Debt Rattle, April 21 2008: Hordes of pitchforks

Marie Antoinette, October 16 1793

Ilargi: How crazy would you like your Monday? Try this on for size:

• The Bank of England doesn’t hand out just $100 billion. No, the program is unlimited! It might be $500 billion. Or more. They won’t tell till six months from now.

• They don’t just buy mortgage securities, insane enough as that is. No, they accept credit card debt as well, and subprime debt too. Any piece of paper that looks halfway official, basically.

• All the securities are worth far less than 100% of their face value, so much is obvious to everyone, and much of them not more than pennies on the pound. If that weren’t true, there’d be no problem selling them in the open market!! So does the Bank of England demand a discount? Hell no, they do the opposite: they pay MORE for the paper than the face value. This could easily mean they end up paying double what the stuff is worth. They give £1 for every 80 pence "value", but that 80 is not worth more than 50 pence.

And then the official word is that banks have to pay all that money back. But they don’t have the money now, with all that paper in their hands, and they most certainly won’t ever be able to pay back double the real value.

• The stated goal of all this is to restart a mortgage market that no longer lends money to people who wish to buy real estate that even the IMF, for one, says is grossly overvalued. And as stupid as these folks obviously are, it is NOT the task of the government to help suck them into situations they won’t ever be able to get out of. And stupid they are, the Brits.

Gordon Brown lifts your wallet out of your pocket, takes your cash and graciously offers to hand it back to you, if you agree to pay him back with interest, and if you buy a house with it that you can't afford and that will lose much of its value over the next two years. What are you thinking?

Residential real estate in the UK, as in the US and many other countries, will drop in value by 30%, minimum, and much more likely by 50% or more. The government knowingly helps setting up its own citizens, willfully enticing them to get deep into big black debt holes. And the government facilitates the set-up using its own citizens’ tax revenue.

Why does the mortgage market need to be kick-started? Not for the buyers, they’d only end up paying far too much. No, for the bankers: they need business. So they now use the people’s money to fleece the people.

This is criminal behavior. And if someone doesn’t do something to stop this scheme of grand theft and highway robbery, for that is what it is, and nothing else, I see very angry hordes of pitchforks in the none-too-distant future for the likes of Gordon Brown and his bunch of made men.

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Update 4.45 pm. Please scroll down for Bank of England tidings.

The worst is behind us, unless massive bank failure is considered a bad thing

I hear many bank CEOs saying they believe the worst is behind us. I am not a banking exec, and I am not on the street, but I definitely disagree. Bank of America has missed estimates by about 44%, and has increased credit loss reserves by 500% to over $6 billion dollars, net income drops 77% amid write-downs, and it is forecasting a best case scenario of minimal GDP growth for the balance of 2008. 2007 was the year these same execs were forecasting no recession and a pick up in the following year.

This is the same company that says it will buy Countrywide, which has a severe credit and NPA problem - and has nearly as many assets in REOs and repossessions as it had in actual performing mortgages. Does this sound like the worst is behind us? Let's take a look at some more banks.

The Bank of England has decided to just go forward and bailout it's banks, "American Style": BOE Aims to Jump-Start Lending - The Bank of England launched a plan to allow banks to temporarily swap $100 billion of mortgage-backed and other securities for U.K. Treasury bills, in a bid to ease the current credit crunch.

Of course, I query (like the bloke I've been known to be), why dump a $100 billion into the market where the worst is behind us? That's a lot of money, considering they've probably pumped much more than that into the market for liquidity's sake over the last few months. 
 
Of course, NatCity is raising money for the hell of it: National City to Raise $7 Billion; Bank Cuts Dividend, Posts a Loss- slashed its dividend to 1 cent a share, shows $1.4 billion in loan-loss provisions, partially offset by $772 million in gains related to Visa Inc.'s initial public offering... Net charge-offs on uncollectable loans, tripled to 1.88% of total average loans, while nonperforming assets surged to 1.95% from 0.8%... 
 
The Wall Street Journal is jumping on my bandwagon, saying "Smaller Banks Begin to Suffer". Capital One ramped up production of commercial real estate loans at the very tippy top of the real estate bubble. Capital One is (now, or at least was) a very prolific commercial lender, and you know how I feel about the commercial real estate market. I ride around Manhattan and downtown Brooklyn (alleged luxury condo hi-rise mecca) and see "Financed by Capital One" signs all over the place.

These are projects that are either just breaking ground or have yet to be completed in an area with at least a 2 year supply of condos going up and in the pipeline, and rising - as the condo market collapse

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Ilargi: As attentive readers here know, I’ve expressed concern over Citi for a long time, and reiterated it the day Bear Stearns came down: when most people thought Lehman would be next, I pointed to Citi and Merrill Lynch. I stand by that. Citi could be carved up and "redone" soon, Merrill may be in that same boat. I think Lehman has too large a stake in the Fed's ownership structure to be capsized.

Citigroup May End Dividend After Losses, Whitney Says

Citigroup Inc., the biggest U.S. bank by assets, may cut its dividend for a second time this year as losses escalate, Oppenheimer & Co.'s Meredith Whitney said. Whitney tripled her 2008 loss estimate to 45 cents a share and reduced her 2009 profit estimate to 90 cents a share from $2.50. The New York-based analyst was one of the first to gauge the depth of the global credit crisis, predicting in October Citigroup would slash its dividend to preserve capital. The bank cut its dividend by 41 percent in January, the first reduction since the early 1990s.

