Sunday, March 30, 2008

Fed: Run the presses 24/7

The Gray Lady Opines

Once, investors could get a read on financial firms’ assets and risks from their balance sheets; those days are history.

Firms now do much of their business off the balance sheet. The swashbuckling Bear Stearns was a party to $2.5 trillion — no typo — of a derivative instrument known as a credit default swap. Such swaps are off-the-books agreements with third parties to exchange sums of cash according to a motley assortment of other credit indicators. In truth, no outsider could understand what Bear (or Citi, or Lehman) was committed to. The thought that Bear’s counterparties (the firms on the other side of that $2.5 trillion) would call in their chits — and then cancel their trades with Lehman, perhaps with Merrill Lynch and so forth — sent Wall Street into panic mode. Had Bear collapsed, or so asserted a veteran employee, “it would have been the end: pandemonium and global meltdown.”

And now Treasury wants to put the Fed, who gave us 17 straight meetings of 1/4 rate increases over two years, before cutting rates 3 points in 6 meetings in six months, sweeping power and latitude to run capitalism. You can read the proposals here.

Since there isn't confidence in financial institutions, they give the job to the institution that didn't see any of this coming, but only reacted when they realized that the banking system's problem wasn't just a liquidity issue, but a solvency issue. Which is why this was said in The Times:

“The Fed oversaw this meltdown,” said Michael Greenberger, a law professor at the University of Maryland who was a senior official of the Commodity Futures Trading Commission during the Clinton administration. “This is the equivalent of the builders of the Maginot line giving lessons on defense.”

And in this market, perceptions can trump reality. With all this government intervention, you better take some short exposure off.

Lehman's latest earnings report

How bad was it really?

They made $489 million, but it looks like they lost $400 million in a scam in Japan. They just didn't tell anybody about it until after they reported their earnings.

Troubled investment bank Lehman Brothers may have been taken for as much as $400 million in a swindle in which con artists used forged documents from one of Japan's largest trading firms.

That loss could amount to more than 80 percent of the $489 million in net income Lehman reported in the three months ending Feb. 29.

But Lehman also fudged their earnings by $600 million. Here's Portfolio's view on it:

For several quarters, all the investment banks have been taking gains on their liabilities. Say you owe $100 to your friend. But you run into severe problems and your friend starts to figure you can only afford to pay back $95. If you were an investment bank, the magic of fair value accounting dictates that you could get to reduce your liability. What’s more, that $5 gain gets added to earnings. Because investors thought Lehman was more likely to default, its liabilities fell in value and Lehman garnered earnings from this. How much did Lehman win through losing? $600 million in the quarter. How much was its net income? $489 million.

Lehman and all the other investment banks are following the accounting rules on this, but that $600 million is hardly the stuff of quality earnings. Indeed, Bernstein’s Hintz called the bank’s earnings quality “weak.”

Lehman characterized this as "debt liabilities measured at fair value" on page 13, on the second to bottom row, on the link below, with the innocuous looking 0.6. (Lehman did their mark-to-market adjustments in billions so it wouldn't look like an exorbitant figure!)

Note (h) explaining it just says this:
Represents the amount of gains on debt liabilities for which the Company elected to fair value under SFAS No. 157 and SFAS No. 159. These gains represent the effect of changes in the Company’s credit spread and exclude any Interest income or expense as well as any gain or loss from the embedded derivative components of these instruments.

The bottom line is that Lehman's earnings were garbage, and we don't have any transparency on their Level III assets, except to know that every quarter, they write off more of them.

And after their earnings, we now find out they got taken for another $400 million, news they knew while closing on a unsecured $2 billion revolving credit facility.

I guess Lehman's definition of risk management is not disclosing their risks.

Saturday, March 29, 2008

"Derivative" pricing?

Last week, the plans for a index that tracked securitized auto loans was scrapped. Nobody wants their auto loans to be "marked-to-market" like home securitizations at the prices the ABX index reflects.

In the simplest measure, these indexes, which reflect prices, don't differentiate between good and bad paper. Imagine if real estate transactions were only based on the zillow price. You would have no need of an appraiser, or a real estate agent. Think of how you could then game that system!

But some mortgage paper is better than others, just like homes. But buyers of the good paper, get the marks that the indexes, say that the paper is worth. So the only buyers, are those that buy the good paper, from distressed sellers, who will unload it at these bad prices. Don't think that this system isn't being gamed either!

How is that for a liquid market?

Is it any wonder why they scrapped plans for a synthetic ABS index?

It would only help the shorts and the bears.

And they don't need the help!

Lehman a "victim" of $250 million fraud

Lehman appears to have been a victim of a fraud in which swindlers used forged documents from one of Japan's biggest trading companies to bilk it out of as much as $250 million...

Lehman grew concerned at the end of February when its funds were not repaid, according to a person familiar with the situation. The LTT Bio-Pharma subsidiary filed for bankruptcy protection on March 19.

Lehman officials acknowledged that the firm has filed a criminal complaint with Japanese police about the situation. A spokesman says the firm believes Marubeni is responsible for repaying Lehman, which is studying how it might proceed.

In a statement, Lehman said it was "working closely with the authorities to seek full recovery of funds it believes to have been fraudulently misappropriated."

Seeking a full recovery? The Japanese documents were forged. Lehman got snookered. The money's gone, in the bank they'll never find.

The only thing left is to move the receivable to a Level III asset!

In the warehouse that never was.

Friday, March 28, 2008

Non borrowed bank reserves: Negative $61.788 billion

Take a look at the following link:

Look at the second column of the non-borrowed reserves of depositary institutions. For the first eleven months of 2007, it averaged $40 billion. Now it's a negative $61 billion!

Today you'll see news that the Fed is providing another $100 billion to the banks:

The Federal Reserve announced Friday it will auction an additional $100 billion in April to cash-strapped banks as it continues to combat the effects of a credit crisis.

The central bank said it would make $50 billion available at each of two auctions, on April 7 and April 21.

Through the end of March, the Fed has provided $260 billion in short-term loans to commercial banks through the innovative auction process. It also has employed Depression-era provisions to provide money to investment banks.

Maybe they should just take some of this paper and put it in the warehouse that never was!

UBS cuts value on Auction Rate Preferreds

UBS Cuts 5% From Clients' Auction-Rate Bond Valuation

March 28 (Bloomberg) -- UBS AG has cut the value of the auction-rate securities its customers have in their accounts by about 5 percent following more than a month of market upheaval.

``This is the right thing to do,'' said Michelle Creeden, a UBS spokeswoman, in a prepared statement. ``It is in the best interest of our clients to provide them full transparency regarding their account. Given current market dislocations, this is the next logical step for any committed wealth manager.''

UBS will inform clients of the reduced value of their holdings via their online statements, said, citing a Dow Jones report. UBS customers had maintained full value without any discount that could reflect bondholders' inability to sell their holdings.

UBS's action comes after auction-rate bond failures rose to about 71 percent this week, up from about 69 percent last week, according to data compiled by Bloomberg. The $330 billion auction-rate securities market originally attracted borrowers by offering financing for 20 years or more at variable costs determined through periodic bidding. They were sold to some investors as money market equivalents.

Auction-rate bonds have interest rates determined through bidding run by dealers every seven, 28 or 35 days. When there aren't enough buyers, the auction fails and rates are set at a predetermined level set in documents when the bonds were issued.

`Not Acceptable'
``The fact that they aren't worth par or may not be worth par is not going to be acceptable to any owners of these securities,'' said Gary Miller, a partner at the Houston law firm of Boyar and Miller. ``It's certainly not acceptable to me.''

Miller invested $750,000 from the sale of his house in auction-rate securities with UBS last December. After signing a contract on a new home, Miller said he called his broker to cash out of the securities and was told he couldn't. When he bought the debt, Miller said he asked his broker whether there had ever been an unsuccessful auction.

``The answer was, `No, there's never been a failure in the auctions,''' Miller said. He has sold $300,000 of his holdings. He still owns $450,000 of auction-rate preferred securities and municipal bonds.

The Fed's next bullet: Investigate rumours

SEC Investigates Trading in Lehman Shares, People Say

March 28 (Bloomberg) -- U.S. regulators are investigating whether traders spread false rumors about Lehman Brothers Holdings Inc.'s financial soundness to profit from a drop in the company's share price, two people familiar with the probe said.

The Securities and Exchange Commission has expanded an inquiry into whether investors including hedge funds tried to manipulate Bear Stearns Cos stock to also review a decline in Lehman's shares, said the people, who declined to be identified because the inquiry isn't public. The Lehman probe examines short sales of the company's stock, one of the people said.

