Friday, October 31, 2008

Libor Dropping, Drastic Fed Actions Finally Working

Three-month Libor fell again to 3.03%, the 15th consecutive drop, indicating that the Fed's dramatic actions are making a difference.  Make no mistake, however, the Fed's actions are dramatic with a capital "D."  Yesterday's release of the Fed's balance sheet showed it ballooning to $2 trillion.  As of October 29th, the Fed had lent $145 billion out of its new commercial paper facility directly to companies which had been shut out from raising short-term financing due to the seizure in the credit markets.  For those unfamiliar with this new facility, it is the first time that the Fed has lent money directly to companies that are not banks (excluding AIG, of course) since the Great Depression.  Other than the new commercial paper funding facility, borrowings from the various other facilities remained relatively unchanged, give or take a couple billion here and there.  
AIG's borrowings declined a bit.  Well, sort of.  It paid back some of the expensive 8.5% money from the special loan it was granted by the Fed, by borrowing from the new commercial paper funding facility at rates of 2-3%.  You can't fault the insurer from trying to reduce its funding costs.  Sadly, there are many other things to fault the insurer for, which require a completely new post (coming soon.)  
In any event, less stress in the money markets is extremely positive news.  Although it doesn't mean the Dow will race right back to 14,000, it does significantly reduce the probability of solvent companies facing bankruptcy because they cannot access short-term financing to run their day-to-day operations.  It also means that every company with an unused revolving borrowing facility doesn't have to draw it down fully from its bank out of sheer panic, thus causing further stress on the banking system.  It is true that we have yet to return to normal business conditions, for without the Fed, we would be facing global banking failures and bankruptcies left and right.  But at least we have stepped back from the precipice.   

Barclays Spurns British Bailout Money in Favor of More Expensive Private Capital

Rather than face the indignity of a capital injection from its own government, Barclays chose instead to raise capital from Middle Eastern investors on more onerous terms.  Alphaville has a nice summary of the financing package it arranged with Qatar and Abu Dhabi and concludes that executives made these decisions in their own self-interest at significant cost to shareholders to keep the British government from meddling in their bonus pools and corporate governance.  Here's a quick summary of the terms:
  • $4.86 billion paying a coupon of 14% until 2019, with in-the-money (as of Thursday's price) warrants worth around $1.2 billion.
  • $7 billion billion short-term converts paying 9.75% until conversion (sometime next June) at a 25% discount to Thursday's close
  • Assuming full conversion, Middle Eastern investors will own 31.2% of the bank.
Compare this to a 10-11% coupon for the British package with no warrants, with the caveat that the bank would have to issue a full blown prospectus and let the British government have a say  in compensation and the composition of top executives.  Shareholders will need to vote on this so the possibility exists of a shareholder revolt.  Barclays may find itself turning to the government, hat in hand, after all.   

Thursday, October 30, 2008

Anemic GDP Helps Market, Except HIG

The first estimate of third-quarter GDP came in slightly better than expected at negative 0.3%.  In a quarter that included the virtual collapse and de-privatization of the global financial system, that is positively rosy.  Of course, because things didn't really hit the fan until the end of the third quarter, the effects of the seizure in most forms of lending won't appear in GDP, a notoriously lagging indicator, until the fourth-quarter.  
Equity markets are higher on a smattering of non-catastrophic earnings reports and yesterday's 50 basis point cut by the Fed.  Here are some company specific headlines:
And then there was Hartford, the insurance company, who shares have plummeted precipitously recently in anticipation of horrendous earnings.  As it turned out, the company managed to disappoint even lowered expectations by reporting a $2.6 billion loss.  As the joker at Fox-Pitt Kelton, who somehow still has a job as an analyst, so eloquently stated: "The risk of a rating agency downgrade and the inability of management to provide comfort on the level of their capital cushion make it very difficult to assess the downside or to argue that there is significant upside in the near term."  And then, Mr. Fox-Pitt Kelton analyst downgraded the stock from "outperform" to "in-line."  I don't know what "in-line" actually means in analyst-speak, but I can say with authority that HIG's stock has outperformed nothing in the past few months, other than maybe LEH, FNM, FRE, AIG and my running shoes.   

Wednesday, October 29, 2008

Even "The Donald" Can't Escape Commercial Real Estate Slump

The Wall Street Journal is packed to the gills with fascinating accounts of commercial real estate developers currently confronting a deadly combination of a precipitous drop in demand for real estate (any type of real estate), surging supply (due to overbuilding), and a lack of refinancing options.  The crack in the market is not due to the current "credit crunch," as struggling developers and lenders would have you believe, but the inevitable result of horrible lending decisions made by banks and lenders to projects with unrealistic expectations hatched into markets flooded with too many competing projects.  Did it really not occur to anyone in places like Las Vegas, Phoenix, and Miami that the market couldn't support 10 years' worth of new  condo supply?  That not every single high-rise project envisioned by real estate developers needed to be built?  Is anyone really surprised by the slow-motion train wreck of failed development projects and those teetering on the brink?  
Interestingly, Deutsche Bank's name pops up with alarming frequency in most of the recent stories about failed commercial real estate projects (see prior posts about Deutsche in Casino Business and Harry Macklowe.)  Deutsche probably would've lent $1 billion to my toddler a year ago to finance her lemonade stand built out of popsicle sticks.  And they would've been stunned to discover a year later that construction of the lemonade stand was way behind schedule because she'd eaten most of the popsicles.
Donald Trump, master of the comeback, finds himself embroiled in perhaps some deja vu of the early 90's, as one of his ambitious projects faces tenuous prospects.  Mr. Trump's 92-story Trump International Hotel & Tower will be the tallest building constructed in the US since the Sears Tower was built in 1973.  According to the Wall Street Journal article, Mr. Trump has sold $600 million in condo units and condo-hotel units, yet owes lenders as much as $1 billion.  Although Mr. Trump's building is apparently on-time and on-budget, the current slump in the housing market begs the question of whether he will be able to pay off the loans.  In order to stay current on the debt, Mr. Trump needs to negotiate by Nov. 1st to exercise an extension provision in the original loan which could prove costly.  The loan includes a $40 million recourse completion guarantee, meaning that Deutsche can both foreclose on the property and go after Mr. Trump for $40 million.  Mr. Trump also has borrowed $130 million in a mezzanine loan from Fortress Investment.  The mezzanine loan includes harsh terms such as a $50 million "exit fee" when the loan is due, in addition to accrued interest.  Fortress, incidentally, proved itself to be the shrewdest of lenders, as evidenced by the investment fund's fortuitous escape from the Harry Macklowe debacle with all of its cash and interest intact while the senior lenders had to deal with a messy foreclosure.  According to the loan terms of Mr. Trump's mezzanine loan with Fortress, he could wind up owing $360 million to Fortress depending on how long the loan accrues interest.  
The outcome of this commercial real estate drama will be determined, as always, by market forces.  Contract signings on condos in downtown Chicago were down 72% the first half of the year from a year earlier, with 10,000 new condo units expected to be delivered in 2008 & 2009.  I suspect this will not end well for Mr. Trump, but I'll be looking for his next comeback in 2015.  Or maybe I'll see him first on QVC hocking his condos.           

GMAC, Cerberus Looking For a Piece of Bailout Money

GM's finance arm, GMAC Financial Services has already been granted some federal assistance.  GMAC was allowed access to the new short-term funding facility created by the Fed that went into operation on Monday.  The Fed's new facility has been credited with returning liquidity back to the commercial paper market which disintegrated after the Lehman bankruptcy caused the largest money market fund to break the buck.  
GMAC is also seeking to become a bank holding company so that it can have access to a piece of the government's $700 billion financial rescue plan.  The Fed has been holding discussions with GMAC about this move for over a month.  The boneheads at Cerberus, the private equity firm that has the misfortune of owning controlling stakes in both Chrysler and GMAC, is attempting to swap its stake in Chrysler for a larger share of GMAC.  Why?  Because why would you own a crappy US auto-maker that cannot compete with foreign rivals that you happened to purchase at the absolute peak of the market, when you can own a bank holding company that has access to federal government bailout money?  So, you see, this swap is absolutely necessary for the good of the US auto-industry, the US consumer, but particularly for Cerberus.  Without some sort of bailout money, both Chrysler and GMAC are toast which would be very bad for Cerberus and its three-headed dog-loving investors.  And that would be bad for America.  When you hear your favorite congressman preaching about the need to bail out the US auto-industry that is finally crashing under its own uncompetitive weight, think about who stands the benefit the most: the private equity clowns that made a terrible investment decision.       

