Malheur County, Oregon. "Siphon, the world's longest, which carries water five miles to Dead Ox Flat.
It is eight feet in diameter.
Ilargi: I’ve read several articles lately suggesting that the troubles in the US and EU finance system are caused by high oil prices. As I’ve said often before, the numbers don’t make sense. The very idea, as well as all the complaining about gas prices, stem from man’s genetically defined tendency to pay attention first and foremost to immediate threats right before his eyes.
And as logical as that may be, it’s not always the best strategy. In cases like this, it’s like being too busy swatting flies to see the entire pride of lions sneaking up on you from behind.
When you get all puffed up about gas prices, you fail to see the overall picture: a thousand gallons of gasoline over the past year have cost about $1000 extra. Home prices fell 14.1% (Case-Shiller), or about $30.000 per home. In other words, an estimated 200 million US drivers have paid some $200 billion extra for gas, while values for the 100 million US homes have fallen by $3 trillion. And that’s just housing; trillions more have also vanished from other parts of the economy. It may take longer for some of the effects to be felt, but that makes them no less real.
It’s time to get some perspective here. The rise in gas prices so far is a joke compared to what’s happening in finance. The truly perverse effects of rising oil prices haven’t even started yet.
Home-Price Gains Are Erased, Now Stand at 2004-2005 Levels
Home-price declines continued to get steeper in April, according to the S&P/Case-Shiller indexes and the Ofheo home price index, which showed at least three years of gains erased.
Separately, consumer confidence dropped like a stone in June, and expectations hit an all-time low, according to the latest survey from the Conference Board. Home prices in 20 major U.S. cities have dropped a record 15.3% in the past year and are now back to where they were in 2004, according to the Case-Shiller home price index released Tuesday by Standard & Poor's.
In a separate report, the Office of Federal Housing Enterprise Oversight said U.S. home prices fell to December 2005 levels during April as the housing downturn continued to affect states at the heart of the real estate boom. The S&P/Case-Shiller home-price indexes, a closely watched gauge of U.S. home prices, show price declines continued to get steeper in April, with prices in every region surveyed now showing year-over-year drops.
No region -- not even Charlotte, which had been the only city in the survey to post annual growth the other months this year -- was able to avoid a year-over-year drop. Charlotte saw its prices decline 0.1%. Las Vegas and Miami were again the weakest markets over the past year, posting 26.8% and 26.7% drops, respectively.
Las Vegas and Miami were the weakest markets each of the other months this year. S&P noted that the two markets saw some of the fastest growth in the 2004/2005 periods, with annual growth rates surging above 53% and 32%, respectively.
The S&P/Case-Shiller results come a day after Harvard University's annual report on housing said the housing slump, already shaping up to be the worst in a generation, still hasn't run its full course. The study said the fall in home prices and the rise in mortgage defaults are the worst since the 1960s and 1970s.
Meanwhile, the Commerce Department said last week that construction of new homes dropped 3.3% in May to a seasonally adjusted annual rate of 975,000. Housing starts were down 32% from a year earlier, while permits for new-home construction, a gauge of future building activity, dropped 1.3% in May to an annual rate of 969,000.
Ilargi: Would there be a single reporter left in the US with the guts to ask Paulson what his optimism is founded on?
House prices and consumer confidence dive
Consumer sentiment slid to a 16-year low in June while house prices suffered record annual drops in April, according to data on Tuesday that suggested a retrenchment in spending that will keep squelching economic growth.
The Conference Board's monthly survey of consumers showed the overall index of consumers' mood fell to 50.4 in June, the lowest since 47.3 in February 1992. The index has now dropped by more than half since 111.90 last July, before the housing market troubles triggered the most severe credit crisis in at least a decade.
"To put it in perspective, that's a bigger decline than what we saw after the September 11 attack and Hurricane Katrina," said Dana Saporta, economist at Dresdner Kleinwort Securities. "It sends out the signal that the consumers are not about to ramp up their spending," he said. "We worry about the contraction in the economy once the tax rebates dissipate."
In addition, the survey showed an index measuring consumer expectations for the future sank to a record low as inflation forecasts matched an all-time high this month. The inflation threat has been highlighted in the past 24 hours by massive price increases announced by some of the world's largest basic materials conglomerates.
First, mining titan Rio Tinto secured an agreement with China's largest steel maker to nearly double the price Rio gets for iron ore, and rival producer BHP Billiton is expected to follow through with similar price hikes. Then early on Tuesday, Dow Chemical Co. said it would raise prices up to 25 percent, just weeks after the largest U.S. chemicals maker implemented a 20 percent across-the-board price increase.[..]
U.S. Treasury Secretary Henry Paulson said on Tuesday he thought that most of the slump in U.S. housing prices would be over by year end and that growth should be stronger by then. In an interview on Mexican television, Paulson said the global economy was being strained by costly energy but said U.S. economic fundamentals were sound.
"I feel moderately optimistic that at the end of the year we will have signs of an economic recovery," Paulson said. "Hopefully the biggest part of the housing decline will be over by the end of the year."
Ilargi: What, you thought the madness was over? HA HA HA!!!
U.S.-Backed Mortgage Program Fuels Risks
Mortgages that allow consumers to put little if any money down when buying a home have largely disappeared as a financing option available from private lenders. But they are still available -- and growing more popular -- through a government-backed program.
That's raising concerns among critics who blame no-money-down mortgages for many of today's housing market woes. And while federal housing officials are moving to end the practice, for now home builders are promoting the programs to move unsold inventory. "I just smell a massive taxpayer burden coming," says Sen. Christopher Bond (R., Mo.), who calls the programs "too good to be true."
The offers -- including "100% financing" -- are made possible due to down-payment assistance programs run by nonprofit organizations. These programs are funded largely by home builders and also by private homeowners desperate to sell. The seller-funded groups provide enough down-payment money to buyers that they can qualify for a mortgage backed by the Federal Housing Administration, which requires at least a 3% down payment.
Supporters of the down-payment programs say they help the FHA fulfill its goal of assisting first-time home buyers. But critics say the programs will burden the government agency, and taxpayers, with bad loans. The FHA, which essentially is filling the void left by the collapse of the subprime market, renewed a push to eliminate the programs this month, after warning that above-average default rates for seller-assisted down-payment programs will force the agency to request a government subsidy for the first time in its 74-year history. The agency says it will need $1.4 billion next year.
The FHA estimates that down payments provided by nonprofit groups account for 34% of all 200,000 loans backed by the FHA so far this year, up from 18% in all of 2003 and less than 2% in 2000. And the agency says that borrowers are two to three times as likely to default on their payments when they receive a down payment from a nonprofit.
D.R. Horton Inc., the nation's largest home builder by volume, is touting "100% financing" for its two- and three-bedroom condominiums near the beach in Maui, Hawaii, which start at $498,000. In the Seattle area, local builder Quadrant Corp. is advertising townhouses that can be purchased with as little as $500 down.
"Use your coffee budget to move into a new home", says an online promotion. In the St. Louis area, Vantage Homes recently promoted its suburban developments with ads suggesting a new home should be on the list of things to buy for those "looking for something to spend your economic stimulus check on."
A flier promoting D.R. Horton's Maui development, for example, says that funds for the down payment would be provided by Nehemiah Corp. of America, the largest private down-payment assistance provider. D.R. Horton, based in Fort Worth, Texas, didn't return calls seeking comment. Scott Syphax, president and chief executive of Nehemiah, a nonprofit organization, said D.R. Horton is one of 95,000 companies and individual home sellers that have participated in the assistance program.
To critics, mortgages with down-payment assistance are similar to no-money-down subprime loans, which have triggered a wave of foreclosures. Most bankers believe defaults are so high because borrowers who encounter financial difficulties are more willing to walk away from a home when they didn't put much of their own money into the purchase.
"The inescapable fact is that seller-funded down-payment assistance is particularly susceptible to losses," says Howard Glaser, a mortgage-industry consultant and former official at the Department of Housing and Urban Development. "Too often today's seller-funded loan is tomorrow's foreclosure."
Bank of America sees $3.5 billion writedown at Merrill, $7 billion at UBS
Banc of America Securities expects Merrill Lynch & Co Inc and UBS AG to write down $3.5 billion and $7 billion respectively in the second quarter and forecast a quarterly loss for the investment banks. Analyst Michael Hecht expects continued markdowns on troubled asset inventories, tough comparisons and weakness in a number of sales and trading areas for the second quarter.
Hecht forecast a quarterly loss of $1 a share for Merrill, compared with his earlier view of a profit of 21 cents a share, saying the marks on its collateralized debt obligations and mortgage-related exposures would be more severe than prior expectations.