Lehman, the fourth-largest U.S. securities firm, has tumbled 26 percent this month amid speculation that Wall Street firms can't fund their operations. A run on Bear Stearns two weeks ago forced the fifth-largest U.S. securities firm to sell itself to JPMorgan Chase & Co. at a fraction of its market value with financial support from the Federal Reserve.

``It makes a lot of sense to me to look at Lehman if you see the same movements,'' said Tamar Frankel, a law professor at Boston University. ``If someone is spreading baseless or misleading rumors in order to profit from the impact on the market, that's really a threat to the system.''

Lehman spokesman Brian Finnegan declined to comment.John Nester, a spokesman for the Washington-based SEC, said the agency doesn't confirm or comment about ongoing investigations.

Probe Confirmed
Two people familiar with the Bear Stearns probe confirmed its existence March 18. The investigation looks at short sales and trading in put options, one of the people said at the time.

In a statement that day, the SEC said it may look for signs of market manipulation or insider trading when examining incidents such as the near collapse of Bear Stearns. Such inquiries may focus on ``the dissemination of false or misleading information to investors by companies or other market participants,'' the agency said.

Lehman stock plunged March 17, falling as much as 48 percent on speculation it would face a cash shortage similar to the one at Bear Stearns. The shares recouped all their loss and then some by the next day's close of trading, after the firm announced first-quarter earnings and its cash position.

The stock slipped 84 cents to $37.87 in composite trading on the New York Stock Exchange today....

Banks sweat meltdowns in private; In public they say "Trust Us"

Here's a great look behind the scenes of the panic that the Central Bankers currently fear. And stock prices of the financials, must reflect the perception that the Central Banks want the public to think, not the reality of their balance sheets that exist on the financials.

The weighing mechanism of these opposing forces is the stock market. Which makes it a difficult time to be short the financials, when you have the Central banks throwing money at the problems that currently exist, which they want to pretend don't!

Here's the story:

"Germany and other industrialized nations are desperately trying to brace themselves against the threat of a collapse of the global financial system. The crisis has now taken its toll on the German economy, where the weak dollar is putting jobs in jeopardy and the credit crunch is paralyzing many businesses....

For some time, there has been a tacit agreement among central bankers and the financial ministers of key economies not to allow any bank large enough to jeopardize the system to go under -- no matter what the cost. But, on Sunday, the question arose whether this agreement should be formalized and made public. The central bankers decided against the idea, reasoning that it would practically be an invitation to speculators and large hedge funds to take advantage of this government guarantee.

Everyone involved knows how explosive the agreement is. It essentially means that while the profits of banks are privatized, society bears the cost of their losses. In a world in which the rich are getting richer and the poor poorer, that is political dynamite.

Nevertheless, central bankers are running out of options. They are anxious to avert the nightmare scenario of a financial crisis like the one that rocked Germany in 1931, when the failure of a major Berlin bank prompted a massive run on other banks by a nervous public, which plunged those banks into insolvency. For decades, a repetition of that disaster had seemed unthinkable. But ever since former Fed Chairman Alan Greenspan dubbed the current financial crisis the worst since the end of World War II, old certainties have no longer applied.

So, what does apply? Should the state use taxpayer money to help greedy bankers repair the damage caused by their unscrupulous speculation? Should it invest billions to save ailing financial institutions, thereby engendering new risks and side effects? And should the government, to use the words of a Frankfurt investment banker, "treat a drug addict with cocaine"?

How does one explain to honest taxpayers that they should pony up their hard-earned money for a bank like Bear Stearns, whose long-standing CEO forked out $28 million (€18 million) for a 600-square-meter (6,500 square-foot) duplex apartment on New York's Central Park shortly before the collapse of his company? Or that UBS, the crisis-ridden, major Swiss bank, fired three of its senior executives for poor performance only to turn around and pay them roughly 60 million Swiss francs (€38 million/$59.2 million) in golden parachutes?

The central banks and governments of the major industrialized nations are still dodging the answers to these questions. They see themselves in the role of an emergency room doctor, whose job is to provide acute treatment. Like a dangerous virus, the crisis in the US real estate market has infected large parts of the worldwide financial system. After being burned by scores of bad loans, the banks have become deeply distrustful of each other. They have gambled away their most important asset: trust.

As the weeks progress, the disaster scenarios painted by prophets of doom, such as the American economist Nouriel Roubini, are becoming more and more likely. For months, Roubini, a professor of economics at New York University, has warned of the risks of a "core meltdown" of global financial systems and has summarized his thoughts in an analysis entitled "The Twelve Steps to Financial Disaster." According to an assessment by the International Monetary Fund, the crisis could lead to global losses exceeding $800 billion (€520 billion).",1518,druck-543588,00.html

Citigroup "upgrades" Lehman

Citigroup Investment Research AM Call:
“Upgrading To Buy; Reality Will Trump Fear”
March 28, 2008
SUMMARY Buy Lehman.

After being on the sidelines for a couple of years, we see the current valuation as an extremely attractive entry point into Lehman shares. Furthermore, the recent profitable quarter in a tough environment, the coordinated actions taken by the Fed & Treasury to provide meaningful liquidity, and Lehman’s management team’s excellent track record of creating value and managing risk all serve as excellent downside protection.

In our view, it’s tough to have a liquidity-driven meltdown when you’re being backed by government entities that have the ability to print money. Lehman has ample liquidity to run its business. With $34b in liquidity at the parent company, the ability to get access to over $200b in liquidity from the Fed’s primary dealer credit facility, and its ability to tap the term auction facility, access to liquidity is a non-issue. Actions speak louder than words and in a post Bear Stearns era, the coordinated Fed & Treasury actions are designed to prevent a crisis of confidence leading to liquidity issues for any of the major investment banks. The liquidity backstop buys the time necessary to restore confidence and quell fears that are not based on fundamentals. It’s worth noting that Lehman has not used the facility other than the initial $2b test run.

Core earnings highlight diversity and excellent risk management. We estimate that writedowns aside, Lehman had its 2nd best fixed income trading quarter ever and generated a 20%+ ROE during 1Q08. We estimate that even in a stress-case scenario on the commercial real estate, residential mortgage, and leveraged loan portfolios, Lehman will generate positive earnings and grow book value per share this year. See our 3/20/08 note for analysis of 1Q08 earnings.

We see 70% upside in Lehman shares. LEH’s valuation is compelling based on virtually any historical metric, leading to an excellent risk/reward opportunity. Using our DCF based valuation model, LEH shares are discounting less than a 10% over-the-cycle ROE and our 15% ROE forecast results in a $65 stock or almost 70% upside. Furthermore, on an absolute P/B, tangible P/B and relative P/B basis, Lehman is trading at some of its lowest levels in more than a decade.

On the 19th, Citigroup was sanguine about Lehman when the stock was at 42, and was "on the sidelines." Today Citigroup is pounding the table with the stock under 39.

Yesterday, Meredith Whitney, from CIBC, on CNBC said, "even the financials that I like, I don't like..." She apparently didn't get the missive from the Fed -"talk up Lehman, and talk down any problems there." So Citigroup slaps a buy recommendation on the stock. Here's the story on the Fed's behind the scene dealings:

One American banker said: "[We heard] from the top, 'Do not encourage calls to Lehman clients. We want to run that up the flagpole. We don't want another run on a bank.' "

As a result, it is believed that bankers were told not to solicit Lehman's clients for business or to give the impression the bank is uncreditworthy.

Lehman's business model is closest to that of Bear Stearns, and there has been considerable speculation surrounding the state of its balance sheet. A spokesman from Lehman Bros declined to comment. The other banks involved in the calls also declined to comment.

A spokesman for the New York Fed said: "We never talk about private discussions between the Federal Reserve and commercial banks."

According to a source close to one of the banks, the Wall Street club remains very supportive of Lehman and is wary of doing something that might harm the bank's financial position.

With Lehman's Level III mortgages, (see post below), and Lehman's $7.5 billion in Variable Interest Entities (VIE's) of which decidedly negative CreditSights said Citigroup's could be worth just .27 cents on the dollar, you are recommending a stock, of which you don't know the quality of the assets on their balance sheet.

Lehman which wrote down the net value of subprime securities by $1.5 billion, guaranteed $6.1 billion of investors' money in VIEs and $1.4 billion of clients' secured financing as of Nov. 30, according to a filing also made on Jan. 29.

``We believe our actual risk to be limited because our obligations are collateralized by the VIE's assets and contain significant constraints,'' Lehman said in the filing...

