Disappointing New Home Sales and PCE

New home sales unexpectedly fell 11% in November to an annual pace of 355,000 and the median sales price declined by 1.9% from a year ago. Furthermore, October was revised down from 430,000 to 400,000. As Calculated Risk points out, in November 2009, a record low 25,000 new homes were sold, beating the previous record low of 26,000 in November 1966. Yes, you have to go all the way back to 1966. Were they even making new homes back then? If so, I think Toll was building the main house and Beazer would install the outhouse for you. In any event, this is a very weak report that puts a major damper on yesterday's more robust-appearing existing home sales data.

Personal income was up 0.4%, disposable income was up 0.5% and personal consumption expenditures were up 0.5%. The personal savings rate as a percentage of personal income was 4.7% in November, unchanged from October. While a higher savings rate is good for the long run, economic growth today is dependent on spending, spending and MORE SPENDING.

In honor of the weak personal consumption report and given that it is two days before Christmas, I'm asking all of you to do your patriotic duty and go stimulate the economy. Buy something significant. Like a car, for example (maybe in the shape of an Audi, preferably in red?) Or a new house. You can worry about getting a job in the New Year.

Posting will be light and sporadic for the next few weeks. Happy Holidays!

GDP Revised Down But Everybody Buys a House

Third-quarter GDP was revised lower again to a 2.2% annual pace from a previously reported 2.8% gain, which had already been revised lower from an initially reported 3.5% pace. It seems the more the folks at the Commerce Department looked at it, the worse it got. But no worries, the third-quarter of 2009 is so yesterday and all the bullish analysts are now focused on predicting that GDP growth is going to be 4% in the fourth quarter and then at least 10% in 2010. Comically, Bloomberg has a quote from a senior economist in the article about the GDP revision saying "We are really starting to see the mechanisms for a sustained recovery coming into place." It's as if Bloomberg had already written the article with the quote intact before the actual statistic was released when everyone was still expecting the number to be 2.8%, and then just stuck in the part about the downward revision. Unless they just screwed up and meant to put it in the article about existing home sales.

In better news, existing home sales in November were up 7.4% to a 6.54 million annual rate from a revised 6.09 million pace the prior month. The median price declined 4.3% from the same month a year earlier. This was the highest rate of home sales we've had since Feb 2007, right before all the subprime lenders imploded. So congrats to the government for re-inflating the housing market back to its subprime, no down-payment, no doc, no income, no problem glory. We'll see how everything goes when the tax credits expire in April (if they ever do) and the Fed stops purchasing agencies and MBS.

Buy Low/Sell High Still Best Way to Make $7 Billion

The WSJ reports today that David Tepper's hedge fund Appaloosa was the big winner this year in the competitive world of hedge funds. Appaloosa managed to eke out gains of 120%, which amounted to over $7 billion in profits this year. Even taking into account Appaloosa's lousy 2008, where it punted 25%, a 120% return is amazing. What complicated strategy did Mr. Tepper employ? Surely something involving derivatives, structured something or others, hedged against CDS. Nah. He just bought the low. He bought some Bank of America while it was trading below $3 and Citi when it dipped below $1. He kept buying and buying bank stocks, preferred shares and bank debt, even though at times in the depths of the market's misery in February and March, it seemed as if he was the only one buying. While rumors of bank nationalization floated around earlier in the year, investors dumped bank stocks for fear that shareholders would be wiped out, much like in the case of the conservatorships of Fannie and Freddie. However, Mr. Tepper steadfastly held onto his belief that the government would do nothing of the sort. After all, Geithner promised to prop up the banking sector by injecting additional capital and the Fed swore it would take drastic measures to pump free money into the economy. It seemed only logical that we would avert a Great Depression. He didn't understand why government officials would lie about this type of thing, so he just kept buying. And then he rode the rally all the way up.

Market volatility of the kind we've seen in the past couple of years always produces a couple of huge winners. John Paulson emerged as the big winner on the short side as the market imploded, with his prescient shorting of subprime, while Tepper is being crowned king of the long side on the way up. It's usually never the same guy who outperforms in both directions, which is why I personally find Mr. Paulson's returns to be far more impressive so far. Not only did he short financials and produce spectacular returns, but he's had decent returns this year as he was also a big buyer of bank stocks earlier in the year.

Regardless, Mr. Tepper deserves his time in the limelight as the reigning hedge fund master of 2009. Certainly the folks at Carnegie Mellon will be calling him soon. The business school of Carnegie Mellon is named after Mr. Tepper since his $55 million donation in 2004. Although generous to his alma mater, Mr. Tepper still lives in the same two-story home he purchased in 1990 for $1.2 million. And if you discount the fact that he owns a brass replica of a pair of nuts that he likes to rub for luck during the trading day, he doesn't sound like your run-of-the-mill mega-rich hedge fund clown.

Hedge Fund Manager Having Ex-Wife Issues

One of the world's most successful hedge fund managers, Steven Cohen, is being sued by his ex-wife for at least $100 million. Patricia Cohen, who was married to Mr. Cohen from 1979 until their separation in 1988, claims she was stiffed in their divorce settlement. What makes this case more interesting than the average, run-of-the-mill, angry ex-wife of a rich guy, is that she is also accusing him of a long-running racketeering scheme. Ms. Cohen claims that Mr. Cohen engaged in insider trading while they were married and then proceeded to hide assets from her by concealing a Miami bank account that held millions, in order to avoid having to pay her a bigger settlement. Let me get this straight. According to Ms. Cohen, Mr. Cohen made his money illegally, then hid those illegal gains from her. So she's mad that she didn't get a cut of his illegal profits? And now she wants at least $100 million to compensate her for...what exactly? For her bad timing of choosing to marry him in the 80's instead of the 90's, when his annoying habits would've been far more tolerable when they came with an enormous estate with a hockey rink?

I suppose that Ms. Cohen thinks that her ex, who is reportedly worth billions now, is rich enough to fork over, say, $50 million to get her to drop the case, particularly since he has been the target of allegations of insider trading by a former employee. He doesn't need any more bad publicity. Besides, with the recession and all, $50 million can actually buy you something decent to live in in Manhattan. Maybe she's thinking "$100 million is nowhere nearly enough compensation for having to endure watching my jackass ex become a billionaire over the past couple of decades. The emotional pain, well, it's just excruciating. I've gone through eight therapists." Or maybe, she really has a case. Either way, this will get interesting.

Financial Headlines 12/17/2009

• Yesterday's Fed decision yielded little unexpected news. Chairman Bernanke and his cronies basically said that the economy was a bit better, but not enough for them to actually do anything to stop the potential for a massive bubble reflation. The fed funds target will remain stuck between zero and .25%, so please, won't you please, keep buying the long bond cause we're going to need to sell ALOT more of those. But don't worry about agencies and MBS, we plan to buy another $150 billion or so of those. Oh, and by the by, you should expect some volatility in Feb after we let most of the artificial liquidity supports expire.
• Citi completed its $20 billion offering. The sale was considered a bit of a bummer, as the shares wound up being priced at around a 20% discount. Furthermore, the government backed out of its plans to sell up to $5 billion in Citi's shares that was intended to lower its stake from 34% to 30%. According to the FT, the government backed out because it would have suffered a loss on its investment. Frankly, that's a fairly stupid reason to back out of selling stock. I know the government wants to keep crowing about what a great money manager it turned out to be and how much money it has made on the TARP so far. You know, because Paulson and Geithner were smart enough to buy preferred stock in GS with a 5% dividend when Buffett got his with a 10% dividend? While the rest of the market was pricing in insolvency and the government could've and should've received a 25% dividend? Yeah, they're a bunch of geniuses. In any event, they're probably going to wait until the stock hits $2 and then try to offer it out at $3.
• In the cheery world of commercial real estate, Morgan Stanley handed over 5 more office buildings in downtown San Francisco to lenders. In yet another example of why we don't want these "savvy" investors, who don't lend to small businesses or consumers, playing with money that carries an implied government guarantee, the buildings have lost around 50% of their value since the purchase. The buildings were part of a $2.5 billion deal where MS purchased 10 buildings from Blackstone Group in May 2007. Blackstone had just purchased the buildings in its $39 billion buyout of Equity Office Properties and then flipped them for a nice profit. It's still hard to fathom how nobody recognized a bubble back in 2007 when office building flipping was a major financial activity.
• Bank of America finally found a new CEO. The job went to Brian T. Moynihan, a longtime B of A employee. In a sign that big transformative changes will be afoot as a result of hiring an insider, Mr. Moynihan said that he doesn't foresee any "big changes," nor does he plan to exit any of the companies current businesses. So yeah, his hiring will make a really big difference.

Abu Dhabi Wants Its $7.5 Billion Back

Back in the day when it seemed like a great idea to pay over $30 a share for Citigroup, Abu Dhabi struck a deal with the bloated investment bank to pump billions of dollars into the bank. At the time, Citi needed the cash, and Abu Dhabi was looking for a sure thing. The sovereign wealth fund invested in Citi in November 2007, in return for an 11% dividend until March of 2010. Doesn't sound like a horrible investment so far, right? Alas, part of the deal was for Abu Dhabi to begin buying $7.5 billion in Citi shares at $31.83 each. I'm certain I don't have to remind readers of the sad fact that Citi's shares are currently trading at around $3 and change. The good news is that this makes the folks at Citi look like maybe they weren't the biggest bunch of bumbling idiots in the sea of financial idiocy of the past couple of years. The bad news is that Abu Dhabi is pissed and no longer wants to honor the contract. You see, the thing is, it has to fork over $10 billion or so to prop up Dubai World, so it kind of needs the cash.

