Vacation Alert

K10 is taking off with the family for a much-needed vacation. It's bound to be a fairly slow week for financial market news so I'm not packing the laptop. Having said that, if anything wild and crazy happens, I'll track down a computer somewhere and blog about it. Otherwise, I'll be back mocking the market on September 1, 2009. Hope everyone has a great week.

Prime Loan Delinquencies Mounting

According to the MBA's latest survey, 13.2% of mortgages on homes with one to four units were at least a month overdue or in the foreclosure process in the April-June period, up from 12.1% in the first quarter and 9% a year earlier. While foreclosure starts have slowed on subprime mortgages, they have picked up on prime loans. Among prime loans 9% were past due or in foreclosure at the end of June, up from 5.35% one year ago. For subprime loans, the rate was 39.5% compared with 30% last year. Prime loans, however, accounted for 58% of foreclosure starts, up from 44% last year, while subprime accounted for 33% of foreclosures down from 49%.

The spike in foreclosures that began two years ago in the subprime market was triggered by a halt in rising home prices. Once subprime borrowers couldn't use their magical equity that the bubble created out of thin air to refi into a better loan, they could no longer avoid the painful resets on their mortgage rates. So they began defaulting in droves. This led to more downward pressure on home prices as foreclosures starting hitting the market and adding to the growing supply of houses for sale. Problems in the subprime market have now spilled over into the prime market as the economy has taken a turn for the worse. Prime borrowers are defaulting now for more traditional reasons, such as the crappy economy. They can't refinance or sell their house because they are upside down on their mortgages. While subprime defaults may be peaking (although this too might be temporary due to various moratoriums), prime defaults are just beginning to pick up steam. Way more pain ahead on the housing front.

Here's the chart from the WSJ article:

Pension Plans and Private Equity

Bloomberg reports on pension plans' enormous contribution to the recent boom in private equity. Three of the biggest investors in private equity are the state pensions of California, Oregon and Washington, which shelled out $53.8 billion in the past decade to private equity funds. In return they have recouped just $22.1 billion in cash by the end of 2008. One can easily assume that they've collected nada in 2009 as private equity-backed firms have done nothing other than go bust since the start of the year. In fact, the three pension funds haven't reaped a paper gain from funds formed in the past seven years.

According to the Bloomberg article, investments made in 2006 and 2007 are currently valued at $15.8 billion on the pension funds' books as of the beginning of the year. Whether those valuations, which are theoretically marked to market due to FAS 157, will bear out is anyone's guess, but I'll go ahead and try. My sense is that the equity in private equity deals struck in 2006 and 2007 is virtually worthless. The deals were all highly leveraged and done at ridiculous prices. Maybe not all of the companies will go bankrupt, but certainly very few of them will have any equity value left for investors. This might be why college endowments such as Harvard were punting their private equity holdings at 50% of their value. It's a very easy scenario to envision these investments going straight to zero, and Harvard has bills to pay.

Now that everyone expects a large V-shaped recovery, supporters of illiquid private equity investments for pensions and endowments are coming out of the woodwork claiming that a turn-around in valuations is now beginning. An Oregon spokesman is quoted as saying "The market is in a trough. The picture would've looked different at the end of 2007." Sure, it would have. Because back in 2007 everyone was marking all of their holdings way too high based on silly expectations for growth that turned out to be dead wrong. 2007 valuations weren't real. They were a mirage. And maybe we're in a trough, but it's also highly likely that valuations will go much lower. These are illiquid, highly leveraged investments.

Instead of pulling back from private equity deals as the bubble grew, pensions actually continued to raise their allocations. The three state funds more than doubled their buyout commitments in 2005 to $8 billion from $3.1 billion. Then they committed $18.7 billion the following year. Essentially, they invested most of their allocation towards the asset class at the very peak. A foolish choice that will certainly cost their retirees greatly.

