Boys salvaging coal from the slag heaps at Nanty Glo. They get 10 cents for each hundred-pound sack
Ilargi: No, we are not surprised when people start to doubt what we say here, or even walk away, every time the Dow numbers move out of the reds for a day or two. If only because we are a species with a notoriously short attention span.
If the situation is as dire as The Automatic Earth has been claiming for a long time, then why is the Dow still above 10.000, let alone 12.000? Let me give you a very short explanation.
1/ There is still an enormous amount of capital floating around the world. You may choose to label it money, or credit, or virtual money, or anything you wish; what’s important is that it’s still accepted as a currency with which assets can be purchased. Much of this virtual capital is on the move these days: many assets that once were safe and reliable, no longer are. So the capital moves into, among other things, commodities: oil and food are the most obvious. People call the resulting price rises inflation, but that idea is as virtual as the capital behind it.
The reason I call it virtual is that much of it would "vanish" from one day to the next if a long overdue law or regulation would be implemented to require financial institutions to provide realistic assessments of what their assets are worth, instead of "values" based on computer models they themselves developed (and which therefore can take any shape they desire). I liken that to valuations as they would have been reported by Timothy Leary: great fun, but with a real risk of lasting damage.
2/ As a result of the lingering mark-to-model, instead of mark-to-daylight, numbers emanating from Wall Street, it’s easy for players like the Fed, Congress and the banks to keep on issuing reports and numbers and valuations that are as realistic, and have as much credibility, as the doctored computer models that the whole scheme is based on.
And since these players all have tons of personal reasons to keep it all going, and know that the media will report on their words much more than on any more critical voices, the treadmill keeps on churning away. What is the result of all these LSD-induced stage performances is that they get away with:
3/ Most of what keeps markets afloat until now is the fast growing transfer of losses to government books. All the buy-outs and stimulus packages and discount windows lead to one and same final destination: you and your ability to work and pay taxes over the fruits of your labor. As long as your government and their friends in the financial system feel they can get away with it, they will keep on transferring those losses to your accounts, and those of your children.
They will not stop themselves. Never. There are two parties who can stop them, and one of the two eventually will.
First, there are the foreign countries and central banks who buy bonds and other assets issued by the US, which by now have no other collateral than the labor of your children years from now in a highly uncertain future economy. That paper won’t be worth much, once these guys realize what the rate of discounting it truly is.
Second, there’s you.
PS: Someone said recently that if 2007 was the year of subprime, 2008 is the year of everything else.
Update 4.00 pm EDT Ilargi: Today's closing numbers for US financials. That red you see there means: bloodbath. The DOW was down "only" 2.08%.
A massive taxpayer bailout of the GSE's, banks and lenders is now upon us
The situation is dire. Remember that, as what happens next happens. The situation is dire.
Having the nations' housing 'wealth' destroyed is catastrophic, especially since we're a nation of spenders and not savers. And having home values plummet 20% to 50% or more is devastating. But having the banks fail, that's a whole different ballgame. Having Fannie and Freddie collapse, that's financial Armageddon.
So our leaders and our central bank, having gotten us into this mess, are going to do whatever they can to get us out of it. Which of course is not possible - since home prices have already collapsed, millions of homes sit empty or foreclosed, hundreds of thousands of REIC have lost their jobs, and the damage has been done.
But financial Armageddon can be avoided, moral-hazard-be-damned, if they can stop the banks and GSE's from failing. And they can. It's just gonna take billions and billions and billions and billions of taxpayer dollars to do it.
And that's where we are today. Countrywide is gone, and Angelo is retired and soon on his way to jail. Indymac is no longer a going concern, and is now essentially just closing up shop. Fannie and Freddie are also no longer going concerns, but we're just pretending they are because it makes us feel better.
And now, without massive, and I mean MASSIVE taxpayer intervention, this whole house of cards could come tumbling down even worse than people expect. So get the printing press going. The bailout is here. Resistance is futile.
But a bailout won't put a floor under house prices like some trolls here spout. It won't put food on the realtors' tables. It won't save the already-destroyed mortgage broker profession. And it won't allow the builders to start building (and hiring illegals) again.
A $8,000 tax credit for first-time buyers is nice, but good luck getting loans. Allowing BofA to sell off their crap Countrywide loans to the US government, that'll stop BofA from failing. And raising Fannie and Freddie's caps might stop some McMansions from going into foreclosure. But home prices will still come down to their natural level. Nothing can stop that now.
The bailout is here. We lost that battle. The situation is that dire. And your hard earned money sent to the government in the form of tax payments is going to be blown on a mess that should never happened. Throw the bums out. All of 'em.
In another whodathunk moment comes developments that Fannie Mae and Freddie Mac will need to raise $75 billion in new capital. I think the $75 billion would be simply a start to what the GSEs will need.
The irony of all this desperation phase (panic?) capital raising is that it now illustrates in spades the need to come clean and raise money early on. Instead many banks played the Aunt Millie card, downplaying the truth about their fictitious capital (FC) and hid problems in the Milky Way. Failing to conduct themselves in a forthright manner means we now have the serious crisis of confidence that I have been predicting for several years.
It has arrived with a vengeance. I just watched an illustrates in spades clip on Kudlow where one of my heroes Joe Battipaglia in classic fashion takes on those who are still apologists and front men for FC and smoke and mirrors. Those days are over, and or very soon will be. Desperation is here, and we could be close to panic with the Fannie and Freddie news.
Even looking at the trading prices of the large preferreds issued by banks last spring at the 8% range, we now see quotes in the 10-14% range. Clearly a number of large US banks will need to be outright sold, and there are virtually no other US institutions strong enough to do so. If foreigners don’t step up soon and buy out some of the big walking dead like Wachovia, then this crisis will get ever more acute fast.
