Debt Rattle, February 2 2008

Ilargi: We’ll be hearing a lot about the rescue attempts for the bond insurers, especially the big ones, Ambac and MBIA. A bit of perspective was provided yesterday on CNBC, where Sean Egan of independent rating agency Egan-Jones said none of these “monolines” deserve an AAA rating (though most do have one). His estimate is that it will take over $200 billion of added capital to raise the bond insurers (he mentions 7 of them, at an average of $30 billion a piece) to an AAA rating. CNBC’s journalists themselves emphasized the pressure applied in recent years within the industry, from investment banks through ratings agencies to bond insurers, to “get into CDO’s and other securities”.

Click image to watch video in new window.

8 Banks Discuss Aid for Bond Insurer

Eight major banks are in talks to bolster the Ambac Financial Group, the troubled bond insurance company, as part of an industrywide rescue being orchestrated by state regulators, people briefed on the negotiations said Friday. The banks, which include Citigroup and UBS, are considering injecting capital into Ambac and assuming some of the risks associated with guarantees written by the company, these people said.

The plan is still in flux, and it is unclear how much money the banks might commit to the effort, either by extending credit to Ambac or by buying a stake in it. It is also uncertain if such moves would be enough to restore confidence in the insurer and safeguard its triple-A credit ratings from Standard & Poor’s and Moody’s. A spokesman for Ambac declined to comment, but people briefed on the talks said Ambac’s management is involved in the negotiations. The group is planning to reach a deal in “days, rather than months,” one person involved in the talks said. Once the parties have reached a deal they will present it to the ratings agencies to make sure the plan meets their requirements for a triple-A rating.

Regulators are hoping to arrange similar rescues for other guarantors like MBIA and the Financial Guaranty Insurance Company, which have been hit hard by declining values in mortgage securities they insured, but are moving one company at a time. Ambac is in more dire financial straits than its larger rival, MBIA, which has raised $1.5 billion in recent weeks. [..] Speed is crucial, according to people involved in the talks. On Friday, Moody’s warned that it might downgrade the bond guarantors by late February if the companies did not raise capital and pursue a “viable business plan.”

Investors fear a chain reaction of losses might rock the financial industry if even one big bond insurer were to lose its top credit rating. The concern is that Ambac and MBIA, which have guaranteed more than $1 trillion in municipal, corporate and mortgage debt, will not have the capital they will need to pay claims as defaults rise. Many big banks and investors that hold mortgage securities guaranteed by the companies would have to write down the value of those investments if the insurers were to lose their top ratings. Those losses could total tens of billions of dollars for some banks.

The banks participating in the Ambac talks are said to be those that have the most direct exposure to that company, people briefed on the talks said. Likewise, other banks that have heavier involvements with MBIA and Financial Guaranty are working on plans to help those companies. Shares in Ambac rose 13.4 percent on Friday, closing at $13.20. “Generally speaking, these deals are being commercially driven,” said one person briefed on the negotiations. “It is related to each bank’s own situation.”

---

Ilargi: We now have two main opponents of the bailout attempts as they are unfolding. Sean Egan and of course Bill Ackman, on whom we reported extensively this week. The problem with the bailouts is that the banks involved are merely trying to save their own interests, perhaps even ensure their very survival; they are invested deeply in paper insured by the insurers. And this will, as usual, be done over the backs of everyone else. Well, that won’t come easy, or cheap. The model is broken and wears no clothes.

When all is said and done, all of these rescue missions depend on one little fantasy: that the credit crisis won’t get worse than it is today. If it does get worse, all bets are off, and all rescue attempts will fail.

Bond-Insurer Foe Soldiers On

At a time when most investors would be counting their winnings, William Ackman, head of hedge fund Pershing Square Capital Management LP, is ramping up his high-profile campaign against bond insurers, even as news swirls that a possible bailout is in the works for the insurers. Mr. Ackman, who has been criticizing the bond insurers for five years, says he still has a multibillion-dollar wager against them, including credit-default swaps he used to bet specifically against MBIA Inc. shares in 2002.

