Debt Rattle, February 7 2008

Update 3.30 pm

Ilargi: Just thought I'd share this little thingy, since it got me thinking. Off the top of my head: The Koreans lose 83% on their CDO's, a Chinese state bank recently wrote down 70%, Bank of America announced 60% write-downs, while Citigroup, as far as I've seen, until today wrote down a mere 30%. There is something about this picture that scares me. A lot.

Korea struck by subprime crisis

South Korean local banks lost $563 million as of the end of December after investing in US subprime mortgage-related instruments, said the Financial Supervisory Service.

Seven local banks, including Woori Bank, the country's No. 2 lender, invested $682.5 million in US collateralized debt obligations (CDOs) derived from subprime mortgages and lost 83% of their total CDO investments, the financial watchdog said.

Among the seven lenders, Woori Bank posted the biggest losses with $445 million, followed by the National Agricultural Cooperative Federation with $107 million, the watchdog sa

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Ilargi: Another day, another bag of trouble in the monoline mine field. This time it's yet another hidden treasure: negative basis trades. Simplified, this means banks were making money off taking out insurance against risks, especially in collateralized loan obligations, CLO's, on leveraged buy-outs. They'd often do it more than once, "insuring against the insurance".

These so-called negative basis trades were done in large volumes in recent years. They allowed both banks and monolines to book apparently “free money” and saw monolines writing guarantees on each other. If they have to be unwound, it will be a costly business for all involved.

Yes, you're right, it's as complex as it is ridiculous.

A bank buys a bond - say it’s AAA - and then it takes out a Credit Default Swap against that bond with a monoline. Since spreads in the CDS market for such tranches have been typically much lower than in the cash market, the bank pockets the difference. But as well as banks’ much-dissected CDO exposures, there have been two other big markets for that kind of trade: on infrastructure bonds and - most interestingly - in structured finance, on CLOs (collateralised loan obligations) - CLOs being the vehicle of choice in which to park massive buyout loans.

Reuters has a letter from Bill Ackman, urging regulators to let the monolines fail. Ackman is simply right, no matter if he stands to make a billion dollars of those failures. The whole situation involving monolines and banks is so rotten to the core that we should get rid of it as soon as possible. It cannot be repaired or mitigated, it can only be hidden for a while longer, and that’s in nobody’s best interest except for those who’ve made a killing off shady deals.

If the regulators decide to let the rot linger, we will see the mistrust between monolines and investors, banks and monolines, and banks amongst each other, grow exponentially as time goes on. It’s over, the story’s finished and there’s no happy ending that is believable to anyone in the audience.

Ackman to regulators: Let bond insurers fail

Bill Ackman, whose hedge fund has been betting against bond insurers since at least 2002, said in a letter to U.S. regulators that rescuing the bond insurers will only prolong the credit crisis, and the insurers' holding companies should instead be allowed to fail. In the letter obtained by Reuters, Ackman said bond insurers in recent years have become a means for banks to avoid reporting their full credit exposure and make their capital ratios appear stronger, but that banks should be forced to own up to their full credit risk.

"(W)e understand that the banking industry counterparties to the bond insurers would prefer to avoid taking these ... risks back on balance sheet -- particularly at a time when their balance sheets are strained by subprime and other losses that have not been hedged," Ackman wrote, adding that "there are no such free lunches available in the capital markets." Bond insurers have in turn been critical of Ackman and other investors betting against the companies. On a recent conference call, MBIA Inc. Chief Executive Gary Dunton railed against "the fear mongering and intentional distortions of facts about our business that have been pumped into the market by self-interested parties."

New York State Superintendent Eric Dinallo is working with banks to rescue bond insurers including Ambac Financial Group Inc and FGIC Corp, which face billions of dollars of potential losses after guaranteeing bonds linked to risky subprime mortgages and other debt. One idea floated by Dinallo early in discussions was banks putting up a rescue fund of about $15 billion to save the insurers, according to a person briefed on the matter. That idea has now given way to separate rescues of the companies, which collectively guarantee more than $2.4 trillion of bonds.

But some analysts argue a rescue will take a lot more than $15 billion. Sean Egan, managing director of independent credit rating firm Egan-Jones Ratings Inc, says the top six bond insurers face roughly $80 billion of eventual losses, and probably need more than $200 billion of new capital. Ackman said in his letter that given the eventual losses the bond insurers face, banks that have traded with the companies should write down their exposure today and raise enough new capital so they can continue to operate safely.

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MBIA to Sell $750 Million of Stock to Avert Downgrade

MBIA Inc., the world's biggest bond insurer, plans to sell $750 million of stock in an effort to bolster capital and retain its AAA credit rating. MBIA, based in Armonk, New York, said the private-equity firm Warburg Pincus will make up any shortfall in the sale by buying convertible participating stock. Warburg Pincus has already purchased about $500 million of MBIA shares.