Abu Dhabi is insisting that Citigroup scrap the deal entirely, or pay $4 billion in damages if the deal is upheld on account of some "fraudulent misrepresentations" it claims Citi made. I'm not sure exactly what those representations were. Mismarking assets? Accounting fraud? Who knows? But I'm fairly certain than anyone who paid over $30 for Citi in 2007 suffered from the same misrepresentations. Maybe some enterprising lawyer can pick up Abu Dhabi's case and turn it into a class action lawsuit.

Fund of Funds Losing Assets

Investors are finally catching on to what may have been the best fee-skimming scam of the past decade: the fund of fund. 2009 has turned out to be the worst year on record for funds of funds, with net redemptions totaling $164 billion in the first 11 months of the year, leaving total assets at $440 billion. The fact that $440 billion remains invested in these money-leaching parasites is a bit of a mystery given how lousy performance has been in 2009. Funds of funds have underperformed hedge funds by around 9% this year. Ordinarily funds of funds underperform by a few percentage points, mostly due to their fees. But this time, it appears as if the underperformance was marred by poor investment choices as well, that included large allocations towards ponzi schemes. Why pay a money manager a bunch of fees so they can pay someone else higher fees, if they can't be bothered with investing in the best performing funds? It seems as if I'm not the only one asking these questions anymore.

President Obama Talks to the Fat Cats

Upon hearing the news that Wells Fargo, the last of the big bank holdouts, had announced plans to repay TARP, President Obama rounded up the chief executives of the big banks for a stern tongue lashing. In addition to calling them "fat cats," the President let them know that he was not happy at all with how well they were doing. In fact, all the promised bank bonuses contrasted against the sorry state of employment was really getting on his nerves. So he urged them all to increase lending to small businesses and boost mortgage refinancing. Fortunately the heads of Goldman Sachs and Morgan Stanley exchanged confused glances and possibly exchanged the following words as they listened to the President on mute (neither of the two CEOs could be bothered to make it to the meeting in person, so they were conferenced in):

Blankfein: Do you know what he's talking about? We don't do small business loans. Do you?

Mack: Hell no! Why would we waste our time with that crap? We don't do refi's either. You?

Blankfein: Be serious! Although we do love to buy MBS from Fannie and sell it to the Fed the next day at a huge mark-up. Does that count? That's got to count.

Mack: Beats me. Anyway, just agree with everything he says.

When the executives pledged their support of tougher regulation of the financial services industry, the President responded with: "The problem is there's a big gap between what I'm hearing here at the White House and the activities of lobbyists on behalf of these institutions."

Mack: Crap! He's on to us.

Blankfein: Who cares? You want a sandwich? I'm sending my guys out for some lunch.

Citi, Dubai, and Other News

Equity futures are higher on some bullish headlines:

• Dubai received $10 billion from Abu Dhabi, which will pay part of the debt held by Dubai World and its property unit Nakheel. $4.1 billion of the bailout will be used to repay Nakheel's bonds that mature today. The rest of the money will be used to finance Dubai World's needs up until the end of April 2010. So, if you were confused about whether Dubai World was going to get a bailout, (and why wouldn't you be? What part of "investors understand nothing!" did you not understand?) this should help clear things up. At least until the end of April.
• Citigroup has finally negotiated its partial exit from the TARP. However, the government is requiring that the bank raise $20.5 billion in equity to replace the $20 billion in TARP funds its wishes to repay. Additionally, the US Treasury will sell up to $5 billion of the common stock it holds in a secondary offering at the same time. The rest of the government's 34% stake will be sold "in an orderly fashion," or in a frenzied panic, whatever the case may be. Here's hoping Citi's efforts to escape the claws of the government is worth all the dilution shareholders will suffer.
• Speaking of dilution, Exxon Mobil will spend $31 billion in stock to acquire XTO Energy in a bid to boost its presence in the natural-gas industry. The bid represented a 25% premium to Friday's closing price. The market still loves a good M&A deal, particularly on Monday morning. You know, because all of those huge M&A deals are always such value creating opportunities. Like all of those big bank mergers from the past ten years, not to mention AOL-Time Warner. That one worked out really well...for the investment bankers.

UK Bonus Tax Angers Bankers, Emboldens Foreign Governments

Yesterday's announcement by the UK government that it intended to levy a 50% tax on bankers' bonuses has taken the bonus discussion to a whole new level. For a while, it seemed as if we were stuck in a cycle of banks preparing to pay record bonuses (and somehow not being able to keep their traps shut about it, despite all the populist anger) and regulators and legislators responding by telling them that they were bad and greedy people. Other than the Pay Czar, who really only controlled pay for a select few and a few firms, nobody was willing to take a hard line. But a 50% windfall bonus tax? Alistair Darling has just put his foot down. And UK bankers are pissed!

Emboldened by the UK, France has stepped up to the plate and plans to impose a similar tax. Both France and the UK are pushing for an EU-wide windfall bonus tax, just to make things fair. While the US has yet to follow suit, the WSJ is hinting that some sort of similar restrictions might take place. In a front page story on comp, the WSJ claims that the Pay Czar is poised to enact much tougher rules for pay at companies receiving large amounts of government assistance. After capping salaries of top employees, he is moving on to the next tier and planning to impose $500,000 salary caps on hundreds of employees at the firms. He is expected to allow firms to pay more if they can show "good cause," but which managers are going to step up to the plate for their employees when their own pay is getting capped? We're talking about a bunch of greedy folks, aren't we?

Generally speaking, I am strongly opposed to windfall taxes. I don't think a government should pick and choose specific people or industries to penalize whenever they get angry about something and need to raise extra bucks. A few years back when oil companies were making a killing due to high oil prices, legislators in the US wanted to impose windfall taxes on oil companies. Fortunately, that never went anywhere. The key difference here is that banks have disproportionately profited from significant government subsidies that were enacted by governments around the world at a huge cost to taxpayers. To add insult to injury, the bailouts and subsidies were the result of recklessness, greed, excessive risk-taking, and a huge dose of stupidity that caused a massive bubble (for which bankers were highly rewarded for years,) followed by an extraordinary crash (during which bankers didn't have to give any of that money back.) Now banks are rushing to pay back TARP specifically so they can reward their employees again with large payouts, even though it isn't entirely clear whether some of the banks will be able to survive another downturn in the economy.

The UK bonus tax is aimed at the employer, not the employee, and only on bonuses above 25,000 pounds. Consequently, it provides a disincentive for the firms to pay out large individual bonuses as it will affect the capitalization of firms that pay out a large percentage of their revenues every year. The most likely outcome, assuming that a similar tax is enacted in most global banking centers, will be less of a catastrophe than predicted by the banking industry. The tax is only for one year so firms are unlikely to move their headquarters to more tax-friendly locales in far off places, particularly if every government is doing the same thing. Pay will probably be deferred, and certainly some firms firms will find other clever ways around the restrictions. A few angry bankers might leave for hedge funds. But mostly, there will be some grumbling from those affected by the tax (in the UK, we're talking about roughly 20,000 bankers according to the Treasury) and probably predictions of the apocalypse from the opinion section of the Wall Street Journal. But we'll be back to business as usual in a matter of months.

Got $2 Million For a Manhattan Hotel?

The glitzy W Hotel in Manhattan was sold to the highest bidder in a foreclosure auction on Tuesday. The winning bid was $2 million. That's a far cry from the $282 million ($50 million in equity and $232 million in debt) that Dubai World's private-equity arm Istithmar World Capital ponied up in 2006 for the prestigious property. Oh sure, Dubai has some financial issues and many high profile real estate investors are losing properties left and right, so what's the big deal? Well, Istithmar World Capital has $20 billion in private equity investments, much of it spent in 2006-2007. As evidenced by the loss taken on the W, any or all of those investments can go to zero in a hurry. And you thought Nakheel was Dubai World's biggest problem...

The $232 million in debt on the W was divided into $115 million in senior debt, now in CMBS, and $117 million in mezzanine debt. The mezzanine debt defaulted in October and the most junior of the three mezzanine investors, LEM Mezzanine, pushed the property into foreclosure and won the auction with the $2 million bid. It is now LEM's responsibility to bring current any defaulted debt that is senior to it ($97 million of mezzanine debt senior to LEM's original $20 million piece) as well as keep the first mortgage current. Istithmar made a last ditch effort to keep the property by throwing out a $2.1 million bid contingent on not having to pay anything to bring the hotel's senior debt back to current status. That whole "we don't feel like keeping our debts current" thing might work in Dubai, but not in the US. Unless, of course, you are a systemically important financial institution and can get the Fed to bail you out.

