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?

Bear, AIG and Other Headlines

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

Bear Stearns Fund Manager Trial Gets Interesting Before It Begins

We're still about a month away from the start of the Cioffi/Tannin trial. For those who don't recall, the collapse of two Bear Stearns hedge funds in 2007, run by Ralph Cioffi and Matthew Tannin, marked the official beginning of the credit crisis. Mr. Cioffi and Mr. Tannin are facing charges of conspiracy, securities fraud and wire fraud in a nine-count indictment in a criminal case that cost investors more than $1 billion. In retrospect, what's $1 billion after everything that's happened since? But given the lack of criminal charges brought against wrong-doing since the crisis began two years ago, at least somebody's going to trial.

The defendants have asked the federal judge to keep from introducing evidence during their trial next month that Mr. Tanin's computer and trading notebook disappeared. Apparently, the defendants believe that it might look as if the computer and trading notebook were purposefully disposed of to keep damning evidence from surfacing, when really it was just an innocent mistake. I mean, really, I lose notebooks and computers every single day and I'm not being criminally prosecuted for anything. So, I can totally understand how Mr. Tannin, after finding out that prosecutors were investigating him, might have accidentally bludgeoned his laptop with a hammer, before trying to flush it, before driving to a remote location to bury it.

Mr. Cioffi has a more general request of the judge. He would like the court to preclude the government from discussing settlements between Bear Stearns and investors and to exclude evidence concerning Mr. Cioffi's lifestyle, including discussions of furniture, antiques, automobiles and real estate. I suppose Mr. Cioffi is worried about being considered guilty-as- charged once the jury hears tales of the lavish lifestyle that he lived at the expense of his investors, and ultimately, the American taxpayer. Maybe he threw a $2 million party in Sardinia that was videotaped and we'll get to watch it on CNBC over and over again, like Dennis Kozlowski of Tyco fame? Mr. Kozlowski is doing 25 years after being found guilty of siphoning millions from Tyco's coffers, owing mostly to that video tape that I'm sure the jury had a hard time forgetting. Regardless, Mr. Cioffi seems to understand that a "jury of his peers" might not include a bunch of hedge fund managers who live similar lifestyles, but instead a bunch of angry populists bearing pitch forks. I, for one, look forward to reading about this trial

Unintended Consequences of the SEC's Short-Selling Ban

Anyone who believes that the SEC's ban on short-selling was a positive development for the market should take a look at some compelling trading data from Friday.  While the US markets rallied over 3% on Friday, it was the result of a panic to cover shorts in financials, rather than renewed confidence in the US economy.  Some argued that Paulson's proposed RTC-like bailout of the banks was the reason behind the rally, but a look at price action in bank stocks tells a much different story.

Ordinarily staid bank stocks were behaving like internet stocks in 2000 with extraordinary trading ranges.  Zions Bancorporation (ZION) had a $92.44 trading range.  Yes, you read that right:  An ordinarily $50 stock ripped up to $131.20 before plummeting to $38.76 and then rallying back to $50.84.  Wachovia (WB) opened up 65% before selling off and closing up 30%.  Morgan Stanley opened up 50%, erased all of its gains, then rallied back to close up 20%.  What exactly is wrong with this kind of volatility?  You can ask the guy who paid $131.20 for ZION.  I guarantee that those trades weren't sent from hedge funds or mutual funds.  It was more than likely the result of some poor schmo retail investor that ordinarily sends market orders without suffering any real consequences.  This time he sent a market order and paid through the nose for it because there were not enough sell orders in the system to stop the stock from ripping higher.

A far better example of the dangers of manipulating stocks higher is exemplified by the Lloyd's Bank/HBOS merger in London.  After agreeing to purchase struggling HBOS the day before the short-selling ban was announced by the FSA in London, Lloyds took advantage of the artificial 20% rally in its stock by quickly issuing more stock to raise additional capital.  Any bank with half a brain will take advantage of the short-selling ban to raise new capital at these higher prices while only long investors can participate.  What do you think will happen to prices after the temporary short-sale ban is over?  Gee, I wonder.

