Debt Rattle, March 24 2008

Ilargi: It’s getting funnier by the minute. Not only do disgruntled shareholders’ voices get louder, there are now accusations of the Fed/Bear/JPMorgan deal being downright illegal (see my post last night: Bush Bear Belongs Behind Bars), courtesy of Karl Denninger.

There is a new deal. Bear and JPMorgan have focused on diluting the voices of angry shareholders: 95 million new Bear Stearns shares were issued, and bought by JPM. This will lead to more hefty lawyers' fees. At noon, Bear shares were at 13.85, up about 125% from last week's close. Think we'll see more new deals soon?

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Updated 2.30 pm EDT

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Ilargi: The NAR report on US housing was published this morning. 98% of headlines say that existing home sales are up. This is complete and misleading nonsense. Look, they all do it:

• US existing home sales post surprise rise: Reuters
• Homes Sales Rise, But Prices Slide Sharply: Forbes
• Sales of Existing Homes Rise 2.9% in February: New York Times
• Home resales up first time in seven months: MarketWatch
• Home Resales Rose 2.9% Last Month: Wall Street Journal
• US home sales see surprise rise: BBC News

Those are media you would trust, right? But take a better look, and you see that "rise" is from Jan '08 to Feb '08. Homes don't sell in January. In reality, sales fell off a steep cliff, and prices are down a lot, even in a report issued by the industry's sluttiest cheerleaders. Don't be fooled by poor journalism, please. Instead, wonder why they do it.Look at the Barron's graph, there's nothing ambivalent about it!!! (the grey bars represent sales)

February Existing Home Sales Fell 23.8%, Median Price Down 8.2%

Today's fictional headline, via The Onion, National Association of Realtors: "Sales of existing homes increased in February and remain within a fairly stable range."

Why is this fictional? Changes from January to February are measuring seasonal differences, not actual improvements. January is one of the slowest months of the year for home sales. (We would never report retail sales from December to January this way; We always use year over year data).



Year over year changes showed that single family home sales were 23.8% below February 2007 levels. The national median sales price was also a big surprise, freefalling down 8.2%. Single-family home sales decreased 22.9%, while the median existing single-family home price was $193,900 in February, down 8.7% from year ago prices.

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Fannie Awaits the Wrecking Ball

There's a singular moment when a wrecking ball swings, when it sits poised above its return arc seemingly able to sustain that position forever. Then gravity resumes and the ball hurtles down again to slam into a building facade, shattering brick and splintering timber.

That singular moment is where Fannie Mae is now. It is suspended above a wrecked housing market that is waiting for the ball to fall forward again and smash into the brick-and-mortar of reality.

Fannie and Freddie have been given the authority to lower their capital to just 3% of the mortgages they hold, down from 3.25%, allowing them to support about $200 billion more in mortgage commitments. Regulators agreed to cut Fannie and Freddie's capital requirements by a combined $5.9 billion while allowing them to borrow up to $33 for every dollar they have on hand. Bear Stearns, by comparison, was leveraged $34 for every dollar in capital at the end of 2007.

Mortgage lenders now own or guarantee about 45% of all U.S. mortgages in existence, but they are expected to buy or guarantee about 80% of all the mortgages made this year. The additional capital they'll be raising as part of the agreement (The Wall Street Journal reports that it could be $10 billion each) will allow them to buy even more loans above the $200 billion level just set.

Fannie will use part of its additional capital to help distressed borrowers that have resetting ARMs while also funding bigger loans in high-cost areas. Both Fannie and Freddie got temporary Congressional authority to purchase loans of up to $730,000 in regions with the most expensive homes.

This is not the Fannie Mae I originally bought. It has become overextended, too exposed to subprime mortgages, and too subject to the twin vagaries of rising defaults and falling home prices. When the break comes it will fall harder, faster, and further than it did before. 

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Welcome to Bailout Nation

Bear's stock has popped to $10, now that the Fed has caved and Bear and JPMorgan have announced a new, higher-priced deal. What does this mean?

Among other things, it means tha all that jawboning from Treasury Secretary Hank Paulson last week about how the government wasn't bailing out Bear Stearns was a bunch of hooey. The Fed and the Treasury Department gave Bear and JP Morgan shareholders a $30 billion gift from taxpayers.

And the moment Bear Stearns realized that all the crap on its balance sheet had been transformed into a Treasury Bill, it, sensibly, demanded more for itself. And why shouldn't it have?

When the Fed suddenly guaranteed Bear Stearns with the full faith and credit of the US government, it became worth more. Specifically, it went from being worth zero to at least $10 a share.

And now US homeowners, justifiably, will scream that the government cares more about Wall Street fat cats than it does about the Little Guy. And the Fed and Treasury will have to start scrambling to put together a plan to buy everyone's house. Welcome to Bailout Nation.

"You didn't expect me to let my friends at Bear Stearns lose their shirts, did you? They're my FRIENDS, for goodness sake."

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Ilargi: I don't think I can improve on Aaron Krowne’s comment:
“Look what you've done now, Bernanke. Now every fat cat banker is lining up for a handout, in the form of guaranteed buyouts of smaller distressed rivals. This must be why the market is rallying: Fed guarantees have replaced private equity as the savior du jour of ailing financial companies stuffed to the gills with garbage loans. Only, the market will soon find out the Fed has limits as well...”

Wells Fargo CEO open to a 'Fed-assisted' deal

Wells Fargo CEO John Stumpf said the financial crisis is presenting the bank with more acquisition opportunities. "I would not be averse to a Fed-assisted transaction," Stumpf said in a recent interview. "Fixer-uppers don't bother us."

The San Francisco banker said any deal would have to meet the company's traditional acquisition targets and benefit the bank's acquired customers. Wells has built a reputation as a disciplined buyer over the years, focusing on deals that generate at least a 15 percent internal rate of return and contribute to the bottom line within three years.

Wells is considered a potential bidder for troubled National City. The Cleveland bank, which made a big bet on subprime mortgages during the housing boom, is looking for a buyer. National City's disastrous foray into subprime mortgages was fueled in large part by its 1999 purchase of First Franklin Financial Cos., an issuer of "nonconforming" or subprime mortgages. The bank began holding more and more of these high-yielding loans on its books during the boom.