More From the Property Report

A couple more highlights from the WSJ Property Report this morning:

Calpers has given up control of its stake in a trophy office tower in Portland, Ore. The Koin Center, nicknamed the "mechanical pencil" for its signature shape, was purchased for $109 million in 2007 by a partnership that included Calpers and CommonWealth Partners, a real-estate investment company based in LA. The partnership has defaulted on the $70 million debt, and New York Life, the lender, has appointed a receiver to control and possibly sell the property. The article has a great quote from a senior vice president of corporate services for Colliers in Portland "Calpers is the gold standard, and its surprising that their backup plan is to walk away." I wonder why that is so surprising since it appears to be Calpers' least expensive option. That's sort of the whole point of an option. I might have paid $1 for the Microsoft $50 calls, but since the stock is only trading a $23, I'd be an idiot to exercise them. The building's office vacancy rate is set to rise from about 7.9% in the second quarter to the 26% range by about October. I'm sure that California retirees are cheering Calpers decision to walk away from this turkey.

Stockbridge Real Estate Funds is considering a takeover bid for the management of a $2.6 billion fund run by Deutsche Bank's real estate investment unit. Apparently, this is a rare move in the real estate world. In this instance, however, some of Stockbridge's top executives are intimately familiar with the 92 investments in the fund because they used to work there and manage the fund. The former managers of the Deutsche fund bolted in 2007 when their five-year retention pay plans ended and were hired by Stockbridge. They did such a great job managing the fund at Deutsche that the fund has warned investors that it may seek bankruptcy protection. Safe from their new perch at Stockbridge, the former managers would like to buy back the crap that they left behind at Deutsche. Isn't it fun doing this with other people's money? As long as you get a nice retention package to pay you for all your talent, who really cares about the consequences when you saddle your former investors with a bunch of really crappy real estate investments?

Meanwhile, the "Technically Speaking" section of the WSJ has a ridiculously bullish piece on REITs. It explains why REIT stocks are going to continue to rise despite the many, many problems in the commercial property market. The article gives such solid evidence as "Because the sector's heavy debt load was such a big contributor to its precipitous drop last fall, REIT stocks are expected to go nowhere but up if debt refinancings occur." Also "Given the appearance that the banking system has stabilized, that leads you to the belief that most of these REITs will be able to get their refinancing in order." And my favorite "From a technical view, REITs look set to rise as much as 35% from current levels." I don't know about you, but I'm convinced. Forget everything I said in the past two posts about commercial property values plummeting, "gold standard" investors walking away from their investments and saddling lenders with half empty buildings, defaults, declining cash flows and covenant violations. I'd better go load up on some REIT stocks!

Tishman Speyer's Commercial Real Estate Debacles

The WSJ Property Report has an interesting piece on Tishman Speyer this morning. For those who haven't heard the name, Tishman is a venerable real estate property developer that holds an approximately $35 billion portfolio of properties from all over the world. Tishman, the cream of the cream of the commercial real estate crop, finds itself in the unfortunate position of being in default on debt tied to one of the largest office portfolios in the Washington area. Back during the Great Bubble Pandemic of 2006, Tishman Speyer paid $2.8 billion for what was known as the CarrAmerica portfolio, a collection of 28 buildings leased to law firms, lobbyists and other hoity toity tenants. Naturally, Tishman borrowed from the piles of easy money lying around at the time, levered up, and paid way too much for the properties based on unrealistic cash flow assumptions. Cash flows have since declined so much that they barely cover the debt service. The company is in violation of its covenants and must find a way to refinance the debt due in 2011. By the way, who were the lenders? Lehman was involved, of course, and also happened to put equity into the deal too. Because every good investor knows that the best hedge against a debt investment is a side-by-side equity investment. The seller of the CarrAmerica portfolio to Tishman was Blackstone, who proved to be the winner in the 2006 commercial real estate hot potato tournament by flipping the portfolio for an enormous profit months after buying it.

But fear not, Tishman Speyer itself isn't threatened by the problems with the CarrAmerica portfolio, according to the WSJ. No, Tishman is probably more threatened by other bigger, dumber deals like the monster $20 billion LBO of Archstone- Smith, which closed after the credit crisis was in full swing, and the brilliant $5.4 billion acquisition of Peter Cooper Village and Stuyvesant Town that paid a fabulous 2.5% cap rate. The Archstone deal was also done with debt and equity investments from Lehman, (seriously, did that firm even have a risk management department?) which recently received bankruptcy court approval to put $230 million more into Archstone, hoping the apartments will regain their value on the other end of the recession (you can take a few minutes to laugh, I did.) Tishman pointed out that it has been very profitable over the years and it has $2 billion in liquidity for new deals. Seems like it should focus on cleaning up the old deals first before they throw any money into new deals. After all, Bear Stearns had $17 billion in cash and Lehman was most definitely NOT HAVING ANY LIQUIDITY PROBLEMS days before they went bankrupt.

