Sunday, April 20, 2008

Debt Rattle, April 20 2008: The camel's back

Food line, New York City 1932

Ilargi: Three main themes of craziness today: Citi’s hazardous position, completely overlooked by the investors who raised it stock over 4% on Friday; England rapidly decending into a kind of financial no-man’s land; and the unending amounts of your money that are being fed to the monster with the insatiable appetite.

The overall situation in the world’s main money markets is deteriorating fast, and I think this cannot hold much longer; something will have to give. The camel’s back is ready to be broken.

Update 12.45 pm

Ilargi: I got a -free- promotional newsletter from Addison Wiggin at Agora’s Whiskey and Gunpowder today. It’s not my intention to promote anything here, and I won’t; to learn more, you can go to their site.

Still, I wanted to share a few of Wiggin’s numbers. Note: he quotes last year’s derivatives numbers. We know today’s are higher, even though, as he states, we can only estimate them. I mostly use a $700 trillion total outstanding estimate, based on numbers provided by the Bank for International Settlements earlier this year.

Combining those with Wiggin’s estimates, it’s easy to reach the chilling conclusion that a mere handful of the largest US banks could now be holding $300 trillion in derivatives, which are becoming less stable every single day.

Brace Yourself for the Next “Super-Shocks”
How far could all this really go? How deep will the final damage be, thanks to this "perfect storm"? The feds say the investment banks alone could lose $100 billion. Even an economist for Moody's says losses could reach $225 billion. And one of Goldman Sachs' own economists says that's too conservative still, with the tally rallying up to a $400 billion blow.

Well, gee, a few hundred billion here...a few hundred billion there...and now you're talking some real money! But did we mention? The hedge fund industry alone has ballooned to over $1 trillion. Plenty of that is tied up in these mortgage-backed securities, too. And what happens if total housing wealth — $21 trillion and falling — drops another 15%, to 20%? Now you're talking as much as $4 trillion in housing "wealth," gone just like that. Vanished. At a time when 70% of boomers say they're counting on their homes as their key "retirement asset." Ouch!

If the stock market or bond market slips another 10%, that's another $5.1 trillion or $4.5 trillion, respectively...also gone. Plus losses in the value of the dollar itself. Total stocks, property and other wealth of Americans — priced in dollars — is about $50 trillion. If the dollar drops just 10% more, as it did in 2007, that's another $5 trillion up in smoke!

At $10 trillion down and sinking, I haven't even mentioned what a crash in the $480 trillion derivatives market could do. Let alone the fact that an estimated $200 trillion of that is parked with major U.S. banks!

I say "estimated" because nobody knows how many derivatives anybody owns, let alone how much of those are deeply tangled up in the subprime affair. It's unregulated, burbling below the poisoned groundwater. Computers manage it because the sums are too big...and the money relationships too complicated...for any one human to track. What happens if the computers make a mistake?

That's exactly what happened with Long-Term Capital Management. I'm sure you remember. It had "perfect" computer models. But when interest rates swerved, the computer didn't anticipate it. Like the Titanic, which nobody thought could sink, the hedge fund collided with a $4.6 billion loss in less than four months.

Remember, that was a $4.6 billion problem. Still, seven months of stock market turmoil followed. Financial stocks plunged 34%. Other sectors lost 20–30%. What happens with today's hedge fund and derivatives market, cresting as high as $480 trillion? As I said, some of the world's biggest financial firms — Citibank, Bear Stearns, J.P. Morgan, USB, Goldman Sachs, the Bank of China and HSBC — have huge exposure to the world derivatives market.

And remember, these are often the "Enron" type of investments — hidden off the books where you can't see them. These toxic leveraged instruments could easily be sharing shelf space with your own capital, right now! Recently, Goldman Sachs lost 30% in a single week in its global equity fund, thanks to confounded computer "quant" programming. Morgan Stanley traders lost $390 million in a single day for the same reason. The computers couldn't compute the level of panic selling in the market.

Fed: US banks 'should raise capital to shield against credit losses'
Charlotte:  A top Federal Reserve official said on Friday some banks must raise capital to shield themselves from future losses and it would be better to cut dividends to achieve this than shrink their balance sheets. "Many financial firms have raised significant capital. Unfortunately, while in many cases these equity issues have offset recent losses, they may leave little additional buffer should further credit losses occur," said Boston Federal Reserve Bank President Eric Rosengren.

"A number of large financial institutions have reduced their dividends, and given the potential for additional capital shortages it goes without saying that financial institutions should continue to assess whether further reductions or cessation of dividends would be advisable," he told a credit market symposium here hosted by the Richmond Fed.

Rosengren, who is not a voting member of the Fed's interest-rate setting committee this year, said "truly well capitalised" counterparties were essential to easing counterparty risk concerns that have dogged the interbank market for months. He blamed these fears for the premium of the Libor, or London Interbank Offered Rate, above dollar swap rates, which he said was "unhinged".

The interbank cost of borrowing three-month dollars rose on Friday by its biggest daily amount since the beginning of the credit crisis in August, as concerns that Libor quotes had been understated combined with growing doubts about the extent of further further US interest rate cuts.

Treasury sell-off hits housing recovery hopes
US mortgage rates soared this week after a dramatic sell-off in the Treasury market that hit housing sector recovery hopes even as it suggested investors were growing more confident in the medium-term US economic outlook. The yield on the 10-year Treasury rose as high as 3.85 per cent on Friday from less than 3.50 per cent last week as investors sold bonds on expectations that the Federal Reserve could soon end its rate-cutting cycle.

