Wednesday, November 26, 2008

Economic Data to Go With Your Turkey

In honor of the impending Thanksgiving Holiday, I have vowed not to insert the words "the worst level since [pick a year that was a long time ago]" after every economic number I report.  Instead, I will report the facts followed by some commentary.  First the bad news:
  • Mortgage interest rates fell dramatically yesterday on the heels of the Fed's announcement that it would purchase $600 billion in GSE direct debt and MBS.  This is great news for anyone looking to refinance or purchase a home.  The Wall Street Journal reported anecdotal evidence of a surge in refinancing efforts yesterday.  We'll see the actual data when the MBA refinance index is reported.
Yesterday's economic data pointed to continued declines in home prices via the Case-Schiller index, which showed that prices were off 16.6% year-over-year in the third quarter and 21% from the peak.  Third quarter GDP was revised down from an initial estimate of 0.3% to 0.5%.  Also, the FDIC reported that the number of problem banks increased to 171 from 117 in the quarter.

In summary, the economic data is very weak.  But, the Fed and the Treasury have put the printing presses in high gear, hoping against hope, that we might avoid a horrible deflationary spiral, like Japan in the 90's.  Then, if we make it out of the deflationary spiral, perhaps they will start to deal with the potential inflationary spiral they have created from all the money printing (such as [pick your favorite Latin American country].)  Economic experts are weighing in everywhere with their opinions about the unintended consequences that will result from the clear path of quantitative easing (like what Japan did in the '90's) that we are on.  

I'm certainly no economist, but I too believe that the unintended consequences of the Fed and Treasury's actions will be many.  Maybe some brilliant economist has predicted what they will be, but nobody knows for certain and surprises will abound.  Perhaps the most interesting part of all of this so far is that despite everything the Fed has done to devalue our currency, investors still view treasuries as the safest investment in the world.  All of the dire predictions about foreign central banks abandoning US treasuries and pushing our interest rates to double digit levels have not come true.  Remarkably, during a period of time when the Treasury is auctioning enormous amounts of debt to fund all of the bailouts, investors are snapping it all up and requiring virtually no return on their investment.  The market is desperate for US treasuries.  Gold hasn't rallied to $3,000 an ounce.  So, what's the story?  Why are investors still believers in the US?  I suspect because the alternative is too grim for any of them to fathom.  A reshuffling of the world financial order, where the full faith and credit of the US is considered a worthless promise, is not something investors are ready to contemplate yet.  That should certainly give every worried American something to be thankful for this holiday season.  On that note, I would like to wish my readers a very Happy Thanksgiving.  

Tuesday, November 25, 2008

Fed Throws $800 Billion More At Credit Markets

The Fed initiated yet another lending facility called the Term Asset-Backed Securities lending Facility (TALF.)  The TALF will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans.  The Treasury will provide $20 billion of credit protection to the Federal Reserve Bank of New York in connection with the TALF.  This new facility is aimed at freeing up lending in the consumer and small business loan arena, and should help companies like American Express who were begging for TARP funds because the ABS market had essentially shut down.  

Additionally, the Federal Reserve announced this morning that it would purchase as much as $600 billion in debt issued or backed by GSE's.  The $600 billion will be broken down into $100 billion in direct debt of Fannie, Freddie and the Federal Home Loan Banks and $500 billion in MBS.  The direct debt will be purchased through auctions from primary dealers, while the MBS will be purchased from asset managers to be selected via a competitive process (i.e. PIMCO)

These programs are aimed at alleviating the continued pressure in the credit markets that have forced spreads to widen to unprecedented levels.  Consequently, despite the Fed's easing to a 1% fed funds target, borrowing rates for consumers on mortgages and other types of debt remains stubbornly high.  Will this work?  Who knows?  Bringing down the cost of mortgages was the initial goal of putting Fannie and Freddie into conservatorship, and that didn't seem to go too well.  Furthermore, I'm not sure if it's just my twisted sense of humor, but I find it hilarious that the Fed is buying GSE debt.  The government already owns the GSEs.  So, the government is basically buying debt from...itself.  Why this should tighten spreads further is a mystery to me, but it will probably work in the short term.  Much like yesterday's announcement of the Citigroup bailout, a detailed outline of how losses would be allocated to each government entity had me in hysterics.  In the end, does it really matter if the FDIC or the FED takes the hit?  It's ultimately all going to come out of our pockets.       

Monday, November 24, 2008

US Government Bails Out Citi, Who's Next?

After much see-sawing and several leaks to the press on Sunday, the government finally reached an agreement to bailout Citigroup.  The terms of the deal include splitting the bank's assets into a "good-bank/bad-bank" format.  Alas, the government will be guaranteeing the assets in the "bad bank" as well as administering spankings when appropriate.  The outline of the terms of the deal can be found here, but here are a few highlights:

$306 billion in bad assets will be "ring-fenced" in the bad bank.  Citigroup will absorb all losses up to $29 billion in addition to existing reserves.  Beyond $29 billion, the losses will be split, with the government taking 90% and Citigroup absorbing 10%.  For anyone who actually cares which of the institutions will be bearing the loss, the government has broken this out as well.  Although ultimately it is all coming from the same kitty, the breakdown matters because investors need to know how much is left in the TARP for other beleaguered institutions.  The US Treasury will absorb the first $5 billion, followed by the FDIC with $10 billion, with the Fed on the hook for the balance as it will be financing the debacle with a non-recourse loan at a rate of OIS plus 300 basis points.

What is the government getting in return for assuming all of this risk?  Citi will issue $7 billion in preferred stock with an 8% dividend rate.  However, Citi will retain the income stream from the guaranteed assets insuring that the government's investment has little upside and enormous downside.  Citi will be prohibited from paying common stock dividends for three years and, of course, compensation of executives will need to be approved by the government.

Frankly, this is a fantastic deal for Citigroup and a really lousy one for the government.  The maximum downside to the government on this deal is $209 billion.  Certainly that is if the assets go to zero, and nobody measures risk that way, blah blah blah.  But a failure of risk managers to consider catastrophic losses as a possibility is what got Citi in this mess to begin with.  The original purpose of the TARP, to purchase toxic assets from banks, has been revived, but apparently only for Citigroup.  I suspect that the market is going to continue punishing the stocks of all the banks, until the government agrees to do the same with any institution it deems as holding too many crappy assets.  Does this sound like a crazy conspiracy where the banking industry attempts to cannibalize itself in order to force the type of government bailout it wants?  Absolutely.  But a front page story in the WSJ detailing how traders at Merrill, Citi, Deutsche and UBS attacked Morgan Stanley in late September by purchasing credit default swaps in what may have been a coordinated attempt, points out how willing Wall Streeters are to punish each other.  Somehow, they don't seem to understand that forcing Morgan Stanley into collapse may pose irreparable damage for their own business.  Or perhaps they understand the business is doomed and only the government can save them now?  They want the TARP back and the governments seems only too willing to comply.        