Bond insurers led by MBIA and Ambac Assurance Corp. in New York need to bolster capital to avert downgrades that would cast doubt on the quality of $2.4 trillion of securities the industry guarantees. Fitch Ratings said this week it may cut MBIA's AAA insurance ranking, after lowering Ambac by two levels to AA last month because of mounting losses on subprime-related debt.

"The most significant fact is that they're raising the amount of capital from what they previously announced," Wilbur Ross, an investor in distressed companies, said in an interview with Bloomberg TV. "I would be astonished if they hadn't consulted with the rating agencies before they made this announcement," he said, adding that MBIA may retain its AAA. If the offering announced yesterday is successful, MBIA will have raised about $2.25 billion since November.
MBIA rose 79 cents, or 5.5 percent, to $15.07 in Frankfurt trading at 1:15 p.m. The stock is down 79 percent over the past 12 months. Ambac increased 21 cents, or 2 percent, to $11.22 in Germany.

The extra funds may not be enough to avert a downgrade because rating companies are increasing the capital they demand bond insurers set aside, Bank of America Corp. analysts led by Jeffrey Rosenberg wrote in a note yesterday. "What we see is an almost day-to-day change in the rules of the game," said Donald Light, an insurance analyst at Boston consultancy Celent. "At best we can say we're not sure" if the capital will be enough three months or a year from now, he said.

New York Insurance Superintendent Eric Dinallo is trying to organize a bank-led rescue of bond insurers. Bailouts may be a cheaper option for banks compared with the costs they would incur from bond insurer downgrades. Banks may need as much as $143 billion of additional reserves if bond insurer credit ratings are lowered, according to analysts at Barclays Capital.

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Ilargi: And just when you thought you’d seen it all, here’s a New York Times op-ed from an industry cheerleader. He wants the government to guarantee the principal of subprime mortgages for 15 years, so the banks can get rid of the risk in their books. That would allow them to happily start issuing loans again. What a great idea. For the banks.

Well, first of all, this is not about subprime, Mr. Milstein. When Option ARM’s start crashing later this year, I’m sure you’d want the taxpayer to guarantee all those as well?! What’s really perverted in this idea is that guaranteeing the principal is a sure way to lose a lot of money, if and when home prices keep on dropping, losses that would be transfered away from banks and onto taxpayers.

... they would suddenly be assessed, on bank balance sheets, at their original value ...

Yes, real dandy, but what is the original value? Is it the one the houses sold for last year, or the one before you guys started handing out loans to deadbeat losers, or should we maybe go back, say, 15 years (not coincidentally, the same timespan you propose for the guarantees). Let’s see what the original value was in 1993, and let that be guaranteed. Any difference would then be eaten by the banks. Sound good to you? No, I didn't think it would.

Banks should be “allowed” to fail, just like all other parties who have behaved like a bunch of Soprano killer chimps. And we should stop protecting them.

Give the Banks Some Credit

Howard P. Milstein is the chairman and chief executive of New York Private Bank and Trust, which owns a significant share of stock in The New York Times Company.

The losses that have been incurred as a result of the excesses in subprime mortgage lending will take years to work their way through the worldwide financial system, as dozens of banks act to replenish their lost capital by issuing more common stock in the public markets and trading other equity securities to sovereign wealth funds. Until the banks rebuild their capital, they will not have the wherewithal to lend money and support economic growth. If banks of all sizes could regain their capital immediately and easily, it would be a tremendous benefit to the American economy.

The federal government could make this happen by entering into an arrangement with American banks that hold subprime mortgages, in which homeowners typically pay a low interest rate for two or three years then face much higher payments. Here’s how it would work: The government would guarantee the principal of the mortgages for 15 years. And in exchange the banks would agree to leave their “teaser” interest rates on those loans in effect for the entire 15 years.

This would instantly give the lending banks new capital. As these mortgages would be guaranteed by the Treasury, they would suddenly be assessed, on bank balance sheets, at their original value — and a significant amount of the banks’ lost capital would be restored. Plus, the banks would receive, from most of the homeowners with subprime mortgages, up to 15 years of teaser-rate payments.

By solving the bank capital crisis immediately, this strategy would ensure that fewer families would lose their homes, that fewer neighborhoods would deteriorate because of abandoned housing and that, as a consequence, there would be less downward pressure on local real estate prices and property tax revenues.

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Ilargi: And fail they will. Just a shame that it's of course the little ones that go first.

Dozens of U.S. banks will fail by 2010: analyst

Dozens of U.S. banks will fail in the next two years as losses from soured loans mount and regulators crack down on lenders that take too much risk, especially in real estate and construction, an analyst said. The surge would follow a placid 3-1/2 year period in which just four banks collapsed, all in the last year, RBC Capital Markets analyst Gerard Cassidy said.

Between 50 and 150 U.S. banks -- as many as one in 57 -- could fail by early 2010, mostly those with no more than a couple of billion dollars of assets, Cassidy said. That rate of failure would be the highest in at least 15 years, or since the winding down of the savings-and-loan debacle. "The initial round of failures will come from smaller banks with limited access to capital and overexposure to commercial real estate," Cassidy said.