"The company has seriously constrained earnings power," Whitney wrote in a report today. Citigroup also may have to "seek additional capital from outside investors." Banks, brokerages and insurance companies have led the Standard & Poor's 500 Index's decline from an October record. Deterioration in the housing market sparked $288 billion in credit losses and asset writedowns and pushed the U.S. economy to the brink of recession. Financial companies in the S&P 500 have averaged first-quarter profit declines of 85 percent from a year earlier, the biggest drop among 10 industries, according to data compiled by Bloomberg.

Bank of America Corp., the second-largest U.S. bank by assets, said today profit dropped for a third straight quarter as it set aside $6.01 billion for bad loans. Whitney predicted today that Wells Fargo & Co., the biggest bank on the U.S. West Coast, may have to fund a $4.5 billion shortfall in reserves. On April 18 the bank posted a $5.11 billion net loss for the first quarter and announced plans to cut 9,000 jobs.

Whitney predicted on Feb. 25 that Citigroup would report a first-quarter loss of $1.6 billion. On March 26, she changed her estimate to a $6.6 billion loss. The average of six analyst estimates compiled by Bloomberg, including Whitney's, was $4.75 billion. A weakening U.S. economy and rising consumer delinquencies forced Chief Executive Officer Vikram Pandit and Chief Financial Officer Gary Crittenden to back away from assurances the bank didn't need to raise more capital. In January, Crittenden said Citigroup "stress-tested" its assumptions under "multiple recessionary scenarios." Asked last week if the bank might seek an additional infusion, Crittenden said, "You can never say never."

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Alistair Darling in £50 billion gamble to aid banks

Alistair Darling will unveil an unprecedented scheme to offer £50 billion in taxpayer-backed loans to high street mortgage lenders today in an attempt to solve the credit crisis. The Chancellor hopes that the cash injection - the biggest ever by the Bank of England - will lead to cheaper mortgage deals and stop the housing market slipping further.

Under the controversial scheme, the Bank will loan money to banks and building societies in return for potentially risky mortgage debts. If the housing market fell and borrowers defaulted on their mortgages, taxpayers could be left nursing losses. The total size of the loans is expected to be £50 billion but officials said they were prepared to lend more, prompting fears that the taxpayers' exposure may rise.

Ministers believe the scheme is essential and will allow lenders to offer more competitive deals for borrowers. Gordon Brown has been closely involved in drawing up the package. The loans are intended as a short-term measure lasting for up to three years and government sources say the banks "have to guarantee the money is returned". The scale of the bailout alarmed some opposition MPs and comes just months after the nationalisation of Northern Rock, which exposed the taxpayer to as much as £100 billion in liabilities.

Vince Cable, the Liberal Democrat Treasury spokesman, said: "It is necessary for action to be taken to unblock the mortgage market and to break the crippling effects of the credit crunch. "However, we cannot have a situation where the banks are able to privatise their profits and nationalise their losses. Since the mortgages from the banks are of inferior quality and higher risk than the government bonds, the implication must be that taxpayers are shouldering the risks and losses of the banks. This cannot be right."

The Conservatives support the proposal in principle but George Osborne, the shadow chancellor, said: "Unblocking the financial system and getting the Bank of England to do this swap, where it is basically taking on some mortgages in return for the equivalent of cash from the bonds, is a good idea but we have got to make sure the taxpayer is protected."

Mr Darling will make a statement to Parliament this afternoon and will meet the country's main mortgage lenders tomorrow, when he is expected to urge them to build on the Government's intervention. He will discuss the possibility of people at risk of defaulting being offered "mortgage holidays" or flexible mortgages allowing them to underpay for a few months before compensating with higher payments when conditions improve.

In an interview with the BBC yesterday, Mr Darling said the economic turmoil had created an "unprecedented shock to the system". "What it [the scheme] will do is effectively lend banks money to un-freeze the situation," he said. "We are trying to un-bung that situation so that the Bank will be making money available to the British banking system. It's got to be repaid, and we will take securities in return for it.

"The idea is that it will open up the market and begin the process of opening up the mortgage market, which will help householders. We believe that this will be an essential step in trying to get the financial market stabilised." Last week, it emerged that Royal Bank of Scotland, Britain's second biggest lender, would seek to raise up to £12 billion from its shareholders in a "rights issue". Mr Darling indicated that he expected to see "much, much more of that".

He said he wanted banks to "pass on the benefits of the three interest rate cuts" following criticism that the costs of mortgages had risen despite reductions in the base rate. The loans to be unveiled today, which will have interest attached to them, will be repayable in a year, although the arrangement can be rolled over for up to three years. There will be a "haircut" between the value of the government loan and the value of the mortgages offered in return.

For example, the Bank may offer £1 in taxpayer-backed loans for every 80p or 90p in mortgage debt. The gap will vary depending on the perceived quality of the mortgages being offered. Banks would have to put up greater amounts for credit card and sub-prime mortgage debt.

