Thursday, April 30, 2009

It's Official: Chrysler Files Chapter 11

Sometimes it’s fruitless to read the articles until the real deal hits the tape. No amount of frenzied negotiation by the government could cement a deal between Chrysler and the holders of its bank debt, some of whom seemed to believe they were getting the shaft relative to the unions. So Chrysler is going to court and will have this whole messy business wrapped up in a jiffy, 30-60 days according to the President, which seems hard to believe.

Despite its loss of market share over the years, Chrysler still employs over 50,000, many of whom will certainly lose their jobs. Additionally, dealerships will be forced to close, as the automaker has fewer brands to sell. Although a newly restructured company is necessary and healthy, the interim will be painful, particularly since the rest of the economy stinks. What are all those former employees and out of business dealerships supposed to do now? Go make or sell GM’s crappy cars?

In any event, there are two bright spots out of all of this. First of all, the clowns at Cerberus will have their entire equity investment wiped out, proving that no amount of financial wizardry or political clout can save a really stupid investment. Maybe they’ll think twice before piling a bunch of debt onto a company in a highly cyclical industry six years into a boom. Hopefully, they won’t ever get the opportunity again. Second of all, Bob Nardelli, Cerberus’ choice to lead Chrysler directly into bankruptcy, finally proved definitively that he was the most overrated CEO hire in the history of the US corporation. What kind of a tool leaves a company (Home Depot, where he worked prior to his gig at Chrysler) in a huff because he refuses to take a pay cut off of his ridiculous $200 million pay package, despite the company’s lackluster performance during his leadership? This was Mr. Nardelli’s shot to prove that he was worth all that money and Home Depot made a mistake by forcing him out. Turns out, he was just grossly overpaid.

Waiting For Chrysler

As we sit around and wait for the "imminent" Chrysler announcement, I take a moment to ponder the market's recent rally. If there’s anything that spells “rip-snorting equity market rally,” it’s a negative 6.1% contraction in GDP. Or perhaps it’s a Fed announcement that says things are really bad, but maybe only getting worse at a slightly lower pace. Or is the bullish nes the fact that the yield on treasuries has crept higher than where it was when the Fed announced its quantitative easing program? In any event the market is in the mood to filter through any bad news to find the “green shoots.” An announcement such as the imminent bankruptcy of one of our big three automakers becomes “thank goodness we’re finally putting it out of its misery.” Or the fact that continuing unemployment claims hit yet another record at 6.3 million becomes rabidly bullish because the pace of increases appears to be slowing. While I certainly believe that a decrease in the pace that the economy is falling off a cliff is positive, it seems entirely too soon to claim that we’re headed for a quick rebound in the second half and that the consumer is going to save us yet again because we had one month’s worth of happy consumer confidence numbers. It certainly can’t be the case if unemployment is headed for 10%, housing price declines fail to stabilize and commercial property defaults surge.

Wednesday, April 29, 2009

Administrative Note

I'm on the road this morning so no time to blog. Besides, what else is there to mock, other than Citigroup needing more capital on one front page, contrasted with Citigroup asking for permission to pay excess bonuses to its energy traders because they're threatening to flee on another?

If I think of anything intelligent to say about the Fed's announcement this afternoon, I'll comment later. Otherwise, I fully anticipate the market to open down, rally back, and then close unchanged. Isn't that what it does every day?

Tuesday, April 28, 2009

GM Bondholders, BAC, C Shareholders – Not Happy With Government

Not surprisingly, GM’s unsecured bondholders weren’t pleased with the offer from the government of 10% equity plus zero cash, particularly since the UAW would wind up with 39% of equity plus 50% cash recovery. Bondholders are preparing a counteroffer, one that perhaps involves meeting everyone in a bankruptcy courtroom.

Meanwhile, in top leaked news, Bank of America and Citigroup may be required to raise more capital according to “people familiar with the situation.” I’ll never understand why people familiar with the situation felt it was wise to leak the news a week before the results of the stress tests were due, but I suspect it may just be someone who has a bone to pick with Ken Lewis, who is already facing a world of hurt from angry shareholders for not informing them in December that Bank of America was about to pay far too much for Merrill Lynch’s pile of garbage. Everyone knew Citi would need more capital, but Bank of America was perhaps tougher call. Both banks will contest the government’s findings, but this could mark the end of the road for Mr. Lewis’s career at B of A. Prepare yourselves for more leaks about other banks’ conditions in the next week. While the government may not want you to think that the need to raise capital is a sign of insolvency, it’s hard to take the news in any other way.

Monday, April 27, 2009

Fed Discovers Ideal Interest Rate Policy

The good news is that a Fed study has revealed the perfect interest rate for the current economic climate. The bad news is that the interest rate is -5%. Unfortunately, knowing the solutions to our economic woes and being able to implement them are two different things, as it is impossible for the Fed to lower rates below zero. However, the Fed can enact unconventional policies that provide stimulus roughly equivalent to an interest rate of minus 5% (i.e. quantitative easing.) The Fed staff separately estimated what size and type of unconventional operations, including asset purchases, might provide this level of stimulus. Apparently, it is far more than the $1.15 billion increase that policymakers authorized at the last meeting. Clearly we’re looking at zero interest rates for some time to come. Investors from now on will focus less on what the Fed’s stated interest rate policies are and instead turn their attention to how many securities the bank intends to purchase.

