Debt Rattle, March 7 2008: The day the wheels came off

Ilargi: I'm strongly inclined to call today, March 7, for the record, "the day the wheels are coming off". Look at these quotes, all from professionals in the world of finance:

• "Everything is telling you the financial system is broken"
  
  
• "The markets have become "utterly unhinged""
  
  
• "All the lights are flashing red''
  
  
• "The gears of capitalism are pretty much grinding to a halt”
  

Do keep checking back here during the day.

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Ilargi: This is insane, people, this is absolutely crazy. US home prices have more than doubled since 2000, and all that extra value, in principle, was for the home owner. Now, prices have dropped less than 15% so far overall, yet home equity is at its lowest level in over 60 years, and quite possible its lowest level ever.. Let that sink in! And it’s not even all: 6% of all US mortgages is already delinquent.

U.S. homeowners' equity drops below 50%

Americans' percentage of equity in their homes fell below 50 per cent for the first time on record since 1945, the U.S. Federal Reserve Board said Thursday. Homeowners' portion of equity slipped to downwardly revised 49.6 per cent in the second quarter of 2007, the central bank reported in its quarterly U.S. Flow of Funds Accounts, and declined further to 47.9 per cent in the fourth quarter — the third straight quarter it was under 50 per cent.

That marks the first time homeowners' debt on their houses exceeds their equity since the Fed started tracking the data in 1945. The total value of equity also fell for the third straight quarter to $9.65-trillion (U.S.) from a downwardly revised $9.93-trillion in the third quarter.

Home equity, which is equal to the percentage of a home's market value minus mortgage-related debt, has steadily decreased even as home prices jumped earlier this decade due to a surge in cash-out refinances, home equity loans and lines of credit and an increase in 100 per cent or more home financing.

Economists expect this figure to drop even further as declining home prices eat into the value of most Americans' single largest asset. Moody's Economy.com estimates that 8.8 million homeowners, or about 10.3 per cent of homes, will have zero or negative equity by the end of the month. Even more disturbing, about 13.8 million households, or 15.9 per cent, will be “upside down” if prices fall 20 per cent from their peak.

The latest Standard & Poor's/Case-Shiller index showed U.S. home prices plunging 8.9 per cent in the final quarter of 2007 compared with a year ago, the steepest decline in the 20-year history of the index.

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About 6% of U.S. mortgages delinquent

Nearly 6% of all mortgages were delinquent nationwide in the fourth quarter and foreclosure starts were at the highest levels ever, according to a report issued Thursday by the Mortgage Bankers Association.Michigan continues to rank high for delinquencies and the number of homes in foreclosure. The state ranked second nationwide with 8.97% of its home loans more than 30 days delinquent during the three months ended Dec. 31. Mississippi was first with 11% of loans delinquent and Georgia was third with 8.37%.

The total national delinquency rate of 5.82% is the highest in the mortgage bankers survey since it reached 6.07% in 1985, said Doug Duncan, chief economist for the mortgage bankers. The housing market bust could end up being even more dramatic than the long boom that ran from 1998 to 2005 and drove prices to astronomical levels in states like California and Florida. Those states are now suffering with a disproportionate share of foreclosure starts.

California and Florida represent 21% of loans outstanding and 30% of foreclosure starts. They also account for 18% of gross domestic product, Duncan said. And with no end in sight to the cycle of foreclosures and resulting fire sales that drag down overall home prices and glut the housing inventory, Duncan expects default and foreclosure rates to rise in the next two quarters.

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Ilargi: Pinocchio, Pinocchio, you have a nose from here to Tokyo


Ambac's Callen Says Confidence Can Be Restored in 6 Months

Ambac Financial Group Inc. Chief Executive Officer Michael Callen said investor confidence in the bond insurer can be restored this year. "We think it takes six months," Callen said in a Bloomberg Television interview today from New York.

Ambac, the world's second-largest bond insurer, has lost 92 percent of its market value in the past year as losses on mortgage-linked securities it guaranteed raised concern that it would lose the AAA rating it depends on to write policies. About $1.5 billion in stock and unit sales this week, a dividend cut and other efforts mean "the AAA is now solid," Callen said. "We have a viable business," Callen said. "I think we are positioned as well as anyone in the industry to go out and underwrite municipals."



Bond insurers including Ambac and its larger competitor MBIA Inc. stumbled after expanding beyond their traditional business of municipal insurance to guarantees on collateralized debt obligations that have since plunged in value. CDOs package pools of securities then split them into pieces with different ratings. Moody's Investors Service and Standard & Poor's threatened to downgrade Ambac unless it raised capital.

New York-based Ambac sold 185.2 million common shares at $6.75, raising $1.25 billion, according to data compiled by Bloomberg. Ambac also sold $250 million of units convertible into shares in 2011, according to a person with knowledge of the sale. "It was a really big challenge," Callen said today. "We started this process 24 hours ago. I was worried about the response, but we worked hard," he said.

Ambac today fell 70 cents, or 9.4 percent, to $6.72 as of 9:43 a.m. in New York Stock Exchange composite trading after dropping 15 percent yesterday.

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Ilargi: A nice overview of what’s happening in the markets. Take a good look at those numbers. Basically, companies involved in mortgages lost on average some 10% in one day.

Missed margin calls slam stocks

Worry about the health of the credit markets made a noisy comeback Thursday, leveling financial stocks and sending many investors scampering for the safety of government debt. Revelations that two large investors had missed recent margin calls raised fears that more investors could be forced to liquidate assets to meet their obligations to lenders, possibly setting off a nasty spiral in which assets are unloaded into a declining market, placing even more downward pressure on values and leading more lenders to call in loans.

"The uncertainty in the market is rising," especially in light of the margin calls, said Jim Russell, senior portfolio strategist at U.S. Bank. "Once those things get triggered you can have forced selling by leveraged players. That just adds fuel to the fire."[..]