Finally, banning options market makers from shorting stock shows a real ignorance of financial market function.  Options market makers carry tremendous inventories of options and stock that they constantly hedge in real time by buying and selling stock.  They rarely place directional bets on stocks and focus on risk management of their volatility positions.  They need to have the ability to short stocks in order to make markets for customers, otherwise they will have difficulty quoting options prices.  While regulators might believe they are preventing investors from expressing their bearish views through put-buying, they are also penalizing long investors who sell calls against long stock to juice returns (a practice referred to as buywriting.)  The options community is attempting to gain an exemption from the SEC.  If the SEC fails to grant an exemption, options markets in the 799 financial stocks on the list will be severely repriced, wreaking havoc on some market makers' ability to make markets in certain stocks.  Then maybe, someone can sit Mr. Cox down and explain to him how the market he is supposed to regulate actually works.

Frankly, all of the accusations that have been hurled at hedge funds and short-sellers blaming them for the collapse of Bear, Lehman, AIG etc. are absurd.  Mr. Cox continues to spout about the manipulation and malicious rumors that has led to these firms' demise.  Yet it has been six months since Bear Stearns collapsed, and the SEC has not filed a single charge against anyone for nakedly shorting Bear's stock, spreading malicious rumors, etc.  I have to ask what Mr. Cox has been doing this entire time?  If there were malicious rumors, I certainly would've found them by now.  How?  I'd go to every prime broker, subpoena the trading records, identify the buyers of credit default swaps, puts, naked-shorts in Bear Stearns, and then pull the tapes from the trading desks who talk to the hedge funds.  Every dealer is required to tape record their conversations and the SEC can simply ask for the tapes from every salesman at a Wall Street firm that had a hedge fund client that was shorting Bear through some bearish financial instrument.  Really, is that so hard?  The SEC should start punishing all of the manipulators and abusers if they exist.  Instead it has chosen to greatly distort financial markets by penalizing every player in the market.  Mr. Cox needs to be very careful that he doesn't ruin the integrity of the US financial markets in his quest to go after a few (if any?) bad apples.          

Former Bear Stearns Hedge Fund Managers Arrested By FBI

Ralph Cioffi and Matthew Tannin, the managers of two collapsed internal Bear Stearns funds that were the first casualties of the credit crisis, have been arrested by the FBI.  In a sign of what may result in a rash of criminal indictments, regulators have shown they are serious about doling out the punishment to those responsible for investor losses.  I find it interesting that they would start with these two guys.  According to the Wall Street Journal, prosecutors are zeroing in on an email that Mr. Tannin sent to his senior colleague Mr. Cioffi, indicating his concerns that the markets for the structured products they held as investments were "toast."  He also suggested they consider shutting down the funds.  Mr. Cioffi responded and suggested that the two meet to discuss his concerns.  The two apparently met, discussed the issues and decided Mr. Tannin's concerns were unfounded.  However, Mr. Cioffi did withdraw $2 million of his own money from one of the funds in March, which would contradict his assertion that he felt the funds were on solid footing.  Four days after their supposed meeting, Mr. Tannin told investors in a conference call that he was "quite comfortable" with their holdings.  In the weeks that followed, investor redemptions and margin calls forced them to dump positions into an unfriendly market and wiped out the funds.  While it is certainly true that these two guys are guilty of being terrible investors, I certainly hope the Feds have more than this email to base their case.  Frankly, if you are managing other people's money and you never worry about the markets moving against your trading positions, you're in the wrong business.  It's not that I don't think these guys should suffer if they truly misled investors, I just have a hard time believing they are were the worst offenders on the long list of those who used the credit market boom to deceive investors.  It seems as if much more egregious conduct occurred during the boom that should be prosecuted.  Should everyone involved in securitization of subprime and Alt-A mortgages be investigated for baking unrealistic default rates into the pie?  What about all of those AAA ratings on securities that are now trading at distressed levels?  Don't the ratings agencies need to be investigated for misleading investors?  How about every mortgage broker that steered an unsophisticated borrower into an unsuitable mortgage because he received higher fees on those types of products?