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Bank of England Swaps Bonds to Revive Bank Lending

The Bank of England offered to swap government bonds for mortgage securities to kick-start bank lending, with Governor Mervyn King pledging to meet demand even if it exceeds an estimate of 50 billion pounds ($100 billion.) "There is no arbitrary limit on this so it could well go higher," King told reporters in London today. He said the plan aims to restore confidence to the banking system and the most important aspect is that "everyone needs to know this is there for them to access as needed."

The measures, backed by Prime Minister Gordon Brown's government, mimic a swap of $200 billion of securities by the U.S. Federal Reserve last month as central banks around the world struggle to prop up financial markets. A surge in borrowing costs prompted U.K. banks to withdraw their best mortgage offers, threatening to exacerbate the worst housing downturn since 1992. "This package may help ease money-market strains, and provide a welcome route to liquidity for some particular banks and building societies that otherwise may face extreme difficulties in obtaining funds," said Michael Saunders, chief western European economist at Citigroup Inc.

Financial institutions will retain responsibility for losses from the assets they loan to the Bank of England. The swaps will be for a period of one year, renewable for up to three years. Only assets existing at the end of 2007 can be used in the swap.
The Bank of England won't announce how much money has been tapped until the borrowing window closes in six months. The swap is double the value of loans King extended in September to prop up Northern Rock Plc. The government nationalized the mortgage lender in February, the first U.K. bank to fall victim to the credit freeze. That stemmed from the collapse of the U.S. subprime market, which has now cost more than $288 billion in bank writedowns and credit losses.

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There must be a limit to the Bank's generosity

Uncertainty is the bane of any economy. When people are suddenly unsure how much their money is worth, a wobble can quickly turn into a catastrophe. The restoration of confidence is the only medicine that works; but it has to be administered at just the right time, and in just the right dose. If the Bank of England is prepared to take debt off the hands of high-street lenders in return for its own bonds, that could be precisely what is needed to calm everyone's nerves and prevent a panic.

The Bank is big enough to absorb some of the risk acquired by lesser institutions, while the value of its own stock is not in doubt. The collective reaction should be a sigh of relief. But there are difficulties here, not least whether the banks that got themselves, and us, into this mess are sufficiently humbled to meet their helper half way.

It is reassuring to know that they will not be allowed to dump their bad debts on the taxpayer, and can only swap their soundest mortgage and credit card holdings for government paper. But they must also ease the strain on their remaining borrowers, and mend their ways to ensure that there is no repetition of recent folly.
Otherwise the Bank could be seen as an interventionist charity of infinite wealth, and that is an idea that must be squashed before it has a chance to take hold.

Public companies with a cash-flow crisis should apply to their shareholders, who are, after all, voluntarily engaged in the business of risk for profit. Just as we are too quick to regard reckless borrowers as the victims of aggressive lending practice, so we forget that shareholders gamble on the wisdom of directors, and must occasionally lose. However, even if the Bank's initiative works (and we earnestly hope it does), there is another side to it.

As a nation, we are now owned and run by the government machine to an extent far greater than any in our history. Millions are now dependent on the state for employment; millions more for the degrading substitute of benefits. And, as a new report from the think tank Reform concludes, the fatter the client state becomes, the less well it works, and the more it lets down those who have been obliged to grow up in its thrall.

The "why bother" society identified in the study is the result of poor education and a misconceived welfare structure that discourages personal responsibility and hope; and it is not just the young unemployed who have been corrupted by this culture. As the scale of the lending crisis emerged, it seemed no one accepted any blame and everyone expected to be bailed out by government.

But when Northern Rock was taken into public ownership, a dangerous precedent was established; and for the Bank of England to acquire a mortgage portfolio of its own, assuming direct control of private property, is another giant leap for the client state. Both arrangements must be temporary, and they must not be repeated.

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Some Bailout

The Bank of England's Fed-like confidence booster for the British banking sector, doesn't seem to be boosting confidence. The central bank is swapping £50 billion ($99.2 billion) worth of low-risk government bonds for unpalatable mortgage-backed assets held by lenders. But the plan has fallen short of the "bailout" banks were hoping for, and economists are warning that more financing could be needed as lenders announce further losses and multi-billion dollar rights issues in the coming weeks. The FTSE 100 slipped 0.2%, led down by banks, on Monday morning in London, after the Bank of England unveiled its plans to boost liquidity within the banking sector, which fell below the £100 billion ($198.4 billion) that the market had been hoping for.

The Royal Bank of Scotland fell 2.6%, to 380 pence ($7.53), while HBOS fell 2.9%, to 555 pence ($11.01). Alliance & Leicester was down 2.5%. "It’s the right move, but £50 billion ($99.2 billion) is just too small, given the level of write-downs that institutions have had and are expected to have," said Stephen Pope, chief global market strategist at Cantor Fitzgerald Europe. Last week RBS announced a $23.9 billion rights issue to shore up its capital position, and analysts also widely expect other banks to follow suit.

Mark Priest, a senior trader at spread betting firm TradIndex, added that the plan was not quite the "bailout" that banks had been hoping for. Though each asset can be swapped for a year and may be renewed for an additional two, the risk of losses on the loans remains with the banks, according to the Bank of England press release. For instance, if the value of mortgage-backed assets that have been swapped for bonds falls in the coming months, the banks that originally held them would still have to book a loss, even though those assets would be officially held by the Bank of England.