Friday, November 21, 2008

Obama Transition Team Considering Bankruptcy "Prepack" for Automakers

President-Elect Barack Obama's transition team is considering a prepackaged bankruptcy for the automakers as a potential solution.  This may be the answer for the beleaguered automakers.  Although many have been calling for a bankruptcy solution for GM, F, and Chrysler, the implications of a potential bankruptcy have been weighing on the markets like a ton of steel.  A Chapter 11 filing during ordinary markets wouldn't necessarily be catastrophic; the airlines seem to do it every couple of years.  The biggest concern about a bankruptcy filing by the automakers right smack in the middle of the credit crisis has been the lack of availability of debtor-in-possession financing.  DIP financing is crucial during a Chapter 11 in that it allows companies to continue to fund operations while working through complicated negotiations with creditors.  GE Capital, the largest provider of DIP financing, recently announced it was exiting the business.  Without access to this type of financing, the probability of a Chapter 11 bankruptcy leading to a liquidation has increased dramatically for any company seeking protection from creditors.  The thought of all three automakers needing a huge amount of this type of financing during a period of such constrained credit is just too much for the markets to bear. 
A prepackaged bankruptcy with the government providing the interim financing is perhaps the ideal solution.  The automakers could restructure all of their burdensome obligations, allowing them to better compete with the foreign automakers.  If a deal was reached with creditors prior to a bankruptcy filing, with the government's financial support, consumers would not shy away from purchasing vehicles from the companies because a clear exit strategy would be in place.    

Thursday, November 20, 2008

Top Ten Surefire Signals of a Market Bottom

Not a minute goes by on CNBC when commentators aren't furiously debating whether a "bottom has been set."  First there was definitely a bottom in March.  Definitely.  Followed by another bottom in July.  I've never seen a better bottom.  Then we had October 10th.  Seriously, has anyone seen a bottom more definitive than October 10th?  The inverse upside down quadrangle band was reaffirmed at least 17 times!  That had to be it.  Unfortunately, equity investors are facing yet another potential bottom today.  Could this one be it?  To help those confused investors determine the actual bottom, I have put together a short list of events that must occur for a bottom to be put in place.  If you see these events occurring simultaneously, I strongly urge you to start buying stocks with both hands.
  1. Prince Alwaleed stops thinking Citigroup is a great investment.  Believe it or not, the Saudi Prince is STILL buying
  2. Debt investors throw in the towel on GMAC and ResCap, refuse to swap their debt for more debt and mark that garbage down to zero where it belongs.  GMAC still seeking bailout from Feds; still swapping debt.
  3. Maria Bartiromo jumps out the window on live TV (but lives and returns to work the next day in a cast; I'm not that morbid.)  Ms. Bartiromo is still on my tube shrilly yelling at guests to explain to her WHAT the HELL is GOING ON because she's been telling people for ten years that stocks are a great investment and this is making her look like an idiot!
  4. Vladmir Putin stops threatening the Russian market with violence if it doesn't cease collapsing.  Mr. Putin pledged to do "everything" to prevent a financial crisis.  He did not rule out invading the stock exchange.
  5. Somali Pirates lower their ransom demands from $25 million to $1.50 when they realize that an oil tanker is virtually worthless in this economy.  Somalis still not following commodity futures market; still want $25 million
  6. News reports stop including "The worst level in 27 years!" in every headline.
  7. Microsoft uses its $30 billion cash hoard to buy Chrysler, Ford, GM, Citigroup, JP Morgan and Bank of America.  The Justice Department does not block the deals on anti-trust grounds.
  8. Ben Bernanke and Hank Paulson cry like babies in unison on television at some sort of press conference that they called to attempt to instill confidence in the market.
  9. Not a single airline files for bankruptcy during the downturn.
  10. SEC Chairman Chris Cox comes out from whatever hole he's been hiding in ever since his short-sale ban was a flop, and tries to institute a ban on selling stocks.  Hank Paulson punches him in the face on live television at the aforementioned conference (see 8.) and Ben Bernanke has to hold Mr. Paulson back to keep him from doing any real damage.  All of them are still crying as they make a beeline for the hellicopter.  (This last one is more of a fantasy and less of a real indicator.) 

Wednesday, November 19, 2008

AutoMakers Plead For Government Funds as Economic News Worsens

The CEOs of GM, Ford and Chrylser are scheduled to testify for a second day on Capital Hill, this time in front of the House Financial Services Committee after hitting up the Senate for cash yesterday.  I don't have a particularly strong stomach so I only watched bits and pieces of the testimony as the remarkably contrite auto chiefs attempted to make a case for some sort of capital injection.  They repeatedly emphasized that a Chapter 11 filing would be catastrophic and would more than likely push them into Chapter 7 liquidation as consumers fled their brands due to fears that their warranties would not be honored.  Not surprisingly, the Senators bashed the CEOs and accused them of financial mismanagement.  It is hard to stomach, given that this administration that has presided over the grossest financial mismanagement in the history of the free world.  Aside from the billions upon billions that have been thrown at the banking system, let's not forget that AIG just received $150 billion in government money about a week ago.  Why, for the love of god, is okay to grant the giant money-sucking-CDS-selling-insurance-mismanager $150 billion in government funds to prevent systemic risk, but not okay to give the auto-companies a $25 billion injection?  What about Citigroup?  Citigroup, made the front page of the Financial Times today because it is liquidating it's ninth hedge fund due to catastrophic losses.  This is a fund, mind you, that the bank already injected capital into and will wind up costing Citi hundreds of millions of dollars.  The US government had no problem forking over $25 billion to Citigroup so it could bailout its failed hedge funds.  But somehow, because the unions are involved and blue collar workers face the prospects of losing what are viewed as very cushy benefits, it is not as palatable as handing money to an industry that paid out billions in bonuses for years on phantom profits that ultimately caused the collapse of the global economy.  I don't like the UAW either, but seriously, isn't anyone else disgusted by this hypocrisy? 
I definitely don't think our government should've bailed out any of these firms but the systemic risks were viewed as too high and even with government bailouts our economy is tanking, so clearly something had to be done.  The problem is that decisions now need to be made to determine who is big enough and poses enough of a systemic risk to need bailout funds.  Had you asked me a year or two ago if we should bailout the automakers, I would have emphatically said "no."  But I think that the unintended consequences of a Chapter 11 filing right now of the entire US auto industry would be far too catastrophic.  The economy is too fragile, and attempting to settle all of the outstanding debt of the automakers would send the credit markets into a further tailspin.  
Meanwhile, in headline economic news, CPI fell 1% last month mostly due to a plunge in energy prices (good), although food prices rose .3% (not good) and ex food and energy declined .1% (just okay.)  Housing starts plunged to an annual rate of 791,000, the lowest since records began in 1959.  Although economists and the media will focus on the devastating effects of deflation and start comparing the US to Japan in the 90's, I actually think it's positive that builders are slowing down the pace of construction.  Maybe at some point we can finally clear out all of the inventory that is sitting around.  As for paying less at the pump for gas, frankly, I'm a big supporter of that too.  

