Category: banking & finance

Libor problems expose central bank incompetency

Rolling back the tape to August 2007 we’ve witnessed several failed attempts by global central banks when trying to alleviate the international credit crunch. Massive interest rate cuts by the US interventionists have resulted in climbing credit spreads across the entire debt market. Of late the powers at be instituted numerous credit facilities to both banks and brokers in a last ditch effort to keep the walking dead from following the Bear Stearns demise. Of course, when looking at Libor, one of the few remaining barometers in credit land, the rational investor should question the “knowledge and wisdom” of the Bernanke Fed.

Since the introduction of temporary and permanent lending facilities from the man behind the curtain the US Fed’s balance sheet has swapped out over $300 billion in treasuries for questionable mortgage backed securities. The unintended consequence has been a banking system reluctant to lend to one another since the Fed will take just about anything as collateral and lend at reasonably low rates. Based on the most recent auction results the Fed will have lent over 50% of their treasuries to the banking/brokerage community by the middle of June!

Commentary the other day by Federal Reserve Governor Richard Fisher should tell us everything about the impotency of our central bankers:

“This is a new development,” Federal Reserve Bank of Dallas President Richard Fisher said during an appearance in Chicago. “I need to learn more.”

Maybe Mr. Fisher, Mr. Bernanke and the other Fed members should take notes when Mr. Volcker speaks:

“A direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time-honored central bank mantra in times of crisis: lend freely at high rates against good collateral,” Volcker told the Economic Club of New York on April 8. “It tests it to the point of no return.”

My Comments: Ongoing intervention by global central bankers continues to distort the credit landscape. As banks and brokers drag their feet on mark to market issues related to Level 2 and 3 assets while failing to disclose off balance sheet exposure the lender of last resort has entered the arena. Unfortunately, the policies implemented have failed miserably leaving the obvious question to ponder: How much of the worthless collateral temporarily inherited by the Fed will ultimately end up being owned by the US taxpayer?

Denial runs rampant in rating agency land

When placing blame on the latest bubble without a doubt the rating agencies are near the top of the list. Ongoing denial seems to permeate the credit landscape and after further review we know why.

Even after downgrading almost 10,000 subprime-mortgage bonds, Standard & Poor’s and Moody’s Investors Service haven’t cut the ones that matter most: AAA securities that are the mainstays of bank and insurance company investments.

None of the 80 AAA securities in ABX indexes that track subprime bonds meet the criteria S&P had even before it toughened ratings standards in February, according to data compiled by Bloomberg. A bond sold by Deutsche Bank AG in May 2006 is AAA at both companies even though 43 percent of the underlying mortgages are delinquent.

Sticking to the rules would strip at least $120 billion in bonds of their AAA status, extending the pain of a mortgage crisis that’s triggered $188 billion in writedowns for the world’s largest financial firms. AAA debt fell as low as 61 cents on the dollar after record home foreclosures and a decline to AA may push the value of the debt to 26 cents, according to Credit Suisse Group.

The 20 ABX indexes are the only public source of prices on debt tied to home loans that were made to subprime borrowers with poor credit histories. About $650 billion of subprime bonds are still outstanding, according to Deutsche Bank. About 75
percent were rated AAA at issuance.

Regulators require banks to hold more capital against lower- rated securities to protect against losses; a downgrade would force them either to sell the securities or bolster reserves. While most banks haven’t disclosed the ratings of their subprime holdings, S&P estimated in January that losses on the debt may exceed $265 billion. American International Group Inc., the world’s largest insurer, has $20.8 billion invested in AAA rated subprime-mortgage debt, not including asset-backed securities that caused the company’s biggest-ever quarterly loss last period, according to the New
York-based company’s disclosures.

Further analysis of the AAA rated structured paper market clearly illustrates significant downgrades are on the way over the next few months.

My Comments: When 74 of 80 “AAA” bonds fail the investment grade test one should realize the Wall Street machine is beyond broken. Of course that same machine actually owns this paper with leverage beyond belief. Is the US taxpayer the buyer of last resort? Or are US and foreign savers the patsies of last resort?

"Council on Foreign Relations Fund" collapses

As bailout fever spreads like wildfire we are hit with the shocker of 2008: “Carlyle Capital (aka the Council on Foreign Relations Fund) Nears Collapse as Rescue Talks Fail.”

