Revised GDP Down 5.7%

First quarter GDP was revised to minus 5.7%, which is less of a contraction than originally estimated, but slightly higher than the minus 5.5% anticipated by economists. The market is interpreting this bit of data as positive, as we've already moved on to anticipating a massive V-shaped recovery beginning in the third quarter of this year. This bit of optimism is based on what exactly? A near certainty of 10% unemployment by the end of the year? The continuing parade of cheery news including record low new home sales and the record number of homes facing foreclosure? An auto industry facing massive downsizing and restructuring? The pending implosion of the commercial real estate market? No. One month's worth of "surging" consumer confidence, and all of those other nebulous "green shoots" sprouting up everywhere. We're in a market where bad news is ignored and slightly less bad news is bandied about as a sign that we're going to return to growth in the third quarter. You've got to try harder than that to convince a curmudgeon like K10.

PPIP and the Ever-Steepening Yield Curve

Not two months after it was announced with much fanfare, the “Legacy Loan” portion of the PPIP looks DOA, due to lack of interest. The funny thing is that yesterday, an article appeared in the WSJ claiming that banks were jockeying to buy their own toxic assets to move them into off-balance sheet partnerships, complete with government supplied leverage. Sheila Bair wisely put the kibosh on that idea. For one thing, mysterious off-balance sheet partnerships were a big part of the problem (SIV’s anyone?) For another, merely shuffling assets around from one subsidiary to another was never the intention of the PPIP. The PPIP was supposed to provide transparency in pricing. It was supposed to tell us what all of this crap was really worth. How’s that going to happen if banks are buying the assets from themselves with the government just providing leverage to banks that have already received capital injections? In any event, after much furor in the blogosphere, Ms. Bair put her foot down with a resounding “That’s not gonna happen! Now if you’ll excuse me, I have some more loss-guarantees I must work out with some private equity funds.” Ms. Bair hinted that not enough interest, other than that from banks wanting to buy their own assets at inflated prices, was evident to go ahead with the legacy loan plan, which makes me fairly happy because I hated the idea to begin with.

Speaking of government plans gone awry, anyone notice the complete and utter bludgeoning of mortgages and treasuries yesterday? Poor Bernanke, this quantitative easing business is not quite as easy as he thought it would be. The problem with the idea of the Fed buying treasuries to drive down mortgage rates is one simply of supply versus demand. While it may seem like the Fed is buying a lot of treasuries, it is nothing compared to amount of treasuries that the Treasury has to issue to finance our ballooning deficits. So rates go higher. I mentioned earlier in the year that one of the big issues tugging at the market would be the question of deflation vs inflation. Is all of the fiscal and monetary stimulus being heaved at the economy going to cause run away inflation, or is the continuing deleveraging of the financial sector going to cause a deflationary spiral? My answer is that we get deflation first, and then inflation later, which is perhaps what bond investors are betting on right now, as the yield curve is very steep. Declining home prices, fabulous sales on consumer goods, and auctions of downsizer’s valuables are clear signs of deflation. But once the economy turns, which admittedly might not be for awhile, who knows if the Fed will be able to pull back the spigot fast enough to avoid an inflationary spiral?

S&P Awakes From Slumber, Downgrades CMBS

When the Fed decided to open up the Term Auction Lending Facility to newly issued AAA-rated CMBS in March, CMBS investors cheered. The CMBS market has been dead for nearly two years, with zero issuance so far this year and only $10 billion in all of 2008. How’s anyone supposed to make any money if nobody is doing deals? After their success with opening up the TALF to new issuance, commercial real estate investors lobbied the Fed, begged and pleaded to seek inclusion of legacy CMBS, particularly those issued during the highly toxic 2005-2007 era, into the TALF. It seems the market has been “distorted” by the fact that everybody on the planet knows that most of those deals were structured using too little equity and anticipating overly optimistic increases in rent and valuation. Nobody wants to buy these deals anymore, at least not at the prices where current investors are wearing them. So if the Fed could just do everybody a big favor and grease the wheels a little bit, then we could all just get back to the business of doing really moronic commercial real estate deals that make zero financial sense with everyone collecting their fees along the way, leaving the US taxpayer holding the bag. The Fed, of course, complied by allowing legacy CMBS into TALF, much to the chagrin of many a taxpayer that actually understands how disgusting it is that the Fed, who is supposed to be the steward of monetary policy in this country, has somehow morphed into a big supporter of commercial real estate dealmakers that made their own bed, in this case even without the help of unsophisticated subprime lenders. But then something remarkable happened. One of the rating agencies actually woke up from its slumber and decided it must put an end to the madness. Yesterday, S&P warned that it would downgrade billions of dollars of AAA rated CMBS, specifically those issued between 2005-2007, thus making them ineligible for TALF. Now a cynic might claims that perhaps S&P should’ve never rated these deals AAA to begin with, because frankly, they were stupid. But at least they’re doing something now. I would like to offer my gratitude to S&P for finally doing its job, that of protecting investors, which in this case could’ve included all US taxpayers.