"Could banks with $75 billion or $100 billion of assets fail? That's hard to say, but it depends on the severity of the economic downturn and the real estate decline," he added. Banks are under pressure as a slowing economy, the housing crunch, weak job growth and rising energy costs make it harder for individuals and businesses to pay their bills. Compounding the problem has been the seizing up of capital markets that has led to more than $130 billion of write-downs worldwide, including at lenders such as Citigroup Inc , Bank of America Corp and Washington Mutual Inc .

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New danger appears on the monoline horizon

As the bond insurers, or monolines, have seen their seemingly rock-solid AAA ratings begin to buckle, worries have grown about what downgrades for these companies might mean for banks. Now, one particular type of trade done between banks and monolines is being seen as an extra hidden danger.

These so-called negative basis trades were done in large volumes in recent years. They allowed both banks and monolines to book apparently “free money” and saw monolines writing guarantees on each other. If they have to be unwound, it will be a costly business for all involved.

The real problem is that almost no one has any idea how significant the profits taken on these trades might be. These trades were profitable because a bond could pay out more in interest than it cost to buy the insurance available in the derivatives market to protect the holder against default. In the world of structured finance, a bank would buy a bond, get it guaranteed, or wrapped, by a monoline to support the bond’s AAA rating, but then also pay another monoline to write a default swap on the first monoline, to guard against it defaulting on its guarantee.

The difference between what the bank paid for the insurance and what it received in yield from the bond could be pocketed as “risk-free” profit – and in many cases banks took the entire value of that income over the life of the bond upfront.
One senior industry insider admits that billions of dollars worth of these trades were done, but insists they were mostly restricted to the arena of utility and infrastructure debt. These were attractive both because they were of long maturities and because they were often linked to inflation, which would increase the returns. “On a £100m deal over 25 years a bank could conservatively book £5m up front – even more if it was index linked,” says the senior industry executive.

For the monolines, the trades were also seen as near risk-free profit when taking the position of writing protection on peers.
The same executive insists that monoline activity in CDOs was restricted to the hedging of senior tranches that banks had retained on their books after structuring deals and had nothing to do with negative basis trades. However, others are less sure. Monoline analysts at some of the banks believe a large amount of negative basis trades in the US were done on super senior CDO tranches, but admit they have no idea what proportion of total CDO business for the monolines that was.

The problem is that if monolines are downgraded and their protection becomes ineffective, profits booked up-front need to be reversed. Restating earnings is a very tricky area for investment banks – not least because the traders involved will have long ago pocketed their bonuses.

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'Anyone for Some Used Corporate Debt?'

Why Leveraged Loans That Financed Buyouts Are Causing Bottleneck

A new problem is rippling through credit markets: Many of the corporate loans used to finance giant buyouts in the past few years are reeling in secondary market trading, making it virtually impossible for banks to unload other commitments they have made.

The loans of First Data Corp., which was taken private in September by Kohlberg Kravis Roberts & Co. for about $28 billion, were sold into the market this past fall at a 4% discount to their par value; they now trade in the market at a steep 11.5% discount to par value, according to Reuters LPC. Loans of Freescale Semiconductor Inc., taken private by a consortium of private-equity firms in December 2006 for about $28 billion, are trading at a 15.5% discount to their original value; Tribune Co., which was taken private in April by investor Sam Zell for $8.2 billion, issued loans now trading a 26% discount.

The loans are known by investors as "leveraged loans," used by companies often with low credit ratings to raise money, often for buyouts. They are issued by banks and sold to investors like junk bonds, though leveraged loans tend to be safer because their investors get paid off in a bankruptcy before junk-bond investors.

Double-digit declines in the market value of these loans are very unusual, and a big problem for many banks, which sit on a pipeline of $152 billion in loans that they have promised to make but have yet to sell to investors.
With the prices of existing loans tumbling, investors have little incentive to buy new loans unless they are sold at steep discounts, something banks are reluctant to do. The result: More assets building up on bank balance sheets, growing tensions among rival bankers who had grown accustomed during the buyout boom to cooperating with each other and a deepening crisis in the market for buyout debt.

The crisis started last summer, when investors turned up their noses at billions of dollars in buyout debt, just after many buyout firms and their bankers made commitments to history-making megadeals. Many investors say January was the worst performance for this market since those summer months. "This is bizarre and baffling," said Thomas Ewald, chief investment officer of Invesco Senior Secured Management, on a panel at a Loan Syndication and Trading Association event Monday. "Loans trading in the 80s are typically on the verge of bankruptcy or a major restructuring event."

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A new monoline exposure for banks: CLO negative basis trades

Banks’ exposures through bond insurers, or monolines, is far from limited to mortgage-related MBS and muni bonds. There’s a third big exposure - to leveraged buyout loans - that banks will have to deal with if monolines hit the rocks.

Negative basis trades have been around for a while. A bank buys a bond - say it’s AAA - and then it takes out a CDS against that bond with a monoline. Since spreads in the CDS market for such tranches have been typically much lower than in the cash market, the bank pockets the difference. But as well as banks’ much-dissected CDO exposures, there have been two other big markets for that kind of trade: on infrastructure bonds and - most interestingly - in structured finance, on CLOs (collateralised loan obligations) - CLOs being the vehicle of choice in which to park massive buyout loans.