Carlyle Group said creditors plan to seize the assets of its mortgage-bond fund after it failed to meet more than $400 million of margin calls on mortgage- backed collateral that plunged in value.

Carlyle Capital Corp., which began to buckle a week ago from the strain of shrinking home-loan assets, said in a statement it defaulted on about $16.6 billion of debt as of yesterday. The fund fell 87 percent in Amsterdam trading. Carlyle Group, co-founded by David Rubenstein, tapped public markets for $300 million in July to fuel the fund just as rising foreclosures caused credit markets to seize up.

One of Carlyle Group’s talking heads – I’m sorry, “advisor” – was also the head of that incredibly efficient SEC which sat idle during the last mania. Here are a few of his brilliant comments:

The fund’s losses were caused by “excessive leverage,” said Arthur Levitt, a senior Carlyle adviser, in a Bloomberg Radio interview today. “This did not affect the overall Carlyle enterprise,” said Levitt, former chairman of the Securities and Exchange Commission and a board member of Bloomberg LP, the parent of Bloomberg News. ”This was a single fund, and I suspect as this plays out, you are going to see a lot of other private-equity companies, a lot of banks, going down the same road,” he said.

My comments: Why would someone like Arthur Levitt watch one of his funds, which he advises, take leverage to 32-1? Additionally, where was Carlyle Group’s Chairman Lou Gerstner during this irresponsible behavior? If the most politically-connected private equity group in the world can’t be saved by the Fed, remaining credit fund managers may want to order some sleeping pills.

Predatory lendor’s partner in crime

Like any fraud, the details emerge after the bubble bursts and this one is clearly exposing the wonderful actions or inactions by the beltway boys. Yesterday Elliot Spitzer wrote the following in the Washington Post:

Several years ago, state attorneys general and others involved in consumer protection began to notice a marked increase in a range of predatory lending practices by mortgage lenders. Some were misrepresenting the terms of loans, making loans without regard to consumers’ ability to repay, making loans with deceptive “teaser” rates that later ballooned astronomically, packing loans with undisclosed charges and fees, or even paying illegal kickbacks. These and other practices, we noticed, were having a devastating effect on home buyers.

What did the Bush administration do in response? Did it reverse course and decide to take action to halt this burgeoning scourge? As Americans are now painfully aware, with hundreds of thousands of homeowners facing foreclosure and our markets reeling, the answer is a resounding no.

Not only did the Bush administration do nothing to protect consumers, it embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from the very problems to which the federal government was turning a blind eye.

The administration accomplished this feat through an obscure federal agency called the Office of the Comptroller of the Currency (OCC). The OCC has been in existence
since the Civil War. Its mission is to ensure the fiscal soundness of national banks. For 140 years, the OCC examined the books of national banks to make sure they were balanced, an important but uncontroversial function. But a few years ago, for the first time in its history, the OCC was used as a tool against consumers.

In 2003, during the height of the predatory lending crisis, the OCC invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks. The federal government’s actions were so egregious and so unprecedented that all 50 state attorneys general, and all 50 state banking superintendents, actively fought the new rules.

But the unanimous opposition of the 50 states did not deter, or even slow, the Bush administration in its goal of protecting the banks. In fact, when my office opened an investigation of possible discrimination in mortgage lending by a number of banks, the OCC filed a federal lawsuit to stop the investigation.

When history tells the story of the subprime lending crisis and recounts its devastating effects on the lives of so many innocent homeowners, the Bush administration will not be judged favorably. The tale is still unfolding, but when the dust settles, it will be judged as a willing accomplice to the lenders who went to any lengths in their quest for profits. So willing, in fact, that it used the power of the federal government in an unprecedented assault on state legislatures, as well as on state attorneys general and anyone else on the side of consumers.

My comments: So the rules were changed in 2003, right about the time when subpime lending went from 3% of toal mortgages to 17% by the end of 2006! Of course one must also ask how much money Mr. Spitzer accepted from Wall Street during his campaign for NY governor? The same Wall Street who provided most of the credit lines for these subprime outfits.

St. Valentine’s day massacre

Latest figures out of the Mortgage Bankers Asscociation clearly rang the alarm bells this week on Capital Hill.