The securities in the VIEs may be worth as little as 27 cents on the dollar once they're put back on balance sheets, according to David Hendler an analyst at New York-based CreditSights.

But if you had a balance sheet, like Citigroup, stuffed with the same securities Lehman has, and you had the urging of the Fed to return "confidence" in the markets, what would you do?

You would upgrade the stock.

Thursday, March 27, 2008

The "run" on Lehman

Lehman keeps telling the marketplace that they have a ton of liquidity, and they have stress tested their balance sheet when market conditions seize up. But can anybody read their balance sheet?

We can read a 10-K, and we can look at Lehman's Level III assets. Here's what Lehman has to say about their Level III assets:

Level III – Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

Remember assets that are marked-to-market are Level I. Mark-to-model is Level II. Mark-to-myth is Level III.

Anyone wonder how Lehman is doing with their mortgage and asset backed assets that are marked Level III? They've been accumulating them! Maybe they are "hoarding" them because Lehman feels they cannot trust the market's judgement of it's value, or the opportunity they represent.

So the market should trust Lehman, and trust their CFO. New Yorker's don't even trust their government leaders. And if the CFO dresses like one of Eliot Spitzer's girlfriends, they won't give her a pass even if she has a nice, flattering profile in the business press. But she'll be able to deflect the questions that the hedge fund boys won't ask!

But Wall Street isn't sexist because she's pretty. It's not that she has a proclivity for wearing revealing clothes, but that her firm keeps their assets hidden! Look at these figures from the 10-K.

On December 1, 2006, Lehman had $8.575 billion in Level III mortgage and asset backed positions.

On February 28, 2007, Lehman had $11.157 billion in these Level III positions.

On May 31, 2007, Lehman had $12.876 billion in these Level III positions.

On August 31, 2007 Lehman had $23.791 billion in these Level III positions.

On November 30, 2007 Lehman had $25.194 billion in these Level III positions.

And that's the Lehman story. It's the steady accumulation of assets in the mark-to-myth category.

Which is why the shorts are "raiding" the stock and spreading "rumors."

Maybe Erin Callan can quiet them.

Meredith Whitney slams Mother Merrill

The financial "axe" slammed Citigroup yesterday, and today, Merrill and UBS were in her cross-hairs with lowered estimates. The writedown for Merrill is now $6 billion for the quarter (versus $2 billion) and a $3 loss, and UBS is now projected to lose $2.75 for the quarter.

At some point, being right on the fundamentals for the financials will be wrong on the price of the stock.

And if you're short, you should use the opportunity given to you by Meredith to take off your shorts, and cover, now that we have the Bank of England and the ECB rumbling about taking much larger action in the markets.

Here's what the FT had to say:

The Bank of England is poised to take revolutionary action to find a “resolution” to the problems faced by British banks unable to sell or refinance portfolios of mortgage-backed debt, Mervyn King, the governor, signalled on Wednesday.

Mr King also suggested that the Bank was becoming more open to interest rate cuts. His comments came as Hank Paulson, US Treasury secretary, offered strong support for the Federal Reserve’s handling of the Bear Stearns crisis.

Wednesday, March 26, 2008

Housing tanks in California

Home sales decreased 28.5 percent in February in California compared with the same period a year ago, while the median price of an existing home fell 26.2 percent, the CALIFORNIA ASSOCIATION OF REALTORS® (C.A.R.) reported today...

The median price of an existing, single-family detached home in California during February 2008 was $409,240, a 26.2 percent decrease from the revised $554,280 median for February 2007, C.A.R. reported. The February 2008 median price fell 4.8 percent compared with January’s revised $429,790 median price.

"The Federal Reserve Bank’s recent action to reduce the federal funds rate will have little near-term direct effect on the housing market," said C.A.R. Vice President and Chief Economist Leslie Appleton-Young. "However, Fed rate cuts should result in more favorable real estate finance rates as we move through the year."

Monday, March 24, 2008

Bear Stearns new bid $10?

The sweetened offer is intended to win over stockholders who vowed to fight the original fire-sale deal, struck only a week ago at the behest of the Federal Reserve and Treasury Department.

Under the terms being discussed, JPMorgan would pay $10 a share in stock for Bear, up from its initial offer of $2 a share — a figure that represented a mere one-fifteenth of Bear’s going market price.

The Fed, which must approve any new deal, was balking at the new offer price on Sunday night after several days of frantic, secret negotiations, these people said. As a result, it was still possible the renegotiated deal might be postponed or collapse entirely, said these people, who were granted anonymity because of their confidentiality agreements.

Why wouldn't Bear get a higher bid? I said the $2 bid was nuts in the first place. If Jamie Dimon doesn't want every lawyer in the world looking over Bear's books, they had better offer more money.

And the Fed will blink and "let" them. It seems that JPMorgan made a little error in the first contract. According to the NYTimes:

One sentence was “inadvertently included,” according to a person briefed on the talks, which requires JPMorgan to guarantee Bear’s trades even if shareholders voted down the deal. That provision could allow Bear’s shareholders to seek a higher bid while still forcing JPMorgan to honor its guarantee, these people said.

Saturday, March 22, 2008

Is CIT getting a partner?

Someone was bidding up credit default swaps on CIT huge on Thursday. The "disruption" forced CIT to draw down it's unsecured $7.3 billion credit line.

But it didn't prevent the buyers of credit default swaps, of going crazy with prices. Is this what Gretchen Morgenson of the NY Times was talking about in the previous post? You can bid up credit default swaps, and short the stock, and cause a panic. Here's the story on Bloomberg:

Default Swaps

Credit-default swaps tied to CIT's bonds traded as high as 27 percent upfront and 5 percent a year today, according to broker Phoenix Partners Group in New York, meaning it cost $2.7 million initially and $500,000 a year to protect $10 million in bonds for five years. That's up from 23 percent upfront and 5 percent a year yesterday.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

CIT has been around for 100 years, and it's franchise has been coveted by financial buyers. Now they can get it on the cheap.

A deep pocketed investor would allow funding at much lower levels, giving increased margins to help compensate for the risk, especially for the middle market environment CIT operates where the margins are good to begin with.

Here's a few highlights from the after-the-close conference call:

It's very early but over the next few weeks we will be looking at various options to refine the mix of assets and businesses in our portfolio so that we can focus on our go forward core commercial finance franchises...

....we will have higher levels of asset dispositions as we size the Company to the new environment and continue to work to optimize the portfolio of businesses that we have at CIT. And the second is something that we have recently started to pursue and it have made some progress on and that's the possible edition of a strategic funding partner to provide an ongoing financing source for select asset classes such as asset based or our middle market leverage loans. And finally we are hopeful that the Fed will continue their efforts to restore liquidity and market stability to the overall markets, enabling us to return to a more normalized funding program over the next several years...

....strategic funding partner to provide an ongoing financing source for select asset classes such as asset based or our middle market leverage loans. And finally we are hopeful that the Fed will continue their efforts to restore liquidity and market stability to the overall markets, enabling us to return to a more normalized funding program over the next several years.....

When a question was asked about selling the company, CIT had this reply:

And in terms of the strategic direction, we are all about shareholder value and that's probably about as far as we can go on that topic.

The Fed's new tactics

Get the bearish speculators. In the NY Times:

"Yet an effect of both deals, should they go through, is the elimination of all outstanding credit default swaps on both Bear Stearns and Countrywide bonds. Entities who wrote the insurance — and would have been required to pay out if the companies defaulted — are the big winners. They can breathe a sigh of relief, pocket the premiums they earned on the insurance and live to play another day.

Investors who bought credit insurance to hedge their Bear Stearns and Countrywide bonds will be happy to receive new debt obligations from the acquirers in exchange for their stakes. They are simply out the premiums they paid to buy the insurance.

On the other hand, the big losers here are those who bought the insurance to speculate against the fortunes of two troubled companies. That’s because the value of their insurance, which increased as the Bear and Countrywide bonds fell, has now collapsed as those bonds have risen to reflect their takeover by stronger banks.

We do not yet know who these speculators are, but hedge fund and proprietary trading desks on Wall Street are undoubtedly among them.

The derivatives market is huge, unregulated and opaque because participants undertake the transactions privately and don’t record them in a central market. The growth in the market and the potential for disruption, as a result of its size, has surely caused regulators to lose plenty of sleep.

Credit default swaps were created as innovative insurance contracts that bondholders could buy to hedge their exposure to the securities. Like a homeowner’s policy that insures against a flood or fire, the swaps are intended to cover losses to banks and bondholders when companies fail to pay their debts. The contracts typically last five years.