Headlines 12/8/2009

• Both Fitch and Moody's out stating the obvious today, with massive downgrades of both Greece and Dubai. The Dubai downgrade is patently ridiculous. If there is anyone left out there that doesn't know that Dubai World defaulted on its debt and the Dubai government refused to step in to bail it out, Moody's is here to educate and protect those investors about to make a foolish decision. Maybe word hasn't reached those sitting in debtor's prison in Dubai? Who knows? Oh, and also, in a completely shocking development, Nakheel, Dubai World's real estate development subsidiary that owns all those half-built buildings on man-made palm shaped islands, lost a boatload of money, $3.65 billion in the first half of 2009 to be exact. As for the Greek downgrade? Rumors abound about the country's troubled finances. But don't worry. The Dubai crisis, much like the subprime crisis, is contained.
• US consumer credit shrank for the ninth month in a row, by 1.7% in October. A couple of interesting highlights from the WSJ article: In 2005, over six billion credit-card offers were sent out to consumers. This year just 1.4 billion have been sent out. Also, Visa reported earlier this year that people for the first time were using their debit cards more than credit cards. The trend lower is likely to continue for some time in order to reverse the absolute explosion in consumer credit over the past few decades. What's shrinking along with consumer credit? The probability of a strong V-shaped recovery. Good chart at Calculated Risk.
• Citigroup and Wells Fargo are getting in on the "We wanna pay back the TARP" action, according to the WSJ. The banks are wrestling with the US government over how much capital they need to raise to exit from the program so they too can "compete" with all the other large banks that have managed to negotiate an exit. The problem is that issuing more stock is expensive. Of course, with the strong market rally looking like its finally petering out, they'd better pick up the pace before it gets even more expensive. I'm all for paying back the TARP. Get on with it. Just as long as everyone agrees that there is no next time if you were wrong about your balance sheet being strong.
• As if you needed yet more evidence that the government employees in charge of protecting our TARP dollars are a bunch of spineless twinkies, the Pay Czar actually caved in to AIG's general counsel's demands for no pay cuts for her and her cronies. It seems that the five employees who threatened to quit so they could collect a fat severance package will get to keep their over-$500,000 salaries. That's right, because without the right general counsel, there's no way that AIG will ever crawl out of that $100 billion hole.

AIG Pay Problems Grow More Ridiculous

The WSJ presents yet more evidence this morning that the true reason for AIG's failure was its executives' propensity to spend all day crafting their pay packages rather than focusing on running an insurance conglomerate profitably. Five high-ranking executives threatened to quit last week if their pay is cut significantly. The charge is being led by AIG's general counsel, Anastasia Kelly, who informed her other co-conspirators of how they can "protect themselves" against losing what amounts to some golden-parachute payments that the executives are "entitled" to collect.

The new pay fracas revolves around a severance plan that was put in place before the bailouts, where certain executives are entitled to severance benefits if they resign for "good reason" which includes significant cuts in their annual base salary or target bonus. First of all, what compensation committee in their right mind would agree to this type of a provision? If your pay is about to be cut, it generally means that you are doing a lousy job. So, why would a company agree to let you quit and then agree to pay you a huge severance? Yet more evidence that boards are too conflicted and not operating in the best interest of shareholders.

Worried that this opportunity to collect severance won't be around next year, the execs thought it only fair to use it as a negotiating tactic to keep their current pay packages in place. I know that Mr. Geithner and Mr. Bernanke don't enjoy negotiating and have pretty much let AIG dictate their own bailout terms. But maybe the Pay Czar is a better negotiator. Here's my advice on how to resolve some of these pay standoffs. Anyone threatening to quit over comp at AIG should be immediately fired for cause for neglecting their professional duties and devoting too much time to personal matters at work. I'm sure the company would have no trouble finding another general counsel. There are plenty of highly skilled, out of work lawyers floating around who would love the job.

Nonfarm Payrolls Boost Stocks

Did you ever think the phrase "unemployment falls to 10% would elicit such enthusiasm?" Relatively speaking, the employment report was not too shabby, with the Labor Department reporting that nonfarm payrolls fell by only 11,000. That's practically an increase. Last month's number was also revised to an 111,000 drop. The unemployment rate edged slightly lower to 10% from 10.2% the prior month. See? Obama's jobs summit, begun just yesterday, is already working.

Assuming Mr. Bernanke gets to keep his job for another four years, an improvement in employment conditions should convince the Fed Chairman that it might be time to pull in the reigns on the quantitative easing. But then again, wouldn't it be nice to let the banks have yet another year of blockbuster profits so everyone on Wall Street can party like it's 2007 again? Certainly, that would be the easy thing to do. After all, easy has been the road that the Fed has chosen time and time again over the past few decades. Easy first, then worry about the mess from the blow-out later. Certainly, Chairman Bernanke had to take quite the beating yesterday from angry Senators who berated him for allowing the financial crisis to occur and then bailing out Wall Street, without taking any blame themselves for not enacting any regulation that might have enforced some discipline on a banking sector run-amok. And certainly his easy money predecessor Alan Greenspan never had to listen to this kind of garbage when he was in office. But it's a small price to pay to hold on to the coveted position of the man who controls the money supply in the US. No doubt Mr. Bernanke will be reconfirmed, but soon enough we are likely to learn that who we really need right now is Paul Volcker.

Bank of America To Pay Back TARP, Pay New CEO Whatever It Wants

Bank of America has reached an agreement to pay back the $45 billion in TARP dollars it required to stay solvent last year. The first $25 billion came in October when Hank Paulson force fed capital to all the major banks. The following $20 billion in extra cash came later, when Ken Lewis finally realized that maybe purchasing Merrill Lynch for $29 dollars a share the Friday before the investment bank would've filed for bankruptcy wasn't such a hot idea. Bank of America is the first of the seven companies that received "exceptional" assistance from taxpayers to pay the government back and it is doing so ahead of schedule so this is being viewed positively by the market. With this move, B of A will be free from the shackles of government meddling in its bonus pool and hopefully will be able to lure another CEO with promises of a big fat paycheck. For those who don't recall, in an unanticipated move, Ken Lewis resigned, leaving the board scrambling for another CEO, because somehow, they were blindsided by the fact that their embattled CEO, despite growing a beard and looking somewhat haggard, would leave ahead of schedule. Apparently, nobody wants the CEO job because of fears of going head-to-head with the Pay Czar. The truth is, I'm sure the board has looked at a handful of candidates, all of whom think they need $50 million a year to properly run the bank. In reality, all of the money boards have thrown at CEOs for the past decade didn't stop any of them from taking too much risk, blowing up their companies, requiring government bailouts and tanking our economy, so I'm still pretty amazed that this idea of a rock star CEO persists in banking. Frankly, I'm sure if B of A's board broadened its search a bit, it could find someone who would do a decent job without requiring a huge pay guarantee. But, better to just pay back the government its $45 billion and dilute shareholders AGAIN by raising yet another $18 billion or so in capital. That way, we can all bury our heads in the sand, go back to business as usual, and forget that 2008 ever happened..

Headline Financial News 12/2/2009

Another relatively slow news day, but here are some highlights:

• GM's CEO Fritz Henderson was given the boot after less than a year, and replaced on an interim basis by Chairman Ed Whitacre. Let's see how much better Mr. Whitacre is at getting US auto sales back up to a 16 million pace.
• The ADP employment report showed companies axing 169,000 jobs in November. This is the smallest drop since July 2008, but, alas, still a negative. All eyes are on Friday's employment report to get a better picture.
• If you are one of those crazy types (yours truly included) that are concerned that the extraordinary amount of monetary easing is going to lead to another bubble, then rest assured, you may not need to be institutionalized after all. The FT reports the return of covenant lite, PIK toggle notes and dividend recaps. Considered by many sane folks to be a preposterous assumption of risk for no upside, the fact that debt investors are willing to throw money at these types of deals again shows that the credit bubble might be back. Mission Accomplished Fed!
• Across the pond, the UK Treasury has taken control of the bonus pool at RBS. Seems like a fair deal considering the fact that the UK Treasury owns a 70% stake. RBS bankers, however, may not be so thrilled.

Dubai "Reassures" Investors

The ruler of Dubai on Tuesday attacked the media for coverage of Dubai World's debt default and blamed investors for misunderstanding the situation. In response to questions related to Dubai World, Sheikh Mohammed bin Rashid Al Maktoum said that international investors "do not understand anything." He went on to call the media's reaction as "exaggerated." It was quite an interesting attempt to reassure markets, and ahem, investors, after two days of rather strong sell-offs in the regional equity markets. But then maybe Dubai doesn't have a particularly developed PR industry.

While I totally agree that investors often overact and behave in mysterious way, I'm not sure how investors misinterpreted the phrase "we don't want to pay our debt obligations for at least six months, give or take" coming out of Dubai World. And sure, maybe investors shouldn't have expected an explicit guarantee from the Dubai government, or the UAE, but then maybe the subsidiary should've been named something other than Dubai World. But sure, you can blame that on investors. As for the "media uproar" over a large debt default of a quasi-government guaranteed subsidiary in the Middle East right before the holiday weekend? Totally shocking. The news rightfully should've been buried in the lifestyle section of the New York Times.

In any event, Dubai World is in talks to restructure $26 billion of its debt with its stupid investors. International markets have moved on to misunderstanding other events and rallied back nicely. The media awaits other news to exaggerate.

The Problem With Dubai

Dubai World, builder of man-made palm tree shaped islands and lover of other absurdly ostentatious and expensive property development projects, has run into a bit of a problem. Lacking oil, or any other valuable commodities, it fueled its building ambitions by issuing debt, piles of it, roughly $60 billion or so. Banks were eager to lend because government-backing of Dubai World's debt was implied. So when Dubai World came out with its shocking announcement right before the Thanksgiving holiday that it just wasn't in the mood to pay its debt investors anymore, markets around the world were miffed and sold off. They regained their composure a bit when all those savvy analysts and commentators assuredly pointed out that a $60 billion debt default was no big deal. The markets had overreacted blah blah blah.

