Street to Log Best Quarter Since Crisis

According to the WSJ, securities firms are set to log their most lucrative financial performance since the credit crisis erupted. The article mentions that the usual suspects such as JP Morgan, Goldman Sachs, Morgan Stanley and Bank of America are banking huge profits. The best part is, the article says that "instead of relying on risk and leverage to drive profits," they are deriving profits from trading and underwriting. Apparently, whoever wrote the article doesn't seem to know that the definition of trading is "taking risk." Sure, you can call it market making, but you're still risking capital to make money from buying, selling, and hedging financial instruments, particularly if we're talking about derivatives trading. Furthermore, the article goes on to say that the record underwriting fees that the banks collected in the quarter were mostly from underwriting shares for banks (i.e. themselves) that were forced to raise capital to replenish their beaten down coffers. The article doesn't even mention all of the cheap financing that the government has thrown at them to keep their financing costs down, a huge oversight, in my opinion. If you could borrow money at zero percent from the government, you'd be having a banner quarter too. Too bad your bank just raised your credit card fees, jacked up your rates, cut off your credit and won't let you refi your house. So thoughtful of those banks to pass all those savings along to the consumer right?

If banks think that continuing to underwrite their own equity and debt offerings ad infinitum is a sustainable business model, then they are sadly mistaken. Eventually, investors are going to figure out that whole dilution business and not participate in the 50th capital raising plan that Bank of America or Citi, for example, try to shove down investor's throat. The article cautioned about one time accounting issues that are likely to obscure the results, but as usual, I'll be waiting for the actual earnings announcement and the 10-Q release before I make any judgements about the financial health of our financial institutions.

Madoff Sentenced to 150 Years

Bernie Madoff was sentenced to 150 years in prison today for orchestrating the largest Ponzi scheme in the history of Ponzi schemes. Although Mr. Madoff's attorney pled for leniency and a mere 12 years, the judge seems to have aimed for the maximum sentence, and that just short of what Mr. Madoff's victims wanted; public stoning or perhaps a more humane burning at the stake.

In honor of Bernie Madoff's sentencing today, the WSJ devoted the entire front page of the Money & Investing section to discussing a.) Where all the money went (Irving Picard has only scraped together $1.2 billion so far) and b.) How some of the hardest hit victims have adjusted their lifestyles to face their new financial reality. As for where all the money went, Jeffrey Picower and Stanley Chais may have some idea, as they collectively withdrew over $6.1 billion above and beyond their initial investment, despite claiming that they were victims. I'm sure the rest of Madoff's victims would have a few choice words to describe Mr. Picower and Mr. Chais, and none of them resemble "victim". Certainly Ms. Brown, the 60 year old profiled in the WSJ article who had to take in her 91 year-old mother and look for a job because both lost money, probably isn't particularly sympathetic to anyone skimming $6.1 billion off of the ponzi scheme that robbed them of their life savings. It seems that nobody has been immune to Mr. Madoff's inverse Midas touch. His wife Ruth, who enjoyed the high life for many many years, has just handed over all of her assets, including furs, jewelry and lush properties in Manhattan and Mantauk, is being forced to live off of a mere $2.5 million for the rest of her life. Anyone who lives in Manhattan will tell you that living the high life off of $2.5 million is preposterous. But then maybe she can go buy back her furs at half price in an auction.

UBS Still a Mess, AIG Ditto

UBS, Europe's poster-child for the most egregious financial and ethical performance during the credit crisis, has announced that it will raise $3.5 billion in a share sale and post yet another loss. The bank sold shares to a "small number of institutional investors" that somehow still think that this pig is a good investment. I'm not sure how many more billions the bank has to punt in order to finally discourage supposedly savvy investors from throwing good money after bad, but some folks just never give up. Even the recently highly optimistic Bloomberg can't think of anything more positive to say than "UBS decided to raise the funds to bolster confidence in the bank following record losses, client defections and a US probe into possible tax evasion by wealthy clients." Given that the noose has been pulled around UBS's tax evading neck, it's hard to imagine more clients aren't going to flee. I mean if you can't get a good tax shelter out of these guys anymore, what good is their money management advice? If they really know how to make money, don't you think their investment bank would stop pissing it away?