"These loans are readily saleable to third parties at a premium to origination cost, but have greater lifetime value when held on the balance sheet," National City's then-CEO David Daberko wrote in his letter to shareholders in the 2001 annual report. Today, the market for these types of mortgage-backed securities is in a deep freeze.

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Ilargi: In case you thought it couldn't get any worse, I recommend you take a deep breath. I know, you're thinking: This can't be true...

Clinton proposes Greenspan lead foreclosure group

Former Federal Reserve Chairman Alan Greenspan and other economic experts should determine whether the U.S. government needs to buy up homes to stem the country's housing crisis, Democratic presidential candidate Hillary Clinton will propose on Monday.

Clinton, a presidential candidate and senator from New York, said the Federal Housing Administration should "stand ready" to buy, restructure and resell failed mortgages to strengthen the ailing U.S. economy.

"Just as it has in the past, this kind of temporary measure by the government could give our economy the boost it needs and families the help they need," Clinton will say, according to excerpts of remarks prepared for a speech in Philadelphia.

"It would not require a single new government bureaucracy, and would be designed to be self-financing over time -- so it would cost taxpayers nothing in the long run." Clinton threw her weight behind legislation proposed by Democrats Rep. Barney Frank of Massachusetts and Senator Chris Dodd of Connecticut that would "expand the government's capacity to stand behind mortgages that are reworked on affordable terms."

But she said a bipartisan group should determine whether that approach was sufficient or whether the U.S. government should step in as a temporary purchaser. The working group could be led by bipartisan economic heavyweights such as Republican Greenspan, Democratic former Fed Chairman Paul Volcker and Robert Rubin, the treasury secretary under President Bill Clinton.

Under the Frank plan, the government would take failing mortgages off the hands of investors and write new terms that would prevent foreclosure. It would see lenders write down the mortgage amount in exchange for a government guarantee.

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Fitch to Continue Rating MBIA, Snubs Request to Stop

Fitch Ratings said it will still assess MBIA Inc.'s financial strength, snubbing a request by the bond insurer to withdraw the ratings. Fitch will rate MBIA as long as it can maintain a "clear, well-supported" view without access to non-public information, the ratings firm said today in a statement.

"While we respect MBIA's decision not to provide us that information, we trust that they will respect our decision to continue to maintain a rating on MBIA, a company about which many investors are so clearly interested," Fitch Chief Executive Officer Stephen Joynt said today in the statement.

MBIA asked Fitch earlier this month to stop rating the company because of disagreements about modeling for losses. Fitch is the only credit rating company considering a downgrade of MBIA. Moody's Investors Service and Standard & Poor's both affirmed the company earlier this month after MBIA raised $3 billion in capital, eliminated its dividend and stopped issuing asset-backed insurance. Fitch will complete its review in "the next few weeks," Joynt said.

Fitch probably won't be able to continue rating the company for long, MBIA said today in a statement responding to the announcement. "The non-public information currently in Fitch's possession soon will become out of date, and public information alone will be insufficient to maintain the ratings," MBIA said.

Fitch, a unit of Paris-based Fimalac SA, discussed MBIA's request with several major investors, Joynt said. If Fitch withdrew its rating from some tender option bonds that are only rated by Fitch, the investors would be forced to sell their holdings "into a market already challenged by liquidity issues," Joynt said. "We have concluded that maintaining the MBIA ratings at this time is most appropriate for investors and causes the least disruption to the marketplace," Joynt said.

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Bank of England refuses to bail banks out of toxic mess

The Bank of England yesterday rejected persistent lobbying from Britain's banks to follow the example set by the US Federal Reserve and buy "toxic" mortgage-backed securities from ailing banks hit by the credit crunch. Britain's central bank ruled out joining its US counterpart, in a move designed to quell growing speculation that it was preparing to take a more sympathetic stance on helping banks facing severe liquidity problems.

Governor Mervyn King is understood to have informed the major banks that he will ease the situation by joining the European Central Bank in offering extended loans based on a wider range of collateral. Threadneedle Street has refused to go further and follow the Federal Reserve, which has agreed to buy more than £100bn of the debt securities at the heart of the liquidity crisis.

Its stance was supported yesterday by Britain's largest trade union, Unite. Derek Simpson, Unite's joint leader, said public funds should be used to support public services before the government spent money propping up the money markets on top of the huge loan it has already made to Northern Rock.

A spokesman for the Bank said: "All central banks, including the Bank of England, have been looking at how to ease the strains in their banking markets. The Bank is not, however, among those proposing schemes that would require the taxpayer rather than the banks to assume the credit risk. We can, however, confirm that we have been examining a number of other options, but it is too early to go into any detail."

Steps to improve liquidity in the money markets and potentially kick start competition in the mortgage market are thought to be under consideration. After a meeting with executives from the big five banks - Barclays, HSBC, Royal Bank of Scotland, Lloyds TSB and HBOS - it is thought the Bank of England is looking at ways to enhance its regular money market operation each Thursday, when it traditionally offers funds to the financial system.

The major banks have argued that this does not provide them with enough options for financing at a time when they are refusing to lend each other money because of the credit crunch.

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Bear On a Tear

Bear Stearns shares surged Monday following a report in The New York Times that J.P. Morgan Chase is nearing an agreement to quintuple the price that it agreed last week to pay for Bear to $10 a share. The move is aimed at mollifying angry Bear shareholders who had threatened to veto the deal, which was engineered in a matter of hours last weekend as Bear Stearns faced a severe liquidity crunch.

Other terms of the new deal are expected to be substantially different than the original pact. In particular, the role of the Federal Reserve, which played a critical role in the week-old deal, is expected to change, a person familiar with the situation told The Wall Street Journal. Shares of Bear Stearns rose 54% to $9.16 in premarket trading. Shares closed Thursday at $5.96 in composite trading.

Credit default swaps for Morgan Stanley, Lehman Brothers, Goldman Sachs and Merrill Lynch were 10 to 15 basis points tighter on Monday morning from Thursday, according to data from broker Phoenix Partners Group. Bear Stearns’s credit default swaps tightened by 35 basis points to 330 bps from 365 bps.

