Debt Rattle, May 3 2008: 98% or more to go

Dorothea Lange: Miserable poverty - Elm Grove, Oklahoma August 1936

Ilargi: $300 billion written down, and that's perhaps 2% of the total losses. All the somewhat valuable securities have been swapped for Treasuries of some kind. Now comes the hard part.

Of course I know that the longer it takes, the more people think we must be wrong. Good luck with that.

What has me thinking today can particularly be found in the first two articles, from the Financial Times, that talk of things out of sync and whack. Both ratings and markets seem to have reached a stage that makes the in-crowd say: "It shouldn't be like this, good assets should still be good assets, regardless".

What they have missed is that there has been a seismic shift all across the world of finance and investment, or even multiple shifts. The malady has spread, and by now infected all parts of the body, from the heart to the fingertips. The body will never be the same. Some parts will have to be amputated, others need to learn to walk again, all over again.

And not even then is there any guarantee it will not simply pass away. The only certainty is that there is no way back to what was before, that what will come will be different from what has been, and profoundly different.

And that is hardest to accept for those who rely for their livelihood on things being what they've always been.


Triple A prices are out of sync

Why have the prices of triple A mortgage-linked securities slumped so dramatically this year? That question has recently caused anguished debate in the banking world. After all, as the credit turmoil enters its ninth month, it has become painfully clear that it is not the behaviour of risky debt, such as BBB-rated securities, which is currently causing the most grief.

Instead, the key problem at banks such as UBS and Merrill Lynch is that the price of triple A rated instruments (such as the so-called “super-senior” tranche of mortgage-linked collateralised debt obligations) has tumbled by up to 30 per cent in recent months – although nobody used to think they would ever fall more than a few basis points.

And as bankers stagger about trying to make sense of these swings, it seems that the Bank of England has now joined this “dazed and confused” club too. In its latest financial stability report, the Bank suggests that the price of some AAA securities only makes sense if you believe that the ultimate loss ratio on securitised subprime mortages will be 38 per cent. However, that loss can only occur if three out of four households defaulted on their loans and house prices tumble dramatically too.

But no one is forecasting defaults on this scale right now. Indeed, virtually no triple A CDO tranche has actually suffered a tangible credit loss yet. Hence the bank concludes – with a sense of pique – that “prices?.?.?.?appear to be particularly out of line with credit fundamentals.” So does this imply that the markets is nuts? Not quite. For the real source of the price swing lies not so much in credit analysis – but a crisis among the investment community.

In the past couple of years, a huge chunk of triple A mortgage securities have been quietly sold to hedge funds, which have leveraged these instruments on an extraordinary scale to produce steady returns. Banks have also been gobbling up this stuff, since the regulatory regime made it easy to hold this on their balance sheet. (As Rick Watson of the European Securitisation Forum points out to me, under the existing Basel II guidelines, the AAA tranche of a high quality granular retail mortgage-backed securities pool would have a capital charge of around 0.56 per cent, theoretically implying it could be leveraged close to 200 to 1.)

However, these days banks are nursing losses, and don’t want to buy more of this stuff; meanwhile, hedge funds can no longer get access to the all-important leverage to make this AAA-linked strategy work. And while this situation should create an opportunity for new investors – such as pension funds or money market funds – to come in, this is not happening on a large scale. That is partly because the triple A spreads are not high enough to tempt unleveraged pension funds to invest time in understanding these complex deals. However, another crucial problem is that money market funds simply cannot tolerate any mark-to-market volatility – of the type that has just occurred.

So is there anything the authorities can do? One solution would be for central banks to put their money where their risk-analysis mouth is and buy this stuff themselves. After all, if the prices of triple A did rebound, that would remove some of the balance sheet pressures that are weighing down on the banks – which is exactly what the central banks want to see. But don’t expect the triple A cavalry to emerge soon. The Bank of England is leery of acquiring US mortgage-linked instruments; meanwhile, the American authorities have no appetite for unveiling more measures to prop up investment banks, in an election year.

So, for now, the implication is clear: yes, the price of triple A securities looks nuts from a fundamental credit point of view; but this reflects the fact that the leverage which has underpinned the structured credit world in recent years has been mad too. And restoring sanity is likely to take more time – whatever the rational models of bankers (or central bankers) might imply.

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Is something wrong in credit markets?

Is something wrong in credit markets? A simple look at the risk premiums, or spreads, on cash bonds and those on credit derivatives shows a heightened dislocation has developed since last summer, says Geraud Charpin at UBS.
The market, he says, has become polarised between buyers of risk that focus on new corporate issues (cash bonds) and sellers of risk that focus on credit default swaps (CDS), the derivatives that provide a kind of insurance against non-payment of corporate debt.

“In cash bonds, companies [that wish to borrow money] provide an offset to investors [who wish to lend]. This allows an equilibrium between supply and demand to form. In CDS, the lack of supply side creates a major imbalance, which increases volatility.”

The problem is that complex investments known as synthetic collateralised debt obligations previously acted as big buyers of credit risk. But these products have withered and left the CDS market dominated by people who want to sell credit risk (go short, or buy protection) when things look bad, or switch to buying back credit risk to cover their shorts when the outlook improves.

“Until the synthetic CDO market re-emerges, the CDS market might be doomed to heightened volatility, moving above cash levels in bear runs (everyone buying protection) and below in bull runs (everyone covering shorts), while volatility of cash spreads will be tamed by supply/demand forces

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Satyajit Das: Credit crisis far from over

A derivatives expert who two years ago warned of a potential meltdown in global credit markets has cautioned that the crisis is far from over, and has endorsed recent calls to relax controls on inflation and allow higher prices to help markets trade their way out of their problems. Longtime critic of derivatives markets, Satyajit Das, says those who believe the US sub-prime loans crisis, and the drought in credit markets it triggered, are nearly over are wrong.