The Mortgage Bankers Association says default rates on all outstanding home loans in the US have reached 7.3%, the highest level since modern records began in the 1970s.
The default rate in America’s ‘prime’ mortgage market has hit a record 4%, prompting fears of house prices crashing by 25%. Arrears on “prime” mortgages have reached a record 4%, confounding expectations that middle-class Americans with good credit records would be able to weather the storm.
While sub-prime and close kin “Alt A” total $2,000bn of debt, the prime market in all its forms is roughly $8,000bn. If prime default rates rise on their current trajectory, they could ultimately cause huge financial damage.

Across the pond our friends in Switzerland were obviously drinking excess mortgage koolaid circa 2002-2006:

UBS reported a fourth-quarter net loss of 12.45 billion Swiss francs ($11.23 billion), including a $13.7 billion write-down on investments tied to U.S. mortgage investments. The bank posted its first full-year net loss — 4.4 billion francs — in the 10 years since it emerged from a megamerger between Swiss Bank Corp. and Union Bank of Switzerland in 1997. Write-downs for 2007 were $18.4 billion.
For the first time, UBS provided details of nearly $70 billion in holdings of subprime-mortgage and other problematic securities — an exposure that led analysts to predict more trouble.

Finally, as Rome continues to burn the noise on Capital Hill sounds more and more like a coordinated bailout is in the works:

Bank of America Corp., Citigroup Inc. and four other U.S. lenders will announce steps today to help borrowers in danger of default stay in their homes, according to three people familiar with the plans.

Encouraged by Treasury Secretary Henry Paulson, the banks will offer a 30-day freeze on foreclosures while loan modifications are considered, two people said on condition of anonymity. The initiative, which follows a week of talks with Bush administration officials, will apply to customers who are at least three months late on payments and include prime borrowers, as well as those with poorer credit histories.

Make sure the Swiss are included in the bailout mission.

The banking industry, struggling to contain the fallout from the mortgage debacle, is urgently shopping proposals to Congress and the Bush administration that could shift some of the risk for troubled loans to the federal government.

One proposal, advanced by officials at Credit Suisse Group, would expand the scope of loans guaranteed by the Federal Housing Administration. The proposal would let the FHA guarantee mortgage refinancings by some delinquent borrowers.
Credit Suisse officials have met with senior officials from the Department of Housing and Urban Development, which runs the FHA, and other policy makers to discuss the proposal. The risk: If delinquent borrowers default on their refinanced loans, the federal government would have to absorb the loss.

My comments: Record mortgage defaults of prime residential mortgages will continue to impede commercial bank lending for many quarters to come. And to think most analysts and money managers believed the fiduciaries back in December when they echoed “the worst is behind us”. Fool me once shame on you, fool me twice shame on me.

Bank bailout 2.0

As the truth gets exposed and global bankers reach for fire extinguishers the drumroll appears to be getting louder and louder-can you hear it? If not, maybe this op-ed will wake you up:

The federal government could make this (ability for banks to recapitalize) happen by entering into an arrangement with American banks that hold subprime mortgages, in which homeowners typically pay a low interest rate for two or three years then face much higher payments. Here’s how it would work: The government would guarantee the principal of the mortgages for 15 years. And in exchange the banks would agree to leave their “teaser” interest rates on those loans in effect for the entire 15 years.
This would instantly give the lending banks new capital. As these mortgages would be guaranteed by the Treasury, they would suddenly be assessed, on bank balance sheets, at their original value — and a significant amount of the banks’ lost capital would be restored. Plus, the banks would receive, from most of the homeowners with subprime mortgages, up to 15 years of teaser-rate payments.
By solving the bank capital crisis immediately, this strategy would ensure that fewer families would lose their homes, that fewer neighborhoods would deteriorate because of abandoned housing and that, as a consequence, there would be less downward pressure on local real estate prices and property tax revenues.