The Fed sees the rise in yields as signalling increased market confidence in US economic prospects. However, mortgage rates also moved higher, making it more expensive to buy homes and less likely that existing homeowners will be able to refinance mortgages.
Rates on 30-year fixed-rate mortgages rose to 5.87 per cent from 5.63 per cent a week ago, said. Jumbo mortgages, those of more than $417,000, rose to 7.19 per cent from 7.06 per cent.

“The back-up in yields is a concern as it will damage the economic outlook,” said Jane Caron, strategist at Dwight Asset Management. The three-month London interbank offered rate – Libor – increased to 2.91 per cent from 2.71 per cent this week, indicating underlying stress in the financial system. Stocks rallied, said Anthony Conroy, head of equity trading at BNYConvergEx, because “the equity market is focused on a second-half recovery...and is not paying attention to the rise in bond yields yet.

Fed lends less but banks, dealers still need cash
Wall Street demand for cash and loans from the Federal Reserve fell this week, but remains at lofty levels, suggesting bottlenecks persist within the credit market. The rates which banks charge each other for short-term loans have been rising, pointing to reluctance among banks to part with their money, analysts said on Thursday.

"We are still stuck, banks still don't trust each other, liquidity is poor and lending is not happening. We are not going to get out of this in the near term," said Kurt Karl, head of economic research at Swiss Re in New York. The three-month London interbank offered rate posted its biggest one-day rise on Thursday. The global rate benchmark rose to 2.81750 percent from 2.73375 percent on Wednesday.

Although funds have flown more freely given the Fed's menu of liquidity measures, greater credit availability may also be due to falling loan demand by companies facing an economy at the brink of recession, analysts said. "Going forward we would have to look to see, with the economy now in the throes of a recession as most people think, whether the appetite for commercial paper will lessen," said Kenneth Kim, economist with Stone & McCarthy Research Associates, in Princeton, New Jersey.

Overall, commercial banks' and Wall Street dealers' borrowings from the Fed's discount window totaled $32.7 billion in the week ended April 16, down 24 percent from a week ago. Dealers also pared their participation at the Fed's latest auction of Treasury securities from its term securities lending facility.

The TSLF program allows dealers to exchange mortgage-backed securities for ultra-safe U.S. government bonds for 28 days. The latest TSLF auction fetched a bid-to-cover ratio, a gauge of demand, of 1.40, down from 1.88 at a similar-sized auction two weeks ago. The stop-out rate, or clearing level, was 0.10 percent, the minimum bid rate set by the Fed and below 0.16 percent two weeks ago.

Fed to protect consumers from credit card sharks
The Federal Reserve will soon unveil a broader plan to protect consumers from abusive credit card practices than a proposal it issued last year, a Fed official told lawmakers. The Fed's new plan, which it hopes to finalise by December, would restrict retroactive rate increases and other fees that consumer groups and lawmakers have criticised as exorbitant.

In February, US House of Representatives Demo-crats introduced a bill to stop arbitrary interest rate increases, penalties for consumers who pay only a portion of their balances on time, and excessive fees charged by credit card issuers. Sandra Braunstein, director of consumer affairs at the Fed, acknowledged that a Fed proposal last June did not go far enough to help consumers. That plan would have required plain-English disclosures by credit card issuers to help consumers understand fees and rates.

"Careful measures that would restrict credit card terms or practices may, in some instances, be more effective than disclosure to prevent particular consumer injuries," Braunstein told a House Financial Services subcommittee hearing. Chairing the hearing was Carolyn Maloney, a New York Democrat who wants Congress to adopt a credit card holder's bill of rights.

Some lawmakers expressed concern that the regulators' efforts could conflict with congressional efforts to revamp credit card rules. "I'm very concerned about how we are doing this," said Mike Castle, a Republican from Delaware.

Also working on the proposed regulations to crack down on abusive practices are the US Office of Thrift Supervision (OTS) and National Credit Union Administration, she said. OTS Deputy Director John Bowman said his agency shared lawmakers' concerns about the practice of increasing the annual percentage rate on an outstanding balance for reasons other than cardholder behaviour directly related to the account.

Citi exposed to $60 billion in subprime loans - may need more cash
Citigroup, which posted another whopping $12 billion in mortgage-related write downs, still has exposure to $60 billion in subprime-related loan bets and will likely need to raise additional capital. In it’s quarterly earnings call during which the company announced a $5 billion loss tied to that ridiculous $12 billion disclosed that it still has direct exposure to $29 billion in subprime loans and $38 billion to LBO loans (leveraged buy-out). If you count in their exposure to dubious-quality Alt-A loans the total is at close to $80 billion.
From Market Watch on Citi’s $5 billion quarterly-loss:
Citigroup Inc. reported Friday another oversized quarterly loss as the company wrote down about $12 billion of soured mortgage investments and other credit-related items while adding to reserves for further losses on consumer loans.
“Valuations of our subprime-related exposures in fixed-income markets and leveraged-finance assets have further declined and credit costs in our consumer-lending businesses have increased,” CEO Vikram Pandit said in a press release.

From Market Watch and Citi’s $60 billion in subprime exposure:
Citigroup Inc. still has more than $60 billion of exposure to subprime mortgages and loans used to pay for leveraged buyouts, despite the giant bank taking a $12 billion first-quarter write-down.
Citi said it had $29.1 billion of direct exposure to subprime mortgage securities at the end of March. That’s down from $37.3 billion at the end of 2007. The bank also has $37.7 billion of exposure to leveraged loans, down from $43.2 billion at the end of the fourth quarter.
Citi also reported that it has $18.3 billion of exposure to securities backed by Alt-A mortgages, which were offered to more creditworthy borrowers but required less documentation. That’s down from $22 billion at the end of 2007.