"I think the cycle has some way to run yet," he told a Financial Services Institute of Australasia function in Sydney yesterday. "It's a matter of years, not a matter of months." In particular, investors in the US stock market, which has climbed off its lows amid a growing mood that the worst of the crunch was over, were being too optimistic, he said. The author of Traders, Guns & Money warned that many of the problem financial instruments were still hidden and the total amount of debt attached to them largely unknown.

Losses incurred by US banks were certain to rise as $US1 trillion ($1.06 trillion) in sub-prime housing loans was due to reset to higher interest rates in the next two years. The use of credit card debt -- now totalling $US915 billion -- was cushioning US home owners. But, in an ominous sign, card issuers were rapidly increasing their provisions for bad debts, by as much as 500 per cent in the case of one bank. The use of sub-prime debt structures was also a feature of other markets, such as private equity, where $US300 billion in loans were due to be refinanced in the next two years.

Mr Das said another $US1-$US5 trillion of assets would have to come back on to US bank balance sheets as a result of defaults on housing and other debts, and it was unclear how the banks could fund them -- issuance of preference shares by US banks was already at a record high. He said losses at financial institutions from the credit crunch were likely to almost double to $US400 billion. There were also second-round effects to come as the damage done to the real economy from financial sector losses fed back into further bank losses.

Mr Das said there needed to be a massive reduction in debt levels globally or a "nuclear deleveraging" before the crisis could be said to be over. That could be achieved through an economic crash "on the scale of 1929" but allowing inflation to rise would help to avoid that scenario. Higher inflation was a legitimate policy option since it reduced the real value of debt and gave companies and individuals breathing space to reduce their leverage by helping to put a floor under asset prices.

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Consumer bankruptcies jump 47.7 percent

Bankruptcy filings by U.S. consumers jumped 47.7 percent in April from one year ago as families cope with fallout from the subprime mortgage crisis, the American Bankruptcy Institute said on Friday. The 92,291 bankruptcy filings in April also marked an increase of 7 percent from March, the non-partisan institute said.

"The sharp spike in consumer bankruptcies reflects the growing financial stress faced by American families, saddled with household debt and mortgage woes," said Samuel Gerdano, executive director of the institute. "We expect consumer bankruptcies to top 1 million new cases this year". For all of 2007, there were 850,912 U.S. bankruptcy filings, up 38 percent from 2006.

The all-time high of more than 2 million consumer bankruptcy filings occurred in 2005, just before the federal bankruptcy law was reformed to make it more difficult for consumers to discharge their debt under Chapter 7 of the law. The reforms also increased debt payments required under Chapter 13 filings and eliminated some protections such as delaying housing evictions or delaying child support proceedings.

Some Democrats in Congress this year unsuccessfully sought another change in the federal bankruptcy law to let bankruptcy judges reduce mortgage amounts to reflect the current fair value of a home. That move was opposed by Republicans and the banking industry. Under current Chapter 13 bankruptcy law, a judge may restructure most of a consumer's loans ranging from credit cards to car payments, but may not modify a secured debt such as a home mortgage.

Bankruptcy filings made under Chapter 7 allow a consumer or business to liquidate assets to pay off creditors. Chapter 11 filings are made by companies seeking to reorganize and pay debts while staying in business.

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Downgrades show storm isn't over

Financial markets have been on a winning streak lately, but land mines lurk. Two of them resurfaced Friday, when credit-rating services downgraded the debt of a pair of big of mortgage lenders, Residential Capital LLC and Countrywide Financial Corp. ResCap's credit rating was cut deep into "junk" territory after it unveiled plans to restructure $14 billion of debt and possibly borrow billions more from its parent, GMAC LLC.

Countrywide's debt rating was slashed to junk from investment grade by Standard & Poor's after Bank of America Corp. said it isn't sure it will stand behind roughly $38 billion of Countrywide debt. Credit markets have become substantially calmer since the Federal Reserve helped avert a complete collapse by Bear Stearns Cos. in March. Friday's downgrades were a reminder that other big financial institutions are still struggling under the weight of problem mortgages.

ResCap, a big subprime-mortgage lender, intends to exchange around $12.8 billion of its bonds -- some due this year -- into new debt that matures later. It also plans a cash offer for another $1.2 billion in bonds that come due in June. The company also is negotiating a $3.5 billion credit line from GMAC that will have the first claims over ResCap's assets. The proposal is aimed at averting a default that could force ResCap into bankruptcy and lead to more losses for GMAC and its owners, Cerberus Capital Management and General Motors Corp. The clock is ticking. ResCap has around $4 billion in debt that comes due this year, and barely enough cash to cover it.

"This feels like an attempt to muscle bondholders into refinancing into longer-maturity debt," said Geoffrey Gwin, a principal at Group G Capital, a hedge fund. It doesn't own ResCap debt. Prices of ResCap bonds rose on the news, because the bonds were already trading at deeply distressed levels, and the terms of the exchange were slightly better for some holders and could help the firm stave off bankruptcy. S&P, Moody's Investors Service and Fitch Ratings slashed ResCap's credit ratings to CC or C, just above default. Fitch pushed parent GMAC's rating deeper into junk, to B-plus from BB-minus.

"The situation at ResCap is getting worse and worse, but [GMAC] is not letting it go," said Andrew Feltus, a bond-fund manager at Pioneer Investments in Boston. "It is not a happy moment for bondholders." GMAC spokeswoman Gina Proia said the plan will improve ResCap's flexibility. "We're focused on moving through a very challenging period." Countrywide's bond prices dropped Friday after a regulatory filing by Bank of America suggested the big bank might not back the struggling mortgage lender's debt.

In a Securities and Exchange Commission filing, BofA, which is acquiring Countrywide, said it is evaluating options for $38.07 billion in Countrywide debt, "including the possibility of redeeming, assuming or guaranteeing some or all of this debt, or allowing it to remain outstanding as obligations of Countrywide and not Bank of America." "We haven't made a decision yet," said a BofA spokesman. Craig Emrick, a vice president at Moody's Investors Service, said he believes BofA won't allow Countrywide to default, which would be "very damaging" to BofA's reputation.

