter of 2006. The average return on assets (ROA) in the quarter was 0.18 percent, down from 1.20 percent a year earlier.

This is the lowest quarterly ROA since the fourth quarter of 1990, when it was a negative 0.19 percent. Insured institutions set aside a record $31.3 billion in provisions for loan losses in the fourth quarter, more than three times the $9.8 billion they set aside in the fourth quarter of 2006.

Trading losses totaled $10.6 billion, marking the first time that the industry has posted a quarterly net trading loss. In the fourth quarter of 2006, the industry had trading revenue of $4.0 billion. Expenses for goodwill and other intangibles totaled $7.4 billion, compared to $1.6 billion a year earlier.

One in Four Large Institutions Lost Money in the Fourth Quarter

More than half of all institutions (51.2 percent) reported lower net income than in the fourth quarter of 2006, and 57.1 percent reported lower quarterly ROAs.

One out of every four institutions with assets greater than $10 billion reported a net loss for the fourth quarter. Institutions associated with subprime mortgage lending operations and institutions engaged in significant trading activity were among those reporting the largest earnings declines.

Net Charge-Off Rate Rises to Five-Year High

Net charge-offs registered a sharp increase in the fourth quarter, rising to $16.2 billion, compared to $8.5 billion in the fourth quarter of 2006.
The report also shows the number of problem institutions is 76 as compared to 50 in 2006. Insured deposits total $4.29 Trillion as compared to $52.4 billion in deposit insurance. Here is a chart in the report that caught my eye.

Estimated FDIC-Insured Deposits by Type of Institution

click on chart for sharper image

Notice the discrepancy between total assets, domestic deposits, and insured deposits. That's a huge potential disaster for someone. I recommend getting while the getting is still good. Anyone over the FDIC limit is likely to get hammered. Don't let it be you.

Mike "Mish" Shedlock
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1:51 AM

Old Maid: Bill Gross Has Right Game, Wrong Solution

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I continue to be amazed at the ability of Bill Gross to identify problems but come up with precisely the wrong solution. Before we get to the latest Bill Gross post we need to understand how to play the game of "Old Maid".

"Old Maid" is children's card game. The idea of the game is to not get stuck holding the "Old Maid". In a regular deck of cards, that would typically be the queen of spades.

With that background, please consider: No Country for Old Maids. Following is the key excerpt.

If capitalism is a going enterprise – and we think it is – then investors will eventually return to play similar, perhaps more conservative games – much as they have in the past. And if Washington gets off its high “moral hazard” horse and moves to support housing prices, investors will return in a rush. PIMCO wants to sit at this more attractive return table – to provide an attractive return on your money (no matter what the asset class) as well as a return of your money. No Old Maids. No silicone AAA ratings. And ladies – no crotchety old bachelors either. The game, as well as the name of the game, is changing. It’s no country for Old Maids anymore.

William H. Gross
Managing Director
Good Lord! Listen to that nonsense.

Since when are government price supports capitalism? Clearly, Bill Gross, manager of the world's largest group of bond funds does not know what capitalism is. Price supports and price fixing are part of failed Soviet and Chinese central planning. And as China and Russia embrace capitalism, Bill Gross embraces failed central planning.

If this was the first time, one might conclude that Gross was writing in a drunken stupor. But it's not the first time.

Please consider Bond Guru Bill Gross on the Housing Crisis.
Bill Gross, founder and chief investment officer of PIMCO, the world's largest family of bond funds with $746 billion in assets under management, believes that without government intervention, home prices could drop as much as 20 percent over the next two years. U.S. News spoke with Gross about what he thinks the government should do to prevent such losses.

U.S. News: So it's necessary for the government to essentially subsidize mortgages?

Gross: Yes, I think so. You need an interest rate below existing interest rates. I think they need to subsidize it. Let's not get ridiculous, but with a 4.5 or 4 percent interest rate and 0 percent down for people who have demonstrated good credit and a willingness to pay on time. Let's get it over with and move forward. Otherwise, nobody knows for sure, but the futures market is projecting another close-to-10-percent decline in housing prices. If that's correct, we're really in trouble. We need to do something.

U.S. News: It seems that you’re saying a stimulus package alone won’t solve the housing problem.

Gross: Definitely not. .... It's OK as an emergency stopgap thing, but the real problem is in the housing market, and that's where Washington should be really focused. I get the sense they're beginning to get it.
It is sickening to see someone like Bill Gross and PIMCO who are only where they are today because of opportunities provided by capitalism, openly embrace failed central planning policies. The ultimate irony is that Gross is embracing failed central planning just as China is rushing like mad to embrace capitalism.

Mike "Mish" Shedlock
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Tuesday, February 26, 2008 10:45 AM

MBIA Maintains Highest Rating, Pfizer Cut

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Let's compare the financials of two stocks: MBIA (MBI) which has Moody's top rating of Aaa and Pfizer (PFE) recently downgraded by Moody's to Aa1 and by Fitch to AA-Plus from AAA. Here are two recent downgrades of Pfizer.

December 12, 2007
Pfizer loses top "AAA" rating from Fitch

December 13, 2007
Pfizer's 900 mln eur new senior unsecured notes rated 'Aa1' - Moody's

Pfizer Financials

click on chart for sharper image

MBIA Financials

click on chart for sharper image

What is Moody’s rating scale?