I would argue that the $18.3 billion in Alt-A loans are just as suspect and dangerous to the company as the subprime loans. While many subprime loans are made to homeowners with bad credit, the Alt-A loans were made to specuvestors with little or no documentation that will be unable to afford the new mortgage payments when these Alt-A loans reset or recast in the near future. At least subprime homeowners typically want to stay in their homes, amateur investors (a la Casey Serin) may just walkaway, take their credit lumps and call it a day.
I say lump it in there and call it $80 billion worth of bad mortgage exposure. Plus commenter Ann reports that Citi announced layoffs of 9,000 yesterday - at least their trying to conserve the cash they have left. Although they will most-likely need to raise additional capital to weather the storm.
Citigroup’s Tier 1 capital ratio — a closely watched measure of banks’ financial strength — stood at 7.7% at the end fo the first quarter. That was below Harte’s 8.1% expectation.
A Tier 1 ratio below 8% will probably fuel speculation that Citigroup needs to raise more capital again, Harte said.

Citigroup's Earnings Mess
Minyanville's Mr. Practical weighed in on Citigroup's Earnings Mess early Friday morning.:
Citigroup’s earnings report this morning is a confusing mess. Although bulls loved it, any accountant looking through the numbers would notice right away how much the company's financial condition continues to deteriorate and how many tricks it can use to hide that fact. Moody’s put them on negative watch and Fitch actually downgraded them.

Take, for example, the headline write-down number of $6 billion. Nice headline, but if you look through all the numbers and add them up the total write-downs are actually $15 billion. And it gets worse. The company states that “revenues included a $1.3 billion gain related to the inclusion of Citi’s credit spreads in the determination of the market value of those liabilities for which the fair value option was elected.”

In other words (words which bulls don’t like to pay attention to), because the market based price of their bonds fell it reduced the value of their liabilities. So by the fact that their credit became worse they are allowed to show an actual gain to earnings. I know it makes no sense that when a financial company’s financial condition worsens they are somehow able to show a gain in earnings because of it, but don’t complain to me. You’ll have to take it up with Citi's CFO.

The bottom line is this: The U.S.' major banks are barely holding on to life itself. Citi’s financial condition will keep them from making money for a long time even if they do not bust. As speculators pile into the financial stocks again, maybe they should sharpen their pencils a little more.

Citi's Leverage Grows Despite Dumping Assets
Despite a flurry of recent actions to clean up its balance sheet, Citigroup's leverage continues to rise.

Citi's new CEO, Vikram Pandit, has spun off units, cut the dividend and handed out pink slips to preserve shareholders' precious equity. The moves, however, have not offset the erosion of its capital base caused by declining asset values.

The company announced yesterday, ahead of this morning's earnings release that it's selling CitiCapital, a commercial lending operation with 160,000 customers in North America and $13.4 billion in assets, to General Electric. The two companies didn't disclose the price of the acquisition, but GE expects the new division to be a "significant growth opportunity."

Despite efforts to shed assets and reduce exposure to risky mortgage-backed securities, Citi's leverage grew in the fourth quarter of last year to 19:1, up from 18:1 the quarter before. It looks like bean counters in the bowels of the company's accounting department are still trying to lever the struggling bank out of its problems.

Citigroup Posts $5.1 Billion Loss
Ailing Hedge Funds Infect the Wealth Unit; Shares Still Gain 4.5%

When one Citigroup Inc. unit sneezes, another seems to catch a cold. The phenomenon was on display Friday, as Citigroup reported that first-quarter profit in its wealth-management division, long considered a crown jewel of the financial empire, fell 33%, dragged down by the poor performances of internal hedge funds that were ravaged by turmoil in the credit markets.

The disappointing showing in the wealth-management business -- which includes the Smith Barney retail brokerage and a private bank catering to ultrarich individuals -- illustrates a pitfall of Citigroup's "universal bank" model, in which a diverse array of businesses are supposed to complement each other and yield superior results. Now, it turns out that ailing units can infect each other as well.

Brokers in the wealth-management group had been peddling the hedge funds, run by Citigroup's alternative-investments division, to their clients. When the funds incurred steep losses, the wealth-management group moved to help the investors exit their positions. The bill: $250 million. The problems in the wealth-management unit were the least of Citigroup's troubles Friday. The company announced a $5.1 billion first-quarter net loss -- on the heels of a $9.8 billion fourth-quarter loss -- precipitated by more than $18 billion in various credit-related hits.

Profits in all four of Citigroup's main business lines fell sharply from a year ago, and executives warned that the tough times are likely to drag into next year. Citigroup's investment bank endured about $12 billion in write-downs on its exposure to various parts of the credit markets, bringing the division's total losses to about $32 billion since last summer. More hits are possible.

The global consumer group suffered from $6 billion in costs arising from troubled mortgages, home-equity lines, credit cards and auto loans. Losses may "extend beyond where we've seen historical levels go," said Chief Financial Officer Gary Crittenden. "We are in uncharted territory." That is among the starkest warnings sounded this week by big banks that reported first-quarter results. It suggests the industry may continue to be bogged down by losses, as the crisis that originated with subprime mortgages afflicts other types of consumer loans.

And despite stockpiling more than $30 billion in capital in recent months, and repeated assurances from executives that Citigroup has a plethora of capital, Mr. Crittenden said in an interview he couldn't rule out the possibilities that Citigroup will raise more money or that the board will further cut the firm's dividend.