Meanwhile, in the repo market, where investors go to finance their securities, interest rates for certain scarce issues are already trading at negative interest rates. This situation will only be further exacerbated by the Federal Reserve Bank of New York’s suggestion that banks be charged a three-percentage point fee for failing to deliver securities. The new fee is intended to discourage failures and make Treasury repo transactions much smoother. Whether it will work or not remains to be seen, as a fee on failures to deliver may encourage even more hoarding of scarce issues. The only thing that’s certain is that dealers will figure out how to game the new system to their advantage. After all, it is what they do best.

The Fed, with all of its quantitative easing, is attempting to encourage risk taking in the economy again. With a zero interest rate policy, banks are supposed to be lending and, to a certain extent, passing on the savings to consumers. With the recent announcement made by several large banks that they are actually raising fees on credit card customers coupled with the scarcity of financing for any type of mortgage that isn’t conforming (i.e. provided by the government,) the Fed’s policies have only served to fatten banks’ profits (i.e. keep them alive for another quarter.) Investors, however, are dipping their toes back in the market, as spreads in the bond market have narrowed and equities have rallied off of their depressing lows hit on March 9th. This is marginally positive news.

What happens if interest rates are negative and you are still not ready to jump back into the stock or bond markets? What if you’re sitting on the sidelines and your bank decides that it is going to start charging YOU for the privilege of holding your money? It’s a wonder that mattress sales haven’t gone through the roof.

Friday, April 24, 2009

Automaker Update

Ford posted a smaller than expected loss of $1.4 billion in the first quarter and said it doesn’t need more cash in 2009. The car company lost 60 cents a share, significantly less than the $1.23 share loss that analysts were expecting. Ford slowed its cash burn rate down to $3.7 billion from $7.2 billion, as it idled most of its North American assembly plants during the first week of January. The company ended the quarter with a cash hoard of $21.3 billion.

Meanwhile, GM and Chrysler continue to suffer through the steep collapse in demand for new cars. Chrysler is preparing itself for a bankruptcy filing as early as next week, which would allow the company to shed some liabilities and allow Fiat to pick over the carcass of the bankrupt automaker. Apparently, the UAW is on board with the plan and the government would provide crucial DIP financing so operations could continued uninterrupted. Tensions are high between Chrysler’s lenders and the government, as the lenders believe they can receive more in a liquidation than the current deal they are being offered. Chrysler’s lenders are owed $6.9 billion. They are roughly $3 billion apart in negotiations. What’s $3 billion among friends, particularly when the government has thrown multi-billions at the lenders already? Suddenly banks are shrewd negotiators, when two years ago they were tripping over themselves to give everyone with a pulse a no-doc, no-downpayment loan.

Fiat is playing the field and also looking at doing a deal with GM to form some sort of partnership in Europe and Latin America. All of this is in the air, of course, until the Chrysler situation is resolved, which is also very much up in the air. One bankruptcy at a time, please. We’ll get to GM’s bankruptcy in a month or so.

Thursday, April 23, 2009

Default Notices Jump to Record Highs in California

Dataquick released the latest notice of default statistics in California and while the results are certainly not pretty, the report is filled with many interesting tidbits. A total of 135,431 defaults notices were sent out during the January to March period in California, an increase of 80% from the prior quarter and 19% year over year. According to John Walsh, Dataquick President: “The nastiest bunch of home loans appears to have been made in mid-to-late 2006 and the foreclosure process is working its way through those.”

According to Dataquick, the median origination month for last quarter’s defaulted loans was July 2006. That’s only four months later than the median origination month for defaulted loans a year ago in the first quarter of 2008. Default rates for loans originated before 2004 have a default rate of 1%, compared to 4.9% for loans originated in 2005, 8.5% for loans originated in 2006, and 4.7% for 2007. While the 2007 vintage is just getting warmed up, many of the subprime lenders had the decency to go bust in the first quarter, so perhaps 2006 will wind up being the peak when all is said and done. Dataquick has isolated the period between August 2006 and November 2006 as particularly toxic, with a 9% default rate on all loans issued in that period so far. Particularly jarring is the rates of default for many of the now-defunct sub-prime lenders during this period; ResMae (69.9%), Master Financial (64.6%), and Ownit Mortgage Solutions (63.6%). Of the major lenders, IndyMac wins with an 18.9% default rate, followed by World Savings (8%), Countrywide (7.7%), Washington Mutual (6.3%), and Wells (3.4.%.) Both Bank of America and Citi had default rates of less than 1% for loans originated in late 2006.