Word emerged Thursday that Carlyle Capital, managed by Washington private-equity giant Carlyle Group, had failed to meet margin calls on its $21.7 billion portfolio. And Thornburg Mortgage disclosed late Wednesday that it had failed to meet a margin call of about $28 million, triggering a string of cross-defaults. Shares of Thornburg Mortgage plunged 52%.

Those developments caused investors to worry that other mortgage investors could also be facing margin calls. Shares of Anworth Mortgage Asset, MFA Mortgage Investments, Annaly Capital Management, the most active issue on the New York Stock Exchange, and Capstead Mortgage each dropped by more than 18%. An iShares exchange-traded fund tracking REITs slid 15.2%.[..]

Fannie shares fell 10.7% and Freddie slid 6.9% after the Treasury Department denied rumors that the government would provide an explicit guarantee of the lenders' debt. Fannie shares have now fallen more than 22% over the last five trading days and have dropped 46% since the start of the year. Freddie shares have fallen 20% in four days and are down 41% for the year to date.

"You're starting to see more signs of counterparty risk" among companies that were on the opposite side of one another's credit trades in recent years, said Jeff Middleswart, president of Behind the Numbers, a Dallas-based research firm. "It raises the possibility that some of these companies could have a fire sale to raise capital." Among mortgage lenders, IndyMac Bancorp shares tumbled 10% and Countrywide Financial fell 8.8%. Washington Mutual shares fell 8%. S&P cut its rating on Washington Mutual's debt one notch to two steps above junk.

Other reports indicated further mortgage tumult could lie ahead. The Mortgage Bankers Association said 5.82% of mortgages were at least 30 days delinquent in the fourth quarter on a seasonally adjusted basis, up 23 basis points from the third quarter and up 87 basis points from the fourth quarter of 2006. The figure was the highest in the group's survey since 1985 and suggested that efforts by regulators and firms to quell the problem so far are having little effect. Moody's Investors Service said that the global default rate on speculative-grade debt increased for a third straight month, to 1.3% in February, up from 1.1% in January.

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How reverse leverage is killing the credit markets

The Wall Street Journal reports that banks lent a mind-boggling $32 for every dollar of equity in Carlyle Capital, the bankrupt mortgage investment joint venture between Carlyle Group and the now-bankrupt Thornburg Mortgage. This demonstrates that while leverage can magnify returns in an up-market, it can also magnify losses in a down one.

The cause for both bankruptcies was that banks made a margin call -- a request for some of their loan to be repaid immediately -- and neither party was willing to cough it up. In the case of Thornburg's $28 million cash call, it is a bit less surprising that it could not come up with the money. But Carlyle Capital's parent is an $80 billion private equity firm -- so it's interesting that it chose not to fork over the $37 million the banks wanted.

What's going on here is that our capital markets depend on the health of Wall Street banks. The banks are running out of capital because the value of their assets -- particularly asset-backed securities (ABSs) such as Collateralized Debt Obligations (CDOs) - are plummeting. As those assets drop in value, banks need to write down those values and raise capital to maintain their capital ratios - for example, Citigroup's target ratio of capital to assets - its so-called Tier One Capital Ratio - is 7.5%.

Hedge funds, like Carlyle -- that invest in CDOs -- are extensions of the banks -- linked to them through the money they borrow to buy those CDOs. As the value of their collateral declines, the banks realize that the hedge funds will not be able to pay back the money they borrowed. That's because there is no active market for those CDOs that might be willing to pay the hedge funds so they, in turn, could pay back the banks.

The failure of these hedge funds to pay back the money they borrowed makes things worse for the banks. This matters because hedge funds manage $1.9 trillion worth of clients' money. I am not sure about this, but if that $1.9 trillion is treated as equity and those hedge funds borrowed $32 for every dollar of that equity, the hedge funds would owe $60.8 trillion to the banks.

Since hedge funds are so lightly regulated, public information about how much they've borrowed is hard to come by. But let's say that 20% of the hedge funds' assets were invested in CDOs -- assuming they borrowed $32 for every dollar of equity that would mean they owed the banks $12.2 trillion which would be backed by $12.5 trillion worth of CDOs on the hedge funds' books.

But if those $12.5 trillion CDOs are now worth, say, 25% of their stated value, or $3.1 trillion, then the banks are going to be nervous about the $9.1 trillion gap between the value of the collateral and the amount the hedge funds borrowed. And they'll look for a way to force the hedge funds to pay back that $12.2 trillion. If the hedge funds don't happen to have that money available, they'll default just like Carlyle Capital did. This will mean huge additional write-offs for the banks.

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Bank Debt More Risky Than Corporate Bonds, Default Swaps Show

The risk of European banks defaulting rose higher than their clients for the first time in four months as credit-market losses spread, according to credit- default swaps traders.

Contracts on the Markit iTraxx Financial index of banks and insurers jumped to as high as 153 basis points today, surpassing the Markit iTraxx Europe index by 3.5 basis points, according to JPMorgan Chase & Co. The last time the financial index exceeded the broader benchmark was in November, when both were trading at about 40 basis points.

Speculation banks will take more losses rose this week as trading in Carlyle Group's mortgage-bond unit was suspended in Amsterdam after banks forced the fund to sell some of its holdings amid margin calls and default notices from lenders. Banks are hoarding cash and cutting lending to hedge funds as record U.S. home foreclosures and loan defaults stoke concern financial firms may collapse.

"Banks have counterparty exposure to funds," said Willem Sels, head of credit strategy at Dresdner Kleinwort in London. "The market is anticipating more forced selling."

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Agency Mortgage-Bond Spreads Rise; Markets 'Utterly Unhinged'

Yields on agency mortgage-backed securities rose to a new 22-year high relative to U.S. Treasuries as banks stepped up margin calls and concerns grew that the Federal Reserve may be unable to curb the credit slump. The difference in yields, or spread, on the Bloomberg index for Fannie Mae's current-coupon, 30-year fixed-rate mortgage bonds and 10-year government notes widened about 21 basis points, to 237 basis points, the highest since 1986 and 103 basis points higher than on Jan. 15. The spread helps determine the interest rate homeowners pay on new prime mortgages of $417,000 or less.