Banks will also only be allowed to swap high-quality mortgage-backed assets, and will be expected to pay a fee for the assets they swap, based on the inter-bank lending rate, Libor. "They aren't getting something for nothing. They probably thought they were going to be able to borrow a lot cheaper. It's definitely not a Northern Rock scenario," remarked Priest, referring to the mortgage lender which was nationalized in February, and whose £24 billion ($47 billion) emergency loan from the Bank of England was criticized for being funded by taxpayers.

“The Bank of England’s Special Liquidity Scheme is designed to improve the liquidity position of the banking system and raise confidence in financial markets, while ensuring that the risk of losses on the loans they have made remains with the banks," Bank of England Governor Mervyn King said Monday in a press release. The Bank of England's move mirrors one by the U.S. Federal Reserve in March. Banks in Britain have been suffering from an overhang of mortgage-backed securities which they have been unable to sell or pledge as collateral, making them reluctant to lend to one another.

The Libor rate has thus remained close to 6.0%, even though the Bank of England has cut the base rate of interest to 5.0%. This has added pressure to the British housing market, as banks have cut back on their mortgage lending and put up the rates they offer to consumers.

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Food Rationing Confronts Breadbasket of the World

Many parts of America, long considered the breadbasket of the world, are now confronting a once unthinkable phenomenon: food rationing. Major retailers in New York, in areas of New England, and on the West Coast are limiting purchases of flour, rice, and cooking oil as demand outstrips supply. There are also anecdotal reports that some consumers are hoarding grain stocks.At a Costco Warehouse in Mountain View, Calif., yesterday, shoppers grew frustrated and occasionally uttered expletives as they searched in vain for the large sacks of rice they usually buy.

"Where's the rice?" an engineer from Palo Alto, Calif., Yajun Liu, said. "You should be able to buy something like rice. This is ridiculous." nThe bustling store in the heart of Silicon Valley usually sells four or five varieties of rice to a clientele largely of Asian immigrants, but only about half a pallet of Indian-grown Basmati rice was left in stock. A 20-pound bag was selling for $15.99. "You can't eat this every day. It's too heavy," a health care executive from Palo Alto, Sharad Patel, grumbled as his son loaded two sacks of the Basmati into a shopping cart. "We only need one bag but I'm getting two in case a neighbor or a friend needs it," the elder man said.

The Patels seemed headed for disappointment, as most Costco members were being allowed to buy only one bag. Moments earlier, a clerk dropped two sacks back on the stack after taking them from another customer who tried to exceed the one-bag cap. "Due to the limited availability of rice, we are limiting rice purchases based on your prior purchasing history," a sign above the dwindling supply said. Shoppers said the limits had been in place for a few days, and that rice supplies had been spotty for a few weeks. A store manager referred questions to officials at Costco headquarters near Seattle, who did not return calls or e-mail messages yesterday.

An employee at the Costco store in Queens said there were no restrictions on rice buying, but limits were being imposed on purchases of oil and flour. Internet postings attributed some of the shortage at the retail level to bakery owners who flocked to warehouse stores when the price of flour from commercial suppliers doubled. The curbs and shortages are being tracked with concern by survivalists who view the phenomenon as a harbinger of more serious trouble to come.

"It's sporadic. It's not every store, but it's becoming more commonplace," the editor of SurvivalBlog.com, James Rawles, said. "The number of reports I've been getting from readers who have seen signs posted with limits has increased almost exponentially, I'd say in the last three to five weeks." Spiking food prices have led to riots in recent weeks in Haiti, Indonesia, and several African nations. India recently banned export of all but the highest quality rice, and Vietnam blocked the signing of a new contract for foreign rice sales.

"I'm surprised the Bush administration hasn't slapped export controls on wheat," Mr. Rawles said. "The Asian countries are here buying every kind of wheat." Mr. Rawles said it is hard to know how much of the shortages are due to lagging supply and how much is caused by consumers hedging against future price hikes or a total lack of product. "There have been so many stories about worldwide shortages that it encourages people to stock up. What most people don't realize is that supply chains have changed, so inventories are very short," Mr. Rawles, a former Army intelligence officer, said. "Even if people increased their purchasing by 20%, all the store shelves would be wiped out."

At the moment, large chain retailers seem more prone to shortages and limits than do smaller chains and mom-and-pop stores, perhaps because store managers at the larger companies have less discretion to increase prices locally. Mr. Rawles said the spot shortages seemed to be most frequent in the Northeast and all the way along the West Coast. He said he had heard reports of buying limits at Sam's Club warehouses, which are owned by Wal-Mart Stores, but a spokesman for the company, Kory Lundberg, said he was not aware of any shortages or limits.

An anonymous high-tech professional writing on an investment Web site, Seeking Alpha, said he recently bought 10 50-pound bags of rice at Costco. "I am concerned that when the news of rice shortage spreads, there will be panic buying and the shelves will be empty in no time. I do not intend to cause a panic, and I am not speculating on rice to make profit. I am just hoarding some for my own consumption," he wrote.