The good news is that defaults turn into foreclosures which then get auctioned off to new buyers who can actually afford the properties. According to the WSJ, bidding wars are emerging at foreclosure auctions as potential homeowners and investors duke it out for properties that are trading at enormous discounts relative to the bubble years. Housing is actually becoming affordable for those willing to jump into the foreclosure fray and the glut of homes on the market is shrinking with some areas running into shortages of moderately priced homes in middle-class neighborhoods. What appears to be happening in some of the hardest-hit areas is a two-tiered pricing system. Most of the sales occurring are foreclosed properties while the non-foreclosed listings sit on the market at higher prices gathering dust. In Sacramento, for example, about two-thirds of all March sales were foreclosures. The supply of foreclosed homes currently listed for sale is about enough to last about a month at the recent sales pace. But the rest of the homes constitute an 8 months supply. Home prices will most likely decline further as sellers of non-foreclosed homes are forced to cut their asking prices to do a deal, but the trend towards affordability is encouraging. A family earning the median pretax income of $52,800 a year needs to spend 25% of that income to buy a median-priced home, down from 44% in mid-2006. For the Los Angeles metro area that ratio has dropped to 45% from 105%and in Phoenix it is down to 19% from 46%, according to John Burns, a real-estate consultant in Irvine.

Wednesday, April 22, 2009

Morgan Stanley Earnings Subpar

Morgan Stanley posted a worse than expected loss of $177 million or 57 cents a share, as a dramatic improvement in the spreads on its own debt impacted its earnings by a negative $1.5 billion. Revenue slumped 62% to $3.04 billion. The company also announced it was slashing its dividend by 81%. It’s about time. Analysts were expecting a loss of 8 cents a share on revenue of $5 billion.

I’m not sure how the recent financial stock cheerleaders are going to paint this into a positive, but I’m sure they’ll find a way. I’d be hard pressed to call this earnings release anything other than horrible and the stock is actually trading lower in pre-market trading. On the other hand, with results like these, spreads on MS debt are likely to widen back out, helping the investment bank post a profit next quarter.

More Thoughts on Commercial Real Estate

The WSJ Property Report provides yet more evidence that the commercial real estate slump is only just beginning. The article highlights four speculative office buildings currently under construction in the Buckhead neighborhood of Atlanta, two of which are financed by Bank of America. Additionally, 35 recent condominium projects will add to a 40 year supply of condos in Atlanta at the current sales pace. Finally, a $600 million outdoor shopping mall under construction has suspended construction to save money. While suspending construction is a fabulously creative way to cut costs on a construction project, it doesn’t leave the developer with much with much of an exit strategy in terms of repaying the construction loan. Half-built construction sites are not very good generators of revenue.

The irrational construction boom is not unique to Atlanta, of course, as the current landscape of most major US cities is littered with shiny new office and condo towers eagerly awaiting occupants. Even without a steep economic downturn, the level of easily financed commercial development over the boom years was insanity. How could a 40-year supply of condos make sense to anyone? Blame has already been heaped upon the foolish lenders and debt-addicted real estate developers that seemed to care little about whether the market could handle such a crushing supply of new properties. It’s been particularly fun on my part to poke fun at all the high-profile real estate developers who have ridden the crazy roller coaster of boom-to-bust twice. If you blew out in late 80’s and you’re blowing out again now, you can’t blame the “unexpected credit crisis.” You’re just a boob who got lucky twice but only possesses the information retention and reasoning ability of a two-year-old.

There is one more group of people left to blame for those in the credit-crisis-finger-pointing business; city planners. After all, city planners are responsible for approving construction projects, rezoning where appropriate and determining the future shape of a city’s skyline. It appears as if the city planning departments in most major cities were in the business of rubber-stamping any project that landed on their desks. Consequently, the shape of nearly every major American city skyline is filled with a bunch of new nearly-empty buildings. With $248 billion in commercial real estate debt coming due this year and another $566 billion in 2010 and 2011 (according to Foresight Analytics LLC,) it’s hard to imagine that this can end in any way other than with lender ordered mass scale liquidations of defaulted properties. This is precisely why the recent worst-is-over bullishness on REITs and bank stocks confounds me. TALF, TARP, PPIP? None of these programs can change the fundamental imbalance between supply and demand.

Tuesday, April 21, 2009

Bank of New York, US Bancorp, State Street Earnings Weak

Bank of New York, US Bancorp and State Street reported disappointing results, adding further pressure to bank stocks in pre-market trading:

Bank of New York’s net income dropped 51% on weak fee income and investment losses as custodial account assets declined. The bank slashed its dividend in order to speed up its ability to pay back the TARP. Revenue decreased 24% to $2.85 billion as assets under management declined 20% to $881 billion due to market declines. The custodian also experienced $12 in net outflows due perhaps to customers who were not happy with the aforementioned market declines. In the slightly alarming department, unrealized investment losses increased to $4.5 billion from $74 million the prior year.
US Bancorp’s net curiously also declined by 51% as credit loss provisions increased sharply to $4.11 billion up 69% from the prior year. Net charge-offs rose to 1.72% of average net loans outstanding, up from .76% a year earlier and 1.42% in the prior quarter. Non-performing assets rose to 1.85% from .53% in the prior year and 1.42% in the prior quarter. US Bancorp also slashed its dividend to pay back the TARP.
State Street first quarter income fell 10% to $476 million on a 22% decline in revenue to $2 billion. Curiously, unrealized mark-to-market losses on State Street’s portfolio actually declined to $5.9 billion from $6.3 billion.