I, for one, will be interested to see whether two guys who managed funds that were supposed to be complex and sophisticated can get away with claiming they were too stupid to see the storm building.  Wall Street will be nervously awaiting the result of the this trial as well, perhaps while cleaning out their email boxes...  

Lehman Brothers Seeks to Raise $5 Billion, Move Up Earnings Report Date

A Bloomberg report this morning claims that a "person" insists Lehman is now upping the amount of capital it intends to raise to $5 billion from the previously reported $3-$4 billion.  Who is this person?  It could be my cat, given how much speculation has occurred around Lehman's financial situation.  Furthermore, the same or another "person familiar with the matter" has informed Reuters that Lehman may release its second quarter results earlier than originally planned.  Apparently, Lehman is sick and tired of all the speculation about its financial condition and believes that releasing its earnings report early will quell investor unease.  Alternatively, Lehman may actually be having problems with counterparties not wanting to trade with it and believes that once the company comes clean and trading partners see that the situation is not as bad as the rumors, confidence will return.  That strategy did not work for Bear Stearns, who moved up its earnings report for the same reason but never made it to the date to report its "profits".  Those "profits" were based on a belief announced by the CEO right before Bear failed, that book value of the company was still roughly $80 a share.  Now that the Fed synthetically owns $29 billion in securities that no dealer on Wall Street would touch with a 10-foot pole, and JP Morgan has taken a $9 billion after-tax charge to account for the acquisition, one must question Bear's pricing of its portfolio.  How close to reality were those prices anyway if nobody wanted to buy securities that equaled nearly all of Bear's supposed "book" value?  Similar doubts currently swirl around Lehman.  They may or may not be cleared up at the earnings conference call, says a person only slightly familiar with the matter.

Moody's Keeps Bear Stearns on Review for Possible Upgrade, Officially Loses All Credibility

According to MarketWatch "Moody's said it will continue to review Bear Stearns debt for a possible upgrade." Separately, and yet completely related, Bear Stearns shareholders begrudgingly approved the firm's sale to JP Morgan Chase yesterday. Despite the close of the sale, Moody's thinks it might possibly be a good idea to upgrade the debt, but it's not entirely certain so for now, it's just going to put it on review. Whatever shred of credibility may have remained after the Financial Times reported that Moody's accidentally awarded AAA ratings on billions of dollars of derivatives because of a computer bug, has officially evaporated. In the statement released today Moody's claimed that it would like to wait until it receives more clarity on the ultimate legal structure of the Bear Stearns and JP Morgan deal. Seriously, who cares? The merger is a done deal. How can any further analysis of legal issues possibly be of use to any investors? Anyone who is trading Bear's debt at this point is probably far more in tune with the legal issues than Moody's. Wanna work on some useful analysis? Here's my top four list of things Moody's can investigate that would actually help investors:
1.) Ask for a detailed list of Level 3 assets and their prices from every highly leveraged institution. Then tell me what they are actually worth. Make sure to downgrade those that refuse to offer the information, particularly any institution with an implied government guarantee.
2.) Go through GE's balance sheet and force them to describe the $25 billion in assets that it has labeled as "other" on its balance sheet. Then tell me what they are actually worth.
3.) Take another peek at the monoline insurers. Do everyone a favor and downgrade them from AAA BEFORE they go out of business.
4.) Take a look at all the assets being used as collateral against the Fed loans being offered to primary dealers. Tell me what they're really worth and if the Fed is using an appropriate haircut.
Anyone else want to add to the list?

Jim Cayne sells Bear Stearns' Stock, Risks Death Threats

I don't profess to be an expert in PR, however, if Jim Cayne would've come to me for advice about how to save his job at the end of 2007, the meeting would've gone as follows:

Jim: K10, I don't know what to do. I'm getting alot of flack from the board to step down as CEO because of this stupid credit mess that I had nothing to do with. I already fired Warren. What else should I do?