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Rice, death and the dollar

The global food crisis is a monetary phenomenon, an unintended consequence of America's attempt to inflate its way out of a market failure. There are long-term reasons for food prices to rise, but the unprecedented spike in grain prices during the past year stems from the weakness of the American dollar. Washington's economic misery now threatens to become a geopolitical catastrophe.

Months ago, I offered that China, Russia and other cash-rich nations held the antidote to the incipient credit crisis: "If the US wants to remain the magnet for world capital flows it became during the 1990s, it will have to allow the savers of the world to become partners in the US economy, that is, to buy into its first-rank companies." No such thing occurred, of course, as Washington has made it clear that it would not allow sovereign funds to own the likes of Citicorp.

What are the world's investors doing with the trillion dollars a year they used to invest in American securities, including subprime derivatives and various forms of collateralized obligations that turned out to have more obligation than collateral? They aren't buying American companies because they are not permitted to. They are buying food and other stores of value instead. Washington has weakened the value of the dollar as a palliative for the credit crisis, so much so that "nobody seems to doubt that the US dollar will lose its status as the world's reserve currency", as journalist Amity Shlaes wrote in an April 9 Bloomberg News column entitled "Monks may hold clue to dollar's future".

"Perhaps the dollar won't surrender its anchor role so soon," Shlaes continued. "And perhaps that loss, if it comes, will happen because of events that take place nowhere near men in suits at a central bank. Maybe the answer to the dollar's riddle can be found in the cellphone photo image of a Tibetan monk in crimson and orange squaring off with a Chinese soldier ... China might recede into years of ethnic chaos. In any of these cases, the new Chinese government won't be forced to deliver the same growth, and therefore won't spend commensurate energy tending the dollar ... The flash of orange in the robe of the monk is important enough to change the picture for the greenback."

Misguided is not the word for this sort of thinking. However unlikely it might be, one cannot exclude the possibility that "ethnic chaos" will afflict China at some future point. The one thing that can be stated with certainty is that long before chaos reaches China, it will have shattered a great deal of the rest of the world. China is exchanging its depreciating reserves of US dollars for things of value, notably rice, with frightening consequences for dependent countries, and deadly consequences for American foreign policy.

The chart below shows the price of 100 pounds of rice against the euro's parity against the US dollar during the past 12 months. The regression fit is 90%. There is an even tighter relationship between the price of rice and the price of oil, another store of value against dollar depreciation.

Rice price vs Euro/US$ rate, April 15, 2007 to April 15, 2008
 
As the chart makes clear, the ascent of the cost of rice to $24 from $10 per hundredweight over the past year tracks the declining value of the American dollar. The link between the declining parity of the US unit and the rising price of commodities, including oil as well as rice and other wares, is indisputable. China has bid aggressively for rice all year, and last week banned rice exports, along with Vietnam and several other producers.

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Analyst Whitney Thinks Wells Fargo Needs Reserves, Capital

While investors are now getting used to banks holding their hands out for capital reinvestments, they may be surprised if a consistent performer such as Wells Fargo & Co. comes begging. But that's exactly what may happen, according to Oppenheimer & Co. analyst Meredith Whitney. Whitney believes that Wells Fargo is under-reserved by at least $4.5 billion as of Monday and will need to raise capital to restore its balance sheet this year and perhaps by even more in 2009. The analyst has won acclaim in recent months for her accurate calls that Citigroup Inc. and Wachovia Corp. would have to cut their dividends.

Other analysts have pointed to the bank's continued exposure to consumer debt as a source of concern, but were generally comforted by the bank's diversification and the strength of its loan portfolios. Shares of the San Francisco-based bank may take an especially harsh beating if Whitney's prediction turns out to be true, since investors are generally positive about the stock following its better than expected first-quarter results last week. Through Friday, Wells Fargo shares had risen more than 9% since the bank reported results on Wednesday. Shares were down 2.3% in pre- market trading Monday.

Whitney cut her estimate of Wells Fargo's 2008 profit to $1.20 a share from $ 2.15 a share, making hers the lowest estimate on the Street and leaving it well below the average estimate of $2.34 a share. "Given our now dramatically below consensus estimates, we believe few if any are anticipating what we believe to be the inevitable consequence of Wells' current reserve position," she told clients in a research note Monday.

Whitney bases her estimates on a historical study of Wells Fargo's charge-off rates, which she says during the first quarter exceeded the bank's loan loss reserves for the first time since at least 1990. She assumes that credit conditions will continue to deteriorate, forcing the bank to increase its reserves to offset the growing number of charge-offs.

"If losses continue to accelerate past the 2Q, our well below Street estimates will prove too optimistic," she wrote. tA capital raise from Wells Fargo may also throw cold water on last week's rally, in which the broad stock market rose on mediocre but better-than-expected first-quarter earnings at banks including Wells Fargo and JPMorgan Chase & Co. ( JPM).

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Bank of America Net Income Falls 77% on Writedowns

Bank of America Corp., the second- largest U.S. bank, said profit dropped for a third straight quarter as the company set aside $6.01 billion for bad loans. First-quarter net income declined 77 percent to $1.21 billion from $5.26 billion a year earlier, the Charlotte, North Carolina-based bank said today in a statement. Results included $1.31 billion in trading losses and $2.72 billion in costs for uncollectible loans. Earnings per share shrank to 23 cents from $1.16, falling short of analysts' estimates and sending the bank's stock down as much as 2.6 percent in New York trading.

