Friday, August 27, 2010

GDP and 3Par

Second Quarter GDP growth was revised downward from an initial estimate of 2.4% to 1.6%. Economists were anticipating a larger downward revision to 1.3%, so the market is breathing a sigh of relief at the moment. It has moved on to bigger and better things, such as Ben Bernanke's upcoming speech, but more importantly, the exciting bidding war between HP and Dell over 3Par.

You know the market is grasping at straws when a $1.8 billion merger war over a company that nobody outside of Silicon Valley had ever heard of a few weeks ago is plastered all over the front page of the financial press. Moments ago Hewlett-Packard topped Dell's bid (again), by the way. Analysts are struggling to make sense of the valuation, but at this point, who really cares? The feeding frenzy over this company is beginning to rival the Sotheby's auction of the Giacometti "Walking Man I" back in February. Sure it's a neat sculpture and all, but really, $104.5 million? Ok, it's three times taller than the "Toppling Man" that sold for $19.3 million last November. But even the optimistic art lovers at Sotheby's were shocked by the final sales price. Don't those rich folks have better things to do with their cash?

Therein lies the rub. The folks at the Fed are desperately trying to goose the economy with super easy monetary policy. When banks can borrow at zero percent, but they are refusing to lend to lousy credits, they buy Treasuries. As the economy remains sluggish, firms refrain from expanding payrolls and increasing costs, so they look for other ways to generate growth. So they get into ridiculous bidding wars over the few companies out there that are in growth industries. The irony is that even though Wall Street might love M&A because of the fees, M&A isn't exactly a growth engine for the economy. M&A frenzies, particularly dumb deals, typically happen at market tops. After all, what is the first thing that happens when a company buys another one? Layoffs. I mean "synergies." How's that gonna get GDP on the right track?

Tuesday, August 24, 2010

Existing Home Sales Hit Already Nervous Market

Equity markets were off to a rough start, nervous about the existing home sales number, even before the actual data came along to make matters worse. Existing home sales plunged 27.2% to an annual rate of 3.83 million in July, a number much worse than anticipated. Also, the lowest level in 15 years. Inventories leapt to a 12.5 month supply, up from the previous month's 8.9 months. Bad news all around.

Before everyone goes into a giant tizzy about the sky falling, let's just contemplate what exactly this number means. As the always enlightening Calculated Risk pointed out yesterday in a post by economist Tom Lawler, it was impossible to understand given how horrible the pending home sales index had been, the expiration of the tax credits in June, and huge fall-offs in activity in many local markets, how on earth economists had arrived at such an optimistic consensus forecast of a mere drop of 10%. So really, had economists done a better job of forecasting, nobody would've been surprised by this horrendous economic number. Then again, bad economic forecasting or not, the number still stinks.

What does this mean? Bad economic news points to deflation which leads the nervous nellies at the Fed to buy more treasuries, mortgages, whatever it takes to reflate assets, which doesn't actually get rid of housing supply, instead just leads to pockets of inflation, say in commodities, which leads to takeover battles for fertilizer companies (see Potash) and niche tech firms (see 3Par.) See? It really is all so predictable...

Wednesday, August 18, 2010

Banks and Loan Buybacks

The WSJ reports today on the battle banks are facing over potential loan buybacks. Banks face the prospect of a new round of losses from loans they originated right before the credit markets collapsed. While originating and securitizing loans as fast as they could to fuel the bubble machine, some banks forgot to do a few basic things, like make sure the borrowers had income, for example. So they just filled out loan docs and made up the info that didn't fit normal underwriting standards. While it was easy to just shovel the loan off and forget about it, Fannie and Freddie, at the behest of their regulator the FHFA, are stepping up efforts to recoup losses on delinquent loans if they find any violations of "reps and warranties" (i.e. lies lies and more lies on loan docs.)

Last month, the effort to claw back loan losses was stepped up when FHFA broadened its probe to include private label, or non-agency, MBS. The FHFA sent out subpoenas to 64 issuers of MBS and other parties to probe for potential loan repurchases. Even the Fed has stated it may make repurchase claims after reviewing some of the dogsh-, I mean "collateral", it inherited from Bear and AIG.

What does this mean? More losses for banks and more pummeling of MBS securities. Who is this going to affect the most? The analyst quoted in the WSJ article, Chris Gamaitoni of Compass Point Research & Trading, believes losses at Bank of America might hit $21.8 billion for the bank. Losses at Wells and JP Morgan are estimated to be a mere $6 billion or so. The article does not mention how much he believes non-agency losses might be. In any event, the banks are not going down without a fight, as it pays to spread the losses out for as many years as they can. The irony is if they would've spent as much time and effort underwriting the mortgages to begin with, they wouldn't be in this pickle.

Friday, August 13, 2010

Lehman Pointing Fingers at Och-Ziff

Nearly two years after Lehman's failure, despite the piles of evidence pointing to neglect, mismanagement and outright fraud committed by Lehman's leaders, some people still believe that short sellers caused Lehman's downfall. Lawyers for Lehman's estate are furiously subpoenaing Wall Street firms and hedge funds for documents that they think will show that rumor-mongering led to the demise of the storied investment bank. Apparently, Och-Ziff was the only target that objected outright in court to producing the documents. Oh sure, it makes the fund appear guilty, but perhaps it's the $3.3 million cost associated with producing 3.9 million documents that the fund objects to? The lawyers for Lehman's estate claim that Och-Ziff was involved in the spreading of false rumors but provided no additional evidence to support the that claim, other than the fact that Och-Ziff refuses to produce the documents.