Recently, however, speculators have swamped the market, using the derivatives to bet on companies they view as troubled. That has helped the swaps become some of the fastest-growing contracts in the derivatives world. The value of the insurance outstanding stood at $43 trillion last June, according to the Bank for International Settlements. Two years earlier, that amount was $10.2 trillion.

But before a contract can pay out to a buyer of the insurance, a company must default on its bonds. In both the Countrywide and Bear Stearns takeovers, the companies were saved before they could default. Both deals also specify that the acquiring banks assume the debt of the target.

As a result, the insurance policies that once covered Bear Stearns and Countrywide bonds will become the obligations of much stronger issuers: JPMorgan and Bank of America. No payouts are coming, guys.

So consider all those swaggering hedge fund managers and Wall Street proprietary traders who recorded paper gains on their credit insurance bets as the prices of Bear and Countrywide bonds fell. Now they must reverse those gains as a result of the rescues. If they still hold the insurance contracts, they are up a creek — and the Fed just took away their paddles.

An interesting side note: It’s likely that JPMorgan, the biggest bank in the credit default swap market, had a good deal of this kind of exposure to Bear Stearns on its books. Absorbing Bear Stearns for a mere $250 million allows JPMorgan to eliminate that risk at a bargain-basement price. JPMorgan declined to comment on the size of its portfolio of credit default swaps.

We’ve yet to hear a peep about losses stemming from the Countrywide and Bear Stearns debacles. That doesn’t mean they aren’t there. Remember all those months that the subprime problem was supposed to have been “contained”?

IF we’ve learned anything from this year-long walk down the credit-crisis trail, it is that speculators on the losing end of such deals don’t typically volunteer that they have suffered enormous hits in their portfolios until they are forced to — often when they’re on the brink of collapse.

Do the Bear Stearns and Countrywide deals represent a regulatory template? Both had the same types of winners and losers. Bondholders won, while stockholders and credit insurance owners lost. Although there aren’t that many big banks left that are financially sound enough to buy out the next failure, it’s a pretty good bet that future rescues will look a lot like these.

Maybe it’s just a coincidence that both these deals involve wiping out billions of dollars worth of outstanding credit default swaps linked to Bear Stearns and Countrywide bonds.

Still, helping to trim the risk just a tad in the $43 trillion credit default swap market certainly qualifies as a side benefit. Had either Bear Stearns or Countrywide defaulted, the possibility that some of the parties couldn’t afford to pay what they owed to insurance holders posed a real risk to the entire financial system.

It’s pretty clear that some major losses are floating around out there on busted credit default swap positions. Investors in hedge funds whose managers have boasted recently about their astute swap bets would be wise to ask whether those gains are on paper or in hand. Hedge fund managers are paid on paper gains, after all, so the question is more than just rhetorical.

Losses, losses, who’s got the losses?"

Rumour Mill Mafia

Amid widening financial aridity, there's one enterprise that is not just coping but thriving. Where many banks and hedge funds are gasping for liquidity, this unconventional operation is a gushing well.

But don't bother looking for details at Companies House or the Stock Exchange's noticeboard. The entity to which I refer keeps no records. It is located beyond regulation - in the twilight zone of spivvy blogs and illicit whispers. It is, of course, the Rumour Mill.

This is a ruthless business, but highly effective. Its raw material is a sinister blend of greed, fear, ignorance, credulity and stupidity. Its product is the enrichment of a few insiders at the expense of the rest of us, with a capacity to destroy mighty fortunes and fancy reputations.

On Wednesday, the Rumour Mill was churning out messages of doom about HBOS, the combination of Halifax and Bank of Scotland. Even before the bank's branches had opened, the City was buzzing with talk that HBOS required emergency funding. An email, which falsely claimed that the Bank of England would become involved, pinged between brokers' screens.

The upshot, for a while, was carnage: about £3 billion wiped off HBOS's value, as jittery shareholders dived for cover. The reaction told us much about the market's unstable mindset. After the unravelling of Northern Rock and Bear Stearns, tawdry gossip can be readily traded as 24-carat fact.

The reasons are clear. When the Rock started to disintegrate, first its directors, then the regulators and finally the Chancellor insisted that the business was sound. But depositors called their bluff and the company's finances crumbled. The bank exists today, thanks entirely to the taxpayer.

Something not dissimilar happened at the Bear. As the Rumour Mill began shaking the bank's foundations, Alan Schwarz, its chief executive, told CNBC that the firm's position was "strong", describing it as "virtually unchanged" from the end of last year. A few days later - whoosh! The cash surpluses were gone and with them went the business. Schwarz's promises were empty.

Not unreasonably, savers are asking: "Who's next?" They have concluded that, in a crisis, banks cannot always give the full picture without triggering calamity. So, when faced with a share-price chart that resembles the cardiogram of a heart-attack victim, investors have learned to panic first and ask questions later. Neurosis overcomes analysis.

Last week, Paul Krugman, professor of economics at Princeton university, warned of an unholy financial mess that will cause trillions of dollars of losses. "Things are falling apart," he wrote in the New York Times. In such conditions, the Rumour Mill mafia has a gun to our heads. It extorts vast sums from the system by frightening us - and we're already terrified.

These banksters, as one of our readers branded them, profit from a system of "trash and cash". They trash the shares with unfounded tales, and then cash in by cheating gullible investors. It works because traders are allowed to sell stock they don't own, as long as they buy enough in time for future delivery.

Thursday, March 20, 2008

Merrill's $3.1 billion dollar loss

Merrill Lynch sued XL Capital for $3.1 billion today. Here's the Bloomberg story:

Merrill Lynch & Co. sued XL Capital Assurance Inc. to force the bond insurer to honor $3.1 billion of guarantees on collateralized debt obligations as the securities firm attempts to avoid more writedowns of mortgage-backed debt.

"We filed suit to make clear that XL Capital Assurance Inc. is required to meet its contractual obligations," Mark Herr, a spokesman for New York-based Merrill, said in an e-mailed statement today.

Why didn't Merrill just sue the neighboring homeless man? Anyone check the price of XL Capital's parent, SCA? It's at .79. With a $50 million market cap.

And they're going to collect $3.1 billion? Anyone think the rating agencies are going to pay the bill for XLCA?

Or you can just read the SEC filings. Here it is on page 46:

While XLCA was solvent as of December 31, 2007, it would be an event of default under certain of the CDS contracts insured by XLCA, if XLCA should become insolvent or placed into rehabilitation, receivership, liquidation or other similar proceeding by a regulator. If there were an event of default under these CDS contracts insured by XLCA, as a result of XLCA’s insolvency or otherwise, while the event of default continued the holders of these CDS contracts would have the right to terminate the CDS contracts and to obtain a termination payment from the trust, guaranteed by XLCA, based on the market value of the CDS contracts at the time of termination. Under current market conditions this would result in a substantial liability to XLCA which would be in excess of its ability to pay.

Now the pretending is over. XLCA's guarantee, on their contracts will be worth nothing. And Merrill will have to have another capital raise, at a discounted price to the common stock.

BBC on California tent cities

Wednesday, March 19, 2008

$4 gallon of gas surprises Bush

The bulletin reached President Bush toward the end of his news conference Thursday.

Peter Maer of CBS News Radio asked: "What's your advice to the average American who is hurting now, facing the prospect of $4-a-gallon gasoline, a lot of people facing ... "

"Wait, what did you just say?" the president interrupted. "You're predicting $4-a-gallon gasoline?"

Maer responded: "A number of analysts are predicting $4-a-gallon gasoline."

Bush's rejoinder: "Oh, yeah? That's interesting. I hadn't heard that."

The president, once known for his common-guy skills, sounded eerily like his father, who in 1992 seemed amazed to discover that supermarkets had bar-code scanners.

The $4-a-gallon forecasts were reported widely in newspapers and on TV in the past week. The White House press secretary took a question about $4 gas at her Wednesday media briefing. A poll last month found that nearly three-quarters of Americans expect $4-a-gallon gas.

The president, however, had difficulty grasping the possibility, even after Maer told him.

"You just said the price of gasoline may be up to $4 a gallon — or some expert told you that," Bush repeated. "That creates a lot of uncertainty."

Now that Bernanke and Paulson finally get the weakness of this economy, it's comforting to know that President Bush understands gasoline prices.

Maybe he'll even quit stockpiling the SPR! And judging by the action in commodities today, it looks like the unwinding of the great commodity bull market has started.

Leverage is being squeezed out everywhere.

Look what happened now that the President acknowledged gas is $4 a gallon. What's next? Fisher and Plosser of the Federal Reserve getting the deflation clue?

When three month T-bills hit a 50 year low yields of .5% today, it may just be the number that awakens even these guys.