Mr. Ackman's bet against bond insurers Ambac Financial Group Inc. and MBIA is based on the assumption that any rescue plan by big banks will be designed to allow the insurers to make good on their policies. Those policies were issued by subsidiaries of the publicly listed parent companies. He believes that any bailout will only save the subsidiaries, leaving shareholders in the listed entities with nothing. "The reason why we're still short the holding companies of MBIA and Ambac is because we believe the regulators and the banks are working to help policyholders, and not holding-company shareholders," he says.

In recent weeks, ratings agencies have started to come around to his argument that the bond insurers have flawed risk-management practices that have left them with significant shortfalls in capital. As the mortgage crisis increases the potential for more losses in securities they guarantee, bond insurers are under pressure to raise more capital to preserve their triple-A ratings, which are critical for doing business.

Moody's Investors Service Inc. and Standard & Poor's have placed both Ambac and MBIA on watch for downgrade, while Fitch Ratings has already downgraded Ambac to double-A. On Friday, news that a consortium of eight U.S. and European banks were working together with regulators to save Ambac from further downgrade lifted its shares 13% to $13.20 in 4 p.m. New York Stock Exchange composite trading. MBIA shares rose 5.6% to $16.36. They are still down more than 75% from their highs of last year, but have more than doubled off their lows of January.

While Mr. Ackman says he supports efforts to protect bond insurers' policyholders, he says he is against a bailout on grounds that it would set back efforts to increase transparency in the financial markets.He characterizes the bailout as an attempt by banks to "arbitrage" the stringent capital requirements of federal bank regulators with what he says are less-stringent requirements of the ratings agencies, which oversee the bond insurers. That is, a bailout to prevent the bond insurers from downgrade would cost the banks much less than taking the losses that would occur if the insurers went out of business.

---

America’s Teetering Banking System

“Where Did All Our Deposits Go?”

Somebody goofed. When Fed chairman Ben Bernanke cut interest rates to 3% on Thursday, the price of a new mortgage went up. How does that help the flagging housing industry? About an hour after Bernanke made the announcement that the Fed Funds rate would be cut by 50 basis points the yield on the 30-year Treasury nudged up a tenth of a percent to 4.42%. The same thing happened to the 10-year Treasury which surged from a low of 3.28% to 3.73% in less than a week. That means that mortgages — which are priced off long-term government bonds — will be going up, too.

Is that what Bernanke had in mind: to stick another dagger into the already moribund real estate market? The Fed sets short-term interest rates (The Fed Funds rate) but long-term rates are market-driven. So, when investors see slow growth and inflationary pressures building up, long-term rates start to rise. That’s bad news for the housing market. Now, here’s the shocker: Bernanke KNEW that the price of a mortgage would increase if he slashed rates, but went ahead anyway.

How did he know? Because nine days ago, when he cut rates by 75 basis points, the 10-year didn’t budge from its perch at 3.64%. It just shrugged it off the cuts as meaningless. But a couple days later, when Congress passed Bush’s $150 “Stimulus Giveaway,” the ten year spiked with a vengeance — up 20 basis points on the day. In other words, the bond market doesn’t like inflation-generating government handouts.

So, why did Bernanke cut rates when he knew it would just add to the housing woes? Some critics say that he just wanted to throw a lifeline to his fat-cat investor buddies on Wall Street by providing more liquidity for the markets. But that’s not it, at all. The fact is, Bernanke had no choice. He’s facing a challenge so huge and potentially catastrophic, that cutting rates must have seemed like the only option he had. Just look at these graphs and you’ll see what Bernanke saw before he decided to cut interest rates.

The first graph (Total borrowings of Depository Institutions from the Federal Reserve) shows that the banks are “capital impaired” and borrowing at a rate unprecedented in history. The second graph (Non borrowed reserves from of Depository Institutions) shows that the capital that the banks do have is quickly being depleted. The third graph (Net Free or borrowed reserves of Depository Institutions) is best summed up by econo-blogger Mike Shedlock who says: “Banks in aggregate have now burnt through all of their capital and are forced to borrow reserves from the Fed in order to keep lending. Total reserves for two weeks ending January 16 are $39.98 billion. Inquiring minds are no doubt wondering where $40 billion came from. The answer is the Fed’s Term Auction Facility.”