UPDATE: It’s official.

JPM will pay $10 a share for Bear and also buy 95 million new shares of Bear, giving it a 39.5% stake in the company and a big leg up in getting shareholder approval to approve the takeover. The purchase is slated to close by April 8. The new terms call for each Bear share to be exchanged for 0.21753 share of JPMorgan; the original exchange was 0.05473 share.
Bear shares are now up 78% at $10.15. JPM shares are up 2.4% at $47.

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Morgan in talks to quintuple Bear Stearns offer

J.P. Morgan Chase Co. was in talks on Sunday night for a deal that would quintuple its offer for Bear Stearns Companies Inc., in an effort to pacify angry Bear shareholders, according to a media report Monday. The sweetened offer is intended to win over stockholders who vowed to fight the original fire-sale deal, struck only a week ago at the behest of the Federal Reserve and Treasury Department, the New York Times reported in its online edition, citing unnamed according to people involved in the negotiations.

Morgan was also in negotiations with the Fed on Sunday night to assume the first $1 billion in losses on Bear assets before the Fed's $30 billion cushion kicks in, the Times said, but the Fed may now be seeking to raise that number. Under the new purchase terms being discussed, Morgan would pay $10 a share in stock for Bear, up from its initial offer of $2 a share, a figure that represented a mere one-fifteenth of Bear's going market price, the Times said.

The Fed, which must approve any new deal, was balking at the new offer price on Sunday night after several days of frantic, secret negotiations, according to the report, and it was still possible the renegotiated deal might be postponed or collapse entirely. If the Fed were to reject the new proposal, it could set off a furor among shareholders of both firms that the government was preventing them from making a fair deal, according to the Times.

In an unusual attempt to win approval from a majority of Bear shareholders, Bear was seeking on Sunday night to authorize the sale of 39.5% of the firm to Morgan, the Times said. Under state law in Delaware, where the companies are incorporated, a company can sell up to 40% without shareholder approval, according to the report. The renegotiation, which would set a sale price of more than $1 billion, comes after a tumultuous week on Wall Street and in Washington because of the near collapse of Bear and the hastily devised deal to save it, the Times said..

While the initial agreement appeared to have defused the financial crisis of confidence that undid Bear, the initial terms of the deal and the government's controversial role in reaching them drew criticism from those who say the takeover amounts to a government bailout of Bear, a firm at the center of the mortgage meltdown, according to the report.

A new deal could raise even more questions about the Fed's involvement in the negotiations. As part of the original deal, the Fed guaranteed to take on $30 billion of Bear's most toxic assets and the central bank also directed Morgan to pay no more than $2 a share for Bear to assure that it would not appear that the Bear shareholders were being rescued, the Time reported, citing people involved in the negotiations.

If the price is increased, some critics could have more ammunition to complain that taxpayers are helping to bail out a Wall Street firm that should be responsible for its own risky behavior, the Times said, adding that is one reason the Fed was hesitant on Sunday night to approve the transaction at $10 a share.

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More Moral Hazard: Now, Watch Bear And JP Morgan Play the Fed

Ah, the hazards (moral and other) of central bank intervention. Ladies and gentlemen, gather around and watch Wall Street play Fed Chairman Ben Bernanke.

A week ago, Bear Stearns (BSC) was about to declare bankruptcy, which would have sent its stock to zero. At the 11th hour, JP Morgan (JPM) agreed to buy Bear for $2, a price reportedly mandated by the Fed so the Fed wouldn't be accused of funding a "bailout" (and a price enjoyed by JP Morgan and agreed to by Bear because it was better than zero). But of course the Fed was accused of funding a bailout anyway, because the only way JP Morgan agreed to move forward was the Fed's $30 billion no-questions-asked guarantee of whatever crap Bear has piled on its balance sheet.

Meanwhile, instead of thanking the Fed and JP Morgan for at least saving them something, Bear Stearns shareholders were outraged that JP Morgan was absconding with the firm at a "derisory" price, and JP Morgan CEO Jamie Dimon was trashed as a heartless bastard. Bear's stock traded to $6, on the assumption that Dimon would be forced to raise the price. Etc.

And now, according to the New York Times, JP Morgan and Bear Stearns want to raise the price to $10, at which level Bear Stearns' board will authorize an immediate sale of 40% of the company to JP Morgan (under Delaware law it can do this without a shareholder vote). This will leave JP Morgan needing only slightly more than 10% of the shareholder vote to get the deal done, and Bear's board members own 5%.

What is preventing this simple price adjustment from taking place? The Fed, says Andrew Ross Sorkin at the New York Times. What is the Fed thinking? Probably this:

A week ago, we saved the financial system by orchestrating a Bear Stearns bailout in which Bear shareholders got basically nothing--and we were still accused of a "bailout." If we hadn't intervened, Bear Stearns shareholders would have gotten nothing--zilch--but now that we've let them live, they're demanding more. If we cave, we'll set another awful precedent: Not only do we now look like we'll rush to the aid of any rich Wall Street firm in need, we'll let Wall Street use us however it pleases. We can't let that happen!

But the Bear-JP Morgan contingent was of course smart enough to leak this news to the NYT--so now it's the Fed who looks like a bunch of heartless bastards. And when the Fed caves--perhaps later today--it will come under a new round of fire for saving Wall Street fat cats and the expense of the little guy. And the nation's homeowners, who are also underwater, will clamor ever louder for their own bailout. And so on...

Over the past week, Wall Street has been showering praise on Bernanke & Co for "saving the financial system." A bank the size of Bear Stearns couldn't have been allowed to fail, the story goes, or the world would have ended. Of course, everyone said the same thing when Enron, Drexel, and a bunch of other too-big-to-fail firms failed. And last time we checked, the world's still here.