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Buffett sees euro, sterling strong against dollar

Warren Buffett said on Saturday he expects the euro and the sterling to hold their own against the U.S. dollar, in part because of U.S. fiscal and trade policies that weigh on the value of the greenback.
"I do not have a feeling that those currencies are likely to depreciate in a big way against the U.S. dollar," Buffett said at the annual meeting of Berkshire Hathaway Inc, his insurance and investment company.

"Overall, the U.S. is going to continue to follow policies that have made the dollar weaker over the years."
Buffett said he plans to go to Europe later this month to visit businesses, to be more on the continent's "radar screen," and perhaps lay the groundwork for future acquisitions. Berkshire owns about 76 businesses, and plans to add more in the coming years, he said.

"We are happy to invest in businesses that earn their money in euros in Germany, or France or Italy, or earn their money in sterling in the UK," Buffett said. "I feel no need to try and hedge those purchases."

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Countrywide Rating Cut to 'Junk' By Standard & Poor's

Countrywide Financial Corp.'s credit rating was unexpectedly cut to junk by Standard & Poor's Corp., which cited doubt about whether Bank of America Corp. will back the home lender's debt after a pending takeover is completed. The revision reflects "the new level of uncertainty as to the ultimate legal status of Countrywide's creditors" after the lender's sale to Bank of America, Standard & Poor's said in a statement today.

Prices on some of Countrywide's $97.2 billion in debt tumbled and instruments that protect investors from default posted their biggest jump in almost four months. S&P made the cut just two days after saying it might raise Countrywide's ratings. The reversal squelched expectations among bond owners that their holdings would become more secure after Bank of America buys Countrywide, and renewed doubts among analysts about whether the $4 billion stock-swap will be completed at all.

"There's no way that bondholders come out of this with anything but a severe haircut," said Christopher Whalen, managing director at Institutional Risk Analytics, a banking research firm in Torrance, California. Bank of America may be trying to compensate for the anticipated cost of lawsuits tied to Countrywide mortgages that have gone sour, he said.

Bank of America, the second-largest U.S. bank by assets, agreed in January to buy Countrywide, the largest U.S. mortgage lender. The bank, based in Charlotte, North Carolina, rose 1 percent to $39.79 at 4:15 p.m. in New York Stock Exchange composite trading. Countrywide, based in Calabasas, California, dropped 1.1 percent to $5.98. Countrywide had run short on cash when the deal was announced and continued to lose money since then, posting an $893 million deficit for the first quarter. That means bondholders may have to go to court if Bank of America refuses to stand behind all of the lender's debt.

S&P said doubts about Countrywide's debt were raised by Bank of America in an April 30 regulatory filing that included a passage on whether the bank will honor debt issued by Countrywide. The documents said "there is no assurance that any such debt would be redeemed, assumed or guaranteed," adding that no decision had been reached. "Until this filing, it was our understanding that Bank of America would acquire all of Countrywide," Standard & Poor's analyst Victoria Wagner wrote today. "This new filing raises the possibility that this assumption is no longer true."

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Could Countrywide creditors get stiffed?

There are more questions about Bank of America’s planned purchase of Countrywide. A Bank of America regulatory filing this week notes that the big bank hasn’t decided whether to guarantee Countrywide debt after BofA’s $4 billion takeover of Countrywide, due to be completed later this year. A decision not to guarantee the parent company’s $38 billion in debt would be unusual and could leave Countrywide debtholders facing default, Bloomberg reports.

The wording of the filing has some observers wondering if Bank of America chief Kenneth Lewis “may be playing chicken with all of us,” reasoning that worries of a Countrywide default could push the price of its bonds lower, allowing Bank of America to buy them at a discount rather than redeeming at par. But if not, says Chris Whalen of Institutional Risk Analytics, investors could be in for quite a shock. If Bank of America were to let the Countrywide debt go into default, it could “adversely affect the entire market for bank debt.

What investor in their right mind would want to hold the debt of any bank holding company were BAC to elect the nuclear option and place [a post-merger Countrywide] into a bankruptcy?” he asks. “If bondholders get stiffed by Bank of America, it will scare the hell out of everyone,” Whalen tells Bloomberg. “This is called thinking the unthinkable.”

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TOLD YOU SO! BAC Threatens To Ram CFC Debtholders! Is Bear NEXT?

Just have to gloat a bit. I called this one when the original deal was announced. I said that BAC was going to set this up as a toxic dumping ground, refuse to guarantee jack, and reserve the right to set it adrift and bankrupt it on purpose. Guess what Bloomberg just published?

"''There is no assurance that any such debt would be redeemed, assumed or guaranteed,' the Charlotte, North Carolina- based bank said in an April 30 regulatory filing, adding that no decision has been reached. Investors have grown more optimistic the bank would back Countrywide debt, and Standard & Poor's said this week it may raise Countrywide's rating to match Bank of America's.
....
'I'd be quite concerned if I was a bondholder if the intent of Bank of America is as it reads in the filing,' said Gary Austin, founder of PDR Advisors LLC, an investment management firm in Charlotte."

No really? You'd be concerned? Told 'ya so. Now let's see what the bond market thinks of this tomorrow. Why do I think it will go over like a lead balloon? Hint: All of CFC's preferred and bonds are going to be treated as zeros, or damn close to it, at the open tomorrow. Betcha the stock reacts well to this one too.

Next question: How do you think the bond market will react if JPM decides that the same sort of posture is appropriate with regards to a certain "Bear" they recently consumed, and do you think the bond market just might front-run any attempted play like that starting, oh, tomorrow? Here's validation of what I said back when this deal was first announced, but now someone else is saying it.... nearly four months later. Gee, what took you idiot "analysts" so long to figure out what was obvious to me the instant this deal was announced?