Financial Headlines 8/18/2009

• Housing starts declined 1% to an annual rate of 581,000, the first drop in three months. While single family starts actually rose slightly, a 13% plunge in multifamily homes weighed on starts. Building permits also fell 1.8% in July to a 560,000 annual pace from 570,000. Hardly the upbeat economic report economists were hoping for.
• Wholesale prices in the US fell 0.9%, following the 1.8% gain in June. Excluding food and energy, core prices unexpectedly fell 0.1%. Score another point for the Deflationists out there.
• Reader's Digest filed for Chapter 11 bankruptcy protection. Another day, another bankrupt publication. What makes this one so special is that it didn't have to happen. Two years ago, the geniuses at Ripplewood Holdings, a private equity concern, thought it would be a brilliant idea to pay too much for Reader's Digest and pile a bunch of debt onto a company that had steadily declining revenues. I'm sure Ripplewood spoke proudly of all the "operational efficiencies" they would wring out of the deal, but a leveraged deal is still just a leveraged deal. When revenues fell off a cliff, the company defaulted on its debt. Ripplewood's equity stake has been wiped out and JP Morgan, the lender to the deal is the new owner. I'm happy to see that Capitalism is still alive and well in this country but wonder what on earth I'm going to read next time I'm sitting in the dentist's waiting room.
• Home Depot reported better than expected earnings of 66 cents a share, down from 71 cents a share a year ago. Revenues decreased 9.1% to $19.07 billion on a 8.5% decline in same store sales. The company reaffirmed its forecast for sales to fall 9% but raised its guidance for earnings.
• Researchers at the University of Houston's C.T. Bauer College of Business have identified at least 141 companies that appear to have awarded options to their executives at particularly advantageous prices. I smell another options backdating witch hunt in the works. As an avid options trader, I too would love to retroactively purchase call options at the absolute lowest stock price of the year. Unfortunately, my patented method of throwing darts at the dart board is not nearly as lucrative as looking at a chart one year later and picking the lows. If options backdating is indeed widespread, I expect many heads to roll as I consider this practice corporate looting.

Failed Banks Weigh on FDIC Insurance Fund

So the count of failed banking institutions hit 77 on Friday, with the FDIC seizing its biggest fish to date: Colonial. Fortunately, the FDIC found a buyer for the bank with $22 billion in assets, but not without providing the purchaser, BB&T, with one of its famed loss-sharing agreements. You know, the kind of deal you'd like to get on your trading account? I'll take 100% of the upside, and let the government eat the losses on my crappier trades. The loss-sharing agreements with the FDIC lessen the ultimate cost to the insurance fund, which is rapidly shriveling, and probably shivers with fright every Friday afternoon awaiting the news of the latest subtraction from what remains of its meager pool.

As I've noted several times before in my posts about bank failures, it is surprising how costly the recent bank failures have been as a percentage of assets. Lo and behold, the WSJ reports today that the recent period of bank failures are even more costly when measured as a percentage of assets than those during the S & L Crisis. The largest hit so far is coming from Community Bank of Nevada where the cost to the FDIC's insurance fund is estimated to be roughly 51.4% of the bank's $1.52 billion in assets. For the 102 banks that have collapsed in the past two years, the FDIC's estimated cost averaged 25% of assets. This is up from the 19% rate between 1989 and 1995 when 747 financial institutions were closed by regulators. What accounts for the increase in cost? First of all, many regional banks that were shut out of the mortgage boom chose to delve into risky construction lending that is now coming back to bite them. Is it any wonder that the most expensive bank failure to date as a percentage of assets is based in Nevada where the construction boom was particularly pronounced? Also, clearly regulators did a horrible job of supervising these banks, allowing them to grow at unsustainable rates through high-risk lending. For example, Integrity Bank of Alpharetta, Ga was permitted to continue accepting deposits while promising unusually high interest rates for more than two years after examiners noted deficiencies in its loan underwriting. The funny thing about lax regulatory supervision is that we wind up paying for it twice. First we pay the salaries for a bunch of bank examiners to sit around and do nothing while the largest real estate bubble we've ever witnessed percolates around them. Then we pay to clean up the mess when all of the institutions fail. Sure the FDIC's deposit fund is financed by premiums collected from banks. But the fund is down to $13 billion and there are 300 banks on the problem bank list. Does anyone really think the FDIC isn't going to have to draw down on that $100 billion line of credit with the Treasury?

