Debt Rattle, January 29 2008

Ilargi: Spain is blowing up, and has been doing so under the radar for quite a while. This will reveal the Achilles' heel in the Euro zone: the weakest link in the chain and all that. Europe starts to unravel, and there's what, 27?, countries aligned like so many domino stones.

Also, read the whole CNN/Fortune story on CountryDied, and observe the snide remarks. They would have been impossible until very recently. A THIRD of its subprime loans are delinquent. And then the share price goes up, after BoA says again that the takeover is on. Yes, second half of 2008. HA!!!! That deal was stillborn, it's a PR trick.

ECB aid to Spanish banks matches Rock rescue

Spanish banks are issuing mortgage securities and asset-backed bonds on a massive scale to park at the European Central Bank, using them as collateral to raise money at favourable rates from the official credit window in Frankfurt.

The rating agency Moody's said lenders had issued a record €53bn (£39bn) in the fourth quarter, yet almost none of the securities have actually been placed on the open market. Most have been sent directly to the ECB for use in "repo" operations. "The market has shut down," said Sandie Arlene Fernandez, the author of the report.

"Few, if any, of the transactions in the RBMS market (mortgage securities) have been placed since September. Some of the banks are hoping that the market will open up again but most are just preparing these deals to use as repos, which they can do since the ECB accepts AAA-rated securities," she said. The total volume of securities issued since the credit crunch began to bite in July has reached €63bn.

Reliance on the ECB window appears to have kept the mortgage sector afloat despite the sharp slowdown in the Spanish property market and the de facto closure of the capital markets for this type of business, allowing Spain to avoid the sort of mishap suffered by Northern Rock in Britain and Countrywide in the US.

Countrywide: From bad to worse

Countrywide on Tuesday reported a loss of $422 million in the fourth quarter and revealed that an astounding one-third of its investment portfolio's sub-prime mortgage loans are delinquent.

The loss threw cold water on Countrywide chief operating officer Steve Sambol's confident assurances to investors in October that, "We view the third quarter of 2007 as an earnings trough, and anticipate that the company will be profitable in the fourth quarter and in 2008." Seen in this light, Countrywide's fourth-quarter loss, compared to a $621 million profit a year ago, is what the numerous class action attorneys circling Countrywide will surely call "an unfavorable fact." Countywide finished 2007 with a loss of $704 million.

The numbers didn't appear to faze Bank of America CEO Ken Lewis's determination to acquire Countrywide, however. In a conference Tuesday, Bloomberg quoted him as telling investors. "Everything is a 'go' to complete this transaction." Just over two weeks ago, BoA agreed to buy Calabasas, Calif.-based Countrywide in a $4 billion deal. If and when the deal goes through, the combined company will control just over 25 percent of the U.S. real estate loan origination market.

The market took the highly scripted BoA support as crucial and sent Countrywide stock up 20 cents to $6.15. At the fulcrum of the mortgage credit crisis, Countrywide's earnings are seen as a bellwether for the once vibrant - and now largely collapsed - United States mortgage industry. The primary culprit remains a combination of old-fashioned credit deterioration plus an alarming new development: Borrowers simply are walking away from their homes as their equity value falls ever further below their loan amount.

Ilargi: Bloomberg has further developments in the SocGen case (thanks, webjazz). Ummm, this is starting to smell like some French cheeses. If you're on the board of a bank in France, and you ditch $200+ million in shares right before a revelation like this, you’re French toast. Which, of course, goes well with the cheese. The last article in this post states that Citigroup "cut its [SocGen] target price from €130 per share to €65, reducing its market price tag from €72.9 billion to €36.4 billion." So Mr. Day saved himself $100 million, but the Elysée will look at what this cost the French.