Moody's Rating Scale
runs from a high of Aaa to a low of C, and comprises 21 notches. It is divided into two sections, investment grade and speculative grade. The lowest investment grade rating is Baa3. The highest speculative-grade rating is Ba1.

Long-Term Debt Ratings (maturities of one year or more):

Investment Grade
Aaa – “gilt edged”
Aa1, Aa2, Aa3 – high-grade
A1, A2, A3 – upper-medium grade
Baa1, Baa2, Baa3 – medium grade

Speculative Grade
Ba1, Ba2, Ba3 – speculative elements
B1, B2, B3 – lack characteristics of a desirable investment
Caa1, Caa2, Caa3 – bonds of poor standing
Ca – highly speculative
C – lowest rating, extremely poor prospects of attaining any real investment standing
Compare Financials
  • Profit margin -61.76% vs. +17.07%
  • Return on Equity -35.54% vs. +12.13%
  • Revenue $3.12 Billion vs. $48.61 Billion
  • Earnings Per Share -$15.22 vs. +$1.20
  • Total Cash $5.73 Billion vs. $20.30 Billion
  • Total Debt $17.44 Billion vs. $8.69 Billion
Do the finacials of MBIA look "gilt edged"?

Heck, do they look investment grade at all?

With that, I invite you to read two posts I wrote yesterday in regards to MBIA.
Is there any other way to interpret the above ratings other than incompetence or corruption? If there is, can someone please tell me what it is?

Minyan Michael noticed the date of the downgrade from Moody’s as originally published was from 2006. I had several downgrades I was looking at and did not put in the most recent ones. The article above now shows the correct links, from December 2007.

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4:52 AM

Citigroup VIEs Raise Question Of Solvency

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Bloomberg is reporting Goldman, Lehman May Discover They Haven't Dodged Credit Crisis.

Even Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc. may find they haven't dodged the credit crisis.

The new source of potential losses: so-called variable interest entities that allow financial firms to keep assets such as subprime-mortgage securities off their balance sheets. VIEs may contribute to another $88 billion in losses for banks roiled by the collapse of the housing market, according to bond research firm CreditSights Inc. Goldman, which hasn't had any of the industry's $163 billion in writedowns, said last month it may incur as much as $11.1 billion of losses from the instruments.

VIEs, known as special purpose vehicles before Enron Corp.'s collapse in 2001, finance themselves by selling short- term debt backed by securities, some of which are insured against default.

Now that Ambac Financial Group Inc. and other guarantors have started to lose their AAA financial strength ratings, Wall Street firms may be forced to return those assets to their books, recording the declining value as losses.
My Comment: This is yet another reason why there is a fraudulent attempt to prop up the debt rating of MBIA and Ambac.
MBIA Inc., the biggest insurer, said yesterday it plans to separate its municipal and asset-backed businesses, a move Peters said would likely result in a lower credit rating for the types of assets owned by VIEs.
My Comment: So VIEs have one rating if they are hidden but a different rating if they are pooled together? Excuse me for asking, but didn't we just go through this with pools of CDOs lumped together and rated AAA?
The industry's VIEs, also known as conduits, had $784 billion in commercial paper outstanding as of last week, according to Moody's Investors Service and the Federal Reserve.

"There's a big number at work here and it will have significant consequences," said J. Paul Forrester, the Chicago- based head of the CDO practice at law firm Mayer Brown. "The great fear is that a combination of subprime CDOs, SIVs and conduits result in a flood of assets into an already-stressed market and there's a price collapse."

One type of VIE that's already been forced to unwind or seek bank financing is the structured investment vehicle, or SIV. Like SIVs, VIEs often issue commercial paper to finance themselves and may have multiple outside owners that share in the profits and losses. Because banks agree to back VIEs with lines of credit, they have to buy commercial paper or notes when no one else will.
My Comment: How many types are there?
Goldman, which earned a record $11.6 billion in the year ended in November 2007, said it avoided writedowns by setting up trades that would profit from a weaker housing market. Now the threat is $18.9 billion of CDOs in VIEs, the firm said in a regulatory filing on Jan. 29. Goldman spokesman Michael DuVally declined to comment.
My Comment: I see we can hold CDOs inside of VIEs. I suppose we can hold VIEs inside of SIVs. As for me I want to trade VIEs squared. It would be a travesty of justice if we could trade CDOs squared but not VIEs squared. Heck, I've changed my mind already, what I really want to do is trade (CDOs inside of VIEs) squared.
Lehman, which wrote down the net value of subprime securities by $1.5 billion, guaranteed $7.5 billion of VIE assets as of Nov. 30, according to a filing also made on Jan. 29.