Tuesday, March 18, 2008

Bears Stearns: The Grisham Version

Secretary Paulson was on "Good Morning America" asking viewers if they thought Bear Stearns shareholders got bailed out. Main Street is wondering. The Feds have opened up $660 billion to financial institutions, while homeowners get a 800 number to call. But maybe Bear Stearns played the best hand it got. And it remains to be seen how this plays out.

We know that JPMorgan is locked into Bear's business. How did this come about? The Fed needed someone to handle Bear's derivative business. So they had to turn to JPMorgan who has notional derivative contracts of $92 trillion, about 74x the 1.2 trillion of assets they boast. But they had the "balance sheet" that Bernanke wanted. Because any of their problems, if they exist, exist in the notional land of derivatives.

So Dimon gets the Fed to take $30 billion of Bear's securities. Why wouldn't JPM be "locked" into Bear Stearns? All the risk is off the table. It has been transferred to the Fed. And to pretend it isn't a bailout of the banking system, Bear Stearns shareholders get just $2 a share. Now Treasury Secretary Paulson can proudly pontificate Bear's shareholders suffering proves there wasn't a bailout. There is no "moral hazard" as Bear shareholders get sacrificed.

So Dimone can brag how he got a good deal. Paulson can brag that Treasury didn't bail out Bear. And Bernanke can be brag that he saved the counter parties. The hedge funds can brag about the puts the bought and how they then yanked their business, hastening the run on the bank, and Bear's demise. And their won't be any tears shed on Wall Street for Bear shareholders, because 10 years ago, they didn't play ball in the bailout of Long Term Capital. And Bear burned while Jimmy Cayne played bridge. Wall Street justice has been done.

Or is it?

Why did JPMorgan get an option on Bear's downtown building? And why did they need an option to buy almost 20% of the shares at $2?

The run pushed Bear on the brink of insolvency. But the Fed's $30 billion took Bear's problems away. Now shareholders can just vote down the deal. And see how much more they are going to get.

The only thing that we know now is that Bear Stearns isn't toast, but the $2 bid for the shares is. And that Jamie Dimon, was bragging yesterday that Bear would add a billion to their earnings.

Does anyone remember listening to JP Morgan's third quarter conference call in 2006 crowing about the $750 million they made for buying Aramanth's energy portfolio of natural gas positions, when they had "margin calls" and were forced to liquidate? Who was their prime broker that gave Aramanth the margin call that forced the liquidation?It was JP Morgan, who were able to buy this "distressed" merchandise and sell it two weeks later to Citadel for almost a billion dollars of profit.

Maybe the only way out of insolvency was for Bear to agree to a $2 a share buyout, knowing that the deal would be voted down. And that, they would eventually pay Bear more, when the "moral hazard" argument isn't in the public eye, because who wants to litigate this?

It would eat in Dimone $6 billion reserve for "litigation" expense. And the Fed isn't paying that!

So they'll pay Bear shareholders more. And then Jimmy Cayne can keep both his condos in The Plaza.

He just won't smoke pot in the expensive one!

Fed gives taxpayer money to JPMorgan

That's the real headline. The Bear Sterns takeunder at $2 is the moral hazard misdirection play. Secretary Paulson, when asked about the moral hazard of bailing out Wall Street replied, "You should ask a shareholder of Bear Stearns if they got bailed out."

JPMorgan added almost $13 billion in market cap today. Someone thinks someone got a good deal. So Dimon is smugly in the catbird seat, with the Fed's $30 billion backstop of Bear's suspected suspect paper. Until the deal closes that is.

So Bear shareholders just have to reject the offer.

If the Fed was so concerned about the contra-party exposure that the demise of Bear Stearns would cause the banking system, then the Fed and Treasury can get off the moral high horse, and offer Bear shareholders another billion or two so they'll agree to a deal. After all what's a couple billion amongst friends-especially when it's not your money? Bear shareholders have nothing to lose. JPMorgan has already guaranteed their book of business for the next twelve months. Now it's how much they're going to pay. And it ain't gonna be $2.

These guys don't even know how to cut a deal. Can you imagine a frat house having a party, and instead of having a couple of kegs, they had just a sixpack?

Last I checked, it's been a couple thousand years since the masses were fed on two fishes, and five loaves of bread. So who was the joker that thought Bear shareholders would exchange their shares for a Filet-of Fish?

We already knew that Treasury couldn't walk on water; did we have to find out that they can't even stand on ice?

Sunday, March 16, 2008

Lehman to follow Bear Stearns example?

Lehman announced a $2 billion line of credit closing Friday, and a 100 million share buyback a few weeks back financed with a preferred. What company would leverage themselves up in this environment?

Lehman guaranteed $7.5 billion of Variable Interest Entities (VIE) of which they said, "We believe our actual risk to be limited because our obligations are collateralized by the VIE's assets and contain significant constraints...."

CreditSights said Citicorp's VIE could worth .27 cents on the dollar. Most people believe CreditSights likes to get headlines. But what is Lehman's worth? Is anyone buying their story? The market isn't. And that's the only price that counts.

Thursday, the CEO of Bear went on national television saying they have plenty of liquidity. Now we know what he means by liquidity. It's $2 a share.

We'll soon see Lehman's version of liquidity.

And it probably won't be pretty either.

Saturday, March 15, 2008

What sank Bear Stearns?

Bear Stearns was taken to the very brink of insolvency over the past 24 hours by a sudden collapse in confidence on the part of its hedge-fund clients.

There was a wholly modern hedge-fund run on the investment bank.
Here’s how it happened.

One of Bear Stearns’s most profitable businesses was its prime brokerage, which provides lending and admin services to hedge funds with a fixed-income bent.

These hedge funds deposit their assets at Bear Stearns, which the investment bank uses as a source of liquidity.

But – according to a banker close to Bear Stearns – in the last day or so a number of those hedge funds decided to terminate their respective relationships with Bear Stearns.

They were spooked by the rampant speculation about Bear Stearns’ fragility and its supposedly excessive exposure to US mortgages.

The hedge funds stampeded to withdraw their assets, so the investment bank was deprived of a vital source of liquidity.

That’s why it had to go cap in hand to the New York Fed for financial succour.

Perhaps the most shocking aspect of this episode is that help was in sight for Bear Stearns at the very moment the hedge funds pulled the plug.

As of March 27, Bear Stearns would have been able to exchange its illiquid holdings of mortgage-backed securities for high-quality, liquid US Treasuries, under a scheme announced last Tuesday by the US Federal Reserve.

That would have provided Bear Stearns with sufficient liquid funds to continue as a going concern.

But its hedge-fund clients weren’t prepared to stick with it even for 13 days.
It’s a very frightening manifestation of the nervousness of even sophisticated investors such as hedge funds.

In today’s highly uncertain markets, they are not prepared to give an 80-year-old Wall Street firm the benefit of the doubt for even a fortnight.

Or maybe a bunch of hedge funds bought puts on Bear Stearns and then decided to jump ship. Anyone remember the 50,000 March 35 puts bought at .15 when the stock was at 60? For a cost of $750,000, these puts, that closed at $9 on Friday, were worth $45,000,000. Add in the exceedingly heavy purchases of the 50, 55 and 60 strike, and you are starting to talk real money.

Dr. J had this to say about BSC last week:
Bear Stearns (BSC) volatility in the front month March calls now tops 160 for the at the money 60 puts. Volatility in April at the money options is also sky-high, pricing at 125%. As a metric for comparison, the 100 day average volatility in Bear Stearns was 55%.

We've got very active put buying all the way down to the March 30 puts, but the institutional paper is trading in the March 60, 55 and 50 puts. In other words, the amateurs are buying up what they perceive to be “cheap” puts below the 50 strike, but most professional paper is more realistic.

The April 55 put (BVDPK) are up $3.90 to $6.00 on double the open interest. Volume tops 6,300 puts at this strike, against 3,200 open interest. Just how desperate are the put buyers?

Well, my DepthCharge shows buyers of the January 10 puts of 2009, where nearly 3,000 puts have trade up $.55 to $.85, a gain of 185 percent on the session. Like the action in Washington Mutual (WM) we cited Friday, this is bankruptcy fear rearing its ugly head in Bear Stearns, folks.

On the session over 95,000 puts have changed hands in BSC, or nearly five times the open interest in the first 2 ½ hours of trade.

Only in this market, where nerves are so frayed, can a "run on the bank" start and end so quickly.

Thursday, March 13, 2008

An Intermeeting cut from the G-7?