Consumers Not Too Confident

The famed University of Michigan index of consumer sentiment declined to 63.2 from 66 in July. While up from the three-decade low of 55.3 it set in November, the index was supposed to rise to 69 according to economists. Economists must be absolutely shocked that consumers still get bummed out about things like not having a job, being upside down on their mortgages, and having their credit cards cancelled by AmEx. But isn't the stock market up 50% from the lows? Shouldn't they be feeling better? Sure, they've stepped back from the ledge, but still, economic conditions are tough for the majority of Americans. It might take some time before everyone has a bounce in their step again, regardless of whether Wall Street is already handing out record bonuses or Bill Gross is buying a $23 million tear-down in Newport Beach.

Speaking of the market, it is taking a bit of a beating today, with all of the averages down about 1.5% so far. The market seems to finally have stalled out after staging a spectacular rally for the past several months. As investors stop to catch their breaths, many must be asking if they've gotten ahead of themselves. But earnings have been great right? I mean, they've beaten all of those expectations that analysts slashed right before earnings were announced. Right? A very interesting piece in the FT yesterday, written by Chief Investment Officer of Lombard Odier, Paul Marson, questioned the quality of earnings and pointed out the jarring difference between reported earnings per share and earnings on an adjusted operating basis. So far reported earnings per share for the S&P 500 companies is $7.20 per share, down 91% from the 2007 peak. On an adjusted operating basis (which excludes all of those "one time items" that often don't wind up being one-time only), earnings are $61.2, down 34% from the 2007 peak. This $54 gap between reported and adjusted operating earnings is apparently a record. Something to mull over before you dive in and buy more stocks on the dip.

Financial Headlines 8/13/2009

• In case you missed it yesterday, the Fed left the fed funds target unchanged at roughly zero, and plans to wind down its purchases of treasuries by October. The statement released by the FOMC also stated that economic activity was "leveling out." Not "bouncing back mightily" but "leveling out", as in "no longer plummeting." The Fed is slowly taking its foot off the gas pedal and hoping it doesn't squash the recovery.
• Retail sales fell 0.1% in July despite the car-selling spree going on at auto dealerships due to the government's "cash for clunkers" program. This was a huge disappointment for Wall Street, which was somehow expecting everyone to turn back into the shopping crazed maniacs of 2007 despite high unemployment, curbs in credit card lending, lack of home equity to draw from, and all those other minor details that are still the economic reality of 2009.
• Wal-Mart's earnings were better than expected, but same-store sales fell 1.2%. Net income for the retailing giant was $3.44 billion, down from $3.45 billion but net sales decreased 1.4% to $100.08 billion. Declining sales at the world's largest retailer? Not good.
• Jobless claims rose to 558,000 from a revised 554,000 the week before. But continuing claims fell by 141,000 to 6.2 million.
• Some loon who lost her life savings to Bernie Madoff has actually written a book disclosing an extramarital affair with the imprisoned ponzi schemer. I'm not sure why anyone would ever admit to this, or who on earth actually will want to read the steamy details of Bernie Madoff's love life, but the book will be hitting the shelves by August 25th. Sheryl Weinstein penned the tome, with the help of a ghostwriter, perhaps to raise the cash to make up for the fact that she lost her family's life savings by investing in a ponzi scheme. Or maybe she's hoping the proceeds can help her reimburse the Hadassah foundation's $40 million investment, which she was entrusted to invest and funneled to Madoff? One thing I know for sure, if I were her husband of 37 years, I'd be calling my divorce lawyer right about now.

The Fed's Been Busy

When Ben Bernanke isn't busy giving interviews to 60 Minutes to shore up his image just in time for his reappointment, or inventing new liquidity schemes to prop up the global economy, or negotiating against Cerberus in the Extended Stay Bankruptcy owing to the Fed's kindly acquisition of a bunch of crappy Bear Stearns assets that JP Morgan didn't want, it occasionally still meets to set interest rate policy. Today happens to be one of those days. So while we wait for the Fed's statement on interest rate policy, shall we take a moment to review how much the Fed's role has changed in the past two years?