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Treasuries Drop on Report JPMorgan May Raise Bear Stearns Bid

Treasuries fell amid speculation JPMorgan Chase & Co. will increase its offer for Bear Stearns Cos., bolstering U.S. stock futures and lessening the safe haven appeal of government debt. Two-year notes extended their biggest weekly loss this year before the Treasury's monthly sale of the notes March 26. The losses shrank the extra yield that 10-year Treasuries offer over two-year notes to 1.71 percentage points, the least in six weeks, a sign demand for shorter maturities is waning.

"There's been a pretty strong negative correlation between equities and Treasuries where Treasuries sell off when equities are stronger," said James DeMasi, a fixed-income strategist in Baltimore at the brokerage Stifel Nicolaus & Co. The two-year note's yield rose 9 basis points to 1.69 percent as of 8:19 a.m. in New York, according to bond broker Cantor Fitzgerald LP. The price of the 2 percent security due in February 2010 declined 6/32, or $1.88 per $1,000 face amount, to 100 19/32.

JPMorgan may quintuple its takeover offer for Bear Stearns to more than $1 billion in an effort to win support from employees and shareholders opposed to the deal, the New York Times said. U.S. stock-index futures advanced, indicating shares may extend the biggest rally in almost two months. June futures on the Standard & Poor's 500 Index rose 0.6 percent, while Dow Jones Industrial Average contracts climbed 0.5 percent.

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Premarket: Bear now worth $10

Whoever said Bear Stearns investors were crazy for bidding up the shares even after JPMorgan Chase & Co. sealed a deal to buy the failing investment bank for just $2 (U.S.) a share awoke to sweet vindication on Monday morning.

According to a report in the New York Times, JPMorgan may up its offer to $10 a share – still well below the price Bear Stearns' shares used to command in better days, but 400 per cent better than the original offer.

The new price had a big impact on the wider market, as investors decided that if Bear Stearns is suddenly worth more than originally expected, then everything must be worth more. In premarket trading, futures for the Dow Jones industrial average jumped 244 points, to 12,377. Futures for the broader S&P 500 rose 9 points, to 1333.

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Ilargi: John Hussman paints the situation in the clearest colors I’ve seen to date.

Why is Bear Stearns Trading at $6 Instead of $2?

Again, this is not water under the bridge, and the deal struck last week should not be allowed to stand if we care at all about the integrity of the capital markets. The Long-Term Capital crisis was resolved by a consortium of financial institutions providing capital in return for ownership. The panic of 1907 was resolved the same way. This deal should be busted, and fast.

If there's not a single buyer that will take on both the assets and liabilities without the government assuming private default risk, Bear's assets should be put out for bid, Bear's bonds should go into default, and by the unfortunate reality of how equities work, Bear's shareholders shouldn't get $2 – they should get nothing.

Bear's stock is selling at more than $2 for two reasons – one is that the market evidently believes there is some chance for the deal to be busted, either by Congress or by shareholder rejection. And second, because Bear's bondholders are frantic to own the stock so they can vote for this lousy deal to go through.

After all, buying up a few hundred million in stock to secure $75 billion of debt doesn't seem like a bad trade. Whatever happens, this is not over, for the simple reason that it is wrong.

If the market was “certain to crash” in the event that Bear Stearns failed, then the market is certain to crash anyway, because Bear Stearns wasn't the last shoe to drop – it was one of the first. Unfortunately, we're standing in a shoe store. Wasn't the market “certain to crash” without the Fed's surprise rate cut in January too? At what point will investors figure out that the liquidity problems are nothing but the precursors of insolvency problems?

At what point will investors stop begging the government to save private companies and recognize that the losses should be taken by the stock and bondholders of the offending financial institutions? If the Fed and the Treasury are smart, they will act quickly to figure out how to respond to multiple events like we've seen in recent days, to expedite turnover in ownership and quickly settle the residual claims of bondholders, without the kind of malfeasance reflected in the Bear Stearns rescue. As for the future of the free markets, Dylan Thomas comes to mind:

Do not go gentle into that good night
Rage! Rage against the dying of the light

The Fed overstepped and the Treasury overstepped. At the point where unelected bureaucrats pick and choose who to subsidize – who prospers and who perishes – in a free capital market, and use public funds to do it, more is at risk than just $30 billion. Instead, we cross a line, and stumble off a very clear edge down an interminably slippery slope. We speak up now, or forever hold our peace.

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Fed May Buy Mortgages Next, Treasury Investors Bet

Forget lower interest rates. For the Federal Reserve to keep the financial markets from imploding it needs to buy troubled mortgage bonds from banks and securities firms, say the world's biggest Treasury investors.

Even after cutting rates by 3 percentage points since September, expanding the range of securities it accepts as collateral for loans and giving dealers access to its discount window, the Fed has been unable to promote confidence. The difference between what the government and banks pay for three- month loans doubled in the past month to 1.95 percentage points.

The only tool left may be for the Fed to help facilitate a Resolution Trust Corp.-type agency that would buy bonds backed by home loans, said Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co. While purchasing some of the $6 trillion mortgage securities outstanding would take problem debt off the balance sheets of banks and alleviate the cause of the credit crunch, it would put taxpayers at risk.

"An RTC-type structure is interesting, and it may not be that much of a burden on taxpayers in the long run," said Barr Segal, a managing director at Los Angeles-based TCW Group Inc. who helps oversee $80 billion in fixed-income assets. The government should purchase the mortgages and reissue "debt that's backed by the U.S. government and there you go, you've unclogged the drain," he said.

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Home Loan Banks cleared to lift mortgage holdings

The Federal Home Loan Bank system will be permitted to expand their holdings of Fannie Mae and Freddie Mac securities by more than $100 billion under a plan endorsed by their regulator on Monday.

The Federal Housing Finance Board voted to let the banks use their existing capital to increase their holdings of agency mortgage-backed securities for two years, effective immediately. The move is expected to help stabilize the mortgage finance market roiled by months of increasing foreclosures and other failed investments.

"Increasing the agency MBS investment authority for the banks is another way in which the system can perform its traditional mission," said Finance Board Chairman Ronald Rosenfeld, in a prepared statement.

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Split Is Forming Over Regulation of Wall Street

As Congress and the Bush administration struggle to contain the housing and credit crises — and prevent more Wall Street firms from collapsing as Bear Stearns did — a split is forming over how to strengthen oversight of financial institutions after decades of deregulation.