The markets have become "utterly unhinged," William O'Donnell, a UBS AG government bond strategist in Stamford, Connecticut, wrote in a note to clients today. A lack of liquidity has "led to stunning air-pockets in price levels." Investors are realizing that banks have little room to make new investments amid rising losses and a flood of unwanted assets, said Scott Simon, head of mortgage-backed bonds at Pacific Investment Management Co. The world's top banks have reported more than $181 billion in asset writedowns and losses, been stuck with $160 billion of leveraged buyout loans, and bailed out $159 billion of structured investment vehicles.

"Everything is telling you the financial system is broken," Simon, whose Newport Beach, California-based unit of Allianz SE manages the world's largest bond fund, said in a telephone interview today. "Everybody's in de-levering mode." Agency mortgage securities outstanding, which are guaranteed by government-chartered Fannie Mae and Freddie Mac or federal agency Ginnie Mae, total almost $4.5 trillion, about the same size as the U.S. Treasury market

The widening spreads prompted speculation the government may step in to support securities guaranteed by Fannie Mae and Freddie Mac, said Tom di Galoma, head of U.S. Treasury trading in New York at Jefferies & Co., a brokerage for institutional investors. The Treasury Department said the rumor isn't true. "The Fed can't really save the mortgage market," di Galoma said. "As they keep cutting, mortgage rates aren't going lower."

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Spreads hit record highs, entering “wild and inexplicable” territory

European credit spreads surged to record highs on Friday, breaking through levels that analysts fear could represent a tipping point. The iTraxx Europe index, which measures the cost of protecting 125 investment-grade credits against default, hit 156 basis points in morning trade, entering territory where sudden feedback effects come increasingly into play.

“The 150bp level is a significant threshold,” said analysts at BNP Paribas. “According to our calculation, it is where a “typical” CPDO may be forced to unwind its risk portfolio and trigger a cash-out event.” Liquidating CPDOs and other structured credit instruments requires buying large amounts of protection using credit default swaps. This, in turn, drives the cost of protection higher, potentially triggering a chain reaction. “There is potential for some wild and possibly inexplicable price movements as the unwinds get bigger,” the analysts said.

While many analysts play down the importance of CPDO unwinds, countless other structured products — as well as hedge funds and banks — are coming under intense pressure to cut their losses. Any optimism that the market might escape further violent swings has become increasingly rare. BNP Paribas said: “While deleveraging has taken an accelerated path since the beginning of the year, we believe that this is only the beginning of a trend which will look to unwind the excesses of the last few years.”

In recent days new horrors surfaced from the hedge fund world. As credit spread have risen, highly-geared funds have come under increasing pressure from uneasy investors who want their money back, and brokers terrified on counterparty risk. Willem Sels at Dresdner Kleinwort said: “Price changes, multiplied by leverage, leads to redemption risk and margin risk, which ultimately also leads to unwind risk. This creates a technical sell-off as the unwinds happen in a bearish market.” The trauma is not contained to Europe. US and Asian credit derivatives indices are also hitting record highs.

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Ilargi: Carlyle is (was) leveraged 32 times, a typical hedge fund. If its equity loses just 3,5% in value, it’s dead in the water. That equity is residential mortgage backed securities, all backed by Fannie and Freddie. So apparently the market's faith in the GSE's is not what you might have expected.

Carlyle Reports Additional Margin Calls; trading suspended

Carlyle Capital Corp. Ltd., a listed mortgage-bond fund managed by private equity firm the Carlyle Group, said Friday it was considering "all available options" after lenders started liquidating securities from its $21.7 billion portfolio. Shares in the fund, which trade on Euronext Amsterdam, were suspended Friday pending a further statement. The stock closed down Thursday nearly 60 percent at $5.

The fund said it received additional margin calls and default notices Thursday from banks that help finance its portfolio of residential mortgage-backed securities. It indicated it may not be able to meet the increased requirements, and that further liquidations were possible. Carlyle Capital on Thursday said it had been unable to meet margin calls with four banks the day before, roiling financial markets and raising fears that its entire portfolio could be liquidated.

Such a move would further depress prices on fixed-income securities, which have dropped sharply in recent weeks as banks pull back on their lending to funds and investment vehicles, leading to forced asset sales. In Friday's statement, Carlyle Capital said it had received "substantial additional margin calls and additional default notices from its lenders." It also said that lenders were selling off securities held as collateral. Risk premiums on residential mortgage-backed securities widened Thursday, stocks fell, and U.S. Treasurys rallied as investors sought safety.

Carlyle Capital said Friday it is in continued discussions with its lenders about its financing situation, but warned shareholders that the additional margin calls and increased collateral requirements to keep funding in place could quickly deplete its liquidity and impair its capital. Carlyle Capital leverages its $670 million equity 32 times to finance a $21.7 billion portfolio of residential mortgage-backed securities issued by U.S. housing agencies Freddie Mac and Fannie Mae.

To do this, it enters into repurchase agreements with banks, which involve posting the mortgage securities as collateral in exchange for cash. If the value of the security held as collateral falls, the lender will ask for more collateral _ a "margin call" _ in order to secure the loan. If the borrower does not meet the margin call by putting up more collateral, the lender may sell the security.

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ING gave $1.46 billion loan to Carlyle Capital - report

ING Group NV reportedly made a loan totaling $1.46 billion to Carlyle Capital Corporation in January, Internet news site Z24 reported. Z24, a joint venture between Het Financieele Dagblad and television station RTLZ, found reference to the loan in Carlyle Capital's annual report. ING declined to tell Z24 whether the loan had been repaid or not. ING spokesman Raymond Vermeulen said ING never commented on reports.

Carlyle Capital shares were this morning suspended in trading by the Dutch stock markets watchdog AFM after it said it has received substantial additional margin calls and additional default notices from its lenders. An AFM spokesman said Carlyle Capital shares will remain suspended until the company issues a new statement. The spokesman did not comment on when a statement is expected.