Other interesting tidbits in the WSJ Property Report are follow ups to recent posts. First is a quick story about Arcandor’s potential impending insolvency. Arcandor, the German department-store operator is 51% owned by Whitehall Funds, which is run by Goldman Sachs, faces a June 12th deadline to gain an extension on its debt. It is hitting up the German state-owned development bank for a loan, because government funds are the best bet in getting an investor to throw good money after bad these days. In any event, this would be yet another pie in the face of Whitehall Fund investors, not to mention Goldman Sachs.

A follow up to another recent post is an snippet on real estate developer Kent Swig. Last we checked in with Mr. Swig, he was tied up in legal proceedings with the Lehman bankruptcy estate over 25 Broad, a 346-unit luxury condo development that has since soured. Lehman filed to foreclose in January, and last week a New York state court granted a request to appoint a receiver for 25 Broad. No doubt this story will only get more interesting. I'll keep you posted.

Bling Bling and Luxury Homes

You know the recession is for realzz when rappers have been forced to cut back on their purchases of bling (or “bling bling” if you prefer.) According to the WSJ, a brutal combination of a deepening recession coupled with plummeting music sales have forced aspiring hip-hop moguls to downsize from diamond encrusted baubles to faux-ice. Celebrity jewelers say that rappers are asking them to make medallions with less precious stones and metals and even requesting cubic-zirconia, the diamond substitute. This has given rap luminaries, such as 50 Cent, more ammunition to call out his musical adversaries for not wearing the real deal. This is a great way to get the old hip-hop rivalry going again as rappers seemed to have run out of good things to fight about. If anything is going to stop the downward spiral in music sales, it’s a good feud. And verbal sparring over the authenticity of their bling seems like a much safer way to establish street cred than say bustin a cap in another rapper’s ass (okay, I admit, I’m an old school rap fan and am about 20 years out of date with the lingo.)

While flashy customized pieces of jewelry may seem like a safe investment for a rapper, when times are no longer flush, the secondary market is apparently not particularly liquid. The WSJ article references the cancelation of a planned charity auction where rappers were set to auction off pieces of bling that they no longer needed. The auction was eventually canceled due to lack of interest. While these rappers were selling jewelry for charity, the cancelled event spells doom for any rapper actually hoping to generate cash to pay bills by selling the family jewels.

Speaking of illiquid assets like customized rapper-flavored bling, Barron’s had a front page story on the luxury second-home market. Barron’s assertion was that the secondary luxury home market was off around 30%, and while it may fall another 5% or so “professionals” claimed that the bottom was near and that if you were in the market, you should pounce now or risk missing out when the market “snaps back.” Among the “professionals” that Barron’s quoted in the article were no less than two real estate brokers, both of whom were looking to sell secondary homes due presumably to some belt-tightening. What amused me about the article was how it continued to reference 2007 as the year from which to judge how much the market had changed, as if 2007 was some sort of real barometer and not a complete aberration. While a 30% discount to 2007 peak prices might sound cheap to some, it still seems ridiculous to use 2007, which was the peak in an overblown housing bubble. You know what? Cisco is still 65% off of its 2000 peak price. Does that make it a cheap stock, or a stock that was just overvalued in 2000? Furthermore, the stock market is down 40% from its 2007 peak and it is liquid. Anything illiquid, such as art, luxury homes, rapper’s bling is down considerably more. Why? Because the liquidity premium has grown wider as financing for many assets has dried up. My guess is that the secondary luxury home market is down significantly more than 30% and that the only houses that are off 30% are the ones that are actually changing hands. The article mentions that inventories have grown substantially and very little is actually trading. How much is your high-end luxury house really worth if you can’t get a single bid? Luxury homes are nowhere near a bottom. It is the foreclosed homes that are changing hands briskly in places like Southern California that are near a bottom. If you’re shopping for a second home, keep your powder dry and wait for the real discounts. Trust me, they're on the way.