IRA who certainly knows more about banks than I do, and whose analysis I trust, thinks Wells Fargo can do it. I’m not so sure. Japanese banks are decently capitalized to do this. But to attract capital beyond just screwing Aunt Millie, at least some banks will need to come clean and become more transparent.
I think that these transparency issues need to come to a head. The FDIC needs to start the process of shutting down the beyond any hope cases. Incredibly until about the last two weeks, the banks who have been the most transparent and honest have been trashed the most. The reaction in an efficient market should have been the opposite.
Fannie and Freddie: Let’s Call the Whole Thing Off
Fannie and Freddie are levered more than 50 to 1 (considering their assets on their book, and about 200 to 1 considering also their off balance sheet guarantees). These are levels that would make a Peloton or Bear Stearns portfolio manager blush. Consider their precarious situation:
- They have had a substantial decline in collateral value (house prices) of perhaps well over 10 percent or so, and with an expected further decline of another 10 percent or so (Case-Schiller index figures are higher than these and OFHEO index figures are lower).
- They have growing default rates and the economy is going through what may be a long and deep recession, most likely the most serious since the 70s, and possibly since the great depression of the 1930s.
- They have significant exposure to sub-prime and ALT-A (actually several times their equity capital)
- "Conforming" mortgages were also affected by the lax and fraudulent practices in the mortgage market, so their quality is not as good in the later vintages as it used to be.
- The mortgage insurers they were relying on to cover first losses were recently downgraded and most likely will not be able to meet the their obligations on all upcoming claims; they are going out of business and will probably become insolvent.
- Management, particularly FNM’s, has been in a state of denial.
- Accounting and controls at the firm are still weak. Management seems to be still tempted to window dress; e.g. they've recently changed the way they calculate their loss ratios which makes them look better, and stopped buying the portfolios of defaulted mortgages for which they provided guarantees to avoid recognizing losses upfront; they now provide the guarantee payments to the holders of the MBS on an as-needed, ongoing basis, and they have not written down their investments in equity in affordable housing tax credits, which the company can only take advantage of if it has profits.
The compounded effect of all these adverse elements, particularly the increase in default rates coupled with falling collateral and the weakness in the mortgage insurers, leads to an exponential, not linear, increase in losses for the agencies.
So the equity market value of the housing agencies, Fannie Mae and Freddie Mac, continues to get smoked, with a 15%+ drop yesterday. I fully expect, with over 90 percent confidence, that FNM and FRE shares will end up virtually worthless in the coming few months (they are no more than a deep out-of-the-money call option).
Given that these entities, with a current combined equity market value of about $25 billion, are supporting a book of mortgages of about $1.5 trillion and over $4 trillion of guarantees (so with ratios of equity to assets of 1.5 percent or 0.5 percent, respectively), it follows that they will have to raise substantial amounts of equity to rebuild their capital bases, perhaps as much as $50 billion each, possibly more.
Now who would be willing and able to invest such large amounts at this stage? The New Jersey investments division?...
The answer is no one - except the US tax payer. I suggest that rather than trying to throw sand in the eyes of the public and come up with a more aesthetic solution, the government should just look at an outright nationalization.
The agencies experiment did not work; let's call the whole thing off. Equity holders should be wiped off, and perhaps debt holders should take a very modest hair cut (say 5-10 percent of principal).
This solution would presumably allow a full recapitalization of the agencies, an improvement in their ability to do business and contribute to avoiding an overshooting on the downside of the decline in housing prices. It would also allow the government and the tax payers to fully participate in any upside of the agencies' business. To paraphrase Dave Einhorn : “No more private profits and socialized risks”.
Update 1.00 pm EDT
Ilargi: I feel I must address this stupidity, just so you know why we will NOT do anything at all to save this planet; something that was by the way clear to me many years ago.
After yesterday’s G8 "decision" to cut emissions in half by 2050, which was Gad-domn-it labeled a breakthrough, and which by the way never said how that would be none, nor even, Holy Mother, indicated half of what exactly they were referring to, earlier today there’s this prose from Canadian Prime Minister Stephen Harper:
"By 2050 the developed world will probably represent no more than 20 per cent of emissions. So when we say we need the participation of developing countries this is not a philosophical argument this is a mathematical certainty," Harper said. He added: "In the developing world we may not be talking about cuts...we may be talking about slowing the growth in emissions.
So China and India have to cut or slow their economic development, while the US and Canada sit back and watch, that’s what Harper’s math tells him. And don't tell me he doesn't understand. He's been the US mouthpiece through the G8, and he's a good brownnosing hand-puppet for them and his other masters. And while most people will take this "math" at face value, there is of course no proof, or reason to believe for that matter, that in 42 years emissions will develop according to these models. Nobody knows. It just gets Canada and the US off the hook today, because people are too stupid to think about it.
Who fickung cares anymore that James Hansen gives us ONE YEAR ONLY to prevent complete and utter disaster, and by 2050 Harper and George Waterboard will be over 90 years old or dead, who gives a fcuk that CO2 lingers for decades, and rich countries have emitted far more than developing ones in the past 50 years, who gives a rodent’s behind that Canada is set to hugely increase its emissions throug the oil sands?
Well, whoever it is, they are not among the "democratically" elected self-gloating money worshipping blind horses that represent you in Japan’s most glitzy hotels and restaurants these days. And let me tell you, as long as you accept this kind of doo-doo without rushing to the nearest convenience store to purchase a good old-fashioned hardened-steel pitchfork, you fully deserve to live in excrement, and all of your family, and you deserve all the blame that your grandchildren will bestow upon you. I foresee them slow-roasting you above a smouldering garbage heap, and I'll be the last to blame them. But I'll still bet that once you get to the store, you'll pick up a "green" lightbulb instead of that pitchfork; your brain died many years ago.