Carlyle Capital said there has been a rapid and severe deterioration in the market for US government agency AAA-rated RMBS in the past several days. It added that, although it believed last week it had sufficient liquidity, it was informed by lenders this week additional margin calls and increased collateral requirements would be significant and well in excess of the margin calls it received Wednesday.

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U.S. Unexpectedly Lost 63,000 Jobs in February

The U.S. unexpectedly lost jobs in February for the second consecutive month, adding to evidence the economy is in a recession. Payrolls fell by 63,000, the biggest drop since March 2003, after a decline of 22,000 in January that was larger than initially estimated, the Labor Department said today in Washington. The jobless rate declined to 4.8 percent, reflecting a shrinking labor force as some people gave up looking for work.

A weakening job market, combined with lower home values, higher fuel bills and stricter lending rules, raises the odds consumer spending will keep slowing. Falling employment is one reason Federal Reserve Chairman Ben S. Bernanke has signaled central bankers are prepared to lower interest rates again.

"All the lights are flashing red'' said Nariman Behravesh, chief economist at Global Insight Inc. in Lexington, Massachusetts, in an interview with Bloomberg Television. "We're in a recession. I don't think there is any doubt about it at this point.''

Minutes before the figures were released, the Fed said it will expand two short-term auctions this month to $100 billion, from $60 billion, to address "heightened liquidity pressures'' in markets. Treasury notes surged and the dollar weakened after the employment figures.

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U.S. Stock-Index Futures Decline on Unexpected Loss of Jobs

U.S. stock-index futures tumbled after the biggest drop in jobs in almost five years added to conviction that the economy has tipped into a recession. Procter & Gamble Co., Citigroup Inc. and Alcoa Inc. led declines in Dow Jones Industrial Average stocks trading in Europe. Futures began their retreat before the Labor Department reported a loss of 63,000 jobs last month as the Federal Reserve's plan to expand two short-term auctions this month to $100 billion failed to assuage concern that credit-market losses will deepen.

"This is definitely bad news," said Ed Peters, chief investment officer at PanAgora Asset Management in Boston, which manages $25 billion. "It increases the chance for a real recession happening if consumers start to pull back significantly." Standard & Poor's 500 Index futures expiring in March retreated 15 to 1,292.9 at 8:50 a.m. in New York.

Dow Jones Industrial Average futures lost 131 to 11,939. Nasdaq-100 Index futures decreased 11.25 to 1,703. The Labor Department also increased its tally of job losses in January to 22,000 from a previous estimate of 17,000. The jobless rate declined to 4.8 percent, reflecting a shrinking labor force as some people gave up looking for work.

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Financial System Broken: The deflation genie

If you were by any chance wondering why mortgage rates were not following the Fed's slash and burn policy of lower rates, the long answer is above. The short answer is rising default risk. But let's not be too gloomy here.

Other than overleverage, bad debts, sinking home prices, no jobs, shrinking wages, cash strapped US consumers, rising oil prices, a sinking US dollar, $500 trillion in derivatives not marked to market, rampant overcapacity, underfunded pension plans, looming boomer retirements, no funding for Medicaid, no funding for Medicare, and no Social Security trust fund, everything is just fine.

And even though the Fed, central bankers in general, and governments combined to create this problem, the irony is nearly everyone is begging for them to fix the problem by encouraging still more speculation in housing, commercial real estate, and the markets.

Sorry folks, it's the end of the line and payback time for the world's most reckless financial experiment in history. The deflation genie can't be put back in the bottle until leverage everywhere is unwound.

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US corporate bond spreads approach widest on record

Spreads on U.S. corporate bonds on Thursday approached their widest levels since the bankruptcy wave of 2002 on worries about hedge fund selling of a wide range of corporate, mortgage and municipal bonds. Spreads, the extra yields that corporate bonds pay over US Treasuries, gapped out across the board, though banks and brokers were especially hard hit on fears of more writedowns as mortgage problems spread.

"Basically the gears of capitalism are pretty much grinding to a halt," said Mirko Mikelic, portfolio manager for Fifth Third Asset Management in Grand Rapids, Michigan. "What started as a little subprime problem has kind of morphed into a bigger problem for the bigger economy."

Average investment-grade spreads had closed on Wednesday at 264 basis points over Treasuries, just 8 basis points shy of a record set on Oct. 10, 2002, a year of massive bankruptcies, according to Merrill Lynch data going back to December 1996. Thursday's widening was likely to put the index at or close to a new record, analysts said.

In the credit default swap market, the main investment-grade index rose about 19 basis points to a new record wide of about 184 basis points, while swaps on brokers' bonds rose about 30 basis points, an analyst said. "All the financial issues of last summer, of the September period, are definitely back in full force," one corporate bond analyst said. "This is probably the worst the market's been."

Hedge Fund Selling Blamed

Credit default swaps on Lehman Brothers' debt traded near 300 basis points, or $300,000 a year for five years to protect $10 million of debt, while Goldman Sachs' swaps were around 215 basis points, the analyst said. "What's driving it is this massive deleveraging that's going on within some of the hedge funds and the mortgage bond funds," said Dan Sheppard, a director at Deutsche Bank Private Wealth Management in New York. "They can't make margin calls and so they're basically selling just about anything they can their hands on."

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Countrywide's Mozilo concerned about underwriting

Countrywide Financial Corp CEO Angelo Mozilo told a congressional panel on Friday that he is "extremely concerned" that recent tightening of mortgage underwriting criteria has gone too far. "For the market to recover, underwriting guidelines need to strike a better balance between providing borrowers with access to loans and lenders and investors with the assurance that these loans will be repaid," he said in remarks to be given to a House of Representatives committee hearing.

Mozilo urged Congress to reform the Federal Housing Administration, expand tax-exempt mortgage revenue bonds for both home purchases and refinancing and to take other steps to address the widening crisis in mortgage finance markets. "This is the worst housing market I have ever seen," Mozilo said in written testimony for the House Oversight and Government Reform Committee, chaired by Rep. Henry Waxman.