BankUnited Seized By FDIC, Private Equity Consortium Gets Sweet Deal

BankUnited, the largest independent bank in Florida that specialized in that low-risk business of lending money to foreigners so they could buy properties in Florida during the housing bubble, was finally laid to rest by the FDIC. The FDIC has been looking for a buyer for the beleaguered bank for months, and conducted its auction yesterday. Although the FDIC was hoping to find a legitimate buyer, no bidders emerged that were willing to acquire the failing financial institution without massive loss guarantees. The winning bidder of the carcass of BankUnited was a consortium of private equity investors including Blackstone, Carlyle, Centerbridge and WLRoss yesterday. With assets of nearly $13 billion, BankUnited is the 34th and largest bank failure of the year, and is second only in size to IndyMac’s colossal failure last year.

On the surface, it should seem like a huge relief that the FDIC found a buyer for this large banking dud. That would certainly seem to be the case if the private equity buyers weren’t getting a ridiculously sweet loss guarantee from the US government. The government will take 80% of the first $4 billion in losses and 95% of any remaining losses. The next time I make any investment decision I’m calling the FDIC to see if I can arrange some sort of guarantee where the federal government eats around 90% of my losses, leaving my only risk to be that I break-even instead of make a mint. Oh sure, the FDIC will receive warrants giving it a share of any future upside, but the details on how much it will receive are scant, and it can’t possibly make up for the fact that the government is taking nearly ALL of the downside. Yes, the private equity firms are putting $900 million of equity into the bank and relieving the FDIC from the burden of having to wind down another large bank, but really, is all of that worth $10.7 billion in potential losses?? Seriously, why is the FDIC giving massive loss guarantees to private equity firms? Somehow this arrangement is still billed as a private sector deal with the FDIC claiming that the deal “is projected to maximize returns on covered assets by keeping them in the private sector.” But the truth is that, once again, only the profits go to the private sector, our rapidly dwindling deposit insurance fund gets to eat the losses. It’s “heads I win, tails you lose” all over again. Sadly, this is what our private sector is evolving into, only if you are a well-funded, politically connected finance firm, of course. The FDIC never called me to ask if I wanted to bid and I definitely would’ve tossed my hat into the ring with terms like these. At least the FDIC was approved on Wednesday to borrow $100 billion from the Treasury if it has a shortfall in its insurance fund. That piece of legislation couldn’t have been signed into law soon enough.

Continuing Claims Continue Rising and Other News

While new jobless claims fell to 631,000, continuing claims rose yet again to 6.7 million, another record. More grim employment data.

In government bailout news, GMAC will receive a cash infusion of $7 billion, part of a package that could reach $14 billion. If you’re in the car business, which the government finds itself knee-deep in, you have to have a way to provide financing to your remaining dealers, as well as to the consumers who are supposed to buy your cars. The government needs some version of GMAC, and GMAC won’t make it without more financial help. So, now we own GMAC too. Sigh.

In depressing global economic headlines, the WSJ has a very nice chart displaying how poorly the US’s main trading partners around the world are faring. Mexico’s GDP contracted by 21.5% on an annualized basis, while Japan’s fell 15.2%, and Germany’s declined an abysmal 14.4%. These steep declines are mostly our fault, as US consumers have scaled back purchases of foreign goods due to our own economic contraction. The US’s milder yet not-insignificant 6.3% contraction shows that maybe it’s not the worst thing in the world being a net-importer of goods. We can just stop buying foreign stuff, but our trade partners who depend on us buying their stuff are suffering far worse economic fates.

Finally, in more “at least we’re not doing as poorly as they are” news, S&P lowered its outlook on the UK’s debt. The rating agency warned that the country must get its finances in order or risk losing its triple-A rating on its debt. Predictably, the FTSE and pound took a tumble. With the way the US spending coupled with the sharp decline in tax receipts, it’s hard to imagine we’re too far behind.