Societe Generale Board Member Sold Shares on Jan. 18

Societe Generale SA board member Robert Day and his foundations sold shares of the bank worth 45 million euros ($67 million) on Jan. 18, the day it said management discovered trading frauds costing 4.9 billion euros. Day's sales totaled 40.5 million euros for himself and 4.5 million euros for the Robert A. Day Foundation, France's market regulator, the Autorite des Marches Financiers, said in two statements on its Web site.

These sales bring to 140 million euros the amount of shares in Societe Generale that Day or his foundations have sold since the start of the month. "The AMF has opened an investigation into Societe Generale," Christine Anglade, a spokeswoman for the regulator, said today. She declined to say what the AMF was looking into at the bank.

Ilargi: The new revelations about what really happened with Countrywide and Bank of America are a perfect starting point to send out a warning, and an explanation.

Countrywide contacted BoA after issues arose over the 'Advances' (borrowings) it obtained from the Federal Home Loan Banks (FHLB) system. CFC was theatening to break through the ceiling of what it could borrow from the Atlanta FHLB. At a certain point it had over $51 billion in advances.

The warning here is in this, from TickerForum :

Legislation provides the Federal Home Loan Banks with a "SUPER LIEN" on any bank assets if a member bank fails. This means the FDIC may not have enough funds to pay depositors after the FHLB Advances have been paid.

The FHLB is a GSE, a government sponsored entity, like Fannie Mae and Freddie Mac, private but 'covered'. The FHLB has never lost a penny on defaulting loans. When a bank goes tummy-up, its Super Lien gives it first rights to whatever of value is left.

The FDIC itself says this:

Through her research, she advised, she was fascinated to learn about the FHLBs' "super lien" against the assets of banks to which they make advances. These rights, she added, including prepayment fees, are provided by statute and are superior to the rights of depositors and even to the FDIC after an institution fails.

In general, people expect the FDIC to guarantee the first $100.000 in deposits for every account. But the FDIC insures the banks, not the depositors. In other words, depositors will have to hope something will be left after the FHLB have taken back their loans. In case of a large numbers of defaulting banks, we are looking at hundreds of billions. And it's questionable if the FDIC will have enough left to pay to depositors. Knowledgable TickerForum poster Karen 'Nothing':

The depositors will have to get in line behind the FHLB to negotiate with the bank to get their "insured" deposits back.

This does not necessarily mean that no-one will get back a penny if their bank fails, for one thing nothing like a large scale bank failure has happened in a long time, but it does make clear that the situation is much more complicated than most people think.

Countrywide Deal Driven by Crackdown Fear

The fear of potential regulatory crackdowns helped drive Countrywide Financial Corp. into the arms of acquirer Bank of America Corp., people familiar with the situation say.

Though the big home-mortgage lender faced large and unpredictable losses on defaults, the more immediate danger was pressure from regulators, politicians and rating firms, these people say. That realization helped spur Countrywide co-founder and Chief Executive Angelo Mozilo to call Bank of America in December and start talks that led to the Charlotte, N.C., bank's $4 billion deal to acquire Countrywide, which was announced Jan. 11.

Countrywide, due to report fourth-quarter results today, faced "a cascading series of regulatory issues" as it pondered whether to try to stay independent, says one person briefed on the situation. A Countrywide spokeswoman declined to comment.

After falling home prices and mounting mortgage defaults rattled investors in mid-2007, Countrywide could no longer raise money through short-term borrowings in the capital markets or sales of mortgages other than those that could be guaranteed by government-sponsored investors Fannie Mae and Freddie Mac. That forced Countrywide to rely much more heavily on two other sources of funding: deposits at its savings-bank unit and borrowings -- so-called advances -- from the Federal Home Loan Banks system. But the sustainability of those funding sources was increasingly in doubt by late last year.

In late November, Sen. Charles Schumer, a New York Democrat, wrote to regulators of the 12 regional Federal Home Loan Banks, cooperatives that lend money to banks and other financial institutions. Mr. Schumer argued that a surge in Countrywide's home-loan bank borrowings to $51.1 billion as of Sept. 30 from $28.8 billion three months earlier might "pose a risk to the safety and soundness of the FHLB system as a whole."