"We believe our actual risk to be limited because our obligations are collateralized by the VIE's assets and contain significant constraints," Lehman said in the filing. Spokeswoman Kerrie Cohen wouldn't elaborate.
My Comment: Now I see we have Faith Based VIEs. Kerrie Cohen wouldn't elaborate probably because the structure is so complicated no one knows what it even is. Nonetheless, I am quite sure the structure is rated AAA by Moody's, Fitch, and the S&P.
Citigroup, which has incurred $22.1 billion in losses from the subprime crisis, has $320 billion in "significant unconsolidated VIEs," according to a Feb. 22 filing by the New York-based bank. New York-based Merrill Lynch & Co., which recorded $24.5 billion in subprime writedowns, has $22.6 billion in VIEs, according to CreditSights.
My Comment: Is there a snowballs chance in hell Citigroup is solvent?
The securities in the VIEs may be worth as little as 27 cents on the dollar once they're put back on balance sheets, according to David Hendler, an analyst at New York-based CreditSights.
My Comment: Heck, there's your answer right there already.
Predictions for losses vary widely because banks aren't required to specify the type of assets being held in the VIEs or how much they are worth, said Tanya Azarchs, managing director for financial institutions at S&P.

"The disclosure on VIEs is hopeless," Azarchs said. "You have no idea of the structure or how that structure works. Until you know that you don't know anything. It's like every day you come into the office and another alphabet soup."
Bank Failures Expected

After reading the above article it should come as no surprise that the FDIC Adds Staff as Bank Failures Loom.
The Federal Deposit Insurance Corp. is taking steps to brace for an increase in failed financial institutions as the nation's housing and credit markets continue to worsen.

The FDIC is looking to bring back 25 retirees from its division of resolutions and receiverships. Many of these agency veterans likely worked for the FDIC during the late 1980s and early 1990s, when more than 1,000 financial institutions failed amid the savings-and-loan crisis.

"Regulators are bracing for well over 100 bank failures in the next 12 to 24 months, with concentrations in Rust Belt states like Michigan and Ohio, and the states that are suffering severe housing-market problems like California, Florida, and Georgia," said Jaret Seiberg, Washington policy analyst for financial-services firm Stanford Group.
Last Warning

If you are over the FDIC limit at any bank, do something about it immediately.

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12:25 AM

VISA IPO to Raise Cash and Transfer Litigation Risk

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Marketplace is reporting Visa's IPO not feeling the crunch.

Despite the credit crunch, credit card giant Visa filed the largest initial public offering in history.

JILL BARSHAY: This IPO will change the shape of Visa. Right now Visa is owned by thousands of banks collectively. Marc Sacher specializes in credit cards at Aurriema Consulting Group. He says after the IPO, Visa will be mostly owned by investors who buy shares.

MARC SACHER: Previously, their directive was not really to make a profit, but rather to serve the interest of their members. Now, going forward they're going to be a for-profit company.

Sacher says the credit crunch isn't hurting Visa. It's the member banks who have to worry if you pay your bill or not. Visa's money come from the fees it gets every time you buy something with the card.

RICH MELVILLE: The banks are then distanced from litigation risk. If Visa loses the lawsuit from the retailers, the banks don't have to pay out of their own money. It's Visa's headache.

Some of the $19 billion will go to pay off the retailers. Another big chunk will help shore up the member banks' balance sheets.
Credit Card Transaction Fee Lawsuit

The Travel Guide For Your Finances has details on the Credit Card Foreign Transaction Fee Lawsuit.
The lawsuit is about the price cardholders of Visa, MasterCard, or Diners Club branded payment cards were charged to make transactions in a foreign currency, or with a foreign merchant, between February 1, 1996 and November 8, 2006. Plaintiffs challenge how the prices of credit and debit/ATM card foreign transactions were set and disclosed, including claims that Visa, MasterCard, their member banks, and Diners Club conspired to set and conceal fees, typically of 1-3% of foreign transactions, and that Visa and MasterCard inflated their base exchange rates before applying these fees.

The Defendants include Visa, MasterCard, Diners Club, Bank of America, Bank One/First USA, Chase, Citibank, MBNA, HSBC/Household, and Washington Mutual/Providian. They deny the Plaintiffs’ claims and say they have done nothing wrong, improper, or unlawful.
Who's Eligible?

Anyone who traveled abroad between February 1, 1996 and November 8, 2006 is eligible for cash back. We received forms several weeks ago. If you traveled abroad and have not received a form, click on the above link to submit a form online. Don't expect to get rich. For some, it may not be worth the time. We filled out the forms as a matter of principle more than anything else. I do not remember what we stand to get. I think it was $100.

Asset Sale To Raise Capital

The New York Times is writing Visa: Bailing Out The Banks.
Visa plans to go public this spring, and the prospectus filed today indicates that it will get $15.6 billion (after deducting about $481 million in underwriting fees) from the offering if it is sold at $39.50 a share, the mid-point of its offering range.

Of that money, how much do you think will stay in Visa to help the company grow?

In round numbers, zero.

This offering is evidently intended to serve two purposes. First, to bail out the banks that now own Visa from the financial responsibility of antitrust violations involved in Visa’s effort to keep its member banks from offering American Express or Discover cards. The first $3 billion raised goes into an escrow account to pay damages.

The second purpose is to get cash to banks that may need additional capital, which is to say a lot of banks. Essentially all the remaining cash from the offering will end up with the banks, from repurchasing stock from them. The banks can use the extra capital.

Whatever else this prospectus does, it lays out one of the most convoluted capital structures you will ever see. It has Class A shares — the ones the public is being asked to buy — Class B shares, which go to banks, and no fewer than four different kinds of Class C shares, which also go to banks.