The slide casts doubt on Chief Executive Officer Kenneth Lewis's goal to increase profit by at least 20 percent this year. The bank's consumer unit, which contributed more than 60 percent of operating income in 2007, faces a nationwide jump in unpaid debt and the highest unemployment rate since 2005. Overdue U.S. credit-card bills are the most in more than three years and foreclosures soared 57 percent in March.

"It's quite a bit below expectations," Walter "Bucky" Hellwig, senior vice president of Morgan Asset Management in Birmingham, Alabama, said today in a Bloomberg TV interview about the earnings report. "They are paddling upstream with regards to credit losses and credit quality." Morgan Asset, a unit of Regions Financial Corp., manages $30 billion. Revenue fell 6 percent to $17.3 billion. Profit decreased 59 percent to $1.09 billion in the consumer and small business unit, and dropped 92 percent to $115 million at the corporate and investment bank. The bank said home equity, homebuilder and small business loans were "particularly" affected by the slowing economy.

"These results clearly did not meet our expectations," Lewis said in the statement. "The weakness in the economy and prolonged disruptions in the capital markets took their toll on our performance." Citigroup Inc., the biggest U.S. bank by assets, reported a first-quarter loss last week of $5.1 billion, smaller than analysts' most pessimistic estimates. JPMorgan Chase & Co., ranked third, said earnings declined 50 percent. Both are based in New York. Wachovia Corp., ranked fourth and based in Charlotte, posted an unexpected loss of $393 million.

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Citigroup's CFO says consumer credit now biggest risk

Banking giant Citigroup has warned that defaults on credit cards and other consumer products could drag on the economy for the next two years.Gary Crittenden, chief financial officer of the financial conglomerate, believes that it is consumer credit - rather than institutional credit - which now poses the greatest risk to the banking sector, and therefore the economy at large.

To date, the bulk of the losses besieging the banking sector have stemmed from corporate and leveraged loans and complex credit products between banks and other institutions. The crisis was triggered by hundreds of thousands of American home owners being unable to pay their mortgages, but manifested itself in the corporate credit markets.

However, in the last few months, there has been growing evidence that serious problems now exist in the consumer credit market with defaults on personal loans, credit cards and car loans on the rise. Mr Crittenden, who last week unveiled $5.1bn (£2.5bn) of quarterly losses at Citigroup, said history suggested the consumer downturn had some way to run. However, he would not comment on the impact on two of the bank's most exposed British consumer businesses - Citi Financial, its sub-prime loan business, and Future Mortgages, its sub-prime mortgage business.

When asked about credit card provider Egg, Mr Crittenden would only reiterate Citigroup's comments that it intends to have a global credit card franchise. Last month Egg's chief executive Ian Kerr resigned after the division closed credit cards agreements with 161,000 customers amid accusations that it didn't find them profitable.

Mr Crittenden, second-in-command to Citigroup chief executive Vikram Pandit, also expressed concern about the health of the real estate market. He said the bank is anticipating an 8pc fall in real estate values this year, and a further 3pc decline next year. The Citigroup executive said the consumer credit and real estate sectors are now of considerably more concern from a future credit quality perspective than the institutional side of the bank's business.

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Carlyle, Deutsche Bank Seek to Raise $500 Million CLO

Carlyle Group, the world's second largest private-equity firm, is raising a $500 million collateralized loan obligation to buy high-risk, high-yield debt being sold by banks at discounted prices, according to people with knowledge of the plan.The CLO is being arranged by Deutsche Bank AG, said the people, who declined to be identified because the terms aren't public. The fund follows a similar $450 million CLO that Carlyle and JPMorgan Chase & Co. closed this month.

Carlyle, the Washington-based buyout firm run by David Rubenstein, joins Blackstone Group LP and Apollo Management LP in purchasing loans from banks that have struggled to offload the debt after losses on securities tied to subprime mortgages caused investors to shun all except the safest of government bonds. Private-equity firms are emerging as buyers at a time when financial institutions from Goldman Sachs Group Inc. to Citigroup Inc. are willing to sell the loans for as little as 63 cents on the dollar.

"Private-equity firms have the capacity and interest in buying these loans," said Martin Fridson, chief executive officer of high-yield research firm FridsonVision LLC in New York. Michele Allison, a Deutsche Bank spokeswoman in New York, and Ellen Gonda, a Carlyle spokeswoman, declined to comment. CLOs, a form of collateralized debt obligation, package loans and channel the income to investors in portions, or tranches, of varying risk and ratings.

Banks have cut their backlog of so-called leveraged loans to $95 billion from $245 billion in July by offering discounts, according to New York-based Standard & Poor's. New York-based Citigroup sold $8 billion of loans to buyout firms in the past quarter, the bank's Chief Financial Officer Gary Crittenden told investors April 18. Frankfurt-based Deutsche Bank sold $5 billion to private-equity firms, according to analysts at Lehman Brothers Holdings Inc.

Prices for average actively traded loans have risen almost 5 cents to 91.16 cents on the dollar in the past two months, according to Standard & Poor's. Even so, the percentage of loans trading below 80 cents on the dollar is at 14 percent, up from less than 1 percent in November, according to Lehman analysts.