G8 climate stance an 'important advance
The leaders of the world's industrialized nations have made an "important advance" on cutting greenhouse gas emissions, said Prime Minister Stephen Harper at the close of G8 meetings in Japan.
The G8 leaders issued a statement that outlined their plan to cut greenhouse gas emissions in half by 2050. And for the first time, Russia and the U.S. have endorsed the long-term plan to reduce emissions.
"Stephen Harper said with the Americans in for the first time and with the changing winds in the United States on climate change, this is a significant breakthrough and he believes it's a very big success for the G8," CTV's Graham Richardson told Canada AM, reporting from Japan. He said Harper's goals going into the conference were achieved.
"The prime minister has said many times he's not going to come in and throw big numbers around to try and get a headline," Richardson said. "His point of view is these are very difficult targets to meet and we're going to try and get a consensus on achievable targets in terms of greenhouse gas emissions, and from that perspective that's what he says he's done here."
Harper told a news conference on Wednesday morning that the declaration represents a victory for the G8. He pointed out that last year, Canada, Japan and the European Union agreed emissions needed to be halved by 2050. However, Russia and the U.S. wouldn't sign on until now. Harper acknowledged there's still a lot of work to be done.
On Thursday, G8 members will be meeting with leaders from the emerging industrialized nations of South Africa, Mexico, Brazil, India and China. Harper said real progress won't occur until those developing nations also pledge to cutting emissions -- a commitment he will likely be pushing on Thursday.
He pointed out that developing countries are most at risk from the effects of climate change and their contribution to global greenhouse emissions is growing rapidly with the expansion of their economies and populations. "By 2050 the developed world will probably represent no more than 20 per cent of emissions. So when we say we need the participation of developing countries this is not a philosophical argument this is a mathematical certainty," Harper said.
He added: "In the developing world we may not be talking about cuts...we may be talking about slowing the growth in emissions." Environmental and opposition groups, however, have called for more specific targets and short and medium-term emissions cuts from G8 members.
However, the G8 declaration leaves it up to individual countries to make their own emissions cuts. Antonio Hill of Oxfam International denounced the announcement as a stalling tactic. "At this rate, by 2050 the world will be cooked and the G8 leaders will be long forgotten," he said.
Toxic CDOs Given Up for Dead Coming to Life With Pension Funds
CDOs are back. Collateralized debt obligations that helped drive banks to $400 billion of writedowns and credit losses are finding buyers under a different name: Re-Remics.
Goldman Sachs Group Inc., JPMorgan Chase & Co. and at least six other firms are repackaging unwanted mortgage bonds as sales of CDOs composed of asset-backed securities fall to less than $1 billion this year from $227 billion in 2007 because of the global credit crunch. Re-Remics contain parts that are structured to guard against higher losses on underlying loans than most CDOs, allowing holders to sell or retain other sections at lower prices that can translate to potential yields of more than 20 percent.
"It's just the reincarnation of the CDO," said Paul Colonna, who manages more than $100 billion as chief investment officer for fixed income at GE Asset Management in Stamford, Connecticut. "The mechanics are the same, but you're getting in at a much different level of valuation." GE Asset Management has considered buying the debt, Colonna said. The General Electric Co. unit may also have Re-Remics made out of bonds it owns if disposing of the riskier pieces boosts the securities' overall value.
Re-Remic stands for "resecuritizations of real estate mortgage investment conduits," the formal name of mortgage bonds. Sales of the securities may help revive the market for new home-loan debt, according to Bernard Maas, an analyst in New York at credit- "The hope is that by moving illiquid bonds to interested parties, the structured-finance community can look to restart," he said.
More than $9.3 billion of Re-Remics were created in the first five months of 2008, almost triple a year ago, according to Inside MBS & ABS. The debt represented 47 percent of mortgage bonds issued in the period, excluding those guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. A record $25 billion of Re-Remics were formed in 2007, the newsletter said. Sales in 2008 may exceed that, according to Sharon Greenberg, a Barclays Capital analyst in New York.
Unlike most CDOS, Re-Remics don't own debt or credit-default swaps based on the lowest-ranking subprime mortgage-bond classes. They are composed of AAA rated bonds backed by so-called Alt-A mortgages, issued to borrowers with higher credit scores who don't prove their incomes, seek higher debt ratios or buy investment properties.
While CDOs are backed by more than a hundred bonds, Re- Remics typically combine fewer than a dozen, allowing holders to more easily analyze the debt. Holders of mortgage bonds use Re-Remics to separate better- quality from riskier debt. That increases the chance the higher- ranked debt will retain its AAA rating, enhancing its value enough to boost the total worth of the mortgage pool, said Doug Dachille, chief executive officer of New York-based First Principles Capital Management LLC, which oversees $7 billion in fixed-income investments.
Lower-ranked pieces of the Re-Remics would be the first to record losses from defaults on the underlying mortgages, once lower-ranking bonds from the initial deals are wiped out, Dachille said. A bond trading at 40 cents on the dollar could be split into a piece worth 80 cents and another piece that could then be sold cheaply enough to offer returns as high as 20 percent, Dachille said.
Banks advised by First Principles bought lower-yielding senior pieces and some are also considering buying the bonds for their pension funds, he said. The firm is also starting a fund for pension clients that would invest in the debt, Dachille said. "A lot of the stuff they wouldn't buy without the additional credit support," he said. "They're happy with the 7.5 percent return. They just wanted greater certainty that they're going to get that 7.5 percent return."