The administration and Democratic lawmakers in Congress agree that the meltdown in credit markets exposed weaknesses in the nation’s tangled web of federal and state regulators, which failed to anticipate the effect of so many new players in the industry.

In Congress, Democrats are drafting bills that would create a powerful new regulator — or simply confer new powers on the Federal Reserve — to oversee practices across the entire array of commercial banks, Wall Street firms, hedge funds and nonbank financial companies. The Treasury Department is rushing to complete its own blueprint for overhauling what is now an alphabet soup of federal and state regulators that often compete against each other and protect their particular slices of the industry as if they were constituents.

But the two sides strongly disagree about whether, after decades of a freewheeling encouragement of exotic new services and new players like hedge funds, the pendulum should swing back to tighter control.
One central battle is likely to be over tightening supervision of the risk-management practices of Wall Street investment banks and perhaps requiring them to keep higher cash reserves as a cushion against unexpected trading losses.

The Democratic proposals would subject Wall Street firms to the kind of strict oversight that banks have had for decades. If firms like Goldman Sachs and Merrill Lynch were required to set aside substantially bigger capital reserves, they would have that much less available for lending, trading and underwriting new securities.

Wall Street firms played a central role in packaging and financing trillions of dollars in high-risk home mortgages, and the losses tied to those mortgages are at the heart of the deepening crisis in the financial markets that has pushed the economy to the brink of a recession.

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The Asian debt default problem

Asian balance sheets remain healthy and economic growth resilient despite the global credit crunch, but by one market measure, Asian bond issuers are an even worse risk than they were during the financial crisis a decade ago. The credit problems that originated in the U.S. housing sector have led to much smaller asset write-downs in Asia than in Europe and the United States, yet the cost of insuring against Asian debt defaults, as measured by credit default swaps, has reached record high levels.

"Asian borrowers are asking: 'What's subprime? Why do I care? What's going on in New Jersey shouldn't impact the strength of my balance sheet,' " Fergus Edwards of UBS said. One big problem, analysts say, is the relative lack of liquidity in Asian debt, compared with that in more developed European or U.S. markets, although hard data are hard to find in the opaque, over-the-counter credit default swaps market.

According to one default swap trader, global investors, when offered a choice between similarly rated issues, will more often than not plump for U.S. or European bonds over Asian debt because those are easier to sell quickly if the need arises. "Fundamentals-wise, Asia is definitely stronger than the U.S. or Europe," said the trader, who spoke anonymously because he was not authorized to speak to reporters. "But people still prefer to be in European or U.S. names because they are much bigger. Market liquidity is bigger and volumes are larger."


That helps explain why levels of Asian credit default swaps - which are priced in terms of percentage points above the London interbank offered rate - are well above the levels seen elsewhere in the world. The levels are also above those at the time of the Asian financial crisis, making it prohibitively costly for Asian issuers to raise money from overseas borrowers. Any recovery in the region's credit markets depends on an easing in a global liquidity crunch in which Asia has played little part, compounding the frustration felt by investors.

Asian bankers said that clients were complaining about having to pay for U.S. problems. "Asia is still strong," said the head of Asian debt capital markets for a major U.S. investment bank, who asked not to be identified discussing conversations with clients. "Credits are improving, economies are improving, balance sheets are improving, therefore borrowing costs should be improving."

The iTraxx Asia high-yield index excluding Japan, which tracks the cost of insuring against the default of 20 noninvestment-grade names like Hynix Semiconductor in South Korea, hit a record at about 6.60 percentage points last week. That means that insuring $10 million in the underlying debt over five years would cost an investor about $660,000, more than triple the $210,000 paid in mid-October, when bond spreads started to shoot up as a result of the crisis.

In comparison, the iTraxx crossover index, which measures 50 similar "junk"-rated credits in Europe, hit about 5.80 percentage points last week. Put another way, the iTraxx index for Asia is implying a five-year default probability of at least 30 percent, according to some calculations, or that more than six names will default in that period.

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With Economy Tied to Wall St., New York Braces for Job Cuts

New York is accustomed to job losses on Wall Street. They come with just about every economic slump, and their impact is felt throughout the city. But now, as the city braces for a big contraction in the financial sector as a result of the credit crisis and the collapse of Bear Stearns, the fallout could be worse than in the past. The New York economy is more dependent than ever on high Wall Street incomes, which have jumped by more than half since 2001, to an average of $387,000, according to the city comptroller’s office.

Last year, the finance industry was responsible for nearly a third of all wages earned in the city, the highest in modern times. And each Wall Street job supports three workers in other sectors. A great many of the 14,000 employees of Bear Stearns are expected to lose their jobs because of the firm’s cash shortage and its pending acquisition by JPMorgan Chase. As the credit crisis unfolds and other firms discover the depths of their losses related to bad loans, few expect the layoffs to stop there.

“Up to this point in New York City, the material result of the credit crunch hasn’t been felt as quickly as people were expecting,” said Marcia Van Wagner, deputy comptroller for the budget of New York City. “It took a while for the other shoe to drop.” Indeed, even though economists say this slowdown started in the financial sector, New York has felt little of its pain. For example, real estate prices have largely held steady in the metropolitan area even as they have plummeted in other regions.

Now there are signs of nervousness, and not just among bankers and traders. Some prospective buyers in the pricey condominium market have put their plans on hold. Companies like SeamlessWeb, which delivers food to financial firms, are reconsidering plans to hire more staff. A newsstand operator across from the New York Stock Exchange greeted his customers last week by saying, “It will be O.K.”

Analysts are predicting wider cuts across the industry, even among workers who had nothing to do with mortgages. A UBS analyst, Glenn Schorr, said the major banks had already cut 5 to 10 percent of their work forces, and he said he expected them to make cuts on a similar scale again in the next few months. “It’s fair to, unfortunately, expect another wave of cuts as they batten down the hatches,” said Mr. Schorr, who covers several major banks.