Countrywide already was near a cap on the amount of FHLB borrowings it could obtain under rules that limit those to 50% of assets held by the borrower. Ordinarily, FHLB borrowings equal no more than about 15% to 25% of a bank's assets, a former bank regulator says, and much higher levels would tend to make regulators jittery. Sen. Schumer says Countrywide now has reduced its FHLB borrowings by about $4 billion. The next quarterly disclosures on those borrowings are due in late March.

A spokesman for Countrywide says the FHLB borrowings declined "primarily because of growth in customer deposits, which reduced our need" for funding from the home-loan banks. "This decline was not driven by any action taken by the FHLB of Atlanta," the spokesman says.

Derivatives boom raises risk of bankruptcy

A boom in the use of derivatives is giving creditors strong incentives to push troubled companies into bankruptcy rather than help rescue them, according to new research and industry experts.

A study by academics Henry Hu and Bernard Black concludes that, thanks to explosive growth in credit derivatives, debt-holders such as banks and hedge funds have often more to gain if companies fail than if they survive. The study suggests this development could endanger the stability of the financial system.

The findings highlight a crucial problem in corporate restructuring when more and more companies are facing financial difficulties as a result of the credit crunch and US economic slowdown. According to the research and industry practitioners, creditors have a strong interest in voting against a restructuring plan if they have bought credit or loan default swaps, which trigger payments when a company fails.

“Investors now accumulate positions in a company by targeting layers of debt or multiple layers of debt,” said Michael Reilly of the financing restructuring practice at Bingham McCutchen.

“Where their interests lie are less predictable, especially if they also hold credit default swaps. Their financial interests may be best served by forcing a default if they are on the right side of a CDS position.” The problem is compounded by creditors not having to disclose derivatives positions, making it very difficult for companies and regulators to find out their real intentions.

IMF head in shock fiscal warning

The intensifying credit crunch is so severe that lower interest rates alone will not be enough “to get out of the turmoil we are in”, Dominique Strauss-Kahn, the managing director of the International Monetary Fund, warned at the weekend.

In a dramatic volte face for an international body that as recently as the autumn called for “continued fiscal consolidation” in the US, Dominique Strauss-Kahn, the new IMF head, gave a green light for the proposed US fiscal stimulus package and called for other countries to follow suit. “I don’t think we would get rid of the crisis with just monetary tools,” he said, adding “a new fiscal policy is probably today an accurate way to answer the crisis”.

Mr Strauss-Kahn’s words rip apart a long-standing global consensus that fiscal retrenchment in the US and Japan is needed to help reduce huge trade imbalances. It comes as the IMF is due to release new economic forecasts this week which, he said, would show a “serious slowdown and it needs a serious response”.

Expect the eurozone to show some resistance

Within minutes of last week’s rate cut by the Federal Reserve , market analysts predicted that the European Central Bank would have to do the same. When the US sneezes – you know the rest.

It is not going to happen. The ECB may cut interest rates at some point, though I would not bet any hard currency on this. One of the most important reasons historically for monetary union in Europe was to become less dependent on the US. Today, monetary policy in Europe is geared towards domestic targets. If the ECB cuts, it will happen because of firm evidence of a fall in domestic inflationary pressures.

Some central bankers have even advocated a rate increase. If there is concrete evidence that the most recent spike in headline inflation rates is translating into higher wages, that may still happen. Most probably it will not. But the prospect of a rate cut is just as remote.

US foreclosures rise in December; reach 2.2 million in 2007, up 75 pct from 2006

The number of foreclosures filed by US homeowners increased sharply in December and left calendar-year 2007 foreclosures higher by nearly 1 mln compared with 2006, according to a private sector report released today.

The number of foreclosure filings for December was 215,749, up 6.8 pct from November, according to California-based RealtyTrac.