Tuesday, November 18, 2008

CMBS Hitting the Fan

Stock market investors who find themselves perplexed by the continued weakness in insurers and financials can look for clues in the commercial mortgage backed securities market.  In addition to the residential mortgage debacle, banks and insurers hold huge portfolios of commercial mortgage loans and securities, investments which are currently getting pounded due to increasing fears of impending defaults.  The Wall Street Journal has a great story detailing the rapid deterioration in CMBS.  According to the article, the market for debt used to finance hotels, offices and shopping malls tumbled Tuesday on fears of a wave of defaults in the $800 billion commercial real estate securities market.  Two big commercial mortgages that were packaged into securities in the past year are on the verge of defaulting.  Both of the large loans, a $209 million loan backed by two hotels and a $125 million loan backed by a mall, were "pro forma" loans.  For those unfamiliar with the jargon, "pro forma" is investment banking-speak for "numbers we invented."  You see, if the actual cash flows from the building were utilized, the loans wouldn't really make sense financially.  In order to get around this minor inconvenience, the goons at JP Morgan, who underwrote these specific loans, just assumed that operating income would go up, alot, in the future.  And really, why would they even care?  The loans were just shoveled into a CMBS and passed along to the boob investor who bought the securities because some idiot at the rating agency slapped it with a AAA rating.  Given that this level of underwriting scrutiny was the status quo for several years, can anyone possibly be surprised that spreads in AAA CMBS have widened to record levels?

The overall number of commercial mortgages packaged into securities that are 30 days or more past due rose to .64% in October from .39% at the end of last year, with most of the increase coming in October.  Although fairly low by historical standards, the delinquency rate was the highest in two years.  Clearly delinquencies are set to soar as borrowers are unable to refinance into new loans on terms similar to those they negotiated during the boom.  Furthermore, with the economy weakening significantly, operating income is more likely to decline as office vacancies increase, consumers stop visiting malls, and both business and pleasure travelers cut back on time spent at hotels.  The news in the commercial real estate market is likely to get much worse.  


YHOO and HP Goose the Market, Financials Slap It Back Down

Jerry Yang has announced he will step aside and allow Yahoo to seek a new CEO.  This is probably one of the best decisions Mr. Yang has made for the company in a very long time.  His decision to scorn Microsoft's $40 billion bid for Yahoo will go down in history as one of the worst made by a non-financial company CEO.  That statement is not in hindsight.  It was patently clear at the time to anyone with half a brain that the company should've accepted Microsoft's bid.  I don't attest to have more than half a brain but you can read my comments mocking the idiot analysts at the time who kept claiming how badly Microsoft (holder of multiple billions in cash) needed Yahoo ($18 stock at the time with declining prospects) and how Mr. Softy would certainly raise his bid to win his prize.  Microsoft may or may not be back now that Mr. Yang is stepping down, but it is unlikely to bid much of a premium in this market.

In the surprisingly good new department, Hewlett-Packard actually raised guidance for the fourth quarter.  I know, I can't believe it either.  But good news is rare these days, so the market will take what it can get.  

Futures were higher on the HP and Yahoo news, but the market is roughly flat in early morning trading as attention returns to battering the living stuffing out of financials.  Make no mistake, the financials deserve their battering.  Hank Paulson and Ben Bernanke are testifying on Capital Hill today with Sheila Bair in tow.  Mr. Paulson has noted that he does not intend to use any more of the TARP while in office, unless absolutely necessary (i.e. some bank or insurance company calling him at 3 am).  Since financials trade mostly on government intervention news, investors are hoping to figure out what the newly elected administration plans to do with the rest of the money and if some companies will actually make it until the new administration takes over in January without an injection of funds.  This explains why insurance stocks are getting pounded and why they are considering buying small savings and loans to access to more liquidity.          

Monday, November 17, 2008

Are Citi and Goldman Finally Facing the Music?

Citigroup's CEO Vikram Pandit held a town hall meeting intended to boost morale, and then announced that the bank will be eliminating more than 50,000 jobs or about 14% of its workforce.  I'm not sure how that town hall meeting was supposed to bring anyone back from the ledge, but at least the bank is getting realistic.  Citigroup announced that the company was planning to reduce expenses by 20%, targeting 2009 expenses of $50 to $52 billion.  The reports do not mention whether Citi plans to cuts the rest of its dividend.  But at some point it should sink in that paying a government-sponsored dividend in these times is flat-out moronic, not to mention politically unwise.
Meanwhile, in a masterful public relations move, top executives at Goldman Sachs have decided to forgo their 2008 bonuses.  Although Goldman has (so far) had a reasonably profitable year in what has been a disaster for other banking institutions, senior management has figured out that it is far less painful to give up a bonus than try to explain their compensation to Henry Waxman.  It is hard to make a case that your executives "deserve" millions in pay when the investment bank is surely being kept afloat by the Fed through its numerous new toxic-asset financing facilities.  Furthermore, partners at Goldman make $600,000 in salary and have all been showered with millions in compensation for the past several years.  Nobody at the senior ranks of Goldman is going to starve without a bonus this year.  Employees of Goldman Sachs are no doubt nervous about this announcement as it has implications for their own end-of-year compensation.
It is widely known that securities industry professionals are an extremely well-compensated lot.  The industry is clearly shrinking and many who were accustomed to getting paid hundreds of thousands and even millions a year are now facing the prospects of living off of their salaries or being unemployed for a very very long period of time.  The interesting follow-up question remains:  How will the contraction of the securities industry affect other sectors of the economy that thrived off of the Wall Street boom of the last few years?  It is widely known that investment banks were leveraged 35-to-1 during the boom.  But how leveraged were the bank's employees?  While it is certainly probable that some percentage of securities industries professionals lived within or even beneath their means, it seems more likely that a large percentage expected to collect huge bonuses every year to maintain their extravagant lifestyles.  How many of those shiny new Manhattan luxury condos are going to come on the market within the next two months?  What will this do to other luxury goods retailers?  Villa rentals in the Caribbean?  Prices on contemporary art?  Ferrari dealerships?  Secondary home prices in the Hamptons and Nantucket?  The list goes on and on.  But I suspect that if you're in the market for a slightly used Rolex, you're probably going to get a great deal. 