Monolines, of course, are no longer in a position to be writing new contracts for banks to use as one half of their negative basis trades. The consequence of that has been that banks have stopped buying AAA tranches of CLOs. Unable to sell those, CLOs have faltered and banks in turn, have found themselves with lots of big buyout loans stuck on their books. No new financing is available for private equity deals. According to Euroweek, 90 per cent of all CLO AAA-tranches have been bought and then wrapped in negative basis trades. Which begs a second question. What of all the AAA CLO and infrastructure paper that banks already have on their books? None of it, of course, shows up as exposures in filings because, net, there is no exposure. Assuming, of course, your CDS counterparty is safe. Err…

Even if monolines don’t crash and burn, banks will still have to make writedowns on these trades. As the value of the CDS written by the monoline decreases, so, too, will banks exposure to CLOs, and through them LBOs, have to increase. And higher exposures will also, of course, put pressure on capital. And one final point: having set up one negative basis trade, it hasn’t been uncommon for banks to take out a CDS against the CDS counterparty in that trade

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Monoline update: hedge funds the only people who know what they’re doing

Markets don’t seem to know how to react. It’s pretty clear that as far as trading monolines goes, equity investors are in hock to whatever the latest headline is. Naked Capitalism points us in the direction of a new scenario, via Morgan Stanley’s credit analysts: Downgrades might well come, but the consequent losses for banks might be negligable - between $5bn-$7bn.

We don’t see how MS figures’ can be the case. Take ACA. Unlike some other monolines, ACA was required to post collateral against its insurance contracts in the event of a downgrade. It couldn’t manage that, and is on death row consequently - awaiting a declaration of insolvency, or a massive bailout. ACA has hedging agreements on $6.6bn of CDO paper with Merrill Lynch. That’s not reported in Merrill’s headline figures - which are all net of such hedges. If ACA goes bust, the contracts will, of course, be worthless, and Merrill alone will be instantly exposed to $6.6bn more of CDOs. ACA has another $55bn of such contracts with other banks.

Standard & Poor’s bore out that point on Tuesday, when they estimated banks had around $125bn of such CDO hedges with monolines in place. Morgan Stanley’s analysis looks optimistic then. And S&P’s figure doesn’t even take into account the potential price crashes on the hundreds of thousands of other vanilla bonds monolines insure. Fitch, for example, put 172,168 muni bonds on ratings watch on Tuesday in line with its deteriorating outlook for MBIA.

Fitch indeed, leads the rating agency pack:

Fitch believes that a sharp increase in expected losses would be especially problematic for the ratings of financial guarantors — even more problematic than the previously discussed increases in ‘AAA’ capital guidelines, which has been the primary focus of recent analysis of the industry. Expected losses reflect an estimate of future claims that Fitch believes would ultimately need to be paid by a guarantor. A material increase in claim payments would be inconsistent with ‘AAA’ ratings standards for financial guarantors, and could potentially call into question the appropriateness of ‘AAA’ ratings for those affected companies, regardless of their ultimate capital levels.

All of which makes talk of a bailout look premature. Banks are, of course, afraid of the Warburg Pincus/MBIA scenario - commiting money (at a time when they can’t afford to) to a black hole. Only the Europeans appear keen to assist. For Wall Street, better the CDOs you know, apparently. Whether that’s a wise strategy or not… As is fast becoming the rule, the only people who seem to know what they’re doing are the hedge funds. Our money is still with Bill Ackman.

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Ilargi: Get a hold of this jewel:

".. a GSE reform bill should also clarify that the US government does not stand behind GSE obligations.."

Wait a minute: the Democrats are pushing for Fannie and Freddie to take on jumbo loans, which would vastly increase their $1.4 trillion portfolio (read: exposure), but the same bill that regulates that should EXPLICITLY state that the government doesn't guarantee ANY of it? I'm speechless, for a change. Think of the huge boost in confidence around the markets!!!

US Treasury says govt regulator must gauge risk of Fannie, Freddie portfolios

 A top Treasury official asked Congress today to create a new federal regulator for mortgage giants Fannie Mae and Freddie Mac that has the authority to review the risks associated with the large and growing retained mortgage portfolios that both companies hold. ‘The new housing GSE regulatory agency must be provided (with) specific review authority over the retained mortgage portfolios of Fannie Mae and Freddie Mac,' Assistant Treasury Secretary David Nason told the Senate Banking Committee today.

'Such authority must establish a clear and transparent process based on guidance from the Congress on how the new regulatory agency will evaluate the retained mortgage portfolios in terms of risk and consistency with mission.'
Nason said it has been understood for some time now that the mortgage portfolios that both government-sponsored enterprises (GSEs) hold are so large -- 1.4 trln usd as of 2007 -- that they present a 'systemic risk' to the financial system.