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RBS Plans Fund to Transfer $2.3 Billion LBO Loan Risk

Royal Bank of Scotland Group Plc, the U.K.'s second-biggest lender, plans to start a fund to transfer the risk of losses from 1.5 billion euros ($2.3 billion) of high-yield loans, according to three people with knowledge of the proposal. The fund will earn a return for investors by selling contracts to RBS that protect the bank from losses on 15 loans in euros and pounds and a further six in dollars, said the people who declined to be identified because the discussions are private.

RBS is offering the fund to investors at the same time as it seeks to weather losses triggered by the U.S. subprime mortgage crisis through a possible sale of shares. Banks have cut the $245 billion of leveraged buyout loans they got stuck with as investors fled the market last year to $95 billion by selling the debt at a loss, according to data compiled by Standard & Poor's. Banks "have a revenue problem if they don't clean up their balance sheets to make new loans," said Jeffrey Kushner, a managing director at Blue Mountain Capital Management LP in New York, which manages $4.5 billion of assets. "It's in everybody's interests from the LBO firms to the banks to institutional investors to move on."

RBS will pay the fund the interest generated by the loans plus any capital gains after deducting fees, according to fund documents sent to investors. The fund's investors would have to pay the bank if the loans continue to lose value. As part of the so-called total-return swap, the fund will pay RBS annual interest of 1.5 percentage points above interbank borrowing rates.

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UBS Report Blames Lax Controls for Credit Losses

Poor risk control and a narrow focus on revenue growth at UBS's investment bank helped cause huge credit losses, UBS said on Monday, as it prepares to meet restive shareholders this week. The subprime-battered bank blamed itself for a lack of risk control in a report ordered by Switzerland's EBK banking watchdog and said it had let the rapid build-up of its investment bank run out of control.

"The investment bank was focused on the maximization of revenue. There appears to have been a lack of challenge on the risk and reward to business area plans," UBS said about its fixed-income business. The world's largest wealth manager has written down about $37 billion in assets -- more than any other bank -- and got rid of most senior management, including its chairman, after asking investors for emergency cash two times in as many months.

Roughly 16 percent of UBS's subprime losses were on the back of trading strategies in the Dillon Read Capital Management hedge fund unit. Some two-thirds were attributable to the collateralized debt obligation (CDO) desk within UBS's fixed income business.Other problems were confusion about management structures and cheap internal funding, the report said.

There were gaps in risk management and expertise, and the bank did not respond adequately when the sector started worrying about subprime exposure. The report was a summary of a review UBS had sent to the EBK, which is probing the bank over its losses."We will proceed with our investigation. This is quite a big thing and it will take a lot of time," the watchdog's spokesman Alain Bichsel said.

Shareholders will be asked to approve another 15 billion Swiss franc ($14.76 billion) capital increase at their annual meeting on Wednesday, bringing the total of measures to fortify UBS's balance sheet to around 34 billion francs. The bank's share price has more than halved since June and it is under increasing pressure from shareholders, some of whom want it to split up its business, with speculation rising the bank could be taken over.

The bank will replace its chairman, Marcel Ospel, widely criticized for allowing UBS to take on risk in a bid to become the world's biggest investment bank, with Peter Kurer, the group's top lawyer. Activist investor group Olivant -- controlled by former UBS chief executive Luqman Arnold -- has been the most outspoken critic of UBS's strategy, urging it to appoint a heavyweight banker at its helm, saying Kurer is the wrong choice. Olivant has said it will not seek to force UBS's hand by rallying a wider vote at Wednesday's AGM, however.

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Business economists gloom on economy rising

Business economists are turning pessimistic about the U.S. outlook and increasingly fear economy will slip into a recession in coming months. The National Association for Business Economics said on Monday that the 109 members who responded to its quarterly survey between March 24 and April 8 were "notably downbeat" about their first-quarter experience and about near-term prospects.

"For the first time in five years, reports of falling profit margins outnumbered reports of rising margins in the first quarter of 2008, while demand at respondents' firms grew more weakly than at any time since the recession of 2001," said Ken Simonson, chief economist for Associated General Contractors of America.
About 30 percent of respondents expected gross domestic product, the broadest measure of national economic activity, to decline in the first half of 2008 and most others thought growth will be below an annual rate of 1 percent.

By contrast, only 10 percent expected the economy to contract in the first half when they were surveyed in January. A recession is typically defined as two consecutive quarters in which GDP declines. The last U.S. recession ran from March to November 2001. NABE said the steep drop in goods and services demand its members reported in the first quarter "is consistent with other evidence that the U.S. economy is slowing and may be in recession."

The Bush administration has steadfastly refused to speculate whether a recession has begun, although Treasury Secretary Henry Paulson concedes the economy "has turned down sharply." President George W. Bush said on Friday the White House foresaw a downturn last fall and acted to put a stimulus program in place to counter it. None of it was making businessmen happy.

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The market's worst is yet to come

Now that a few Wall Street folks have finally dared to utter the word 'recession' aloud, most of the rest are assuming this downturn is practically over. Expect the bulls to stumble.