But this is a big problem: it's not the size of the debt but the wider implications of a sovereign nation defaulting on its debt. This morning, the Government of Dubai said that it would not stand behind its wholly-owned subsidiary Dubai World. So much for that implied government guarantee. For the past year, vast government guarantees have boosted markets around the world on the belief that sovereign nations don't default. There's no need to actually do any due diligence into the value of the assets backing the debt if the government is just going to step in and bailout the lenders. Except that sometimes, governments change their minds. Certainly emerging markets have been guilty of this in the past, so you'd think investors would have learned their lesson. But with near-zero interest rates permeating the globe, it's that much easier to ignore these risks and plow head-first into risky investments, some with a host of massive unfinished construction projects around the world, just because some government is supposed to bail you out. Not all bailouts will stand the test of time. Defaulting on your debt is theoretically supposed to make it extremely difficult for you to borrow money at reasonable interest rates in the future, if at all. But if a few adventurous sovereigns start to do it, then the stigma related to default might just go away. So how does that make you feel about Fannie and Freddie's debt? GE Capital's? How about GMAC?

Data and More Data

First the good news:

• Case-Shiller was up again, for the fourth month in a row. It's true that a .27% increase in prices from the prior month is nothing to write home about, but still better than a decline. Year-over-year, prices were still down 9.36%.

Now the not-so-good news:

• Third quarter GDP was revised lower from an initially ebullient 3.5% rate to a less perky 2.8% annual rate. The downward revision was mostly due to a widening of the trade deficit and lower consumer spending than initially estimated.

In obvious news:

• Just in case you've spent the last year and a half on Mars, the WSJ reports that lots of folks are upside down on their mortgages, around one out of four US homeowners. The good news is if we keep allowing borrowers access to 3.5% down-payment financing courtesy of the FHA, and prices tick down a bit more, it's going to get worse.
• Also in the Journal, a report on how banks have trillions in debt coming due, $7 trillion by 2012 and $10 trillion by 2015, and how this could prove to be a bit of a problem when borrowing costs go higher once a.) FDIC guaranteed debt matures b.) interest rates head higher because the Fed has ended its QE program and/or c.) buyers of bank debt actually start to care about credit risk again.

In can-we-really-beat-this-dead-horse-anymore??? news:

• For those with a strong stomach, yet another article on how "difficult" the AIG bailout has been for the government to manage, and how frustrated everyone in the administration is. Blah blah blah, griping over pay, blah blah blah.

Existing Homes Sales Surge

Existing home sales were up 10.1% to a 6.1 million annual pace in October, proving that if you give people sub-5% mortgages requiring only a 3.5% downpayment AND hand them checks for $8,000, they will buy houses. Inventories fell to a seven month supply and the median was down year-over-year by 7.1% to $173,100. Thanks to all the government subsidies, even if technically you didn't buy a home in October, you still sort of bought a home for someone else in October. In any event, the plan seems to have worked by artificially stimulating demand for housing. It will be interesting to see if this type of enthusiasm can continue when all of the stimulus plans expire.

In the meantime, enjoy the market rally and your turkey. Blogging may be a bit sparse this week, depending on material.

Goldman's Shareholders Finally Speak Up About Bonuses

So far, Goldman bonus anger has spewed forth mainly from the lips of legislators, angry mobs, and pregnant women who can't get access to the swine flu vaccine. Lloyd Blankfein has been making the media rounds, which everyone knows he hates to do, defending the firm's aggressive pay practices by pointing out that the firm paid back the TARP, never needed the money anyway, and would've made a mint even without an AIG bailout, FDIC guaranteed funding, zero interest rates blah blah blah. Mr. Blankfein probably never thought any of the hot air would lead to anything. After all, Goldman is pretty used to getting what it wants. But lo and behold, folks that actually matter, who aren't just spouting rage to get reelected, might take action to limit Goldman's plans to shell out record bonuses to its employees: shareholders. The problem is that shareholders fund Goldman's annual pay extravaganzas. The more Goldman pays out in bonuses, the less it retains for shareholders in the form of earnings. Somehow shareholders of Goldman and other investment banks have put up with this reality, until now that is.

According to the WSJ, some of Goldman's largest shareholders are miffed. They want more of the pie. Apparently, despite record net income and compensation, earnings per share will be 22% lower than 2007 and roughly equal to 2006 earnings due to dilution from the 100 million share issued in the past year to bolster its financial position. So if you're going to dilute them, then at least ratchet back on the record payouts to employees. Fair point. An even more interesting tidbit is that a little-noticed change in the company's financial statement increased the firm's total head count by adding temps and consultants, thus making comp per-employee appear to look less than it actually is. In response to shareholder's ire the company's spokesman said that shareholders "have historically been more focused on the absolute return on equity and on book value per share growth." Looks like times are changing.

Delinquencies and Foreclosures Rise on Prime Mortgages

The MBA released its National Delinquency Survey today and the findings were not pretty. The delinquency rate for mortgage loans on one-to-four unit residential properties rose to a seasonably adjusted rate of 9.64% of all loans outstanding as of the end of the third quarter of 2009, up 40 basis points from the second quarter and 2.65% from a year ago. The combined percentage of loans in foreclosure or at least one payment past due was 14.41%, the highest ever recorded in the MBA delinquency survey.

While subprime began the mortgage mess we're in, the latest increases in delinquencies were driven by prime and FHA loans. 33% of foreclosures started in the third quarter were on prime fixed-rate loans and those loans were 44% of the quarterly increase in foreclosures. Option ARMs are lumped together with prime adjustable loans, which helps explain why the foreclosure rate on those loans exceeded the rate for subprime fixed-rate loans for the first. Both fixed and adjustable subprime loans saw decreases in foreclosures.

The foreclosure rate on FHA loans also increased, despite the large increase in the number of FHA-insured loans outstanding. The foreclosure rate was 1.31% for FHA loans.

The MBA's Chief Economist, Jay Brinkman, maintains that: "The outlook is that delinquency rates and foreclosure rates will continue to worsen before they improve," with a persistently high unemployment rate being the main culprit. He adds that "Job losses continue to increase and drive up delinquencies and foreclosures because mortgages are paid with paychecks, not percentage point increases in GDP." He's pretty eloquent for a mortgage banker eh?

Calculated Risk has great graphs, as usual.

Housing Starts, More on Fannie and Freddie

Housing starts fell 10.6% in October to a seasonally adjusted 529,000 annual rate. Building permits also declined. Those ever-accurate economists were forecasting a 1.7% increase in starts so this number was disappointing to say the least. It seems as if builders are reluctant to break ground on new projects with inventories and vacancies on existing properties sitting at record highs. With both the expiration of the housing tax credits and the end of Fed's aggressive purchases of MBS looming on the horizon, it's not surprising that builders are hesitant. It seems like their time and money is better spent coming up with new programs to lobby the government for, rather than building houses.

Good article in the WSJ about Fannie and Freddie's involvement in the apartment market. If you thought that Fannie and Freddie were just doing their civic duty to prop up the residential mortgage market, you're wrong. The housing behemoths are also huge lenders to multifamily projects. How huge? They did 84% of all multifamily lending in 2008. The 2008 numbers don't scare me quite so much since at least underwriting was tightened up a bit by then and nobody else was lending. What does scare me is the 43% of market share the combined companies had in 2007 and 34% in 2006, back when banks like Lehman brothers were still around doing moronic deals. For example, Fannie and Freddie helped finance the massive and overpriced Archstone Smith apartment LBO by lending $9 billion to the deal. Or my vote for the dumbest real estate transaction of the bubble, Tishman's $5.4 billion purchase of Stuyvesant Town, where Fannie and Freddie purchased $1.5 billion in CMBS from that deal. I'm not sure I understand exactly how financing bloated leveraged buyouts became part of their mission statement, but it was a bubble and fortunately taxpayers are here to clean up the mess. The good news is that Fannie and Freddie's apartment building loans only add up to around $300 billion, which is a mere drop in the bucket compared to the $5 trillion of single-family loans that they back. It always helps to put these things in perspective, doesn't it?

Fed Lousy Negotiator During AIG Crisis

So why did the Fed pay off AIG's couterparties at 100 cents on the dollar during AIG's meltdown late last year? Many of us critical of the Fed's drastic and opaque actions with respect to AIG, which it didn't even regulate or have authority to lend to, lie awake at night pondering this question. According to a government audit by the special inspector general for the TARP, the answer is that the folks at the Fed are terrible negotiators. Apparently the Fed called up AIG's counterparties late last year, asked them to cancel the swaps and take a haircut on the securities, the counterparties refused and demanded they be paid 100 cents on the dollar. The Fed said "Ok. Fine." That's your government working hard for you, as it shoveled multiple billions of dollars to Goldman Sachs, Merrill Lynch, Soc Gen, Calyon and others. Just keep that in mind next time you ever wonder who the Fed is really working for. Clearly, its allegiances lie with the big banks.