The public will end up with just over half the ownership of the company, after bailing out the banks, and the banks will own nearly all of the rest.

The lead underwriters for the offering are JP Morgan Chase and Goldman Sachs. JP Morgan may have set the modern record for conflicts of interest by a lead underwriter. It is:

1. The largest shareholder in Visa.
2. The company’s largest customer, getting breaks of pricing not available to most other customers.
3. A member of the bank syndicate that agreed to lend $3 billion to Visa.
4. Slated to get $1.1 billion from the offering, through redeeming shares.

Here are the other estimated payouts to big banks from redeeming shares, assuming the $39.50 offering price:

Bank of America (Charlotte, N.C.) $545 million
National City (Cleveland) $380 million
Citigroup (New York) $261 million
U.S. Bancorp (Minneapolis) $241 million
Wells Fargo (san Francisco) $238 million
There is litigation from consumers over fraudulent fees as well as antitrust lawsuits against the banks who own Visa. Although the banks admit no wrong doing, their actions may be speaking louder than words. In addition, Citigroup and WaMu desperately needs to raise capital. This is one way to do it, and arguably the real driving force behind the IPO. Otherwise, this is clearly not the best time to be doing an IPO.

Mike "Mish" Shedlock
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Monday, February 25, 2008 7:37 PM

MBIA has Questions, Cancels Dividend, CEO Feels Pinched

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CNNMoney is reporting MBIA eliminates quarterly dividend, saving $174M annually.

MBIA Inc. (MBI) said late Monday its board voted to eliminate its quarterly dividend. The Armonk, N.Y.-based bond insurer said the elimination will save roughly $174 million annually, which is the amount that the company paid out in dividends in 2007.

MBIA said the action was taken at the recommendation of Chairman and Chief Executive Jay Brown 'to further strengthen the company's financial resources and to increase its operating flexibility.' The dividend was reduced on Jan. 9 to 13 cents, although no dividends were paid out at that rate.

MBIA added that its board also voted to move to an annual dividend evaluation in the first quarter of each year.

'MBIA will continue to take reasonable and prudent actions such as this dividend elimination in an effort to retain and strengthen our Triple-A ratings,' said Brown in a statement. 'As a very large individual shareholder of MBIA, I'm the first one to feel the pinch from this action.

But I think this, coupled with my recent commitment to buy a substantial number of additional shares, demonstrates my absolute commitment to be aligned with our owners and to maximize long-term value.'
CEO First One To Feel Pinch

I am sure everyone feels sorry for Mr. Brown and Mr. Chaplan. Please keep them in your prayers.

I sure would hate to be pinched like that. How can they possibly get by?


Let's Do The Math

In MBIA Admits $30.6 Billion CDO Exposure we saw that in addition to the $30.6 billion in worthless CDOs that it guarantees, MBIA has an additional $8.1 billion in worthless CDO squared (CDOs of CDOs) securities that it guarantees. That's makes MBIA's total CDO exposure $38.7 billion. And it hid that for months. It has total cash of $5.73 billion. Even if one pretends those CDOs will be worth 50% on the dollar, how does one possibly get AAA out of that mess?

Questions Galore

Inquiring minds are wondering if $38.7 billion is the total CDO exposure. What about CDS exposure? Other MBS exposure? What losses are expected? That a lot of questions. But I am not the only one with questions.

Please consider MBIA Will Halt Asset-Backed Business, Split Units.
MBIA Inc., seeking to stave off a crippling credit rating downgrade, will stop writing guarantees on asset-backed securities for six months and will separate that business from its municipal unit within five years.

Chief Executive Officer Jay Brown also said he has "questions" about the company's 2007 preliminary results released last month and hasn't yet signed off on the statements, according to a letter to shareholders today.

Brown said he has been reviewing the company's 2007 financial statements, with a focus on MBIA's loss reserves and mark-to-market losses. The markdowns reflect the difference between what MBIA charged to insure certain securities and what it could have charged based on a change in the value of the underlying security during the period.

"It is a difficult and complex task for both the internal teams and the company's auditors to establish best estimates in the most volatile credit markets in the company's history," Brown wrote. "I have a few more follow-up questions that need to be answered for me to confirm the company's preliminary results which were released a few weeks ago."

MBIA's ability to raise $2.6 billion was "a strong statement of management's ability to address the concerns relating to the capital adequacy of the company," S&P said.

Moody's is still reviewing MBIA and Ambac for downgrades. Fitch cut Ambac's insurance rating to AA last month and is considering cutting MBIA. MBIA raised money through selling common shares and warrants to private-equity firm Warburg Pincus LLC and issuing $1 billion of surplus notes.

S&P estimated that MBIA may have losses of $5.5 billion before tax, eliminating its entire capital cushion.
Here's The Deal
  • MBIA hid $38.6 billion in CDO exposure for months
  • MBIA Posted a loss of $1.93 billion last year
  • MBIA CEO Brown will not sign off on results
  • MBIA CEO Brown has questions about how big the writeoffs will be
  • The S&P estimated that MBIA may have losses of $5.5 billion before tax, eliminating its entire capital cushion.
  • MBIA wants to hide losses for up to 5 years, hoping nothing else blows up, and future earnings cover the losses.
Anyone who thinks those CDOs are marked to market has holes in their head. To top it all off, earlier today the S&P Sniffed Horse Hockey and Called it a Rose, by reaffirming the AAA rating of MBIA and Ambac.