---

Ilargi: The biggest weekly US stocks gain in 5 years, led by Bill Gates’ Yahoo despair bid, a very suspect lender, WaMu, and a homebuilder, Lennar, that is scraping the gutter (we stopped building homes, didn’t you hear?). Yeah, why not join the party. No, but seriously, get out of there while you still can!

U.S. Stocks Post Biggest Weekly Gain in Five Years on Fed Cut

U.S. stocks rose the most in five years, sparing the Standard & Poor's 500 Index from its worst January ever, after the Federal Reserve's second interest rate cut in nine days boosted banks, homebuilders and retailers. Washington Mutual Inc., the largest savings and loan, Lennar Corp., the third-biggest homebuilder, and Wal-Mart Stores Inc., the largest discount chain, helped lead gains. All 10 sectors and 461 stocks in the S&P 500 advanced after the half- point reduction in the Fed's target for overnight loans between banks bolstered speculation a recession may be averted.

"The Fed finally stepped up," said Jeffrey Kleintop, who helps oversee about $163 billion as chief market strategist at LPL Financial Group in Boston. "They gave us what the economy really needed and what investors needed to get their confidence back."

The S&P 500 climbed 4.9 percent for the week, trimming its yearly loss to 5 percent. The Dow Jones Industrial Average added 4.4 percent and the Nasdaq Composite Index increased 3.8 percent, boosted by Microsoft Corp.'s bid for Yahoo! Inc., owner of the most-visited U.S. Web site.
The drop in interest rates to 3 percent overshadowed the first decrease in jobs since 2003, the biggest yearly drop in new-home sales on record and fourth-quarter economic growth that was half the rate economists forecast. Fed policy makers have cut rates by 1.25 percentage points since Jan. 22, the fastest since 1990.

---

Ilargi: Someone will soon open a website dedicated solely to litigation in the world of investment (if one doesn’t exist yet). As we reported earlier this week, Merrill reimbursed the sity of Springfield, MA, for losses on investments, for which the city had never even given permission to purchase in the first place. Excuse me?

But it won’t be that easy for Merrill, or for the other investment banks. Not that it’s obvious all this will lead to actual court cases: the matter is so complex that intentional wrongdoing may be hard to prove.

Massachusetts Accuses Merrill of Fraud

The top securities regulator in Massachusetts accused Merrill Lynch on Friday of defrauding the city of Springfield with subprime-linked investments, casting light on how Wall Street banks sold complex mortgage securities that are now plummeting in value as the housing slump deepens.

William Galvin, the Massachusetts secretary of state, filed a civil fraud complaint against Merrill a day after the firm took the unusual step of agreeing to reimburse Springfield for losses on the investments. Merrill agreed to buy back the securities at their original value, $13.9 million, after determining that its brokers had not been authorized by Springfield to buy the securities on the city’s behalf.

“They are alleging fraud against a municipality, which carries with it much more gravitas than a simple lawsuit,” Mark A. Flessner, a partner at Sonnenschein Nath & Rosenthal in Chicago, said of the complaint. An official in Mr. Galvin’s office said the Springfield case was part of a larger investigation into Merrill’s sales of similar investments to other Massachusetts towns and cities.
Asked about the Springfield case, Mark Herr, a spokesman for Merrill Lynch, said, “We are puzzled by this suit.” He declined to comment on the broader investigation.

The case underscores how subprime investments keep turning up in unexpected places and raises new questions about Wall Street’s sales practices and its role in the mortgage crisis. In recent years, as home prices soared and mortgage lending boomed, investment banks packaged hundreds of billions of dollars of home loans into securities for sale to investors around the world. Now, record defaults are resulting in huge losses for municipalities, states, banks, insurance companies and nonprofit organizations.