Regulation and More Regulation

Congress passed new restrictions on credit card companies that would ban extra fees and fluctuating rates and order credit card companies to provide more information on consumer’s debts. The Senate bill would ban practices such as charging consumers to pay by phone and sudden surges in interest rates. Payment above the minimum due would be applied to balances with the highest interest rates. The legislation bans the practice where a late-paying consumer is assessed interest on a prior month’s balance that had been paid in full in addition to the late balance. Issuers also will have to send bills 21 days before the due date and provide at least 45 days notice before changing any significant terms on a card. Opponents of the bill argue that this will raise fees across the board even for good credits, to compensate for the rising cost of not being able to completely rip off less desirable credits. I’m not so sure I agree. First of all, many of these tactics are incredibly scummy and predatory in nature and are the result of credit card companies not doing a good job of verifying credit of the consumers they choose to lend to. To make up for the fact that delinquencies are surging in the downturn, which somehow they hadn’t factored into their models, even though they routinely granted credit card lines of $50,000 to consumers who had income of around $30,000 a year, they unduly punish everyone across the board anyhow. Squashing some of the most egregious practices is a good thing. Making credit card companies inform consumers of how long it will take them to pay off their balances while only paying the minimum might wake a few people up and teach them some valuable lessons about compound interest and maybe not needing that new flat screen TV if your old TV still works and you can’t afford it. Furthermore, for those consumers in good financial shape who feel slighted because their credit card company raises their fees for no discernible reason, there is a simple solution; cancel the card.

Meanwhile, the administration is discussing giving a federal agency authority to police mortgages and other consumer oriented financial products. Sadly, we’re about five years late on this one, but maybe by the time the next housing bubble rolls around, we’ll have all the regulators we need in place. The agency may also have authority over mutual funds and insurance. So, um yeah, that’s a lot of sort of unrelated things. But maybe if they find a four-headed mortgage/credit card/insurance/mutual fund expert to run the agency it may be more effective than the 15 agencies or so that were in charge of regulating Wall Street and the banking sector that sort of missed the whole credit crisis and allowed our entire economy become a ponzi scheme.

Finally, in a drastic regulatory overhaul, the administration is weighing stripping the SEC of much of its power. As an avid SEC-hater and wonderer of what it is exactly that those clowns do all day because they certainly aren’t rooting out financial fraud and regulating Wall Street, I cheer this move. Of course, the administration aims to give some of the power to the Fed. So a bunch of lawyers can’t get the job done, but a bunch of economists somehow are going to do a better job. In any event, regulatory change is afoot, moving us into a much heavier regulated environment that will probably overshoot in its restrictiveness. But one can only hope that if the new regulators manage to unearth the next Madoff ponzi scheme while in its infancy, before it morphs into a $65 billion debacle, then we’re better off.

Small Banks Vs. Big Banks

The Wall Street Journal did a study of 940 smaller banks and concluded that commercial real estate loans could generate losses of $100 billion by the end of next year. The WSJ’s analysis used the loan-loss criteria that the Fed used in its stress tests of the largest banks. The Financial Times did a similar analysis recently. There is nothing new or shocking about this analysis. The high likelihood of many small bank failures due to commercial real estate exposure has been floating around in the news for some time.

The FDIC, the government entity charged with seizing failed banking institutions is at least attempting to be proactive. It is weighing levying a one-time fee to replenish the agency’s deposit insurance fund that would hit big banks harder than small banks. The deposit insurance fund has been whittled down to $19 billion at the end of 2008, but there have been around 25 bank failures already this year, so clearly, the agency will run out of moola if it doesn’t do something soon. The new proposed fee is to be $.05 for every $100 of assets after deducting certain capital holdings. In February the FDIC had proposed a $.20 fee for every $100 of deposits, but smaller banks didn’t like this proposal because they felt they were being unduly punished for the financial crisis, which they contend was primarily caused by the big banks. Executives at the big banks counter that almost all of the banks that have failed in the past 18 months have been small institutions. I’m curious which large bank executive the WSJ interviewed to get that quote and could he have possibly said it with a straight face? Was it Vikram Pandit? Ken Lewis? Can you possibly make such a ridiculous assertion after your institution has received multiple billions in direct capital infusions, the ability to issue government guaranteed debt, and the ability to finance ANY collateral including equities via the Fed? Sure most of the banks that have failed have been small, but that’s only because the government has absolutely no mechanism for seizing large banks and chose to prop them up indefinitely instead.