Back in the old days (i.e. pre-mid 2007), the Fed was tasked with implementing monetary policy to help ease the economy through the ups and downs of the business cycle by setting a target for the fed funds rate. The Fed could buy or sell treasuries outright when necessary, but mostly would stick to mundane daily repo operations to help guide the fed funds rate to its target. Since mid-2007, when it began to dawn on Mr. Bernanke that maybe, just maybe, the subprime meltdown was not contained, he began what amounted to an unprecedented change in the Fed's directive. He introduced a series of new liquidity mechanisms aiming to provide cheap financing to our beleaguered banking institutions that could no longer find suckers to finance their risky investments at affordable rates. He facilitated the bailout of Bear Stearns by JP Morgan by offering a $30 billion loan, where the Fed bears the risk of $29 billion in losses, if they arise (see Extended Stay Bankrupcy above if you still believe that the Fed won't take any losses.) He opened up the discount window to the few dealers chosen to survive post-Lehman Apocalypse until the market recovered a bit. He engineered several bailouts of AIG, an insurance company over whom it had no jurisdiction, where the Fed now bears the risk of billions in losses unless, by some miracle it turns out that AIG really was solvent and can break itself into a million little pieces and has enough left over to pay back the Fed. He began a program of quantitative easing, where the Fed has agreed to massive outright purchases of Treasuries and Agencies in order to keep interest rates low so that the fragile recovery (or whatever it is) isn't stunted. Did I cover everything? Feel free to chime in if I've forgotten a few monumental changes.

So does anyone even care anymore about the Fed's boring announcements on interest rate policy? Does it even matter that rates are zero, in the face of all of the other interventions mentioned above? Certainly, if the Fed buys into the "green shoots" theory of our economic recovery, then perhaps the announcement today will hint at an end to quantitative easing and the nearing of the end of its zero interest rate policy. But why would it take the risk of squashing the nascent recovery? Better to sit tight and let the market breathe and enjoy the uptick. After all, fewer midnight frantic phone calls from bankers equals a happier wife.

Traders Moving to Smaller Firms

The WSJ highlights one of the changes rippling through Wall Street's trading community due to the government's attempts to crack down on compensation. The article begins with the tale of Steven Schonfeld, the 50-year old owner of the trading firm Schonfeld Group Holdings. Mr. Schonfeld took home $200 million in pay last year and bought himself a $90 million house near the Long Island Sound. Since Mr. Schonfeld's firm is private and didn't need any help from the government to stay afloat, you won't see him testifying to Congress to explain his compensation package or apologizing for his grandiose lifestyle. Furthermore, last year's volatile markets gave his traders unprecedented opportunities to make money, allowing Mr. Schonfeld to expand and hire traders from A-list firms.

Fed up with compensation restraints, proprietary traders from big name broker dealers, who don't dependent on order flow for profits, are flocking to smaller securities firms. Smaller firms give larger payouts based on profits generated by the individual trader. Meanwhile, many larger firms, burdened by losses from the credit crisis, not to mention regulatory pressure, are scaling back on proprietary trading operations. This is a positive trend that should continue until no systemically important financial institution is in the business of making huge proprietary trading bets. Profitable traders should get paid as a percentage of profits generated. I just hate the idea of government-subsidized risk taking. If Schonfeld Group does a poor job of risk management and happens to lose its capital due to poor trading decisions, Ben Bernanke is not going to get a phone call in the middle of the night. The company will file for bankruptcy and all the other traders who were up on the year and hadn't been paid out yet will be pissed off. No systemic risk. Nobody else will care. This is where the real trading "talent" should go. Mr. Schonfeld claims that his best traders make $5 to $10 million a year. Very few good proprietary traders operating under compensation constraints at big firms would argue that that kind of take home pay is too paltry to trade for the prestige of working for, say, Citigroup. The catch is, you have to be really good. Smaller firms typically don't pay large salaries, some only in the form of a draw, and if you aren't making money trading, you get zip.

For less talented traders who aren't as confident of their trading skills and don't mind government intervention in their pay checks, there's always the New York Fed. According to the FT, the NY Fed is on a hiring spree in order to get a handle on its exploding balance sheet. Don't like working for a small entrepreneurial firm? Surely the $2 trillion in assets that the NY Fed has acquired over the course of the last two years should keep you busy. No word on what your comp might be, but I'm guessing it won't be $5-$10 million.