Hecht also changed his second-quarter estimate for UBS to a loss of $1.70 a share from a profit of 31 cents, saying the company's U.S. sub-prime exposure had overshadowed the firm's other segments including wealth management, investment banking and asset management.
Slowing economic growth and still-large balance sheet exposure to residential and commercial mortgages suggest a lackluster, low visibility environment for the large investment banks through 2008, Hecht said.
UBS shares rise on HSBC takeover talk
Shares in UBS jumped in morning trading on rumours HSBC could announce a takeover for the Swiss bank. UBS stock rose almost four per cent this morning on speculation HSBC is planning an $80 billion (£40.7 billion) bid for the bank. Shares in UBS shares were up 1.99 per cent at CHF22.50 (£11) by 12:24 BST, ahead of a 0.5 per cent rise in the European banking sector index.
In addition, UBS said it has agreed to buy Dutch wealth management company VermogensGroep for an undisclosed price. VermogensGroep serves wealthy private clients, foundations and institutions in the Dutch market with client assets of approximately €4 billion (£3 billion) and an additional €10 billion (£8 billion) assets under administration, UBS said.
UBS was the biggest European casualty of the credit crunch with over £19 billion in mortgage write-downs. Analysts believe more is yet to come when the bank announces its second quarter earnings in August. The bank is attempting to return to profitability by expanding into more lucrative regions as the Swiss market slows.
Gas and Home Prices: What a Difference Two Years Can Make
It was only four years ago that home prices were rising at the rate of 20 percent per year and gasoline cost less than two dollars a gallon, yet it seems like a distant memory.
When you think about the Hummer in its heyday back in 2004 and early 2005, this chart just about tells the whole story - home equity burning a hole in the pockets of millions of homeowners and being able to fill up a 33 gallon tank for about $50 or so. Once the hurricanes struck in 2005 ... well, we all know what Hummer lots looked like after Katrina and Rita swept through the Gulf Coast.
Ilargi: David Blanchflower is one of the few Brits who have made sense lately, so he’s seen as a bit of a doomer. But the best even he can do here is suggesting price drops of 33%. I can’t imagine everybody is blind, but nobody tells the truth yet.
UK home loan approvals dive to record low in May
New home loan approvals nosedived at their sharpest annual pace in at least a decade to hit a record low in May, figures showed on Tuesday, raising fears the housing slowdown is about to escalate into a crash.
The credit crunch has forced banks to toughen up lending terms, making it harder for Britons to get affordable mortgages and house prices have already started to fall at monthly rates not seen since the slump of the early 1990s. Economists worry that a housing market meltdown will drag the economy into recession at a time when the cost of living is rising fast as food and fuel prices soar on global markets.
The British Bankers' Association said mortgage approvals for house purchase -- an indicator of future house prices -- fell to 27,968 in May from 34,752 in April. That was 56 percent down on a year ago -- the biggest drop since the series began in 1997. "A very worrying picture of how the credit crunch is unfolding. A U.S.-style housing slump looks increasingly likely," said Michael Hume, an economist at Lehman Brothers investment bank.
"The drop in mortgage approvals and lending points to a housing market that is rapidly grinding to halt under the pressure of higher mortgage interest rates, tighter bank lending standards, and declining confidence." One Bank of England policymaker -- arch dove David Blanchflower -- has suggested house prices could fall by about a third unless the central bank acts now.
And signs of worsening conditions will do little to help struggling Prime Minister Gordon Brown who has lost the public's confidence on the economy in the wake of the collapse of credit crunch victim and mortgage lender Northern Rock. Two thirds of Britons own their homes, putting millions at risk of negative equity -- when the house value falls below its mortgage -- if house prices crumble.
However, that may be a way off yet, given that prices trebled over the last decade. While soaring commodity prices across the globe have forced inflation to the top of the political agenda and convinced financial markets that interest rates are heading higher, most economists expect rates will eventually have to fall.
Even hawkish Bank policymaker Andrew Sentance said this week he expected slowing growth to help cool price pressures, suggesting the central bank is in no hurry to raise rates. But lower borrowing costs are unlikely to come in time to help anyone in Britain looking to buy a home.
Despite three cuts in official interest rates to 5 percent since December, banks have actually been raising rates on their mortgage deals because the credit crunch has made it harder for them to get hold of cheap funding on financial markets.
Economists warn of a worsening outlook
Economists and market prognosticators are growing increasingly skeptical that Americans will be able to keep pulling their wallets out of their pockets to shop and pay their bills. Sure, they trundled off to the store to put their tax rebate checks to work during the last few weeks. The Redbook survey, used to track retail sales growth, just climbed to 2.3 percent for the week of June 14. It grew 1.5 percent preceding the rebates.
But cracks in the consumer's happy face are showing nevertheless. In an apparent move of desperation Monday, General Motors announced that it was so eager to clear away the glut of 2008 vehicles, the company is offering zero percent financing for six years to people buying certain models this month.
Goldman Sachs strategist David Kostin recommended in a note to clients that they unload financial company stocks and stocks in companies that sell discretionary items like cars, clothes and electronics to consumers. The reason: Credit problems won't peak until 2009 and inflation will curtail consumer demand.
The IRS apparently gave in to gasoline inflationary pressures Monday, announcing that people who drive for business can now deduct 58.5 cents a mile, versus the old 50.5 cents, for mileage between July 1 and the end of the year. Meanwhile, United Airlines announced plans to cut hundreds of employees and Citigroup thousands. Merrill Lynch strategist Brian Belski told investors to be skeptical of pundits claiming that the length of past recessions might provide clues to the duration of the current downturn.
"It's hard to believe that this will be an 'average' recession as the consumer continues to weaken," said Belski. And research by Oppenheimer and Co. Meredith Whitney goes further: "The state of the U.S. consumer continues to deteriorate," she said in a recent report. Her analysis of consumer debt points to problems that will worsen as high food and gasoline prices weigh on people who have fewer options for escaping their debts.
In the past few years, many Americans had an escape that no longer is available to some. They ran up credit card debt and then took out home equity loans, or drew on home equity lines of credit, to wipe the credit card debt away. Now, however, Whitney points out that average equity in homes is at an all-time low of 46.2 percent and dropping at an annual rate of 7 percent. So people cannot borrow on homes that have lost value. Whitney notes that taking cash out of homes is at the lowest level since the beginning of 2004.
Further, even people with equity are constrained by lending practices. Some lenders no longer let people draw on home equity lines of credit if they live in zip codes where other homes have lost value. Meanwhile, the consumer credit growth rate is at a five-year high, says Whitney. With the benefit of rebate checks in May, consumers made a larger dent in their credit card debt than they did in April.
Yet, compared to a year ago they are falling considerably behind. Despite having a windfall from the IRS, consumers made payments on their credit cards that lagged May 2007's by almost a full percentage point. That's a red flag for what lies ahead, Whitney said. Payment rates on credit cards are a leading indicator for future delinquency rates. So given the fact that payment levels have been down for seven consecutive months, she says delinquencies should rise.
That, of course, will be bad for delinquent consumers, who will tarnish their ability to get affordable loans in the future. But it is also a reason why investors should be cautious about buying financial company stocks, says Whitney. Typically, consumers wouldn't be showing so much weakness this early in the cycle, she said. The weakness "signals to us that ultimate loss experience will be far worse than most current expectations."
As lenders fear losses, she estimates they will withdraw $2 trillion in credit card lines by 2010, leaving consumers with less ability to buy on credit.
Are we really ready for this financial storm?
According to Bob Janjuah of the Royal Bank of Scotland: "A very nasty period is soon to be upon us. Be prepared." It's not like the RBS to go around making alarmist statements but it has warned of a "global equity and credit crash" this autumn. Morgan Stanley bank has forecast a "catastrophic event". The hedge fund guru John Paulson says global losses from the credit crisis, currently $300bn, may reach $1.3 trillion.
Yet only a few weeks ago, everyone in the City and Wall Street seemed to be saying that "the worst was over"; that the fundamentals were sound; and that once the banks had owned up to the full extent of their losses, then things would get back to normal. Clearly, they haven't, as anyone who has tried to get a mortgage recently will have discovered. And with the oil price spike - which Gordon Brown is trying to flatten at the oil summit in Jeddah - there has been a switch of sentiment back to deepest gloom.
You think I'm exaggerating, don't you? Well, let me quote an e-mail I received at the weekend from Moneyweek Magazine. Under the heading "Bloodbath Britain" the magazine screams in bold type: "The UK is about to be battered by the biggest financial storm of our lifetimes."
