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?
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?
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!
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?
Despite recent rhetoric from the talking Feds, credit markets continue to deteriorate for reasons previously discussed. For example, Libor has now increased 11 days in a row due to interbank lending apprehension. Further, the credit flu has spread globally as recent turmoil in European covered bond trading literally shut down last week. Covered bonds are securities backed by mortgages or loans to public sector institutions. The notes offer more protection to bondholders than asset-backed debt because the issuing bank is liable for repayments. They typically have the highest credit ratings.
“There’s a crisis of confidence for everything but AAA government bonds,” Arnd Stricker, a management board member at Corealcredit AG, the German commercial property lender owned by Lone Star Funds, said at a conference in Frankfurt. “Covered bonds are being thrown in the same basket” as mortgage securities, even though they are safer, he said.
Back in the USA, recent FDIC data for the third quarter indicates ongoing problems for the credit creators.
As of June 30, 2007, the net income of all FDIC insured banking institutions totaled $36.8 billion. Annualized, that represents about 2% of all loans outstanding. Meanwhile, net charge-offs for bad loans were already running at an annual rate of about 0.50% in June. Of course prior to June the credit markets were relatively subdued so loan loss reserves remained near 32-year lows. One should expect net charge offs to more than quadruple in a mild recession.
My comments: Bubblevision guests hope for more rate cuts while the rational investor asks why. By now it is more than obvious that the Federal Reserve is impotent as insolvency rears its ugly head.
Apparently Mr. Paulson’s subprime “containment” theory has been tarnished. Over the past few days numerous financial institutions, including GE , have announced impairments to either money market or short term bond funds.
A short-term bond fund run by General Electric Co.’s GE Asset Management returned money to investors at 96 cents on the dollar after losing about $200 million, mostly on mortgage-backed securities.
The GEAM Trust Enhanced Cash Trust, a short-term bond fund with about $5 billion in assets, told non-GE investors on Nov. 8 that they could withdraw their money before losses mounted. Enhanced cash funds usually offer higher yields than money- market funds by investing in riskier assets.
GE joins a growing list of other US asset managers warning of credit related hits. The $1.4 billion State Street Limited Duration Bond Fund, which lost more than a third of its value in the first three weeks of August, has recently been sued by Prudential and other institutional investors. On Monday, Bank of America announced over $3 billion in CDO write downs while adding $600 million to various money market funds in order to preserve the $1 NAV. Other asset managers announcing similar charges include Legg Mason, SEI Investments and Suntrust Bank.
My Comments: It seems every time a write down is announced from one of the large financial institutions we hear the spin “worst is behind us” or “charges were lower than expected”. At what point do investors scream uncle?
As the WSJ reported yesterday, Wachovia took a $1.3 billion hit to its bond portfolio during the 3rd quarter:
“We had an institutional bias against subprime,” G. Kennedy Thompson, Wachovia’s chairman and chief executive, told analysts in a conference call. But subprime-backed bonds held by the fifth-largest U.S. bank lost as much as half their value when credit markets suddenly froze, even though the vast majority of the bonds were AAA-rated, according to Wachovia. “We didn’t expect paper could degenerate that fast,” Mr. Thompson said.
The $347 million in resulting losses from those securities was just part of an overall $1.3 billion decline in the value of various investments held by Wachovia’s corporate- and investment-banking unit. The unit’s profit tumbled 80% to $105 million from $533 million a year earlier.
Contributing to the losses was the ill-timed acquisition of Golden West Financial in May, 2006:
The Charlotte, N.C., bank also reported a large boost in the size of its loan-loss provision, as it girds itself for more trouble from the weak housing market. Of particular concern to some analysts and investors are mortgages that Wachovia inherited from Golden West Financial Corp., a thrift acquired for $24 billion last year. Golden West’s loans were concentrated in California, where home prices are slumping, and the thrift specialized in option adjustable-rate mortgages, which let customers choose how much to pay each month.
As it turns out, the housing bubble had peaked roughly nine months earlier, yet Thompson was optimistic about Golden West, a mortgage lender operating right at its epicenter:
“We feel like we are merging with a crown jewel. This is a transformative deal for us.”
On June 28th of this year, Thompson spoke with CNBC‘s Maria Bartiromo about his stewardship of Wachovia:
“I’d say look at our track record. We’ve done four large mergers since I’ve been CEO and they’ve all been successful.”
My comment: The credit bubble floated many egos and dicey business plans. We are about to find out who is swimming without a bathing suit as the tide goes out.
Returning from New York this past weekend I opened the Wall Street Journal on Monday to discover yet one more chapter in the structured finance shell game. Evidently Treasury Secretary Henry Paulson picked up the bat phone to several of the largest US banks, begging them to work together in order to facilitate an orderly unwind of numerous off balance sheet structured investment vehicles (SIVs). The proposed Super SIV will try to float one year capital notes with proceeds earmarked for the purchase of SIV assets originally created by Citigroup. Thus Citi avoids two problems, an increase in reserve requirements from assets returning to their balance sheet and ongoing reputational risk.
At this point, the rational investor is throwing up his hands, and why not?