'It is paramount that the housing GSEs properly manage and supervise the risks they undertake and that a strong regulator oversee their operations,' he said. 'Otherwise their solvency could be threatened and this could have a negative impact on the stability of other financial institutions and the overall strength of our economy.' The House has already approved a bill that would reform the Office of Federal Housing Enterprise Oversight (OFHEO), although that bill does not include language creating clear authority to review mortgage portfolio holdings.

Nason's testimony comes just weeks after Senate Democrats pledged to pass a GSE reform bill this year. Democrats agreed to take up the Bush administration's request as part of a deal under language allowing Fannie and Freddie to buy higher-cost mortgages for one year was included in an economic stimulus bill that was agreed by House Democrats and the White House.
Democrats have pressed the administration to allow this change as a way to increase liquidity in the troubled mortgage market. The Bush administration, in contrast, favored expanding the operating abilities of Fannie and Freddie only as part of legislation to reform OFHEO.

Nason said today that a GSE reform bill should also clarify that the US government does not stand behind GSE obligations, a misperception that has given the two companies preferred funding rates.

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These Loans Were Made for Walking: The End of the Subprime Crisis

The latest data show house prices were falling at a 16 percent annual rate in the fourth quarter of 2007 and were already down by almost 8 percent from their year-ago levels. In several cities, the rate of price decline was considerably more rapid. In San Francisco, prices were dropping at a 22.2 percent annual rate, in Los Angeles at a 24.7 percent rate and a 27.0 percent rate in San Diego.

This rate of price decline means millions of recent homebuyers, who put little or nothing down on their home, now have houses that are worth less than the value of their mortgage. This is important for two reasons. First, homeowners with no equity in their homes have no margin for error. If they lose their job or get a serious illness, they cannot borrow against equity to pay their mortgages through the bad times. This is the situation that has caused many subprime homeowners to lose their homes. While predatory mortgages are a key part of the story in many cases, if the house was worth more than the value of the mortgage, it would always be possible to borrow against the equity to meet a monthly mortgage payment. If house prices were not falling, the subprime crisis would not be happening.

However, there is another dimension to this story. When the house price is less than the value of a mortgage, there is a strong incentive to give up a home even if the homeowner is able to pay the mortgage. The logic is simple. Suppose a homeowner owes $400,000 on a home that is now worth just $300,000, a situation common in places like Los Angeles, Miami and San Diego. If the homeowner continues to pay their mortgage, they will have eventually paid $400,000 (plus interest) for a home that is worth $300,000. That’s not a very good deal.

Alternatively, suppose the homeowner decides to buy the comparable home across the street for $300,000, and stops sending the mortgage check to the bank each month. The bank will presumably foreclose on the first house, but the homeowner has effectively pocketed $100,000 on the day he moves across the street. That would be a good payday even for the Wall Street crowd. Of course, the bank will take a big hit, since it will not be able to recover anything close to its original $400,000 loan, but that is not the homeowner’s problem.

Is it moral to just walk away from a loan and leave the bank holding the bag? That’s an interesting question.

We live in a country in which CEOs can run a corporation into the ground and then walk away with pay packages worth tens, or even hundreds, of millions of dollars. Equity and hedge fund managers, who rank among the richest people in the country, have successfully lobbied Congress so that they pay a lower tax rate on their earnings than schoolteachers and firefighters. After walking away with this multi-million dollar tax break, at least one prominent member of this crew has been leading the charge to cut Social Security, pointing out he doesn’t need his Social Security check.

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Chart Fun With the S&P Case-Shiller Home Price Index

By popular demand, the collection of charts featuring the S&P Case-Shiller Home Price Index has been updated. First, the home price index versus one of stupidest things that economists have ever dreamed up - the home ownership cost substitute used in the consumer price index, otherwise known as "owners' equivalent rent".

No, it is not being suggested that the HPI be used in place of OER in the inflation statistics because there are other factors that should be included as well - interest rates, property taxes, etc. The chart above simply demonstrates how completely different these two measures are and how disconnected OER and home prices had become.
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In recent months, the slide in home prices has been overwhelmed by soaring energy prices in the chart above, however, if food and energy are removed from the price index, as economists are wont to do to calculate core inflation, another big red warning light is clear to see in the chart below.

If real home prices are substituted for the almost 30 percent weighted OER component in core inflation, that important inflation statistic would now be minus one percent, and people would be talking about the dreaded "D" word that contemporary economists abhor - "Deflation".
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A recent addition to the known list of fun things you can do with the Case-Shiller Home Price Index is to lay it up against all sorts of other economic statistics. For example, you can put the HPI curve up against job growth as shown below and get the expected results. Housing bubbles are generally good for creating jobs - all the way up to the point when they start deflating.

Yes, breaking out some of the individual labor categories, such as residential construction and retail trade, would be the next logical step here. Maybe next time.

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Ilargi: For now, the EU has an easy time getting what it wants: by not lowering interest rates, it makes sure the Euro doesn’t rise any further vs the USD, plus foreign investors are more likely to invest in the Eurozone with higher rates.