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3:50 PM

S&P Sniffs Horse Hockey, Calls It A Rose

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In a widely expected move, the S&P proved they have an iron stomach for gall and/or a nose that cannot distinguish horse hockey from a rose. Today the S&P Affirmed The AAA Rating Of Insurers MBIA, Ambac Ratings.

Standard & Poor's reaffirmed the Triple A rating on the two biggest bond insurers, MBIA and Ambac Financial Group, sparking a rally by both stocks and the market in general. S&P ended its downgrade review for MBIA's (MBI) Triple A rating, citing success by the largest U.S. bond insurer in raising new capital.

The action reflects the company's ability to successfully access $2.6 billion in extra capital that can be used to pay claims, S&P said in a statement. The outlook is negative, indicating a rating cut may still be likely over the next two years.

The "AAA" ratings of Ambac (ABK) were affirmed but remain on review for downgrade. A group of banks has largely finalized a deal to recapitalize Ambac and is now trying to sell the plan to the rating agencies to save Ambac's triple-A rating, CNBC has learned.

S&P's affirming of Ambac doesn't take into account the recapitalization plan, but the review will continue until details of the plan are clearer. S&P's affirming of Ambac doesn't take into account the recapitalization plan, but the review will continue until details of the plan are clearer.

A tentative structure for up to $3 billion in capital for Ambac has been agreed to by the consortium, which includes Citigroup (C)and Wachovia (WB). The banks are trying to save Ambac, as well as other bond insurers, because a ratings downgrade could force the banks to write down billions more of their own debt.
Citing ability to raise $3 billion in capital (a deal that is not even finalized), and in the face of monolines holding $70-$150 billion of worthless CDOs, the S&P held its nose and confirmed horse hockey smells like a rose.

Following is a recap of what I said last Friday in Ambac Bailout Hopes Excite Bulls.
Who's Holding The Bag?

If you want to know who's holding the bag if the monolines fail, simply look at the who's who list of sponsors.

Who's Who Bagholder List
  • Citigroup (C)
  • UBS AG (UBS)
  • Royal Bank of Scotland (RBS)
  • Wachovia Corp (WB)
  • Barclays (BCS)
  • Societe Generale SA
  • BNP Paribas SA
  • Dresdner Bank AG
The two key sponsors (Citigroup and UBS) were on the list of recommended shorts by Meredith Whitney. See Analyst Meredith Whitney Asks Banks "Where's Waldo?" for more on expected bank writedowns and dividend cuts.

Some Problems Can't Be Solved

A $2-$3 billion infusion simply cannot fix a gaping long term $70-$150 billion problem (depending on who you believe) in the monolines. Should an attempt to do so be made, I confidently predict the banks will have to go back to the well again and again to provide additional capital.

If instead the banks agree to an upfront writeoff of the entire amount of worthless CDOs in return for an equity stake, exactly where are the banks going to come up with the necessary cash? Even if they do manage to pull that off, they will have accomplished nothing but buying a business model that is slowly dying and facing competition from Buffett as well.

"Sometimes there are problems that just can't be solved", and this is likely one of them. Oh sure, the market may rally a bit, especially if Moody's, Fitch, and the S&P keep their collective heads buried in the sand and reaffirm the AAA ratings on a mere $2 billion infusion, but long term the problem cannot go away until the entire package of CDOs guaranteed by the monolines is properly marked to market at a value close to zero.
What's interesting is that Citigroup did not even rally today (It closed down 1.5%), while the S&P 500 closed up 1.25% and Ambac and MBIA closed up 16% and 20% respectively.

Insurers' Day of Reckoning

Minyan Peter was writing about Insurers' Day of Reckoning earlier today before this news hit. Nothing happened to change the relevance of what he had to say so let's take a look.
A hurricane comes through your town and levels your house. A few weeks later, you receive a letter from your insurance company telling you that unless you buy some of its stock, it won’t be able to pay your insurance claim. What do you do?

As far fetched as this question may feel, this is, in principle, what’s behind the bailout of the monoline insurance companies. Unless their biggest CDS counterparties step up with more capital, the insurance companies won’t be able to make good on their CDS and the banks will be forced to take write-downs.

How this all plays out remains to be seen, but I would suggest that until additional capital comes into the financial services system from organizations other than other financial services companies, I am afraid that all that is happening is the further leveraging of an already leveraged and highly interdependent financial system.

Now there are those who suggest that creating a “good bank/bad bank” out of the insurance companies will create the opportunity for the incremental outside capital that I suggest is so much in need. And in general I would agree. Adding capital to the “good” municipal business would put that business on more solid footing. But what about the “bad” CDO business?

A review of history suggests that there was really no such thing as a good bank/bad bank strategy – only a good bank/dead bank strategy. For one to live, the other had to die. And to be clear, looking back in time, no matter how the good and bad eggs were unscrambled, the banks’ equity holders (and some holding company lenders) ultimately lost it all.