Friday, November 14, 2008

Freddie Mac Posts $25 Billion Loss, Requests $14 Billion From Treasury

Freddie Mac posted a $25 billion third-quarter loss.  The losses were tied to the writedown of $14.3 billion in deferred tax assets, $9.1 billion in security impairments on its available-for-sale securities and $6 billion in credit-related expenses arising from the "dramatic deterioration in market conditions."  These losses officially take Freddie's book value into the negative by $13.8 billion, requiring a capital infusion from the US Treasury.  As a refresher for any readers who have successfully blocked all the horribly depressing financial news from their memories, both Fannie and Freddie were placed into conservatorship of the Federal Housing Finance Agency of September 6th.  The Treasury has pledged to inject capital in the form of preferred shares into the mortgage lenders when the value of their assets declines below the value of their liabilities up to a maximum amount of $100 billion for each company.  Fannie's $29 billion loss reported on Monday did not require a capital infusion yet, but most analysts expect that the company will need one after the fourth quarter unless the mortgage market improves dramatically.

Thursday, November 13, 2008

Why is GE Still Paying a Dividend?

GE reaffirmed plans to maintain its 31-cents-per-share through the end of 2009.  The company went on to say that "GE expects industrial cash flow to be greater than the amount needed to fund the dividend in 2009."  Here's a suggestion:  Maybe use all of that industrial cash flow to pay off some of your debt?  Because aren't you paying the FDIC a fee to guarantee $139 billion of GE Capital's debt?  Wouldn't it be prudent to instead reduce some of the $65 billion or so in commercial paper that you can't hock to any investors except for the Fed?  Maybe save some of that cash flow to help pay for the 10% dividend you handed to Warren Buffett for his $3 billion "confidence" investment?  Perhaps preserve some capital to increase loss reserves on GE Capital's loan portfolio that is certain to get the stuffing beaten out of it in a nasty recession?  I don't know.  Call me crazy, but GE is not in any position to be paying a dividend right now.  I'll give Mr. Immelt small bonus points for halting the stock buyback program earlier this year, but continuing with a dividend payment is ridiculous for a finance firm that has meaningful risk tied to the mortgage market and depends on the bond market for financing.
I have written several posts about the lack of transparency of GE's balance sheet and the inherent risks lying in its GE Capital finance unit.  Given the drubbing the stock has taken, investors are waking up to the reality that GE really is a finance firm with an attached industrial conglomerate.  I know that GE doesn't want to anger its loyal shareholders, but I'm fairly certain that any shareholder with half a brain will understand.

Foreclosure Filings Rise 25% in October, Initial Unemployment Claims Rise

According to RealtyTrac, 279,561 borrowers received foreclosure filings in October 2008, a 5% increase from September, and a 25% increase from October 2007.  Nearly 85,000 houses were lost to foreclosure in October 2008.  California, which continues to have the highest number of foreclosures in the country, benefited somewhat from a new law requiring banks to contact struggling homeowners 30 days before delivering a notice of default, in order to give them time to restructure their plans.  Foreclosures in California fell 18% from September, indicating that the new law has had some affect, if only to delay the inevitable.  
It will likely be some time before the various mortgage modification programs introduced by banks and the FDIC in the past few weeks have any affect on slowing down the rate of foreclosures.  Furthermore, it is unclear how much the positive effects of these modifications will be outweighed by an increasingly unstable employment and economic picture.  Initial unemployment claims reached 516,000, the highest since Sept. 2001.  Continued unemployment claims are at the highest level since 1983.  Certainly, the news continues to be bleak.  Many "pundits" are now calling for a recession the likes of which the country hasn't seen since the Great Depression.  Former Goldman Sachs chairman John Whitehead was quoted as claiming that the current slump will be worse than the Great Depression.  Although I certainly believe we are in for one heck of a nasty recession, I respectfully disagree with Mr. Whitehead.  But for those who are interested, here's a nifty graph of what happened to GDP during those difficult times.  Please make sure to take anti-depressants before looking at the graph.


Wednesday, November 12, 2008

Treasury Changes Plan: Will Not Use TARP to Buy Mortgages

Hank Paulson has announced a drastic change to the original architecture of the TARP.  The Treasury no longer plans to purchase distressed mortgage debt from banks, but will instead focus on relieving pressures on consumer credit.  The Treasury is exploring a new facility for purchasing asset-backed securities.  Mr. Paulson also stated that companies accepting new taxpayer funding may be required to get matching private capital.  My original reaction to this news is positive.  I hated the idea of buying crappy assets at inflated prices from banks that had made terrible investment decisions.  I like the idea of providing stimulus to industries and consumers that are suffering directly, rather than granting a bailout to the jokers that got us in this mess to begin with.  However, this news is really bad for all the banks, insurers, etc that were hoping to unload their illiquid assets to the Fed.  The market is not happy with the news, but for the taxpayer, this is potentially positive.