Even the Citigroup hedge fund co-founded by Mr. Pandit struggled, leading Citigroup to record a $202 million write-down. The wealth group also set aside $250 million in the first quarter to help clients liquidate their positions in Citigroup's Falcon fund group, which was burned by big bets on some of the hardest-hit areas of the credit markets.
Longer-lasting damage may lie ahead. People inside the wealth-management unit said they expect the debacle to cost them some of their most lucrative clients. They also worry that frustrated financial advisers may bolt.

Mr. Crittenden said in the interview that Citigroup is working with the company's financial advisers to help contain fallout. Adding to Citigroup's hedge-fund woes, the company on Friday marked down by $202 million the value of Mr. Pandit's Old Lane fund. Citigroup shelled out more than $800 million for Old Lane last year, but the fund, which launched in 2006, has generated lackluster returns.

Ilargi: Looking at Britain these days is a saddening and frightening experience. Credit is vaporizing at break-neck speed, leaving victims in its trail all over the country.

Far too late, UK banks begin to raise try and raise capital. They do this all at the same time, and they all need entire fortunes just to stay alive. Theer won’t be nearly enough capital that can be raised. They’ll try regardless, which means lost of good assets will be sold for pennies.

Yet, the only thing this government can think of doing is throwing dozens of billions into a deep dark hole, presumably to “kick-start” the housing market. It can’t be kick-started, and it shouldn’t be. Prices are far too high. Buying a home in Britain these days is an act of lunacy. So where is all that tax money thrown? To the wolves.

Still, no matter how many billions are squndered, the next Northern Rock is not far away now, and it’ll be interesting to see what the government will do about that. Another $200 billion salvage is out of the question. Or so one would hope. Once the public figures out what has been going on, there’s going to be hell to pay. Poverty will return to England on a scale not seen in many decades, and people will not accept that willingly or gladly.

Bank of England to Detail Swap Plan for Easing Credit
The Bank of England tomorrow will release its plan to swap government bonds for mortgage-backed securities in an effort to ease credit costs and help British homeowners, Chancellor of the Exchequer Alistair Darling said.
This will "unfreeze the situation we've got at the moment," Darling said today in a BBC television interview. "What the Bank of England will do is in effect lend the banks that money. In the meantime, the Bank of England will take a security," he said.

Prime Minister Gordon Brown's government is looking for ways to promote lending after a surge in borrowing costs has caused a pullback by banks. Companies including HBOS Plc have curbed lending and raised the cost of mortgage loans even after central bank policy makers cut the benchmark lending rate three times since December to help avert a U.K. recession.

By offering commercial lenders government bonds, the central bank will be adding to their inventory of liquid assets and making it easier for them to both raise cash and lend, especially to consumers seeking mortgages. In return, the government will hold the riskier mortgage-backed assets as security.

The central bank and the Treasury may offer a swap of 50 billion pounds ($100 billion), the British Broadcasting Corp. reported yesterday. Former Bank of England policy maker Willem Buiter said that may not be enough. The authorities may need to provide double that amount to kick-start the mortgage market, he said in an interview.

"This is an essential initial step in trying to get the financial market stabilized and that in turn will help the mortgage market," Darling said today. "We can re-open the financial markets, because that is an essential pre-condition for the provision of mortgages." Darling, who didn't specify the size of the program in the interview, said he wants British banks to be as transparent as possible in declaring losses on bad loans. He also urged them to pass on interest rate cuts to consumers.

Treasury budget shortfall rockets to £10.2bn
The treasury's budget shortfall soared to £10.2bn last month, leaving the Government's coffers in a perilous state as the UK enters what could prove a prolonged downturn. The figure was a third more than economists expected and the largest since records began in 1993, driven by higher government spending and lower tax receipts.

However, favourable revisions to earlier figures ensured that borrowing for the full financial year to March came in at £35.6bn - a whisker under Chancellor Alistair Darling's Budget forecast last month. Economists said it was a feat he would be unable to pull off this year. Paul Dales, of Capital Economics, said: "To start with, the Chancellor's projection that public spending will rise by just 4.8pc this year looks pretty demanding.
"And a sharper slowdown in economic activity than the Chancellor expects means that the tax-take is unlikely to live up to expectations."

"The public finances are in no way ideally positioned for the slowdown," said David Page, an economist at Investec. "They've almost no room to step up borrowing." The International Monetary Fund is forecasting growth of just 1.6pc both this year and next. If realised, this would be the weakest rate for well over a decade.

Mervyn King’s liquidity deal may avert economic downturn
The Bank of England’s package to restore liquidity and confidence to the money markets could provide the economy with a significant boost and head off part of the widely expected economic downturn, analysts say. While details of the package were still being hammered out this weekend, the broad shape is believed to be a £50 billion swap arrangement in which the Bank will take mortgage-backed securities onto its books in return for gilt-edged securities.

The arrangement is intended to run for just over a year, by which time the authorities believe a degree of normality will have returned to credit and money markets, particularly the market in mortgage-backed securities. While officials refused to speculate on the arrangement ahead of this week’s announcement, sources close to the discussions said it would involve the the Bank imposing a “hair-cut” on the securities it takes onto its books – valuing them at a discount.

Banks taking part would have the flexibility to opt out of the swap if market conditions improved, though the Bank would also have the right to call in additional collateral should conditions in the housing market, for example, deteriorate sharply. The package has been master-minded by Mervyn King, the Bank governor, in consultation with chancellor Alistair Darling and senior Treasury officials – who will have to sign off the arrangement and order the additional issuance of gilt-edged securities.