Maguire Prepares to Mail Keys to Lenders, Reports Loss

Maguire, one of the largest Southern California office-building owners, has warned it plans to hand over ownership of seven buildings with $1.06 billion in debt to its lenders. Like many commercial property investors, Maguire borrowed heavily in recent years to purchase properties based on hockey stick-shaped assumptions for future rent increases. The reality of a 20% office vacancy rate in Orange County, up from 6% just three years ago, is not really helping Maguire meet debt service payments. Who are the lucky new owners of the buildings? LBA Realty, who purchased the debt on one property at a discount in the spring, already has a deal in place to take over Park Place One, in Irvine, California. The other six properties were packaged into CMBS and are coming to a default rate near you in CMBS Land. The seven buildings make up about 20% of Maguire's portfolio.

It should come as no surprise then that Macguire posted a $375.7 million loss this morning due mostly to the $384.7 million in write-downs related to the aforementioned properties. Funds from operations were a negative $7.10 a share, but it you exclude the write-down, they were a nifty eight cents a share. From a company that only reported revenue of $134.78 million, results like these are disastrous.

For other, depressing commercial real estate news, please turn to page A5 in the WSJ where an article discusses how difficult it will be for commercial real estate in Southern California to rebound from current depressed levels. During the peak four years ago, construction was the fourth-largest employer in the Inland Empire counties of San Bernardino and Riverside. Housing contributed more than $24 billion in revenue to the Southern California economy in 2008, more than double the revenue from Hollywood movies. Fast forward to today where construction has ground to a complete halt and new office buildings sit empty or with few tenants. A few stark statistics: the greater Los Angeles area has lost approximately 15% of the total construction jobs, while the Inland Empire has lost 49% since 2006. The number of housing permits in the five county greater Los Angeles area has dropped by 85% from 2005. San Bernardino has seen housing permits plunge 96% since the 2005 high. Office vacancy rates have grown to 24% in Riverside counties while the retail vacancy rate in the Inland Empire hit 10.6% in the second quarter. With stats like these, it is hard to imagine that construction will help lead the area out of its current slump.

Unemployment, AIG, FNMA

• Nonfarm payrolls fell by 247,000 and the jobless rate dropped to 9.4% from 9.5%. This report was slightly better than expected, yet the economy is still shedding jobs. This month's jobs losses bring the total number of jobs lost since the recession began to 6.7 million.
• Egads! AIG reported a profit, the first one in seven quarters as investment losses narrowed. The insurance company, now 80% owned by the US government, posted net income of $1.82 billion, or $2.30 a share. So if you were looking for an explanation as to why the stock ripped this week, here it is: Somebody leaked the crop report.
• To help offset AIG's tidy profit, Fannie Mae, also 80% owned by the government, reported a $15 billion loss and put in its request for another $10.6 billion from Uncle Sam to cover the resulting net worth deficit. The mortgage giant had a few sobering comments in its press release: "We are experiencing increases in delinquency and default rates for our entire guaranty book of business, including on loans with fewer risk layers...Total nonperforming loans in our guaranty book of business were $171.0 billion on June 30,2009 compared with $144.9 billion on March 31.2009."

On Economic Numbers and AIG's Rally

Retail sales were sluggish last month with discounters posting largely lower results. Wal-Mart no longer reports monthly sales figures but other discounters had sales declines for the month. Costco reported a 2% drop and Target posted a 6.5% decline. One of the worst performers was Abercrombie and Fitch with a 28% decline in same-store sales. I guess everyone is too busy trading in their clunkers for shiny new cars to load up on teen clothing. It will be interesting to see whether the resounding success of the cash for clunkers program cannibalizes sales from other retailers or if it is a boost as everyone decides it's time to max out their credit cards again and start spending.

In slightly more uplifting economic headlines, jobless claims dropped by 38,000 to 550,000 in the week ended August 1st. The four-week moving average also decline slightly to 55,250. Continuing claims, however, rose by 69,000 to 6.31 million in the weekend ended July 25th. While a number over 500,000 is still considered a very weak labor market, the trend of lower claims in the past few weeks is positive for the economy. Unfortunately unemployment benefits will begin to run out soon for those who were axed at the beginning of the recession and have failed to find work. The big daddy of employment reports released tomorrow should shed some light on whether the jobs pictures is really improving.