Ilargi: I like Mike Mish Shedlock, most of the time. But every now and then he misses the point by such a margin, I refuse to read him for a week or so.
Listen, I don’t give a flying fish whether Fannie and Freddie are nationalized. For all intents and purposes, at least those that matter to the taxpayer, they already are. What’s much much more important today, but is completely ignored by everyone, including Mish, is this:
Since last summer, when the whole trend that he now writes about was already crystal clear, and when he should have written this, not now, Fannie and Freddie have been pushed both by their regulator, the Ofheo, and by Congress, to go on an unparralled shopping spree, and have bought such a truckload of dead-in-the-water mortgages, it starts to defy our imagination.
So while outright nationalization has been inevitable for a year or more now, trillions of dollars in ugly debt and commitments have been added to the taxpayer’s tab. That is the true scandal, and that should be the topic of any article written by serious analysts on the topic. So where is it?
What I do compliment Mish for, is that he mentions the fact that governments have no place encouraging homeownership. That kind of policy is perverse, and boy, do they know it. So why is it happening? Because it puts people in long-term debt to the banking system.
What’s most perverse about it, and yet everyone is utterly bind to, is what’s most obvious: when governments start promoting homwownership, and making housing "accessible" for more people, the result is this: PRICES GO UP. So much for accessibility. The real access issue is that banks get access to people’s money. If you look in teh dictionary under "perversity", this is what you’ll find.
Nationalizing Fannie and Freddie
Unsurprisingly, the lie of the day today is Fannie, and Freddie are Adequately Capitalized.
Mortgage financiers Fannie Mae and Freddie Mac are adequately capitalized and continue to be active in the mortgage market, said James Lockhart, director of the Office of Federal Housing Enterprise, which regulates the two enterprises.
"Both of these companies are adequately capitalized, which is our highest criteria," Lockhart said in an interview with CNBC. "They have been very active in the mortgage market, and they are continuing to be. And, in fact, Congress has put on them the requirement to do jumbo mortgages and they have been doing those as well."
Fannie Mae holds or guarantees over $5 trillion in mortgages. A mere 1% decline would wipe them out. Is that adequately capitalized? I do not think so and neither does Minyanville's Kevin Depew.
The second lie of the day is that "Fannie and Freddie are continuing to do their job in the marketplace." Nothing could possibly be further from the truth. There is a rock solid Case for Abolishing the FHA and GSEs for many reasons. Here are some of them:
- Fannie Mae has failed to help make housing affordable (its primary mission)
- Fannie Mae's CEO was forced out in disgrace
- Fannie Mae and Freddie Mac were both involved in multi-year derivative scandals where they had no idea what their derivative books ever were.
- Government sponsorship of housing is absolutely guaranteed to drive up prices (until things implode as they did in the US).
And most importantly the government has no business promoting housing over renting for any reason. Such promotion causes bubbles and the biggest bubble in history is now imploding. If ever there was a complete model of precisely what not to do, the US government sponsorship of Fannie Mae and Freddie Mac would surely be on the list.
EU action on Britain over budget deficit
European Union finance ministers have voted to condemn Britain for flagrant breach of the Maastricht spending rules, irked that the UK government has not even tried to keep its budget deficit below the treaty limit of 3pc of national income.
By its own admission, Labour will need to borrow at least 3.2pc of GDP this year, even if the economy holds up well. Brussels described this as "prima facie evidence of a planned excessive deficit". It warned that UK public finances were no longer on a sustainable course after the spending blitz of recent years.
Yesterday's vote is the first time the EU has launched disciplinary action against a big Western state under the revamped Growth and Stability Pact. While France and Germany both violated the old pact, they did so at the bottom of the dotcom mini-slump.
Britain's sins are more serious. The breach has occurred at the top of the cycle when tax revenues should be at their peak. Brussels said there had been a "deterioration of the structural balance of 4.5pc of GDP" since 1999. Brussels said Britain did not qualify under the "exceptional" circumstances clause.
The humiliating verdict came as Slovakia won approval to adopt the euro at the beginning of next year as the 16th member of Europe's monetary union. The country will join at an exchange rate of 30.126 koruny. Fitch Ratings yesterday raised the country's sovereign debt from "A" to "A+". "Fitch considers euro adoption as a net positive for a country's external creditworthiness.
As a member of the euro area, Slovakia will be sheltered from monetary shocks and the risk of a self-fulfilling currency crisis," it said. With just 5m people, Slovakia will scarcely make a ripple in the eurozone. Its accession will make life marginally more difficult for the European Central Bank, which is already struggling to manage the chasm between the German and Latin blocs.
The ECB has been trying to slow down the pace of expansion, warning east European candidates that it is hazardous to join the one-size-fits-all interest rate regime before they have carried out root-and-branch-reform of their economies. The UK now has the worst fiscal profile of any developed country in the North Atlantic sphere.
The European Commission expects the UK's public debt to rise from 43.2pc of GDP last year to 47.5pc by the end of next year. The ritual of naming and shaming at EU meetings is likely to prove a constant thorn in the side for Labour.
There is no chance that the deficit can be brought back under control in the foreseeable future. The deficit always deteriorates in a downturn. Capital Economics said borrowing needs could explode to £120bn a year if the country tips into a severe recession, as many now fear.
Britain is now in an ugly predicament. Unlike Spain or the US, it cannot easily resort to a fiscal boost - either tax cuts or extra spending - to cushion the effects of the property collapse.
Fannie, Freddie Downgraded by Derivatives Traders on Concerns over Capital
Fannie Mae and Freddie Mac, ranked Aaa by the world's largest credit-rating companies, are being treated by derivatives traders as if they are rated five levels lower.