Has the worst been seen, or is the worst yet to be seen? The majority of market participants find themselves in the former camp (which, regular readers know, is not where I stand). They believe that because a handful of folks have now said the word "recession," it's nearly over. As a result, they say all the bad news we see is a function of what we "already know." Thus it has been discounted and should be ignored.

Similarly, they take confidence in the fact that the stock market reached a low in January, created around the Société Générale banking panic, and retested that low as Bear Stearns supposedly almost took apart the financial system (which led the Federal Reserve to create the latest alphabet soup of funding facilities). The combination of recession, massive Fed easing and those two financial panics has encouraged the bulls to think that we now have seen all we need to see before we have a bull market. Therefore, we should buy stocks.

That glib notion has arisen because of the policies pursued by the Fed and then-Chairman Alan Greenspan over the past two decades, which led to the current sad state of our bailout nation. Bulls have been conditioned by that ride, in Pavlovian fashion, to believe that anytime there is an admission of recession or any kind of panic, it will resolve itself positively in relatively short order, if not almost instantly. (They forget that it took a little time, between 2001 and 2003, to resolve the stock bubble. But that's a minor point.)

That same class of animal also believed that as the credit bubble initially burst, in the form of the initial subprime FPDs (first payment defaults), it would be limited to subprime mortgages and thus be contained. Everyone knows how the story went from there. I believe folks in that camp never understood that the housing bubble was the economy, which is why they are now quite sanguine.

Listening to the speakers at a recent conference hosted by Grant's Interest Rate Observer, I found that some thoughtful people remain in the it's-going-to-get-better camp because it hasn't yet gotten all that bad. Perhaps they are right, but I don't think so. I think the better arguments are made by those who understood what the unwinding of the credit bubble meant, who understood that it wasn't just subprime, who understood that it wasn't contained -- and, armed with that knowledge, realized the ramifications of that bubble's unwinding are quite large.

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Millions wrongly believe they are middle class

Millions of Britons who consider themselves middle class are less well off than they think, and are keeping up appearances by depending on loans and credit cards, research suggests. Around 15 million people - a quarter of the population - are in denial of their true working class status, a study by moneysupermarket.com, the financial website, concluded. It found that one in 10 households purporting to be middle class had an annual income of less than £15,000.

Around 4.5 per cent were using unsecured loans to pay for private school fees, second homes or even household staff, and were in an average of £13,000 in debt. Loans totalling £35 billion have been taken out to help people maintain a middle-class illusion, but in reality, the lifestyles and spending patterns of the aspiring middle class differed little from the working class. The study determined that the average income of a working-class household was £23,000 a year compared with £33,000 for middle-class homes.

Rent and mortgage payments were, however, virtually the same between working-class households (£366) and their middle class counterparts (£334). To be upper middle class, the study estimated that a household must have an income of almost £52,000 a year. Those in this class spent twice as much on entertaining and going out and were more likely to employ home help such as a cleaner or a gardener. Sue Hayward, a personal finance expert, said: "It's amazing to see how close the earning and spending patterns of these people claiming to be working and middle class are.

"I know class divides have moved in different times, but this shows the gap is shrinking. This research will drive home to people that if they really want to get their hands on the luxuries the true middle classes are enjoying then they need to save money where they can, and look at better ways of managing their money and not relying on credit cards to see them through."

Richard Mason, managing director of insurance and home services at moneysupermarket.com, said: "With the credit crunch taking hold and the housing market faltering, it's worrying to see that so many people are spending and borrowing beyond their means to try and keep up with the lifestyles of others. "Consumers need to take immediate stock of their household budgets to identify the pressure points and seek money saving opportunities."

The poll also disclosed a significant degree of "reverse snobbery", with 25 per cent of those who identified themselves as working class actually earning £50,000 or more. The study found that Cardiff had the highest number of aspirational class climbers, followed by Leicester and Newcastle.

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Ponzi Squared

I’m at the annual Hyman Minsky Conference at the Levy Institute at Bard College. Minsky, if you do not know him, was an economist who pointed out that stability is destabilizing. Because stability breeds confidence that it will continue, it encourages people to make ever riskier investments, and to take on ever more leverage.

Minsky argued there were three levels of investment as the cycle progresses. First comes hedging, in which investments are made to reduce risk. Then comes the speculative phase, and finally the Ponzi phase, in which the investment can be justified only by the assumption that prices will keep rising, not by the expected income.

Paul McCulley of Pimco, the big bond manager, gave an interesting speech in which he said the recent subprime mortgage fiasco proceeded to a fourth level — one that he called “Ponzi-squared” — before it collapsed. At the end, he said, the marginal subprime loan was:
• No money down
• No documentation of income
• Initial below-market teaser interest rate
• Negative amortization

That is not a loan, he said. Instead, it amounted to giving the home buyer a call option to buy the house at the current market price, coupled with a put option to sell the house back at that price. If house prices kept rising, the “buyer” could make the small interest payments to keep the option open, and eventually sell the house. That happened for a time, and led to the conclusion by rating agencies that such borrowers were good risks.

But when prices went down, the “buyer” would suffer no loss if he exercised the put and gave the house to the lender. That is just what happened.As Paul Simon wrote in 1975, said Mr. McCulley, the strategy became:
Drop off the key, Lee,
And set yourself free.

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