Best Buy Warns and Other Stomach-Churning Headline News

Best Buy warned of a "rapid seismic" slowdown in consumer spending and lowered its profit forecast for the full year ending in February significantly, from $3.04 to $2.30 per share.  October sales plummeted 7.8% for the electronic retailer, indicating that consumers aren't racing out to buy new flat screen TVs in the face of rising unemployment, tightening credit, and declining home prices.  Frankly, a bit of prudence is called for by the American consumer in these uncertain times and I am somewhat relieved that consumers are actually behaving rationally.  Unfortunately, from the retailers' perspective, this new reality is tough to swallow, for it indicates that many face a particularly difficult year and some, like Circuit City, will throw in the towel.  The shifting retail scene has negative implications for commercial real estate as well, as mall operators will be forced to confront lease cancellations and empty space they cannot fill.  General Growth Properties, a mall owner, warned on Monday that it was near default on several loans that mature before the end of the month.  As vacancies rise and lease rates fall, the most heavily indebted REITs will face serious difficulty refinancing their debt.  Make no mistake, tough times lie ahead.
Meanwhile, the government continues its frantic efforts to prop up the US economy by offering money to just about everything that moves:


Tuesday, November 11, 2008

Money From The Feds: Don't Leave Home Without It

American Express won expedited approval to become a bank-holding company allowing it to gain access to the $700 billion in bailout money from the Treasury.  Of all the crummy news reported in the past several months, I would rank this high on the list of things I never would've seen coming.  AIG and Fannie losing a combined $50 billion in the last quarter?  Highly predictable.  GM begging for money from the government?  Seen that one coming since 2005.  Circuit City going bankrupt?  Did anyone actually think that any of their 17 attempts to restructure in the past year would make a difference?  Discovering that Lehman's assets were greatly inflated and the company was a ponzi scheme?  Even my toddler knew that one in March.  But American Express becoming a bank holding company?  Why do they need to be a bank holding company if their two bank units already have access to the discount window?  I actually had to read the entire Wall Street Journal story for the answer which I believe was included in this quote from CEO Kenneth Chenault:
"Given the continued volatility in the financial markets, we want to be best positioned to take advantage of the various programs the federal government has introduced or may introduce to support U.S. financial institutions."  Of course, the quote can be interpreted in one of two ways:
  1. Amex views this as a great money making opportunity and wants to take advantage of huge dislocations in the markets by getting cheap money from the Fed and investing in high yielding assets.
  2. Amex is in much worse shape than anyone suspects and they need an equity infusion from the government.
Being a cynic by nature, I'm inclined to go with the latter.  
A few days ago, Bloomberg revealed that it was suing the Fed under the Freedom of Information Act to force the central bank to reveal who is borrowing from its fancy new funding facilities and what type of collateral are they pledging against the loans.  Sadly, I think the answers to Bloomberg's probing questions are fairly easy to answer without a lawsuit.  Which institutions are borrowing from the Fed through these new facilities?  Anyone that is eligible.  If you think that any bank or former broker dealer isn't going to the Fed for financing right now because they are "healthy", you are greatly disillusioned.  The money is cheap and easy so why go anywhere else?  What type of collateral are these banks pledging?  Anything they can get away with.  As I have mentioned many times in my previous posts about the Fed's new facilities, I don't actually believe the Fed can price these securities.  That is precisely why the Fed only accepted Treasuries and agency pass-throughs as collateral for its loans until the banking industry started to implode a year ago.  Even if the Fed does reveal who and what is going on behind the scenes, what difference does it make?  The Fed's balance sheet has already ballooned to $2 trillion.  It's too late to do anything about that.  The Fed can't pull the plug or it would wreak havoc on an already fragile financial system.  Besides, there are limits even to my level of outrage.
I hope that American Express really does see this as a money making opportunity and that it will invest any funds it receives from the TARP wisely.  The alternative, that Amex is just another American-made government money-sucking pit, is far too depressing for me to contemplate.  


Monday, November 10, 2008

Fannie Loses $29 Billion, Can't Afford New Pants

Fannie Mae posted a net loss of $29 billion for the third-quarter.  The loss is not quite as bad as it seems, as $21.4 billion is related to a write-down of deferred tax assets.  The company is merely admitting early that those assets will expire before it can generate profits again.  The balance of the loss came from increased loan loss reserves and other investment losses.  The losses cut Fannie's book value in half but because book value is still positive, an equity injection from the government is not necessary yet.  The good news is that net revenue jumped 53% to $4.06 billion as net interest income more than doubled and guaranty-fee income rose 20%.   The bad news is that the serious delinquency rate was 1.72% up from .64% a year ago and is estimated to head higher next year as the housing market continues to deteriorate.        

AIG Government Bailout Take Two

Apparently, AIG needed more than just a temporary $85-$125 billion loan to dispose of some assets, raise some cash, and go about its merry way organizing motivational corporate retreats for all of its "high performers."  The severity of the insurer's dire straits was revealed this morning when it posted a record loss of $24.5 billion or $9.05 a share, thus stealing the title of King-of-largest-quarterly-loss-ever from Wachovia.  These losses should not have been a surprise to anyone who was wondering why the hell a perfectly solvent institution  would require over $100 billion in loans to remain in business.       

AIG's earnings announcement came with the assurance of a new and improved government bailout.  The old bailout will be replaced with an extremely complicated rescue package valued at $150 billion.  The more complicated the better, as it allows the government to buy some time by claiming that this time the rescue package is going to work and nobody will be any wiser until the next bailout package is introduced.  The new package reduces the $85 billion loan from the Fed to $60 billion, injects $40 billion into the company in return for preferred shares, and purchases $52.5 billion of mortgage securities.  This package is certainly better, for AIG, not the government, as it removes risk from AIG and transfers it directly to the taxpayer.  However, if you had already figured out that AIG was toast and the government was going to wind up owning all the crappy collateral anyway, then really this is just a reshuffling and reclassification of the money.  The $40 billion in preferred and $52.5 billion in purchases are now "investments" and not just "loans secured by collateral."  The press release states that $40 billion of the TARP is being utilized for the preferred investment, but I believe that is actually misleading.  The $52.5 billion used to purchase mortgage securities is what, exactly?  Where is that money coming from if not the TARP?  The Bloomberg story quotes a boob analyst with: "This gives AIG much more breathing room.  Now they have the time and flexibility to sell assets to closer to the intrinsic value rather than at fire-sale prices."  Here we go again with the "fire-sale prices" rhetoric.  What if the truth is that AIG had completely mispriced all of its assets at artificially high prices and that today's asset prices are the real deal? 