I've never actually taken a negotiations class, but common sense tells me that when you have even the tinniest bit of leverage, you use it to get a better deal. When you hold all the cards, you squeeze the living daylights out of the counterparties. Of course, when you have none, you cave. A fine example of someone who did a terrible job of negotiating was former CEO of Lehman Brothers, Dick Fuld. Mr. Fuld kept pretending that he had leverage, insisting on a ridiculous price for Lehman during its final days. Yet everyone knew he had no leverage, but Mr. Fuld refused to cave, costing him his firm. That's lousy negotiating taken to the opposite extreme. In the Fed's case with AIG's counterparties, the Fed held all the cards. Or rather, all the money. At the time, the Fed was the only game in town. Had it let AIG collapse, AIG's counterparties would've lost multiple billions of dollars. Why the Fed didn't use its leverage remains a complete mystery to me, despite its lame explanations in the inspector general's report.

In a letter accompanying the inspector general's report, the Fed claims it "acted appropriately" in its dealings with AIG's counterparties. It said its intervention in the insurer was designed to prevent a system-wide collapse. Curiously, it couldn't use its leverage as a regulator because it was acting on behalf of AIG. So instead of protecting the interests of taxpayers, whose money the Fed seems to have no trouble risking at every turn, it was protecting the interests of the bankrupt insurer that blew itself up through sheer greed and stupidity.

According to the WSJ's account of the inspector general's report, AIG's counterparties played hardball with the Fed because the Fed had already made it clear it wouldn't allow AIG to go bankrupt. They claimed they were contractually due the full value of the securities and that they had a fiduciary duty to their shareholders. Lucky for them, the Fed fell for it. The article goes on to say that the Fed's lack of leverage was rooted in decisions it made earlier in the fall, in September 2008, when the Fed felt confident that the banking industry would solve AIG's problems. After Lehman's failure, it tried to get the banks to pony up $75 billion for a loan to AIG, during which time AIG tried unsuccessfully to get the banks to accept less than full payment to cancel the swaps it had written. When those negotiations fell apart, the Fed itself lent the insurer $85 billion and then took over negotiations in early November to try to get the banks to accept haircuts. With the exception of UBS, who agreed to a 2% haircut, the banks refused. The Fed then decided that the only way to stop the cash bleed was to buy out the securities at par and cancel the swaps. There was another way, of course. It could've just given the banks the finger and let AIG fail. But then that's what a good negotiator would've done.

Retail Sales Better Than Expected, Sort Of

US retail sales rose 1.4% in October, much better than anticipated by our already optimistic analyst friends on Wall Street. Equity markets are higher, as everyone celebrates with glee that people are still willing to spend with abandon despite record high unemployment rates. One somewhat major detail glossed over by the optimists is that the 1.4% gain is from September to October, and September was revised down to a 2.3% loss from a previously estimated 1.5% tumble. So maybe this retail sales report was a bit lackluster after all. Excluding autos, other sales rose just 0.2%. Year-over-year retail sales are down 1.7%. Nifty charts available at Calculated Risk for those who like to visualize their economic statistics.

GM Shows Improvement, Only Loses $1.15 Billion

GM posted a $1.15 billion loss for the shortened third quarter and confirmed plans to accelerate repayments to the US and Canadian governments. The good news is that this loss was better than the $2.5 billion it punted last year. Furthermore, the automaker actually had positive cash flow to the tune of $3.3 billion instead of burning through $6.9 billion, like it did in last year's third quarter. But still, the automaker supposedly shed its burdensome cost structure in bankruptcy, emerged from Chapter 11, benefited from the government's massive cash-for-clunkers subsidy and it still lost money? Sorry, but color me not wildly impressed by this quarter's earnings report.

Nevertheless, an improvement is an improvement, so I'll give GM bonus points for that. Unfortunately, GM lowered its expectations for US auto sales in 2010 to 11 million to 12 million from the 12.5 million forecast in April. It expects global sales to come in between 62 million and 65 million sales. As for the loans that GM is planning to pay back to the US and Canadian governments, it will use other money it received from the government to pay back the borrowing. Just like a ponzi scheme, but it only requires one eager participant.

FHA Reserves Below Minimum

The FHA's capital-reserve fund fell to $3.6 billion as of September 30th, leaving reserves at just 0.53% of the $685 billion in total loans insured by the FHA. This is far below the 2% requirement level that the FHA said it had breached months ago. The Secretary of HUD, Shaun Donovan, downplayed the FHA's problems and claims that the FHA won't need a federal subsidy except under the most severe economic scenarios. Like 10% unemployment, maybe? The problem is that projected capital losses in 2009 were worse than the most pessimistic assumptions from last year's review, so really, I'm not sure we should trust Mr. Donovan's reassurances of the agency's solvency.

Apparently, this is what happens when the government tries to prop up a mortgage market that was initially propelled aloft by private no-downpayment mortgages to people with terrible credit. While FHA-insured mortgages require small downpayments, they are still offered to borrowers with lousy credit. The only difference between FHAs and Alt-As is that FHA mortgages have very low fixed rate mortgages, so there is no surprise doubling or tripling of payments a few years down the road. Unfortunately, default rates on FHA insured mortgages are surging, proving that minimal downpayment mortgages to borrowers with terrible credit are extremely high risk, even with a fixed rate. The '08 vintage already has a 15% delinquency rate, handily outpacing earlier years' vintages. Furthermore, the volume of loans insured by the FHA jumped 75% in the 2009 fiscal year to more than a quarter of the mortgage market, from a mere 2% in 2006. During the second quarter the FHA backed nearly half of all mortgages made to first-time home buyers. No matter how much HUD tries to downplay it, it is inevitable that we will be bailing out the FHA too. So, sure the housing market is stabilizing. But at what cost to the rest of us?

Benmosche Backtracks

AIG's feisty and possibly manic depressive CEO has backtracked on his threat to quit after just three months on the job. In an internal memo, conveniently leaked to the press, and aimed at assuaging employees' fears of losing all of his talent after only getting a taste of it, Mr. Benmosche wrote that he remains "totally committed to leading AIG through its challenges." Well, maybe except for when he's on vacation in Croatia. Or, maybe except for if he's not getting paid $10.5 million for his trouble. Or, if it means having to suffer more indignities at the thought of some Paz Czar telling him how he can pay his employees. But other than that, he's really committed.

According to the FT, a meeting last week in New York between AIG's directors, led by Mr. Benmosche, told Ken Feinberg (aka "Pay Czar") that his recent decision to slash salaries for 12 of its top executives by more than 90% was leading to high level departures and upsetting employees morale. That's interesting, because I can only think of one thing more upsetting to employee morale than getting a cut in salary and that would be bankruptcy. The great thing about your employer going bankrupt is that you not only lose your job, but you now become an unsecured creditor for any accrued benefits that you had tied up in the company. Then you get to join the other 8 million or so people who've been laid off in the past year and a half. Or better yet, you get to join the many, many people who have exhausted their unemployment benefits and are taking huge cuts in pay just to get a job. In any event, Mr. Feinberg replied that AIG "did not get" the fact that it had been bailed out with billions of dollars in taxpayers' funds. Nice response, Mr. Feinberg. At least somebody gets it.

What's interesting about this whole brouhaha over pay is that there is a brouhaha over pay going on. Mr. Benmosche has been on the job for three months and all we're doing is arguing over pay, as if pay is the most important thing going on at AIG. Furthermore, AIG is using comp as a way to insist that somehow paying people more is going to miraculously make the company earn over $120 billion in the next few years to pay back the government. It's just not going to happen. With the huge rally in credit spreads and the stock market in the past six months, AIG should be making multiple billions now if it had a shot of ever paying the money back. Sure the company turned a $455 million profit this quarter, but so what? Every time it sells off a unit, it takes another huge hit to earnings, because it seems everything was carried at extremely optimistic valuations on its books. So, I say, let the talent leave, replace it with others who want or need the job and wind the damn thing down and put it out of its misery.

Bear, AIG and Other Headlines

• Ralph Cioffi and Matthew Tannin, the two former Bear Stearns hedge fund managers were found not guilty of securities fraud and insider trading. Ever since these two bozos were arrested, I've marveled that somehow they wound up as the only ones prosecuted for securities fraud from the credit crisis. After all the obvious mortgage fraud, horrendous underwriting, bogus creation of securities, stupid AAA ratings granted by the rating agencies, not to mention major conflicts of interest from certain regulators with crucial decision making powers, somehow all prosecutors could come up with were these two clowns. Two former salesman who had dreams of hedge fund greatness, who discovered in a few short years that they were really really lousy money managers. In any event, the jury didn't buy the prosecution's case, which is amazing considering how much average Americans are dying to see Wall Streeters burned at the stake.
• AIG's CEO Robert Benmosche, who has spent a whopping three months at the helm of the beleaguered insurer, told the board that he is considering stepping down. Apparently, he is really mad that the government is interfering with his ability to run the company like he wants. Pretty unbelievable that the government, which owns 80% of AIG, due to a massive $125 billion or so infusion into the otherwise bankrupt insurer would have the nerve to interfere with how the company is run. I'm not quite sure why anyone would actually care if Mr. Benmosche stays or goes. So far his biggest accomplishments have been taking a two week vacation in Croatia during the first two weeks on the job, threatening to quit when his $10.5 million pay package wasn't yet approved, and then publicly insulting various regulators with outlandish comments that no sane CEO would ever make. Here's hoping that when Mr. Benmosche does retire, he goes back on his meds.
• US Treasury Secretary Tim Geithner said Wednesday that maintaining a strong dollar is "very important" for our country's economy. Then he was caught winking at Ben Bernanke. Meanwhile, the dollar fell through 15-month lows and gold hit new highs.
• Chris Dodd, chairman of the Senate banking committee, introduced a new bill that would strip the Fed of its powers and create a single banking regulator. Naturally, neither the Fed nor the FDIC are happy about losing some of their powers, but when you've spent years asleep at the switch while the banking industry created a massive bubble, maybe you shouldn't be the one in charge next time. The bill does include a new Consumer Financial Protection Agency, which the Republicans (i.e. the banking industry) adamantly oppose, but it does not call for the break-up of large banking institutions.