Waiting on the Fed

US equity markets are clinging to yesterday's 10% rally, awaiting the Fed's decision on interest rates.  Investors are anticipating a 50 basis point cut in the Fed Funds target, with some calling for 75 basis points.  It's hard to imagine that the Fed will do anything to surprise the market today given how fragile conditions remain in the credit markets.  I anticipate a 50 basis point cut, because that is the most expected action and frankly, it really doesn't matter what the Fed does with the Fed Funds target.  Three-month Libor fell 5 basis points to 3.42%, which is a huge improvement over October 10's fix at 4.82%, but still nearly 200 basis points over the current fed funds rate.  It seems hard to imagine that another 50 basis points is going to crack Libor if 17 new Fed Facilities have yet to do the trick. 
In the "completely unexpected good news" department, durable-goods orders rose 0.8%, although the ex-transportation number was down 1.1%.  The rebound was due to an increase in aircraft orders (seriously?) and an increase in defense bookings (yeah, that makes sense.)  The durable-goods numbers are notoriously volatile so reading anything into this number about the US economy being "strong" would be foolish for anyone other than, perhaps, a Presidential candidate of the current US ruling party.
In the "genuinely good news" department, Proctor & Gamble posted solid earnings, benefitting from price increases and favorable foreign exchange rates.  Both Kraft and Kellogg reported higher-than-expected third-quarter profits also due to price hikes.  Despite all of the bleak news related to housing, banking, and stock market declines, Americans can still afford food and diapers.  That, my friends, is better than nothing.      

Tuesday, October 28, 2008

US Equity Futures Perk Up on the Heels of Global Rebound

Optimism about the Fed rate-cut? Renewed confidence that the government interventions are working?  Dead-cat bounce?  Whatever the underlying reason, equity investors around the world decided that stocks are a bargain, for today at least.  The Japanese Nikkei was higher by 6.4%, and Hong Kong soared 14.4%.  European stocks joined the party with sharp rallies across the board.  Germany's DAX jumped an astonishing 8.3% (related in part to a 90% surge in Volkswagen shares due to Porsche's plan to take three-quarter's of Volkswagen's stock.)  Germany aside, the FTSE 100 was 4.6% higher and the French CAC-40 rose 3.2%.  US futures are poised for a rebound.  
GM may receive a $5 billion loan to aid its planned merger with Chrysler.  Ordinarily I would spend at least a paragraph mocking the idea of two huge money-losing companies getting government aid to become one gargantuan money-losing company, but at this point, I am just relieved that they are ONLY receiving $5 billion.  If the government is giving $25 billion to Citigroup, might as well throw the US auto industry a small, but tasty, bone.  The only disheartening aspect of this news is that it indirectly aids the private equity firm Cerberus, who owns part of Chrysler and GMAC.  But at least the private equity guys are finally having to work their butts off to save an investment rather than just borrowing money to pay themselves dividends every few months.  If Cerberus can single-handedly turn the US auto industry around, then they've officially earned all the fees they've been collecting for operating in an easy-credit bull market for the past 15 years. 

Monday, October 27, 2008

US Equity Markets Muster a Rally, For Now

US markets were higher Monday morning, despite sharp declines in virtually every single foreign stock market.  A smattering of good news may have been cause for the return of equity investors, although volumes are still relatively light and recent history proves that the market could wipe out all of its gains before I even get a chance to finish this post.  First the good news:
  • New home-sales were better than expected, although still pretty weak.  Sales were up 2.7% to a seasonally adjusted annual rate of 464,000, down 33% from September of last year.  Inventories fell to 394,000, representing a 10.4 months' worth supply of sales.  The median sales price fell to $218,400 down 9.1% in the past year.   
  • Verizon posted a 31% rise in earnings on a 4.1% increase in revenues, handily beating earnings estimates.  
  • CenturyTel announced a plan to buy Embarq in a $5.8 billion stock swap.  Why is this good news?  Because the local telecom industry is due for consolidation.  Investment bankers will tell you that the smaller players must merge due to the decline of the traditionally lucrative landline business.  The truth is, the telecom industry has to consolidate so it can do a bunch of spin-offs in a few years.  Why?  Because the telecom industry exists not for customers who need telecommunications services but for the investment banks, who need to do consolidations and spin-offs every few years to keep churning out those fees.  I have no idea why this is the case.  All I know is that telecom firms are the biggest contributors to the investment banking spin of "synergies" vs. "extracting value."  I can only offer you copies of my phone bill as evidence.  I get the same crappy service year after year but my telecom provider changes annually due solely to mergers.  As much as I try to avoid it, somehow I'm always doing business with AT & T.  But I digress...
  • The Fed began buying commercial paper directly from issuers today.  Although credit conditions are still extremely tight, at least regular issuers of commercial paper have access to financing and there is less of a concern about a solvent company going bankrupt because of the money market panic.
It is interesting that the US markets have held it together today.  I can only speculate why this is case.  Once again, although our economic and financial problems are very scary and very serious, we are still viewed as some sort of a safe-haven.  Furthermore, the media's attention has shifted from pundits who kept unsuccessfully calling the bottom over and over again, to those who are incredibly bearish and are calling for all sorts of enormous market crashes.  If listening to Roubini and Taleb doesn't scare you half to death, then maybe the fact that they are all over the news these days could be some sort of indicator that sentiment is really bearish enough to expect a bounce.  Although it is too soon to know if their bleak forecasts will bear out, we can at least hope that this time they are wrong.     

Global Market Rout Continues

Markets around the world tumbled again on Monday as investors shed assets to raise cash to weather the impending global recession.  Emerging-market stocks received yet another beat-down following a difficult week last week.  News of a $16.5 billion IMF loan to the Ukraine and a planned "substantial financial package" for Hungary failed to assuage emerging market equity investors.   
Meanwhile, in the Persian Gulf, Kuwait's central bank guaranteed bank deposits and bailed out one of the country's largest banks.  The Kuwait intervention is the first bank rescue in the Gulf, as even the oil-rich countries face spillover effects from the worldwide financial crisis.  Of course, with oil prices off more than 50% from their peaks, "oil-rich" may soon turn into "oil-middle class." 
Asian markets continued to get slaughtered on Monday, with the Japanese Nikkei dropping 6.4% to a 26-year low.  Hong Kong's stock market dropped 12.7%.  Hong Kong's Financial Secretary John Tsang said that the government had prepared a series of measures that it was ready to implement if needed.  Investors were unimpressed.  South Korea's market rallied 0.8% after the central bank lowered its key interest rate by three-quarters of a point early Monday and South Korea's National Pension Service stepped in to buy shares before the close.
European stocks followed the Asian markets lower, with little positive news to buoy them.  All eyes are on US stock futures, which point to a lower open.  
Meanwhile, the Treasury handed out more cash to US financial institutions adding $7.7 billion to PNC on Friday, aiding its purchase of NCC.  Over the weekend, the Treasury handed over $3.55 billion to Capital One Financial.  KeyCorp announced a $2.5 billion investment from the Treasury this morning.  Huntintgon Bancshares and Suntrust will also receive billions from the Treasury.
With the Fed expected to slash interest rates again, and a slew of earnings reports on the docket, investors should expect another volatile week.  

Friday, October 24, 2008

Existing Home Sales Rise 5.5%

A bit of good news on a bleak day for the market.  Home resales rose to a 5.18 million annual rate, a 5.5% increase from August's unrevised 4.91 million pace, according to the NAR.  The median home price declined to $191,600, down 9% from $210,500 a year ago and $203,100 from August this year.  Inventories of homes fell 1.6% at the end of September to 4.27 million, representing a 9.9 month supply, down from a 10.6 month supply at the end of August.  Sales jumped 16.8% in the West, mostly due to brisk activity from foreclosures.  As I mentioned yesterday, a high level of activity from foreclosure sales indicates that prices in the West are potentially nearing a bottom.  Home prices in parts of California are down an astonishing 50% from obviously unsustainable levels that were not supported by incomes.  As home prices drop, affordability returns to the market, and buyers who previously could not afford to buy a home are now in the market.  Investors are also looking for opportunities to pick up properties where the rental income may provide a nice return.  As I've mentioned before, the only solution to our housing crisis is the return of affordability to the market.  If prices drop low enough where owning is attractive again, and financing is available to buyers with decent credit, and the economy manages to avoid a severe and protracted recession, then perhaps things might be looking up for the housing market.  Unfortunately there are alot of "ifs" and "ands" in that sentence.  

Capitulation Friday?

Markets around the world are plummeting on continuing fears about a global recession and forced delevering of the financial system.  Although money markets had shown marked improvement in the past couple of weeks, credit markets are still suffering from a lack of buyers and a swarm of sellers liquidating position in the face of redemptions from terrified investors.  Dow futures are limit-down before the open.  If the Dow declines 1,100 points, the market will halt for an hour.  If you were looking for capitulation, this might be it.        