"Whalen expects Bank of America will seek to absorb the best assets including Countrywide Bank, while the debt remains with a new company created by the merger, Red Oak Merger Corp. Red Oak may then file for bankruptcy, shielding Bank of America from liability, Whalen said."

Those of you who didn't unload either the preferred or the CFC bonds when you had the chance, after I warned 'ya - there's a word for you tomorrow. SUCKERS!

Expect spreads to have a certain parabolic look to them tomorrow on anything related to Countrywide and, if there is a man with a brain in the bond market, all these other "sticksave" deals - like Bear Stearns - will get the same treatment. Now consider this - CFC drew an awful lot of money out of the FHLB system via their Atlanta branch. What happens to all of that if they go "boom"? Could this take the FHLB system out too? This has the potential to get very, very interesting in a hurry.

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Buffett's Berkshire Says Profit Declines on Insurance

Billionaire Warren Buffett's Berkshire Hathaway Inc. said first-quarter profit declined 64 percent as falling rates reduced returns from insurance operations. The company had $991 million in investment losses as it marked down the value of derivative contracts. Net income decreased to $940 million, or $607 a share, from $2.6 billion, or $1,682, a year earlier, the Omaha, Nebraska- based company said today in a statement.

Operating earnings, which exclude investment losses, were $1,247 a share, lagging behind the $1,430 average estimate of three analysts compiled by Bloomberg. "Berkshire Hathaway has a significant risk posed on derivative contracts," said Charles Hamilton, an analyst at FTN Midwest Securities Corp., in a Bloomberg Television interview. "We've seen some of those derivatives come back to bite them." Hamilton has a "neutral" rating on the stock.

Buffett is looking to acquire businesses in Europe and is adding to holdings of consumer-products companies as competition forces down insurance rates in the U.S. Berkshire, which owns National Indemnity, General Re Corp. and Geico Corp., typically gets about half its profit from insurance. Profit from underwriting insurance policies fell 70 percent to $181 million. Pretax underwriting profit at Berkshire Hathaway Reinsurance Group, which sells catastrophe coverage, dropped 95 percent to $29 million.

Most companies in the KBW Insurance Index have reported declines in first-quarter profit on the falling value of investments, slipping rates for commercial coverage, and higher costs from auto accidents. Berkshire's investment loss compared with a gain of $382 million a year earlier. Berkshire recorded $1.7 billion of unrealized losses from contracts that protect fixed-income investors and from options sold on the value of the Standard & Poor's 500 Index and three other stock indexes. The S&P Index dropped by 9.9 percent in the first quarter.

"Berkshire's earnings may swing widely because of the accounting regulations that govern the reporting of derivatives," the company said in the statement.

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Berkshire scrutinized on Moody’s stake

Warren Buffett’s Berkshire Hathaway is coming under fire for its push into bond insurance. Connecticut’s attorney general is investigating possible conflicts of interest tied to Berkshire’s ownership of a new muni bond insurer, Berkshire Hathaway Assurance, and its 19% stake in ratings agency Moody’s. The attorney general, Richard Blumenthal, tells Bloomberg he is examining the “clear and direct conflict of interest for Moody’s to rate a company owned by such a significant Moody’s shareholder.” Moody’s recently gave Berkshire Hathaway Assurance a triple-A rating.

One fact that seems to weaken the conflict case here is the fact that McGraw-Hill’s Standard & Poor’s also has given Berkshire Hathaway Assurance a triple-A rating. Beyond that, a triple-A rating for Berkshire seems eminently justifiable given the firm’s pristine balance sheet. Meanwhile, both Moody’s and S&P continue to rate much less well capitalized insurers such as Ambac and MBIA triple-A, much to the amazement of many observers.

For that and other reasons, it’s all too easy to pick on Moody’s and S&P. They have been rightly criticized for their poor performance in rating bonds tied to subprime mortgages. After initially putting their triple-A rating on hundreds of collateralized debt obligations and residential mortgage-backed securities, the firms have been forced into embarrassing downgrades and repeated revisions of their loss projections.

That subpar showing has led critics to conclude that the practice of getting paid by bond issuers clouded the rating agencies’ judgment - a charge the agencies reject. So it’s tempting to conclude that the Moody’s investment is turning into a headache for Buffett. But that judgment is probably premature: While his holdings in the ratings agency have lost almost half their value over the past year, he’s still up 274% on the investment.

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Ambac on thin ice

Ambac’s finances continue to look stretched. The bond insurer said late Friday that it and its Ambac Assurance unit “remain in full compliance with the terms and conditions of their $400 million credit facility which remains undrawn.” The comment comes just over a week after Ambac posted a $1.7 billion first-quarter loss, prompting analysts at Goldman Sachs to say they expect Ambac and rival MBIA (MBI) each to have to raise $3.4 billion in new capital.

Ambac said after its first-quarter earnings report that it didn’t expect to have to return to the market for new money any time soon, but the company’s comments Friday show why investors remain concerned. “While our preliminary calculations suggested that there may be a modest non-compliance to the minimum net assets requirement, we can now confirm that we are in compliance by approximately $65 million,” said finance chief Sean Leonard.

“The difference relates to an adjustment that properly reflects the full tax benefit associated with our first quarter results.” Ambac said that while it’s in compliance now, it “will continue its discussions with the lender banks to provide additional flexibility relating to the credit facility.” By all indications, Ambac is going to need every bit of that flexibility.

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Ilargi: There are typically all sorts of restrictions for investors when it comes to pulling their money out of hedge funds. But we’ll see a lot of them doing exactly that, when given the chance. And on such a scale that few hedge funds will be left alive at all

Citigroup Says Old Lane Investors Intend to Cash Out in July

Citigroup Inc., the biggest U.S. bank by assets, said virtually all investors in its Old Lane hedge fund will withdraw their money. The investors will be allowed to exit the fund as of July 31, the New York-based bank said in a regulatory filing to the Securities and Exchange Commission yesterday. The Wall Street Journal reported today that the clients will pull about $3 billion from Old Lane, citing unidentified people familiar with the fund.