It goes on to predict five forthcoming disasters. "Disaster 1: The housing market crashes wiping up to 40% off the value of your property. Disaster 2: 1000s of businesses go bust as the credit crunch hammers consumer spending. Disaster 3: Unemployment leaps by 30-50% as a 1980s-style crisis devastates the job market. Disaster 4: Sterling collapses by 10% and the price of everything from petrol to food skyrockets. Disaster 5: Shares, investments and cash all lose value destroying wealth and crushing retiral dreams."
At first I thought this might be a spoof, or perhaps a posting from the Socialist Workers Party. But this is no leftist doom-monger warning of the collapse of capitalism but a hard-headed and practical share and property buying guide. Moneyweek goes on to advise what stocks you should buy to hedge the stock market collapse, mainly commodities. It would be as well handing them a razor and some hemlock.
Now, we do not want to "talk ourselves into a recession", to use the current political cliche in Westminster. But it's important to know what the financial world is thinking. It's not just prophets like the billionaire George Soros, who has been warning that this is a crisis comparable to the Great Depression. Look at the work of Nouriel Roubini, the prolific New York University economics professor, whose "12 steps to financial Armageddon" is essential reading. Even Martin Wolf of the Financial Times said last week that "on the supply side of the world economy, almost every piece of news has been bad."
Or try looking at the Market Oracle website, which has been running increasingly apocalyptic posts from highly-informed US financial commentators, many of them on the political right. It's UK editor, Nadeem Walayat, correctly forecast the British housing slump, almost to the month, and continues to chart its decline, which he now believes will lead to a 50-60% drop in British property prices, peak to trough.
I'm almost tempted to say: lighten up guys, it can't be as bad as all that. Warren Buffett, the "sage of Omaha" is said to be buying shares again. Employment is still high and retail sales actually jumped last month - to everyone's surprise. Maybe all this hysteria is a temporary blip. But I think the warnings should be listened to precisely because they are not coming from the usual suspects, but from people who know the financial system from the inside.
What has spooked them is a complex of factors, of which the doubling of the price of oil is only the most obvious. The oil spike is viewed as a consequence of low interest rates and the decline of the dollar, which has ignited a speculative boom in commodity prices, similar to the dot.com bubble which burst in 2000 and the real estate bubble which has been imploding since 2006. This is a highly unstable situation. It has arisen just as inflation has returned with a vengeance to Asian countries such as China and India, the countries which manufacture most of what we buy. Inflation in Vietnam is 25%.
This inflation is feeding back into the West through import prices just at the moment when central banks are trying to head off recession by lowering interest rates. The fall in the value of the dollar and sterling (down 14% this year) has turbocharged imported inflation in the two most indebted countries in the developed world: Britain and America. Cash-strapped British consumers are sitting in houses which are dropping in value just as they are coming under pressure from the banks to repay some of their £1.4trillion debts.
As the British property market follows America into default and repossession, there is expected to be a collapse of consumer spending. The next wave of bank losses is expected to be credit cards, car loans and student loans, which are already defaulting in America, and corporate bonds which are looking highly vulnerable. This has caused further shockwaves through the derivatives market - the collateralised debt obligations and such like - which are being marked down once again.
Despite hundreds of billions of dollars worth of "liquidity" being pumped into the system by central banks, the credit crisis is actually getting worse. The mortgage market has flatlined. Hedge funds are collapsing as their leveraged bets go sour. Libor - the rate at which banks lend to each other - is almost back to levels it reached last summer. Everyone is looking for the next big bank failure and wondering how long central banks can continue to bail out these failing institutions.
Meanwhile, the world's stock markets are falling: 50% in China, 30% here if you strip out unstable oil, mining and commodities. The commodities boom is due for a sharp correction and many banks are in deep trouble. Which is why analysts are warning of further stock market and credit shocks this autumn. They believe we haven't begun to recognise the scale and ramifications of this crisis. Until that happens we, and the politicians, will remain passive victims, unable to recognise the need for concerted global action.
Goldman Cuts Financials, Admits Goofed on Upgrade
Goldman Sachs & Co strategists urged stock investors on Monday to "underweight" U.S. financial and consumer shares, admitting it was wrong when it upgraded both sectors just seven weeks ago. The downgrades sparked selling in the two sectors as investors feared that weakening consumer demand and deterioration in the credit markets will weigh on profitability.
"We boosted our consumer discretionary and financials weights in May on the belief the sectors would benefit from bank recapitalizations and fiscal stimulus," Goldman strategists led by David Kostin wrote. "Our thesis was clearly wrong in hindsight." Goldman had previously urged investors to overweight consumer stocks and maintain a neutral weight in financials.
In afternoon trading, the Standard & Poor's Financials Index was down 1.8 percent while the S&P Consumer Discretionary Index was down 1.1 percent. The S&P 500, in contrast, was up 0.2 percent. Among the decliners was Merrill Lynch & Co, whose shares were down 3.4 percent after a Banc of America Securities analyst projected a wider loss for the securities firm.
Others that fell included Citigroup Inc, down 2.6 percent, Home Depot Inc., down 4 percent, and General Motors Corp, down 4.9 percent. "Banks are what's weighing on the market," said Steve Goldman, a market strategist at Weeden & Co, citing the Goldman Sachs report.
Financial stocks had fallen 18 percent since the May 5 upgrade, compared with a 5 percent drop in the S&P 500, Goldman said, as investors grew increasingly worried that more lenders would cut their dividends and conduct dilutive capital-raisings as losses mounted from mortgages and other debt.
Consumer discretionary stocks, which include such industries as cars, clothing and leisure, fell 7 percent in the same period, the Goldman strategists said. Many analysts have been concerned that the tax rebates the government began handing out earlier this year might not provide much stimulus for the U.S. economy as debt-burdened consumers use them to pay bills or buy increasingly expensive necessities such as food and gasoline.
Besides, the strategists asked, "What sustains consumer spending after the tax rebate checks have been spent?"
Goldman urged clients to allocate 13 percent of their holdings in S&P 500 stocks to financials and 7 percent to consumer discretionary stocks, compared with respective index weightings of 15.1 percent and 8.3 percent.
"The credit situation facing the consumer is still deteriorating, house prices are falling sharply, and unemployment is rising," Goldman said. The strategists urged investors to overweight the energy, materials and information technology sectors, saying they will likely outperform in an environment of rising inflation and weakening consumer demand. It rates those sectors "overweight."
Ilargi: Some extended attention for the monoline downgrades, in order to be better prepared for the fall-out, which could be hurtful. If and when institutional investors start the massive forced sales their internal regulations require for downgraded bonds, it’s hard to say how deep down all this will lead.
Bond Downgrades May Soar After MBIA, Ambac Are Cut
Downgrades on securities guaranteed by MBIA Inc. and Ambac Financial Corp. may only "scratch the surface" of rating cuts after the bond insurers lost their top grades, CreditSights analysts said.
As much as $1.28 trillion of debt is covered by the so- called monolines, CreditSights said, citing data compiled by International Swaps and Derivatives Association.
Standard & Poor's cut the ratings of 0.42 percent of securities included in Merrill Lynch & Co. indexes of asset-backed debt, the analysts said. "The downgrades that we have seen so far, numerous though they have been, have yet to scratch the surface of the potential downgrades that will ultimately be required," New York-based analysts Brian Yelvington and Rob Haines wrote in a report today.
"Downgrades of the monolines themselves result in ipso facto downgrades for the paper they have insured." MBIA and Ambac were stripped of their top grades by Moody's Investors Service last week, following downgrades by Fitch Ratings and S&P. Armonk, New York-based MBIA said it will probably be required to make $7.4 billion of payments and collateral postings after being downgraded five levels.
Investors should brace for a "roller-coaster ride" caused by an "avalanche" of rating cuts that may force some investors to sell holdings, according to analysts at Merrill Lynch. "While we believe that many investors have been preparing for such events, we still fear that there are some investors who need to take action," Altynay Davletova, an analyst at Merrill Lynch in London, wrote in a report today.
The downgrades are likely to put "further stress" on the structured credit market, Lehman Brothers Holdings Inc. analysts led by Ashish Shah in New York said in a report today. Many of the world's largest banks may be forced to write down the value of their positions following the downgrades, the report said.
Banks may also have to bring some municipal securities on to their books because some of the money market funds that buy them aren't able to hold lower-rated notes, Bank of America Corp. analysts said in a report. "This form of systemic risk from monoline downgrades represents another negative development for credit markets," the analysts wrote.
It's the Models, Stupid
To get an update on the situation facing the monolines and the ratings agencies, we spoke to Josh Rosner, principal of Graham-Fisher in New York.[..]
The IRA: Josh, have you been watching the latest fun and games in Washington with the scandal concerning Senate Banking Committee Chairman Chris Dodd and the "Friends of Angelo," a reference to members of Congress favored by Countrywide Financial CEO Angelo Mozillo? It seems that the former Democratic presidential candidate has stepped on his appendage yet again.