Lifestyles of the Formerly Employed

The WSJ has an interesting article today about unemployed Americans who have blown through severance and savings in order to maintain their lifestyles who are finally waking up to a new downsized reality. The article is merely anecdotal, with no statistics, but it offers a harsh look at how the length and depth of this recession is truly worse than others we have faced in the past couple of decades. It seems that the recent spate of quick and light recessions has lulled many Americans into an overoptimistic sense of their future prospects. Even when these avid consumers lose their jobs, they continue to spend as if they had jobs, refusing to face the realities of much worse job prospects at lower levels of compensation.

The WSJ introduces us to Paul Joegriner, who was laid off in March 2008 from his CEO position at a small bank that paid $200,000 a year. Mr. Joegriner is not unemployable, in fact he has turned down several job offers in hopes of finding one that matches his former rate of pay. In the meantime, the family has blown through most of its $100,000 in savings and has only recently begun to cut back on fancy vacations, expensive Porterhouse steak dinners, and other amenities. One would think that a 44-year old who used to make $200,000 a year would have more than a year and a half's worth of savings, but the family is upside down on the mortgage on its primary residence, as well as two investment properties that produce no cash flow. So it seems as if poor investment decisions are also an issue. Furthermore, he recently turned down an out-of-state job offer because it didn't include severance pay. "I just couldn't take the risk," says Mr. Joegriner, of uprooting his family just to get laid off again. Although somehow, taking the risk of continuing to be unemployed in this economy is somehow a better idea. To summarize: no revenues, plus excessive spending, plus poor investment decisions, plus lousy risk management skills, equals the kind of guy you'd want to hire to run a bank, right?

For those interested in more stories of BMW-driving, $150 haircut-wearing, $200-a-month flower-budgeting, $36-a-bottle case of wine-purchasing types who are unemployed and have blown through their severance, just click on the link above. The article has many examples of folks who earned far less than $200,000 a year, who are just waking up to the reality that they can no longer live beyond their means. No more cash-out refis, because there's no equity in the house. No more zero percent credit card transfer offers in the mail, because banks aren't passing along their gift from the Fed. Investment portfolios are still battered, even with the recent rally. Fortunately, the government is offering some relief by extending unemployment insurance benefits up to 20 weeks. This should help soften the blow for the 1.3 million or so whose benefits are set to run out by the end of the year. Unfortunately, $150 haircuts are no longer an option.

Treasury Nixes Sale of Fannie Tax Credits to Goldman

Apparently, there is only so much humiliation the Treasury can take from the profiteers of Goldman Sachs. While the Treasury's investment in Fannie continues to bleed cash out of its eyeballs, Goldman Sachs has money coming out of its ears. The folks at Goldman have daily meetings trying to figure out what on earth they are going to do with all the money they keep making, and then during those meetings, they just keep coming up with more ideas on how to make more money! Like buying tax credits from Fannie. After all, there is no way in hell Fannie is ever going to make another penny and everyone hates to waste a good tax credit. Really this is all in the interest of tax efficiency.

Not so fast, says the Treasury. According to a letter Treasury sent Fannie, selling the $2.6 billion in tax credits would cost taxpayers more than the company would gain from the sale. So the Treasury has nixed the sale. Fannie claims to be reviewing the decisions, whatever that means. When the Treasury owns you, I'm not sure how much of a say you get in these matters. Poor Goldman is stuck writing a big check to the government. Although, I'm sure their tax guys already have a few more tricks up their sleeves.

Fannie and AIG: The Dogs of the TARP

All of those optimists who think the US government is going to make a killing on its TARP investment have yet to take a look at Fannie's latest earnings report, released yesterday after the close. The good news is that Fannie actually reported a narrower loss than in last year's third quarter. The bad news is that the loss was still $18.87 billion. Really, how excited can an investor get over the phrase "losses narrowed to a mere $19 billion?" The loss was primarily due to a $22 billion increase in credit-loss provisions and foreclosed-property costs due to spiking delinquency rates. The mortgage giant put in its quarterly request for more money from the government, this time a puny $15 billion.

So really, why should anyone care about Fannie anymore? It's barely a public company since the government seized the mortgage giant and put it into conservatorship last September. Fannie Mae is the mortgage market. In fact, Fannie, Freddie and FHA loans account for approximately 95% of mortgage issuance this year. Earnings reports from Fannie and Freddie aren't merely company earnings for investors in those firms, but they are important barometers of the economy. Spiking delinquencies and foreclosures for Fannie's properties paint a rather bleak picture of the state of the housing market, one that counteracts all the bullish carping of those who believe that a few months of slightly higher medians for housing prices means it's back to the boom years of 2005. The government is keeping the housing market alive. And it's costing us a pretty penny.

In other Fannie news, the WSJ reports that Fannie has introduced the "Deed for Lease" program, a new program that allows delinquent borrowers to transfer their property to Fannie Mae in exchange for a lease. Borrowers-turned-tenants will pay market rents, which in many cases are much lower than their mortgages and might be offered extensions when their lease expires. The hope is that allowing delinquent borrowers to stay in their homes will keep another wave of foreclosures from hitting the market and depressing prices further, causing yet more homeowners to go upside down on their mortgages thus continuing the endless downward spiral in housing prices. The program is only offered to those who are seriously delinquent, which seems to create an enormous incentive for those who are upside-down but current on their mortgages to stop paying so they too can remain in their house for much lower monthly payments. Furthermore, it doesn't really solve the problem of the massive losses that Fannie needs to take when owners who paid too much for their homes hand the properties over to Fannie. It just delays the loss recognition for a few years (depending on how Fannie chooses to account for it, and everyone knows Fannie is famous for its scrupulous accounting.) Unless, of course, housing prices miraculously rebound and Fannie can just sell its mounting inventory for a huge profit in a few years. Yeah, right. Other than those minor pesky issues, I think it's a great idea.

Finally, we get to AIG. The formerly highly regarded insurance conglomerate that everybody loves to hate on. AIG posted a highly anticipated profit of a whopping $455 million. Of course, compared to the year-earlier loss of $24.47 billion, these results were spectacular. New CEO Robert Benmosche did not miss the opportunity to pat himself on the back, remarking that AIG's results "reflect continued stabilization in performance and market trends." Yeah, AIG will be out of the $120 billion hole in no time. Mr. Benmosche's strategy is to become more patient in selling off all of those valuable businesses AIG owns. You know, like the airline leasing business, AIG's "crown jewel," which is looking for a new buyer along with just about every other airline leasing operation in existence that is currently up for sale. That crown jewel that just had to borrow money from AIG (i.e. the government) because it couldn't refinance its debt. On the horizon is another $5 billion charge the company plans to take as it closes an SPV connected to its foreign life-insurance business to pay off $25 billion of its New York Fed credit line. Then there's the investment company Primus Financial Holdings that AIG sold last quarter for $2.15 billion, its biggest sale globally so far. The company will book a $1.4 billion fourth-quarter loss on that sale. Seems like the CDS book wasn't the only thing on AIG's books being mismarked.

Unemployment Hits 10.2%

Nonfarm payrolls fell by 190,000 last month, with the largest job losses in construction, manufacturing and retail. Since the beginning of the recession in December 2007, the number of unemployed has increased by 8.2 million. The unemployment rate hit 10.2%, the highest rate in 26 years. The employment picture continues to be very weak and threatens the nascent recovery. Raging bulls claim that employment is always a lagging indicator, which is definitely true. But there is a big difference between recovering from a 6% unemployment rate and a 10% unemployment rate. Zero interest rates don't seem to be doing the trick.

Productivity, Jobs and the Fed

• Jobless claims declined by 20,000 to 512,000 for the week ended Oct 31, the lowest level since Jan 3. Continuing claims fell by 68,000 to 5,749,000. Some improvement in the employment picture, but still pretty high numbers overall. Tomorrow's employment report should be more enlightening.
• Productivity rose at a 9.5% annual rate last quarter. Naturally, companies are more efficient as they are shedding employees left and right and those left behind are forced to pick up the slack. The hope is that companies will eventually return to hiring once they've squeezed the lifeblood out of their remaining employees.
• Yesterday's decision from the Fed wasn't terribly surprising. The central bank left rates unchanged and promised The Street not to raise them for an "extended period of time" unless they sense inflationary pressures brewing. Although many (World Bank, IMF Nouriel Roubini, just to name a few) are worried about brewing bubbles popping up in asset classes around the world, the Fed has made it clear that it doesn't care about such silly things. After all, the Fed didn't care about the mother of all credit bubbles that inflated between 2005-2007, so why should it start caring now? We have all the rescue vehicles we need in place. We'll just bail everybody out again when we have to, right?
• When I said that the Fed promised The Street it wouldn't raise rates for an extended period of time, I was being very specific. It is a promise to the Street, because Wall Street is benefitting the most from the zero interest rate, quantitative easing, free money bonanza. That is why we keep seeing articles with headlines such as "Goldman Benefits From Trading Bonanza" in the FT today, as well as "Big Bonuses Are Back For Many on Street" from the WSJ.