Mozilo urged raising loan limits for government-chartered housing finance giants Fannie Mae and Freddie Mac, as well as other steps Congress could take, such as reforming the Federal Housing Administration, giving first-time homebuyers a tax credit and expanding tax-exempt mortgage revenue bonds for home buying and refinancing.

"I also want to strongly suggest that traditional guidelines be reexamined relative to the appraised value of a home versus the outstanding mortgage so that current borrowers can refinance at lower interest rates," he said.

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U.S. Fed Says March TAF Auctions to Expand to $50 Billion Each

The Federal Reserve said it will expand two short-term auctions this month to $100 billion, from $60 billion, to address "heightened liquidity pressures in term funding markets." The Fed said it will increase the amount of its March 10 and March 24 term auction facility sales to $50 billion each from $30 billion each. The Fed also said it will initiate a series of 28-day term repurchase agreements.

The Fed has loaned $160 billion in funds since mid-December in six auctions through the Term Auction Facility, known as TAF, in an effort to increase the supply of funds available for lending. The auctions began as part of a coordinated effort with central banks in the U.K., Canada, Switzerland and the euro region to increase temporary funds after losses on subprime mortgages made banks reluctant to lend. The European Central Bank and Swiss National Bank have halted their auctions.

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Fannie, Freddie Loan Limits Raised For More Than 70 U.S. Counties

More than 70 counties across the U.S. will see limits for mortgage loans backed by Fannie Mae and Freddie Mac rise to $729,750 -- the new maximum limit set by the economic stimulus bill, the Federal Housing Administration announced today. The counties now eligible for the highest limits are mostly in California, New York, New Jersey, Virginia, Maryland and Washington, D.C. But hundreds of counties across the country had their loan ceilings increased from $417,000, the previous limit.

Allowing mortgage giants Fannie Mae and Freddie Mac to guarantee bigger loans will likely encourage lenders to drop interest rates for loans over $417,000, known as "jumbos." Before the credit crunch, rates on jumbo loans were about 0.25 percentage point higher than those on smaller loans. Now, with credit tighter, jumbo rates are as much as a percentage point higher.

New limits were also released for FHA-backed loans. The highest limit for those loans is also $729,750, while the minimum ceiling -- the maximum loan allowed in lower priced areas -- is now $271,050. The agency estimated that the FHA increase could benefit nearly 250,000 families across the country. Prior to the change, FHA loans were capped at $362,790. The minimum ceiling was $200,160.

"Many families all over the U.S. will benefit from this access to credit, and increasing these loan limits will inject much-needed liquidity into the housing market," FHA Commissioner and Assistant Secretary for Housing Brian Montgomery said in a press release.

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Ilargi: I've said it many times before in the past year: the BCE buy-out is peak insanity. I called it that before the LBO market collapsed, but they still wish to push through. A major pension fund, Ontario Teachers, will put in $4-5 billion of its own, take on $32 billion of new debt, and pay a total of $51.8 billion. Please God, let that judge slam this deal into Kingdom Come. For Ontario's workers.

BCE to learn fate of buyout Friday

A Quebec Superior Court Justice will deliver a set of key rulings Friday that could determine the fate of the proposed $52-billion buyout of BCE Inc., the parent company of Bell Canada. Justice Joel Silcoff will deliver his ruling at 4 p.m. ET on a proposed plan of arrangement under which the buyout led by Ontario Teachers' Pension Plan will be structured. The parties to the case will review the judgment in private before it is released publicly at 7 p.m.

Weighing on the decision are court challenges from Bell bondholders upset that the value of their investments will fall as a result of the leveraged buyout, which will saddle the telecom giant with $32-billion in new debt and drag down its credit ratings to junk status. Two groups of bondholders have argued that the buyout -- which has already cut the market value of their securities -- will harm their interests and is not in good faith, nor "fair and reasonable."

The bondholders have asked the court to reject the plan or to make its approval subject to the consent of the trustee of the bond issues. One of the groups has asked for $400-million compensation. BCE's lawyers argued the complaints were without merit and that language in the indentures governing the bonds does not give bondholders a say in the deal's fate.

At the outset of the trial last December, BCE lawyer William Brock presented the court with a binder containing the plan of arrangement and the indentures for the three bonds, and said little else was required for the court's decision. Thousands of pages of documents were subsequently filed and the case dragged out for two months. The ruling comes as credit markets continue to deteriorate, which has led to the unravelling or renegotiation of some buyouts. If the court favours the bondholders and that results in added costs for the buyers, it could put the deal in jeopardy.

Lenders are worried they will not be able to refinance pledges they made to buy out in the public markets without taking big losses. Citigroup, one of the banks most affected by the market crisis, is the lead lender to the BCE buyout group. In addition, Teachers told the court that should the group be forced to pay the bondholders, it would be unable to find the extra cash in the tight credit market.

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Ilargi: Try this with a straight face: Citi plans to refocus on home loans, has $213 billion of them on its books, and will sell 90% of that to Fannie and Freddie.

Citigroup overhauling U.S. mortgage business

Citigroup Inc. on Thursday said it aims to cut its home loan exposure by $45-billion (U.S.), reduce risk and save $200-million a year in an overhaul of its U.S. residential mortgage business. The largest U.S. bank, which suffered a $9.83-billion fourth-quarter loss tied largely to mortgages, also plans to fold its Citi Home Equity and Citi Residential Lending businesses into its existing CitiMortgage Inc. unit.

New York-based Citigroup and other lenders across the U.S. have been curbing mortgage risk as the housing slump deepens and credit markets tighten, weighing on profitability and share prices. Merrill Lynch & Co. on Wednesday announced plans to shut down its subprime mortgage unit, cutting 650 jobs. Citigroup plans to reduce by about one-fifth over the next year its roughly $213-billion U.S. consumer mortgage portfolio, largely by running off existing loans.