Along with King, deputy governor Sir John Gieve and head of markets Paul Tucker have been most closely involved at the Bank. The senior Treasury officials advising Darling and Gordon Brown have been Dave Ramsden, head of its macroeconomics division, and Tom Scholar, who recently returned to the Treasury after a brief spell as Brown’s chief of staff at 10 Downing Street, and who heads the Treasury’s financial-services arm.

While it is recognised that this week’s package is only one element in containing the effects of the credit crunch, there is optimism at the Treasury this weekend that Royal Bank of Scotland’s proposed rights issue was greeted enthusiastically by the markets. The hope is the package maintains the improvement in sentiment. “It is not the solution but it is part of the solution,” said one senior banker. The banks have become frustrated waiting for action from the Bank and have accused King of dragging his feet.

Peter Spencer, economic adviser to the Ernst & Young Item club, which uses the Treasury’s model of the economy, warns in a report this weekend that the economy is on course to slow to 1.5% growth next year after a weak 1.8% this year, alongside a 10% fall in house prices. But Spencer, who said the need for action from the authorities was urgent, said that it was possible that the Bank, if successful, could both stabilise and improve the outlook. “If it does the job things could look quite a lot better next year,” he said.

Royal Bank of Scotland board to decide Sir Fred Goodwin fate
Sir Tom McKillop, the chairman of Royal Bank of Scotland, is expected to give a public display of support for chief executive Sir Fred Goodwin as the bank this weekend prepares to announce a £10 billion to £12 billion rights issue, the biggest in British corporate history. Goodwin’s fate will be decided at a board meeting today, where the final terms of the fundraising will also be decided.

However, McKillop’s expected support will not deflect criticism from RBS’s biggest investors about the make-up of the bank’s board and there will be calls for the appointment of a senior independent director with banking experience. Goodwin will confirm this week that the bank will raise as much as £12 billion - equivalent to a third of its current market value - to repair its capital base.

He will also announce write-offs from the exposure to American sub-prime mortgages of between £5 billion and £7 billion.
In addition, the bank intends to raise between £4 billion and £5 billion by the end of this financial year from asset sales, the biggest of which could be the sale of a 20% stake in its insurance businesses, Direct Line and Churchill. These operations, while generating a lot of cash, are no longer seen as core. If a high enough offer came in for the entire business, it is possible it would be sold.

AIG, the American insurance giant, is expected to be interested in a possible deal, along with Warren Buffett’s Berkshire Hathaway and possibly Aviva, sources said. The £3 billion sale of Angel Trains, the RBS-owned leasing company, is also imminent. RBS’s Australian corporate-finance business is also for sale. Goodwin and McKillop are expected to tell shareholders that the latest write-down, in addition to the £2.4 billion hit already taken, will be the last.

One source close to the company said: “We have no intention of coming back to the well, either to raise money or to make further provisions.” Speculation is mounting regarding the possibility that other banks will also look to raise capital.
Bradford & Bingley last week stalled on plans for a rights issue that would have raised around £300m.

Barclays is understood to be looking at possible fundraising moves. It has held talks with several sovereign funds in the Far East, but nothing is imminent. John Varley, the bank’s chief executive, would prefer to raise capital this way rather than through a rights issue. Analysts believe HBOS and Alliance & Leicester may decide to raise capital, now that RBS is setting a precedent.

RBS Writedowns May Reach 7 Billion Pounds
Royal Bank of Scotland Group Plc will announce writedowns of between 5 billion pounds ($10 billion) and 7 billion pounds this week as it prepares a share sale, the Sunday Times reported, without saying where it got the information. The U.K.'s second-biggest lender, whose board meets today, also plans to announce a stock offering of between 10 billion and 12 billion pounds, and is looking to raise as much as 5 billion pounds by the end of this financial year through asset disposals, the newspaper said.

Led by Chief Executive Officer Fred Goodwin, Edinburgh- based Royal Bank is the most indebted of the biggest U.K. banks after paying about 72 billion euros with Banco Santander SA and Fortis for ABN Amro Holding NV, mostly in cash.
"It probably is worse than what people are expecting," Sandy Chen, a London-based analyst at Panmure Gordon, said yesterday, referring to the potential credit-related losses at Royal Bank. He has a "sell" recommendation on the stock.

Royal Bank is considering a share sale to shore up capital, according to a person with knowledge of the plan. The bank needs to meet capital-adequacy requirements after about 2.6 billion pounds of markdowns, the person said on April 18, declining to be identified as no decision had been made. "We will fully update the market next week on both trading and capital," Carolyn McAdam, a spokeswoman for Royal Bank, told Bloomberg News today. She declined to comment further.

Royal Bank of Scotland's secret talks with FSA
Sir Fred Goodwin, chief executive of Royal Bank of Scotland, held secret talks with the City regulator over a multibillion pound rights issue days before he reveals that the group has racked up £6bn of losses from the turmoil in the credit markets.

Goodwin met with Hector Sants, chief executive of the Financial Services Authority, in the last fortnight, and is understood to have been given the FSA's support for the biggest-ever rights issue by a British company. The capital-raising will be confirmed this week and is expected to total between £10bn and £12bn. Sants has also held regular discussions over the same period with the bosses of other major British lenders, including Barclays and HBOS, and they are now expected to consider similar exercises.