Wells Fargo Attempts Loan Mods With Option ARMs

I will give Wells Fargo bonus points for trying to make the best out of a rather dicey loan portfolio. Known as a conservative lender through most of the insane lending of the housing boom, Wells Fargo inherited a the toxic portfolio of option ARMs when it chose to purchase Wachovia in a fire sale last year. The bank is being proactive by introducing loan mods to deal with the pesky problem underlying most option ARMs: borrowers used them to purchase homes they couldn't actually afford and once the minimum payment resets higher, the borrowers will default. Wells Fargo is attempting to solve the problem by converting option ARMs into interest only loans that will defer balances for as long as six to 10 years. The bank is essentially extending the minimum payment period on the option ARM because it knows that the borrower would otherwise default if the payment were allowed to adjust to the fully amortizing amount. Also known as "kicking the can down the road" this strategy clings to the hope that either housing prices will stage a miraculous recovery in the next few years, or that the borrower's financial situation will improve dramatically so that he can meet higher mortgage payments in the future. In reality it is just delaying the inevitable and allowing Wells to take smaller writedowns in the present against the souring portfolio. Wells Fargo claims that it is keeping borrowers in their homes, which, I suppose is slightly better than having to deal with yet another foreclosure. However, the fundamental problem of borrowers being upside down on their mortgages and having a rather large financial incentive to walk away remains.

RBS and Lloyds Receive Yet More UK Government Funding

It's hard enough keeping track of the latest nuances of the US banks' various government bailouts, paybacks, comp battles etc. Who has time to keep an eye on the UK? But today's headlines from across the pond are fairly ominous and worth mentioning. RBS and Lloyds will receive a total of $51 billion in a second bailout from UK taxpayers. RBS is set to receive 25.5 billion pounds bringing the government's ownership stake up to 84% from 70%. Lloyds is opting to do most of its new capital raising from money managers, accepting roughly a quarter of the 21 billion from the government, allowing the mortgage lender to avoid near-nationalization. However, both banks have agreed not to pay cash bonuses to any employees earning more than 39,000 pounds this year. That is quite a concession. In fact, the scrooges at the UK Treasury make the US Pay Czar look like the tooth fairy. Mark my words, nobody from AIG is going be lured away by 39,000 pounds in cash and the balance of comp in RBS or Lloyds stock.

In any event, bailouts of this size from two of the UK's largest banks foreshadow worse to come for some of our problem banks. They're in the same business, just in different countries. RBS has essentially been nationalized, and Lloyd's is struggling to avoid the same ultimate fate. Think of RBS as the Citibank of the UK and Lloyds as the Bank of America. Both Bank of America and Lloyds/HBOS pursued disastrous value destroying mergers when it appeared that the worst would be over. Right before things got much worse. I am absolutely shocked that financial stocks in the US are taking this news in stride today. But it's not the first time that the recent bullishness of this market has surprised me.

Goldman Shopping For Fannie Tax Credits

Ever the savvy financial engineer, Goldman Sachs is seeking to purchase unused tax credits from Fannie Mae. It's a simple idea really. Fannie, the former mortgage giant now 80% owned and controlled by the US government, has punted close to $38 billion in the first half of the year. Meanwhile, the folks at Goldman are swimming in dough thanks to ridiculous amounts of easy money tossed their way courtesy of the Fed, FDIC and the Treasury. Goldman is merely being tax efficient and trying to cut its bill a bit with some fancy accounting footwork. Besides, there's no way Fannie is ever crawling out of the hole and has no use for the mounting tax credits sitting on its books.

The only small problem with the plan is that it doesn't look or sound quite right to all of those angry plebians carrying pitchforks that are out for Goldman's hide. Why should Goldman be allowed to skip out on paying its tax bill after it's already received so much help from Uncle Sam? So the government is scrutinizing the deal and trying to determine whether it is worth the political furor that is sure to follow if it swaps some of the tax credits with Goldman for cold hard cash to help boost Fannie's bottom line. I personally don't care one way or the other. What difference does it make if Goldman gives money directly to the IRS or to Fannie? It all winds up in the same bucket. If Treasury is smart, it will just price the tax credits so that there is no financial benefit to doing the deal and Goldman will just pay its taxes directly. Problem solved. Given what an incredibly poor job Treasury has done so far negotiating its deals with Wall Street Banks (i.e. handing out 100 cents on the dollar to terminate the AIG swaps and doling out TARP funds without any restrictions, just to name two) it's hard to imagine it will negotiate a savvy deal this time around. After all, if there were no financial benefit, Goldman wouldn't be itching to do a deal. My advice to Goldman? Just pay your damn taxes and try to stay out of the papers.

The Duffman

Every once in awhile, when not busy crafting ridiculous headlines, Bloomberg actually writes fairly decent "exclusives" on interesting finance stories. Today's tasty treat covers Phil Duff, a finance whiz that flamed out in a rather large and embarrassing way in 2008. According to Bloomberg's account, Mr. Duff earned degrees from Harvard and MIT, became CFO of Morgan Stanley at 36, and was recruited as CFO to Tiger Management in 2000. Then, he founded his own hedge fund firm, FrontPoint Partners, which he sold to Morgan Stanley in 2006 for $400 million. So far, so good.

Not satisfied with this impressive winning streak, Mr. Duff decided to try to top himself. With much fanfare in March 2008, Mr. Duff founded Duff Capital Advisers LP, claiming it would be bigger than Tiger. He secured $100 million from Lindsay Goldberg, a $10 billion buyout firm in New York, and then promptly blew through all the money in under a year. Most hedge fund start-ups would consider $100 million in investment capital to be a gift worth investing right away, particularly during some of the most volatile and interesting markets we've seen in decades. But no, the $100 million was just working capital for Mr. Duff, that he used to create some fairly spectacular infrastructure for a massive fund, without really bothering to figure out how he was going to raise any capital. Mr. Duff signed a 15-year lease, costing $5.5 million a year, on 43,400 square feet of office space in Greenwich Connecticut. The new digs had a custom food court, two jumbo flat-screen televisions, showers, a boardroom table for 20 and a skylight with panes that filtered bright light to keep traders from squinting. Did I mention Mr. Duff's $39,000 desk? Mr. Duff hired approximately 104 employees and offered some of them lucrative pay packages, although several actually invested in the fund by purchasing shares.

Right before Lehman's collapse, Linsay Goldberg started asking some questions. Well, actually just one important one: Why are you spending so much money and not earning any? They eventually forced Mr. Duff to fire many of his employees and eventually forced him to hand over control of the firm. The firm was renamed Investment Risk Management Group and changed its focus to developing risk analysis tools. The company was strung along until May 21st, when Lindsay Goldberg finished raising its next private equity fund. Cause really, embarrassing failures like this need to be swept under the rug until new investment capital is raised. The private equity concern was forced to settle with some of the former employees over a pay contract dispute, but everyone signed NDAs, so nobody's talking.

Stories of hubris and excess like this sometimes make me thankful for the great recession of 2008. Anytime people begin to resemble cartoon characters, particularly from the Simpsons, you know we are due for a correction. Mr. Duff should've seen the writing on the wall when he ordered his $39,000 desk.

GDP Finally Up

• After a full year of wrenching declines, US GDP rose by a seasonally adjusted 3.5% annual rate in the third quarter. The gain was driven by consumer spending, which rose by 3.4% in the third quarter compared with a 0.9% drop in the April-June period of 2009. You can thank our federal government for cash for clunkers, the first time home buyer tax credit, and the piles and piles of stimulus cash showered on the economy. But with unemployment at 10%, and consumers continuing to shed debt, it seems unlikely that this sort of momentum can hold for a sustained period of time. Equity markets are not impressed, posting a meek rally this morning.
• Another hedge fund scandal hits the tape, with the founder of K1 (no relation to K10, I promise) Helmut Klener arrested in Germany amid a fraud probe. The hedge fund is entangled in an international criminal investigation after banks including Barclays, JP Morgan, BNP Paribas and Soc Gen were saddled with $400 million in losses. Apparently the fund of funds deceived the banks when borrowing money to boost returns. Unheard of! In any event, details are forthcoming and likely to be juicy.
• The Fed has finished purchasing its $300 billion in Treasuries, having met its quota, and grown tired of playing patty-cake with Treasury. The program has kept long term interest rates artificially low for the past seven-months, allowing lots of folks to refi into much lower interest rates on their mortgages. Lower rates have also led to a massive spurt of bond market issuance by firms, particularly since it's so tough to get a bank loan these days. The low interest rate mortgage boom, however, will continue as the Fed's much larger $1.25 trillion game of patty-cake with Fannie and Freddie goes on through March. Given how much money Wall Street dealers have made being the middle man between the Fed and Treasury and the Fed and Fannie and Freddie, it sort of makes you wonder why the Fed didn't cut them out and trade directly with the other government entities. In any event, rates are likely to head higher so get your refis done while you still can.
• Here's a quick update on the Lembis, my favorite local real estate mogul family that punted generations' worth of real estate wealth in a few short years. Walter Lembi, managing director of the San Francisco based Lembi Group, is wanted for passing around $298,500 worth of bad checks at Caesar's Palace. Mr. Lembi was about as good at gambling away his money at the tables as he was with gambling away the real estate fortune that it took his family decades to build. Apparently, Mr. Lembi is no longer living in his Burlingame home, the address that was listed on court documents so authorities are having trouble tracking him down. Maybe they should check in one of his old apartments? Although judging from all the lawsuits, his tenants hated him so much, they're likely to rat him out.