This time its the world's central bankers and not just the Fed, who are now alarmed by the weakness in the dollar, in the face of Secretary Paulson's "strong dollar" policy! ECB President Trichet said, "In the current circumstances, I'm preoccupied by excessive currency moves." But not pre-occupied to do anything about it! The next G-7 meeting is in Washington April 12-13.

When Giselle said she wanted to be paid in dollars, the financial prognosticators laughed. $1.44 dollar for a euro? Now a few months later we are up to $1.56. And oil is $110. Now no one is laughing. It's hard to laugh when you are panicking.

Bloomberg has a good article today on what Bernanke might do with housing and currencies tumbling. The conclusion...
So, brace yourself for a Fed funds rate close to zero, interest-rate-free loans in exchange for a much wider range of debt collateral, and further dollar weakness. And, if Helicopter Ben sticks to the script, the Fed might even guarantee the value of two-year Treasury notes. Strange days indeed.

It took Bloomberg a month to come around, but I'll take it. Here was Bernanke's 2002 speech and my take on it.

Spitzer's tryst

"I am all about my music, and my music is all about me… It flows from what I’ve been through, what I’ve seen and how I feel. I live in New York and am on top of the world. Been here since 2004 and I love this city, I love my life here. But, my path has not been easy. When I was 17, I left home. It was my decision and I’ve never looked back. Left my hometown. Left a broken family. Left abuse. Left an older brother who had already split. Left and learned what it was like to have everything, and lose it, again and again. Learned what it was like to wake up one day and have the people you care about most gone. I have been alone. I have abused drugs. I have been broke and homeless. But, I survived, on my own. I am here, in NY because of my music."

A million hits today. A jump start for her music career or a book deal.

Commodity Prices

With housing deflation, and commodity inflation--forget about stagflation, we have traders touting the next Great Depression. And the chart above, is a graphic portrayal of Google searches for the "great depression."

So some people must be looking for it. Anyone wonder where these searches are coming from?

In Chicago, the commodity capital of the world! A statistic that would elude commentary even from Rick Santelli!

Wednesday, March 12, 2008

Share shenanigans

Crazy Patrick Byrnes is getting some readers. Look at Washington Mutual. Institutions own 929 million out of the 882 million shares outstanding. Yes that's right. They own more shares than the numbers of shares outstanding. Before housing imploded, wasn't this an old "widow and orphan" stock? How about if you count those holders?

Here's a bit of what Byrne said:

It may surprise you to learn that there are loopholes in our nation’s regulations that permit some people, when it comes time to settle, to hand over nothing but an IOU. By using one of these loopholes, when the time comes for settlement I can take your money but say, “I’m not delivering you any stock. I’m just giving you an IOU for a share of stock that I will deliver later.”

There are reasons these loopholes came into existence. If someone made a mistake by signing the wrong line on a form, for example, or mistakenly sold more shares than he really had, one would not want the entire system to vapor-lock as the mistake was rectified. So the system has been designed so that the gears do not get hung up on minor mistakes. The general idea is that, if someone sells shares it turns out he cannot deliver, he can create these IOU’s and send them on as though they were real shares, giving himself time to clean up whatever error he is experiencing, and sending the real shares a couple days later.

There is no system in place to alert you to the fact that you sent me your money and received nothing but an IOU. The system treats these IOU’s just as though they were real shares. Your brokerage statement will say that you got shares, even though I never sent anything but an IOU. You can sell them, and that IOU will pass on through the system into someone else’s account.

The problem is, suppose I (having mastered these loopholes) start using the system’s “forgiveness” strategically? Suppose I find a company that is likely to need capital to expand, or simply survive, in the near future? They plan on raising that capital by issuing shares of stock to the public (there is no crime in that: for example, lots of young pharmaceutical companies sip at the capital markets for years as they get going). Imagine that I target one of them, and deliberately go out selling that company’s shares into the marketplace, yet instead of delivering stock, I deliver nothing but IOU’s. I flood the market with them, always standing ready to sell more than anyone wants to buy. My IOU’s are anything but temporary: they drift around in the market for weeks, months, and eventually years. If anyone gets mad and tells me that I have to deliver real shares against one of the IOU’s I sold, I say, “Sure, I’ll deliver shares against that IOU,” but what I deliver is … just another IOU. Eventually I flood the market with so many IOU’s that people end up reselling them, and they go and on until there are more share-IOU’s bouncing around than there are actual shares."

You could almost argue that the hedgies have moved up from the small cap arena.

Google to bounce

The catalyst? At 440, it's still down 300 points! You need a reason? How about display advertising? Look for the analysts to get on board again, especially after the closing of the Double-Click acquisition.

Remember American Airlines at $1?

The shorts had pressed that number, and were declaring victory and bankruptcy. Now we have this mortgage mess, and Thornburg Mortgage (TMA 1.57) was battered down under a buck, forced to sell good money loans at a discount to the buyer of last resort-PIMCO. The shorts and vultures were declaring victory.

Yesterday TMA has gotten off of the canvas. The bears say it was the sucker punch the Fed threw. But it looks like Thorburg isn't getting knocked out in the early rounds. Does anybody think the Investment Banks are going to give TMA another margin call after the Fed has stepped in? To the shorts chagrin, TMA is making it a fight.

Remember the Alamo! Remember American Airlines! Remember Thorburg??

Tuesday, March 11, 2008

David slays Goliath

As of February 27th, primary dealers held the following positions: $139.7 billion of agency securities $60.2 billion of mortgage-backed securities

I mention these, because the Fed said today that it would lend up to $200 billion of Treasuries in exchange for the above, which means that the Fed’s facility literally is able to handle all of the agency securities and mortgage-backed securities that dealers hold.

Before the bears try and crucify Bernanke for providing liquidity to the bulls, the bears should remember that when David slayed Goliath, he brought his head back to Jerusalem from the Valley of Elah. What happened to the skull? It found it's place under the cross on the hills of Golgatha.

The Fed's TSLF (term securities lending facility) stopped the housing bears and the distressed mortgage sellers in their tracks. Now Bernanke, the much aligned academic, is dragging the shorts to their crucifiction. They're still partying with Judas and don't even realize they are carrying their own cross!

When you hope to profits on people's misery, and the plummeting value of workers 401K's and homes, while you self righteously laud your intellect, it eventually exacts a price. Maybe they should watch The Valley of Elah. Eventually, people want normalcy in their lives, and they want it faster and quicker than what circumstances seem to allow. But when you find the bones, you get closure.

In the market, we've already found the bodies, but the bears want them to be bones, picked over by the vultures. But today the Fed has said enough. Now the bears are going to have to play by different rules. And that's their beef. They thought they had time. Now they don't. The bulls want the markets to be better now. And they bought today.

So we'll lose some of the invincibles this week. Like Governor Spitzer, the shorts and bears are being prepared to be "steamrolled." Isn't it ironic that the words they use, is what will happen to them?

It couldn't happen to a nicer bunch!

Liquidity is Back! Finally! Bears Squealing!!

Fed moves! $200 billion!

What's up the Fed's sleeve?

Who is selling the two year? Is the Fed preparing some liquidity measures for the market? I think something is afoot....

Selling treasuries and buying agencies? That's "sterilization" that the market would love.

Monday, March 10, 2008

Imelda Marcus acquited

Imelda Marcos, the well-heeled and eccentric former first lady of the Philippines, is free to shop. A Philippine court acquitted former first lady Imelda of 32 counts of illegally transferring money abroad on Monday due to insufficient evidence. Yes, there was a paper trail in question, but the judge ruled the documents "were not authenticated and proved in the proper manner."

Lucky she didn't pay for sex.

Governor Spitzer?

Wall Street's schadenfreude for Spitzer will know no bounds, and if you're interested in the "client 9's" activities the day before Valentine's day, it is in the post below.

Dick Grasso and Hank Greenberg are buying rounds tonight.

Client 9

At approximately 8:12 p.m., TEMEKA RACHELLE LEWIS,
a/k/a "Rachelle," the defendant, using the 6587 Number, received
a call from Client-9. During the call, LEWIS told Client-9 that
the "package" did not arrive today. LEWIS asked Client-9 if
there was a return address on the envelope, and Client-9 said no.
LEWIS asked: "You had QAT . . .," and Client-9 said: "Yup, same
as in the past, no question about it." LEWIS asked Client-9 what
time he was interested in having the appointment tomorrow.
Client-9 told her 9:00 p.m. or 10:OO p.m. LEWIS told Client-9 to
call her back in five minutes.