December foreclosure filings are 97 pct higher than the number of foreclosures seen in December 2006.

This rise led to a total of 2.2 mln foreclosures in 2007, up 75 pct from the roughly 1.26 mln the company reported in 2006. RealtyTrac said 1 pct of all US households was in 'some stage of foreclosure' in 2007, up from 0.58 pct in 2006.

Ilargi: You may have noticed that we have so far ignored the SocGen rogue trader story. That's because we never felt till now that the real story was out in the open. Now, however, we're getting somewhere: French magistrates have refused to keep Jerôme Kerviel in custody, and haven't even charged him with anything (contrary to what many news sources claim). The government is chiming in as well, and the directors have hot feet. SocGen is in deep trouble.

Prosecutors let SocGen fraud rap drop: source

French prosecutors will not appeal against a decision to throw out the accusation of fraud leveled against a trader blamed for huge losses at Societe Generale, a senior judicial source said on Tuesday.

If confirmed, the move would represent a blow for SocGen managers, who last week branded trader Jerome Kerviel a "fraudster" and said the bank had been the victim of "massive fraud". The judicial source said it was also "inevitable" that many staff within SocGen would be questioned over the affair.

Investigating judges reviewing the case decided on Monday to place Kerviel under formal investigation for lesser allegations concerning breach of trust, computer abuse and falsification, which carry a maximum three-year prison term. Being placed under investigation can lead to trial, but falls short of filing formal charges.

Prosecutors had asked the magistrates also to consider charges of fraud and "aggravated breach of trust", which carries a maximum seven-year prison term. Judges Renaud Van Ruymbeke and Francoise Desset decided there was not enough evidence to back this up. They also rejected a request by prosecutors that Kerviel remain in custody as investigations continue.

SocGen director offloaded €100m worth of shares

Société Générale is facing legal action from shareholders claiming the bank is involved in insider dealing as today it emerged that a non-executive director at the French bank sold off nearly €100 million worth of SocGen shares eight days before the discovery of "irregular trades" made by "rogue trader" Jérôme Kerviel.

Documents released by the AMF, the French market regulator, show that Robert A. Day, an non-executive director at Société Générale, sold off €85.7 million in shares on January 10. Also, two trusts connected to Mr Day, offloaded large chucks of shares on the same day - the Robert A. Day Foundation sold €8.6 million in stock and the Kelly Day Foundation sold €959,066. Details of the share sales emerged as Mr Kerviel was charged with attempted fraud by the French financial police.

Paris prosecutor Jean-Claude Marin said that Mr Kerviel has admitted hacking into computers and faking e-mails to hide trades since 2005.

Mr Kerviel also disclosed that Eurex, the derivatives exchange controlled by the German stock exchange, contacted Société Générale in November 2007 to flag up Mr Kerviel's trades with France's second largest bank - two months before the irregular trades were fully investigated and announced to the market. Mr Marin said: “Questioned by the bank, [Mr Kerviel] produced a fake document to justify the risk cover."

A group of around 100 Société Générale investors have brought a suit against the bank. Mr Day, 65, is the founder of TCW, a Los Angeles investment company which is a subsidiary of Société Générale's asset management group. TCW, based in Los Angeles, has a portfolio of $66 billion in collateralised debt obligations (CDOs) of which $52 billion are under management for Société Générale Asset Management.

CDOs are complex financial instruments which are often backed by sub-prime mortgage debt. Société Générale revealed last week it has €4.9 billion in CDOs backed by US sub-prime mortgage debt.

Today Citigroup cut the bank's possible target price by 50 per cent, saying the French bank is suffering "damaged credibility" and is unlikely to be taken over. Citigroup, which downgraded the scandal-hit French bank’s shares from a "buy" to a "sell" also cut its target price from €130 per share to €65, reducing its market price tag from €72.9 billion to €36.4 billion.