Thursday, October 23, 2008

Investors Throw in the Towel on Homebuilders

Investors have tolerated quarter-after-quarter of gut-wrenching losses from the homebuilders.  And yet, despite the magnitude of any ridiculously large loss posted, there was always some bullish goon on CNBC talking about how "cheap" the homebuilders were and how housing prices had bottomed and a turnaround was right around the corner.  The stocks would nearly almost always rally in the face of horrendous earnings reports.  So, I find it interesting that today, of all days, investors actually care that Pulte punted another $280 million on a variety of land-related charges and other impairments.  For some reason, despite watching revenues plummet every single quarter for the past eight quarters or so, today it really matters that Pulte's revenues dropped 37% and that the CEO refuses to even attempt to forecast.  Suddenly, all of the homebuilding stocks are down at least 20% in one day.  Could it finally be homebuilder capitulation?  Not until we get to zero.  

Foreclosure Filings Surge 71% in Third Quarter

According to RealtyTrac, a total of 765,558 properties received a default notice, were warned of pending auction or were foreclosed on in the quarter, up 71% from the third quarter of last year.  Filings rose 3% from the second quarter and actually fell 12% in September from August as state laws to keep people in homes slowed the pace of defaults.
Six states accounted for more than 60% of defaults, led by California.  California had six of the 10 metropolitan areas with the highest foreclosure rates in the quarter.  According to the September 2008 homes sales report released by Dataquick yesterday, 51.1% of all sales in California were foreclosure resales, indicating they have been foreclosed on at some point in the prior 12 months.  The number of homes and condos sold statewide was up 6.1% in September from August and an astonishing 64.8% from September of last year.  The median price paid for a home last month was $283,000 down 6% from $301,000 the month before and 34.2% from $430,000 in September a year ago.  According to the Dataquick report, around half of the drop in the median is due to depreciation, with the other half due to shifts in the types of homes selling, and how those homes are financed.  The typical mortgage payment that home buyers committed themselves to paying last month was $1,337, down from $1.428 in August and $2,046 in September a year ago.
The silver lining in all of this disheartening news for homeowners is the return of affordability.  Lawmakers around the country are taking drastic measures to "keep people in their homes" by launching programs such as the $300 billion FHA-backed Operation Hope for Homewoners.  The FDIC's Sheila Bair has been the most vocal about helping beleaguered homeowners.  Today's Wall Street Journal reports that Ms. Bair is suggesting that the government allocate $40 billion to purchasing mortgages, renegotiating terms with the lenders and sharing in potential future losses.  Frankly, with the government throwing billions around like chicken feed, might as well try to help those borrowers who really were victims of predatory lending, as well as those who were just flat-out foolish enough to borrow more than they could afford and assume that 20% appreciation per year was a given.  $40 billion is nothing compared to the $1.7 trillion in loans to dealers, banks, money market funds, AIG, and foreign central banks currently sitting on the Fed's balance sheet.  If the government is going to bailout everybody, make sure to pass the hat around. 
I think the California housing market hints at the eventual resolution to the nation's housing crisis.  In many parts of the country, particularly in places where housing values skyrocketed to levels not supported by median incomes, cheap and ridiculous financing options drove up the prices of homes.  Now that values are crashing, we see affordability returning to the California housing market.  Although this obviously hurts many people who bought into the market in the past few years, it makes houses more affordable for the average family.  The strong level of sales activity that we are seeing in California indicates that a bottom in prices is being set in some of the hardest hit areas.  In the same way that I don't believe that a true bottom in prices on CDOs will be reached when the government buys them, I also don't believe that a bottom in housing prices can be reached by artificial measures designed to prop up prices.  When houses are affordable again, people will buy them.  The government only needs to make sure that financing is available to those with appropriate credit.          

Wednesday, October 22, 2008

Calpers Down 20%, Plans to Hike Contributions

The Wall Street Journal is reporting that the California Public Employees' Retirement System has seen a decline of more than 20% in its assets.  The nation's largest public pension fund may begin to ask for an increase in employer contributions to the fund of 2% to 4% starting in July 2010 and July 2011.  Back in April, I noted that it was highly suspicious that three top money managers at Calpers had left the fund within days of each other.  Media reports claimed their departures were related to boardroom disagreements, while I speculated that it was more likely due to poor performance of the fund, as Calpers had a tendency to invest in alternative assets (such as land deals with homebuilders.)  Needless to say, it seems clear now that the managers who left Calpers in April did so to avoid having to face the music when angry California employees need someone to blame for losing their retirement funds.

On the bright side, angry California employees are probably much better off than anyone who hoped to have a pension in Argentina.  Argentina's government seized the private pension system in order to "protect investors from losses."  The surprise move caused the markets in Argentina to plummet 15%, thereby causing losses for investors.  According to the Wall Street Journal story, "While no one knows for sure what the government would do with the private system, economists said nationalization would let the government raid new pension contributions to cover short-term debts due in coming years."  So the government has seized private retirement assets to pay the public debt.  Now that is depressing.  Argentina, can we cry for you now? 

Earnings Roundup 10/22/2008

The Good:
The bad:
The disastrous:
  • Wachovia posted a $23.9 billion third-quarter loss on what I call "finally figuring out that your assets are virtually worthless."  It's interesting that the bank had to be on the verge of seizure by the FDIC before noticing that its goodwill was overvalued by around $18.7 billion.  My thoughts on Wachovia's toxic portfolio have been expressed for many months here, so I can finally stop warning investors about the risks.  I wish Wells Fargo much luck with its acquisition and sincerely hope that a $72 billion write-down is enough to make it a worthwhile purchase.

Tuesday, October 21, 2008

How to Make $10-$25 Million For One Month's Work

First, befriend John Thain.  Then, have Mr. Thain hire you as the "head of strategy" at Merrill.  Make sure you negotiate a compensation package that rewards you at least $10-$25 million within the next month, regardless of how many additional billions Merrill posts in losses OR how many billions Merrill must seek from the Fed in liquidity OR how many billions in bank debt guarantees it must secure from the Treasury OR how many billions it must get in direct cash infusions from the US government TO AVERT BANKRUPTCY.  If all of this sounds absurd to you, rest assured that it is not a figment of my overactive imagination.  Please click on the link and read the actual Wall Street Journal story about Peter Kraus, who was hired in September to be Merrill's head of strategy and will now be leaving the firm with as much at $25 million in compensation for his brilliant strategic work for the firm.  
Since I tend to harp on executive compensation frequently, I would like to clarify my views on the topic for anyone who may think I'm the average communist.  I am a big believer in personal wealth generated through entrepreneurship, hard work, or brilliant leadership that leads to a profitable company that also rewards shareholders and employees.  I am opposed to executives getting paid absurd amounts of money for working at a company for a short period of time with little result.  This seems to happen far too frequently and I am amazed that shareholders still accept the fact that their boards are offering these types of deals to executives.  However, if shareholders are willing to accept it, than so be it.  I simply choose not to buy stock in companies that throw too much money at executives who don't perform.
However, if you are a taxpayer, Mr. Kraus' compensation should make you very angry.  I don't care how brilliant the man is.  I don't care if he wouldn't have worked for less than $10 million.  I think it is outrageous that anyone should be promised that kind of money when a company is taking large handouts from the government and firing employees left and right.  Merrill is still in business because the US government has taken extraordinary and unprecedented steps by guaranteeing all bank debt, offering Merrill a $10 billion cash infusion, and handing its acquirer Bank of America a $25 billion cash injection.  Without these government actions, Mr. Kraus' strategizing would have amounted to nothing.  Merrill would've faced bankruptcy.  As long as the US government is an investor in the banking system, these types of egregious pay-without-performance guarantees have GOT TO STOP.  Or my head will explode.  Kudos to the Wall Street Journal for publishing this story as I am certain that at least Andrew Cuomo will read it and possibly take action.  One can only hope.  

Dow's Surge Tempered By Sobering Earnings Results

A slew of US companies reported earnings after the close yesterday and this morning:

Kerkorian Throws in the Towel on Ford Investment

Way back in April, when distressed equity investors were still enthusiastic about huge money-making opportunities for beaten-down companies, one man placed of large bet on the future of Ford.  Kirk Kerkorian, the nonagenarian who, until today, still believed in the future of the US auto industry, began accumulating shares in Ford at $8.50.  The Wall Street Journal is now reporting that Mr. Kerkorian is paring back his investment in the auto maker and is pursuing opportunities in the gaming, hospitality and the oil and gas businesses.
With Mr. Kerkorian perhaps the only "smart-money" investor on the planet that thought Ford still had a shot as an ongoing concern, this is obviously not a vote of confidence for the automaker's future prospects.  In fact, the only bullish case to be made for owning the shares is that our government is in a very giving mood, handing out funds left and right to any company with a pulse, and working desperately to keep the US economy from going into a deep and protracted recession.  Perhaps Ford will use its government loans wisely and restructure its business so that it may be profitable again in the future.  Ford's competitors are also suffering so, if anything, relatively speaking, if Ford can keep from going bankrupt first, it has a shot at outperformance.  Unfortunately, that is little consolation to long-term investors who have watched their investment wither away to nearly nothing.     