Credit-default swaps tied to $1.45 trillion of debt sold by the two biggest U.S. mortgage finance companies are trading at levels that imply the bonds should be rated A2 by Moody's Investors Service, according to data compiled by the firm's credit strategy group. The price of contracts used to speculate on the creditworthiness of Fannie Mae and Freddie Mac and to protect against a default doubled in the past two months.
Traders are overlooking the government's implied guarantee of the debt as credit losses grow and concern rises that the companies don't have enough capital to weather the biggest housing slump since the Great Depression. Washington-based Fannie Mae fell 73 percent in the past year on the New York Stock Exchange and McLean, Virginia-based Freddie Mac lost 60 percent of its market value.
"Investors are viewing even an implicit guarantee from the government as potentially troublesome," said Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California. Fannie Mae and Freddie Mac, which reported combined losses of more than $11 billion, have raised more than $20 billion since December.
Concerns that Fannie Mae and Freddie Mac may need more capital were heightened this week after Lehman Brothers Holdings Inc. released a report saying a new accounting rule may require the companies to raise $75 billion. Freddie Mac dropped 18 percent after the report was issued on June 7 and Fannie Mae dropped 16 percent.
Credit-default swaps tied to Fannie Mae's senior debt climbed 39 basis points to 74 basis points since May 1, while contracts on Freddie Mac's senior debt increased 40 basis points to 75, according to London-based CMA Datavision. A basis point is 0.01 percentage point.
The cost to protect the companies' subordinated debt from default rose at a faster rate. That debt is rated Aa2 by Moody's. Credit-default swaps on Fannie Mae's subordinated notes jumped 108 basis points to 195 basis points since May 1, while contracts on Freddie Mac's rose 105 basis points to 193 basis points.
Shares of the companies rebounded yesterday, with Freddie Mac rising 13 percent and Fannie Mae gaining 12 percent, after the companies' regulator said they were adequately capitalized. "It concerns me that people sort of extrapolate well beyond what the facts are," James Lockhart, the director of the Office of Federal Housing Enterprise Oversight, said in an interview with Bloomberg Television yesterday.
Treasury Secretary Henry Paulson said yesterday that the companies can still be a "constructive force" in the economy. The bailout of Bear Stearns Cos. arranged by the Federal Reserve in March shows the government won't allow the companies to fail, Robert Millikan, who manages $5 billion as director of fixed income at BB&T Asset Management in Raleigh, North Carolina.
"We're looking at it from a standpoint of, if the Fed is not going to allow a problem with Bear Stearns, they're certainly not going to allow a problem with Fannie and Freddie," Millikan said. "With all the exposure that banks have to Fannie and Freddie, the ripple effect through the whole financial system would be unbelievable if they were allowed to fail," he said. Fannie Mae fell 28 cents to $17.35 at 9:09 a.m. in Frankfurt and Freddie Mac rose 23 cents to $13.69.
The companies' congressional charters provide exemption from state and local corporate income taxes and give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default. Fannie Mae spokesman Brian Faith and Freddie Mac spokesman Michael Cosgrove declined to comment.
Congress created Freddie Mac and expanded Fannie Mae in 1970 to promote home buying in the U.S. The companies own or guarantee about 46 percent of the $12 trillion U.S. mortgage market. The government is leaning on the companies to help revive the mortgage market.
Congress lifted growth restrictions on the companies, eased their capital requirements and allowed them to buy bigger, so-called jumbo mortgages to spur demand for home loans as competitors fled the market. Their share of new conforming mortgages, or loans of $417,000 or less, almost doubled to 81 percent in the first quarter, Ofheo said.
Merrill Lynch & Co. analyst Kenneth Bruce said in a report yesterday the "highly levered financial institutions" will have pretax credit-related losses of $45 billion. "Fannie and Freddie are going to have to raise more capital and nobody thinks they're going to be able to raise capital when they need to," said Paul Miller, an analyst at Friedman, Billings, Ramsey & Co. in Arlington, Virginia. "It's going to be very expensive."
Recession warnings ruffle Europe as Germany and Italy stall
German industrial output fell at the fastest rate for a decade in May, raising concerns that Europe's economic powerhouse is succumbing to the twin effects of the oil and credit shocks.
In Italy, Fiat announced plant closures and temporary layoffs at factories in Turin, Melfi, Imola and Sicily in order to face an economy "in crisis". Car sales in Italy have fallen by almost 20pc over each of the past two months. Fiat said plants would be shut one week in four through September, October and November. "The situation is evidently more serious than had been understood," said Metalmeccanici, Italy's car workers' union.
France's finance minister, Christine Lagarde, called for joint EU action to head off a recession. "The slowdown is clearly becoming a matter of concern. We must very seriously come up with a way of stimulating growth," she said in Brussels. She later met her Italian counterpart to help prepare an EU-wide "anti-speculation" plan to help bring down oil prices.
Germany's industrial output was down 2.4pc in May. Orders have now fallen for six months in a row, the worst run since the early 1990s. The German Chamber of Industry and Commerce warned of up to 200,000 job losses in coming months.
Spain's factory output slumped 5.5pc in May. The country's business lobby Circulo de Empresarios yesterday warned of a "high probability" that Spain's economy would fall into recession in the second half of this year as the housing collapse takes its toll.
Unemployment has risen by 425,000 over the past year. The government is now paying North African and Romanian immigrants lump sums to leave the country. The group's leader, Fernando Eguidazu, called for "urgent measures" to cushion the crisis, but acknowledged that room for manoeuvre is limited now that Spain had given up control over the levers of monetary policy.