The Sunday Telegraph has also learned that AIG, Allianz, Axa and Generali have made preliminary enquiries to buy RBS's £5bn insurance division, which includes Direct Line and Churchill, as the board of the British banking group convenes to decide how to restore investor confidence in its strategy and its chief executive.

News of the FSA's discussions with major banks comes days before an announcement by the Bank of England of a new scheme designed to breathe fresh life into the battered mortgage lending market. The programme will make up to £50bn available from the central bank to provide loans in exchange for mortgage-backed securities.

The Sunday Telegraph understands that the Bank of England will accept only British and European mortgages and credit card loans as collateral because of the dire state of the US housing market. These will be the highest-grade loans held by the banks, and any "credit event" which leads to them declining in quality - such as an arrears default - would trigger a clause demanding they be replaced.

The Bank of England will also insist that the credit risk remains with the pledging bank or other institution, reducing the risk to taxpayers. The scheme mirrors a similar one operated by the US Federal Reserve.
Alongside the FSA, ministers believe that a slew of capital-raisings will bring some respite to the balance sheets and investor bases of the major banks.

As Goodwin prepares for the toughest week of his 10-year spell at the bank, RBS's board will meet in London today to hammer out a statement likely to be made ahead of its annual meeting in Edinburgh on Wednesday.
Last night, people close to the company said RBS was leaning towards writing down the value of assets held by the bank by between £6bn and £7bn, although the final figure could end up being higher. The bank's board is keen to "kitchen-sink" the writedowns to provide a floor beneath which it is unlikely to fall, said one person.

"They can only go out and raise this money once. Caution is the order of the day," said the source.

Ireland: New rules hit risky customers
Jittery lenders employ ‘credit rationing’ to freeze out higher-risk customers, including first-time house buyers, writes Markets Correspondent David Clerkin. Home owners are starting to feel the pinch from the credit crunch, with what one observer termed ‘credit rationing’ taking its toll on borrowers.

Bank of Scotland (Ireland) last week became the latest mortgage lender to transfer the suffering caused by the credit crunch to someone else’s shoulders. The bank toughened up its lending criteria to freeze out customers deemed too risky in the current climate of falling house prices and tighter credit.

It also joined a lengthening list of lenders, such as Permanent TSB and Bank of Ireland, that have hiked rates charged to customers, even in the absence of an increase from the European Central Bank (ECB). In a throwback to the past, the bank said it would no longer lend owner-occupiers any more than 90 per cent of the purchase price of a property, signalling that borrowers would need to stump up the remaining 10 per cent themselves.

It will be even tougher on buy-to-let investors, imposing a new limit on loans of 80 per cent of the purchase price and making it more difficult for these customers to buy fresh properties without injecting their own cash into deals. The bank also moved to pass on higher funding costs by raising lending rates for new business by up to 0.4 per cent – significantly more than a typical ECB rate increase of 0.25 per cent.

For borrowers who failed to get their hands on loans under the old regime, the changes will force a stark reappraisal of their plans. Those who had sought to borrow 100 per cent of their target home’s value have been sent back to the drawing board and must find 10 per cent of the price from somewhere else.

If they cannot raise this money from another source, they face a lengthy period of belt-tightening while they build up the necessary savings from scratch.They will also face higher lending rates, which will result in a choice between higher monthly repayments (if they can afford to take them on) or cutting back on the amount borrowed.

Florida sits on 5 years condo inventory- and keeps building
Would-be condo buyers have their pick of properties in South Florida, where construction cranes fill the sky.
Too bad nobody's buying. According to the Florida Association of Realtors and market expert Jack McCabe of McCabe Research and Consulting (, there is currently a five-year supply of condo and townhouse units on the market in Dade County, which represents an inventory of more than 24,000 units.

Not surprisingly, prices have dropped accordingly. Median sales prices for existing condo units in Ft. Lauderdale, Miami, and West Palm Beach/Boca Raton fell 10 percent from 2006 to 2007 and now range between $171,000 and $263,500.

Unfortunately for the housing market, McCabe believes the situation will only get worse in 2008 and 2009. More than 19,000 condos are scheduled for completion in Miami-Dade County this year, with 6,400 additional units expected in 2009. "There are over 15,000 more condos under construction in Miami-Dade right now than were built and absorbed in 1995-2004," says McCabe, who estimates absorptions during that time at 1,000 units to 2,000 units per year.

Despite the saturated market and weakening values, though, the sales prices for units in these new properties reach as high as the cranes building them. "Thousands of these units are priced at $1 million and above," says McCabe. "They are in much higher price ranges than the existing stock for-sale on the multiple listing service." What's a developer to do? Hope and pray. "Private developers are faced with a nightmare, truthfully," McCabe says. "They will have cancellations, buyers who litigate to get refunds on their deposits, and people who will want to close, but can't get a mortgage."

To mitigate the damage, McCabe recommends developers close to delivering finished units contact their buyers and ask whether they are still planning on purchasing the unit, and if so, whether they've obtained a mortgage. If buyers are waffling, McCabe suggests offering a price concession that softens the pain of slumping values and thereby keeps them in the deal.
"Some developers will renegotiate," he predicts. "Other developers whose equity is gone may just turn in the keys like individual homeowners

'Darkest winter' looms for South Africa
South African consumers are facing a "winter of discontent" that is expected to get worse. Interest rates, rising inflation, higher food and petrol prices will result in many having their homes and cars repossessed because they can no longer afford to pay for them, warned Goolam Ballim, the chief economist with Standard Bank. "It is genuinely going to be one of the darkest winters for South Africa. People are going to lose their homes and cars," he said.