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Credit crisis has been mutating in a messy manner

In the last few days, or since the Bear Stearns drama came to a climax, a palpable sense of relief has erupted in equity markets. There are all manner of fundamental reasons for this mood shift. If you dig into the details of what the Fed has announced, for example, it is clear that there has been a dramatic increase in the aid it is offering Wall Street.

Moreover, the fact that Goldman Sachs and Lehman Brothers have restricted their write-offs in the latest quarter to a 'mere' few billion dollars has also come as a relief. Most important of all, however, American policy makers are now getting their act together, in the sense that a small band of men, such as Hank Paulson, Timothy Geithner and Robert Steele, has effectively seized control of the banking rudder.

But, amid these fundamental factors, there is also a more subtle psychological factor at work - the sacrifice effect. In particular, the sheer drama of recent events seems to have had a cathartic effect in the minds of some bankers, and unleashed hopes that the market is now being purged of the worst of its credit fears.
In place of a tethered goat, in other words, we now have a stricken Bear being offered up to atone for Wall Street's sins - and, perhaps, slay the demons of moral hazard, at the same time. So will this blood-letting work?

In some corners of Wall Street, it might. After all, investor psychology is absolutely critical in terms of how this crisis plays out - not least because there are many long-term investors on the sidelines right now, ready to put their cash to work if only they believe that a bottom is in sight. More importantly, if you peer into the deepest corners of the credit world last week, there are a few chinks of light. In the credit derivatives sector, for example, bankers say that some buyers are returning for so-called 'super senior' assets.

Similarly, stress levels in the interbank market appear to be subsiding, a touch - alongside the equity rally. However, the problem is that for every sign of progress, new tremors are emerging at a similar pace. For the key thing to understand about the current financial mess is that this is not a financial crisis which is limited to a single, self-contained 'tribe'. On the contrary, it keeps spreading between assets and geographies, as fast as rumours can move by email.

Thus, while the news from Canada is encouraging, the signals emanating from Iceland are dire; similarly, while investors might now be relaxing - a little - about Wall Street brokers, fresh anxiety is bubbling around a swathe of European banks, not to mention hedge funds dabbling in Japanese bonds. This credit crisis, in other words, keeps mutating in an increasingly messy manner, that is apt to irritate investors who have grown up with a Hollywood-inspired assumption that dramas should have a neat beginning, middle and end.

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Oil prices fall on US growth concerns

World oil prices fell by more than a dollar in Asian trade Monday amid fresh concerns that energy demand would be affected by the slowing US economy, dealers said. Concerns over the US economy, the biggest oil consumer, resurfaced after the OECD reduced its US growth forecasts for the first half of this year and said the world's largest economy was teetering on the brink of recession.

In afternoon trade, New York's main oil futures contract, light sweet crude for delivery in May, tumbled 1.61 dollars to 100.23 dollars per barrel. The contract closed at 101.84 on Thursday, at one time sinking to below the 100-dollar level. Markets were closed Friday for a public holiday. London's Brent North Sea crude for May delivery fell 1.31 dollars to 99.07, after settling at 100.38 on Thursday.

"The 100-dollar mark is going to be a support level and prices may congest around that level" as the market focuses on the weakening US demand, said Tony Nunan, of Mitsubishi Corp's international petroleum business in Tokyo.

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Financial crisis linked to bankers' bonuses: Stiglitz

The world financial crisis is closely linked to bankers' bonuses, which "encouraged excessive risk taking," the Independent quoted Nobel Prize-winning economist Joseph Stiglitz as saying Monday. "The system of compensation almost surely contributed in an important way to the crisis," he said in comments published by the newspaper.

"It was designed to encourage risk-taking -- but it encouraged excessive risk-taking. In effect, it paid them to gamble. When things turned out well, they walked away with huge bonuses. When things turn out badly -- as now -- they do not share in the losses. "Even if they lose their jobs, they walk away with large sums." Bonuses paid out in the City of London financial district will top six billion pounds (7.7 billion euros, 12 billion dollars) this year, despite bank failures and write-offs amounting to 60 billion pounds, the paper said.

"The solution is not so much to cap the bonuses, but to make sure that they share the losses as well as the gains -- for instance, holding the bonuses in escrow for 10 years; if there are losses in the second or third or fourth years, the bonuses would be reduced appropriately," Stiglitz said.

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America gets depressed by thoughts of 1929 revisited

When Americans get worried about the economy, their thoughts turn to the Great Depression of the 1930s. And when an eminent US economist, Martin Feldstein, says America is possibly facing its most serious recession since the second world war, those worries are heightened. Could there be a rerun of the Great Depression?

The names may not be familiar to British audiences but in America they resonate enormously. Bear Stearns, the investment bank that went belly-up last weekend, survived the 1929 Wall Street crash and the Great Depression. JPMorgan, the bank that came to its rescue, is a Wall Street legend.

JPMorgan was the target of anticapitalist terrorists in 1920. They placed a bomb outside its office, leaving one scion of the banking dynasty with shrapnel in his bottom. It was Jack Pierpoint Morgan, son of the original JP, who is said to have got worried about the stock market when his shoeshine boy started giving him share tips, and it was at JPMorgan’s offices that Wall Street’s movers and shakers gathered to try to stem the 1929 crash.

Winston Churchill was on a visit to New York in 1929 on one of the worst days for share prices. Churchill was surprised not to see more frenzy among the brokers until he was told that rules prevented them from running, shouting or gesticulating. Churchill did witness something, though, that has become part of the grim history of the era: a man jumping to his death from a nearby hotel window.

The 1929 crash followed a long, debt-fuelled boom for the American economy, the Roaring Twenties. People wanted cars, radios and the other trappings of the new consumer era and borrowed to buy them. The radio age was even more powerful in its impact than the dotcom era of a few years ago.

Americans thought their economy had been transformed. Irving Fisher, one of the country’s most distinguished economists, opined shortly before the crash that was to see stock prices eventually drop by 90% that shares had reached “a permanently high plateau”. A serious recession in modern times would be when gross domestic product (GDP) falls by 3% or 4% over two years. Between 1929 and 1932 America’s GDP fell by 32%.