During the call, LEWIS told BRENER that Client-9 had just called
about an appointment for tomorrow, and that he had around $400 or
$500 credit. SUWAL said that she did not feel comfortable saying
that Client-9 had a $400 credit when she did not know that for a
fact. SUWAL and BRENER talked in the background about whether
Client-9 could proceed with the appointment without his deposit
having arrived. (Call 9462R). At approximately 8:23 p.m., LEWIS
called Client-9, and told him that the 'office" said he could not
proceed with the appointment with his available credit. After
discussing ways to resolve the situation, LEWIS and Client-9 I
agreed to speak the following day. (Call 9467R)

At approximately 3 : 2 0 p.m., TEMEKA RACHELLE LEWIS,
a/k/a "Rachelle," the defendant, using the 6587 Number, received
a call from Client-9. During the call, LEWIS told Client-9 that
they were still trying to determine if his deposit had arrived.
Client-9 told LEWIS that he had made a re'servation at the hotel,
and had paid for it in his name. Client-9 said that there would
be a key waiting for her, and told LEWIS that what he had on
account with her covered the "transportation" (believed to be a
reference to the cost of the trainfare for "Kristen" from New
York to Washington, D.C.). LEWIS said that she would try to make
it work. (Call 9636R). At approximately 3:24 p.m., LEWIS, using
the 6587 Number, called CECIL SUWAL, a/k/a "Katie," a/k/a "Kate,"
the defendant, at the 3390 Number. LEWIS explained to SUWAL what
Client-9 had proposed. SUWAL told LEWIS she would call her back.
(Call 9642R) . At approximately 3 : 53 p.m., MARK BRENER, a/k/a
"Michael," the defendant, using the 0937 Number, called LEWIS at
the 6587 Number. BRENER and LEWIS discussed the problem about
Client-9's deposit. (Call 9654R). At approximately 4:18 p.m.,
SUWAL, using the 3390 Number, sent a text message to LEWIS at the
6587 Number, stating: "[Plackage arrived. Pls be sure he rsvp
hotel." (Call 9659R) .

At approximately 4:58 p.m., TEMEKA RACHELLE LEWIS,
a/k/a "Rachelle," the defendant, using the 6587 Number, received
an incoming call from Client-9. During the call, LEWIS told
Client-9 that his package arrived today, and Client-9 said good.
LEWIS asked Client-9 what time he was expecting to have the
appointment. Client-9 told LEWIS maybe 10:OO p.m. or so, and
asked who it was. LEWIS said it was "Kristen," and Client-9 said
"great, okay, wonderful ." LEWIS told Client-9 that she would
give him a final price later, and asked Client-9 whether he could
give "Kristen" "extra funds" at this appointment in order to
avoid payment issues in the future. Client-9 said maybe, and
that he would see if he could do that. LEWIS explained that the
agency did not want a model accepting funds for a future
appointment, but that she was going to make an exception that way
a deposit could be made so that he would have a credit, and they
would not have to "go through this" next time. Client-9 said
perfect, and that he would call her regarding the room number.
(Call 9686R) .

At approximately 7:51 p.m., TEMEKA RACHELLE LEWIS,
a/k/a "Rachelle," the defendant, using the 6587 Number, received
a call from Client-9. During the call, LEWIS told Client-9 that
the balance was around ,"2611 (believed to be a reference to
$2,600), but she would give him an exact number later. LEWIS
asked if when "Kristen" went to pick up the key she would have to
give a name or would she be able to say that she was one of
Client-9's guests for whom he left an envelope. ~EW1~'and
Client-9 discussed how to arrange for "Kristen" to get the key to
her hotel room. LEWIS said that she would prefer if "Kristen"
did not have to give a name. Client-9 said that he was trying to
'think this through." Client-9 repeated that his balance was
'2600," and stated that maybe he would give "her," a reference to
"Kristen," '3600" and have a thousand on balance. LEWIS
suggested making it "1500fl more. Client-9 said that would make
it "4100," and said that he would look for a bank and see about
it. Client-9 told LEWIS to let him go down and take care of
this, and suggested that maybe he could put it [the hotel key] in
an envelope with the concierge. (Call 9725R).

At approximately 8:47 p.m., TEMEKA RACHELLE LEWIS,
a/k/a "Rachelle," the defendant, using the 6587 Number, received
a call from Client-9. During the call, Client-9 told LEWIS to
tell "Kristen" to go to the hotel and go to room 871. Client-9
told LEWIS that the door would be open. Client-9 told LEWIS that
there would be a key in the room, but the door would be ajar.
LEWIS asked if the hotel staff might pass by the door and close
it, and Client-9 said no it was okay. Client-9 explained that
the door would not be visibly open, but if someone pushed it, the 4
door would open. LEWIS told Client-9 that his balance was
$2,721.41, and that if he wanted to do an additional "150OU or
even "2000" it would be better. Client-9 said that he did not
know if he could get to a machine to do that, but he would see.
LEWIS said that 'Kristen" would go directly to room ,871. Client-
9 asked LEWIS to remind- him what 'Kristen" looked like, and LEWIS
said that she was an American, petite, very pretty brunette, 5
feet 5 inches, and 105 pounds. Client-9 said that she should go
straight to 871, and if for any reason it did not work out, she
should call LEWIS. (Call 9731)

On February 14, 2008, at approximately 12:02 a.m.,
TEMEKA RACHELLE LEWIS, a/k/a "Rachelle," the defendant, received
a call from "Kristen." During the call, "Kristen" told LEWIS ,
that "he," a reference to Client-9, had left. LEWIS asked
"Kristen" what time he got there, and "Kristen" said "15 after .
. . maybe 10." LEWIS asked "Kristen" how she thought the
appointment went, and "Kristen" said that she thought it went
very well. LEWIS asked "Kristen" how much she collected, and
'Kristen" said $4,300. "Kristen" said that she liked him, and
that she did not think he was difficult. "Kristen" stated: 'I
don't think he's difficult. I mean it's just kind of like . . .
whatever. . . I'm here for a purpose. I know what my purpose is.
I am not a . . . moron, you know what I mean. So maybe that's
why girls maybe think they're difficult . . . . " "Kristen"
continued: "That's what it is, because you're here for a
[purpose]. Let's not get it twisted - I know what I do, you
know." LEWIS responded: "You look at it very uniquely, because .
. . no one .ever says it that way." LEWIS continued that from
what she had been told "he" (believed to be a reference to
Client-9) "would ask you to do things that, like, you might not
think were safe - you know - I mean that . . . very basic things.
. . . "Kristen" responded: "I have a way of dealing with that .
. . I'd be like listen dude, you really want the sex? . . . You
know what I mean." Near the end of the call, LEWIS and "Kristen"
discussed "Kristen's" departure via Amtrak, the room that Client...

MBI's shareholder letter

CDS from my chair: “The Place Where the Big Guys Play for Big Stakes!”

Although Fitch dominated our conversations last week, since returning to MBIA I have also heard from many of you regarding credit default swap (“CDS”) contracts written on MBIA’s holding company's debt and insurance subsidiary’s insurance claims-paying ability. You have asked, “Why are MBIA’s spreads so wide, given the stabilization in the business and recent Triple-A ratings affirmations by both Moody’s and S&P?” (You are not the only ones asking this question, as this was also one of the first questions posed to me in the Bloomberg interview on Monday of last week.) According to our team downstairs in Asset Management, the one-year basis point equivalent CDS spread on the holding company is around 1,700 basis points, and the annualized basis point equivalent cost of credit protection for a five-year contract is approximately 800 basis points. Before I delve into my answer, let me first provide a brief primer on the mechanics of CDS contracts. (By the way, I too had to dig a little internally to refresh my memory around this esoteric market.)

Credit default swaps allow investors to insure against the credit risk of an underlying debt security (i.e., our holding company public debt) or a reference entity (in our case, our financial guarantee policies written). The contract is entered into by two counterparties, one being the seller of credit protection and the other being the buyer of credit protection. MBIA is not a party to any of the referenced transactions. These counterparties also have very different incentives than our traditional stakeholders, namely you as owners and our fixed-income investors of wrapped securities, which will become very clear as we look more closely at this market below. Buyers of credit protection pay the seller a fee in return for the promise to receive a cash settlement payment (or, deliver the underlying referenced security in exchange for a full par payment on that security) if a default on the underlying security occurs. In a typical CDS contract there are three possible events that would trigger a payout: 1) a failure to pay a principal or interest payment, 2) a bankruptcy filing, and/or 3) a debt restructuring. CDS contracts have a limited term, which is defined in the contract.