"In April 2008, substantially all unaffiliated investors had notified Old Lane of their intention to redeem their investments," Citigroup said. The bank is "evaluating alternatives for the restructuring of Old Lane."

Citigroup agreed in April 2007 to pay about $800 million for Old Lane, whose co-founder Vikram Pandit became Citigroup's chief executive officer in December. Citigroup's alternative- investments unit posted a loss in the first quarter, taking a $202 million pretax writedown on Old Lane, the bank said last month.

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Home Equity Loans - A Big Bank Killer: S&P Stops Rating 2nd Mortgage RMBS!

Fresh news out…S&P pulled a slick one. They STOPPED rating second mortgage RMBS citing “anamolous and unprecedented” borrower behavior. Remember, this is a $1.3 TRILLION market with the bulk belonging to very few banks such as BofA, Wells, Chase, Citi, Countrywide, Wamu, National City, Gmac and IndyMac. This could turn out to be a fairly large story in the making.

Home Equity Lines of Credit and loans (HELOC, HEL’s, second mortgages) were the true ‘Home ATM Machine’ and could be a big wipe-out for the big banks. These loans were mostly used to avoid Mortgage Insurance on purchase and refinance loans over 80% LTV and went up to 100% of the house value in recent years. As a matter of fact, an appraisal or full documentation was often not required. These loans were very easy to get and primarily relied upon an electronic evaluation of the property value and credit score alone.

They are almost always a total loss when in default. This is because in many cases, the first and second mortgage add up to more than the property is worth, so the second mortgage lender does not get anything in foreclosure - it all goes to the first.  As a matter of fact, most second mortgage holders do not even bother with foreclosure proceedings any longer, choosing more traditional means of collection.

A few months back banks began to freeze consumers out of accessing the available credit on the Home Equity Lines. Countrywide kicked if off by freezing 122,000 in one swoop and WAMU follow-up shortly thereafter with a 50,000 line freeze. Since then, most large named banks have began to freeze lines originated prior to 2008 or with original combined loan-to-values over 80% in regions where property values are substantially dropping. This just so happens to be the regions where these loans were done the most.

This hurt thousands who were not prepared. Many use these lines for highly legitimate purposes such as running a business, college tuition, a rainy-day fund or that brand new Mercedes.  Now, it looks as though the days of extracting all the cash out of your home through Home Equity Lines are gone for good.  This is probably a good thing in the long run, but just as with Jumbo money virtually vanishing overnight, these loans vanishing overnight will reduce housing affordability further extend the housing slump and perhaps cause some real damage to consumer spending.

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Fast and Easy Fannie

The Wall Street Journal had a very disturbing story on Wednesday about the "Fast and Easy" loan program of Countrywide Financial Corporation, many of whose mortgages were bought up by Fannie Mae.
WSJ reports:

Some of the problems are surfacing in a mortgage program called "Fast and Easy," in which borrowers were asked to provide little or no documentation of their finances, according to [people with knowledge of a Federal probe] and to former Countrywide employees.... Fast and Easy borrowers aren't required to produce pay stubs or tax forms to substantiate their claimed earnings. In many cases, Countrywide didn't even require loan officers to verify employment, according to an October 2006 presentation by Countrywide's consumer-lending division. That left the program vulnerable to abuse by Countrywide loan officers and outside mortgage brokers seeking loans for customers who might have been turned away if their finances had been more closely scrutinized, according to three current and former Countrywide senior executives and to several mortgage brokers who arranged loans through the program.

But here's the part that really scared me:

Both Countrywide and Fannie Mae, the government-sponsored company that bought many of the loans, classify the loans as "prime," meaning low-risk.... A Fannie spokesman agreed that the verification of employment wasn't required on all loans, but added that Countrywide was expected to verify employment details on a "sampling" of loans. The Countrywide spokesman said his company fulfilled that obligation.

It's news to me that Fannie was buying no-doc loans and calling them prime. I presume that if the WSJ article is correct as to the magnitude of fraud, Fannie would have a case in trying to recover any losses by suing Countrywide. But if Countrywide goes bankrupt, that plus a few dollars will get you a cup of coffee. Or perhaps we hope our Fannie is covered by credit default swaps that are supposed to pay if these loans default. Unfortunately, it doesn't require much imagination to conjecture a scenario in which the counterparty to those CDS also lacks the resources to make good on their promises. So who's holding the bag here?


Fannie Mae total book of business from their 2007 Annual Report.

From page 102 of Fannie's 2007 Annual Report, as of the end of 2007, the enterprise had leveraged $44 B in stockholders' equity with $796 B in short- and long-term debt to acquire $761 B in mortgages either held outright or intended for resale or trading. I read that as an equity cushion against a 5.8% loss on the mortgages held directly (44/761 = 0.058).

But in addition (page 1), Fannie has guaranteed $2.1 trillion in separate mortgage-backed securities it has sold to outside investors, for a ratio of core capital to total book of business of 1.6%. From the beginning, my conception of a really big financial meltdown would be one that pulls one of the GSEs into insolvency. Please tell me why it can't happen.

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Ilargi: There’s no doubt we haven’t seen the last surprise development in the Bear case yet. You don’t make this stuff up.

Bear Stearns’ second brush with bankruptcy

Bear Stearns nearly collapsed not once but twice before the cash-strapped brokerage firm was rescued, a regulatory filing shows. By now it's well known that JPMorgan Chase agreed on March 16 to buy Bear for $2 a share in a Fed-brokered agreement to fend off a possible bankruptcy filing at the cash-strapped brokerage firm. A week later the sides agreed to boost the value of the all-stock deal to $10 a share. That move, announced the morning of March 24, was widely portrayed as JPMorgan chief Jamie Dimon having thrown a bone to the restive Bear investors who were threatening to veto the agreement when it came up for shareholder approval.