According to the WSJ:

Och-Ziff Capital Management LLC "likely disseminated and/or was the recipient" of an inaccurate rumor that Lehman had spun off debt to two Lehman-controlled hedge funds to reduce the investment bank's leverage, according to the filing. Investors were focused on Lehman's debt levels in the months before its failure.

The rumor was one of many "lies" spread by unscrupulous market participants looking to profit from shorting the troubled investment bank's stock, alleged the filing, made on Wednesday by lawyers investigating Wall Street firms on behalf of Lehman's bankruptcy estate.

Ah yes, all those "lies" that everybody was spreading that the investment bank was insolvent and wasn't going to make it and would wind up bankrupt. Those crazy crazy untrue rumors that the investment bank was lying about its leverage ratio, its liquidity, the value of the assets on the balance sheet etc. etc. And now, we must expose those rumor-mongerers in bankruptcy court after said firm has gone bankrupt. How come nobody is subpoenaing all the real lies from all the investment pros that insisted the firm was solvent and cheap at $15 per share?

Tuesday, August 10, 2010

Pondering the Great Dichotomy While the Fed Meets

The Fed meets today to discuss its next move in the exciting game of "Re-inflate the Bubble." Sure the Fed thinks it's playing whack-a-mole against lousy economic data. Every time a bit of bad news peeps its head out into the supposedly robust economic recovery, the Fed whacks it down with some other ingenious bit of monetary easing. Our monetary authorities are just looking for more and more ways to flood our financial markets with free money, at the behest of Wall Street, so financial assets will rise in value so all of those underwater residential, commercial and other loans can be refinanced or repackaged and sold without another financial catastrophe. You see, it's working really well. Deflation is our worst enemy. Today anyway. That's what Bill Gross says so it must be true. So if we need another $2 trillion in quantitative easing, so be it. Right?

In the economic bad news/deflation corner:

  • Fannie and Freddie continue to bleed cash, albeit at slower rates than before. After posting their most recent losses, the mortgage lenders increased their borrowing from the Treasury to a total of $148 billion. Mind you, Fannie and Freddie are 90% of the mortgage market, so regardless of the economic health of the rest of the banking sector, the true state of the mortgage market is reflected by Fannie and Freddie's performance.
  • Productivity slowed by a unexpectedly jarring 0.9%. So much for the theory about robust profit growth leading to increased productivity leading to increased hiring.
  • Unemployment remains stubbornly high at 9.5% and will likely not decrease unless productivity continues to increase.

In the good news/inflation corner:

  • Money is flooding the system and investors have nowhere to go with it, so they are just piling into anything reasonably safe with a yield and forcing rates lower. The WSJ has two articles this morning, one on MLP shares ripping on zero fundamental improvement this year and another on the relentless march lower in corporate bond yields. The FT has commentary on how the bottom line at strong companies is getting stronger while weak companies are floundering. Case in point: IBM can issue debt at 1%. Can you?
I call this the Great Dichotomy. Part of the economy is flashing deflationary signs, the other inflationary signs. What's a good Fed to do?

Wednesday, August 4, 2010

The Fed Also Forecloses

The WSJ reports on the current state of the Maiden Lane portfolio the Fed acquired in March 2008 when it helped facilitate the sale of Bear Stearns to JP Morgan. You know, that portfolio that was just marked up and showing a "profit" as of the last quarter end? Turns out, not all the assets in the vehicle are performing that well, as it is stuffed to the gills with souring commercial and residential mortgages. The Fed is in the curious position of not wanting to sell problem assets at a discount because it could"disrupt markets and hurt banks." That's funny, because every day I keep reading about how much money banks are making again. Is the Fed suggesting that bank profits are a mirage? In any event, the Fed is going to have to deal with the thorny issue of either foreclosing on delinquent borrowers, or doing workouts. Going ahead with the numerous foreclosures scheduled in coming months on residential properties could raise the hackles of legislators who still believe homeowners need to be protected. Like the real estate investor profiled in the article who is just dying to hand over his investment property because he is obviously upside down on the mortgage. He filed for bankruptcy and the Fed is offering to lower his rate, but he says it's not enough. He needs an extension and a much lower rate to get his investment to workout for him. Apparently, no amount of failed HAMP mods is going to stop politicians from trying more mods!

So far, the Fed has only taken ownership of one commercial property, a mall in Ohio that it is trying to sell. But more commercial foreclosures are on the way. Much less political risk with foreclosing on malls. Malls are as American as apple pie. Why shouldn't the US government own a bunch of them?

Maiden Lane made its first monthly principal repayment in July equal to $30 million. In not entirely unrelated news, Blackrock was paid $35 million in fees last year for its work managing the Maiden Lane portfolio, even though a 22-person team at the Fed is also working on it. I'm guessing the entire Fed team took home roughly $1 million in comp last year? But they probably aren't working as hard as the guy at Blackrock who billed the Fed for $35 million.

Buried in the article is my favorite part: "Maiden Lane now owns a large amount of relatively safe securities guaranteed by GSE's Fannie and Freddie. Many were bought over the past two years with cash Maiden Lane received from interest and principal payments in the portfolio and they have helped make up for some value declines from soured assets." When exactly did Maiden Lane turn into a trading account? Why isn't the money being used just to pay down principal on the loan? Is that because Blackrock's fees are based on the size of the portfolio? So we just want to keep reinvesting so the portfolio maintains its size so we can keep cutting a check to Blackrock? So the Fed, the most leveraged entity on the planet, is buying assets from the other most leveraged entities out there. This is what our government borrows money for, so it can trade with itself and pay money managers in the private sector fees. When will the madness end?