Rosner: There have long been rumors in DC that Fannie Mae had a program where they gave special mortgage loan rates to members of the Hispanic and Black Caucus members on Capitol Hill.
The IRA: Yes, it's called legalized bribery.
Rosner: Why is Dodd's situation any different than what FNM and Freddie Mac have been doing for years? I think it is a bit unfair to try and single out Dodd for what seems to be business as usual in Washington.
The IRA: It's not. Dodd's situation is just another example of the corruption that is SOP for Washington. Until we reform campaign finance laws so that politicians won't have to sell their votes to the highest bidder, we'll continue to see examples like the "Friends of Angelo."
Rosner: Right, but isn't it funny that nobody in the big media talks about the influence peddling by accounting scandal ridden GSEs? Remember, FNM went so far as to have a Senator demand an investigation of its regulator in an attempt to influence its regulation.
The IRA: Instead of the "Keating Five" we now have the "Fannie and Freddie 535." The "Friends of Angelo" is obviously a subsidiary of this group. CFC was simply imitating the way that FNM and FRE incentivize members of the Congress. Yesterday the New York Sun asked us about the two fund managers from Bear, Stearns who were being prosecuted. Our response was that we'd feel better about the prosecution if former Fed Chairman Alan Greenspan and members of Congress were also being held accountable for their role in creating the subprime mess.
Rosner: Ha! Look, the only difference between Ralph Cioffi and the rest of the folks at Bear, and any other investment bank, is that the government stepped in to prevent the other ibanks' businesses from failing. Other than the fact that their funds went into forced liquidation, in terms of what they did, how they overstated, how they mis-marked, they do not seem to have done anything particularly different from nearly anyone else on Wall Street.
The IRA: That's right. It's sad that the Bear and its employees are still being picked on and made the fall guys while the other Sell Side houses get a free pass. We wonder if that won't be an issue in the prosecution. If you applied the standard described in the indictment of Cioffi to the rest of Wall Street, most of the industry would collapse.
Rosner: I said that on Bloomberg last week. If I were Bear's lawyer I would point out in my defense in the Bear prosecution "look what almost everyone else did with their disclosures and marks. Are your prosecuting them?"
The IRA: Let's change topics now to the monoline insurers and ratings agency reform. Tomorrow, June 24th, you and our colleague Sylvain Raines are going to be participating in a session on the ratings agencies organized by Alex Pollock at American Enterprise Institute. We notice that MCO finally moved on downgrading MBI and ABK. And once again, MCO and Standard & Poors, seem to be acting as lagging indicators for changes in default probability, changes that other ratings agencies have recognized for months. Wilbur Ross told Bloomberg on Friday that he thinks the downgrade will help municipal issuers, but we don't see it. Do you differ?
Rosner: The thing which troubles me is that the NY State Insurance Commissioner is clearly picking winners by favoring municipal issuers over other entities covered by MBI and ABK insurance. Frankly, in my conversations with Eric Dinalo's office, they have said that they would rip up the credit default swap contracts before they allowed them to affect the ability to pay on municipal bond insurance.
The IRA: So the article in the New York Times last week suggesting that there is a dilemma facing Dinalo in terms of a trade-off between the muni issuers and the holders of CDS contracts is, in fact, not an issue. BTW, did you see the comment by FDIC Chairman Sheila Bair last week? She reminded banks that they need have all of their CDS documentation in good order because the under the statute the FDIC only has 24 hours to decide whether or not to reject a contract after a bank closure. We feature an excerpt from her speech at the top of this issue of The Institutional Risk Analyst. People in the CDS market need to read that speech.
Rosner: Well, precisely. That is the very same issue raised by Dinalo, who is statutory receiver for a failed monoline insurer domiciled in New York. Thus the question: what event or series of events is going to take down the monoline at this point? There is a broad misunderstanding that because the CDS contracts issued by the monolines can be accelerated they will be accelerated in the event a monoline becomes insolvent. I doubt the investment banks and commercial banks who are CDS counterparties with MBI and ABK have any interest in accelerating these claims. It's not that they won't have a basis for acceleration under NY's insurance laws, but rather it would force them to take mark-to-market losses on their own books, losses that the banks don't want to take.
The IRA: Correct. It's sad to say, but the pain from fair value accounting in terms of mark-to-market is not yet over. One of our readers chided us last week for not offering positive solutions to this mess, but we're still trying to find the bottom of the proverbial pond.
Rosner: This raises another issue, namely the prospect for further problems for the bank CDS counterparties down the road. If, in fact, the banks do not pursue claims against the monolines when they could, the shareholders of the banks may have a basis for claims against bank managers and the auditors for mis-marking their books and therefore not recouping shareholder assets. The banks may be leaving money on the table.
The IRA: Absent that issue of mark-to-market, do you think that the banks should be pursuing acceleration now? Is the statutory accounting for MBI or ABK as dire as the GAAP accounting suggests? MCO and S&P certainly seem to think so.
Rosner: Those are two separate questions. To me, in economic terms, given the current mark on these contracts, the banks naturally should be pushing for acceleration. They would likely get paid out a lot more today than at maturity. New York insurance law suggests two triggers for insolvency, one being claims paying ability and the other being the ability to reinsure. There seems to be claims paying ability at the present time for MBI, but at this point the company does not seem to have the ability to reinsure its entire book. So in terms of economic interest, if the banks were being cutthroat and aggressive, they probably could and should push for acceleration. That is why I believe the NY Insurance Commissioner needs to require that the $900mm held by MBI be pushed down to the insurance company. Sure it is only incremental capital, but it would probably stabilize the rating and, if the parent company ends up in dire straits, they wouldn't then be able to move the capital.
The IRA: But given that the ibanks and the monolines are essentially in the same boat when it comes to valuation, there is not likely to be acceleration. So what happens to the monolines? Do you expect further downgrades?
Rosner: Unless they can figure out a clever way to write new business and use that incremental revenue to reinsure their existing book, I think there is a good chance that both MBI and ABK will be downgraded further. They are in a different situation than CIFG or FGIC, to some degree, but remember that those companies hit almost every single ratings notch on their way down to junk. Once you fall below AA or AAA, every notch below becomes a lot harder to hold onto.
More downgrades seen after bond insurers lose AAA
Downgrades of securities insured by MBIA Inc. and Ambac Financial Group are expected to soar after Moody's Investors Service cut the bond guarantors' top ratings last week, according to a report by CreditSights analyst Robert Haines.
And banks that bought protection from bond insurers with credit default swaps might not get paid and could face additional write-offs if weaker guarantors are seized by regulators, Haines said in a separate report.
Many securities had high ratings because they were insured. Now that all but two guarantors have lost all of their top "AAA" ratings, the securities they insured could also be cut. "Downgrades that we have seen so far, numerous though they have been, have yet to scratch the surface of the potential downgrades that will ultimately be required," Haines said. "With ratings-constrained investors facing downgrades, the market is sure to see forced selling," he added.
There are up to $1.28 trillion in insured derivatives and wrapped deliverables, Haines said, citing the International Swaps and Derivatives Association. An aggregate of 7,417 structured-finance tranches have been downgraded since the beginning of the credit crunch. This figure does not yet account for the "sure-to-be-sizeable" impact of Moody's downgrade of Ambac last week, Haines said.
Moody's cut Ambac Assurance three notches to "Aa3," the fourth highest investment grade, and it downgraded MBIA Insurance five notches to "A2," the sixth highest investment grade. Standard & Poor's stripped both insurance arms of their top ratings on June 5 and said it may cut them again. Smaller rating company Fitch Ratings cut them this year.
Further downgrades of Financial Guaranty Insurance Co., Security Capital Assurance's XL Capital Assurance, and CIFG Guaranty could also impact insured complex securities. Haines estimated that about $1 billion of outstanding asset-backed and mortgage-backed bonds are guaranteed and insured securities comprise close to 15 percent of the Merrill Lynch Global Broad Market Collateralized Index.
Based on S&P data, so far only 0.42 percent of the index deals have been downgraded due to the current financial crisis, and the ultimate par value would be a multiple higher than that, Haines said. U.S. money market funds may no longer be able to hold variable-rate municipal bonds guaranteed by MBIA because the insurer was cut below the "AA" level required by Securities and Exchange Commission rules.
This could trigger another wave of selling by investors and weigh on dealer balance sheets. Heavy selling would push yields higher, raising interest costs for U.S. states, cities and counties. Another concern for the market is how bond insurer claims-paying resources will be divided between various policy holders if any bond insurer breaches the $65 million minimum capital requirement and is taken over by the regulators.