But Bear Stearns' latest proxy statement, filed Monday with the Securities and Exchange Commission, shows that the stakes were much higher. Bear believed that if it failed to get a new agreement that reaffirmed JPMorgan's guarantee of Bear Stearns' obligations, Bear could have been cut off from JPMorgan's Fed-backed funding and forced into bankruptcy - an outcome that many investors assumed had been forestalled by the March 16 merger agreement. The dispute that nearly brought Bear down a second time turned on whether JPMorgan would stand behind Bear Stearns' massive credit default swap book and other liabilities. The firm's lack of access to other funding had Bear lawyers preparing for a possible bankruptcy the weekend before the revised merger agreement was unveiled.

The filing says that Bear execs noted continued reluctance by market players other than JPMorgan and the Fed to lend to Bear even in the wake of March 16's $2-a-share buyout pact. The execs feared they could be left without funding as they sought to clarify the pivotal guarantee issue. In the initial merger agreement, JPMorgan appeared to guarantee Bear's obligations. Later in the week, however, JPMorgan attempted to float the story that this guarantee had slipped into the agreement in error.

Without the JPMorgan backing, the filing says, "Bear Stearns would not be able to open for business on Monday, March 24, 2008, and would have no choice but to file for bankruptcy by that morning. Bear Stearns' bankruptcy advisors were instructed to be prepared for this contingency by the end of the weekend."

The knowledge that other market players doubted the JPMorgan guarantee put both sides in a tricky spot. Without any other financial institution providing liquidity to it, Bear had drawn heavily on JPMorgan's credit, borrowing a total of $9.7 billion - $3.6 billion of which was unsecured. The bank also had $3.7 billion in repurchase agreements with Bear. JPMorgan had, as they say, skin in the game.

Meanwhile, Bear's customers and competitors, with nearly $13.4 trillion worth of derivative exposure to the firm, were refusing to do business with Bear. The loss of customers was highly concentrated in Bear's once-vaunted prime brokerage unit. Specializing in clearing trades and providing margin for the world's largest hedge funds, this group regularly provided a double digit percentage of Bear's net income. Without Bear's prime brokerage unit, and with Bear's mortgage unit at the crossroads of the securitized market collapse, JPMorgan was at risk of buying a business with little profit potential.

For their part, Bear managers knew that a bankruptcy filing might mean liquidation of the firm, which would wipe out shareholders and could have left many creditors holding worthless claims. The filing shows that as the week of March 17-21 came to a close, the sides began discussing a renegotiation of the terms of the deal. "Representatives of JPMorgan Chase informed Bear Stearns that during the week the New York Fed had repeatedly requested that JPMorgan Chase guaranty Bear Stearns' borrowings from the New York Fed, and that JPMorgan Chase was at this time unwilling to do so," the filing states.

"Both parties perceived that the absence of JPMorgan Chase's guaranty could place continued funding from the New York Fed in jeopardy." In response, JPMorgan proposed a deal that would allow it to purchase more than two-thirds of Bear's stock, to fend off the shareholder uprising, and that the deal be sweetened via the issuance of a security whose value would be contingent on the performance of some Bear Stearns mortgage securities. Bear's board rejected that deal, saying it wanted more money for shareholders.

Working through the weekend of March 23, Bear and JPMorgan boards managed to cobble together an agreement that increased the bid to $10 per share, which took the likelihood of a shareholder blocking action off the table. In return, JPMorgan bought enough stock to guarantee the deal's completion - thus safeguarding its loans to Bear. Bear's customers got an operating guarantee from JPMorgan that clearly spelled out the bank's assumption of Bear's obligations.

But while the deal is now securely in place, it's not certain that a happy ending is in sight. After the merger, JPMorgan - with around $91.7 trillion in total derivative exposure - will solidify its position atop the derivative league tables. Citigroup is a distant second at $34 trillion, according to the Office of the Comptroller of the Currency.

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Ilargi: The credit card world is sick to the bone, it has lost all sense of reasonable perspective. These companies are loan sharks, nothing more or less, only with a legal veneer.

Repairing it now is at least 25 years too late; millions of people are in beyond their necks already. A bigger problem yet may be that the Fed is as mentally diseased as the lenders it now allegedly seeks to regulate. In the end the Fed equals those lenders, after all.

Federal Reserve OKs credit-card proposals

The Federal Reserve on Friday issued proposals to restrict various credit-card billing practices, including double-cycle billing and unreasonable late charges. The proposals aim to protect credit-card users and clarify costs by prohibiting actions such as raising an annual percentage rate unless certain exceptions apply, treating a payment as late unless consumers have been provided with a reasonable amount of time to make payments and unfairly maximizing charges.

The rules would also protect consumers using overdraft services, and prohibit double-cycle billing, in which institutions compute charges based on outstanding balances in billing cycles preceding the most recent cycle. "The proposed rules are intended to establish a new baseline for fairness in how credit-card plans operate," said Federal Reserve Chairman Ben Bernanke. "Consumers relying on credit cards should be better able to predict how their decisions and actions will affect their costs."

The Fed is joined by the Office of Thrift Supervision and National Credit Union Administration in issuing the rules. The Fed's proposal would apply to banks, the OTS proposal would apply to savings associations and NCUA's to federal credit unions. The agencies expect to finalize the rules by the end of the year. Industry executives have been making their case in Washington that risk-based pricing strategies enable them to serve a wide range of customers. In a statement Friday, Edward Yingling, president and chief executive of the American Bankers Association, said the Fed's proposal is an "unprecedented regulatory intrusion" into the marketplace.