In predictable banking news:

The FT claims that senior FDIC officials are considering a successor to Vikram Pandit if the stress tests determine that the bank needs yet another bailout. Well, at least the folks at the FDIC are ahead of the curve on this one, um, sort of.

In hilarious banking news (i.e. why the rest of the world hates investment bankers):

The former head of the Capital Markets Group at Dresdner is actually suing the bank for 1.5 million euros is severance that he claims he is contractually due. Apparently, he seems to think he has a good case, despite the fact that the group he headed was responsible for 5.7 billion euros in losses in 2008. I’m not sure why anyone who already received a 3 million euro severance after punting so much money would think it was worth risking a public stoning to collect a few more bucks, but maybe he just stopped reading the news after he was canned.

Monday, April 20, 2009

Bank Bailout Tidbits

The FT reports that strong banks will be allowed to repay bail-out funds they received from the US government, but only if such a move passes a test to determine whether it is in the national economic interest, according to a senior administration official. The FT article doesn’t specify if this test is of the new-fangled variety or is part of the on-going stress tests, the results of which will be released in early May. Present Obama’s top economic advisor, Lawrence Summers told Meet the Press that repayments from stronger recipients of TARP funds could help the government provide further resources to the sector. However, the senior official quoted in the FT article said that even banks that had plenty of capital and had demonstrated the ability to raise fresh capital from the market wouldn’t necessarily be allowed to pay back the TARP unless the government judged such an action to be in the context of the wider economic interest. He pointed to three basic tests (yes, more tests.) The government needed to make sure that the system was stable, that it didn’t create incentives for more deleveraging which would deepen the recession, and that the system had enough capital to provide credit to support the recovery.

Meanwhile, buried on page four of the WSJ is an article stating that the administration is considering advancing a plan to convert the government’s existing preferred stock in banks into common equity, as it has already done with Citigroup. Naturally this has significant consequences for holders of common equity in the 19 largest banks that are currently being evaluated. While equity holders can point to the tripling in Citigroup shares as a result of the massive short squeeze, dilution is never a good thing. One has to wonder if the spectacular rally in bank shares can possibly continue in the face of this news.

Amidst all the hemming and hawing over how to further handle the nation’s ailing banks, the WSJ releases a report that shows bank lending has declined by 23% since October. Administration officials claim that lending would’ve declined far further without the TARP, but the data doesn’t help support the argument that the TARP funds were being used to boost lending to consumers. If that were the true intention of the TARP, neither Goldman nor Morgan would have been included in the TARP. After all, neither of the two investment banks lend to consumers. However, without all of the significant measures taken by the government, they probably would no longer be with us, given the fears that had gripped the interbank lending markets after Lehman’s collapse.

What will the stress tests reveal? Will the results really separate the wheat from the chaff, or will we merely discover that all or most of our banks are technically insolvent? So much is riding on the results of the stress tests that I’m feeling, well, very stressed.

Friday, April 17, 2009

Expiration Earnings - GOOG, GE, C

As if it weren’t enough fun trading equity options during a financial crisis so great that the government had to get in the mix, a few companies like to make things interesting by reporting earnings right before expiration Friday.

· GE reported first quarter profit of $2.82 billion, down from $4.35 billion a year ago. Revenue declined 9% to $38.4 billion. Decent results from GE’s industrial operations, with revenues that declined only 1% helped offset problems with GE Capital (profits down 58%), NBC Universal (profits down 45%) and consumer businesses (profits down 75%.) Although the stock is up on earnings that were “better than expected”, the real story will be revealed when the 10-Q is released.
· Citigroup posted earnings instead of losses for the first time in 18 months. The beleaguered bank, the beneficiary of a “way too big to fail” designation by the government, made $1.59 billion in the first quarter. Of course, $2.5 billion of that profit was due to a decline in the value of the bank’s own debt. More juicy details to come about the true state of affairs after the results of the stress tests and its balance sheet are released in May.
· Meanwhile, in Techland, Google reported actual earnings, real earnings, old- school non-accounting shenanigan style earnings of $1.42 billion, an 8.9% increase from the prior year’s quarter. Revenue rose 6.2% year over year to $5.51 billion, but declined sequentially by 3%. The tech giant is obviously not immune to the slowdown in ad spending, but in an economic environment like the one we’re in, these results were quite solid.

Irony of all ironies, both GE and Citi are trading higher in pre-market trading, while Google is trading lower, having given up all its gains from yesterday’s after hours session. But that’s what makes this market so much fun lately, “better than horrible” = “great!” while “solidly profitable” = “yawn.”