Meanwhile, the folks at Goldman Sachs, JPMorgan Chase, American Express and Morgan Stanley are itching to repay the TARP. The authorities have decided to allow a group of banks to return the funds rather than approving individual applications to avoid a “rush to the exits,” whatever that means. I’m all for banks repaying the TARP. I never wanted government money involved in our banking system to begin with. Here’s the deal, though, they shouldn’t ever get the money back for any reason. Ever. The government should make it clear. Next time you are on the brink, we’re going to allow you to fail. Period. And if the government doesn’t have a mechanism in place to deal with a large institution’s failure, then it’s too soon to allow them to pay the money back.

Madoff Victims Complicit in Fraud?

What's better than a ponzi scheme? How about an interactive ponzi scheme? According to the Wall Street Journal, some of Madoff's investors are under investigation for being complicit in the monumental fraud. Jeffrey Picower, Stanley Chais, and Carl Shapiro are three of the eight investors that are being accused, among other things, of instructing Mr. Madoff of the returns they wished to achieve for their investments. If only you could've called your broker last year and told him that you wanted a positive 14% return instead of the 40% loss, your financial situation would be so much better right now. Curiously, the accused Madoff investors weren't even happy with the boring low double digit returns that Mr. Madoff was fabricating for his other investors. No, they had far more ambitious financial goals, with some asking and receiving returns of 300% to 950% in a single year. Particularly vexing for Mr. Madoff's other victims may be the fact that Mr. Picower and Mr. Chais, who claim to be among Mr. Madoff's hardest hit investors, withdrew "profits" of $6 billion above and beyond the principal they deposited for themselves, their families and their foundations.



Naturally, the accused are denying the allegations, through their various legal representatives. But one has to wonder why Mr. Chais's accounts had average annual returns of 40% when Mr. Madoff's other investors were receiving more boring returns of 12% or so per annum. Furthermore, Mr. Chais allegedly requested fictitious losses to offset the fictitous gains for tax purposes. If you're going to participate in a ponzi scheme, at least have the decency to pay your damn taxes. Mr. Picower had several accounts with returns of 100% in 14 instances and some that reached 950%. Nothing fishy here.



At least Mr. Madoff was a meticulous crook, having kept records of much of his correspondence with his loyal ponzi investors. Evidence exists that these clients were requesting specific returns that Mr. Madoff was granting. The ponzi plot thickens.

Investor's in Money-Losing Goldman Fund Hit With Capital Calls

Even Goldman, widely regarded as one of the savviest traders on Wall Street, couldn’t avoid buying the top in the commercial real estate market. According to the Wall Street Journal, Goldman’s Whitehall, a real estate opportunity fund is faced with irate investors. What, pray tell can these investors possibly be irate about? After all, weren’t they all clamoring two years ago to get into a fund run by Goldman with a hoity toity name like Whitehall? First and foremost, the fund spent $3.7 billion on a wide range of real estate investments in 2007 that it has since marked down by $2.1 billion. Then, Whitehall bought out Goldman employees’ stakes in the fund late last year, albeit at hefty discounts, without granting other investors the similar courtesy. As if all this weren’t enough, Goldman is now asking remaining investors in the Whitehall Funds to pony up another $1 billion to meet capital calls. Sure, the capital calls are well within Goldman’s rights, and the investors are contractually obligated to cough up the dough, but still. It takes a lot of nerve to lose roughly 60% of investors’ money in a year and then ask them for more money. But if you’re Goldman, I guess you can always pull out that whole “We’re the best traders and investors on the street, so you’re better off giving us your money instead of those boobs at Lehman, or Bear, um, I mean Merrill, no wait, Morgan Stanley!” The thing is, according to the newly revised Whitehall business plan, the money from the capital calls will be used to pay back a $677 million credit line, and to recover 71% of investors’ total equity over the funds holding period. How Whitehall plans to pull off that feat in this depressed commercial real estate market where its assets are deteriorating by the minute remains a mystery. In particular, because Whitehall’s debt is guaranteed by Whitehall, the fund’s lenders can go after other assets within the fund besides individual properties. Sounds like one real estate "opportunity" I’d be glad to miss.