Last week's decision by the European Central Bank to raise interest rates a quarter point to 4.25pc could hardly have come at a worse time. The list of European countries in or near recession already includes Ireland, Denmark, Spain and Italy, but the enveloping crunch is now clearly moving closer to core Europe.
Goldman Sachs has slashed its profit estimates for 40 European banks, warning that they may have to raise up to €90bn (£71bn) in fresh money to meet capital adequacy rules. The market value of Europe's banks have already fallen by €900bn since the credit crisis began. The US investment bank warned of a "sharp turn in the European credit cycle" along the lines of the recession in the early 1990s, although in some respects if could be worse.
"The consumer is more leveraged today than in any of the previous cycles," it said. New accounting rules will force losses to the surface more quickly this time. Among the "sell" recommendations are UBI Banca, Carnegie, Swedbank, Bankinter, Banco Popular, Banco Sabadell, Alliance & Leicester, Barclays, and Lloyds TSB. Credit costs are likely to rise by 82 basis points over the next two years, causing a squeeze in lending.
In France, Renault warned of tough conditions for the car industry in the second half of the year as the surging steel costs and stalling sales cut into profits. Carlos Ghosn, the group's chief, said: "In three years, our steel bill has risen by €1bn, equal to half of Renault's total profit. The rise in iron ore prices is now pointing to a further rise over €1bn in 2009.
There is a strong correlation between consumer confidence and car sales. Confidence has plunged over the past three months." European car sales fell 7.8pc in May compared with a year earlier. The slide has almost certainly continued since. Spain's registrations fell 31pc in June.
Selling shares would be extra pricey for Merrill
Merrill Lynch & Co Inc agreed to financing terms in December and January that could end up costing the bank nearly $4 billion if it tries to issue equity now.
The onerous cost of issuing equity makes Merrill Lynch much more likely to sell assets, analysts said, and explains why Chief Executive John Thain said recently the company would consider selling its stakes in Bloomberg or BlackRock if it needed more capital.
"They'd have to pay through the nose to raise equity now. It just wouldn't be a good deal," said Matt McCormick, analyst covering financial stocks at Bahl & Gaynor Investment Counsel in Cincinnati. U.S. commercial and investment banks are broadly raising capital after recording more than billions of dollars of write- downs and credit losses. Merrill Lynch is no exception -- it has recorded more than $30 billion of write-downs since the third quarter of 2007.
Analysts forecast the bank will take up to another $6 billion of write-downs when it reports second quarter results next week, which could force the bank to raise additional capital. Any capital the company raises now would follow big transactions in December, when Merrill sold up to $6.2 billion of common stock, and January, when Merrill sold $6.6 billion of convertible preferred stock.
But both deals had an unusual feature: If Merrill Lynch raised equity at too low a share price in the future, the December and January investors, which included Singapore state fund Temasek and Korea Investment Corp, would be reimbursed with either cash or more shares.
For the December capital increase, those provisions kicked in for equity sold below $48 a share, and for the January deal, for equity sold below $52.40 a share. Merrill would have to sell more than $1 billion of equity to trigger the provision for the January offering.
With Merrill's shares having closed on Friday at $30.36, down more than 40 percent since the January financing, any share issuance now would require nearly $4 billion of reimbursement in cash or shares, according to an analysis by Reuters. In the case of the January deal, the reimbursement would come in the form of additional shares when the convertibles change into equity.
Selling high-quality assets is not usually a company's first choice when raising capital, because strong assets can be a source of future profits. If a company does sell pieces of itself, it usually focuses on pieces that will have the least impact on future earnings. Bloomberg seems to fit the bill there -- the 20 percent stake, which Thain said in a recent call was worth about $5 billion to $6 billion, is not part of Merrill's main business.
But selling all or a portion of the 49.8 percent stake in BlackRock, worth about $10 billion at current market prices, would be less desirable because the asset management company is more closely related to Merrill's main business, analysts said. Merrill, which essentially sold its investment management business in 2006 for a big stake in BlackRock, distributes BlackRock funds through its brokerage.
"Now you're damaging the future earnings power of the company," said Bill Fitzpatrick, equity research analyst covering financial stocks at Optique Capital Management in Milwaukee. Other options are limited. Companies looking to issue equity-like capital without issuing common equity can sell securities that have characteristics of debt and equity, known as "hybrid instruments."
But that option may not open to Merrill Lynch now, judging by a recent comment in a Moody's Investors Service statement. The credit ratings agency said Merrill's percentage of hybrid instruments in its capital structure is more than 25 percent of total equity capital. "This means that Merrill would need to increase common equity to improve capital ratios under Moody's framework," the rating agency wrote in a statement in April.
If issuing securities is unpalatable, selling assets may be the only option left, analysts said. "Among its current options, selling the BlackRock or Bloomberg stakes is the least unattractive," said Michael Holland, founder of Holland & Co, which oversees more than $4 billion of investments.
Merrill may get $5 billion for Bloomberg stake
A blind trust run by New York City Mayor Michael Bloomberg is willing to pay between $4.5 billion and $5 billion to buy Merrill Lynch & Co's 20 percent stake in financial news and data provider Bloomberg LP, the New York Post reported, citing sources.
Discussions are still under way, and a deal could fall apart as Merrill aims to sell its minority stake in the privately held company ahead of its second-quarter earnings call set for July 17, the paper said. Merrill is also looking to sell part of its 49 percent stake in money manager BlackRock Inc, which may be sold to multiple parties, the paper said.
Potential buyers include private-equity firms and sovereign wealth funds, but details on the deal could not be determined, the paper said. Merrill has been considering selling part of its stake in BlackRock and its share in Bloomberg LP to boost its balance sheet.