ECB Keeps Interest Rate at Six-Year High on Inflation

The European Central Bank kept the benchmark interest rate at a six-year high of 4 percent as policy makers focused on curbing inflation rather than supporting a weakening economy.

Inflation in the 15 nations sharing the euro reached a 14- year high in January, overshooting the bank's 2 percent limit for a fifth month. Investors predict that slower economic expansion will force the ECB to follow the U.S. Federal Reserve and the Bank of England in paring interest rates. "Inflation remains the ECB's overriding concern," said Klaus Baader, chief European economist at Merrill Lynch & Co. in London. ECB President Jean-Claude "Trichet will certainly concede that the economic growth outlook is deteriorating, but it will have to get worse before the ECB cuts rates."

All 56 economists surveyed by Bloomberg News predicted today's decision. Trichet will hold a press conference at 2:30 p.m. in Frankfurt. The Bank of England today cut borrowing costs for the second time in three months, lowering the benchmark rate by a quarter point to 5.25 percent. The euro declined to as low as $1.4554 from $1.4597 after the decision.

ECB Governing Council member Axel Weber on Jan. 24 dismissed investors' bets on lower borrowing costs as "wishful thinking," adding that "we have a positive economic outlook and as long as that doesn't change I would say that rates are still on the accommodative side," meaning they support growth.

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New Money Pouring into Funds Targeting Distressed Deals

Some in Industry Wonder Just How Smart This New Money Is

Everybody loves a bargain. And these days, just about everybody thinks they might be able to get one. Since Aug. 1, just before the credit markets went into a tailspin, CoStar has reported on 28 funds that have raised or were in the process of raising more than $30 billion, with the bulk of the money targeted for distressed real estate and value-added opportunities.

That money is on top of more than $23 billion in private equity raised in the first half of 2007 according to Ernst & Young. The total for the year nearly doubles the total amount raised in 2006. Not counted in that group are the existing funds that also have started to shift focus and resources. Funds that were originally looking for solid occupancy in Class A or B office and industrial assets or properties in solid or emerging markets are now buying properties to which they can add value through lease up or repositioning.

These opportunity funds have come to be called somewhat crudely vulture funds for the picture they conjure up of investors perched and poised to swoop in on troubled deals, mismanaged and/or underperforming assets. In many cases, though, it doesn't do the investors justice, because as every bargain hunter knows, one man's discards can be another man's gold - the trick is being able to turn trash into gold. The flock that is now rapidly gathering is starting to raise, if not concerns, then at least a lot of questions about which ones have that ability and which ones can spot the diamond in the rough.

"Many of the new funds are made up of the same groups that were part of the run-up leading to today's distress, only under a new cloak," said Gregory J. Nieder, principal and executive vice president of Foresite Realty Partners LLC in Rosemont, IL. "What is getting lost in the fervor over the rise of these new opportunity funds is the operational inexperience of many of these groups and the need for a buyer of these assets to understand not only the underlying real estate, but also the complexity of the default, workout, foreclosure and bankruptcy process, especially given the dramatic shift in how real estate has been financed over the past 10-15 years."

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Credit markets not expected to recover this year

Wall Street's biggest mortgage investors and bankers aren't betting on a recovery in U.S. credit markets any time soon. Instead, they're searching for ways to restore investor confidence in the so-called securitization market, which has emerged as the epicenter of the U.S. subprime mortgage crisis, while bracing for further hits in commercial mortgages and credit-cards, according to experts gathered on Monday at the American Securitization Forum's (ASF) meeting in Las Vegas.

Roughly 50 percent of ASF professionals recently polled by the group -- whose members helped fuel the U.S. housing-finance industry's boom and bust -- don't believe that current credit market troubles will dissipate in 2008. "People are dour right now," John Devaney, chief executive and trader at United Capital Markets, said in an interview with Reuters at the conference.

"All the innovation over the past 10 years has really helped out the consumer, but inside our industry there's very big sweeping changes that'll take years to heal," he said.
Specifically, changes in how information about risk is provided to investors are needed before the world of securitization -- where mortgages, credit card payments and other types of debt are repackaged into securities -- can return to health, industry experts say.

Devaney, whose net worth has been cut in half by the U.S. subprime crisis, said most investors are too burned by previous mortgage bets to take advantage of new opportunities. "There are a lot of guys who won't buy triple-A any more," Devaney said, referring to the highest credit rating provided by rating agencies and the market's loss of confidence in those agencies. "New outside guys that haven't been involved need to come in."

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European CDO issuance may fall by 50%-Moody's

European market issuance of collateralised debt obligations (CDOs) is likely to drop by 30 to 50 percent this year as investor wariness combines with an expected rise in defaults, Moody's Investors Service predicted. Last year, CDO issuance in Europe, the Middle East and Africa rose 11 percent to 113 billion euros ($167 billion), but that included a slowdown in the second half -- "an unprecedented phenomenon in the history of CDOs in the EMEA region", said Moody's.