Sound familiar folks? It should, Goldman Sachs floated this trial balloon across the pond with Northern Rock several weeks back. Virgin would use a refinancing plan proposed by Goldman Sachs Group Inc. to sell bonds backed by Northern Rock assets and guaranteed by the U.K. government. The proceeds would be used to repay the estimated 24 billion pounds that Northern Rock borrowed from the Bank of England after credit-market turmoil choked off funding and led to the first U.K. bank run in more than a century.
The British government, the Financial Services Authority and the central bank will decide whether to submit one of the private proposals for European Union approval by March 17. The bank will be “temporarily” nationalized in the event that the private bids are inadequate, Prime Minister Gordon Brown said last month.

My comments: Finally, I was on a conference call yesterday with a well respected macro research firm who puts the entire global financial bailout at $3-5 trillion. Chris Whalen (http://www.institutionalriskanalystics/) recently put the entire structured finance business, ex GSE, at $3 trillion. So one should ask who participates and how will the bailout unfold? Most believe the soverign wealth funds in conjunction with central bankers can keep things relatively glued together but at what cost?

Subprime contained in pandora’s box

No less than 5 days after last weeks emergency Fed meeting, Bennie and his merry men were at it again yesterday when they lowered rates by another 1/2%. This total 1.25% cut matched the last desperation move orchestrated under Alan Greenspan back in 1989. Maybe one of the issues keeping Bernanke up all night revolves around this annoying “little” problem:

Losses from securities linked to subprime mortgages may exceed $265 billion as regional U.S. banks, credit unions and overseas financial institutions write down the value of their holdings, according to Standard & Poor’s.

S&P cut or put on review yesterday the ratings on $534 billion of bonds and collateralized debt obligations tied to home loans made to people with poor credit, the most by the New York- based firm in response to rising mortgage delinquencies. Moody’s Investors Service today said losses from mortgages that were packaged into bonds in 2006 could rise to 18 percent.

Of course S&P and their ilk were all embracing the $50 billion containment theme several months ago yet it now looks like Pandora’s box has finally opened. Adding insult to injury for commercial banks is the latest from one of the wise men, Bill Ackman of Pershing Square, who maps out the monoline insurance issues:

“Up until this point in time, the market and the regulators have had to rely on the bond insurers and the rating agencies to calculate their own losses in what we deem a self-graded exam,” Ackman said in a statement preceding release of the letter. “Now the market will have the opportunity to do its own analysis.”

My comments: Further downgrades of the monolines will require approximately $200 billion in fresh capital to make the entire industry AAA rated according to Sean Egan of Egan, Jones & Co. Add in ongoing mark to market losses within the commercial/investment banking business and another $200 billion in new capital is required to recapitalize the system. Of course the interventionists have a “plan” yet we realize all government “plans” lead to additional distortions prolonging the inevitable cleansing process. Can’t we have a nice garden variety recession in order to level the playing field for real wealth creators?

Another $148 billion needed by banking system?

Since August the international financial community has slowly moved from denial to reality. Specifically, over the past 5 months banks have written down over $130 billion in subprime related debt while going hat in hand to a plethora of sovereign funds.

Middle Eastern and Asian investors have contributed about $59 billion to U.S. and European banks after more than $130 billion of write downs from mortgage-related assets. New York- based Citigroup Inc. said last week it is selling $14.5 billion of preferred stock to investors including Singapore, adding to a $7.5 billion investment in November from the Abu Dhabi Investment Authority, the world’s richest sovereign fund. “We still believe the U.S. promises good returns,” Sultan bin Sulayem said today. “Banks present opportunity. Real estate in Manhattan presents opportunity.”

So are we nearly done in the corrective process or are there additional skeletons in the closet? As we discussed in the Wall Street Journal (October of last year) this process is just beginning as the daisy chain of cloud financing touches many aspects of the credit realm. Wait no longer as the recent downgrades in bond insurers create one more set of problems for the money shufflers.

Banks that raised $72 billion to shore up capital depleted by subprime-related losses may require another $143 billion should credit rating firms downgrade bond insurers, according to analysts at Barclays Capital.

Banks will need at least $22 billion if bonds covered by insurers led by MBIA Inc. and Ambac Assurance Corp. are cut one level from AAA, and six times more for downgrades by four steps to A, Paul Fenner-Leitao wrote in a report published today. Barclays’ estimates are based on banks holding as much as 75 percent of the $820 billion of structured securities guaranteed by bond insurers.