AIG will hold its annual meeting on Tuesday, its first with the US government as the controlling shareholder, and it should be a doozy or more likely a snoozefest. Among those expected to be in attendance are the three trustees who are overseeing the 80% government ownership of AIG and their six handpicked candidates who will form the majority on the new 11-member board. If you plan to attend, make sure to bring extra coffee. Meanwhile, the Fed announced a deal yesterday with AIG where it would swap $25 billion in debt for stakes in two of AIG's foreign life insurance units, leaving the beleaguered insurance firm with only $18 billion in debt with the Fed, chump change compared to the $84 billion the Treasury has plowed into the firm. Once again, the company is finagling out of paying interest on debt and swapping it into an equity stake in units whose values are ambiguous. If they were really worth $25 billion, or even more, than the company should just sell them to a private investor or hold an IPO to repay the Fed directly. AIG claims that it plans to IPO the units and that the Fed will get the first dollars from those sales, but it could take a significant amount of time before the Fed gets its money back, if it ever gets its money back. How we keep getting roped into giving AIG better and better deals I'll never understand. But then I've had a very hard time swallowing the leniency the government has shown to our financial institutions that were largely responsible for the financial meltdown.

Fed Holds Steady As Economic Data Remains Weak

Yesterday's Fed meeting yielded no surprises. The Fed said it would keep interest rates near zero "for an extended period" and would proceed with its previously announced plans to buy up to $300 billion in long-term US Treasuries by autumn and up to $1.25 trillion in MBS. Meanwhile, over the pond, the ECB injected an unprecedented $622 billion in one-year liquidity to boost its sagging economy. The world's economic problems are highlighted in the FT's nifty graph with OECD forecasts for growth, or rather lack thereof, for 2009. Japan's GDP is expected to decline by 6.8%, Europe by 4.8%, the US by 2.8% (revised up from a -4.0%), and China's GDP should rise by 7.7%.

The recent spate of economic data has finally begun to discourage all the "green shoots" believers that had bought into the idea that we were headed for a nice second-half recovery. The number of Americans filing for unemployment benefits unexpectedly rose by 15,000 to 627,000 with continuing claims climbing by 29,000 to 6.74 million. First quarter GDP was revised to a negative 5.5% from 5.7%, which was spurred by a slightly smaller trade deficit. According to the Moody's Credit Card Index, losses on credit cards rose beyond 10% of total loans outstanding in May, a new 20-year high and the sixth consecutive monthly record. Moody's expects charge-offs to peak at around 12% in the second quarter of 2010. Calculated Risk notes that Chase increased its monthly minimum payments from 2% to 5%, thus squeezing consumers further and ensuring that charge-offs continue to rise. Rising unemployment + negative home equity = zero ability to pay off credit cards.

Not to be outdone by the poor,working (now unemployed) sods that rely on credit card debt to stay afloat, the FT reports that even the ranks of the super-rich and merely rich have thinned considerably in the past year. According to the latest World Wealth Report produced by Merrill Lynch, who should know this stuff well as it had certainly contributed mightily to the shrinking of wealth last year, those with $30 million or more to invest collectively lost 24% or their wealth and saw roughly 25% of their super-rich friends leave the list. The population of those worth $1 million or more shrunk by 15% and suffered a 19.5% decline in their wealth. Last year's decimation took rich people back to wealth levels last seen since 2005, which actually is not such a bad outcome in the grand scheme of things. Still, it seems few have escaped the brutal economic downturn unscathed.

New Home Sales Vs. Durable Goods

A rosy durable goods report got the equity market off to a strong start this morning. Durable-goods rose 1.8% in May, with non-defense capital goods excluding aircraft rising 4.8%. This report is notoriously volatile (April durable goods were down 2.9%) and nearly impossible to predict, yet economists try and everyone gets excited when the number exceeds expectations.

In a more sobering report of the state of the economy, new home sales were down 0.6% in May to a seasonally adjusted annualized rate of 342,000. Economists were expecting May sales to climb by 2.3% to 360,000. Year-over-year, new home sales were 32.8% lower than the level in May 2008. The median price also fell in May to $221,600, down from $229,300 in May 2008, but higher than April's $212,600. Inventories declined to an estimated 292,000 homes for sale, but this still represents 10.2 months worth of new home inventory.