Investors lost confidence last year in the complex structured debt products due to the credit crisis, which started with U.S. subprime mortgage defaults and struck Europe in July, leading to falling CDO prices and ratings downgrades. As economic growth slows and corporate credit quality weakens, CDO ratings performance -- particularly of synthetic CDOs which are based on portfolios of corporate debt derivatives -- is likely to deteriorate, the ratings agency said in a report on Monday.

"A major question mark for 2008 is the recovery of investors' confidence," wrote Florence Tadjeddine, a Moody's senior credit officer, in the 48-page report. "This is unlikely to occur until the effects of the subprime crisis have been fully measured, especially on financial institutions," she added. "The turn in the credit cycle and the forecast increase in corporate default rates are also likely to start affecting the performance of speculative-grade issuers and, therefore, heighten investors' caution."

A CDO is a portfolio of debt divided into tranches, or slices, by degrees of risk. The riskiest and highest-yielding tranche is exposed to the first few percent of default losses from any credit in the pool. After it has been wiped out, losses move to the next tranche.

Moody's believes Europe's speculative-grade default rate will rise to 3.5 percent by December from 1.2 percent last December. That means a number of synthetic CDO ratings could suffer "if we were to see a few more defaults in the vein of Quebecor World Inc. occurring," the report said. The troubled Canadian commercial printer, in the portfolio of several European CDOs, filed for creditor protection last month.

"This becomes all the more topical as many CDOs have exposures to very low-rated corporates (i.e. with senior unsecured ratings in the Caa category) such as Ford Motor Co., General Motors Corp., Visteon Corp. and Owens-Illinois," the report said.

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Ilargi: I was going to let the New York Times “Americans pay-as-they-go” story alone, but Barron’s reacts to it, and does it well, so here are both:

Recession or Lent? Whatever You Call It, It's Starte

The rout appears to be continuing around the globe. As of Wednesday morning in Asia, the Nikkei in Japan also was down 4% while the Hang Seng in Hong Kong was suffering even sharper declines. Overall, the MSCI Asia-Pacific index was down over 3%, further indication of how closely Asia's fortunes are tied to the U.S. economy and consumers.

In that regard, the New York Times presented on its page one a narrative under the headline, "Economy Fitful, Americans Start to Pay as They Go," which asserted that decades of a credit binge, consumers actually are being forced to live within their means.

In the hoary tradition of "Don't let the facts get in the way of a good story," the Times offers only anecdotes and quotes. But the story ignores data that show consumer borrowing, both against real estate and unsecured by property, continues to grow. Though lacking data, the story does illustrate an actual trend—that American consumers are tightening their belts. Were the reporter so inclined to look at it, the stock market offers ample evidence that tapped-out U.S. consumers can't continue on their spendthrift ways.

Among the biggest losers from the stock market's peak on Oct. 9 through Monday's close, by Baseline's reckoning, was Garmin -- the maker of global-positioning devices that help all those SUV drivers find the best route to the nearest Starbucks and Coach stores -- whose stock is down 38%. Coach, meanwhile, is down 31% while Starbucks is off 28%. And two other purveyors of such discretionary (read "frivolous") goods, Harley-Davidson and Apple, both are down 22%. If it's not clear that the U.S. consumer is in a recession, then it is incontrovertible that discretionary consumer stocks are in a bear market.

The Mardi Gras that's lasted four decades for the American consumer is drawing to an end, if it is not already over. After Fat Tuesday comes Ash Wednesday, which is observed today, and is the beginning of Lent, a 40-day period of fasting, self-examination and renewal for Christians, analogous to Ramadan for Muslims or Yom Kippur for Jews. Lower interest rates are a palliative, not a cure, for the economy's woes. Time is the only healer. Economists call that time a recession, and it can no longer be avoided.

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Economy Fitful, Americans Start to Pay as They Go

For more than half a century, Americans have proved staggeringly resourceful at finding new ways to spend money. In the 1950s and ’60s, as credit cards grew in popularity, many began dining out when the mood struck or buying new television sets on the installment plan rather than waiting for payday. By the 1980s, millions of Americans were entrusting their savings to the booming stock market, using the winnings to spend in excess of their income. Millions more exuberantly borrowed against the value of their homes.

But now the freewheeling days of credit and risk may have run their course — at least for a while and perhaps much longer — as a period of involuntary thrift unfolds in many households. With the number of jobs shrinking, housing prices falling and debt levels swelling, the same nation that pioneered the no-money-down mortgage suddenly confronts an unfamiliar imperative: more Americans must live within their means.



“We don’t use our credit cards anymore,” said Lisa Merhaut, a professional at a telecommunications company who lives in Leesburg, Va., and whose family last year ran up credit card debt it could not handle. Today, Ms. Merhaut, 44, manages her money the way her father did. Despite a household income reaching six figures, she uses cash for every purchase. “What we have is what we have,” Ms. Merhaut said. “We have to rely on the money that we’re bringing in.” The shift under way feels to some analysts like a cultural inflection point, one with huge implications for an economy driven overwhelmingly by consumer spending.