It also plans by the third quarter to sell to Fannie Mae and Freddie Mac, or package into securities, 90 per cent of home loans it makes, up from 65 per cent in 2007. Citigroup will also further tighten underwriting, though it will still offer subprime mortgages and home equity loans, unlike rivals that have stopped as default rates soared. Savings will result from an unspecified number of job cuts, the consolidation of technology and operating platforms, and combining sales staff, CitiMortgage president Bill Beckmann said. The mortgage units employ about 13,000 people, he said.

"Within the mortgage business, it just makes sense," Mr. Beckmann said in an interview, referring to the changes. "The subprime and home equity markets have contracted. Now is an ideal time to put the lending businesses together, refocus on home loans we can sell and streamline the overall business." Citigroup is the fourth-largest U.S. mortgage lender, having made $198-billion of home loans in 2007, according to the newsletter Inside Mortgage Finance. According to its annual report, Citigroup ended 2007 with $150-billion of first mortgages and $63-billion of second mortgages, including home equity loans, on its books.

About half the loans are in California, New York, Florida, Illinois and Texas, with 27 per cent in California alone. While companies such as Countrywide have stopped or curtailed subprime and home equity loans, Citigroup said it still sees demand for both products. Still, Mr. Beckmann said housing prices may not start to recover before late this year.

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Credit crunch catches up with Goldman

Analysts, used to watching Goldman exceed expectations with surprise trading gains, only in recent weeks slashed forecasts. The average estimate for 2008 earnings, down modestly during the second half last year, plunged 13 percent since February 1 as analysts focused on Goldman's exposure to hard-hit markets. Forecasts have come down sharply for all the big banks, as the credit crunch spreads across almost every market -- the contagion effect that Wall Street executives last year assured analysts was not happening.

The most important yardstick, though, is the stock market. Goldman, for years a leader among financial stocks, is down more than 26 percent this year. Only Lehman fared worse among the big broker-dealers, with a 30 percent decline. With roughly $200 billion of risky corporate loans and few willing buyers, bank lenders have scrambled to sell loans at steep discounts in recent weeks. Oppenheimer analyst Meredith Whitney forecast the biggest U.S. brokers could post up to $14 billion of first-quarter write-downs on these loans.

Goldman had about $42 billion of leveraged loan commitments on its books at the end of its fiscal year in November, according to regulatory filings. Analysts predict nearly $2 billion in write-offs at the bank. Another potential source of trouble is Goldman's variable interest entities, vehicles that keep assets off the books by issuing short-term debt. Goldman had $62.1 billion in VIEs holding mortgage securities, real estate and other assets, at the end of November, excluding hedges.

Goldman also is the most aggressive bank investing its own capital in private and public companies, including $6.8 billion in Industrial and Commercial Bank of China and $4.1 billion in Japan's Sumitomo Mitsui Financial Group. Shares of both banks fell about 20 percent during the quarter. Even without these stakes, Goldman carried $11.9 billion of corporate and real estate investments on its books at the end of November. These values are expected to come down in a period when markets around the world slumped.

Investment banking, which plays a small role in overall results, likewise suffered as market woes stalled deal activity. In the first two months of this year, industry-wide announced M&A activity fell 27 percent from last year. Goldman's market share also slipped, according to Dealogic. U.S. initial public offerings are down 85 percent, while junk bond underwriting is down 90 percent.

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Twin peaks

Writing in Thursday’s FT, Tim Bond of BarCap picks up on commodity price rises. The subject of a growing debate on these pages, and in print. For all the current focus on banking, mortgages and structured finance, has the potential for a broader economic crisis - facing commodities - been overlooked?
Writes Bond:

The global economy is facing twin shocks. Natural resource markets are delivering a supply shock of 1970s dimensions, while the financial system is delivering a shock comparable to the bank and thrift crises of the 1988-1993 period. The magnitude of each shock is very different. 

The financial markets require a recapitalisation of the banking system, with estimates ranging from $300bn to $1,000bn. By contrast, prospective capital requirements in the resource markets dwarf the current needs of the banking system

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Global grain inventories at 40-year lows, equivalent to just 15-20 per cent of annual demand. Ditto metals, with inventories in a 30-year trough relative to consumption. Runaway oil prices and a welter of hungry, rapidly industrialising middling economies demanding more goods.

The US governmental response has ignored this crisis, writes Bond, nay made it worse, by pursuing a reflationary strategy in response to a crisis in the banking sector. It’s a policy which is sending a strong signal in support of current price levels, and with it, the expectation that prices have only one way to go… up.

On cue, since Washington started to ease policy, investor flows into commodities and other real assets have soared. Meanwhile, in spite of the slide into near-recession, forward inflation expectations in the bond market have risen to match the highest levels seen this century.

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Dollar's Decline a Crisis of Solvency - Not Liquidity

The U.S. dollar has hit a 35-year low when compared to a basket of currencies, adding fuel to rising fears of inflation. Prices of gold, crude, and other commodities are soaring to near all-time highs despite the fact that the U.S. economy is in the midst of a slowdown. Interestingly, those elevated commodity prices are not included in the standard inflationary data sets of CPI or PPI. The Federal Reserve’s most important task is to keep our currency healthy and stable, so how can Chairman Bernanke justify another rate cut at the FOMC’s next meeting?

Chairman Bernanke has aggressively cut rates in a Herculean effort to counter the credit crisis and the likely recession that it could engender. However, every time he cuts rates, inflation becomes more of a problem and the U.S. dollar depreciates further. This is a de facto tax on people holding and spending dollars. Fed policy should be a balancing act between restraining inflation and maintaining conditions favorable for sustainable economic growth. However, Bernanke’s actions of late have been anything but balanced.

Pleasing Wall Street by continually easing monetary policy could be disastrous for the economy. The dollar has reached its lowest value since this currency basket metric was started in 1973, and further easing will lead to further devaluation. Has the easing really helped the economy anyway? Long term mortgage rates remain virtually unchanged from where they were when the easing process began. It is probably too early to tell, but as many claim and we agree, this is not a crisis of liquidity but of solvency.