So until losses are taken, I continue to believe there is a day of reckoning to come for the monoline insurance companies. And, more sadly, I sense the same day of reckoning for those multinational banks who are stepping up to help. For rather than spreading risk beyond the financial system, it appears that every bailout effort seeks to concentrate it more and more onto the balance sheets of world’s largest banks.

And, while I truly wish it weren’t the case, because of the financial system’s interdependence, we continue to postpone the inevitable.
Raising Capital

Professor Sedacca was talking about the need to raise capital earlier today. Let's tune in.
It now appears that most everyone agrees that most financial institutions are woefully undercapitalized and they have bloated balance sheets that have nary a clue how to value.

So what do they do? Bring on more garbage to the balance sheet via Ambac (ABK) and avoid, for a short time, marking down their other garbage? Remember back in September when Citi (C) said it was marking bonds 'at a reasonable stab'?

Surely Citi jests.

They are shoring up money funds, allowing ARS to fail daily and, yep, raise capital. Today it is Suntrust's (STI) turn to raise 200 million at 8% via a trust preferred.

We continue to be short credit via the preferred market as I think issuance, if anything, will crank up.
By providing precious capital to the monolines they can ill afford to lose, the banks did two things
  1. Threw good money after bad
  2. Delayed the day of reckoning
There may be some financial incentives to delay the day of reckoning, but I suspect it really makes matters worse. Here's how: Instead of addressing the monolines today, the banks pretend they do not need to. Six months from now, the problem with the monolines is not going away. If anything it will be worse. In addition, banks are going to need to raise more capital as "walk aways" continue to add unwanted housed to balance sheets, credit card defaults rise, and commercial real estate plunges.

In the long run, the S&P did not do anyone any favors by their actions today. However, the S&P did manage to further damage their own reputation, presuming of course that was even possible, or they even care.

Mike "Mish" Shedlock
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11:13 AM

Credit Lines Dry Up, Homeowners In Withdrawal

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Consumers have been living beyond their means for a long time. The three primary ways to do this have been cash out refis, credit cards, and home equity lines of credit (HELOCs).

In Love Affair With Credit Cards Is On The Rocks we noted how Bank of America (BAC) and other lenders have raised interest rates on credit cards out of fear of rising defaults.

Citigroup (C) put a Strange New Definition On "High Risk" by canceling customers who actually paid their bills on time.

In regards to Home Equity Lines, Countrywide And Chase Shut Off The Cash Spigot. Now, the Washington Post is noting that Bank of America (BAC) and USAA Federal Savings Bank are following suit.

Let's review the Washington Post story Homeowners Losing Equity Lines.

In one brief phone call, Nancy Corazzi's lender yanked away what was left of the $95,000 home equity line of credit that she and her husband took out five months ago. The lender informed her that her Howard County home had plummeted in value and the company did not want the risk that she would owe more than the house was worth. "I got off the phone and I was shaking," said Corazzi, who was using the money to pay preschool tuition for her twins ."I was near tears. We needed this credit line to get us through some tough times."
My Comment: If this is a typical reaction, and it might be, many consumers are still in denial. Home prices are not going up and attempting to meet ordinary expenses by tapping lines is not going to work.
"Nearly all the top home equity lenders I know of are doing this or considering doing this," said Joe Belew, president of the Consumer Bankers Association, which represents some of the nation's largest home equity lenders. "They are all looking at how to protect themselves as real estate values go down, and it's just not good for the borrowers to get so overextended."
  • Countrywide Financial, the nation's largest mortgage lender, suspended the home equity lines of 122,000 customers last month after reviewing their property values and outstanding loan balances.
  • USAA Federal Savings Bank froze or reduced credit lines for 15,000 of its customers, including Corazzi, and will not reconsider its decisions until "real estate values improve substantially," the company said in a statement.
  • Bank of America is starting to do the same and is contacting some borrowers, said Terry Francisco, a bank spokesman
My Comment: Lending restrictions have tightened dramatically, across the board. Banks are trying (and failing), to prevent ballooning balance sheets. One reason they are failing is that the pace of "walk aways" is increasing. Many homeowners are not even waiting a full 90 days delinquent before turning over the keys.

In case you missed it, please take a look at Evidence of "Walking Away" Found In WaMu Mortgage Pool posted last weekend.

As stunning as it might seem, a Washington Mutual (WM) Alt-A mortgage pool created in May 2007, 92.6% rated AAA is now 15% in foreclosure or REO status, after a mere 8 months. See the above link for details.

Banks are clearly spooked by this trend and are blatantly asking Congress for bailouts. Inquiring minds may wish to consider the "moral hazard" of Bank of America Asking Congress for a $739 Billion Bank Bailout.

Returning to the Washington Post article...
Maggie DelGallo did not realize that when she took out a home equity line a few years ago on her home in Loudoun County. Her lender recently froze the line.

DelGallo, a real estate broker, has used some of her credit line over the years. Had she known the freeze was coming, "I would have drained it," she said. "I would have taken every dime and possibly placed it in a money-market vehicle."

DelGallo said she does not think she is in dire straits. "It's more like a huge disappointment," she said. "I have this line of credit attached to my home that's useless."
My Comment: Attitudes like DelGallo's give banks all the more reason to shut down lines of credit. The point of an equity credit line is to tap equity. DelGallo is proposing tapping non-equity as if that was some God-given right.