Thursday, April 16, 2009

JP Morgan Earnings Vs GGP Bankruptcy

JP Morgan posted that profit it has been promising on the heels of Vikram Pandit’s leaked “we’re actually making a profit” memo in early March. JP reported $2.14 billion in profit, or 40 cents a share, beating analysts consensus of 32 cents a share. The bulk of the profits came from fixed income trading which added $4.9 billion in profits to the investment bank’s total take of $8.3 billion. In the “troubling” department, credit loss provisions nearly doubled to $8.6 billion, rising 18% from the fourth quarter. Credit card default rates surged to 7.72% from 5.56% in the fourth quarter and 4.37% in the prior year’s first quarter, while charge-offs rose to 4.9%. Can JP, in addition to all the banks, continue to out-earn their charge-offs and credit loss provisions with fixed income trading profits? The market seems to think so for the moment, having bid up JP’s shares to nearly double their price a mere month ago. I have my doubts.

Meanwhile, in Retail REIT World, General Growth Properties finally filed for bankruptcy protection. I suppose that debt investors have finally grown weary of not receiving interest payments and pushed the company to file Chapter 11. The company’s stock had been trading around $1, so this has not been too much of a surprise. What may come as a surprise to investors is the actual value of the REIT’s assets, which were listed in the filing at $29.3 billion versus liabilities of $27 billion. Anybody want to buy a mall? I hear they might be selling at a discount.

Wednesday, April 15, 2009

Foreclosure Moratorium Over

In response to government pressure, some large mortgage companies had issued moratoriums on foreclosures while awaiting details of the administration’s housing-rescue plan. As a result of these self-imposed moratoriums, as well as legislation introduced last year in states like California that limited foreclosure activity, foreclosure sales had dropped in the second half of 2008. JP Morgan, Wells Fargo, Fannie Mae and Freddie Mac have all increased foreclosure activity in recent weeks as those moratoriums have expired. According to RealtyTrac, foreclosure-related filings increased by nearly 6% in February, up from a month earlier, and were up almost 30% year-over-year. In California, notices of trustee sales, a prelude to foreclosure, climbed by more than 80% to 33,178 in March from February, according to and the Field Check Group.

JP Morgan Chase has delayed foreclosures on more than $22 billion of Chase-owned mortgages involving 80,000 homeowners. A spokesman says “We had stopped putting additional loans into the foreclosure process so we could be sure that delinquent borrowers would have every opportunity to take advantage of new initiatives that we were putting in place.” Those who are now receiving notices “own vacant properties, have not been in contact with us and/or do not qualify for the modification programs.” Citigroup and Wells Fargo also indicated that they were working on loan mods for those who qualified, but were moving forward with foreclosures on borrowers that did not qualify.

Since this whole mess began, evidence has shown up time and time again that large scale mortgage mods don’t work particularly well. Operation Hope for Homeowners has helped 700 homeowners since its October inception, instead of the advertised 400,000, and the re-default rate on mortgage modifications is pretty discouraging. According to the OCC, for mortgage mods that reduced the borrower’s monthly payments by over 10%, 20% of borrowers were in default again after nine months. If the monthly payment was reduced by less than 10%, the default rate jumped to over 40%. While the evidence points to some relief for those borrowers who received reduced monthly payments, it has not been a resounding success.

I have maintained all along that cleaning up the large inventory of foreclosures and empty houses is the quickest road to recovery. The longer we wait by imposing moratoriums, etc, the more painful the recovery process will be as housing prices decline further due to bloated inventories of empty houses. As it stands, we’ll be having large scale RTC-style auctions of properties at some point as the FDIC seizes more banks and winds up with a large inventory of properties. I’d rather have them in 2009 than 2012.

Tuesday, April 14, 2009

Goldman Posts $1.8 Billion Profit, Announces Equity Issuance

Goldman reported a $1.8 billion profit for the first quarter, handily beating analysts' estimates. If you pay no attention to the $1.3 billion pre-tax loss that Goldman sustained in the month of December, which it conveniently did not have to include in its first quarter results because of the change in its reporting schedule, Goldman's results were positively spectacular. The market certainly liked the report and the stock has sustained most of its recent gains, despite the dilutive $5 billion equity issuance announced in tandem with the earnings report. Desperate to escape the clutches of the government, Goldman plans to use the proceeds from the issuance to pay back the TARP, if allowed once the government-mandated stress tests are complete. As I've noted before, in an economic environment where assets are deteriorating in value on a daily basis, I am far less interested in a financial firm's earnings report than I am in its balance sheet. So somebody wake me up when our banks start releasing their 10-Q's.

Monday, April 13, 2009

Goldman Gets Aggressive

First Goldman announces plans to raise capital to repay the TARP ASAP. No mention, of course, of giving up all the cheap debt it can issue via the FDIC guarantee, but why would it give up such a good thing when it gets to cherry pick from a bevy of government sponsored plans? It is best to just rid itself of that pesky political impediment to lucrative compensation packages.