Lehman Still Trying to Spin Off Assets

The now-bankrupt investment bank originally pitched the idea of splitting off its real estate assets into a separate company to “extract value” a couple of days before it spiraled out of business. It didn’t go over very well then, maybe it’ll work better this time around. The idea involves spinning off a hodge podge of Miami condos, New York apartment complexes, private equity investments and risky mortgages that internal Lehman calculations have pegged the value at around $45 billion, down about half from its value in September. At non-distressed prices, the assets are valued at around $400 billion, including $300 billion in servicing of assets. The best part is that people inside Lehman have been referring to the unit as Lamco, short for Legacy Asset Management Company. Perhaps they have yet to figure out that the name is only one letter short of the moniker LAMEco?

Apparently executives now running Lamco don’t want to miss out on the big rebound in asset values that is sure to be right around the corner. They wish to legally separate the company from the bankruptcy estate by the beginning of 2010 and then sell shares to the public. After that, they plan to make it all back. Good luck to them. With the way the market has rallied in the past couple of months, I’m sure they’ll find lots of folks who are dying to buy into an IPO of a bunch of highly illiquid assets with questionable ability to generate cash flows.

Administrative Note

I'm traveling this morning, so no blogging today.  It is a shame because there are some fairly juicy bits of news to discuss such as:

• Obama administration's efforts to curb executive comp across the entire financial services industry, even those that don't have government funds.  Goldman can go ahead and pay pack that TARP money, says Mr. Geithner, you still won't get big bonuses.  Nice to know that the guy who "forgot" to pay his taxes is deciding on executive comp.
• Retail sales shrunk .4%, worse than expected.  Why  economists were expecting consumers to rush out and buy stuff in this economy is a bit of a mystery.
• A Bloomberg confidence study shows that investors are confident about stocks for the first time since 2007.  And 2007 was a really great time to be bullish on stocks!

Advanta Shuts Down Credit Card Lending

On June 10th, credit card issuer Advanta will cease lending to its 1 million customers amid surging charge-offs.  The credit card company said that charge-offs hit an astonishing 20% on some cards as of March 31st.  Advanta is the 11th largest credit card issuer in the US, with $5 billion in outstanding balances, and the only major lender focused on small businesses.  Maybe $5 billion doesn't seem like much in context of the $45 billion the government has thrown at Citigroup or Bank of America.  But what it represents is more credit contraction in an economy that is struggling for a foothold.  Small business borrowers have fewer and fewer places to turn to finance their operations.  Since smaller lenders like Advanta fail to qualify for too-big-to-fail status, the competition for the big credit card issuers slowly evaporates, allowing the larger banks to do things such as raise fees for no good reason, even though their cost of funding is zero, and even though the government is supporting them so that they lend money.  Nice how the government's plan is working, isn't it?  

Stress Tests Weren't Tests At All

Remember back in high school when you failed that test?  Then you went to your teacher and tried to explain to him why it would be really bad for your social life if you went home with an F and how you sort of wanted to go to the prom?  Then your teacher just changed the grade to a B+ and sent you on your way?  Wait a minute.  That never happened to you?  You mean you never got to renegotiate the results of any test you ever failed in high school?  That's too bad because your teacher missed out on a great opportunity to teach you a very important real life lesson.  Because in the real world, if you're a bank that lost multiple billions on lousy bets on the market, and you did it in such a large way as to pose a systemic risk to the global economy and to require a government infusion of taxpayer dollars, and your regulator tells you that you need to raise X amount of capital, you can argue until you get a better deal.

If you thought the stress tests were rigorous and would reveal the true financial situation of the nation's largest banks, think again.  According to the WSJ, when banks were presented with the initial results of the stress tests, they fought back and the government conceded and adjusted the amount of capital downward, in some cases by a significant amount (see Bank of America that was originally ordered to raise over $50 billion.)  Furthermore, according to the FT, instead of needing to raise the full revised-down $75 billion, banks will now be able to meet their capital raise through "earnings" over the course of the next six months.  With the relaxation in mark to market rules, a zero overnight lending rate (the benefit of which banks don't need to pass on to consumers), and the government's generous support of the credit markets through its variety of programs, drumming up some earnings should be a snap.  Problem solved.  Banking system saved.