By showing willingness to borrow money at 8.5% or so, and putting it in the bank at 3% or so, DelGallo has proven the willingness to get into "dire straits" even if she is not there now. Banks reading the Washington Post article like likely to become even more spooked.
Five months ago, the [Corazzi's] Ellicott City house was appraised at $560,000; the lender says it is now worth $469,100.

"I told them, 'You guys are wrong,' " Nancy Corazzi said. "They said, 'Sorry, this is what we're doing in the entire area.' "

Corazzi said she was blindsided by what's happened. "I didn't know they could do that. I thought I was too smart to have something like this happen to me."
My Comment: This is a clear case of denial, not understanding the law, not understanding the housing market, and refusal to live within one's means.

Like it or not, both DelGallo and Corazzi will be forced by the market to live within their means. Should they refuse, they will go bankrupt. It's that simple. Hundreds of thousands of others may be forced to make a similar choice.

Do Social Moods Drive Action?

Clearly the attitudes of DelGallo and Corazzi did not change, at least on their own accord. Some no doubt will look at that as evidence that social attitudes do not drive action.

Before we go further, let's recap "Social Mood Darkens", point 5 of Professor Depew's "Five Things" on How It's Gonna End.

According to Professor Depew, "Social mood drives social action, not the other way around. Cautious people cause home prices to plunge. Cautious businessmen cause credit to tighten. Fearful people suddenly view debt as harmful, not helpful."

Clever readers will quickly see why Professor Depew's socioeconomic thesis is indeed correct. In this case, cautious (even fearful) bankers are tightening credit. Why? Because it all started with cautious consumers refusing to play the greater fool's game with home prices. The attitude change by consumers caused an attitude change by banks. The attitude change by banks will cause a souring attitude in those who were still in denial and still willing to party.

And so the cycle feeds on itself, and will continue to do so until it reaches an extreme in caution and fear.

Attitudes are like pendulums. Momentum carries both pendulums and attitudes to extremes. The pendulum of consumer recklessness has now reversed, having recently reached a secular peak. It will not stop at equilibrium on the way down. Instead, momentum will progress to a point of complete exhaustion marked by cautious saving instead of reckless spending.

The attitudes of DelGallo and Corazzi from the Washington Post article just may be an indication of how much more attitudes need to change before things bottom. We are a longs ways off in terms of both time and price.

Mike "Mish" Shedlock
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2:14 AM

Manufacturers Pass On Costs As Commodity Prices Soar

Mish Moved to MishTalk.Com Click to Visit.

Commodity prices are soaring. Let's take a look at a couple of them.


click on chart for sharper image


click on chart for sharper image

Manufacturers Pass On Costs

Common wisdom says manufactures have little choice but to pass those costs on.

Indeed, on February 23, 2008 GM announced sticker price hikes of 1.5% due to growing steel, commodity prices.

General Motors Corp. will increase prices by as much as $1,500 on most of its 2008 model year vehicles to offset the rising cost of steel and other commodities, the automaker announced Tuesday.

Prices will go up 1.5 percent on average, though certain vehicles "in hotly contested segments" will be spared increases, including the new four-cylinder Saturn Aura sedan and the base model of Chevrolet's made-over Malibu sedan. Consumers on average will pay about $100 to $500 more for GM cars and trucks.

The Cadillac XLR luxury sports coupe will see the largest dollar increase, at $1,500.

"This targeted price increase is designed to partially recover ever-increasing commodity costs," Mark LaNeve, GM North America vice president of vehicle sales, service and marketing, said in a statement.
On that note, the Mish telepathic thought lines are open.

As is typical when I open the telepathic thought lines, I was once again flooded with telepathic messages. Most were telling me that I have have finally seen the light. Many were crowing that I have finally tossed in the towel. However, the very last message before a sudden, unexpected disruption in the thought lines was asking me to please verify the above dates.

Hmm. Fancy that. A double check shows I accidentally dated the above post February 23, 2008. The correct date of the above article was December 19, 2007.

Following is the correct February 23, 2008 listing.

Big 3 to deepen discounts

Please consider Automakers roll out creative incentives'08 competition, economy tougher.
Detroit's automakers, stung by nearly two straight years of slumping U.S. auto sales, are set to cough up richer, more inventive deals this year as they try to woo weary consumers back into showrooms.

As much as the Big Three want to avoid profit-eating discounts, executives at the companies say incentives -- used well and tactically -- will be a critical part of surviving 2008.
Profit eating discounts? What profit eating discounts? Don't you have to have profits before you can eat them?

Inquiring minds may wish to consider the Implications of GM's $39 billion non-cash writeoff.

For months on end, no make that years on end, I have been told that manufactures "must", "will" or "have to" pass on increased raw materials costs.

Outside of absolute necessities (food and energy), I say they can't. The above is proof. They can't. If they could, they would.

On December 19, 2007 GM announced they would increase prices. I circled the dates on the commodity charts above. Scroll up and take a look. For those who may not know, platinum is used in auto catalytic converters. Iron, aluminum, and copper are used in various components as well. All are soaring and all are way higher than they were on December 19 when GM made its price hike announcement.