Wall Street banks have lost billions of dollars of such investments themselves. Merrill has been one of the hardest hit, writing down almost than $25 billion, the bulk of which came from mortgage-related securities. But banks rarely reimburse clients for losses, because doing so might prompt others to demand refunds when their investments sour. Merrill Lynch officials, however, said the Springfield case was unusual because the central issue was the firm’s sales practices, not whether the city was a suitable buyer for the securities.

The deal between Merrill and the city was brokered on Thursday by the state’s attorney general, Martha Coakley, along with the Springfield Finance Control Board and representatives from the city of Springfield. But Mr. Galvin, in his complaint, argued that the city had not been properly warned of the risks associated with the investments. By the end of 2007, the $13.9 million of securities were worth $1.2 million.

---

The Subprime Cleanup Intensifies

Federal criminal prosecutors in New York are investigating whether UBS AG misled investors by booking inflated prices of mortgage bonds it held despite knowledge that the valuations had dropped, according to people familiar with the matter.
The investigation, by the U.S. attorney in New York's Eastern District in Brooklyn, is preliminary. The U.S. attorney's office frequently works closely with the Securities and Exchange Commission to coordinate efforts to gather information. The New York prosecutors haven't issued subpoenas, according to people familiar with the matter.

The SEC, deepening its own set of investigations into whether Wall Street firms improperly mispriced mortgage securities, recently upgraded probes of UBS and Merrill Lynch & Co. into formal investigations, people familiar with the matter say. This step, which requires approval of the full commission, gives the SEC broad subpoena power, or the authority to require firms and individuals to produce information. Spokesmen for both UBS and Merrill declined to comment.

The investigations could raise the stakes for Wall Street in the multiple probes examining whether financial firms deliberately misvalued, or "mismarked," massive holdings of mortgage securities. Most of the current investigations into mortgage matters involve civil authorities; the U.S. attorney launches criminal investigations and has a history of prosecuting Wall Street-related matters. Last summer, federal criminal prosecutors began investigating the collapse of two internal hedge funds at Wall Street firm Bear Stearns Cos.
There is also a broader effort by the Justice Department to look into whether there was fraud in originating, packaging and selling mortgage-related products. The Federal Bureau of Investigation has said it has opened criminal inquires into 14 companies as part of an investigation of the subprime-mortgage crisis. The FBI wouldn't identify the companies under investigation.

Ilargi: They did specifially identify MBIA and Ambac as being among that group of 14 companies.

---

Memo To The FBI: Expand The Probe Of Economic Crimes

After dragging its G-Man heels for years, someone at the FBI has woken up and realized that laws have been broken by the financial industry. Those violations are part of what led to the economic abyss we are facing. The ever–vigilant bureau that blew its 911 probe has just announced an investigation of 14 unnamed mortgage companies involved in a variety of scams. Talk about going after small fish. In this week of football mania, what we know and they have yet to learn, is that if you dig deeply, you will soon be playing in a Super Bowl of corporate criminal complicity.

We need a special prosecutor and some zealous investigators who know something about white-collar crime waves. One suggestion: bring back former veteran FBI agent turned whistleblower Coleen Rowley, a recent TIME Magazine “Person of the Year,” to head the taskforce. Rowley told me she used to work cases like this with the former Rudolph Giuliani, who once made a name for himself as the scourge of Wall Street crime families. (Maybe it takes someone with a Mafia patrimony to know how to smell the scammers and then use RICO anti-conspiracy laws to put them behind bars.) That was before Rudy decided to join another mob - the Homeland Security fearmongers to cash in on 911.

Today’s financial racketeers span the globe, and are not confined to a solo junior trader at a French bank who lost over $7 Billion on trades. He was driven, he says, to make a big bonus and with, he adds, the knowledge of all his overlords who now feign great shock—SHOCK!—about what he, and in their view, he alone, did. There are even news organizations in Europe who believe that the whole global financial crisis was the work of one bad man. This sounds like a replay of the “lone assassin” theory that always pops up after high profile killings.