The earnings report has a few interesting tidbits indicating where all the money has gone.  The insurer booked $7.5 billion in writedowns on CDS and marked other holdings down by $18.3 billion.  AIG's securities lending program accounted for $11.7 billion of the $18.3 billion in impaired investments.  The credit default swap issues are widely known and have been the main focus of the media reports of AIG's problems.  However, the fact that AIG lost $11.7 billion in its securities lending business is, frankly, astonishing.  Securities lending is not based on some sort of fancy derivatives scheme.  It is a really simple business that requires borrowing and lending money and making a small spread on the difference in interest rates.  AIG apparently became greedy and used the money raised from lending out securities to purchase highly illiquid MBS to make a couple extra basis points and wound up losing $11.7 billion in one quarter.  This is a disastrous number that confirms that this company had absolutely no risk management department.  Furthermore, I have to wonder how many other insurers were engaged in the same business of securities lending that are suffering similar losses.  Is enough money left in the TARP to save them all?    

Friday, November 7, 2008

GM: Can We Really Be That Bad? Yes We Can!

Ok, so it's true that GM reported a net loss of $2.5 billion or $4.45 per share for the third quarter of 2008.  However, the automaker lost $42.5 billion or $75.12 a share in the third quarter of 2007 so this is a big improvement.  Unfortunately, if you were looking for a silver lining in the largest US automaker's earnings results, that's it, because it only gets worse from there.  On an adjusted basis, GM's net loss was $4.2 billion compared with a net loss from continuing operations of $1.6 billion in the same period a year ago.  Revenues dropped to $37.9 billion, down from $43.7 billion in the year-ago quarter.  For those interested in combing through the details of the various charges, offsets etc, and whatnot, you can find them in the press release here.  The company sums up its situation fairly succinctly in the following paragraph from the press release:

"Even if GM implements the planned operating actions that are substantially within its control, GM's estimated liquidity during the remainder of 2008 will approach the minimum amount necessary to operate its business. Looking into the first two quarters of 2009, even with its planned actions, the company's estimated liquidity will fall significantly short of that amount unless economic and automotive industry conditions significantly improve, it receives substantial proceeds from asset sales, takes more aggressive working capital initiatives, gains access to capital markets and other private sources of funding, receives government funding under one or more current or future programs, or some combination of the foregoing. The success of GM's plans necessarily depends on other factors, including global economic conditions and the level of automotive sales, particularly in the United States and Western Europe."

To summarize, GM can't stay in business unless:
  • Automotive conditions improve SIGNIFICANTLY (the government buys everyone a car.)
  • It can sell some assets (to the government)
  • It takes more aggressive working capital initiatives (stops paying suppliers)
  • Gains access to capital markets (Hello Fed?)
  • Or other private sources of funding (Hello Kerkorian?)
  • Receives government funding (Hello Pelosi?)
  • Or some combination of the above (good luck with that)
Not the sort of news you want to drop on the market on a Friday, but perhaps we'll all wake up Monday morning with yet another government bailout announcement.  Sigh.

Equity Futures Unfazed By Lousy Employment Report, Ford Losses

Nonfarm payrolls dropped by 240,000 and the unemployment rate rose to 6.5%.  To add insult to injury, September payrolls were revised sharply lower to a loss of 284,000, bringing total job losses for the year to 1.2 million.  The pullback spanned manufacturing, construction and most service industries and was offset only slightly by an increase in government jobs.  Although economists were expecting a decline of 200,000 in payrolls and a jobless rate of 6.3%, the "whisper numbers" were higher.  This explains, to a certain extent, why equity futures this morning are strangely positive on such disheartening news.  I suspect that two back-to-back days of roughly 5% declines have fatigued even the most fearful investors.
Ford Motor reported a $3 billion operating loss, and announced efforts to cut employment costs by 10%.  The automaker is looking to shed assets and, more importantly, campaigning furiously in Washington for more government loans.  The good news in all of this is that Ford had $18.9 billion in cash on hand at the end of the quarter.  The bad news is that it burned through $6.3 billion in the quarter as vehicle sales plunged 25% and overall revenue fell by $9 billion to $32.1 billion.  What I find amazing about these numbers is just how large they are.  How is it that a company that pulls in $32.1 billion in revenue in a really really bad quarter can't figure out how to trim $3 billion in costs to break even?  I know, I know, union contracts etc.  But still, there's got to be a better way to run these companies.  GM will be reporting earnings later today.  I suspect the only thing about GM's earnings that will be positive is that it may make Ford's earnings look pretty good in comparison.  

Thursday, November 6, 2008

Woe is Private Equity

Blackstone Group, the world's largest public private-equity firm, posted a sizable quarterly loss today, shocking even the most pessimistic analysts' estimates.  The company posted a net loss of $340.3 million, compared with a profit of $234 million a year earlier.  I must admit that the only thing shocking about Blackstone's loss is that it isn't significantly higher.  According to Bloomberg's report on the earnings announcement, the company wrote down its corporate holdings by about 7.5% and its real estate investments by 9%.  Since the beginning of the year, the firm has reduced the value of about a third of the 40 companies it owns.  Seriously?  It has written down the value of ONLY one third of its portfolio?  I admit I haven't a clue as to what assets Blackstone owns, but I can throw out a few thoughts that might put it in perspective: 
  • S&P and Dow down over 35% YTD
  • Commercial real estate prices down at least 15-20%, although nobody even knows because NOTHING IS TRADING
  • All LBO debt getting marked at around 70 cents on the dollar, although even this is highly suspect as very little is trading
  • Zero financing available for any new deals
So really, are we sure that we only want to mark down that commercial real estate by 9% and the corporate portfolio by a mere 7.5%, or are we going to put the crack pipe down and start talking some real numbers?  If that weren't enough, as I mentioned in my last mockery of Blackstone back in May, the company expects to post net losses during the next five years due to vesting expenses.  Why anyone is willing to subsidize insane compensation costs just for a "piece of the private equity pie" is beyond me and yet people buy this stock.  Who are these people?  Even at $7.55 a share, who on earth thinks this is a good business model anymore and that the company's biggest losses are behind them?
The Wall Street Journal had a great story about Blackstone Group's LBO of Hilton Hotels completed roughly a year ago.  It is certainly worth a read for anyone who has forgotten how preposterous the private equity boom period became.  Blackstone put in $6 billion of equity, its largest investment to date, and financed the balance of the $26 billion takeover with debt.  Blackstone paid 13 times estimated 2008 pre-tax cash flow for the company (translation: steep.)  Mind you, this was five years into an economic boom that was already looking tired when the deal was done.  Currently, the hotel chain's closest rival, Starwood, trades at about seven times before-tax cash flow.  The best part, the part you're really going to love as a US taxpayer, is that $4 billion of Hilton's LBO debt now sits on the Fed's balance sheet and we own it.  Apparently the Hilton LBO debt is part of the $30 billion in illiquid assets that the Fed guaranteed for JP Morgan when JP bought Bear.  The funny thing is that Lehman also held some of the Hilton LBO debt when it went bankrupt.  No doubt the bankruptcy court is working on finding a bid for the garbage so that Lehman creditors can be repaid.  Maybe the Fed can buy it and add it to the kitty.
At least the backlash against the private equity community is in full swing.  President-elect Obama will more than likely try to increase taxes on private equity investors from the long term capital gains tax rate to the ordinary income rate.  But not to worry, these guys won't see capital gains again for a really long time.    