The problem now is dealing with the economy.  Friday's unemployment report was grim.  Sure, it was "better than expected" but once revisions were added and the temporary census workers subtracted, the economy lost around another 700,000 jobs.  Even if you ignore the revisions and the census workers, since when has losing 539,000 jobs in a month been considered incredibly bullish?  If this is a green shoot, then, well, shoot me.  Because we still have the fallout from the auto industry, the retail industry, and the commercial real estate market to deal with.  When we've figured out what industry exactly is going to pick up the slack for those we've lost, I might consider being an optimist again.  

   

Stress Test Results Revealed, Finally

The stress test results are finally official. No more beating around the bush. No more mysterious leaks to the press. The Fed is requiring 10 out of 19 banks to raise a total of $75 billion to cover capital shortfalls in the event that the “worst case scenario” for the economy becomes a reality. Whether the Fed’s interpretation of the worst case scenario for the economy turns out to be as bad as the actual economic performance of the economy is an entirely different question. Given that the Fed never thought there was a housing bubble, thought the subprime crisis was contained and sort of missed the whole credit crisis until banks were coming apart at the seams questions its ability to forecast a worst case that’s even in the ballpark. Nevertheless, just keep buying bank stocks. Everybody’s doing it.

The Fed is forecasting losses of up to $600 billion for banks through the end of the year. $600 billion sounds fairly ominous and worst-case-ish, but there are estimates in the trillions floating around, so only time will tell what the final tally will be. Bank stocks have rallied so powerfully since the March 6 low that raising capital right now doesn’t appear nearly as daunting. Already, Wells Fargo and Morgan Stanley have announced common equity offerings. It’s best not to dilly dally as there’s no telling if and when sentiment turns again and bank stocks take another drubbing. What to do if you’re GMAC and you’re privately owned by GM (on government-funded life support) and Cerberus (worst private equity investor of all time) and the government just told you to raise $11.5 billion? Maybe GMAC will give its bankers a call. I hear they just raised a slug of new capital they need to put to work.

Condo Construction Loan Delinquency Rates Not Pretty

Buried within a very interesting WSJ article about a condo investor’s recent woes are some fairly alarming statistics about condo construction loan default and delinquency rates. Delinquencies on condo construction loans jumped to 32% in the first quarter up from 25% the previous quarter. Defaults on nonresidential construction loans rose to 8.9% in the first quarter, from 6.6% in the previous period. Both statistics are courtesy of Foresight Analytics.

The WSJ article details the travails of Kent Swig, the scion of a San Francisco real-estate family who opted to get into the condo development frenzy in Manhattan in 2005. Although real estate investors claim “location location location!” is the key to successful investing, I would argue the new refrain might be “timing timing timing!” or alternatively “don’t buy at the peak of an obvious bubble.” In any event Mr. Swig was working on four condo projects, all of which happened to come on line in the past year. He was fortunate enough to sell one of the condo-conversion projects after one of the lenders launched foreclosure proceedings. Recently, Lehman Brothers, you remember the bankrupt investment bank that wasn’t mismarking any of its real estate positions in the slightest, foreclosed on Mr. Swig’s 25 Broad Street and filed separately to foreclose on 45 Broad, both projects near the New York Stock Exchange. Meanwhile, closings of sales at Sheffield57, a 597 unit condo project which Mr. Swig paid $418 million for in 2005, a record for an apartment building, have stopped. Contractors and their mothers have slapped liens on the building for unpaid bills. The mezzanine lenders, who hold $255 million in debt, get to decide whether to foreclose.

Mr. Swig’s troubles are representative of what is going on in Manhattan as thousands of new units keep piling up with nary a buyer in sight. In Manhattan, vacant inventory stands at record levels, and 4,500 new condo units in 44 buildings are expected to come online this year, according to Reis Inc. I am currently spending a few months in Manhattan, and I can attest to the fact that there is an unbelievable amount of property for sale at preposterous prices. I’ll share some interesting anecdotal data on the Manhattan property market with my readers soon. Make no mistake, the new construction deluge of vacant units can only end with large scale bulk sales at steep discounts. Get your checkbooks ready.

More Stress Test Result Leaks

Bank of America faces a $34 billion gap in its capital as a result of the government stress test, according to the “person familiar with the situation” that is responsible for leaking news to the WSJ. $35 billion is a fairly large nut, it is equal to roughly half of the bank’s current stock market value. It seems unlikely that B of A can raise this amount of money in time by selling assets or more shares to the public, although it is reported in the FT today that it is weighing a sale of its $8 billion stake in China Construction Bank. Conveniently, the lock-in period expires tomorrow, the day the stress test results are officially released, so perhaps the beleaguered bank can announce the sale of its CCB stake side-by-side with the results of the test. Bank of America will more than likely need to convert the government’s preferred shares into common equity to satisfy the shortfall, leaving the government with a large stake, and diluting current shareholders. The stock is up around 5% on the news premarket.