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Britain and France seek transparency by banks

Prime Minister Gordon Brown of Britain and President Nicolas Sarkozy of France will urge banks this week to make "full and immediate disclosure" of write-offs resulting from the global credit crisis, Brown's office said Monday. The two leaders are increasingly concerned that confidence in financial markets is being hit by uncertainty over the scale of bad debts on banks' books, which some estimates put as high as $600 billion, Brown's office said in a statement.

Sarkozy is to hold talks with Brown on Thursday during a two-day visit to Britain as a guest of Queen Elizabeth II.
The two men will "call for greater transparency in financial markets and, as a first step, full and immediate disclosure of the scale of write-offs by banks," Brown's office said. The bank crisis, especially the collapse of the Wall Street firm Bear Stearns, has shown "the scale of the problem and the effect on market stability of difficult-to-value assets and of undisclosed losses' becoming known in a piecemeal fashion," it said.

Mortgage-backed securities have plunged in value in a credit squeeze brought by low-quality mortgages in the United States, leading to a vicious circle of forced sales, falling prices and weakening balance sheets for banks. Banks have written down more than $125 billion in assets since November, hammering their shares. So far, action by central banks and governments has failed to halt the market turmoil.

Sarkozy's visit is seen by the British news media as part of his drive for a close partnership with Brown. The two leaders will call for more talks with the United States and other countries on "measures to promote financial stability" in forums like the Group of 7 industrialized countries, the International Monetary Fund and World Bank, Brown's office said.

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In the Fed’s Cross Hairs: Exotic Game

In the week or so since the Federal Reserve Bank of New York pushed Bear Stearns into the arms of JPMorgan Chase, there has been much buzz about why the deal went down precisely as it did. Its primary purpose, according to regulators, was to forestall a toppling of financial dominoes on Wall Street, in the event that Bear Stearns skidded into bankruptcy and other firms began falling apart as well.

But a closer look at the terms of this shotgun marriage, and its implications for a wide array of market participants, presents another intriguing dimension to the deal. The JPMorgan-Bear arrangement, and the Bank of America-Countrywide match before it, may offer templates that allow the Federal Reserve to achieve something beyond basic search-and-rescue efforts: taking some air out of the enormous bubble in the credit insurance market and zapping some of the speculators who have caused it to inflate so wildly.

Of course, it could be simple coincidence that the rescues caused billions of dollars (or more) in credit insurance on the debt of Countrywide and Bear Stearns to become worthless. Regulators haven’t pointed at concerns about credit default swaps, as these insurance contracts are called, as reasons for the two takeovers. (And Bank of America’s chief executive, Kenneth D. Lewis, has flatly denied that his deal with Countrywide was at the behest of regulators.)

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

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

On the other hand, the big losers here are those who bought the insurance to speculate against the fortunes of two troubled companies. That’s because the value of their insurance, which increased as the Bear and Countrywide bonds fell, has now collapsed as those bonds have risen to reflect their takeover by stronger banks. We do not yet know who these speculators are, but hedge fund and proprietary trading desks on Wall Street are undoubtedly among them.

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It’s Hard to Thaw a Frozen Market

Real estate bubbles have burst before, without bringing such trouble to the financial system. What is distinctive today is the drying up of market liquidity — the inability to buy and sell financial assets — caused by a lack of good information about asset values. The American economy is suffering from an old conundrum: that liquidity is there when you don’t need it, but missing when you do. The results have been a form of financial gridlock.

If you think that traders have been well informed of late, take another look at the wild path of Bear Stearns shares: A year ago, the stock was selling for $170 a share. At the close on March 14, just before the deal by which Bear Stearns was to be bought by JPMorgan Chase, Bear had a book value of $80 a share — and a share price of $30. The JPMorgan transaction, arranged two days later, valued the company at about $2 a share.

Since then, the shares have been trading above $2, which in part reflects the possibility of the deal breaking up.
Every step of the way, the pricing of the stock has surprised the market — and yet Bear Stearns is a firm with a lengthy history, not an Internet start-up or a biotech whose value is based on a new but untried wonder drug.

To understand the depths of the current crisis, let’s go back to an apparently unrelated episode in economic thought: the socialist calculation debate. Starting in the 1920s, Ludwig von Mises, the leader of the so-called Austrian School of Economics, charged that socialism was unable to engage in rational economic calculation. Without market prices, he reasoned, no one knows how much economic resources are worth.

The subsequent poor performance of planned economies bore out his point. For instance, the Soviet Union did a poor job of producing consumer goods and developing innovative industries. In the absence of well-functioning markets for capital goods, these mistakes festered, rather than being rectified by the independent judgments of individual entrepreneurs.

The irony is that the supercharged capital markets of the American economy are now — at least temporarily — in a somewhat comparable position. Starting in August, many asset markets lost their liquidity, as trading in many kinds of junk bonds, mortgage-backed securities and auction-rate securities has virtually vanished.
Market prices have been drained of their informational value and thus don’t much reflect the “wisdom of crowds,” as they would under normal circumstances. Investors are instead flocking to the safest of assets, like Treasury bills.

The absence of trading is a big problem. Financial institutions have been stuck holding illiquid assets, whose value cannot be easily determined. Who wants to lend to the institutions holding them? No wonder there is a credit crisis and a general attitude of wait and see.

This gridlock is especially harmful because leverage is so high, and financial institutions are so interconnected through swaps and loans. Institutions that rely so heavily on debt are precarious and need up-to-date information about valuations. When they don’t have it, markets freeze up. This is what has taken policymakers by surprise and turned a real estate crash into a much bigger financial problem.

You might wonder why asset prices don’t simply fall enough so that someone buys them and trading picks up again. First, many bank managers would rather postpone the day of reckoning; why seek “fire sale” prices when you might lose your job for doing so? Second, only so many financial institutions have the size and expertise to buy up low-quality assets in large quantities. One scary fact about the Bear Stearns situation is how few buyers were waiting in line.

So what now? Regulators should apply capital requirements consistently to the off-balance-sheet activities of financial institutions. This will limit dangerous leverage, contain contagion effects and make the system less dependent on the steady flow of good information.