BOE, ECB Slash Rates as Economic Conditions Worsen

The Bank of England slashed its benchmark interest rate by 1.5% to 3%. the lowest since 1955.  The European Central Bank lowered its interest rate for the second time in less than a month by 50 basis points to 3.25%.  Here in the US, the fed funds target sits at 1% (for those who have lost track due to all the frenzied slashing.)  Market participants expect the Fed to lower rates even further, with some economists anticipating a Japanese-style zero interest rate environment.  Today's reported 1.1% rise in productivity has been the only positive economic news to hit the tape in some time, although an increase in productivity generally means that companies are cutting labor expenses.  The market is bracing itself for a truly horrendous employment report tomorrow.  Yesterday's ADP employment report showed that companies cut 157,000 jobs in October.  This prompted many economists to revise their estimates higher for the number of jobs lost when the non-farm payroll number is released.  
As if a bad payroll number wasn't enough, GM is also slated to report earnings tomorrow.  Yesterday, a top GM executive claimed that the next 100 days were critical for GM.  With auto sales dropping like a stone and financing scarce, the company is pleading for a government bailout.  Given all of this scary news, investors should expect a horrendous earnings report from the automaker.       

Wednesday, November 5, 2008

Grim Earnings News From GMAC, MBI, ABK and AIG?

GMAC, the finance arm of General Motors that is majority-owned by the clowns at Cerberus, continues to bleed cash like a stuck pig.  GMAC's third-quarter loss widened to $2.52 billion, from $1.6 billion a year earlier.  Net revenue declined 43% to $1.72 billion.  ResCap, the mortgage lending arm, was responsible for $1.9 billion in losses for the quarter.  Curiously, these earnings numbers are nearly identical to the losses posted in July, which would lead any rational person to wonder why on earth a company that consistently loses $2.5 billion a quarter should be allowed to stay in business.  The answer lies with GMAC's bond investors, who continue to finance this money-losing venture.  But I suspect their patience for a turnaround is wearing thin.  The company stated that "substantial doubt exists regarding ResCap's ability to continue as a going concern."  In a desperate effort to curtail further losses the company is now only offering auto loans to customers who can actually afford to repay them (i.e. those with the highest credit ratings,) an idea that may have come in handy a few years ago.  GMAC has around $52 billion of bonds outstanding as of last month, with $10.9 billion that mature in 2009.  GMAC may ask bondholders to swap their investments for new debt.  Why am I experiencing deja vu?  Oh that's right, because GMAC tried the old swap-crappy-debt-for-more-crappy debt ploy back in May with ResCap and now "substantial doubts exist regarding ResCap's ability to continue as a going concern."  Perhaps the beleaguered auto-lender will have more luck becoming a bank holding company and asking for handouts from the government.  I, for one, certainly hope not.
In other bleeding-cash-like-stuck-pig news, MBIA posted a third-quarter net loss of $806.48 million due to an increase in loss reserves for its insured exposures to second lien mortgages.  The net loss included an assortment of other realized and unrealized losses on its investments.  You can read further gory details here.
Not to be outdone by its brother MBIA, Ambac lost $2.43 billion as it increased reserves for mortgage securities and derivatives.  I am still struggling with the math on how a company can lose $8.45 a share when its stock price is only $2.30, but the general implication that it sucks and has very little future is crystal clear.  Speaking of sucking, analysts had forecast a loss of 50 cents a share.  Are you finished laughing (or crying) yet?  Because there's more.  The bulk of Ambac's recorded losses of $2.71 billion in credit derivatives came from increased future loss projections on CDOs.  
The real follow-up question here is: if Ambac lost $2.71 billion mostly due to CDO losses, what does this imply about AIG's earnings for the quarter?  AIG, which every American citizen should know by now, has sold credit default swaps on over $400 billion in notional on a variety of CDOs.  The former insurance giant is set to release earnings on Monday, November 10.  I, for one, am officially quaking in my boots as to the number that AIG will post as a loss.  Furthermore, I think it will become painfully obvious with the release of its earnings that AIG will not be able to pay back the loan from the government.  Make no mistake, this is a government-sponsored orderly liquidation.  

Obama Wins Presidential Election, Faces Tough Road to Economic Recovery

Since this is not a political blog, my comments on the results of last night's presidential election will be brief.  On a personal note, watching last night's election results was possibly one of the most inspiring experiences of my life as an American citizen.  As I listened to Mr. Obama deliver his victory speech, it became more and more clear to me that not only did we elect the first African American President, but we also elected a real leader with extraordinary vision, compassion and integrity.  President-elect Obama promised to work together with the citizens of this country, particularly those with differing opinions, to resolve our many problems.  This is exactly the type of attitude that citizens of this country want to hear from their leaders after suffering through years of painfully divisive political leadership.  
As for all the "pundits" proclaiming how bad Obama's policies will be for the market, I just don't buy it.  It is yet another one of those catch-phrases tossed about, like "tax-and-spend liberals" that has no basis in fact, given that Republican administrations have presided over the largest deficits.  Although I am certainly no proponent of huge tax increases and big government, I also find fault with the idea that constantly cutting taxes is the solution for every problem.  The government has to raise revenue somehow and I don't believe it will be the death knell for the market if the capital gains tax rate returns to Clinton-era levels and the estate tax is reintroduced.  If memory serves correctly, the market did very well in the 90's and we had huge surpluses.  The market has gone absolutely nowhere in the past eight years and we are sitting on record deficits while we have had the lowest tax rates this country has ever seen.  Something is clearly not working, and it needs to change.  I am hopeful that the optimism that our newly elected President elicited last night from the people of this country will see us through the difficult road to recovery.  Because it will indeed be very difficult.               