While a takeover by regulators would trigger payouts on billions of dollars of credit default swap contracts, regulators also have the power to stop insurers from making these payments to protect municipal bond holders, Haines said. "We see no scenario in which the regulators would willingly give structured policy holders the first bite at whatever residual capital could be available for municipal policy holders," Haines said in the report.
This could mean additional write-downs for brokers and banks that have already written off more than $400 billion in assets as a result of the global credit crisis. Bond insurer downgrades may also crimp liquidity in the markets because they reduce the amount of collateral that financial institutions can use to borrow from the central bank through repo operations, Haines said.
New Crisis Threatens Healthy Banks
Increasing struggles by consumers and businesses to make payments on a variety of loans, not just mortgages, are setting off a new wave of trouble in the financial sector that is battering even institutions that had steered clear of the subprime-home-loan debacle. Late payments on home-equity loans are at a record high, according to fresh data from the Federal Deposit Insurance Corp.
The delinquency rates on loans for cars, small businesses and construction are spiking to levels not seen in a decade or more. Unlike last year, when soaring mortgage defaults sparked a crisis of confidence in the financial system, the root of these problems is the downturn in the broader economy. Simply put, consumers and businesses are strapped for cash with job losses growing and retail sales falling, economists said.
The institutions most at risk in this new phase of the credit crisis are regional and local banks, many of which stayed away from subprime mortgages. These firms are key drivers of economic activity in communities across the country. Without them, consumers would lose a source of personal loans. Small businesses would struggle to stay afloat. Construction companies often can't finance local projects without these banks.
Because they have fewer options than big Wall Street firms for raising emergency funds, these regional and local banks tend to be more vulnerable in a crisis. In the Washington area, the stock prices of several local banks have already plummeted, with shares of Virginia Commerce Bank falling nearly 50 percent and Alliance Bank dropping about 45 percent since the beginning of the year.
Others swung to a loss in the first quarter after remaining profitable through last year's financial turmoil. The market values of some of these banks have fallen below their book value, or what accountants say the firms' assets are worth minus their debts.
This is a sign that investors expect more losses this year. The market value of Virginia Commerce is about $142 million, below its book value of about $175 million, while Alliance's market value has dwindled to $18.4 million, compared with its book value of $44 million. The situation is worse in the Southwest and Midwest, where several community banks are teetering and a few have already collapsed.
For lenders, there is little recourse when a home-equity loan defaults or a homeowner declares bankruptcy. They can seize the collateral for the loan, in this case the house, only after the primary mortgage is paid off. From October to March, $6.7 billion in home-equity loans became delinquent, increasing the total by 45 percent, according to SNL Financial. The delinquency rate is now 2.24 percent, according to the FDIC, which began tracking the data in 1991.
Losses at banks are going up as a result. J.P. Morgan Chase absorbed $450 million of home-equity-loan losses in the first quarter, up from $248 million in the previous quarter. It said its total home-equity losses could double by the end of the year. Smaller banks have even more exposure to such loans. Overwhelmingly, the institutions that hold the most home-equity loans are regional banks, such as SunTrust Banks and National City, according to Fitch Ratings.
Late payments and defaults in every other major category of consumer debt also rose in the first quarter, the American Bankers Association reported. Auto loans issued through car dealers have a delinquency rate of 3.13 percent, the highest since at least 1990, according the ABA. "The rise in consumer credit delinquencies is consistent with a rapidly slowing economy," said James Chessen, the ABA's chief economist. "Stress in the housing market still dominates the story, but it's a broader tale of an overall weak economy."
Hedge funds reveal large "short bets" on UK bank stocks
Some of the world’s biggest hedge funds were revealed to have taken big positions betting on declines in a number of the most sensitive stocks in the UK market. The disclosures are the first to be made as a result of a ground-breaking move by the UK’s Financial Services Authority to force short-sellers to reveal size-able net short positions in companies undergoing rights issues, in a bid to stamp out suspected market abuse.
The unusual move has been closely watched by regulators and investors around the world, many of whom are also facing contentious short-selling issues. The UK watchdog imposed the rules this month following suspicions that short-sellers – which aim to profit from falling share prices – were targeting particular stocks in rights issues with the aim of forcing the price below the rights issue level in order to trigger further waves of selling. This would be market abuse but hard to prove.
It was revealed that Harbinger, the US fund best known for shorting subprime mortgage debt well before the credit crunch hit, had a net short position worth 3.29 per cent of the outstanding stock in HBOS, Britain’s biggest mortgage lender. Shares in HBOS dipped below its rights issue price of 275p for a third time yesterday.
Others shorting the lender, which is looking to raise £4bn, included Lansdowne Partners, one of the UK’s biggest funds, which notably held a short position in Northern Rock for years before the lender collapsed last year. Short positions in Bradford & Bingley, the British buy-to-let specialist, were shown to amount to about 10 per cent of the outstanding stock.
Those shorting the stock included Tiger Global Management, a New York-based fund run by a protegee of hedge fund manager, Julian Robertson, and GLG Partners, London’s second-biggest hedge fund, which revealed shorts worth 4.14 per cent of outstanding B&B stock.
Crispin Odey, founder of Odey Asset Management, which yesterday revealed a 0.28 per cent short in B&B, said: “We’re not exactly favourable towards the financial sector. It is very difficult for the banks because we are very early in this downturn and they could need a lot more capital than they are raising now.”
The first official day for disclosures was yesterday. Short-sellers only have to make one disclosure regardless of changes in the size of their position, although the regulator has warned it could change this if it thought the rules were being abused. More disclosures are expected if further short positions are created or if investors are still scrambling to follow the new rules.
“Overseas managers are less up to speed because they are not actually regulated by the FSA, they didn’t all realise they were captured,” said Andrew Shrimpton, of Kinetic Partners, the advisory group. Hedge funds, known for their secrecy, have criticised the regulator for introducing the rule.
Odey Hedge Fund Discloses Short Position in Bradford & Bingley
Odey Asset Management LLP, the $5.1 billion fund manager set up by Crispin Odey, holds a short position in U.K. mortgage lender Bradford & Bingley Plc, according to one of the first filings under new U.K. rules.
London-based Odey said it held a short position of 0.28 percent in the Bingley, England-based company whose shares have tumbled 75 percent this year, according to a filing today with the U.K.'s Financial Service Authority. In a short position, an investor borrows stock in a bet that the price will fall.
The FSA imposed new rules June 20 that require disclosure of short positions of more than 0.25 percent of stock for companies that are selling new shares in rights offerings. "This is the first time we've had to do it, and we've done it," said David Stewart, chief executive officer of Odey, in an interview today. "We've made history."
The FSA cited short bets earlier this month for "severe volatility in the shares of companies conducting rights issues." That followed a slump in shares of Royal Bank of Scotland Group Plc, Britain's second-biggest bank, and HBOS Plc, the country's largest mortgage lender, as they tried to raise a combined 16 billion pounds ($31 billion) of capital by selling new shares.
The Alternative Investment Management Association, the $1.9 trillion hedge fund industry's largest trade group, tried to delay the new regulations, which were made without consulting market participants, it said.
"We seem to be missing the justification for this," Andrew Baker, deputy chief executive of AIMA, said in a June 13 interview. "This could be using a hammer to crack a nut."
Stewart said Odey's position was a tiny percentage of Odey's funds under management and has been in place "for months." The FSA disclosure requirement doesn't change Odey's view on the company or Odey's investment strategy, Stewart said.
Bradford & Bingley Spurns Cowdery's $785 Million Bid
Bradford & Bingley Plc rejected an offer that would give British financier Clive Cowdery's Resolution Ltd. control over the mortgage lender in return for 400 million pounds ($785 million). Resolution sought to abort private equity firm TPG Inc.'s agreement to buy a 23 percent stake in Bradford & Bingley, as well as the bank's plan to raise 258 million pounds in a rights offering, the London-based company said today in a statement.
Bradford & Bingley said later in a separate statement it "could not recommend the current form of the proposal," which would have given Resolution "effective control." TPG in its own statement said it remains "fully committed" to its planned investment. Cowdery, who has a personal fortune of at least 130 million pounds after selling his insurance company this year, is targeting Bradford & Bingley after its shares fell 75 percent this year.
The bank, the U.K.'s largest lender to landlords, has been seeking cash after late mortgage payments climbed amid the country's worst housing market since the early 1990s. "Cowdery will get the backing of investors who weren't comfortable with the TPG deal," said Guy de Blonay, who helps manage about $41 billion at New Star Asset Management Group Ltd. in London.
"It will enable him to take a shot at other distressed situations as they emerge over the next couple of years." The bank declined 3.7 percent to 66 pence in London today, valuing Bradford & Bingley at 407.7 million pounds. Its fall this year is almost triple the 27 percent drop for the eight-member FTSE All-Share Banks Index."