K10: Well Jim, since I'm not an expert in PR, I can't really tell you what you should do. What I can tell you is what you shouldn't do.

Jim: Ok, shoot.

K10: You should think about scaling back on all the bridge tournaments. It didn't look too good when you fired Warren for playing in a bridge tournament while you were actually at the tournament itself. Also, you probably shouldn't make any large purchases of real estate because all of that information is public and it will certainly find itself into the press if you purchase, for example, a $26 million condo at the Plaza. You know, that's just a hypothetical example. If you step down as CEO, you shouldn't replace yourself with an investment banker, because, well, BSC is really just a highly leveraged fixed income hedge fund masquerading as an investment bank, so it needs a guy who understands risk management and trading and financing not someone who just knows how to churn fees. The other thing is, if there is a massive liquidity crisis in the financial system where your bank is the target of malicious rumors, you should take them seriously and answer specific questions rather than just brushing them off. Also, in reference to my earlier comment about bridge. You shouldn't be at a bridge tournament when your bank is blowing out. Finally, after being painted into the corner and being forced to sell your company for first $2 a share, and then most likely $10 a share, you shouldn't under any circumstances punt all of your stock in the market at $10.85 before the deal goes through.

Jim: Why not? It's an extra $.85 a share.

K10: Because some disgruntled employee who just lost his life savings and thinks you should be working hard to get him an extra couple of dollars out of JP Morgan, might kill you.

Jim: Hogwash! All of it Hogwash!

K10: There's no smoking in here. Put out the cigar, please.

What We Really Need is an Investigation or Two...

The SEC has decided to open an investigation into possible manipulation of Bear Stearns' stock by evil traders during the crazy events of the past week that ultimately led to the demise of the firm.


SEC investigation


Furthermore, New York City's Comptroller, who oversees the city's pension funds, will investigate if there was any deception by Bear Stearns or if the bank failed due to sheer stupidity. Apparently, the city's pension funds owned some Bear stock and they want their money back.

NYC Comptroller Investigation

So which is it? Was the firm manipulated and ruined by a bunch of traders as the SEC suspects? Or did Bear mislead investors and mismanage itself into bankruptcy within two days as the NYC Comptroller alleges? Because it can't be both, can it? In any case, if I had to guess, I'd bet that the SEC may be on to something. The amount of Bearish activity (the pun is intended) in the options at the beginning of the week was very suspicious (please refer to previous posts). Significant bets were placed on the stock dropping over 50% before options expiration (March 21st). You just don't see that kind of trading in options unless a biotech company is waiting for the results of a phase III trial which will determine if the company ever makes money. Or a company with significant intellectual property is waiting for a ruling on a patent dispute. In any case, it just doesn't happen during the normal course of trading. If I were the SEC, I would start in the credit default swap market. Apparently buyers of credit default swaps drove the spreads wider, and the sellers of the swaps went to the options market to buy puts to hedge their risk. So if the options buyers were just hedging, then the CDS buyers were really speculating that the company would default on its debt. The irony is that the CDS buyers may have gotten scorched as JP and the Fed are now backing Bear's debt, which means the spreads have narrowed significantly. It's the CDS sellers who hedged with options that printed cash. At any rate, there's a great story in here somewhere of who was behind the rumors, because the rumors were incredible. As much as Alan Schwartz, Bear's CEO, tried to quell them, he couldn't keep the rumors from destroying the firm.

Will Bear Stearns Rise From the Ashes?

My "inside sources" are pointing out that the Bear Stearns trade may not be over.  Now, the speculation goes something like this:  Bear Stearns shareholders hate this deal, for obvious reasons.  They still have to vote to approve it.  They are going to vote no, and give the Fed the middle finger.  Out of spite, they'd rather get $0 than $2 a share, and let the Fed deal with the aftermath of trying to get the money back on the $30 billion in illiquid securities that it guaranteed so that JP Morgan would agree to purchase Bear.  Also, maybe the shareholders assume that after the Fed eases and the new $200 Billion dollar Treasury/MBS swap with the broker dealer community commences on March 27th, spreads will have improved so much that they will be able to get a better deal on their portfolio.  In fact, spreads in the agency markets have narrowed considerably so maybe they have a point.  In any case, crazy volatility persists in the options market.  The april 20 calls are .40 bid.  That kind of crazy bullishness on a broker we haven't seen in a long time...  