Tuesday, November 4, 2008

Election Elation Overshadows String of Disappointing Economic Reports

Yesterday's economic reports pointed to a significant slowdown in virtually every sector of the US economy.  Car sales for October fell to a 25 year low, with GM sales, in particular, down an astonishing 45%.  Plunging consumer confidence and a contraction in credit were the primary culprits.  Manufacturing contracted in October at the fastest pace in 26 years, with the ISM falling to 38.9, the lowest level since 1982.  Bank lending continues to tighten, according to the latest survey by the Federal Reserve, further hamstringing the beaten-down economy.  Yet despite the economic gloom, investors are enthusiastic about the prospects of new leadership for the country.  
The markets are being further buoyed by the various government stimulus packages floating around.  According to the Wall Street Journal, the Treasury is considering using the $700 billion rescue fund to buy stakes in a broad range of financial companies, not just banks and insurers.  A few of the names popping up in the article are specialty finance firms such as GE Capital and CIT Group.  No doubt this new iteration of equity injection was spurred in-part by recent announcements by GE Capital, one of the largest providers of debtor-in-possession financing, that it was halting this type of lending.  Debtor-in-possession financing is provided to companies in or near bankruptcy, which allows them to continue paying bills until a reorganization can be worked out with creditors.  Without it, companies that would normally file Chapter 11 because of liquidity issues, may be forced into a Chapter 7 liquidation.  With the prospect of rising bankruptcy filings due to a contraction in the economy, as well as the recent increase in debt-laden companies that arose from the private equity boom, lack of access to DIP financing could make a bad situation much worse.  Of course, an argument can be made that this will aide private equity firms, as it is private-equity backed companies that are overly levered which will ultimately need this type of financing.  On the other hand, helping companies in Chapter 11 stay out of Chapter 7 will keep many employed.   
For those interested in the running tally of the Treasury's allocation of the TARP, of the original $700 billion, $250 billion has been set aside for equity injections, of which $163 billion has already been distributed to banks.  The Treasury has yet to determine how the $87 billion balance of equity infusions will be doled out, although I suspect that a significant portion will go to insurers that are suffering significant investment losses from the recent market carnage.  The remaining $450 billion set aside for purchasing distressed assets, the original purpose of the TARP, may be crowded out by calls for loans and infusions into other struggling sectors of the economy.  Much of this will be determined by the new administration.
The good news is that the coordinated central bank actions to restore lending among banks appear to be working.  Three-month Libor fell again to 2.71%, down from a peak of around 4.87% a few weeks ago.  Some semblance of normalcy appears to be returning to money markets, allowing of course, for the caveat that "trillions in stimulus from governments around the world" is the new normal.  It's still far better than mass pandemonium. 

Monday, November 3, 2008

Update on Operation Hope For Homeonwners and Other Mortgage Modification News

JP Morgan announced a sweeping plan to modify nearly $70 billion in troubled mortgages on Saturday.  According to the Wall Street Journal article, the plan will cover as many as 400,000 borrowers that will benefit from lower interest rates, smaller principal amounts or other more-affordable terms.  The plan is aimed at modifying the terms of option arms, a boatload of which JP Morgan acquired in its takeover of Washington Mutual.  In a shrewd PR move, JP Morgan unveiled the plan days after it received $25 billion from the US Treasury.  
Banks are facing increasing political pressure to use the bailout money to help beleaguered homeowners trapped in upside-down mortgages they either can't afford, or won't be able to afford once their mortgages recast.  The FDIC's Sheila Bair is pushing for widespread mortgage modifications to stop the continuing spiral of increasing foreclosures, plunging home values, leading to more foreclosures.  The government is planning an even larger effort, affecting up to 3 million borrowers, and estimated to cost between $40 billion and $50 billion.  The question remains: Will these modifications prevent foreclosures?  Or were the majority of option arm borrowers only interested in making a quick buck in a hot real estate market and not as keen on homeownership in a flat to declining market where they can rent for less than even their modified mortgage payment?  Perhaps the answers lie somewhere in between.  
A few clues indicating the potential effectiveness of these mass mortgage modifications can be found in the initial results of the programs initiated by Ms. Bair with Indymac borrowers following the FDIC's seizure of the California bank, and Operation Hope For Homeowners.  Operation Hope For Homeowners was passed through congress in July and went into effect on October 1st.  Housing Wire has an update on the progression of this plan, aimed at aiding 400,000 homeowners to refinance into kinder FHA-backed mortgages.  According to Housing Wire, 42 mortgage applications were filed during the first two weeks of the period.  When the plan was originally announced, I suspected that borrowers would not be interested in participating as they had no interest in sharing future equity appreciation with the US government.  According to the story, however, it is the investors that are unwilling to allow modifications, as it requires that they write down the principal to 90% of current LTV (not original LTV) plus pay an upfront premium.  Apparently, investors believe they can achieve higher returns by allowing the homes to go into foreclosure.
And then there's Indymac.  How are Ms. Bair's efforts progressing at Indymac?  The Wall Street Journal had a fantastic story on Saturday about the FDIC's efforts to aid troubled IndyMac borrowers.  IndyMac services 653,000 mortgage loans, about 65,100 of which are seriously delinquent, or at least 60 days late.  Of these, 47,000 might meet its requirement for a new loan.  The FDIC has already completed loan modifications for 3,500 borrowers.  Several thousand more have accepted the FDIC's offer, and are awaiting processing.  However, the FDIC has had difficulty in getting responses from some borrowers.  According to the article, the FDIC mailed out 7,500 letters to delinquent borrowers for whom the FDIC had recent financial information and received responses from three quarters of them.  In the past three weeks, the FDIC mailed offers to another 7,500 borrowers for whom it also has financial information.  Unfortunately, the FDIC has sent letters to another 19,000 borrowers for whom it had no recent financial information.  So far, only 10% have responded.  Uh oh.  If anything, the FDIC's experiment will reveal how many of these delinquent borrowers just flat-out lied on their mortgage applications about their incomes and are willing to walk away.  The statistics are not looking too good.  The Wall Street Journal's story is worth a read for anyone hoping to understand the root of the current mortgage crisis.  It is filled with anecdotal stories, that would be hilarious if they weren't so sad, about house cleaners and tree trimmers who make $35,000 a year that are having problems making the payments on their $700,000 mortgage, while their house is currently assessed at half the value.  Although they claim to want a mortgage modification, their best financial option is just to walk away and rent.  It seems unlikely that any government bailout plan can prevent the inevitability of people taking their best financial option.  After all, it was inevitable that people who were offered ridiculous terms on mortgages that they didn't understand would take those terms to buy a house they otherwise couldn't afford.