The bum new home sales report is unlikely to deter the ever-chipper homebuilders, who are busy snapping up land on the cheap. The WSJ reports that homebuilders are buying "cheap" land from banks and other lenders that are unwittingly finding themselves with too much dirt on their hands due to foreclosures. A reasonable person would ask why buy more land when it's already coming out of the homebuilders' ears? Apparently, most of the land that the homebuilders purchased at boom-time prices were unfinished lots in locations far far away from where anyone wants to live or work for the next 30 years or so. Most of the land they are purchasing now for pennies on the dollar are finished lots in relatively decent locations. Can't blame them for dollar-cost averaging. It works in the stock market. Well, maybe not...

Existing Home Sales Up 2.4%

The NAR reports that existing home sales rose a paltry 2.4% to a a seasonally adjusted annual rate of 4.77 million units in May from a downwardly revised level of 4.66 million units in April. Sales are 3.6% below the 4.95 million-unit pace of May 2008. NAR's chief mouthpiece, I mean economist, Lawrence Yun was optimistic, as he is paid to be, citing that he expected an improvement due to historically low mortgage rates, affordability, and the $8,000 first-time buyer tax credit. He made no mention of the effects that the leap in rates for the 30-year to well over 5%, from their 4.86% average in May might have on the June numbers. Total housing inventory at the end of May fell 3.5% to 3.8 million, which represents a 9.6 month supply at the current pace, down from a 10.1 month supply the prior month. The decrease in inventory is the best part of this report, although 9.6 months is still on the high side. So if everyone could just do their patriotic duty and go out and buy a house this Fourth of July, we'd be out of this mess in no time. Oh, and don't forget to buy a car too, preferably GM. And an office building if you can afford it. They're running a half price sale, I hear...

Who Financed Goldman's Record Bonuses?

The Guardian published a much-ballyhooed article this weekend about a Goldman Sachs staff meeting in London where employees were told that they could look forward to record bonuses if the company registers its most profitable year ever. The bank, which repaid its TARP funds last week is rumored to have had a record first half, although it has yet to complete its second quarter and report results. Before everybody gets out their pitchforks, a moment of rational reflection is in order. First of all, whatever boob in attendance at the staff meeting that actually leaked this news to the press, amidst a worldwide recession where the finance industry's excesses have launched a political firestorm, should be canned. Once that's out of the way, we can talk about what exactly is wrong with the picture.

First of all, it helps to analyze how it is exactly that Goldman Sachs has managed to make so much money. The folks at GS are savvy traders, no doubt. But the real answer is that a host of government subsidies kept the investment bank alive during some of the most nauseating turbulence in the credit market's history. The $10 billion in TARP funds was chump change compared to the trillions in liquidity for illiquid assets that the Fed added to the market last year via its new lending facilities (TSLF, TAF, PDCF etc etc.) By taking over the roll of financing illiquid assets, when the Fed lowered interest rates to zero, it essentially reduced the cost of funds on ALL collateral to zero, not just treasuries, thus boosting profits substantially for the banking system. Meanwhile, spreads on illiquid products continued to trade at historical wides, which, as long as I've been in the market, has been unprecedented during an easing cycle. Furthermore, the Fed bailed out AIG, which meant that GS actually got to collect on its margin calls directly from the Fed. Although GS has made repeated claims that it was properly hedged and would not have had material exposure had AIG failed, I'm not buying that claim. Sure, Goldman might have hedged, but where did it get its hedges? Would those counterparties have survived a failure of AIG and would GS have been able to collect from them without a government guarantee? Last, but not least, GS was allowed to issue billions in FDIC-guaranteed debt at a greatly reduced cost from where its debt was trading at the time. One thing's for sure, if GS is paying record bonuses, that means at least our deposit insurance fund is safe for another year or so.

The Goldman record-bonus story illustrates precisely the flawed thinking behind Paulson and Bernanke's notion that if you bailout the financial sector, you bailout the economy. The economy is still struggling mightily. If it weren't for Fannie and Freddie, that are now direct wards of the government, it would be impossible for consumers to get a loan of any kind. As it is, the financial press is filled with reports of consumers and businesses getting cut off from credit. Yet Goldman Sachs made boatloads of money trading commodities, currencies, and fixed income. What the government did instead of boosting lending to the economy, was subsidize Goldman's, and in fairness, the other banks' trading operations, so they could go on to pay bankers a bunch of money. When populist furor initially erupted, those "in the know" kept saying that the average American didn't understand how finance really works and that they were too stupid to get why it was important to bailout the banks. But couple the Guardian article with the one in today's FT entitled "Bankers' pay soars as struggling groups aim to halt talent exodus," maybe the American public understood the picture after all.