Once the actual results are released, they will likely prove to be anti-climactic and investors will have to return to paying attention to mundane things like earnings and economic data. I’m not sure what Mr. Stress Test Leaker will do with all of his newfound spare time.

How Long Can the Bank Rally Last?

As the stress test results continue to be leaked slowly, the news out today increases the total number of banks that reportedly need capital to 10 out of the 19. Since bank stocks absolutely ripped on the incredibly bullish news yesterday that 4 banks may need capital, the S&P is bound to hit 1450 today. The most reasonable explanation I could find for the return of enthusiasm for owning bank stocks is the belief that banks can easily raise the capital they need and everyone can go about their merry way making money again by lending at some interest rate, any rate will do because it is bound to be higher than zero, their financing cost. What I’ve had trouble reconciling though, is that a number of fairly intelligent people believe that roughly $4 trillion in toxic assets still sit on banks balance sheets. Furthermore, even though everyone keeps emphasizing the “green shoots” in the economic data, I’m having trouble figuring out what on earth they are talking about. Both pending home sales and construction were up slightly yesterday from abysmal levels and the headlines beamed “great housing news boosts stocks!”

But maybe I’m just too pessimistic. Spreads in credit markets have tightened considerably since early March. Investor interest is picking up in the Fed’s TALF program, which had $10 billion in demand this month, the highest since the program was launched. Certainly these are positive signs. But then I remember what a looming disaster the commercial real estate market is facing, and how that is bound to whack bank stocks further. Then I wonder what the employment report will look like Friday, and I think that maybe the market has just gotten ahead of itself. After all, wasn’t it a year ago when the heads of certain banks that have since received significant government infusions or are now unemployed were claiming with confidence that the worst was over? How long can the bank stock rally last? Longer than any short worth his salt can stay solvent.

Citi, B of A Argue Stress Test Results

Citi and Bank of America are not happy with the results of the government-mandated stress tests, which will force them to raise significant amounts of new capital. According to the FT, Citi needs $10 billion more, while B of A needs “well in excess of $10 billion.” The banks are furiously arguing their case, claiming the stress test results were too pessimistic. PNC and Wells are also mentioned as regional lenders that would be required to raise capital, unless they manage to convince the Feds otherwise.

In the event that the government prevails, Citi is rooting around for more securities it has issued that can be converted into equity. The good news, for Citigroup at least but not so much for investors that were hoping to continue to collect interest on their trust preferreds, is that Citi has around $15 billion in trust preferred securities lying around that it can convert. No word yet on how B of A plans to fill its hole.

Stress test results have been delayed and will be released on Thursday, May 7th giving the market plenty of time to continue rallying for no good reason. Somebody wake me up if anything interesting happens before then.

Bond Insurer Ordered By Regulators to Stop Payments

Syncora, aka SCA, was ordered by regulators to stop paying out claims, triggering a default on $18 billion in credit default swaps written on the bond insurer’s own debt. The likely payout on the CDS is estimated to be around $1 billion. However, Syncora has guaranteed more than $140 billion of bonds, mainly municipal debt and structured finance. This is the first of the bond insurers, a mini-me of Ambac and MBIA, to have been forced to cease paying claims. This clearly is not a positive sign of things to come for the other bond insurers.

Remember when buying insurance was a no-brainer? So if I buy some muni-debt, not only is it backed by government receipts but it also comes with insurance! What a great risk-free investment! Want to protect a family in case of an untimely death? I’ll just give AIG a call and get some life insurance! What if I buy a new car and it happens to be a lemon? No problem, it came with a warranty from GM, better yet Chrysler. Remember when you didn’t have to look at a company’s balance sheet to determine if it was a safe company to buy insurance from? Now, not only do you have to figure out if the company will still be solvent, but also if it’s a big enough clustersuck to be considered enough of a systemic risk to be bailed out by the government. Might as well put all your extra cash into Citigroup because it has to be the most guaranteed systemic risk around.