GM Cuts Truck Production Even More, Adds No-Interest Financing
General Motors Corp. reduced its North American truck production plan and added no-interest loans on many 2008 models after a consumer shift to cars contributed to a 16 percent drop in its U.S. sales through May. GM this year will trim output of pickups, sport-utility vehicles and vans by an additional 170,000 this year, spokesman Tony Sapienza said today.
The Detroit-based automaker also said that for the rest of this month it will offer the interest-free financing on loans of as long as six years. The largest U.S. automaker's sales in its home market fell almost twice as much as the industry's 8.4 percent drop through last month, as GM's light-truck total slid 22 percent. Gasoline prices hovering around $4 a gallon in the U.S. have driven down GM's sales of large pickups and SUVs. Its plan to further cut output follows a similar announcement June 20 by Ford Motor Co.
"No one knows where the bottom is in this sales environment," David Healy, an analyst at Burnham Securities Inc. in Sierra Vista, Arizona, said in an interview. "GM has plenty to be worried about since they derive so much of their sales from these large trucks." GM fell 88 cents, or 6.4 percent, to $12.91 at 4:15 p.m. in New York Stock Exchange composite trading, for its lowest close since February 1982.
The shares have slid 48 percent this year. The company will idle 7 pickup and sport-utility vehicle plants in the U.S., Mexico and Canada for as long as 12 weeks this year under its latest production cut, Sapienza said. The reduction is in addition to a plan to close four North American factories and trim output by 500,000 units by 2010.
GM today also said it plans to boost output of cars and smaller, more fuel-efficient SUVs by 47,000 units at North American plants this year, through overtime and Saturday shifts. The increase is aimed at models that are gaining sales, such as the Chevrolet Malibu sedan and GMC Acadia SUV, a so-called crossover that combines car and light-truck features.
The automaker relies on sales of light trucks such as the Chevrolet Silverado large pickup and Cadillac Escalade big SUV for more than 60 percent of its annual U.S. sales. GM may get four times the profit on the sale of an SUV than a small car, according to Citigroup analyst Itay Michaeli.
The company's revenue "is certainly under pressure with the falloff in trucks," GM sales chief Mark LaNeve told reporters on a conference call. "We've got to sell a lot more cars and crossovers" to make up for the drop in revenue from large trucks, LaNeve said. GM is headed toward its ninth straight annual U.S. sales decline and has had three consecutive yearly losses.
Eurozone waits in dread for the ECB's next move
Business confidence has fallen to recession levels in Europe and Japan as the US slump spreads across the world and high oil prices eat into profit margins. The eurozone's PMI index of purchasing managers fell below 50 in May for the first time since the dotcom bust, signalling an outright fall in production.
Meanwhile, Tokyo's BSI index of confidence among large Japanese firms has hit an all-time low. "The Japanese economy is being tossed around by rough waves coming from overseas," said premier Yasuo Fukuda. Even Germany is starting to falter, despite booming exports to Russia and Middle East oil states. German order books have fallen five months in a row as the strong euro takes its toll, the worst performance since 1992.
The IFO Institute's survey of confidence also tumbled in June. "The manufacturing climate has worsened significantly," said Hans-Werner Sinn, the IFO's president. The gloomy picture is unlikely to deter the ECB from raising interest rates a quarter point to 4.25pc in July, although key governors have been at pains to talk down market expectations of a string of rises. Inflation has reached a record 3.7pc.
Albert Edwards, chief strategist at Société Générale, said the ECB risked making a grave policy error by tightening monetary policy just as the economy tips into a downturn. The eurozone's M1 money supply has actually fallen since January.
"As global recession beckons, the ECB clearly doesn't want to be left out. One wonders whether the bank will really carry through their threat to raise rates. If they do, they seek to halt rising inflation expectations by crushing the economy. Whereas many now see a real threat of a wage price spiral, we see nothing of the sort. The main threat over the next 12 months is deflation, which will be revealed when the current liquidity driven commodity bubble bursts," he said.
Sergio Marchionne, Fiat's chief executive, said the outlook in Italy's car market was now "disastrous". Registrations plummeted 18pc in May. He said early sales figures suggest that June is likely to be just as bad.
The picture in Spain has deteriorated dramatically since the start of the year. Premier Jose Luis Zapatero - who recently rebuked the ECB for failing to act "responsibly" - said yesterday that he was taking a pay freeze as he introduced a spending blitz to cushion the hard landing. He insisted that the stimulus measures were within EU rules. "We won't do anything that endangers the solvency of Spain," he said.
The Spanish Confederation of Commerce (CEC) said textile companies were having to slash prices by 30pc to 40pc to cut excess stock. "I can never remember such an alarming situation for the textile sector," said the group's chief, Miguel Angel Fraile. Although Spanish banks steered clear of the US sub-prime debacle, they face a major headache at home as the housing boom deflates.
Property prices have fallen 7.7pc over the past year according to government data. Prices are down 21pc in Rioja, 14pc in Valencia and 10pc in Catalunia. Deutsche Bank expects house prices to fall up to 35pc in real terms, with the purge lasting until 2011 before the massive overhang of unsold properties is cleared. "Spain is facing one of the most difficult periods in recent history. House prices are even more overvalued than in the late Eighties. The adjustment process is likely to take longer than in previous cycles," said the bank.
Rising defaults are already starting to cause problems for the lenders. Jose Luis Olivas, president of Bancaja, says banks will need to roll over €175bn (£138bn) over coming months. They can raise money at the European Central Bank, but this practice is causing increasing concern in Frankfurt. ECB officials are probing whether lenders have issued low-grade collateral to use at the window.
Economists are split over the ECB's hard-line stance against inflation. Frankfurt's hawks are determined to show that the ECB is a worthy successor to the Bundesbank, especially at a time when ordinary Germans have begun to question whether the euro is as hard as the old D-Mark. Hans Redeker, currency chief at BNP Paribas, said the ECB is sticking too rigidly to its rule book.
"Their own research shows that the credit crunch is just as a bad in Europe as it is in America. Bank profits are collapsing and they will have to curtail their lending," he said. Mr Redeker said the ECB had so far failed to adapt to its new role in charge of a world reserve currency. "The ECB is acting mechanically, targeting inflation.
They are behaving as if they were the Swedish Riksbank setting rates for a small economy rather than thinking through the global impact of their actions. If they push up the euro by raising rates, all they do is weaken the dollar and the 45 currencies around the world that are linked to the dollar. They are making the inflation problem worse," he said.
A History of Wall Street Layoffs
Wall Street has seen its fair share of bloodletting over the years, but this latest round brought about by the credit crunch is shaping up to be one of the worst in recent memory. So far, banks and brokerages have announced the dismissals of more than 83,000 employees worldwide – with a large chunk coming from firms based in the New York area. And more layoffs are expected to come in the next few months.
The culling of the ranks is to be expected in an economic downturn, and the industry has seen its fair share of lay offs over the years. One of the most devastating occurred in 1973, when Wall Street let 15 percent of its staff go amid a severe economic downturn. The bloodletting continued into the next year when 12 percent of the workforce was booted out the door.
That pinstriped massacre was caused by a stalling economy, amid skyrocketing oil prices, rising inflation and a faltering bond market — very similar to the problems that the economy is facing today. But the industry recovered and weathered the next recession in the late 1970s and early 1980s well.
But the crash of 1987 and the recession of the early 1990s delivered a one-two punch to Wall Street’s stomach after several years of double-digit employment growth. The Street’s ranks, which had ballooned to 163,000 by 1987, fell to as low as 130,000 in 1991. It would take seven years for Wall Street to recover from that round of pink-slip mania.
From 1995 onward, Wall Street began growing profusely. That coincided with the easy money policies of the Federal Reserve, which caused the money supply to grow twice as fast as the gross domestic product. All that extra money sloshing about brought more opportunities in the industry. By 2000, the economic boom of the late 1990s had pushed the number of Wall Street professionals up to 200,000.
But the bursting of the tech bubble and the events of September 11th led to a massive cut in personnel not seen since the early 1970s. In 2001, 16.4 percent of Wall Street lost their jobs. For example, Merrill Lynch alone slashed 20,000 workers. In 2002 and 2003, investment banks’ workforce contracted by another 1.1 and 1.6 percent, respectively. But the economy recovered and The Street began growing again.
By August 2007, it was near its 2000 peak with 192,000 workers, but then the credit crunch hit, causing a new round of slashing. It is unclear where the bottom of this market will be. But with Goldman Sachs reportedly slashing 10 percent of its M&A team and Citigroup reportedly cutting 10 percent of its workforce, it seems to be getting worse with each passing day.