He said efforts by the Reserve Bank's monetary policy committee to control inflation and curb spending would affect consumers at least until 2009. Ballim said the government could ease some of the pressure on consumers by injecting investment into the economy from money allocated in the Budget for capital projects, such as transport and other infrastructure, thus creating jobs. On Thursday, Statistics South Africa released data showing that the number of bad debts had risen by 17 percent in February compared to the same period a year ago.

This confirmed the fears of banks and retailers, which had reported higher than usual incidents of customers defaulting on home loans, car repayments, credit cards and retail accounts. Stats SA said the 17 percent increase for debts had resulted in 60 920 judgments worth R560-million - the first time it had found an increase since October 2007. The largest contributors to the civil judgments were for loans and acknowledgements of debt.

Ina Wilken, the deputy chairperson of the South African National Consumer Union, said the national credit laws were having a negative impact on consumers and preventing them from consolidating debt, but the direct contributory factors to hardship were interest rates and rising food and fuel costs.

Banks really shouldn't be in charge
Nice try; no cigar. That was my reaction to the attempt of the banking community to forestall additional regulation, by recommending "a suite of best practices to be embraced voluntarily". It was also the reaction of the policymakers meeting recently in Washington. More regulation is on its way. After frightening politicians and policymakers so badly, even the most optimistic banker must realise this. The question is whether the additional regulation will do any good.

In an interim report on "market best practices", the Institute for International Finance, an association of bankers, offers devastating self-criticism. Here then are some of the weaknesses it identifies: "deteriorating lending standards by certain originators of credit"; a "decline of underwriting standards"; an "excessive reliance on poorly understood, poorly performing and less than adequate ratings of structured products"; and "difficulties in identifying where exposures reside".

Would you buy a voluntary code from people who describe their own mistakes in this brutal manner? I thought not. There are two powerful additional reasons for not doing so. First, in such a fiercely competitive business, a voluntary code is almost certainly not worth the paper it is written on. When they can get away with behaving irresponsibly, some will do so. This puts strong pressure on others. That is what Chuck Prince, former chief executive officer of Citigroup, meant when he said that "as long as the music is playing, you've got to get up and dance".

So, as Willem Buiter of the London School of Economics remarks: "Self-regulation stands in relation to regulation the way self-importance stands in relation to importance."

Second, the industry has form. The IIF itself was founded in 1983 in response to the developing country debt crisis. At that time, big parts of the West's banking system were in effect bankrupt. Now, many upsets later, we have reached the "subprime crisis". The IIF was created not only to represent the industry, but to improve its performance. It is clear that this has not worked.

Do not just take my word for it. Last month, Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard published an extraordinary paper on the long history of financial crises. The incidence of banking crises (measured by the proportion of countries affected) has been as high since 1980 as in any period since 1800; that the incidence of crises is correlated with liberalisation of capital flows; and that there was, until 2007, a decline in the incidence of crises in the 2000s.

Yet why, I ask, should this industry have apparently failed to improve its standards of performance over the past century? After all, almost every other industry has done so. Consider how confident we are that the food we buy will not poison us. Yet adulterated food was once a threat. Consider, by those standards, the failures of the banking industry, as admitted by the IIF itself. Its purely operational performance is now impressive. But competition does not work well in finance. The "product" of the financial industry is promises for an uncertain future, marketed as dreams that can readily become nightmares.

Customers are readily swept away by exaggerated promises, irrational beliefs, misplaced trust and sheer skulduggery. So, too, are practitioners: basing risk management on limited data and inadequate models is a good example. Emotions count wherever uncertainties loom. Boeing would not survive if the aircraft it built fell out of the sky. Yet in the financial industry, huge blunders are also almost always made in common. If everybody is in the dance nobody is to blame and, in any case, governments, horrified by the consequences of a collapsing financial system, will come to the rescue.

Ilargi: Credit Default Swaps make betting against the bank a lucrative idea.

CDS may undermine debt governance -law professor
The explosive growth of derivatives has made it possible that holders of credit default swaps (CDS) could sabotage the interests of a company and its other debtholders, a U.S. professor told a conference this week. "Empty creditors could undermine debt governance," Professor Henry T.C. Hu, professor of law in banking and finance at the University of Texas, told the annual meeting of the International Swaps and Derivatives Association (ISDA).

For example, a hedge fund or other investor could hold $200 million of a company's bonds but could also have bought protection against default in the CDS market for $500 million worth of the company's debt. In that case, the investor stands to profit more from its swap position than it would lose from its bonds and may act to help push the company to fail, such as by opposing an out-of-court restructuring.

The issue is taking on greater significance as analysts and debt investors expect the rate of global bankruptcies to increase later in 2008 and 2009 from what have been historically low levels. By debt governance, Hu refers to the creditor's control rights in credit agreements and under bankruptcy law. "Both loan contracts and the (U.S.) Bankruptcy Code are premised on the assumption that creditors ... have an economic interest in the company's success and will behave accordingly," Hu and Professor Bernard Black wrote in a law review paper in January. "Large-scale, hidden debt decoupling weakens our ability to rely on these assumptions."

The January paper extended the work of the two professors, who published a paper in 2006 that caused a stir in the media and the market by identifying the risk of "empty voting" by shareholders with holdings of equity derivatives. "The derivatives revolution in finance has made it easy to decouple financial voting rights from economic ownership," Hu said at ISDA. "Decoupling of control rights can also occur on the debt side."