Blackstone Hoping to Renegotiate Hilton Debt

I give Blackstone bonus points for attempting to fix its pesky $20 billion Hilton debt problem before the crud actually hits the fan. Apparently, the private equity group is hoping to convince holders of the debt to make some minor adjustments, like swapping their crappy debt for crappier equity, or extending maturities out even further, maybe until 2050 when the commercial real estate market starts booming again. Blackstone is even offering to contribute $800 million in additional equity to buy back debt at a discount. So many fancy accounting and financing tricks, so little time. The problem is it is hard to escape a turkey of a deal like the Hilton LBO, that was struck during the fairy tale days of the credit bubble. Unfortunately, it is hard for us to escape the Hilton LBO as well, for the Fed owns $4 billion in Hilton bonds, courtesy of Bear Stearns, via that awesome $29 billion risk-free loan the Fed gave to JP Morgan so it could purchase the more solvent portions of Bear. The only good news is that the terms of the debt limit Blackstone's ability to repurchase Hilton debt.

Blackstone is hoping to cut the debt load by $5 billion, as I'm sure that will make its equity portion worth more. After already writing off the investment by two-thirds, Blackstone needs all the help it can get to make its investors whole. I wish them luck with their negotiations. Personally, as a senior debt holder, I'd tell them to take a hike. Maybe cough up another $5 billion in equity? Then we can talk.

Mr. Bernanke is probably just getting a phone call right now from Steve Schwarzman asking him to take a haircut on the Fed's Hilton debt. Mr. Bernanke wonders out loud "How'd we wind up owning Hilton bonds?" An assistant whispers something in his ear. He sighs, then picks up the phone to call Blackrock, to find out what to do...

GMAC Needs More Dough. Again.

As if $12.5 billion weren't enough, GMAC is knocking on the Treasury's door, looking for another $2.8 to $5.6 billion. You know, just to tide things over until the next bubble kicks in. I'm still a bit perplexed as to why we are bending over backwards to keep GMAC afloat. Sure the auto finance concern has $181 billion in assets, but it can hardly be described as a systemic risk to the market. While it is true that GMAC provides crucial financing to the auto industry, which the government is now firmly invested in, I just don't understand why the bankruptcy option wouldn't work here. Essentially what we are doing is bailing out GMAC's creditors instead of forcing them to take a hit, like they should be doing for having made such a lousy investment.

What is so irritating about this particular bailout is that we have moved past the point of worrying about a global financial meltdown. The economy, although still fragile, seems to have stabilized, and now we're just randomly picking and choosing who deserves money from the government and who doesn't. Why is cheap financing for the auto industry more important that, say, providing cheap loans for small businesses? CIT was allowed to fend for itself and will likely wind up in bankruptcy soon. But GMAC, no GMAC, we have to continue to shovel money into because everybody has to buy cars. How on earth did it become a national priority that everybody needs cheap financing to buy a new car every couple of years? I know that in the grand scheme of things, another $5 billion or so is insignificant, but I still consider it to be a nice chunk of change that could be better spent on at least 50 other things that are more important for the future of this country.

Capmark Files For Chapter 11

Capmark Financial, one of the nation's largest property lenders with $20 billion in assets, has filed for Chapter 11 bankruptcy protection. Capmark used to be the commercial lending unit of GMAC, the residential mortgage lending arm of GM that has since received excessive amounts of government aid. Seems like everything that GMAC ever touched was bound to be a lousy investment. At least GMAC had a bit of foresight in spinning off Capmark in 2006 to KKR, Goldman Sachs Capital Partners and Five Mile Capital Partners, who paid $1.5 billion in cash to acquire the doomed commercial lender. I'll let you guess what that investment is worth today.

Capmark has a bank in Utah with $10 billion in assets that is not part of the bankruptcy filing. However, the bank has been warned by the FDIC that it needs to boost its capital levels. The bank makes and holds commercial mortgages making it a likely candidate for seizure by our friends at the FDIC. Speaking of the FDIC, it closed seven banks on Friday bringing the YTD total to 106. Now if that isn't bullish news for the stock market, I don't know what is. Otherwise, I have no explanation for this morning's rally.

Existing Homes Sales Boosted By Expiring Tax Credit

Existing homes sales were up a whopping 9.4% to a 5.57 million annual rate from 5.09 million in August. August was revised down slightly from down 2.7% to down 2.9%. The level of 5.57 million is the highest since 5.73 million during July 2007. So, the housing market is partying again like it's 2007. Sort of. The median price was down 8.5% year-over-year to $174,900.

In other encouraging news for housing, inventories declined to a 7.8 month level, down from 9.3 months in August. Furthermore, the percentage of distressed sales represented 29% of sales, down from 31% the prior month and 45% to 50% in late 2008 and early 2009. Huge volumes selling at rock bottom prices with inventories returning to relatively normal levels point very strongly to a bottom in housing, if it weren't for three nagging questions:

1. What about the foreclosure pipeline? NODs, delinquencies and foreclosures are still rising, with mortgage mods merely delaying the inevitable.
2. When the tax credit expires, are sales going to plummet again, similar to the expiration of the cash-for-clunkers program?
3. What happens to interest rates when the Fed stops its unprecedented purchases of Treasuries and MBS? (hint: rates are going higher)

AMZN, MSFT Boost Nasdaq

Microsoft handily beat analysts estimates, posting first-quarter net income of $3.574 billion or $.40 cents a share, down from $4.373 billion or $.48 cents a share last year. Revenues for the quarter were $12.92 billion, down from $15.06 billion in the prior year's quarter. Better than expected but still down year over year. Nevertheless, the stock was up 10% on the open, but has given some of that back as the rest of the market is not participating.

Amazon, on the other hand, is up a whopping 20%, on some very robust earnings results. Third-quarter profits were up 69% helped by a 44% rise in sales of electronics and general merchandise. Net income for the quarter increased to $199 million, or 45 cents a share, from $118 million or 27 cents a share in the year ago quarter. Overall sales were up 28% to $5.45 billion. Amazon is forecasting sales growth between 21% and 35% for the fourth quarter, with net income projected to rise between 10% and 56%. Great numbers in the face of a tough retail environment, but the stock is now trading at a 74 p/e. A bit much perhaps?

LTCM Take Three

John Meriwether is back. Remember him? The founder of Long Term Capital Management, the hedge fund that blew itself up in 1998 and almost took down Wall Street with it? Then there was JWM Partners, a vehicle he set up right after Long Term's collapse, a much more conservative fund that only lost 44% in last year's crisis. Mr. Meriwether wound that one down, presumably not thrilled about the prospect of having to work for free to get back to that high water mark again. Not one to rest on his laurels, Mr. Meriwether is launching yet another fund, this one to be called JM Advisors. Has he discovered some new money making scheme? Nah, he's planning to stick to his tried and true strategy of relative value arbitrage, aka "making a little money for a few years before you give it all back in one fell swoop." Anyone willing to invest in this new vehicle deserves exactly what they get. But pensions and endowments should not be allowed in.

Pay Czar Puts Down Foot, Sparks Sell-Off

Kenneth Feinberg, the Treasury Department's special master for compensation (aka "the pay czar") has used his new found powers to slash proposed compensation for the 25 highest-paid employees at the seven firms receiving extraordinary amounts of government aid. The firms include Bank of America, Citi, Chrysler, Chrysler Financial, GMAC, AIG, and GM. Mr. Feinberg will also demand a host of corporate-governance changes at those firms. He is set to lower total comp for 175 employees by a jaw-dropping average of 50%. The biggest cuts will be to salaries, which will drop 90% on average. Details are forthcoming but the person familiar with the matter who leaked the story to the press has revealed that no employee within the AIG Financial Products group will receive compensation of more than $200,000. Any ordinary American reading the news might shrug his shoulders and say "What's the big deal? That's still three times as much as I make." But the employees working for the unit are probably used to making much more and are currently in a state of shock. Will they all walk out on their jobs in protest? That's the interesting question. Will it matter one way or the other? Probably not. The government is not getting its money back on that turkey whether it pays top dollar for "talent" or not.

The market had an interesting response when the news hit the tape. All of the banks stocks sold off on the news. It is as if everyone panicked and said "Oh my God! All the talent is going to leave to start their own hedge funds because of the threat of comp getting slashed across the board." The funny thing is if all of the bank stocks actually slashed their comp expenses by 50%, that would be a huge boost for shareholders. Bank stocks should've rallied on the news. Goldman has set aside over $16 billion for compensation this year. Cut that down to $8 billion and the firm just made another $8 billion in profits, which is equal to more than the past two "record" quarters of earnings. Oh but right, if you cut comp by 50%, all the talent is going to scurry away and the firm will be left with a bunch of monkeys that buy MBS from Fannie and Freddie, finance them at zero percent interest rates and then mark 'em up and sell them to the Fed. And we can't have monkeys doing that kind of rocket science unless we pay them $700k a year. No, the smart folks will go to greener pastures at, I don't know, Citi? AIG Financial Products? Galleon?