Ilargi: This is hilarious, a new law that states: Realtors will be required to ask for the name, address, date of birth and occupation of property buyers and sellers, plus ID such as a driver's licence or passport.
Excuse me, but what did they ask for before? A pulse?
Canadian realtors brace for backlash
Canadian realtors are bracing for a customer backlash starting today, as they become new foot soldiers in the battle against money-laundering. Federal regulations that kick in today will force realtors to start asking property sellers and buyers personal information never before required. In Ontario alone, 47,000 realtors will be expected to fall in line or face stiff penalties.
"We know there is going to be consumer rejection on this and we are just following the law," said Gerry Weir, a London realtor and president of the Ontario Real Estate Association (OREA). Realtors will be required to ask for the name, address, date of birth and occupation of property buyers and sellers, plus ID such as a driver's licence or passport.
Weir said Ottawa has made little effort to educate people about the changes, and realtors feel they're being forced into an uncomfortable enforcement role. He said realtors will have to keep the information for seven years and submit it on request to the Financial Transaction and Reports Analysis Centre of Canada (FINTRAC), a federal agency set up to track suspicious transactions that could be related to money- laundering or terrorism.
If the buyer is foreign or from another part of Canada, the real estate broker will be required to hire an agent in the buyer's community who can confirm the buyer's ID. If a client refuses to disclose the information, Weir said, a realtor would have to walk away from the deal or report the person to FINTRAC. "Even if I have known you for 30 years, I still have to ask for that information," he said. Weir said it could get even worse.
He said Ottawa also wanted to require a receipt-of-funds record, with information on anyone who actually supplied money for sales, including relatives or friends. Weir said the government backed down on that, but he expects it will only be temporary. "That is the next step; that will happen," he said.
FINTRAC officials appear confused about the new rules. Spokesperson Peter Lamey at first said one piece of ID was needed from buyers and sellers, and information such as date of birth and occupation wouldn't be required. He later said the information wouldn't only be required from buyers and sellers, but also from anyone who contributed money to a deal as part of the receipt of funds record, contradicting Weir's belief that Ottawa had backed down on that provision.
Negotiations on the rules were handled by the federal Finance Department and not FINTRAC, Lamey said.
Weir said he understands the need to deal with the problem of money laundering. For years, realtors have been required to report any suspicious financial transactions to FINTRAC, especially those involving cash payments of more than $10,000.
Weir said he's reported three transactions in recent years, and two involved someone trying to buying a house to set up a marijuana growing operation. Still, he said only a very small number of real estate transaction are suspicious.
Weir said the government will only do spot inspections during the next six months to ensure realtors and brokers are meeting the requirements.
After that, any realtor or broker who doesn't meet the requirements could face hefty fines or jail time.
Weir said the OREA wants to educate people about the changes, but there've been long negotiations with the government and the rules weren't firmed up until last week. "We have 47,000 realtors in Ontario that we have to educate by (today)," he said.
CIBC may be forced to raise more capital
Canadian Imperial Bank of Commerce may be forced to raise more capital after another of the bank’s monoline counterparties ran deeper into trouble, said Blackmont Capital analyst Brad Smith.
CIBC has already taken $6.7-billion in writedowns on structured products linked to the U.S. subprime mortgage market. It will likely take another $1-billion hit in the third quarter of 2008 after XL Capital Assurance was downgraded by rating agency Moody’s, Mr. Smith said.
XLCA is a subsidiary of monoline SCA, with which CIBC has about $3.3-billion in exposure. In addition, the bank has about $25-billion in structured products that are not related to the subprime mortgage market.
Mr. Smith notes that the bank can withstand further losses on its remaining subprime exposure, and has a strong balance sheet after raising $2.9-billion in dilutive equity earlier this year. But additional losses in its $25-billion book of of non-subprime investments could push the bank to go back to the market for more capital, he said.
CIBC's writedown woes not over.
The fortunes of Canadian Imperial Bank of Commerce are still tethered to a tangle of massive charges on structured products, which may cost another billion dollars in the third quarter and could even force the bank back to the capital markets to ask for more equity, analysts say.
The latest concerns arise after another of the monoline counterparties to the bank's substantial book of investments in U.S. subprime and non-subprime investments ran deeper into trouble last week, said Blackmont Capital analyst Brad Smith.
CIBC , which has already taken $6.7-billion in writedowns on structured products since the credit crunch began, will likely take another $1-billion hit in the third quarter of 2007 after XL Capital Assurance was downgraded by rating agency Moody's, Mr. Smith said.
XLCA is a subsidiary of monoline SCA, with which CIBC has about $3.3-billion in at-risk exposure. The bank also has about $25-billion in non-subprime exposure backed by monolines. "While CIBC's 10.5% Tier 1 capital ratio can withstand further losses on its remaining $3-billion net notional subprime portfolio, any additional losses on its non-subprime portfolio may cause CIBC to return to the market for more capital," said Mr. Smith.
Tier 1 capital is the regulated amount of capital a bank must set aside to protect its balance sheet. After it raised $2.9-billion of new equity in January to ease the strain of earlier writedowns, CIBC has one of the strongest balance sheets of any bank in North America. However, it remains the only Canadian bank that has been forced to go the markets for new equity that dilutes the stake of existing investors.
Almost all of CIBC's Canadian rivals have taken a hit of some kind, but in total the charges recorded by the rest of the Canadian banking industry are a fraction of those incurred by CIBC, where the losses are as big as those of any bank in the world, once the size of the bank is factored in.
After the banking industry posted its second quarter numbers last month - overall CIBC recorded a loss of $1.1-billion mostly thanks to subprime writedowns of $2.5-billion - National Bank analyst Rob Sedran said core earnings power should now be the focus for industry-watchers. But, he added, the view that balance sheet woes are over "is perhaps most tenuous for [CIBC], given the huge notional exposure."
Meanwhile, Genuity Capital Markets analyst Mario Mendonca said the CIBC's writedowns could be more than $2-billion in the third quarter. However, there are perhaps more important concerns for the bank as it looks ahead to the post-writedown world, added Mr. Mendonca. The bank's second quarter results showed that it has higher funding costs than some of its rivals, and recent debt issues from CIBC suggest those higher costs are persisting.
While the bank's balance sheet is under pressure from further writedowns, there is "the potential that CIBC's margins and competitive position in domestic retail banking have continued to erode," said Mr. Mendonca.
Canaccord sees BCE deal closing at $42.75, UBS says chances are 30%
Despite a big lift on the back of the go-ahead from Canada’s top court, shares of BCE Inc. are still well off their $42.75 buyout price. Everybody seems to have an opinion about whether the deal will close as planned, or at all, and analysts are no exception.
David Lambert at Canaccord Adams thinks the chances of the BCE buyout being repriced are low. This is in part because the $42.75 per share offer was determined by auction. “It is our view that approval of the BCE plan of arrangement, which allows a private equity group to purchase BCE for $42.75, has changed the likelihood of the deal closing from negligible to very likely,” he told clients.
As a result, Mr. Lambert upgraded BCE shares to a “buy” and increased his price target to $42.75 from $28.75, which was based on the net asset value of the company’s business segments. The deal now has to be ironed out by the banks and financing partners. And despite the fact that the Clear Channel Communications Inc. deal demonstrated it is possible for the banks to reset the purchase price, Mr. Lambert said this is “not in the cards yet.”
UBS analyst Jeffrey Fan also upgraded his rating to a “buy” and raised his price target to $39 from $36. While the lenders have said they are working to close the deal in accordance with the definitive agreement between BCE and the equity sponsors, he noted that similar statements were made in the Clear Channel transaction.
“While the lenders do not expect the definitive agreement terms to change, there are still points in the financing documents to negotiate that could result in more favourable terms for the banks,” he told clients, adding that this may lead to an adjusted buyout price.
Mr. Fan’s new price target is based on a 30% chance the deal closes at $42.75, a 50% probability of $40, and a 20% chance the deal collapses. The latter would result in a fundamental price target of $31
Ilargi: If the deputy governor of the Bank of Canada says so, then it must be true... No matter that sales are down 31% in BC, and 15% in Toronto and......
No, that’s just a pause, a breather, and even "expected and welcome". One thing I know: delusions such as these, while they are to be expected, are not welcome. They are far too costly for that. Ms. Kennedy may well be as clueless as she sounds, but anyone who truly thinks that subprime mortgages are the core of the problems, has no place in a function such as hers. Canada doesn’t need any more pied pipers, it needs a reality check.