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Solution to market crisis awaits action on U.S. mortgages

The global financial crisis that has raged for months shows no signs of ending, and the chiefs of the big central banks are scratching their heads over how to restore faith in the world's credit markets. Global policy makers have unveiled a catalog of measures since August 2007 to try to return confidence to markets. All have failed and left in their wake multibillion-dollar banking casualties in the United States, Britain and Germany.

Massive injections of emergency funds worth hundreds of billions of dollars, a giant U.S. economic stimulus package and wholesale rewriting of the rules to allow commercial banks to pledge risky assets to secure high-quality central bank funds, have all come to nothing.

Banks will still not lend money to each other in the wholesale interbank market that ordinarily provides the lubrication to keep the global financial system turning because the fundamental problem that remains to be tackled is how to put a floor under plunging U.S. real estate prices. "The mortgage problem in the U.S. is a direct consequence of a failure of policy making through the 1990s and it's going to take corrective action from policy makers to sort it out," said Paul Markowski, president of investment advisory firm Global Research Partners.

"Some form of mortgage bailout is likely to have to feature at the core of the solution and that's what central bankers and regulators are now coming to terms with." So far, central banks have been prepared only to lend against mortgage-backed securities - one of the fastest-growing areas of the global capital markets and worth about $4.5 trillion - rather than to buy them outright.

A Financial Times article on Saturday said officials in the United States, the United Kingdom and the euro zone were in talks about the feasibility of mass securities purchases using public money as a solution to the credit crisis, but the U.S. Federal Reserve and the Bank of England dismissed the story. The European Central Bank declined to comment. The scale of the problem the leaders of the world's banking system face is colossal. Banks have written down more than $125 billion in assets since November alone, hammering their shares.

Another spate of credit-related write-downs is expected to be announced this week when the latest batch of quarterly results from the global banking industry is published. The ratings agency Standard & Poor's said earlier this month that the total for U.S. subprime losses could hit $285 billion. The ripple effect from losses booked so far has forced bank bailouts in the United States and Europe and asset price write-downs from Berlin to Beijing.

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U.S. Home Resales Probably Fell as Prices Slid, Credit Shrank

Sales of existing houses in the U.S. probably fell in February to the lowest level in at least nine years, economists said ahead of a private report today. Purchases dropped 0.8 percent to an annual rate of 4.85 million, according to the median of 63 forecasts in a Bloomberg News survey. That would be the fewest since the National Association of Realtors began keeping records in 1999.

The real estate slump will persist as a glut of houses on the market depresses property values and lenders toughen mortgage requirements to stem credit losses. The Federal Reserve last week said the outlook had worsened and pledged to do whatever was needed to keep the economy growing. "We expect both purchasing activity and pricing to fall for the remainder of the year," said Joseph Brusuelas, chief U.S. economist at IDEAglobal Inc. in New York.

The National Association of Realtors is scheduled to issue its report at 10 a.m. in Washington. Estimates in the Bloomberg News survey showed sales rates ranging from 4.69 million to 4.9 million. The "deepening of the housing contraction" was one factor Fed policy makers last week said was likely to hurt growth in coming months. On March 18, the central bank cut its main lending rate by three-quarters of a percentage point to 2.25 percent and said recent reports have shown the outlook for the economy has "weakened further."

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Frozen paper has lost 40% of its value: RBC

When you add it all up, the commercial paper in Canada's frozen $32-billion market has lost more than 40 per cent of its face value because of market conditions, according to one analyst. While the figure does not represent the amount that investors might recoup from their holdings, it is indicative of the troubles facing the committee that's been working to fix this market.

RBC Capital Markets analyst Andre-Philippe Hardy based his estimate, which he released in a note to clients Monday, on court documents that were recently made public. They show that a $17.2-billion portion of the market — leveraged super senior swap transactions — were worth about 30 per cent as of March 4, Mr. Hardy noted.

He believes that a further $3-billion portion of the market that's tied to U.S. subprime is probably worth about 20 per cent.
Assuming that all of the other assets underlying this paper are still worth their full face value, that “implies a valuation of 56 per cent for the ABCP,” Mr. Hardy wrote.

Determining exactly how much of their money investors in this paper will recoup is somewhat more complicated, because the restructuring plan for the market involves dividing it up into three types of new investments that will each have different values, because some will be riskier than others.

But Mr. Hardy now believes that National Bank, which holds more than $2-billion of third-party asset-backed commercial paper, could be forced to take a further $300-million pre-tax writedown on its holdings. That would equate to a 38 per cent writedown. National Bank has currently shaved 25 per cent of the value of the ABCP holdings on its books.

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Retail investors prove leery of Crawford's ABCP rescue plan

The committee that designed a plan to salvage Canada's frozen $32-billion commercial paper market is pressuring financial institutions that sold the paper to do more to help the investors who bought it. It took months of marathon meetings, fierce disagreements, and the occasional strong arm of Canada's central bank for Toronto lawyer Purdy Crawford and his committee to wrestle major pension funds and banks into agreement on a plan to fix the market.

One of their toughest tasks lies ahead. Having turned the plan over to an Ontario court, the committee must now convince hundreds of small investors - who haven't been able to access their money for seven months - to vote in favour of the plan on April 25. With that in mind, Mr. Crawford will be seeking help for investors beyond what the committee's plan provides, looking to "convince through moral suasion some of the vendors of the paper to help the investors in other ways."

Those efforts are likely to be a key determinant of whether the plan passes. "I'm not even going to read it," Ron Lawley, a retired computer technician from Nanaimo, B.C., said yesterday. "If they want this thing to pass, then they're going to have to buy me out, because right now, with the little knowledge that I have at this point, I'm going to vote against it." Mr. Lawley wants his broker, Vancouver-based Canaccord Capital Inc. [CCI-T] , to buy back the roughly $210,000 worth of asset-backed commercial paper (ABCP) that's stuck in his account.

"We're not destitute, but that was my bank account and it's frozen," he said. Canaccord has roughly 1,400 customers who collectively hold about $269-million of ABCP. That's peanuts next to the $21-billion held by a number of major players, including banks, corporations and Crown corporations that have already said they will vote for the plan.

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