The notional value of outstanding CDS on a number of companies is many times higher than the value of underlying cash bonds. For that reason, ISDA has devised an auction process to determine cash settlement of CDS contracts in the event of defaults. When U.S. autoparts company Delphi Corp defaulted in 2005 for example, the value of notional swaps on the company amounted to about $30 billion, 15 times its $2 billion in bonds.

David Mengle, ISDA head of research, questioned, however, whether in practice an investor would end up holding both bonds and protection for a distressed company. When companies are distressed, buying a hedge requires an expensive payment up front and dealers may be reluctant to sell protection, Mengle said.

As for companies that are not yet distressed, investors are not likely to buy and hold both bonds and CDS in a consistent way, he added. There is no requirement for creditors to disclose their derivatives holdings, so the extent that they may have different economic interests in companies is not known.

Hu said, however, that bankruptcy judges and lawyers have told him that his theory explains instances of odd behaviour they have observed in recent years. "One bankruptcy judge described a recent case wherein a junior creditor complained of too high a valuation being assigned to the bankruptcy estate," the professors wrote in the January paper. Debt decoupling is also playing a role in the U.S. housing crisis, Hu said.

When homeowners faced difficulty in the past, they could go to their lenders and try to negotiate waivers or modifications, but this is more difficult now that thousands of loans have been repackaged into portfolios, which have then been sold in pieces to investors. "The President's Working Group is calling on the banks to modify the terms of home mortgages, but they don't have the right to do that," Hu said.


Anonymous said...

I couldnt add a comment earlier. Problems?

el_pollo said...

Although the main theme of today's blog is world food price inflation, I have a question for anyone with a semblance of expertise. All the goldbugs are predicting hyper inflation, particularly of the USD, followed by economic depression with hyper deflation, as last seen in the great depression. Since the inflation and deflation must be consecutive, could anyone explain to me in as much detail as possible how they would see this transition? Or, alternately, suggest a good site where this is discussed.

Prometheus said...

Found this online today, might be of interest.

Credit crisis hits student borrowers

Anthony Norton, a junior at the University of Massachusetts in Boston, just learned a tough lesson in economics:

The credit market crisis is spreading to student loans.

Norton thought he was set when he deposited a $16,000 student-loan check to pay for summer classes and the fall semester. But when he started to pay bills for classes, rent, and other expenses last week, his checks bounced.

TenThousandMileMargin said...


I don't think "all the goldbugs" are predicting hyperinflation followed by deflation at all.

Jim Willie at FinancialSense would say that the Fed & congress will cause severe inflation in their attempts to fight asset deflation (trillion dollar bailouts).

Eric Janzen at has a "ka-poom theory" - deflation as debt contracts, followed by severe inflation as attempts to fight deflation finally gain traction.

Karl Denniger at marketticker (not a goldbug) says we have already had the inflation during the bubble, now it is time for deflation.

I don't know ANYONE who sees hyperinflation (greater than 15%) in the future followed by deflation.

And I read a lot of goldbugs.

I think you have your wires crossed.

As they say, "you're not even wrong".

There has never been such a thing as hyper-deflation. The price of gold went UP during the great depression because they devalued the currency. Japan experienced deflation of a few percent per year - no hyper there, just deflation.

Your average goldbug would say that since we no longer have a gold standard, and the USA loves to run up debt, the value of the dollar is going to decline. Full stop. No later period of dollar appreciation.

Perhaps you are thinking of the idea that there will be severe deflation of debt and financial assets (e.g houses) while at the same time prices for essentials rise due to a falling US dollar.

That's pretty much what most of the guys at FinancialSense and PrudentBear would argue.

Karl Denniger has tended to argue against inflation on the grounds that there will be such a catastrophic decline in the money supply that even the cost of essentials will fall. The idea being that no tools big enough to fight the credit crunch actually exist.

I think he may have to backtrack a bit now it has become apparent that the Fed, Congress and White House are simply going to tear up the constitution and redefine the monetary system on the fly any time they feel like it.

If you are no longer constrained by the law, or logic, or common sense, what limits the amount of money you can create?

EBrown said...

Weird cosmic aligning of the stars - I was in the middle of writing about Denninger's opinion on things after reading this ticker - - and got pulled away (to do some actual work of all things!) When I came back you'd posted some of my thoughts.

I actually agree with much of what the poster Travisgod writes in the aforementioned ticker, but I don't know about the timing of it all. I think the deflation followed by rapid changing of the rules of finance to accomodate an inflation is fairly likely. I don't know whether the deflation will strike all asset classes (so far I'm only certain of the really obvious stuff like houses, luxury goods, tourism industries, airlines, cars...), or whether it will only hit the obvious before the rules change.

And I think Denninger is one deeply angry man.

Stoneleigh said...

I agree with Karl Denninger that we've had the (credit) inflation during the bubble period, and what we face now is credit deflation. I also agree that credit deflation will be sufficiently devastating that even the prices of essentials will fall (at least temporarily).

However, falling prices for essentials does not mean that they will be getting cheaper. Against a backdrop of a collapsing money supply, purchasing power would be falling faster than price, making those goods less affordable than before for almost everyone. In other words, prices can fall in nominal terms while rising in real terms (adjusted for changes in the money supply).

Eventually, as a much larger percentage of a much smaller money supply chases essentials, prices may well rise again in nominal terms as well, which (in a deflationary environment) would mean they were going through the roof in real terms.

I agree with Eric Janzsen that we may well see currency hyperinflation after credit deflation has run its course, but this is likely IMO to be several years away at least. Deflation and depression reinforce each other, and I would be very surprised if this depression lasted for less time than the last one.