Analysts expect the No. 3 Wall Street investment bank to record as much as $5.8 billion of writedowns when it reports second-quarter results. It has written off more than $30 billion on complex mortgage-backed securities in prior quarters in the wake of the credit crisis.
The company's BlackRock stake is worth about $10 billion, while its investment in Bloomberg LP is valued at around $6 billion.
Ilargi: Plenty of words about ratings agencies, both in the US and in Europe, but as far as I can tell, very little substance. A touchy subject; forcing too much at once can lead to huge amounts in forced sales and writedowns, and we wouldn’t want that, would we? The problem with this (non-) approach is that entire garbage piles of stinking silly paper remain untouched; everyone’s afraid of what lies underneath. It’s a bit like the streets of Naples.
SEC finds conflicts at rating agencies
Credit rating agencies failed properly to manage conflicts of interest in assigning top ratings to bonds backed by subprime mortgages and other assets, the Securities and Exchange Commission has concluded.
The rating agencies, which are paid by the issuers whose securities they rate, have come under criticism for failing to act quickly enough to warn investors about the risks of investing in complex “structured” securities. Ratings analysts are often managed by the same people who run the business side of such firms.
The findings of the SEC probe, expected to be made public this week, follow months of examinations that sought to determine whether the rating agencies diverged from their usual procedures to publish higher ratings for complex financial products tied to mortgages as the sector began to boom.
SEC officials looked through hundreds of thousands of pages of internal records and e-mails related to the ratings of subprime mortgage-related securities. “The public will see that there have been significant problems,’’ Christopher Cox, SEC chairman, told Bloomberg Television on Monday. “There have been instances in which there were people both pitching the business, debating the fees and were involved in the analytical side.”
He said credit raters were “deluged with requests” for ratings and “the volume of work taxed the staffs in ways that caused them to cut corners, that caused them to deviate from their "models’’. The SEC last month proposed new rules for the industry. The proposals are likely to reflect the SEC probe into the three big agencies: Standard & Poor’s, Moody’s Investors Service and Fitch Ratings.
The proposed rules aim to address conflicts of interest by prohibiting certain activities, such as agency executives providing both ratings and advice on how to structure securities.
EU turns up heat on rating agencies
The European Union will take a first step towards stricter regulation of credit rating agencies on Tuesday by supporting calls to register them and make them answerable to financial market supervisors. Finance ministers of the 27-nation bloc are expected to endorse the argument of Charlie McCreevy, the EU's internal market commissioner, that the agencies' system of voluntary selfregulation has proved inadequate.
EU governments, the European Commission - the bloc's executive - and many members of the European parliament share the view that rating agencies contributed to the financial market turbulence that broke out last year by significantly underestimating the risks attached to structured credit products.
Moody's, Standard & Poor's and Fitch, the main credit rating agencies, must already register in the US under a requirement introduced last year that brings them under the supervision of the Securities and Exchange Commission. The agencies accept the case for registration in Europe, but they are concerned that the push for tighter EU regulation may result in different rules from those in the US and thus inconsistent treatment of their activities in the world's big financial centres.
"Capital markets are global. We understand the need for oversight, but it had better be globally consistent," said one agency executive. "Europe as a market has become large and sophisticated, and there is a desire for separate oversight. We've got to make sure we're part of the conversation, so that there is global consistency."
Mr McCreevy plans to set out his proposals for registration, external oversight and corporate governance reform at credit rating agencies in October, with a view to getting them turned swiftly into law by EU governments and the European parliament. "McCreevy is forcing the pace. He is of the opinion that the industry has not got its house in order quickly enough or to a sufficient extent," one EU diplomat said.
The commissioner previously drew attention to conflicts of interest that he says are inherent in the agencies' business model, especially in relation to structured finance. His prospects for success appear bright, not least because he can count on strong backing from Christine Lagarde, the French finance minister. Last week France took over the EU's six-month rotating presidency. Germany, Europe's biggest economy, is also very much in favour.
Less reliance on rating agencies sought
Alistair Darling will on Tuesday criticise over-dependence on credit ratings in European Union financial rules as he calls for a review of how banks meet their capital requirements. The UK chancellor of the exchequer will urge his fellow European Union finance ministers to become less reliant on credit ratings agencies in order to encourage investors to undertake their own checks on complex financial instruments.
Mr Darling’s call echoes the concerns of many other European finance ministers and central bankers. It follows the US Securities and Exchange Commission’s recent move to reassess its rules that make explicit references to ratings. Over the past decade, regulators on both sides of the Atlantic have increasingly allowed, and in some cases required, credit ratings to be used as a measure of the capital a bank is required to hold.
The EU’s so-called Basel II capital finance directive, which took effect at the end of 2006, requires banks to use recognised credit agency ratings for the assets on their books. Agencies’ ratings are also widely used by central banks in the assessment of acceptable collateral in liquidity operations.
All the recent extensions to the collateral accepted by the Bank of England in its recent liquidity operations have relied extensively on credit ratings to govern both whether the Bank will accept the loans and the terms on which it will turn assets into cash.
The increase in the perceived importance of ratings as a result of such rules may have contributed, critics argue, to the mispricing of risk that led up to the credit crunch. Agencies make the point that they never requested ratings to be built into regulatory systems.
A Treasury official said that while it was important for ratings agencies to “learn lessons” from the credit crunch and “improve their business practices”, it was time also to “look at their role in regulation”. “The use of ratings is hard-wired into many EU regulations,” the official said. “It is not clear this is the best way to encourage investors to conduct the due diligence we need to see.”