Consider that the carry between Chinese and U.S. interest rates is now negative, thus making Chinese investment in U.S. treasuries far less attractive. The massive amount of treasuries that the Chinese already own are losing value due to the dollar’s decline and the yuan’s appreciation. This will make the largest current account deficit in history even harder to finance with the loss of attractive yields.

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BMO shares slide as more ABCP risk eyed

Shares of Bank of Montreal continued to drop Thursday as investors grapple with what appears to be a long string of bad news about risky exposures at the bank. The stock was down $2.44 or 5.42 per cent at $42.58 on the Toronto Stock Exchange in mid-afternoon trading. That compares to a closing price of $52.35 a week ago.

Some investors were surprised by BMO's disclosure earlier this week that it has taken a $39-million provision relating to Fairway Finance Co. LLC, a U.S. asset-backed commercial paper conduit that it sponsors. “We believe that BMO's U.S. ABCP program, Fairway Finance, could lead to more off-balance sheet assets coming on to the bank's books, thereby increasing the potential for writedowns in upcoming quarters,” RBC Capital Markets analyst Andre-Philippe Hardy wrote in a note to clients Wednesday.

Bank of Montreal is also still in talks to restructure two Canadian asset-backed commercial paper trusts - Apex and Sitka - and has cautioned that if those negotiations fail it will take a $500-million writedown in the coming quarter. Meanwhile, one of Apex's investors is fighting BMO's demand for the return of a $400-million funds transfer, while a counterparty is “disputing its obligations” to provide up to $600-million to the bank under a previous deal. Those matters could result in further charges.

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BMO leads decline as Canada bank stocks sideswiped

Bank of Montreal bore the brunt of investor concern over Canadian banking's credit crunch woes yesterday, leading a dramatic stock market drop across the sector. Speculation that Swiss bank UBS has sold a massive mortgage portfolio at a large discount, coupled with news that Citigroup Inc. plans to cut its U.S. consumer mortgage portfolio by about one-fifth in the next year, helped to drive down the shares of many banks around the world.

But while the Canadian banking sector fell roughly 4 per cent, BMO's shares lost 6.7 per cent to close at $41.97, as investors struggled to understand its latest troubled spot, a U.S. asset-backed commercial paper conduit it sponsors called Fairway Finance Company LLC. The bank has lost $5.2-billion in market value over the past week as its stock dropped $10.38. While the sector is down about 10 per cent over that period, BMO shares have lost nearly 20 per cent.

Investors are increasingly lumping Bank of Montreal in the same camp as Canadian Imperial Bank of Commerce, which was punished for its oversized exposure to the struggling U.S. subprime mortgage market. When it comes to the Big Six banks, "we are truly, truly in a freefall now," said Genuity Capital Markets analyst Mario Mendonca.

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$100-million reasons to stay

Canadian Imperial Bank of Commerce rolled out a $100-million-plus retention plan Thursday aimed at preventing defections among 1,300 stockbrokers at the bank, which has been battered by U.S. credit woes. CIBC will advance up to $300,000 to its financial advisers in the form of a loan that will be forgiven over 10 years, providing the stockbrokers stay with the firm, according to documents distributed internally to staff. CIBC has not publicly released details of the compensation plan, which is scheduled to take effect in June.

Top producers at the bank's brokerage division, CIBC Wood Gundy, who already make more than $1-million a year by generating more than $2-million in commissions, would be eligible for the $300,000 loan. The average financial adviser generates revenues of $867,000 for the bank, takes home $400,000 and would be able to borrow $125,000. At the low end of the scale, a new, green broker who takes home $50,000 could borrow $30,000.

"This plan is part of an ongoing investment in our high-value Wood Gundy brokers and our investment advisers," a spokesman for CIBC said.CIBC unveiled the loans in the wake of a quarter that saw the bank lose $1.46-billion, after extensive writedowns of U.S. subprime mortgages and other credit holdings.

CIBC stockbrokers are partly paid in bank stock, which is down 36 per cent in price over the past year, and that has created unrest in the ranks. "They are very worried about clients and brokers being so disgusted with CIBC that there could be a mass exodus," said one executive at the bank, who asked for anonymity.

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World bankers ask: what went wrong?

As the financial sector mess deepened yesterday, global banking regulators and senior bank executives said they are trying to figure out a response to the breakdown in risk management that has led to the crisis. Financial stocks plunged on news of a steep rise in U.S. home loan foreclosures, heightening fears of a further deterioration in the U.S. economy as well as additional writedowns in the global banking sector on top of US$181-billion of charges on structured products so far.

With the risk of further multi-billion dollar charges hitting the financial sector, Canada's big five banks have seen $73.9-billion of market capitalization evaporate from their highs reached last year. Clearly a case where risk management models failed; the overwhelming majority of bankers didn't see the financial crisis coming.

In an unprecedented financial services market crisis, banks "face increasing pressure to understand the risks they face, to measure and assess such risks appropriately, and to take the necessary steps to reduce, hedge, or otherwise manage such risk exposures," said the Fed's William Rutledge.

Also, yesterday, high ranking bank executives, including Bank of Nova Scotia chief Rick Waugh, met at the Copacabana Palace Hotel in Rio de Janeiro in an effort to figure out what has gone wrong and what can be done about it. "We felt we had to put together a very active and formal response to what was going on in the market place," said Mr. Waugh who flew overnight to Rio on a private jet immediately following the bank's annual meeting in Edmonton on Tuesday.

Alongside a senior executive from Dutch financial services giant ING Group, Mr. Waugh is co-chair of a special committee on risk management set up by the Institute of International Finance late last year. The IIF is the leading global banking association with 370 members from more than 65 countries.

"These are the top people in risk management from around the world," said Mr. Waugh in a telephone interview from his hotel in Rio. "Our goal is to assess and identify the weaknesses that have occurred in this crisis and come up with recommendations so we can prevent recurrences in the future."

The special committee is working on about 70 specific recommendations on issues related to liquidity, financial statement disclosure, valuation, and credit ratings. The group will issue an interim report soon with a more detailed report in June. There is a change in mood at this year's IIF spring meeting - the first in Latin America - compared with other recent annual conferences when markets looked rosier, Mr. Waugh said. Risk management and credit market turmoil was "absolutely not" on the agenda at IIF a year ago, he said.