Monday, October 20, 2008

Just a Sprinkling of Government Bailouts

This weekend was light on the government bailouts, indicating that strained credit conditions around the world are easing. The Dutch government injected $13.4 billion into ING Groep, the largest Dutch financial services firm and South Korea agreed to guarantee $130 billion in bank debt.  Meanwhile, Iceland is set to announce a $6 billion IMF Fund-led rescue package to help stabilize its beleaguered economy after a spectacular failure of its highly leveraged banks.  It's nice to know that even though the IMF chief is busy having an affair with one of his subordinates, he can fit in a bailout loan or two into his very busy schedule.  As I noted Friday afternoon, significant signs of improvement were evident in the money markets as three-month Libor dropped 36 basis points to 4.06% and overnight Libor fell 16 basis points to 1.51%.
Crazy volatility in financial markets always unveils a few rogue traders.  Both the Chinese and the French (once again) have been taken to the cleaners by traders executing "unauthorized" trades.  Citic Pacific announced a $1.89 billion losing currency bet that was discovered after an executive violated procedures.  The Jerome Kerviel award, however, goes to Groupe Caisse d'Epargne, a large French mutual bank that uncovered  an $800 million loss resulting from derivatives trades that were supposed to profit from stock market gains.  The losses were attributed to a group of around six traders, so really, it's nowhere near as impressive as Jerome's attempt to bankrupt Soc Gen by himself.  Still, "unauthorized" trading seems to occur a bit too frequently.  I wonder how often the losses are just small enough to be buried into an earnings report.     

Friday, October 17, 2008

Money Markets Show Significant Improvement, Will Volatility Finally Subside?

I am hearing from my sources that money markets are showing significant signs of improvement today.  Three-month Libor has dropped by over 20 basis points from last night's fix and the TED spread is totally cratering (wide=bad, narrow=good.)  For those who are not intimately familiar with the money markets, they are akin to the basic plumbing of the financial markets.  Trillions of dollars of simultaneous stimulation by governments around the world is finally starting to work.  Since stocks tend to lag the credit markets (as evidenced by the fact that it took a year for the stock market to figure out the complete and total debacle occurring in the bond market), I suspect that it may take some time for the news to filter through and the for the panic to subside.  The VIX is still trading over 70 although down from its peak of 80.  These are still incredible levels and I suspect that the VIX will start to decline.  To all of the options traders out there, I wish you a happy expiration Friday.  It's certainly been the most incredible options expiration cycle I have ever witnessed in my life, and if you are an options market maker and you're still standing after this month, Congratulations, you've earned every penny.  In honor of those that made it through the panic, I offer a video for your amusement.  The following is the layman's version of what it must've been like to trade on the floor of any exchange in the past two weeks: 

Sharp Drop in Home Construction Good News?

Home construction dropped by 6.3%, a much sharper decline than the 1.6% that economists were expecting. Headlines screamed "Worst drop since 1991!" and "Another 17-year low!" but I have to ask myself (and my faithful readers) if this is actually such bad news. Record numbers of houses sit in inventory pleading for buyers. Foreclosures in most of the country are still rising adding to housing inventories and depressing prices. Demand for homes continues to decline as potential home buyers sit on the sidelines fearful of job losses, investment losses, the US's future; do I even need to go on?  In any event, it seems to me that the best way to combat the rising inventory issue and slack in demand is to perhaps STOP BUILDING NEW HOUSES!  Just for awhile.  For the love of god.  I know that this isn't necessarily positive for the construction or homebuilding industries but at least it reassures us that they have finally figured out what is going on the economy.  Although I still believe we are probably still a ways away from the bottom in housing, this news means we might be inching closer.  And that, my friends, is good news.

Thursday, October 16, 2008

Hedge Funds Suffer From Losses, Redemptions, Lack of Humility

US hedge funds suffered $43 billion of withdrawals from investors in September.  Seriously?  Only $43 billion?  I would've guessed much more, given how lousy hedge fund returns have been.  Since investors have to give their hedge funds some notice before they pull their money out, September's redemptions are probably not an accurate reflection of how many investors will be stampeding for the exits before the end of the year.  Some industry insiders are expecting hedge fund assets to shrink by around 50% in the coming months, with some of the decline coming from lousy investments and the balance from redemptions.  No doubt much of the volatility in the markets is due to hedge funds liquidating to meet anticipated investor redemptions, in addition to forced liquidations.
Bloomberg is reporting that Highland Capital Management, a hedge fund with roughly $33 billion under management, will unwind its Crusader and Credit Strategies Funds.  According to the letter sent to investors informing them of the funds' unwinding, the funds suffered from "unprecedented market volatility and disruption."  It's funny that the folks at Highland seem to actually believe that they were somehow the victims of market volatility that they should not have been expected to foresee or manage.  I suggest that Highland's investors were the victims of lousy investment decisions and poor risk management and deserve an apology from their hedge fund managers instead of a letter filled with excuses.  After all, had Highland put on the exact opposite of their trades, the funds would have returned 30% to investors, rather than losing 30%.  I am fairly certain that in that situation Highland would not have issued a letter claiming that their magical outperformance was due to unprecedented market volatility.  No.  They probably would have said it was due to superior investing talent and skill and hiked all of their fees.  I will never understand how fund managers can possibly think that they were not responsible for losses because markets behaved in unpredictable ways.  Why is it so hard for these jokers to just apologize?  Something like this might be nice: "We're so sorry for losing your money.  We had no idea that this credit gravy train was going to come to such a screeching halt.  Due to the enormous losses we have taken this year, my fellow portfolio managers and I will gladly refund any fees we have collected from you on profits from prior years that have now been wiped out until you are made whole."  If you've been getting paid 2 and 20, you owe it to your investors to at least feel bad about losing their money and not send lame letters offering excuses for your poor investing judgement.  If you're a hedge fund manager and you don't know how to apologize, please view the following video for instructions:   

Merrill, Citi, UBS: What a Debacle!

Merrill Lynch, the investment bank which slyly sold itself to Bank of America the weekend Lehman went kaput, has proven to the world that it is consistently capable of losing $5 billion a quarter.  The former investment banking powerhouse posted a $5.2 billion loss on, um everything.  Merrill had a total of $9.5 billion related to, CDO's, leveraged loans, paying Temesek back for diluting the funds original investment, you name it.  $3.8 billion was specifically labeled as "write-downs tied to GSE's and other investment banks which were either taken over or failed during the month."  The company declined to offer more details on those investments only to say "yes, we really are that bad at managing risk."
In other horrible bank earnings news, the financial disaster powerhouse that is Citigroup lost $2.8 billion in the third quarter on more than $13.2 billion in charges bringing the total credit losses taken by the bank to an eye-popping $64 billion.  I now know for certain where Citigroup came up with the idea to sue Wells Fargo for $60 billion for stealing Wachovia.
Just as a small reassurance to the US taxpayer who may be reading this news with horror, rest assured that the US investment banking industry remains highly competitive with the rest of the world.  Even the Swiss, those conservative, secretive, banking geniuses, are getting bailouts from the Swiss government.  UBS announced that it is selling $60 billion in garbage to the Swiss government which will be taking a 9% stake in the firm.  Credit Suisse has opted not to take a government handout, but will be raising capital in order to shore up its adequacy ratios.
Needless to say, the global banking industry is in shambles.  But you already knew that because governments around the world have been bailing out their banking institutions.  
What all of this proves, using Merrill as an example, who has now given back all profits since 2001, is that the practice of paying out 50% of revenues in bonuses at investment banks was a complete and total joke.  I wrote a piece on August 4th claiming that the Fed's dramatic financing of illiquid assets of investment banks amounted to a subsidy for investment banking bonuses.  I used the example of Thomas Montag who was awarded a $40 million signing bonus to run Merrill's sales operation in early August.  In light of Merrill's $5 billion loss, Mr. Montag has obviously not been worth the $40 million that Merrill punted on his hire.  My post was viewed by some as controversial, because yet again, the claim was made that all of that great "talent" at banks would flee if it wasn't getting paid.  Maybe now we can return to a more normal world where the neighborhood urologist makes more money than the guy who's mispricing default risk on a CDO.   