Meanwhile, what is going on with AIG's stock? The stock popped $8 yesterday and was up $6 at the open this morning, although it has given back some gains. Surely it can't be ripping on the news reported this morning that investment banks are set to reap a $1 billion bonanza on the breakup of the formerly formidable insurance conglomerate. But isn't it nice to hear that the NY Fed and US Treasury are set to throw even more money into the hands of investment banks that contributed mightily to the crisis that threw our economy into the lurch? Perhaps the stock is playing catch-up to all the other financials that have ripped in the past few months. Or maybe analysts believe that once the company is broken up and its various pieces are spun off, the government will reap gains and investors will stand to collect more than what the current market cap reflects. Or perhaps K10 is just turning into a perfect negative indicator, as I vowed to short the stock into the dust after it completed its reverse split. Fortunately, I was too lazy to actually execute a trade, thus saving myself a bunch of money. Being a perfect negative indicator can be just as useful as being right, so I'm not too upset about it. Nevertheless, AIG's earnings report will add to the drama of tomorrow's trading day. Let's hope its more exciting than today.

Regulators At Work: SEC Fines BAC and GE

In an effort to appear relevant and tough, the SEC extracted fines out of two government-backed financial firms for prior transgressions. First, Bank of America settled its "I know we said we didn't know about Merrill's end-of-year bonus payouts, but we knew" dispute with the agency and forked over $33 million. The fine is for misleading investors when it issued a proxy statement for the acquisition stating that Merrill had agreed not to pay year-end performance bonuses to executives without Bank of America's consent. However, Bank of America had already agreed to allow the firm to pay up to $5.8 billion in compensation. B of A paid the fine. Problem solved. Right? If you can ignore the pesky fact that the government wrote a check for $3.3 billion to Merrill's employees after sinking the firm with a $27 billion loss, then we really can put the matter behind us. Besides, B of A hasn't paid back the TARP yet, so technically the Treasury is just giving the SEC $33 million. This is effective and efficient retroactive regulation.

Next up GE shelled out $50 million to settle civil accounting fraud charges that it used improper accounting methods on four occasions to boost earnings in 2002 and 2003. Once again, the company paid the fine, put the matter to rest. GE seems to have a long history of accounting shenanigans going all the way back to Jack Welch's days, when the company used to mysteriously beat earnings every single quarter and post smooth results quarter after quarter even if it meant under-reserving insurance reserves every once in awhile. What is interesting about this particular fine that was levied, oh approximately seven years after the accounting fraud was committed is that accounting problems occurred during the last recession. So when are we going to get the fines for 2008-2009 shenanigans? Is anyone combing through GE's notoriously complex and opaque financials TODAY? Dennis Koslowski and Bernie Ebber's ears must be steaming from their jail cells.

Meanwhile, in real time accounting fraud action, Huron Consulting, an accounting firm that sprung from the ashes of those Enron-document-shredding accountants at Arthur Andersen had to withdraw its 2009 earnings guidance, lower its outlook, and restate three years worth of financial results. The folks at Huron were experts in forensic accounting, a practice that looks to root out the type of accounting fraud that they have apparently just committed. Maybe they can hire themselves and pay themselves big fees to boost their earnings for 2010? But, how would one account for that? The Chairman and CEO resigned, along with the finance chief and chief accounting officer. While this is somewhat troubling news, rest assured the company stated that "no severance expenses were incurred by the company as a result of these management changes." No word yet on when the SEC plans to get involved in this accounting debacle. Probably 2015.

REIT Earnings Disappointing

Two of the largest REITs, Simon Property Group and Vornado Realty Trust, reported earnings results this morning. Contrary to the recent surge in their shares, which would imply that REITs were having a bang-up quarter, both posted losses, sharp declines in FFO, and lower vacancy rates amid deteriorating fundamentals in the commercial real estate market. Simon Property Group posted a $14.1 million loss on a $140. 5 million write-down, compared with a year ago profit of $114.4 million. Funds from operations fell to 96 cents from $1.49 last year. Revenue decreased 11% to $903.6 million. Occupancy rates were down to 90.9% while average rents rose 3.8%. Vornado Realty reported a loss of $37.6 million on a $122.7 million loan loss, compared with a year-earlier profit of $131.1 million. Funds from operations declined to 54 cents a share from $1.19. Revenue was slightly higher by 0.6% to $678.4 million. Occupancy rates fell to 96.1% from 97.5% in New York offices, but rose to 95.4% from 93.9% in DC. The loan loss was related to the company's 33% interest in Toys "R" Us which the REIT helped take private in 2005.