"The proposal would greatly restrict the ability of card companies to charge interest rates that reflect the risks of different consumers, similar to how insurance companies charge different rates depending on drivers' records. If card companies cannot fully reflect risk, then millions of consumers with good credit histories will end up with higher rates," Yingling said. "The proposal would also have the likely effect of ending zero- or low-interest balance-transfer options, which have helped consumers and small businesses."

Carol Van Cleef, a partner who represents financial-services companies with law firm Bryan Cave LLP in Washington, said the Fed proposals could disrupt the credit-card market and tamp access to credit cards for higher-risk customers. "You're introducing some new rules that are going to take some time to sort out," she said. "And in that interim period we are likely to find that people who have had credit, now may not."

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ABCP judge to delay ruling

The judge overseeing the $32-billion restructuring of the seized-up market for asset-backed commercial paper wants to put off a ruling on the plan's fairness until mid-May, saying he needs more time to review the complex case.
Ontario Superior Court Justice Colin Campbell, who was originally scheduled to rule on the fairness on Friday, said he would like to hold the so-called “sanction” hearing on May 12 and May 13, but could do it sooner in a pinch.

To give more time, the judge asked that a key standstill agreement with banks that prevents a meltdown in the market be extended. The current standstill expires May 9. “I can't think possibly how I can get a decision out by May 9,” the judge said. The lawyer representing the banks that have to sign off on the standstill said he couldn't give “any assurance” that the deadline could be extended. The banks have generally been leery of delaying the fix for the market longer when that's been requested by other players in the market, “but obviously a request from the judge is received very differently,” the lawyer said.

Should the ruling come out in the middle of the month, the engineers of the plan would be unlikely to meet their planned timetable of swapping the frozen ABCP for new notes by month's end. Investors are anxiously awaiting a final resolution after being stuck with the paper since last summer, when the entire market seized because buyers disappeared during the early days of the credit crunch.

The restructuring process has dragged on for months as a committee of big investors worked to negotiate a deal that would thaw the market. The deal, however, includes a controversial clause that would give all the players in the market immunity from lawsuits, something that has angered many holders and led to challenges in court that the judge wants more time to consider.

The lawsuits, if allowed, could run into many hundreds of millions, according to court documents filed Thursday. Aeroports de Montreal, Air Transat A.T. Inc., Cinar Corp., Labopharm Inc. and dozens of other companies laid out the claims they believe they have, which total at least $700-million.

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Thai cartel idea outrages rice consumers

Protests erupted yesterday from rice-importing nations as Samak Sundaravej, Thailand's Prime Minister, proposed a cartel of South-East Asian rice exporters that would seek to gain more control over the price of grain. In the wake of mounting concern about a tripling in the price of rice, Mr Samak said that he would seek to bring together Thailand, Vietnam, Burma, Laos and Cambodia in a price-setting organisation similar to Opec.

The proposal, which emerged as South-East Asian trade ministers gathered in Bali for talks over regional issues, including rice shortages, drew an immediate protest from the Philippines, which has been forced to take emergency measures to ensure food supplies. Edgardo Angara, chairman of the senate committee on agriculture in the Philippines, said: “Almost three billion people are rice eaters. It's not a good idea. It's a bad idea. It will create an oligopoly and it's against humanity.”

Panic over the escalating price of rice has prompted governments to impose export curbs, notably in Vietnam and in India, which recently imposed an export tariff on its high-quality Basmati that had previously been exempted from restrictions. America has offered an extra $770 million (£390 million) of food aid in an effort to bridge the widening gap between the soaring cost of grain and affordability for the world's poor. The World Food Programme, which has mounted a campaign to fill a $775 million budget shortfall caused by soaring grain prices, said it was a major step in addressing the problem.

The WFP, which feeds 73 million people in 80 countries, has suffered a 55 per cent rise in its costs in less than a year. It said it had already received pledges of additional aid from Canada, Australia and Britain, and indicated it had achieved 70 per cent of its target funding.

The proposed rice producers' cartel drew indications of support from Thailand's neighbours, Laos and Cambodia. Thailand is the world's biggest rice exporter but a government spokesman said that the country was failing to benefit from its strong position. “We have had little influence on the price. With oil rising so much, we import expensive oil but sell rice very cheaply and that's unfair to us and hurts our trade balance,” he said.

Laos said it would consider seriously the idea and Cambodia suggested that an association would prevent price wars and enable the exchange of information about food security. Sceptics suggested that an Organisation of Rice Exporting Countries would struggle to achieve the power that Opec has because it would be unable to control supply. Robert Zeigler, of the International Rice Research Institute, noted that oil was produced by a small number of very large companies: “Rice is grown by millions of farmers in one, two, three hectares of land.”

• Global rice consumption has risen by 40 per cent in the past 30 years from 62kg (136lbs) per person to 86kg (190lbs)
  
• Burma has the highest per capita rice consumption in the world at 200kg
  
• Rice prices on the Chicago Board of Trade have risen more than 80 per cent this year

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Thailand's rice cartel goal to face hurdles

Thailand's proposal for an OPEC-style cartel to control rice prices will likely face international opposition and only lead to distortions on the global rice markets at a time when the prices of rice and other food commodities are skyrocketing, analysts said. Thailand, the world's biggest rice exporter, wants to form a rice cartel with four other Southeast Asian countries -- Laos, Burma, Cambodia, and Vietnam -- to acquire more influence over international rice prices, according to media reports Friday.

In the same way that the Organization for Petroleum Exporting Countries (OPEC) sets oil prices, members of the proposed rice cartel would cooperate on prices, thereby wielding their influence. "Firstly and most importantly, this is not the right time to suggest a cartel," said Arpitha Bykere, an analyst at RGE Monitor "With the food prices going so high, the World Bank and the United Nations have suggested it's becoming such a big crisis," Bykere said. "The international organizations will oppose this [a rice cartel]."