Wednesday, October 15, 2008

Credit Markets Arise From the Dead, Economic Numbers Disappoint

Three month Libor slid again overnight to 4.55%, off nearly 30 basis points from the horrifying peaks it hit last week.  Spreads in other credit market instruments have also started to narrow slightly.  We are back from the brink, yet much uncertainty and unpleasant news remains.
Retail sales slid 1.2%, the most in three years as consumers avoided the mall out of a renewed sense of frugality.  Consumers are scared of losing their jobs, worried about their investment portfolios, watching the value of their equity in their homes disappear, so it's no wonder that nobody feels like shopping.  Furthermore, people were far too busy pulling their money out of their equity mutual funds (a record $65 billion was pulled out of equity mutual funds last week) and their bank accounts and putting it into their fire safe boxes at home to wonder if they should pick up a new pair of shoes.  Certainly it will take some time to restore confidence in the battered consumer.  But perhaps after years of cash-out equity refis used to pay off credit card bills, it's appropriate that we become a nation of savers for awhile until we emerge from the recession.
Some glimmers of hope appeared in corporate earnings.  Intel reported a surprisingly sold earnings report yesterday after the close.  The tech giant earned $2 billion on $10.2 billion in revenue and issued an upbeat sales outlook.  Both JP Morgan and Wells Fargo reported profits, yes, that's right profits.  Although both institutions increased their loan loss reserves and had significant profit declines, they proved why the Treasury has entrusted them with its money.  Stocks are down sharply on all of the gloomy economic news.  The volatility in equities is likely to continue for some time as investors digest the new economic environment that we are in.  It is hard to forecast much of anything when so much uncertainty about economic conditions remains so the markets will trade on extreme emotion for some time. 

Tuesday, October 14, 2008


Having spent some time burrowing into the details of the $250 billion capital injection into the banking system, I've come to the conclusion that this is a much better alternative than buying $700 billion in crappy mortgages from institutions and either holding them until they mature at zero or selling them to PIMCO (Bill Gross seemed a bit too excited about that plan.)  So the new version of the TARP is an equity infusion rather than a huge debt puke bucket.  Assuming that the banks leverage the equity 10 to 1 (and they have been sternly instructed to deploy the capital,) this amounts to $2.5 trillion in additional liquidity that has been created out of thin air.  Sort of.  The Treasury still has to finance this venture, but given how dire the situation has grown overseas (see Iceland's 77% stock market plunge the day after trading resumed after a 3 day halt), the United States can comfortably maintain its status as a safe haven for the world, a very very screwed up world.
The capital injections will take the form of senior preferred shares that will pay a 5% dividend for the first 5 years and 9% thereafter.  The Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15% of the senior preferred investment.  The exercise price on the warrants will be the market price of the institution's common stock at the time of issuance, calculated on a 20-trading day trailing average.  Common shareholders will experience some dilution from the warrants and earnings will be negatively affected by the new dividend obligation that will be paid out before earnings are distributed to the common.  Surprisingly, the government did not insist that banks stop paying their common dividends.  I suppose Mr. Paulson thought that investors owning bank stocks for the past two weeks had suffered enough and he'd let them keep their measly dividends.  This deal is extremely similar to the ones that Warren Buffett struck with GE and GS two weeks ago, except Mr. Buffett got much better terms.  While the government is earning 5% and getting 15% in warrants, Mr. Buffett is earning 10% and receiving 100% of his investment in warrants.  Anyone who doesn't want Mr. Buffett as the next Treasury Secretary is a fool.
To ensure that the Treasury's equity investments are protected, the FDIC will provide a three-year 100% guarantee on newly issued senior unsecured debt for banks and financial holding companies.  Firms will need to issue the new debt before June 30,2009.  Covered debt is not allowed to exceed 125% of a company's debt outstanding as of September 30 that was scheduled to mature before Jun 30th of next year.  Firms would pay an annualized fee of 75 basis point for the guarantee.  I'm certain that 75 basis points is a small price to pay when financial company debt has been trading at crazy-wide spreads to Treasuries of late (see Morgan Stanley's CDS,  which finally came in 400 bps today).  I suspect that the first money-making scheme that banks will engage in is to buy back their old debt that is trading at a discount, retire it, and reissue new debt with a guarantee.  They can book a nice profit in the meantime assuming that the arb hasn't disappeared yet.  They can also pay themselves investment banking fees.  So the cycle resumes. 
The FDIC is extending deposit insurance on non-interest bearing transaction deposit accounts to alleviate panicked depositors.  Furthermore, the Fed is expanding its commercial-paper funding program which is set to begin on October 27th.  Both of these actions should help restore confidence and liquidity to the market.
All in all, I believe that these bold plans will unglue the credit markets and borrowing and lending should return to a more reasonable pace.  Unfortunately this plan will not stop further pain in the residential and commercial real estate markets as real estate values are certain to continue to decline.  The residential market suffers from too much inventory, while the commercial real estate market faces increasing defaults as more short-term loans that were originally underwritten with lax standards come due and banks begin to demand more equity capital from developers.  I don't even want to get into what a debacle the US auto and airline industries are in, only to say that if you are patriotic in the least and still have a job, go buy a car and take a trip.  We are most certainly already in a recession.  But I think I can finally say with relative assurance that the worst really is over. 

It's Official: Treasury to Invest $250 Billion in US Banks, Guarantee Short-Term Debt

The US government will invest $125 billion in the following big banks: Citigroup, Goldman Sachs, Wells Fargo, JP Morgan, Bank of America, Merrill Lynch, Morgan Stanley, State Street, and Bank of New York Mellon.  The government's investment will be in the form of perpetually preferred shares that will pay a dividend.  The capital injections are apparently not voluntary.  Since I am not the CEO of a large bank and was not present at yesterday's meeting at the Fed, I can only imagine how the negotiations went...

Paulson:  We're going to inject $25 billion in preferred equity in each of your organizations and you will pay the government a dividend.

Blankfein: We respectfully decline the capital injection.  But please feel free to guarantee our debt.

Paulson:  You'll take the damn money and like it!

Pandit:  We'll take Goldman's $20 billion!

Mack: Wait a minute!  We want Goldman's $20 billion!

Although I can imagine that the healthier organizations weren't thrilled about the unwanted capital injections, I understand the Treasury's need to spread the money around evenly.  Paulson is trying to prevent systemic risk from a single organization's collapse.  If he pumps money into all institutions simultaneously, this reduces speculation about which organization is likely to fail next that would cause a domino effect.  The complete and total credit market panic that resulted from the consequences (both intended and unintended) of allowing Lehman Brothers to fail is something the Treasury would like to avoid.  Furthermore, with the recent disappearance of Fannie Mae, Freddie Mac, Washington Mutual, Wachovia, Lehman, AIG, and Merrill, the weakest and most leveraged institutions have been "contained" either through a merger or a seizing by the government.   
Perhaps the most important portion of the Treasury's announcement involves the FDIC's guarantee of new debt issued by banks.  This obviously helps the US government's equity investment, as banks should hypothetically be borrowing short term money at rates closer to Treasury securities.  Although this should restore some measure of calm back into the money markets and allow investors to trade debt with more confidence, it too will have a host of unintended consequences.  First of all, Treasuries are going to get pounded.  Technically, all short term debt is now a Treasury, so why not buy short-term bank debt at a higher spread?  Furthermore, if only the short term debt of banks is guaranteed by the government, what happens to the outstanding long term debt of these institutions?  Also, what happens to the outstanding preferred equity of US banks?  I suspect that in the short term, everything rallies because of the decreased likelihood of banking failures, but that dislocations in the markets will emerge when investors actually begin to digest the consequences of these actions.
There are my initial observations.  More to come as I get more details about the plan.  

Update:  According to the joint press release from the Fed, Treasury and FDIC this morning, the capital injections were "voluntary" (they were originally reported as not voluntary in the New York Times) and that nine institutions chose to participate.  Yeah, right. 