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Thornburg Off 51 Pct on Bankruptcy Worry, Defaults

Thornburg Mortgage Inc shares sank 51 percent on Thursday on worries the "jumbo" mortgage lender might go bankrupt, after its failure to meet a margin call triggered defaults under other lending agreements.

The decline followed Thornburg's disclosure in a late Wednesday filing with the U.S. Securities and Exchange Commission that it failed to meet a $28 million margin call from JPMorgan Chase & Co, and that the bank would exercise its rights under a $320 million loan. Margin calls force borrowers to pay back loans or post more collateral. Thornburg said the JPMorgan notification triggered defaults under its other reverse repurchase and secured loan agreements, and its obligations under those agreements were "material."

The Santa Fe, New Mexico-based company has suffered as the housing slump and tight credit led investors to shun securities they no longer consider safe. These include the higher-rated mortgages above $417,000, which Fannie Mae and Freddie Mac cannot buy and in which Thornburg specializes. "Thornburg now appears to be on the ropes," wrote Jason Arnold, an analyst at RBC Capital Markets, in a report titled "Game-Over at Thornburg?"

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Fed’s Fisher Says Credit Markets May Not Force Fed to Act

Federal Reserve Bank of Dallas President Richard Fisher said investors shouldn't assume that rising credit costs will force the central bank to cut interest rates as deeply as it did in January or in an emergency meeting.
"We reacted with very deliberate actions that took place over a very short timeframe" in January, Fisher said in an interview with Bloomberg Television in Paris. "That shouldn't lead markets to expectations that we will continue to react in that manner."

Fisher also downplayed speculation that the Fed is set to reduce its benchmark interest rate before policy makers' next scheduled session on March 18. Yesterday, yields on agency mortgage-backed securities rose to a 22-year high relative to U.S. Treasuries, while the cost to protect corporate bonds from default climbed to a record.

"I would discourage you from thinking that simply because of a significant action in the credit markets, like we had yesterday, that suddenly we're going to have an Open Market Committee meeting, and that suddenly we're going to move Fed funds rates in response," said Fisher. "It doesn't work that way." Traders see a 100 percent chance that the Fed will lower its 3 percent benchmark rate by three-quarters of a percentage point this month, according to futures contracts. The probability a month ago of such a move was 30 percent.

At the same time, Fisher said that the credit-market turmoil "has to be processed." "There's a danger if the Fed reacts to new information immediately," said Fisher, 58, a former money manager and U.S. Senate candidate who joined the Dallas Fed in 2005. "But obviously we take into account all the information as closely as we can."

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Vicious spiral haunts debt markets

This weekend the Group of Ten central bankers will convene in Basel for one of their regular pow-wows. The discussions will be fraught. Almost three months ago, a similar gathering paved the way for an unprecedented bout of collective action in the money markets that was supposed to halt the sense of financial panic.

But three months later, the grisly truth is that market anxiety is seeping back with a vengeance. Thus the crucial question confronting the central bankers this weekend, as they fly in to snowy Switzerland is twofold: first, are we on the verge of a new downward lurch? And second, is there anything the G10 bankers can actually do to stop this? A downward lurch does look a real danger now, not least because the central bankers themselves are looking increasingly impotent when it comes to tackling the fundamental reasons why sentiment is so fragile.

The western financial system is caught in a trap. On the one hand, there is an urgent need for clearing prices to be established for impaired assets to restore confidence; on the other hand, if this is done in a mark-to-market world, there is a risk that some banks will run out of capital. Policymakers are in the unenviable position of knowing almost any step they take risks denting sentiment further.

First, a bit of background. History suggests a crucial component for ending a financial crisis is to establish some sense of clearing prices. Once goods look cheap – and it does not seem they will soon become cheaper still – buyers tend to rush back in. This, after all, is Economics 101, and it applies as much to houses and cars as collateralised debt obligations.
Now, in theory, there are plenty of reasons to expect investors to start rushing into the credit markets soon, in a manner that could stabilise sentiment. After all, many credit prices have slumped dramatically.

And while banks may be capital constrained, plenty of investors are sitting on pots of free cash, such as sovereign wealth funds and even mainstream asset managers and pension groups. But these groups are notably not buying credit yet, either because they are still paralysed with shock or, more realistically, because they have a nasty feeling that while a leveraged loan, say, looks cheap, it could be cheaper in the future.

How can you combat this? Fifteen years ago, the US government devised a clever trick in the aftermath of the savings and loans crisis, by conducting firesale auctions of S&L assets. This was brilliantly effective in establishing clearing prices and turning sentiment around, because as soon as investors saw some assets being sold at knockdown prices they starting jumping in, meaning that within a few months, prices were rising again.

But these days the US government faces a crucial impediment to repeating this trick. Back in the days of the S&L crisis, US banks were not forced to mark their books to the firesale prices. But now the mark-to-market creed has taken hold. And it is a fair bet that if US banks were forced to mark their books to the initial clearance price for a CDO squared, say, some would run out of capital. Hence the trap: in the modern financial system, you can have mark-to-market accounting systems, or quick action to establish clearing prices, but probably not both, without blowing up some banks.

Of course one way to exit this trap would be to abandon the mark-to-market rules for a while, or loosen capital adequacy standards. Some furtive discussions between policymakers along these lines are already occurring.

But I would be surprised if any action occurs soon. So the risk now is that we will remain trapped in this climate of grinding fear for months – at best. Few institutions have much incentive to voluntarily create clearing prices. However, hedge funds are now being forced to make asset sales in an ad hoc, opaque manner that is adding to the sense of fear. This is forcing the banks to mark books lower and pull in their horns, sparking even more hedge fund sales and fuelling concern about banks. It is a viciously unpleasant spiral.

Let us all hope the G10 have some amazing new tricks up their sleeves; if not, we are moving into dangerous waters.

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