While some experts question whether most Americans, particularly baby boomers, will ever give up their buy-now/pay-later way of life, the unraveling of the real estate market appears to have left millions of families with little choice, yanking fresh credit from their grasp. “The long collapse in the United States savings rate is over,” said Ethan S. Harris, chief United States economist for Lehman Brothers. “People are going to start saving the old-fashioned way, rather than letting the stock market and rising home values do it for them.”

In 1984, Americans were still saving more than one-tenth of their income, according to the government. A decade later, the rate was down by half. Now, the savings rate is slightly negative, suggesting that on average Americans spend more than their disposable income

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Meredith Whitney downgrades Goldman

It’s tough love.

Meredith Whitney - the heavyweight OpCo analyst who first made a call on Citi’s capitalisation troubles back before $10bn writedowns became ten-a-penny affairs - is downgrading Goldman. To “perform” from “outperform” mind you - so nothing dreadful:

For over two years, GS has been our top pick in financials and we have correctly been well ahead of the Street with our estimates; however, we no longer have the surety of boldness in our earnings outlook for at least the first half of the year.

The bank will suffer from its own success in 2008. We can think of worse things. Whitney cut the 2008 earnings view to $20.90 a share from $25.50. But perhaps more stinging is the fact that Whitney expects shares in Goldman to become part of the hoi polloi:

[Valuations] simply will not be sustainable in a year when Goldman Sachs will probably deliver results that will not be substantially better than its peers.

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Caught In The Middle: Miami's Middle Class Exodus

For decades, South Florida has been proud of being a piece of paradise where you could raise a family, perhaps retire. In the last couple of years, calling the region home has changed dramatically, where more people are moving out than moving in. The Bank of America building in downtown Miami was once known in the 1980's as the Centrust Tower when it eventually faced bankruptcy and a city in turmoil.  

It still lights up the skyline, reinvented and thriving. Dozens of skyscrapers have popped up, and dozens more are on the way. The question posed is while this city appears to be headed to greatness, will the people who made South Florida still live here when all this is done? 

Florida has been faced with more foreclosures in 2007 than 1980, 1981, 1982, 1983, 1984, 1985, 1986, 1987, 1988, 1990, 1991, 1992 combined. The year 2007 was a record.

In Broward County, foreclosures in 2006 were 8,995; in 2007, it was 23,476. For Miami-Dade County, there were 9,814 foreclosures in 2006; in 2007, there were 26,338.  

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The machine gun of capitalism

Dead soldiers, peak oil and mind-boggling profits; praise Jesus, the machine's still working

Surprisingly moving Barack Obama music videos? The potential end of the writer's strike? Cute young deer being saved by helicopters? No no no no no. Here are your most deeply inspiring news stories of the month:
A flurry of pink slips fluttered over the job sector as corporate payrolls were sliced like sour pie. Foreclosures are skyrocketing and new home sales across the nation are plummeting faster than Britney Spears' serotonin levels. A nasty recession is either creeping or flooding in, depending on your perspective and how recently you purchased your home and/or tried to dump your Google stock.

Meanwhile, the largest corporation in the world, the one which has consistently raked in the largest and most appalling profits of any organization on Earth, a company so powerful and deeply influential to the machinations of our own nation, our government, the globe, so ingrained and unstoppable that no president, no administration, no nuclear warhead to its CEO's home planet stands a chance of slowing it down or altering its behavior in any significant way because there is simply far, far too much money involved in its nefarious endeavors, has recently posted the largest profit of any company in American history.

Yes, the Exxon Mobil corporation sucked in a staggering $11.7 billion in a single quarter (more than $40 billion for the year, a new record for an American company) thanks largely to record-breaking prices for a barrel of oil, which are of course only record-breaking because, well, the Bush administration has essentially engineered the economy and launched a bogus war and desiccated the American idea exactly so they would be.

Oh yes, two more trifling stories, buried beneath the nauseating Exxon headlines and the tales of looming economic struggle: More U.S. soldiers are dead in Iraq as a result of Bush's failed war, U.S. military spending in 2009 will reach its highest levels since WWII ($515 billion), insurgents have taken to strapping suicide bombs to mentally retarded women and nearly 100 more civilians are dead in another bombing in Baghdad because the U.S. troop surge is working so well. Oh wait. Do you feel the righteousness? The inspiration? Can you sense the deep connection between these stories? Because the truth is, they merely add up to the heartwarming conclusion that, without a doubt, American capitalism is still firing on all cylinders. Praise!

Yes, the system is working just exactly as those in control of the nation right now wish it to be working, with the most dominant, ruthless corporations in the world (Exxon joined by Shell, Chevron, BP, ConocoPhilips et al) still making the most money in the most destabilizing and environmentally devastating manner possible, while poor uneducated kids die like chattel in unwinnable wars trying to secure a tiny bit more of the source of their profit. And somewhere in between, the nation's overall health and well-being are sacrificed like dazed lambs to an ignorant god, with our government offering up only the most meager, desultory efforts to keep it functional so as to not induce all-out fire-and-pitchfork revolt.

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