Monday, October 13, 2008

Global Government Bailout Capitulation Weekend

Tired of the occasional one-off rescue of a financial institution over the weekend, governments around the world finally threw in the towel and decided to bailout all of their financial institutions simultaneously.  The astonishing coordinated activities are unprecedented and can best be laid out in bullet point form:
  • Australia and New Zealand guarantee all bank deposits
  • UK injects $63 billion into RBS and HBOS/Lloyds
  • Germany set to approve a $600 billion plan to guarantee bank debt and inject money into banks   
  • Spanish government approves guarantees for issues of new bank debt until December 2009
  • U.A.E guarantees bank deposits
  • Norway offers commercial banks $55 billion in government bonds in exchange for mortgage debt
  • Portugal makes $27 billion available for guaranteeing its banks' financing
  • The Fed and other central banks offer unlimited dollar funds with 7, 28 and 84 day maturities at a fixed interest rate
Meanwhile, Neel Kashkari, Hank Paulson's right-hand man, gave a speech outlining the Treasury's intent to inject equity into financial institutions.  The program will be optional and aimed at "healthy" firms.  Mr. Kashkari did not mention a plan to guarantee bank debt.  This is an option that is supposedly under consideration (it has been leaked to the press, so it must be true.)  I suspect that if other major countries follow suit, the US will be forced to guarantee bank debt as well so that its financial institutions' debt is not in a disadvantageous position relative to foreign debt.
What to make of this government intervention frenzy?  Well, it is indeed scary for the average taxpayer.  On the other hand, it should be a huge relief for the average holder of a bank deposit.  The terror in the inter-bank lending markets is threatening the future existence of the global financial system.  Most average American citizens have never been in a situation where they had to question the safety of their bank deposits, much less worry about their retirement portfolio getting cut in half within a month because their stock, bond and money market investments are behaving like some crazed emerging market investment vehicle.  These are unprecedented times that require dramatic actions by our government to restore confidence in its citizens so that they don't rush to pull all of their money out of every financial institution and bury it in their backyards.  
Being a complete and total curmudgeon who has been very critical of the Treasury and Fed, I have to admit that I think these drastic actions may finally start to work.  Although it is inevitable that some institutions will fail, it is essential that the healthy institutions are not dragged down by counterparty credit risk fears and depositor panic.  Furthermore, companies in industries not related to financial institutions require access to credit which has completely disappeared in the past month, or the risk of an implosion of the US economy and the American way of life will increase dramatically.  It appears as if money market rates are actually declining.  If nothing else, it is a start... 

Friday, October 10, 2008

US Considers Backing Bank Debt, Removing Deposit Insurance Limits As Global Markets Continue to Plunge

The global market rout continued overnight, with Asian and European markets suffering sharp drops.  Stock markets were halted in Russian, Romania, Indonesia, and Iceland (just to name a few.)  US futures are pointing to yet another painful drop in the Dow, S&P and Nasdaq.  G-7 leaders are expected to meet today to discuss other drastic measures to take to alleviate the crisis.  The US is now considering guaranteeing bank debt and temporarily insuring all US bank deposits to avoid runs on banks due to worried depositors that have more than the FDIC limits held in their bank accounts.  The credit markets have ceased to function and banks have little access to funding outside of central bank actions.  The UK is proposing guaranteeing up to $432 billion in bank debt maturing up to 36 months.  This should help to alleviate concerns about banks ability to refinance debt within the next three years.  The British government is hoping that by then, some semblance of normalcy will return to the credit markets and banks will be able to borrow money again to meet financing needs.  The US is considering similar plans, as is the G-7.

I believe that guaranteeing bank deposits and bank debt is a much better solution to the panic in the markets.  It is a de facto nationalization of the entire banking system, which renders the $700 billion bailout bill somewhat unnecessary.  The government doesn't need to be buying assets at inflated values from insolvent institutions.  It needs to be prepared to enact liquidations of insolvent institutions while protecting depositors and preventing insolvent institutions from dragging down the rest of the banking sector.  I believe this idea might actually work and would go a long way towards restoring confidence in the lending markets.  That is my hope, at least.   

Thursday, October 9, 2008

Treasury To Capitalize Banks By End of October, Then What?

Reuters claims that the Treasury Department plans to start directly injecting capital into US banks in the form of preferred shares as early as the end of October.  Reuters is citing a source "familiar with Treasury Secretary Hank Paulson's thinking."  The Treasury is aiming to follow the lead of the British government which pledged $87 billion in capital to its own banks in return for preferred shares.  According to this "source familiar with Paulson's thinking", the Treasury is working extremely fast to put together the capital injection plan.  On one hand, it may be advantageous to get this plan underway, I don't know, perhaps tomorrow, as the market is acting suspiciously as if it might pull one of its famous Black Fridays.  On the other hand, bank stocks get cheaper every day so it behooves the Treasury Secretary to wait to get a better deal.  No word from "the source" on whether the US plans to guarantee interbank lending, which is the next extraordinarily drastic action the Fed is likely to take.  Although I'm not intimately familiar with Mr. Paulson's thinking, I suspect if these two actions fail to restore calm to the capital markets he may turn to his buddy Mr. Bernanke and say "Fine!  You win.  Cue the helicopters!"
Some banks may choose to bypass the Treasury and raise capital in more ingenious ways.  Having missed the brief opportunity to issue equity when its stock was in the 20's while the short sale ban was firmly in place, Citi got distracted by its battle with Wells Fargo over Wachovia.  Citi has thrown in the towel and let Wells Fargo walk away with the prize.  Of course while Citi dilly-dallied, its stock was cut in half, so an equity issuance at this price is not particularly appealing.  After witnessing the bludgeoning of Bank of America's stock as it struggled to raise $10 billion, Citi is looking for another way to shore up its balance sheet.  So, it is taking the low road and suing Wells Fargo and Wachovia for $60 billion.  In times like these, an extra $60 billion could come in really handy.
A lack of confidence continues to permeate throughout the capital markets.  Banks aren't lending because of legitimate counterparty risk fears (see Iceland's implosion.)  Shares in Morgan Stanley have received a drubbing based on who knows what?  Rumors are circulating that the Mitsubishi investment may not go through and that the investment bank may not make it (CDS in MS are trading at distressed levels and the stock continues to come under attack every day, reminiscent of Lehman and Bear.)  Furthermore, insurance stocks have fallen off of a cliff in the past two weeks as investors become concerned about the fixed income assets on their books.  But hey, it's just a continuation of the financial beatdown due to frozen lending markets, yada yada yada.  Why were stocks like Exxon and Chevron down nearly 10% apiece while crude was only down 5%?  I suspect it was related to  hedge fund liquidations.  The long commodities/short financials trade was very popular with hedge funds this year and seemed to be the only money making game in town for awhile.  However, in the past month the commodity sector has gotten drilled due to fears of a global economic recession and hedge funds have suffered large losses.  Hedge fund redemptions have soared as investors have grown increasingly nervous about taking risk, forcing these leveraged players to liquidate.  As a consequence, many of the big momentum names from this year have suffered extraordinary losses just in the past month (POT, MOS, FCX, just to name a few.)  
What's an investor to do?  Due to my options trading background, I like to look to the VIX, which surpassed 60 today, an indicator that is flashing "PANIC PANIC PANIC!"  When the short-sale ban was originally announced, I put up several posts castigating the SEC for attempting to manipulate stocks higher.  I predicted that smart financial institutions would issue equity during this period (which they did) and that the market would crash after the short-sale ban expired.  Instead, stocks cratered while the short ban was in place after the initial pop on expiration Friday when financial stocks surged to absurd levels (Wachovia at $24?  Washington Mutual at $5, neither of these institutions made it, by the way.  Thanks Chris Cox, you've been very helpful.)  Stocks continued to crater today as the short-sale ban expired.  I crawled into my bunker a few weeks ago when the short-sale ban was enacted and asked that someone call me when the VIX hit 60 and so it has.  While I'm certainly not going to call the bottom, I will say this:  If tomorrow really is a Black Friday, it may be worth it to anyone with a strong stomach to buy a few shares of stock in the panic.  I'm not recommending that investors do this, I'm just saying that I probably will.
My regular readers should understand that this is a fairly bold pronouncement from a curmudgeon who has been consistently and unwaveringly bearish on the market since I began this blog (and for some time before.)  Unlike most of the equity investment and pundit community (yes that includes you, Jim Cramer) who have called the bottom over and over again and thought that stocks looked cheap with the Dow at 13,000, 12,000, and 11,000, I couldn't buy into the notion that a massive contraction in credit could lead to higher stock prices.  I certainly believe that there are significant risks, but the risk reward equation has altered so much in the past several weeks that it has begun to look tempting to dip your toes in as others panic.  Furthermore, the Fed and Treasury are jumping through hoops to stimulate the market, and at some point the gears will start to move again.  I would still hold lots of cash in FDIC insured accounts, maybe some gold and perhaps some Damien Hirst artwork.  For those unfamiliar with Mr. Hirst's art, he puts dead animals into glass cubes filled with formaldehyde and calls it art.  Sotheby's held an auction where people tripped over themselves to pay $10's of millions of dollars apiece for dead animals in formaldehyde.  So, you see, this might be a really great store of value, tradable for canned goods in the event that the entire world collapses and we're left with nothing but a barter system.  I'm not saying I'll be sinking all of my money into Mr. Hirst's art, only that the neighborhood cat better watch out.        

Rising Libor Defies Global Interest Rate Cuts

Three-Month Libor rose again to 4.75%, as global central bank interest rate cuts had little affect on banks willingness to lend to each other.  Meanwhile, Iceland's government seized control of Kaupthing Bank, the nation's largest lender, completing the nationalization of the country's banking industry.  Iceland's banks were saddled with $61 billion in debt, 12 times the size of the economy according to Bloomberg.  The government is seeking a loan from Russia and may ask the IMF for help guaranteeing deposits.  Pegging the krona to the euro apparently lasted less than a day and all trading in Iceland's equity markets is suspended until October 13th.