World Bank President Robert Zoellick has warned that high food prices are threatening recent hard-won gains in overcoming global poverty and malnutrition. The United Nations World Food Program has said that high food prices are creating "a silent tsunami" threatening to plunge more than 100 million people on every continent into hunger. Soaring prices for agricultural commodities, including rice, wheat, corn, and soybeans, have stirred popular discontent and demonstrations around the world.

In response, Vietnam, India, Egypt, and Cambodia have imposed bans on rice exports. Thailand, the top rice exporter accounting for a third of global exports, is currently not banning or restricting rice sales. Rice prices have tripled this year, with Thailand's benchmark 100% Grade B white rice soaring above $1,000 a ton for the first time last month, according to media reports. On the Chicago Mercantile Exchange, rough rice futures have surged over 95% in the last 12 months.

A spokesman for the Thai government said that the prime ministers of Thailand and Burma discussed the cartel idea on Wednesday, the BBC reported Friday. Cambodia has expressed support for the idea of a rice cartel in the past and Laos has indicated it would seriously consider the idea, the BBC said. However, Vietnam officials were quoted by The Bangkok Post newspaper rebutting Thailand's claim that a rice cartel was close and saying that Vietnam hasn't made any official reaction to the proposal yet.

Vietnam is the world's second largest rice exporter. India is the third-largest rice exporting country followed by the United States in fourth place. Asia accounts for about 90% of global rice consumption. "Thailand, being the largest exporter of rice, would be in a position to take advantage of the current situation [of soaring rice prices]," said Divya Reddy, an analyst at the Eurasia Group. "It makes sense for them to take the lead."

However, "I don't see it working successfully in the near term," Reddy said about the proposal to form a rice cartel. "There would be huge incentive for countries to take their own measures to deal with the problem [of soaring prices]." Bykere of RGE Monitor pointed out that there are political disagreements and different political structures in Southeast Asia that might make it difficult to form a cartel. For example, Thailand is a constitutional monarchy, Burma is ruled by a brutal military junta, Vietnam and Laos are communist states, and Cambodia is a young multi-party democracy.

"More importantly, their economic policies are different," Bykere said. "There is very low probability of these countries agreeing." Also, Thailand and Vietnam are doing better economically than their much poorer neighbors Burma, Cambodia and Laos. A rice cartel would differ from OPEC, because OPEC countries have certain oil reserves, while rice harvests depend on weather conditions, Bykere said.

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'Big Dry' hits Australian farmers

More than 10,000 Australian farming families have had to leave their land as a result of the country's ongoing drought, new figures reveal. There has been a 10% drop in the number of farmers in the past five years, the figures released by the Australia Bureau of Statistics revealed.

Australia is presently in the grip of the what's known locally as the "Big Dry" - the worst drought in a century.
The figures reveal its impact on the nation's farming communities. They show that the number of farmers in Australia has dropped by a third in just 20 years.

Rural communities are now dotted with 'for sale' signs, as farmers try to sell-up. They have been hit not just by the difficulties of farming water-starved land, but interest rates which are at a 12-year high. It is a particularly vicious cycle: farmers borrow heavily to plant seeds for crops which yield well below average harvests.

The result for many is bankruptcy, and the irksome decision to leave land which their families have often farmed for generations. Neither is this a problem restricted solely to Australia. One of the main reasons why global wheat stocks are at their lowest levels since 1979 is because of the ongoing Australian drought.

Normally, the country would hope to harvest about 25m tonnes of wheat - in 2006 the crop yielded less than 10m tonnes.

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Major Arctic sea ice melt is expected this summer

The Arctic will remain on thinning ice, and climate warming is expected to begin affecting the Antarctic also, scientists said Friday. "The long-term prognosis is not very optimistic," atmospheric scientist Jennifer Francis of Rutgers University said at a briefing.

Last summer sea ice in the North shrank to a record low, a change many attribute to global warming. But while solar radiation and amounts of greenhouse gases in the atmosphere are similar at the poles, to date the regions have responded differently, with little change in the South, explained oceanographer James Overland of the National Oceanic and Atmospheric Administration.

What researchers have concluded was happening, was that in the North, global warming and natural variability of climate were reinforcing one another, sending the Arctic into a new state with much less sea ice than in the past. "And there is very little chance for the climate to return to the conditions of 20 years ago," he added. On the other hand, Overland explained, the ozone hole in the Antarctic masked conditions there, keeping temperatures low in most of the continent other than the peninsula reaching toward South America.

"So there is a scientific reason for why we're not seeing large changes in the Antarctic like we're seeing in the Arctic," he said. But, Overland added, as the ozone hole recovers in coming years, global warming will begin to affect the South Pole also. The briefing covered data being reported in a paper scheduled for publication next week in Eos, a journal of the American Geophysical Union. Overland said he used to be among those skeptical about the effects of global climate change. The new findings, which he termed "startling," were developed at a recent workshop, he said.

There is agreement between weather observations, the output of computer climate models and scientific expectations for what should happen, added Francis. All the evidence points toward human-made changes at both poles, she said, a conclusion that "further depletes the arsenals of those who insist that human-caused climate change is nothing to worry about." Climatologist Gareth Marshall of the British Antarctic Survey said that while the term global warming is widely used, things are more complicated at the regional level.

In the Antarctic, he explained, climate change strengthened winds blowing around the continent, helping trap colder air. But that will decrease in the future, allowing warmer conditions to begin, he said. And, Marshall added, all studies now show that human activities are the drivers of climate change in the Antarctic. Asked if this summer will match last year's record low sea ice in the North, Overland that is likely.

"The tea leaves point to a minimal amount of sea ice next September, that would be the same as we had last summer, 40 percent loss compared to 20 years ago," he said. Overland added that the winter freeze got a late start last fall. Francis added: "Over this entire fall, winter and right up 'till today the ice concentration, the amount of ice that's floating around on the Arctic, has been below normal every single day." "All arrows are pointing towards, certainly not a recovery, something like we had last summer and possibly worse," she said.

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