To its shame, our media has once again not been in the lead on this vital story. It is still not framing it in criminal terms. It is not investigating the role of institutions working together—big banks, hedge funds, rating agencies, and the securities industry — making super-profits with deceptive subprime transactions. That is, before their securitized schemes blew up in their faces causing super-losses and the writedowns of billions.
That, in turn, contributed to a larger economic meltdown that may go beyond being a mere “recession.” The press seems to have no “institutional memory” about past crashes and Enronesque scandals, or the way greed and unlawful activity regularly makes for so much misery because it is the people who can least afford it who always suffer the most. Pundits are better at doing post-mortems than insuring accountability with hard-digging watchdog journalism.

So where’s the editorial outrage? Where are the calls for the prosecutions of the fraudsters? As Pam Martens explains on Counterpunch, “Mainstream media has also been implanting the idea that it’s all about homeowners and mortgage loans instead of banksters hiding bad debt.” So there is a trust issue with media as well as the financial overlords. Forbes admits: “This predicament of trust ceased to be a subprime crisis long ago. We face a global credit crisis…”

Mike Whitney puts the problem in a nut shell: “The financial system has been handed over to scam-artists and fraudsters who’ve created a multi-trillion dollar inverted pyramid of shaky, hyper-inflated, subprime slop that they’ve sold around the world with the tacit support of the ratings agencies and the US political establishment.”

---

Groups seek congressional hearings on Countrywide

Four U.S. consumer groups called on the U.S. Congress to hold hearings to ensure that Countrywide Financial Corp customers do not lose their homes after the nation's largest mortgage lender is acquired by Bank of America Corp, the second-largest U.S. bank.

In a letter Friday to Sen. Christopher Dodd and Rep. Barney Frank, the respective chairs of the Senate Banking Committee and House Financial Services Committee, the groups said they want Bank of America to offer Countrywide borrowers on the verge of foreclosure a chance to refinance into 30-year, fixed- rate mortgages with interest rates of 6 percent or less.

The groups, the California Reinvestment Coalition, the Community Reinvestment Association of North Carolina, New Jersey Citizen Action and New York's Neighborhood Economic Development Advocacy Project, also demanded that the bank not conduct big layoffs in Countrywide's 50,600-person work force. "As the acquirer of Countrywide, Bank of America is responsible for rebuilding the broken dreams of Countrywide borrowers," the letter said. "This merger offers all the aspects of the mortgage crisis and potential solutions in one messy package."

---

Bank of America, Countrywide face hurdles

Bank of America's planned acquisition of distressed mortgage company Countrywide Financial Corp. may have hit a major snag this week when hedge SRM Global Fund unveiled its 5.2% stake in the target, issued a blistering attack on Bank of America and asked the SEC to investigate trading ahead of the announcement.

SRM said it would vote against the deal, and other parties filed lawsuits, highlighting the rocky road the firms still face on the way to the altar.
"We think that the board of the company and its advisers should fully explain to shareholders the reasons why they have agreed to recommend the transaction to shareholders at less than half of the company's book value, and explain what circumstances have changed since the company's [third-quarter 2007] earnings," the SRM filing said.

The developments could signal that Bank of America will have to renegotiate a new sales price or scrap the deal altogether.
Bank of America announced Jan. 11 that it would acquire Countrywide in the third quarter of 2008 for $4.1 billion in an all-stock deal. Market participants are closely watching how the deal plays out, its outcome will likely set a blueprint for the way other firms resolve their problems, and just what troubled assets at many firms are worth.

Under the terms of the agreement, investors in the lender would receive a 0.1822 Bank of America share for each Countrywide share they currently own. B. of A. holds a 16% stake in the lender after investing $2 billion in August. But hedge fund SRM Global, led by former star UBS trader Jon Wood, is trying to put the brakes on any sale, and submitted a blistering filing to the Securities and Exchange Commission on Jan. 24. Bank of America fought back, with bank spokesman Scott Silvestri telling MarketWatch on Thursday, "the transaction price was negotiated and we believe it was fair for both companies."

---