My reasons for writing about Iceland are twofold.  First, Iceland's problems are a fantastic lesson in the consequences of allowing too much leverage in a country's banking sector.  Assets at Iceland's three biggest banks have grown five-fold since 2004 and were financed primarily from debt sales not domestic deposits.  More importantly, I am writing about Iceland to make everyone in the US feel a little bit better about the current debacle taking place in front of our eyes every day when we pick up the paper.  Despite all of the turmoil in our markets, it could obviously be alot worse.  We could live in Iceland and be extremely pissed-off at the three banks that basically tanked our economy due to excessive greed.  In the US, we can spread the hate around to Wall Street for its greed, the government for its lack of supervision of Wall Street, and maybe a few real estate flippers that lied about their incomes to buy 17 condos in Florida.  So if you think things are bad, they are way worse elsewhere.  The US stock market is down considerably less than others, and, despite everything, global markets consider Treasury securities as the safest assets in the world.  Amidst the global panic, investors the world over are still flocking to Treasuries, which is nice, because we have lots of Treasuries to shovel down their throats to finance all of our government bailouts.         

Wednesday, October 8, 2008

Fed Lends AIG Additional $38 Billion, No Pedicures Allowed

Undeterred by the discovery that AIG executives spent $440,000 partying at the St. Regis just a few days after being bailed out by the US taxpayer, the Fed has granted AIG an additional $37.8 billion in loans secured by investment-grade fixed income securities.  You would think that this loan comes with the caveat that executives can no longer spend money frivolously on parties aimed at "boosting morale," or put fired executives on $1 million-per-month retainers but unfortunately that doesn't appear to be the case.  A spokesman for AIG told the Washington Post's Investigations Blog that several AIG subsidiaries are going ahead with social and business events that were scheduled before the bailout.  For example, later this month, an estimated 15o brokers and 50 AIG employees are attending a get-together for the company's high-end insurance "private-client group" at the Ritz Carlton in Half Moon Bay, California.  Honestly, boondoggles like this are great fun.  I've been lucky enough to attend a few in my time.  Are they really necessary, or do they actually facilitate business?  Absolutely not.  A good boondoggle should be used sparingly.  For example, 1999 would've been a great year to have plenty of golf outings with some spa treatments and hefty bar tabs thrown in for good measure.  But maybe, just maybe, you want to lay off on the unnecessary trips to the Ritz when the FEDERAL GOVERNMENT HAS TO LEND YOU $100 BILLION DOLLARS TO STAY AFLOAT. Okay?  I rarely use all-caps, but I feel much better now.  

Update:  Apparently the Ritz Carlton Half Moon Bay boondoggle has been cancelled due to an uproar of moral indignation on behalf of US taxpayers.    

Global Coordinated Rate Cut

The Fed, European Central Bank, Bank of Canada, and Sweden's Riksbank each cut their benchmark rates by 50 basis points.  China's central bank also lowered its one-year lending rate by .27%.  The drastic interest rate cuts, rumored for days, came on the heels of severe strains in the money markets and plunging global stock markets after dramatic government intervention around the world has failed to stem the crisis.

The UK will invest directly into its four largest banks and provide other funding totaling $87 billion.  The announcement was anticipated and caused a complete rout in British bank stocks yesterday.  The Nikkei plunged 9% and Indonesia halted trading after its benchmark index tumbled 10%.  Russia pumped another $36 billion in loans to its banks.  Promises of nearly $150 billion from the Russian government have failed to stop the Micex from plunging yet again.

Although futures are up after the rate cut announcement, it is hard to imagine that somehow this act is finally going to solve the crisis gripping the global markets.  It doesn't matter how low interest rates are if banks refuse to lend to each other because of counterparty credit risk fears.  The extraordinary actions that the Fed has instigated through a series of new lending facilities have only made banks more reluctant to lend to each other.  If you can get all of your financing through the Fed, why borrow from a financial institution who may or may not be around in six months?  The Fed and Treasury are praying that something at some point will restore confidence in the banking system again.  But if the TAF, TSLF, PDCF, CPFF, TARP, and various other loans to AIG, FNM, and FRE can't stop the meltdown, how on earth is another 50 basis points going to do the trick?  

Tuesday, October 7, 2008

TAF Undersubscribed. Seriously?

The results of the TAF are out and they are perplexing to say the least.  The stop-out rate was 1.39% with only $138.092 billion submitted out of the total of $150 billion in funding available.  1.39% was the minimum that dealers were allowed to bid and comes in roughly 300 basis points BELOW Libor.  The maturity date of this loan is January 2, 2009 so it covered year-end.  I find these results to be incredibly perplexing.  If dealers are desperate for term funding, particularly over year-end, why was this auction not oversubscribed?  Any bank with room in their balance sheets should be purchasing assets at Libor and then shoveling them to the Fed through the TAF.  In any event, banks are getting a great financing deal with two-month money coming at 1.39%.  Does the Fed really even need to ease?  Other thoughts and comments are welcome.         

Fed to Purchase Commercial Paper and Other Central Bank News

The Fed has announced that it will be purchasing commercial paper.  The new program, the Commercial Paper Funding Facility (CPFF) will serve as a funding backstop to facilitate the issuance of term commercial paper by eligible issuers (US issuers rated A1/P1/F1.)  This plan directly addressed the funding problems of US corporations that are suffering increased borrowing costs due to mess on Wall Street.  The CPFF is a far more efficient way to keep the US economy from entering a depression than the indirect $700 billion bailout.      
Meanwhile, across the pond, a report that the UK government may invest at least 45 billion pounds in three of the country's biggest banks to bolster capital sent UK bank stocks sharply lower.  Royal Bank of Scotland plunged as much as 39% at one point on a downgrade and speculation that the bank had approached the government asking for a capital injection.  Although RBS denied that it had approached the government hat in hand, its shares remained battered.
Overnight interbank lending rates increased again despite the Fed's best efforts to pump liquidity into the money markets.  The Fed released the schedule for the 28-day and 84-day loans to dealers that it plans to auction through the Term Auction Facility (TAF.)  The first $150 billion auction was conducted yesterday with results expected to be announced today.  The equity markets were disappointed when the Fed announced the TAF schedule instead of a global coordinated central bank interest rate cut.  Index futures sold off on the release of the TAF.      
Although common knowledge to those who follow the credit markets, those who don't regularly read the back pages of the Financial Times may not know that the Iceland banking sector is blowing out.  The currency has been in a tailspin, the government was forced to nationalize its second-largest bank and it is supposedly in talks with Russia for a 4 billion euro loan.  Yesterday trading in shares of major banks was suspended and the government declared that it would guarantee all domestic deposits.  Well, actually, it appears as if Russia will guarantee all domestic deposits if Mr. Putin is kind enough to grant Iceland a loan.
That may cover all the highlights.  Phew!  More to come...

Monday, October 6, 2008

BAC Earnings Miss Expectations

After the closing bell, Bank of America announced much worse than anticipated third-quarter earnings results.  BAC reported net income of 15 cents a share, compared to the average analyst estimate of 62 cents a share.  Net income dropped 68% on $952 million in write-downs from subprime mortgage-related investments.  Despite repeated denials that the bank would ever cut its dividend, Bank of America halved its quarterly dividend and announced plans to sell $10 billion in common stock.  This "surprise" earnings announcement has several important lessons for investors: 
  • Even top tier banks that are supposed to be weathering the storm are getting crushed
  • Earnings estimates are still WAY TOO HIGH
  • Banks that issue equity during the short-sale ban are indicating that their stocks are overvalued
A few details on the performance on BAC's loan portfolio offer insight into how poorly the US consumer is faring.  Net charge-offs jumped to 1.84% from .80% a year ago and 1.67% in the second quarter.  Nonperforming assets increased to 1.42% from .43% a year ago and 1.13% in the second quarter.  The company stated that increased loss and delinquency trends first noted in the home equity and homebuilder portfolios have spread to first mortgage, unsecured consumer lending and credit-card portfolios.  A lack of refinancing options to consumers due to a tight lending environment should lead to a surge of delinquencies and defaults.  I suspect that increased charge-offs and delinquencies are not unique to Bank of America's loan portfolio and that investors should prepare themselves for more disappointment this earnings season.         

Fed Paying Interest on Reserves, Increasing TAF, Jumping Through Hoops

The Fed has released a statement announcing significant efforts to boost liquidity in the credit markets.  The Fed will begin to pay interest on required reserve balances and excess reserve balances.  Additionally, the Fed will increase the amount outstanding in the Term Auction Facility (TAF) to a potential amount of $900 billion over year end.  The TAF auctions 28-day and 84-day loans to dealers in return for collateral accepted by the discount window (which currently includes all sort of questionable securities and possibly old shoes.)  The increase in the TAF is meant to alleviate strains in the term market for funds.  Apparently, banks are terrified of lending to each other for more than a few days because of counterparty credit risk fears.  The Fed is the only counterparty that is guaranteed to be around in a few months.  