What did GM do in spite of commodity prices that kept going up? Gm rolled back price hikes and announced price cuts.

GM Sends $635 million to money heaven

For anyone who did not already know that GM was completely clueless, please consider GMAC loans $635M to its mortgage unit.
GMAC LLC, the lender partially owned by General Motors Corp., agreed to loan as much as $750 million to its residential mortgage unit as it seeks to sell a business that finances vacation resorts.

Residential Capital LLC borrowed $635 million under the agreement Thursday, the Minneapolis-based company said Friday in a regulatory filing. GMAC Chief Executive Officer Eric Feldstein has cited the resort operation as one of the company's best performing businesses.

Pressure on Detroit-based GMAC increased Friday after Standard & Poor's downgraded its credit ratings and those of the ResCap home-lending unit because of difficulty in funding loans. GMAC, controlled by buyout firm Cerberus Capital Management LP, said this week it will shut three-quarters of its North American auto-financing offices this year and cut 930 workers after a $2.3 billion loss last year.

"It's going to be difficult for them to sell anything," said Bradley Rubin, a credit analyst at BNP Paribas in New York. "The appetite to buy real estate assets is limited at best."

S&P analysts wrote today that GM and Cerberus support for GMAC "must be materially less than it was several quarters ago." GMAC's counterparty credit rating was cut to B+/C from BB+/B. The rating on ResCap was lowered to B/C from BB+/B, Standard & Poor's said in a statement today.

"We're extremely disappointed in Standard & Poor's action today," GMAC spokeswoman Gina Proia said in an interview. "We remain committed to taking the steps needed to improve our business."
With that decision GM just pissed away 3/4 of a billion dollars it did not have and cannot afford to lose. ResCap is headed to zero and the "brilliant" minds at GM cannot see the obvious.

Bernanke's Surprise

I continue to be impressed with the flexibility of Gary North who is writing about Bernanke's Surprise. Let's take a look at what Gary North is saying:
You have read the headlines about the Federal Reserve's new policy of inflation to solve the credit crisis.

I ask you bluntly: "Have you reallocated your investments so as to hedge against the FED's wave of fiat money?" Be honest. Have you?

I hope not. Why? Because the reports are all wrong. I don't mean a teeny-weeny bit wrong. I mean completely wrong.

The FED has not been inflating. The FED has been deflating.

Hard to believe? It surely is. I find it difficult to believe myself. I had thought the FED would inflate ("Reality Check," August 28). So did everyone else. But the data are clear. The FED has shrunk the money supply since mid-August, 2007.

In support of this, I offer evidence from the FED itself. I have assembled the data and the charts. Click the link: What the Federal Reserve Is Doing to Solve the Credit Crunch.


The bullish stance of American investors is being hit hard by a falling stock market and falling real estate prices. The hope of most investors who are long – and most are long – is that the FED will intervene on the side of the bulls. In fact, the FED has been intervening on the side of the bears.

Because this is so far out of character, the media are blind to the data. They listen to Bernanke's assurances of aggressive monetary policy and think, "stimulus." He even says this magic word.

Do what Nixon's Attorney General John Mitchell once said: "Watch what we do, not what we say." They did, and he went to jail.

Watch the statistics of what the FOMC has done, not what Bernanke says they have done. If you don't, you're in for a big surprise.
I like Gary North. He has his position and he is willing to change his mind when the data changes. I welcome newcomers to the "deflationista viewpoint" and Gray North seems to have taken that position. Please see Bubble Economy Endgame for the origins of the term.

The Fallacy of Cost Push Inflation

Here are two additional excerpts from North that I want to highlight.They are in reference to Bernanke's Valentines Day testimony before Congress.
"[Bernanke] warned about rising oil prices as part of the "inflation front." This, of course, is economic nonsense. Rising oil prices do not cause price inflation. If oil prices rise, then consumers must cut back elsewhere in their budgets. Cost-plus inflation is a fallacious idea based on ancient fallacies that should have died off after the rise of modern economic theory in the 1870's. But it is still popular, even at Princeton University, I guess.

There is indeed a fiscal stimulus: a $150 billion increase in the Federal deficit. Our checks will be in the mail. But where, pray tell, is the monetary stimulus? So far, there has been the opposite of a monetary stimulus. There has been a monetary contractus.
North is one of very few who understand that rising oil prices or commodity prices in general do not constitute inflation. He also sees how ridiculous it is to expect the $150 billion in stimulus to work.

However, I must point out that my model is not exactly the same as Gary North's. I look at the expansion of both money and credit and I also consider velocity. In regards to the latter, I expect the Fed will soon expand money supply. If and when the Fed does start monetary pumping, inflation will only result if it exceeds the destruction of credit and that money makes it into the real economy.

When that happens (and it will), I will be interested to see Gary North's position. No doubt when it happens some will be wondering why I too am not flexible. My answer, in advance, is that my model already presumes monetary expansion will occur, but velocity will negate it.

Monetary pumping lasted for years in Japan. It did not help one iota. Velocity was close to zero and banks hoarded cash. Once again I refer to my Interview with Paul Kasriel, Is the Fed Deflating? and Things That "Can't" Happen for what lies ahead. The answer is not inflation.

Mike "Mish" Shedlock
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