JP Morgan pays $240 million for Bear Stearns...

making Bank of America's purchase of Countrywide for $4 billion look mighty expensive.  This news is not terribly surprising given that Bear was on the brink of failing on Friday until JP Morgan bailed it out with the Fed's guarantee.  Bear's CEO, reassured the markets at the beginning of the week by declaring that the firm had ample liquidity and $17 billion in cash.  This announcement sent a very strong message to the markets:  You'd better get your money out now while we still have $17 billion.  A wave of customer defections followed on Thursday and Bear literally ran out of money in about a day.  Let this be a lesson to all of you leveraged vehicles out there!  If you need to borrow around $150 billion a day to finance your $300 billion inventory of garbage (which was Bear's short term borrowings around year end), $17 billion in cash is chump change!  At any rate, JP got a good deal on a building in New York City (Bear's headquarters which they owned), although I'm thinking they're going to need to look for some new tenants...

Needless to say, tomorrow will be a very interesting day in the markets.  Looks like the markets didn't like this news one bit, as equity futures are down sharply.  The Fed may be forced into a 100 basis point cut in the fed funds target tomorrow, a day before the meeting if the market starts plummeting.  This time, we won't be blaming it on Jerome Kerviel...  

Richard, I have a Bove to pick with you!

Who is this guy Richard Bove from Punk Zeigel?  Better yet, who is Punk Zeigel?  I had never heard of this guy or his firm until a few months ago when he came out with an upgrade of Goldman Sachs claiming they had "superior technology" and therefore could never lose a penny in the market.  About a week later when it became clear that all the investment banks were getting the beatdown, he turned around and downgraded Goldman Sachs.  Both times he was on CNBC chirping about his analysis as if it was news.  He came out today with a downgrade of Bear Stearns, and revised downward his earnings estimates for Bear (note that Bear is down oh, about 60% from its highs).  First, let's just be clear about one thing, nobody and I mean nobody has any idea what the investment banks are going to report this quarter.  It is impossible to forecast.  Although a portion of their earnings comes from fee-based businesses, they are all in the business of proprietary trading.  Unless you know their trading positions, which banks would NEVER disclose to a two-bit analyst, you have no idea if they are going to lose $10 a share or break even.  You can't rely on their balance sheets from year end because all of their trading positions, liquidity needs, and hedges are totally different than they were 3 months ago.  In fact, given that most of the less liquid securities have ceased trading, the banks themselves really have no idea how much money they made.  But given all of the above, I'd like to throw my hat in the ring...I predict that Bear loses $6 a share, Lehman $3, MS breaks even, and GS loses $1.  These are all completely random predictions, but if I'm right then maybe, just maybe CNBC will call me for a comment the next time brokerage earnings are imminent.  I guarantee that what I have to say will be slightly less moronic than Mr. Bove's drivel from the past few months.

Is Bear Stearns Going Bankrupt?

Anyone?  Anyone?  After unbelievably bearish option activity yesterday (supposedly spurred by rumors the firm is having liquidity problems that cased severe widening in Bear's credit default swaps,) the stock had a nice recovery this morning on news of the Fed's liquidity injection.  However, it has now given up its gains and is down on the day.  This does not bode well for the investment bank.  If I had to guess which investment bank was going bankrupt, I would certainly pick Bear given its lack of diversification from fixed income, particularly mortgages.  However, I do believe that if Bear goes bankrupt before march options expiration, the other brokers should take it on the chin as well.  I guess I'd rather short a 160 stock (hint hint) on its way to 50 rather than a 58 stock on its way to zero.  Call me crazy...