Meanwhile, on the heels of that bold proclamation, the banking powerhouse announced plans to raise a $5.5 billion fund to buy discounted private equity holdings. While there is certainly no shortage of pension funds, endowments, banks and hedge funds looking to punt their investments in private equity funds at steep discounts, one has to wonder if this is a wise move, given how poorly many deals struck during the private equity boom are faring. Is there any value left in the equity slice of a highly leveraged deal operating in a harsh economic climate? GS is wagering that there is which makes one wonder; is Goldman getting bullish? After all, the bank let Abbey Joseph Cohen out of whatever hole she’s been hiding in lately to proclaim on CNBC this morning that, surprise surprise!, she’s bullish on the S&Ps! Ms. Cohen, best known for her consistent bullishness during the 90’s had to defend herself this morning as CNBC’s Melissa Lee grilled her about her lousy calls in the past couple of years. Ms. Cohen pointed out in her defense that she was not perennially bullish, and that she did tell investors to sell their tech and telecom stocks in March 2000. This is a fair point, but it doesn’t make up for missing out on warning investors about the credit bubble, which has been far more devastating and should’ve been on every strategist’s radar, particularly one who worked at a firm that was actively shorting subprime and making huge margin calls on AIG.

Goldman is set to report earnings tomorrow so investors will get some clarity into how well the investment bank is surviving all of the money the government has thrown at it in the past few months. It’s easy to make money when the yield curve is incredibly steep, you can shovel anything to the Fed and finance it at zero percent, you’re allowed to issue debt with a government guarantee, and you don’t really have to mark to market. Even Bear Stearns was set to report a profit for the first quarter of 2008, except they went bankrupt the day before they were allowed to report their good news.

Thursday, April 9, 2009

Trade Deficit Plunges to 1999 Levels

The US trade deficit unexpectedly narrowed from $36.2 billion in January to $26 billion in February (click on the link for some great charts highlighting this continuing trend.) The narrowing was primarily due to an $8.2 billion decline in imports. Since the price of oil remained stable in the period, the narrowing can not be attributed to oil-related imports. What is essentially happening is that US consumers are no longer on a buying binge. Nations that were running large trade surpluses due to their reliance on exporting goods to the US are no longer running surpluses as demand in the US plummets. Economies that relied on exports to fuel their growth are hosed. Since they aren’t running surpluses they don’t have extra dollars to plough back into US Treasuries. So what I want to know is this; Who, other than the Fed, is going to buy all of the Treasuries we need to issue in the next few years to finance our massive stimulus efforts?

Uptick Rule? Who Cares?

One would assume that after several large banking institutions have gone bust, and many have posted astonishing losses and required enormous cash injections from the government, our regulators would maybe stop blaming the credit crisis on short-sellers. Perhaps after not a single charge has been brought against “rumor mongers” and “abusive short-sales” following on the heels of the plunge in the stocks of Bear, Fannie, Freddie, Lehman, Citi, BofA and AIG, one would come to the conclusion that this whole mess has nothing to do with abuses by short-sellers. Maybe the market is actually efficient, and short-sellers are just more skeptical of rosy projections offered by CEO’s, such as when Bear’s CEO Allan Schwartz appeared on CNBC and proclaimed that his company did not have a liquidity problem the day before his company ran out of cash? Or maybe when Lehman’s Dick Fuld kept insisting that his company was fine, right before the bankruptcy revealed a gaping $150 billion hole in its balance sheet. If a company is actually solvent, senior secured bond investors get more than eight cents on the dollar in a bankruptcy recovery. Really, do I even have to say any more about AIG? The insurance company took extraordinary risks and despite the fact that many Wall Street analysts somehow missed this crucial part of their business, anyone with a basic understanding of derivatives could’ve easily seen that it had too much risk relative to its capital base. Short-sellers weren’t trying to drive the insurer out of business. AIG drove itself out business. Short-sellers just thought the trade was a layup.

The SEC is once again trying to decide what to do to “reign in the shorts,” as if that somehow would’ve kept many of our financial institutions from becoming insolvent. The regulatory agency is holding hearings on bringing back the uptick rule, as well as instituting a circuit breaker that would be triggered when an individual security falls more than 10%. As a former professional options market maker for several years who shorted stocks only when hedging an options trade, I can say with authority that the uptick rule was good for one thing: allowing the New York Stock Exchange specialists to manipulate the price of stocks so they could make a couple extra pennies per trade. It didn’t do anything to stop the plummet in Nasdaq stocks in 2000-2002. We had a tech bubble and tech stocks went to $300, the bubble burst and they went back to $2. The uptick rule, in my opinion serves no purpose, but is completely benign (if you pay no attention to the cost of implementing it.) Who cares? Why is the SEC even wasting time discussing it? The circuit breaker is a dumber idea and would allow market participants the ability to game the system. The more the SEC restricts the ability to trade stocks, the less the participants will want to trade. A lack of liquidity is never good for markets.

Maybe the SEC should spend some time reflecting on why it failed to adequately monitor our investment banks, since it decided to allow them to leverage 50 to 1. Perhaps it can spend some time analyzing why it failed to investigate, oh I don’t know, a $50 billion ponzi scheme, when it was warned about it several times. That’s just a few suggestions to start with. I have many more.