While I do believe that these actions appear necessary to keep more banks from failing, I still find them extremely disturbing.  The Fed is propping up our banking sector.  How much longer will it work, and what happens if it fails to prevent more banking collapses?  If you thought the $700 billion bailout plan was big, how do you feel about the $900 billion TAF?  Or the $400 billion in "other loans" sitting on the Fed's balance sheet?  While the amount of assets on the Fed's balance sheet continues to increase, it is wise to remain cautious.  I'll be checking in with the Fed every Thursday afternoon for an update on its balance sheet as a decrease in assets will be a crucial indicator of when the worst really is over. 

Sunday, October 5, 2008

Weekend Bailout/Merger/Banking Alert

Germany's Hypo Real will receive a new 50 billion euro "rescue package" after a bailout package negotiated last weekend failed to materialize.  The German government and the Bundesbank have claimed that Germany's second-biggest property lender is too big to fail.  Meanwhile, BNP Paribas will buy 75% of Fortis Bank Belgium from the government for 8.25 billion euros in stock and purchase the Belgian insurance operations.  BNP Paribas will also acquire 66 percent of Fortis's bank in Luxembourg.  
In the US, Citigroup and Wells Fargo spent the weekend in court battling over Wachovia, the US bank that was ordered to merge last weekend with a bank, any bank, just merge before the opening bell on Monday.  The FDIC threatened to seize Wachovia if a merger was not forthcoming.  If you missed the action, here's a quick summary:  Citi bid $2 billion for parts of Wachovia on Monday.  Wells Fargo offered to pay nearly 7x Citi's bid on Friday for the entire bank.  This really pissed off Vikram Pandit so much that he filed suit against Wells Fargo.  He even called the Wall Street Journal and told them to replace the stock photo of him grinning like a loon with one where he looks angry, because he's not fooling around.  It appeared as if Citi won a victory in court on Saturday when it persuaded a New York state trial-court judge to extend the exclusivity agreement between Wachovia and Citigroup until Friday.  However, Sunday a state appeals-court judge overturned the extension of the exclusivity agreement.  Meanwhile, the Fed has jumped into the fray and asked the battling banks to make nice and work out a deal.  According to the Wall Street Journal, Citi and Wells are being asked to carve up Wachovia along geographic lines.  I would bet that a carving up of the bank will not pan out despite the Fed's best efforts and Wells will more than likely wind up owning Wachovia.
As an aside, I must note how amazed I am at how quickly the court system in America works when something "very important" is on the docket.  I spent six weeks serving as a juror on a very brutal murder trial this summer.  The murder happened in 2002 and it took six years to come to trial.  The prosecution had ample evidence for a conviction and the jury found the defendant guilty.  During the six weeks of my service, the court never met on a Friday, much less the weekend.  So I have to ask, how did Wells Fargo and Citigroup get to argue their case over the weekend in two different court rooms?    
A weekend's worth of more bailout negotiations by banks and governments around the globe have only served to intensify fears over the soundness of the banking sector.  Markets that have opened are already falling again this Monday, while S&P futures point to a lower open in the US after a brutal week for equities last week.  The good news in all of this?  The short-sale ban expires on Wednesday, so investors can line up their orders for Thursday morning.  Longs have three more days to sell their stocks which makes me wonder if the market will go down more at the beginning of the week as longs try to front-run the shorts.  Furthermore, with hedge funds having their worst September ever, is there anyone left who can still afford to short?  

Friday, October 3, 2008

Citi Cries Foul, Citing Exlusivity Agreement With Wachovia

The Wall Street Journal is reporting that Citi is claiming that Wachovia is in breach of the Exclusivity Agreement it signed with Citi earlier in the week. Citi states that "Wells Fargo's conduct constitutes tortious interference with the Exclusivity Agreement." Apparently, it's about to get ugly as Citi is using nasty legal terms like "tortious interference." The FDIC has put out a statement that it stands behind the Citigroup deal. Might we see a bidding war over Wachovia, who many had given up for dead at the beginning of the week? I find it hard to believe that the FDIC wouldn't welcome this opportunity to get out of the loss guarantee it granted to Citi and allow a much stronger institution to take over all of Wachovia. Not only is the Wells Fargo deal better for the FDIC, it is better for shareholders of Wachovia, for debtholders of Wachovia and for confidence in the market. Naturally, Citi is pissed because it thought it was getting a sweet deal and had catapulted itself into favored status with the government. But if it wants Wachovia, it better be prepared to pay more.

Wells Fargo Snags Wachovia From Citi's Clutches

In a surprise move, Wells Fargo bested Citigroup's bid and snatched Wachovia as its prize. Wells Fargo agreed to pay $15.1 billion in stock for Wachovia, or roughly $7 a share, a significant improvement over Citi's $1 a share bid. Better yet, the Wells Fargo bid does not include any government guarantees. While Citi's bid included a promise from the FDIC to take a maximum of $270 billion in losses after Citi took the first $42 billion, Wells Fargo has indicated it has the stomach to swallow any potential future losses from Wachovia's ailing mortgage portfolio. This is proof that the market has the ability to find value in the banking sector without any need for a government bailout. Some might say that Wells Fargo waited to pounce on Wachovia until it was relatively assured of a bailout package passing in Congress. But then, it should've waited until the unpredictable House actually passed the legislation. Furthermore, Wells plans to issue $20 billion in additional equity to help finance the deal. With the stock near 52-week highs, issuing stock while the SEC short-sale ban in still in effect is brilliant and entirely predicatable. Any bank that doesn't take advantage of this window of opportunity to raise equity while the shorts are banished from trading should be immediately shorted when the ban expires.

Thursday, October 2, 2008

Fed's Balance Sheet Exploding: Why You Should Care

Once a mundane data point for a handful of money market traders, the weekly release of the Federal Reserve's balance sheet has become an eagerly anticipated newsworthy event covered by the press. Ordinary folks unaccustomed to hearing the financial press describe the money markets as if it were a horror show may wonder why they should care about the recent ballooning of the Fed's balance sheet. How is this any different from what the Fed has been doing for years on end?

The primary reason for concern about the Fed's balance sheet is the recent alarming change in the Fed's mission that was brought about due to the poor investment choices and excess leverage of Wall Street during the housing boom. The Fed's original mission was to enact monetary policy to ease the effects of the business cycle by performing open market operations with Wall Street primary dealers. The Fed injected and withdrew money from the money supply using short term loans that accepted Treasury securities as collateral. The Fed's new mission appears to be bailing out the banking sector by providing cheap financing for their inventories of illiquid securities from MBS and ABS to mutual funds and equities. Don't worry if you don't understand these securities or what they are worth, neither does the Fed. Make no mistake, if the Fed had not broadened the collateral it accepted for its loans, and increased the amount of loans it was granting to banks, the entire banking sector would have already collapsed. Nevertheless, it should matter to every US citizen because the taxpayer is on the hook for any losses that the Fed may take on these loans. If another major bank fails, which at this point is not that hard to imagine, and that bank has loans outstanding to the Fed, the Fed will need to liquidate the collateral into a very unfriendly market. Or, I suppose, it can always hold the securities to maturity like it is doing with the Bear Stearns loan and hope for the beast.

In the past two weeks, the Fed has borrowed money from the Treasury and used it to balloon its balance sheet by $400 billion. Yesterday, October 1, primary dealers borrowed $150 billion from the discount window, banks borrowed $50 billion, dealers borrowed $150 billion in the new ABS CP facility, and AIG increased its borrowing to $61 billion. None of these facilities, nor the TAF or TSLF, existed a year ago and now most of the US banking sector's survival depends on them. On Oct. 23, the Fed will be updating the public on the valuation of the securities backing the loan that the Fed gave to JP Morgan to facilitate the takeover of Bear Stearns. Analysts estimate that the Fed will take a write-down of between $2 and $6 billion on the $30 billion loan. When the Fed granted that loan back in March, the market rallied, credit spreads narrowed and everyone, including our Treasury Secretary, proclaimed that the worst was over. But now, six months later, the securities may suffer a significant loss. This comes out of the taxpayer's pocket. What does this imply about the accuracy of the valuation of the other hundreds of billions in illiquid securities sitting on the Fed's balance sheet in the event of a default by a counterparty? More importantly, what does it indicate about the Treasury Secretary's ability to buy distressed assets at prices he deems cheap and then guaranttee profits for the taxpayer? The implications are not encouraging. I, for one, will be emailing my congressman.