So here is how this relates to us: investors who enter into CDS contracts buying protection on MBIA Inc., our publicly traded holding company, will realize a benefit if MBIA Inc. defaults on its debt before that contract matures. For instance, to insure against default of $10 million of MBIA Inc. debt within the next year costs $1.7 million (using the spreads quoted above), while the same coverage for the next five years costs approximately $800 thousand per year (or, said another way, it costs approximately $4 million to purchase a five-year, $10 million insurance policy on MBIA Inc.’s debt).

By my simple bond math, this pricing on five-year CDS indicates an over 60% chance that MBIA will default within five years (depending on the timing and recovery value assumptions of the bonds at default). As an interesting side bar, Moody’s historical corporate bond default tables show the cumulative defaults for Aa-rated entities (our holding company’s rating) over 5 years to be 0.18%, and the cumulative default history for Ba-rated entities (9 rating notches below where we are currently rated) to be 11.3%. So to be clear, the implied default rate on our CDS pricing is approximately 300 times greater than our rating would imply versus historical data, and approximately 6 times greater than a rating 9 notches lower than ours.

Now let’s consider what a person buying CDS on MBIA Inc. is really protected against. For simplicity’s sake, let’s use our 1-year CDS in this example. Over the next year, MBIA Inc. would have to make approximately $80 million in interest payments on its outstanding debt and no scheduled payments of any principal. Thus, someone buying one-year credit protection on MBIA Inc. is betting that the $1.6 billion in cash and short-term investments currently held by MBIA Inc. will not be sufficient to cover its $80 million of interest expense. As a former old-time CFO, this frankly doesn’t make sense to me. Even when we contribute a substantial portion of the $1.1 billion into our insurance and asset management subsidiaries, we would still be left with approximately $500 million in cash to cover the next year’s financial obligation of $80 million...

Turning back to the CDS market and why I labeled this section “The Place Where the Big Guys Play for Big Stakes,” I had our team downstairs run another little exercise that might explain a bit why some of our critics are more vocal than others. If someone had purchased protection, say, in January of last year when spreads on our five-year CDS were relatively benign, they would have paid about 40 basis points per year. If they wanted to bet a $30 million annual fee that MBIA Inc. would fail, they could have purchased $7.5 billion in protection. How has this trade faired in the intervening period? Throughout 2007 and into this year, credit spreads on the MBIA Inc. 5-year CDS have soared steadily upward through January 22nd reaching a peak of nearly 1,500 basis points before falling back to 600-900 over the past couple of weeks. On paper, the value of the trade peaked north of $2.6 billion on January 22nd and has since fallen back by nearly half that amount. The reality is that for the guys who play in this $45 trillion zero sum game (always a winner and a loser), the $30 million is chump change. It is also why, given the amount of money that can be made here, people will go to no ends insisting the company will be broke in mere weeks. I think it also gives you an idea as to one of the reasons I made the decision to disentangle our insurance subsidiaries from the credit derivative markets, given the different incentives of players in this market from our own stakeholders...

So, after thinking carefully through the facts, I yet again ponder the question asked by many of you: Why are MBIA’s CDS spreads so wide, given the stabilization in the business and recent affirmation of our Triple-A rating by both Moody’s and S&P? It is certainly appropriate that spreads should have widened from a few years ago. Make no mistake about it, we wrote some business that in hindsight we wish we hadn’t, and those decisions have certainly had an impact on the market’s confidence in MBIA. I would also agree that the financial system currently has more risk in it today. There is also the possibility that CDS on MBIA is being used by banks and hedge funds to hedge direct or indirect exposures to other asset classes like RMBS and CDOs, and thus our spreads are being influenced by technical trading which does not really have any bearing on our real financial health. Or is it just that we are being used as a ping-pong ball in a high stakes games by the big guys?...

This is the dilemma we find at the accounting juncture between the guarantors and their financial institution counterparties. If the guarantors maintain a very high rating, the valuation models for financial institution counterparties will allow them to maintain high valuations and only recognize modest MTM losses, therefore significantly reducing the need for additional capital to supplement their regulated capital bases.

The sheer folly of suggesting that MBIA, the largest financial guarantor, could be the linchpin holding up the market value of the global financial system has lit a bonfire under the financial press that has lead to the daily speculation (or real-time if you follow the TV networks) about our fate. Not surprisingly, we have seen many thoughtful pieces starting to appear on the real versus theoretical implications of current accounting valuation dictates, on the moral hazard implicit in the credit derivative market, and on the issues brought about by significant recapitalizations arising from recent valuations...

Saturday, March 8, 2008

Bernanke's solutions

In Bernanke's testimony before Congress, he suggested that lenders just reduce the amount of principal on homeowners loans. So think about that.

Bernanke is suggesting that lenders shouldn't be paid in full. So take this a bit further. If lenders shouldn't be paid in full, how about buyers of our currency? That's the "strong dollar" policy of this administration.

Our President had this to say about the economy yesterday:
Earlier today I spoke with members of my economic team. They updated me on the state of our economy. This morning we learned that our economy lost 63,000 payroll jobs in February, although the unemployment rate improved to 4.8 percent.

But he "saw it coming" and gave us the rebate "booster shot."

In January, the BLS assumed that 78,792,000 were not in the labor force. In February it jumped to 79,436,000. So we have 644,000 who are no longer employed, and 450,000 who left the labor market. So we have a 4.8% unemployment rate, instead of 5.1%. And a President who says the employment rate improved. But the BLS doesn't count illegals, or the marginally attached.

About 1.6 million persons (not seasonally adjusted) were marginally attached to the labor force in February. These individuals wanted and were available for work and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey. Among the marginally attached, there were 396,000 discouraged workers in February, about the same as a year earlier. Discouraged workers were not currently looking for work specifically because they believed no jobs were available for them.

The BLS disenfranchises the marginally attached, and the labor force participation rate workers-I guess they are the equivalent of the Florida and Michigan democratic primary voters.

But we've been living with these lying statistics for years. We just don't look at them, until things get bad.

Just like the mortgage lenders assumed that house price appreciation would bail out both buyers and lenders.

But the deleveraging of the finacial system is becoming systemic, and $50 billion TAF offerings aren't going to solve the problems. David Rosenberg of Merrill Lynch had this to say yesterday about Bernanke's solution: “After all, isn't the new strategy to cut rates eight days before meetings?” David Rosenberg, chief economist of Merrill Lynch, noted with more than a hint of sarcasm in a research report yesterday.

Mr. Rosenberg, who said he wouldn't be surprised if Mr. Bernanke moved early, called the job numbers “an unmitigated disaster,” and seemed unimpressed with the Fed's move yesterday to expand the term auction facility – a mechanism for lending money to large banks and helping to ease liquidity constraints.

“As if that is going to stop Citigroup from paring its mortgage lending unit by 20 per cent, trigger a renewed hiring cycle, or prevent the economy from moving into a full-blown recession."

Let's see what the Central Banks can come up with next week.

Friday, March 7, 2008

We lose 63,000 jobs and unemployment rate declines?

That's because we had a decline of 450,000 workers in the workforce! I guess these workers are doing so well they don't need to work. 38,000 jobs added by the government means we lost 101,000 jobs in the private sector. And the "unemployment rate" goes down to 4.8%.

That's how government counts jobs in an election year. Best that I can figure, the only discouraged worker of the 450,000 was Brett Favre!

Fed increase TAF

The Term Auction Facility was moved up to $50 billion bi-weekly or $100 billion monthly. Not enough. On the last term auction, there was $67.958 billion of bids, for the $30 billion offered.

They should of gone to $200 billion. This takes the inter-meeting rate cut off the table.

Thursday, March 6, 2008

Secretary Paulson's mortgage plan busts

Bush's policies wreck havoc on the market

Pimco and Ross buy municipals

..Beyond that, he argues that with a Democrat potentially in the White House next year, "there's a high probability that personal tax rates will go up," making muni bonds more valuable. That realization could send these investments higher in price, he argues.

A number of hedge funds focusing on the muni-bond market have come under pressure, in part because they used borrowed money to make their bond purchases and now are under pressure from lenders to put up more collateral. That is forcing some to sell muni bonds to try to keep their firms afloat.

Mr. Ross says that Friday his firm bought up long-term muni bonds with an average annual interest rate of "well over" 5.5%, a yield that tops that of comparable Treasury securities, which aren't tax-free on a federal level. In normal times, muni bonds yield less than Treasurys because of their tax-free status.

Friday, Pimco purchased $1.5 billion of munis, and also has seen sharp gains. "These are values that probably won't come around for another generation, but they're here at the moment," Bill Gross, who runs the $123 billion Pimco Total Return Fund, said on Fox television Tuesday. "Yes, they're risky because the prices are moving at the moment down. But they're not un-credit-worthy."