Wednesday, April 8, 2009

TALF a Bust

The TALF is a complete bust so far. The first round in March had $4.7 billion in requested loans. The second round had only $1.7 billion. So much for the $1 trillion boost the TALF is supposed to provide to the moribund securitization market. For those not up to date on their Fed acronyms the TALF (Term Auction Lending Facility) was supposed to provide short terms loans versus highly rated securities to induce investors to purchase credit card and auto loan ABS, and eventually CMBS. Why has the TALF, announced with much fanfare by the Treasury, drawn yawns at best? I can only hazard a few guesses. According to an article in yesterday’s Wall Street Journal, the paperwork is a pain. So, you know, everybody hates paperwork, except for the government, of course.

According to the Wall Street Journal, the real-estate industry doesn’t believe that the short-term nature (three years max) of the loans being offered by the Fed through the TALF adequately fits real-estate investors’ need for longer term borrowing, as most commercial real estate loans have maturities of over five years. The real estate industry is lobbying the Fed for changes to the TALF to avert a wave of commercial real estate defaults on the record amounts of debt coming due in the next three years. The Fed, on the other hand, wants to maintain flexibility in its lending so that it can rapidly reverse its monetary policy in the event that inflation becomes a problem down the road. Hopes for the TALF had led to a rally in CMBS. But with the anemic interest in the TALF so far, and the deteriorating fundamentals in the underlying market (please see earlier post on commercial property vacancy rates), it seems unlikely that the commercial real estate market’s worst days are behind it.

Commercial Real Estate Fundamentals Deteriorate Rapidly

The apartment vacancy rate for the top 79 US markets jumped to an average 7.2%, a full percentage point increase over the past two quarters and the highest level since the first quarter of 2004, according to Reis Inc, a New York real estate research firm. Asking rents, which exclude concessions fell 0.6%, while effective rents declined 1.1% in the first quarter. Among CMBS, the multifamily sector posted the highest delinquency rate in February, reaching 3.3%, from 3% in January, according to S&P. Some $3.2 billion in multifamily debt was delinquent in February, up from $1.5 billion in the third quarter of 2008. Yikes.

Meanwhile, over in the retail sector, conditions aren’t much better. The amount of occupied space in US shopping centers and malls declined a net 8.7 million square feet in the first quarter of 2009. The amount of occupied space lost in that one quarter was more than the total amount of space retailers gave back to landlords in all of 2008 and any other year in recent history. The decline in occupied space pushed the vacancy rate for malls and shopping centers to 9.1% in the first quarter from 8.3% in the previous quarter. It is now the highest rate since the 1990s. Mall lease rates slid 1.2% and those at shopping centers (think strip malls) fell 1.8%.

It’s no wonder that the REITs were pummeled in yesterday’s trading session. Not only are things bad for the nation’s landlords, but they’re getting worse at a faster rate. Optimistic REIT investors have piled into the stocks in recent weeks, eager to snap up shares in secondary offerings despite the fact that most REITs carry significant debt loads and are opting to pay dividends in stock rather than cash. Personally, I like my dividends paid in cold hard cash, and prefer that any stock I purchase in the middle of the worst credit crisis since the Great Depression to have a debt to equity ratio below 0.5, instead of, say, 6.9 (i.e. SPG.)

Tuesday, April 7, 2009

Ezra Merkin: Criminal or Just Really Lazy?

New York attorney-general Andrew Cuomo filed civil fraud charges against Ezra Merkin for allegedly secretly channelling more than $2.4 billion of his client's assets to the Madoff ponzi machine. Curiously, no criminal charges have been filed and Mr. Cuomo isn't attempting to prove that Mr. Merkin knew about the Madoff fraud. Instead, Mr. Merkin stands accused of misleading investors by failing to inform them that he was merely funneling their money into one investment strategy; that of a fraudulent ponzi scheme. According to Mr. Cuomo's complaint, about 85% of investors in the the Ascot fund believed their assets were diversified and didn't know that most of their money was flowing directly to Mr. Madoff. Furthermore, Mr. Merkin informed investors in his two other funds, Gabriel and Ariel, that he was investing in distressed assets and bankruptcies, when he was investing it in a stock and option fund that was actually a ponzi scheme. It's one thing to declare that you are a feeder fund for another, and quite another to claim that you are actively investing when you are just in the business of wiring money. As in the case with Fairfield Greenwich and the other feeder funds, investors are angry that all of the advertised extensive due diligence didn't uncover the Madoff fraud. Mr. Merkin's victims, including an angry Mort Zuckerman who is filing a separate suit, are particularly irked that they were sold one investment strategy and received quite another in return. Mr. Merkin's fees were outrageous for the service he actually provided; that of a high-priced Western Union franchise with Mr. Madoff as the ultimate beneficiary.

The Wall Street Journal provides a great excerpt from the New York state attorney general's deposition of Mr. Merkin. In response to a question from the attorney general asking if Mr. Merkin took steps to conceal his relationship with Mr. Madoff, Mr. Merkin responds with the following classic quote: "I did not have a policy of not disclosing a relationship with Mr. Madoff or not." With eloquence like that and the work ethic of a three-toed sloth, it's a wonder that Mr. Merkin was ever able to amass billions of dollars to manage. Then again, bull markets are not particularly discriminating.