What is with all the recent bullishness in REIT stocks? The WSJ had a front page story yesterday questioning the rally in the sector. According to the article, REITs face $152 billion in debt maturities through 2013 while commercial property values have plummeted and seem likely to continue to do so. The most compelling reason to buy REITs in an environment where asset values are declining has been the yield, which during the lows hit roughly 10%. But at current prices, yields are roughly 4.7%, lower than some corporate bonds. Certainly the bulls will throw out the argument of 4.7% yield plus all that upside appreciation potential. But with the way the commercial real estate market looks today, the days of appreciation in commercial real estate properties are very far away. So if you think a 4.7% yield is "juicy", go buy some long bonds.

High End Homes Miss Out on Housing Rebound

The WSJ has a front page article exposing the dichotomy between the high and low-end of the housing market. Due to significant amounts of government stimulus aimed at fixing the housing market, the low end seems to have clunked to a bottom. Investors and first-time homebuyers are snapping up foreclosed properties at huge discounts and lower priced homes are selling nicely due to the $8,000 first time homebuyer tax credit and super-cheap financing offered by the FHA (3.5% down-payment anyone?), Fannie, and Freddie. The government stimulus stops short of helping those with higher incomes. The $75,000 income cap for singles and $150,000 for marrieds exclude higher income folks from the $8,000 tax credit. Furthermore, jumbo mortgages require 20-30% down-payments and have interest rates roughly 1% higher than conforming mortgages. The inventory statistics provided in the WSJ's article are quite telling. Current inventory for all housing is 9.4 months, down from the 11 month peak a year ago. Meanwhile, at the high-end (defined as homes priced above $750,000) inventory is at 17 months, up from 14.5 months a year ago.

Last week I wrote a post entitled "Has Housing Turned the Corner?," where I discussed the growing gulf between the high and low-end. It does not appear to be a political priority (and shouldn't be in my opinion) to help those looking to purchase a high-priced home. Consequently, those who wish to buy an expensive home have to cough up a sizable down-payment to qualify for a jumbo mortgage under much tighter lending standards. Forget the job losses and the economic downturn, the pool of buyers of high-end homes has shrunk significantly just because of the disappearance of cheap financing. Another interesting phenomenon noted in the WSJ is a change in overall perception about how much to sink into a new house. For many years, the industry (agents, mortgage brokers, and the like), which benefitted dramatically from rising home prices, preached the gospel of leveraging to the hilt to purchase the most expensive house you could barely afford. Homeowners believed in it and many built significant wealth from the growing equity in their houses. The idea of leveraging to the hilt is currently being turned on its head as homeowners discover the "benefits" of too much leverage in a down market. Leslie Appleton-Young, the Chief Economist of the California Association of Realtors declared with brio at a 2007 conference of real estate agents: "This is God's country. When is the 30% decline in Marin County's [a suburb of San Francisco] market going to happen? Not in my lifetime." Rest assured, Ms. Appleton-Young is still alive. I know this because the WSJ got another quote from her stating: "no doubt that the high-end housing prices have adjusted and will continue to adjust." She is clearly still an optimist as she continues to use the word "adjust" instead of coming right out and stating the painful truth that prices are lower, and will likely continue to go lower. Current buyers are more cautious and less inclined to put all their eggs into the housing basket. This shrinks the pool of high-end buyers even further.

The article is littered with stories of homeowners running into financial trouble who cannot unload their homes. The statistics support the anecdotal evidence; the divide between jumbo prime delinquency rates, currently over 7%, and conforming prime delinquency rates, which have yet to hit 5%, is growing. Remarkably, the jumbo prime delinquency rate shown in the article excludes option arms which would pull the delinquency rate even higher.

Given growing inventories, higher delinquency rates, tight financing, and changing attitudes among buyers, it seems inevitable that the higher end is due for more price "adjustments" (and not higher.) To quote a frustrated seller in Winnetka, Ill, an attorney who has commuted to DC for the past year while he waits to sell his home: " You're not sure if it's a price issue or if there aren't any buyers." Interesting that he fails to see the correlation between the two.