Soft landing seen for Canada's housing market
The real estate market appears poised for a soft landing rather than a crash, in a cooling trend the Bank of Canada says is both “expected and welcome.” Sheryl Kennedy, the central bank's deputy governor, said Canada's financial prudence has helped it sidestep the sharp home price declines being experienced in countries including the U.S., Britain and Spain.
“The Canadian housing market does not appear to be characterized by excess supply at this time,” she said in the text of a speech delivered yesterday in Banff, Alta. “The proportion of unoccupied, newly built dwellings in most cities remains below historical averages, suggesting that a major widespread reversal in house prices is unlikely in the near term.”
In the past decade, prices of existing homes in Canada have risen by about 55 per cent, while new-home prices have risen by about 27 per cent. As one of the country's largest housing booms loses steam, most economists are forecasting a small increase in prices this year that will keep pace with the central bank's 2-per-cent target for inflation.
It's a much different story in the U.S. market, where home prices dropped by 14.1 per cent year over year in the first quarter of 2008, according Standard & Poor's/Case Shiller national home price index. That record price decline occurred at a pace five times faster than that of the last U.S. housing recession, according to the index's quarterly report, released last month.
Much of Canada's housing boom was the result of supply catching up with pent-up demand that followed the downturn of the late 1980s and early 1990s, according to Ms. Kennedy. Canada's conservative mortgage culture has helped protect it from the excesses seen during the U.S. boom, which had a much larger amount of subprime mortgages, she added.
How Countrywide Leveraged Washington
Deregulation led to insufficient or non-existent oversight. Documents were altered, signatures were forged, credit ratings ignored – anything to get a subprime loan approved.
In his book, Confessions of a Subprime Lender, former mortgage banker Richard Bitner estimates that 70% of the subprime loans that came from his mortgage broker customers were “somehow fraudulent.” (On Thursday, the Associated Press reported that since March, in the first significant FBI crackdown, more than 400 “real estate industry players” have been indicted for mortgage fraud.)
Mortgage brokers failed to inform their customers of hidden costs, balloon payments or ways that they could finance their mortgages more cheaply. Until recently, the government looked the other way and now we have a mess that makes the S & L crisis of 20 years ago look like a tiptoe through the T-bills. Over the next five years, financial services giant Credit Suisse predicts an astronomical 6.5 million foreclosures. Already, the average rate is 65,000 a week.
In the face of such calamity, where was Congress? Counting its financial blessings. The mortgage perks handed out by loan shark Mozilo to his DC pals were a mere bagatelle, part of a much larger campaign of lobbying and political contributions. From 1990, Mozilo and his family donated $110,000 to federal candidates, including $1,000 to Senator Conrad in 1999.
According to the Center for Responsive Politics, Countrywide’s political action committee gave Conrad $6,000 in 2005 and 2006 and over the last decade has donated $21,000 to Senator Dodd. In turn, Countrywide’s handouts to pols were just part of a bigger DC jackpot.
As per Kathleen Day, “The financial services and real estate industries are far and away the largest federal campaign donors, giving more than $247 million in the 2007-08 cycle alone. Between 1999 and the end of 2006, the mortgage industry and its trade groups spent $187 million lobbying Congress, blocking efforts to ban abusive practices at the national level.”
No wonder so little has been done so far to help those whose savings have been lost. Campaign cash registers and the politicians who love them rule. Facing bankruptcy, Countrywide is being taken over by Bank of America for $4.1 billion, but a Federal judge has approved a shareholders lawsuit against the company and Justice Department and congressional investigations have begun. Cold comfort for those who once honestly thought they had a mortgage they could afford and a home to call their own.
The China Obsession
China bulls have had a rough six months. The Shanghai composite index closed yesterday at a 19-month low of 2,794. That's almost a 55% drop from its Oct. 16 peak of 6,124. And the pace of the relentless collapse seems to be accelerating. Shares in Shanghai fell nine days in a row during the past two weeks, losing 14.4% just last week and dropping 7.7% on a single day. For all of the bad news about the subprime woes and the housing bubble endured by U.S. investors, China's newbie investors have had it much worse. "The China Miracle" has now underperformed the U.S. S&P 500 by well over 10% during the past 12 months.
You can't say you weren't warned. Nevertheless, the remarkable endurance of the China obsession continues to astonish me. Last month, I sat on a panel on "global investments" at the Las Vegas Money Show. The panel consisted of four members, and three of them were either China newsletter writers or Chinese fund managers. It was as though China made up 75% of the world outside of the United States, and everything else was just a politically correct afterthought. After everyone had decided that yes, indeed, China was going to dominate the world, I pointed out that Brazil not only was a bigger stock market than China but it had outperformed China by well over 50% in the first five months of 2008. One China guru calmly retorted -- and with no hint of irony -- that Brazil was actually a "China story," as is, it turns out, Apple, Pizza Hut and Starbucks. To a man with a China hammer, everything is a nail.
I also pointed out that had our panel convened in 1908, we'd have been telling investors about the remarkable opportunities in Russian railroad bonds, the fast-growth economies of Austria-Hungary, the dynamism of Argentina, and the new behemoth of the global economy, the United States. And we all would have been remarkably wrong. Twenty years later, in 1928, Russia and Austria-Hungary had been wiped off the map; Argentina was an economic basket case, and even the United States -- the only long-term winner among the group -- was staring into the maws of the Great Depression from which it did not emerge until 1945.
Nor do you have to go back 100 years to find similar parallels. I recently picked up a book published in 1989 on the United States in the first decade of the 21st century. The words "China" and the "Internet" didn't even make it into the index. The World Bank's watershed book on "The Asian Miracle" published in 1993 does not even mention China, focusing instead on Japan and the "Asian Tigers" (remember them?). Fast forward to 2029 -- 20 years from now and the same distance in time that 1989 is to us today. Yet here was our panel of experts convinced of the watertight validity of their own predictions about China 30-40 years into the future.
The China Obsession: History Rhyming?
The most recent parallel for the rise of China is Japan. It is easy to forget how awesome it was in the late 1980s. In the 40 years after the end of World War II, Japan was Asia's fastest-growing economy, becoming the export champion of the world thanks to a combination of cheap labour, low interest rates and a weak currency. As with China today, this kept Japanese goods, priced in yen, cheap for consumers across the world. During the 1980s, the Nikkei 225 index quadrupled in just seven years, while land prices in the big cities tripled. The land under the Imperial Palace in Tokyo was valued more highly than all of Canada.
Entire U.S. industries crumbled under the weight of Japanese competition as workers in Detroit took to battering Japanese cars with sledgehammers. Japanese industrialists went on shopping sprees, collecting trophies of American industry and culture such as Hollywood studios and Rockefeller Center. An entire generation of MBA students studied Japanese so they could compete in Tokyo, the world's new financial center. At the end of 1989, just before the crash, the dollar value of the Japanese stock market was almost twice that of the United States. The Japanese were the new supermen. As Jack Welch, of General Electric put it: "They're relentless. Make them climb a mountain, and they'll look around for a bigger one."
Today, it's China that has taken on Japan's economic mantle of Asian economic giant. Chinese companies are snapping up anything from IBM's personal computer business (Lenovo) to chunks of Wall Street icons such as Morgan Stanley. China's industries may not yet be dominating the world, (Quick: name three Chinese brands... Gotcha!), but it's taken as gospel that they'll be moving from your local Wal-Mart to Silicon Valley very shortly. And as China bulls never tire of pointing out, the normal dynamics of markets don't apply to China. After all, Chinese savers get negative real returns on bank deposits; they have no alternative but to buy stocks.
Bookshelves that once groaned with titles on Japanese management techniques and evocative titles like "The Enigma of Japanese Power" now buckle the weight of this week's newly published tome of the "The China Miracle." That was before the Japanese property and share-price booms based on cheap credit, and Japan's banks (like the Chinese today, the biggest in the world at the time) turned out to be poorly managed and mired in corruption.
The China Obsession: The Future is Not What It Used To Be
And I can hear the protestations of "but China is different." I don't know how the Chinese economic story will unfold. But neither do any of China's new-fangled experts. The reality is that China's economic fate will unfold in ways completely different from the ways today's China experts believe. But with the human brain being what it is, they'll still find a way to convince themselves they were right all along. As unpredictable as China's economic and political future may be, only one thing is certain: as the collapse of the Shanghai market confirms, the iron laws of stock market psychology apply in China as much as they do anywhere else. And if you want to get a glimpse of the future, study the past. Read a good financial history like Edward Chancellor's "Devil Take Hindmost: A History of Financial Speculation." You'll learn that every investment generation needs its own version of "China." In the 1980s, it was Japan, and in the 1990s it was the Internet. And if it weren't China today, we'd have to invent something else to replace it. And as astonishing as the "China Miracle" appears today, it will be even more astonishing how distant it will appear in twenty years time.