Monday, April 6, 2009

Admistration Talks Tough on Banks, Sort of, Maybe

The Financial Times headline reads "US Prepared to Oust Bank Chiefs." Tim Geithner warned on Sunday that the US government would consider ousting board members at banks as a condition for giving the institutions "exceptional" assistance in the future. He neglected to define "exceptional," but given the size of the bailouts we've seen so far with nary a banking executive ousting, I'm going to assume it as greater than $150 billion.

Meanwhile, the administration's PPIP (aka "Pay a Premium for Investment Pukeage," I'll be accepting suggestions for better definitons that fit the acronym) gave a much needed boost to the equity markets in the past few weeks, as many theorized that this would dramatically alleviate the toxic asset problem that our banks face. In contrast to the tough talk that the Financial Times highlighted in its article, the PPIP is a huge gift to the banks and private investors. Sort of. The government will subsidize higher bids for toxic assets because it is assuming all the risk, while private investors participate principally on the upside as they are required to put up very little capital. The PPIP is similar to the zero down payment, no-doc mortgage loan with a teaser rate. Why would a home owner not overpay for a house if the bank takes all the downside when housing prices decline? The government is attempting to solve one problem by making exactly the same mistake. Again. Except this time with taxpayer funds.

On the other hand, FASB relaxed mark to market rules for banks allowing them significant discretion in valuing their portfolios. As many an astute commentator has pointed out already, allowing banks to make up their own valuations for assets "solves" alot of their problems. For one thing, earnings miraculously improve. For another, banks don't have to sell any assets at the market price if they can just mark them at higher prices and "improve" capital positions that way. The FASB accounting change actually discourages banks from participating in PPIP. Maybe FASB and the Treasury should've gotten together and coordinated on this issue? Mr. Geither has continued to dodge the crucial questions as to whether banks will be forced to participate in the PPIP, or even be required to use the market prices that the PPIP produces.

The $1 (or $3?) trillion question, despite the administrations efforts to goose lending , remains the same; will default rates rise to equal the catastrophic levels currently reflected in the market prices of toxic assets? Mike Mayo, a noted analyst, released a report this morning claiming that default rates will exceed depression era levels. If he is right, no amount of government guarantees or accounting chicanery can help the banking sector.

Wednesday, April 1, 2009

Fairfield Greenwich Charged With Fraud

Massachussets regulators charged Fairfield Greenwich Group, a Madoff feeder fund, with fraud. Regulators claim that the company breached its fiduciary duty to clients by failing to perform adequate due diligence. Meanwhile, a Connecticut judge on Monday froze the assets of the Madoff family members, as well as the feeder funds Tremont, Fairfield Greenwich, and Maxam Capital and their current and former top executives. The noose appears to be tightening around the neck of those that profited handsomely from the $50 ($65?, who really knows) billion Bernie Madoff ponzi economy. Investors who have been devastated by the Madoff ponzi scheme are sure to take some comfort from these measures, particularly those who read yesterday's Wall Street Journal article highlighting the fabulous life of Andres Piedrahita, Walter Noel's, Fairfield Greenwich's founder, son-in-law.

Mr. Piedrahita, by all accounts, particularly his own, had the lifestyle of the many rich people that were beeing fleeced by the Madoff ponzi scheme. Although Mr. Peidrahita was tasked with soliciting investment funds for Fairfield from the very wealthy Latin Americans and Europeans that he wooed with his impressive party skills, he once told a friend that his real job was "to live better than his clients." The article is filled with many juicy details of Mr. Peidrahita's lavish lifestyle. With homes in Manhattan, London, Madrid, a butler, a private jet, a yacht anchored off of Mallorca with accompanying hacienda, and an impressive art collection, Mr. Piedrahita, according to a friend, lived better than many billionaires. "I've never seen anybody live like him and spend like him and I know billionaires that are 10 times wealthier than him" said the friend. Needless to say, any Fairfield Greenwich investor's ire would be rising to dangerous levels by the third paragraph of the WSJ article.

The fabulous life of Walter Noel and his extended family had been closely chronicled by Vanity Fair and the society pages. It was all grand and enviable before the truth was revealed; they were merely parasites feeding off of one of the largest investment scams in history. If it's indeed the case that the Noels considered it their job "to live better than their clients" then they certainly suceeded, although they probably should've disclosed their primary objective to their clients. Just think of all the money Fairfield Greenwich wasted on marketing documents that detailed the extensive due diligence that the fund of fund was performing on behalf of its clients.

The article ends with a curious quote from Mr. Piedrahita, who doesn't appear to have gotten the message that the party is over: "I look at myself in the morning and I am very proud of what I've done, and so are my partners." In reference to the Madoff scandal he says "Nobody knew anything about anything." The problem for Mr. Piedrahita, and the other bozos at Fairfield, is that they were paid alot to know alot. That excuse is not going to fly with regulators.