“I have never seen Treasury play this kind of role,” said John Makin, a visiting scholar with the conservative American Enterprise Institute in Washington and a principal with hedge fund Caxton Associates LLC. The banks made “riskier investments that didn’t work out. They should now put it back on their balance sheet.”
Paulson and Co have their hands full lately as trust and confidence in structured finance have been waning. Apprehension and/or the inability to mark securities to market have sent a shock wave through the credit markets. More recently we witnessed the following acts of desperation:
- Increased injections of liquidity by the Fed
- Broadening the collateral accepted (to include asset-backed commercial paper) and terms (from 7 to 30 days) of the repo market
- 100 basis point cut (two separate actions) in the discount rate and 50 basis points to fed funds
- Encouraging use of the discount window (formerly stigmatized) because banks no longer trust collateral being posted when lending to each other
- Proposed Super SIV whereby roughly 20% of the total SIV market is re-tranched
Clearly the credit markets are faced with unprecedented circumstances due to countless players and massive leverage. Unlike LTCM which required a NY Fed bailout, the credit markets today have grown incredibly opaque while derivative exposure has gone parabolic.
It’s obvious the SIV assets won’t be priced at market rates because there’s not much of a market to begin with (and why the super SIV exists in the first place). But where exactly do they get priced? To whose benefit? And by which standard?
Unlike the Bernanke induced rally two months ago, Paulson seems to be striking out in spades. The banking index is probing 52 week lows while Citigroup has dropped over 6% in 3 days.
This latest scheme, to which the ex-Goldman Treasury Secretary gives his blessing, attempts to put off the structured finance day of reckoning even further. Could the Super-duper SIV create the inevitable mark-to-market across most aspects of the securitization world leading to a run on the bank? Note to Hank: Beware the law of unintended consequences.
As CNNMoney.com reported, today Merrill Lynch joined the subprime hit parade with a $5.5 billion writedown. They join Citigroup and Deutsche Bank earlier this week ($9.8 billion) and Bear Stearns, Goldman Sachs and Morgan Stanley last month ($4.3 billion).
Investor response, so far, has been remarkably positive:
But the mood among bank CEOs has been one of optimism. Executives from firms like Merrill and Citi have said that other areas of their businesses continue to perform well and that there have been signs that credit conditions are improving.
“Have a little confidence – we do,” Bear Stearns CEO Jimmy Cayne implored investors following a half-day meeting Thursday.
So far, investors have been quick to embrace the writedowns, sending shares of Merrill, Citigroup and UBS higher on the belief that the worst of the credit crisis is behind them.
Not everyone is convinced:
Punk, Ziegel & Co.’s Richard Bove labeled that kind of thinking as “deluded.” Mortgage and derivatives businesses at many of these firms have taken a wallop and may not recover for several quarters.
“The assumption that by writing off the stuff, these business will turn around and become vibrant is almost insane,” said Bove. “It’s not going to happen.”
My comment: We are clearly in the Bove camp. The U.S. has over $10 trillion in mortgage debt with half taken on from 2001-2005, a period of the greatest housing/credit bubble this country has seen. And the damage is going to be limited to $50 billion or so? No way.
Exhale…. The worst is behind us according to Chuck Prince and the Citigroup enterprise he presides over. Citigroup released quarterly earnings this week as Wall Street embraced Prince and the banking sector with higher share prices. Consensus on the Street is “the worst is behind us” so let’s take a closer look. Here are a few of the items referenced by the people at Minyanville.com:
-Citigroup stated that forecast earnings for the quarter will be down 60% from the third quarter of 2006 so Citi should earn roughly $2.2 bln. Therefore, Citi’s earnings this quarter will not cover the dividend of $2.7 bln resulting in a lower shareholder equity number. One time event? Not if you read the following: “[Citi] will have additional assets as some portion of our leveraged loan commitments, and drawn liquidity facilities that we have for CP conduits, will remain on our balance sheet.”
-Over the past four quarters, Citigroup’s balance sheet has grown by 36% (roughly $600 bln) while capital has grown by only 11% ($12.4 bln). Further, a significant part of the build in Citigroup’s equity base came through the issuance of trust preferreds. In fact, total trust preferred rose from $6.2 bln to just over $10 bln. Based on
Citigroup’s forecast, Tier 1 capital will likely be less than the 7.9% reported at the end of the second quarter, and well below the 8.6% reported a year ago.
-The bulk of the funding for the $600 bln in asset growth over the past year came not through deposit growth (up $127 bln), but through short term borrowings (up $92 bln from $72 bln to $167 bln) and long term debt (up $100 bln to $340 bln).
Finally, Citi references signs of stress with their mortgage customers…
“First, our reserve increase reflects a change in our estimate of losses inherent in our portfolios, but not yet visible. For example, if a mortgage customer is making payments a few days later than normal or even into the grace period, this behavioral pattern can be correlated with future delinquency and future losses. Our reserve build this quarter reflects such behavioral patterns that we are observing in our portfolio as well as an enhancement to our loss estimation process.”
My comments: Leveraging the balance sheet has become commonplace within the banking world thanks to conduits, CDOs, SIVs (structured investment vehicles) and a plethora of other off and on balance sheet activities. Without question the world has become more precarious for both borrowers and lenders. Of course at present the Bernanke put has provided a short reprieve.