“Barclays Capital has come up with a very big and very scary number,” said Donald Light, an insurance analyst at Boston-based consulting firm Celent. “It indicates that the cost of a bailout of the bond insurers is a lot less than the cost of shoring up these banks’ mark-to-market losses.”

Banks may sell stock or subordinated debt to raise additional capital to cover bond insurer downgrades, the Barclays report said.

My Comments: The scramble is on as mark to market losses create yet one more dilutive round of financing for the money center banks. Signs of a bottom? Hardly!

Staring into the abyss

The beginning of 2008 failed to skip a beat as the monoline bond insurers were dealt a hand of financial reality this week. First, MBIA was forced to raise additional capital or risk losing their AAA rating so with hat in hand went to their friends on Wall Street.

MBIA Inc., the largest bond insurer, paid a yield of 14 percent on the sale of $1 billion of AA rated notes, a rate usually charged to the lowest-ranked borrowers. MBIA’s yield is equivalent to 956 basis points higher than U.S. Treasuries of a similar maturity. The extra yield, or spread, on investment-grade bonds is 217 basis points, according to Merrill Lynch index data. The premium to own high-yield, or junk-rated, debt is 663 basis points.

Not to be outdone, the second largest player within the bond insurance game Ambac announced a $32.83 loss per share yesterday!

Ambac Financial Group Inc.’s AAA credit ratings may be cut by Moody’s Investors Service after the bond insurer reported $3.5 billion of writedowns on securities it guarantees and replaced its chief executive officer. Ambac’s losses were more than the company had previously indicated and may portend further declines in the subprime- mortgage securities that Ambac insures, Moody’s said today in a statement.

As the monoline insurers edge closer to the abyss we now receive word that Merrill Lynch has uncovered several billion in losses pertaining to counterparty exposure.

Merrill also reduced the value of bond insurance contracts by $3.1 billion, saying provider ACA Capital Holdings Inc.’s credit rating had been slashed below investment grade, making it a less- reliable counterparty.

The evolution of our cloud financing system leads us to this new fork in the road. Since all of this incremental credit was hedged with credit default swaps how does one know whether or not the insurer can satisfy claims.

A case in point was the collapse of Dublin-based Structured Credit Company (SCC) in December 2007, which is seeing its 12 trading partners lose about 95 percent of what they are owed, according to the Financial Times. SCC was just a couple of years old and was one of a new brand of Credit Derivative Product Companies. It had no credit rating and $200 million of capital on top of which it wrote $5 billion of credit default swaps (25-to-1 leverage, significantly less than many Structured Investment Vehicles). Low and behold, when the credit markets collapsed last summer and SCC was required to post additional collateral on its trades, there was – to quote Gertrude Stein – “no there there.””Court documents show that collateral demands rose from $55 million to $438 million, but SCC ran out of funds after managing to post $175 million, and the game was up.

My Comments: The next shoe to drop on Wall Street will be credit default swaps as a $45 trillion marketplace meets historical bond default rates (investment grade and junk) of 1.25%. Thus, $500 billion of these default contracts will be triggered resulting in losses of $250 billion or more to the “protection selling” party once recoveries are inserted into the equation.

Pension plan chickens outsource services to big bank foxes

The LA Times wrote this in late October but I thought it was pertinent based on recent fireworks at Citigroup. Past outsourcing trends were relegated to more mundane services yet it seems a firm in London is willing to hire the responsible people at Citigroup, with the Fed’s blessing, for all money management services regarding their existing pension plan.

Citigroup Inc. got the green light from the Federal Reserve for an unusual deal to take over the $400-million retirement plan of a British newspaper company. In exchange for getting its hands on all that cash, Citigroup will run the pension plan — investing the money, paying the benefits and taking on the liability previously borne by Thomson Regional Newspapers.

Do you think the supporters of this decision may want to reconsider?

Advocates say such changes would be a win-win for retirees and employers, retaining all the protections of current law, while putting plans in the hands of sophisticated financial stewards. Plus, large banks are less likely to go out of business or face severe financial strains than smaller employers.

My comments: Why would the Fed approve of such a move, especially when Citigroup can’t even reveal their true assets and liabilities to existing shareholders? And why are pensions handing the car keys to a gang that deserves a starring role in Grand Theft Auto?

WordPress Themes