Hedge Funds Fell 0.75%, Worst First-Half Performance
Hedge funds turned in their worst first-half performance in almost two decades because of the credit crunch and the onset of a bear market in stocks. Hedge funds declined by an average 0.7 percent in June, bringing the year-to-date loss to 0.75 percent, data compiled by Hedge Fund Research Inc. show.
It's the worst start to a year since the Chicago-based firm began tracking returns in 1990. The $1.9 trillion industry has posted one losing year, in 2002, when funds fell 1.45 percent. "Equity markets have made for an incredibly difficult environment," said Mark Dampier, an analyst at Hargreaves Lansdown Stockbrokers in Bristol, England, who tracks the money- management industry.
Managers attracted a net $16.5 billion during the first three months of the year, down from $30.4 billion in the fourth quarter, Hedge Fund Research reported. Investors have become less tolerant of losses and are shifting assets to traders who have shown they can thrive in turbulent markets, said Antonio Munoz, who runs EIM Management USA in New York, which farms out $15 billion to hedge funds. "We don't see investors pulling the plug across the board and putting their capital into cash," Munoz said.
Joseph Oughourlian's Amber Capital Management LP and Polygon Investment Partners LLP are among the firms hurt by redemptions. Amber Capital had $2.5 billion of withdrawals as of July 1 after the New York-based firm dropped 9.5 percent in the first half, according to investors. Oughourlian, who focuses on companies going through corporate changes such as mergers, oversaw $6.6 billion at the start of the year. The fund returned 38 percent in 2006 and 13 percent in 2007.
London-based Polygon, co-founded by former UBS AG hedge-fund chief Paddy Dear, had redemptions of about $1.5 billion this year through May as its Global Opportunities fund lost 4 percent. "Investors are showing less patience than before to live through the bad times," said Patrik Safvenblad, head of hedge- fund research in Stockholm for DnB NOR ASA, Norway's biggest bank.
Hedge funds are mostly private pools of capital whose managers participate substantially in the profits from their speculation on whether the price of assets will rise or fall. Stock markets in the U.S., Europe and Asia have been falling since October amid mounting losses from subprime mortgages, rising oil prices and the weaker U.S. dollar against most major currencies.
The Standard & Poor's 500 Index has dropped 19 percent from its peak on Oct. 9, the U.K.'s FTSE 100 Index fell 18 percent and Japan's Nikkei 225 Index tumbled 24 percent. A decline of more than 20 percent in 12 months is considered a bear market. Stock hedge funds fell by an average 3.3 percent this year, according to Hedge Fund Research. Funds that invest in convertible bonds dropped 7.6 percent on average.
"After saying for years they needed more volatility, many managers suddenly couldn't cope with it," said Bob Michaelson, group investment director for Fleming Family & Partners Asset Management Ltd. in London, which invests about 25 percent of its 4 billion pounds ($7.8 billion) in hedge funds.
Why the outlook for Britain is truly dreadful
The news “just goes on getting worse”, said Michael Saunders of Citigroup. The Purchasing Managers’ Index of manufacturing activity for June was “truly dreadful”. It dropped to a five-year low of 45.8, well below the 50 mark that separates expansion from contraction. Despite the low pound, manufacturing is “heading into recession”.
However, the sub-index measuring input and output prices hit highs not seen since the data series began a decade ago as manufacturers sought to pass on their high costs, further highlighting how the Bank of England is caught between slowing growth and inflationary pressure. Meanwhile, business confidence has tumbled to a 16-year low, according to BDO Stoy Hayward.
What’s more, the housing market is starting to “nose-dive”, as Capital Economics said. Nationwide reported that prices fell for an unprecedented eighth successive month in June, leaving them 6.3% down on a year ago, the fastest slide since 1992. Mortgage approvals for new house purchase plummeted to a record low of 42,000 in May.
Yet mortgage rates are still on the rise, so further falls in approvals look likely. Throw in the weakening overall economy and labour market, and the upshot is that house prices look set to fall 15% this year and 35% from their 2007 peak by 2010. That’s grim news for housebuilders. According to Merrill Lynch, land prices fall by around 3% for every 1% decline in house prices, noted George Hay on Breakingviews.com.
Most of the sector will have to raise capital to avoid breaching banking covenants, but this week’s “fiasco at Taylor Wimpey” means that will be an uphill struggle: it failed to secure a deal with shareholders and potential new investors to raise around £500m, and could be in breach of its covenants next year if the housing market doesn’t recover.
Falling house prices bode ill for consumption, which accounts for the lion’s share of GDP, as people feel less wealthy and no longer tap their houses for cash. Warner cites research from Morgan Stanley’s David Miles suggesting that a 15% slide in house prices and a 40% fall in transactions this year could reduce growth by 3%, leading to a recession. Transactions have already fallen by more than 40%.
With consumers already gloomier about the economic outlook than at any time during the last recession, the high street is suffering: 25% of London retailers issued negative sales updates in the past quarter, a three-year high, said Grant Thornton.
M&S reported a 5.3% drop in like-for-like sales in the quarter to late June, citing rapidly deteriorating consumer confidence, while Carpetright founder Lord Harris said next year will be one of the toughest of his 50-year career. Britain, says Capital Economics, is heading for “a very painful period”.
U.K. Mortgage Rates Surge, Consumer Confidence Slumps
U.K. mortgage rates surged to the highest in eight years and consumer confidence dropped as the worst housing slump in three decades deepened. "This is doom and gloom," said Alan Clarke, an economist at BNP Paribas SA in London. "The housing market is in freefall and unemployment is rising."
The rate on a home loan fixed for two years rose to 6.63 percent in June, the highest since February 2000, the Bank of England said today in London. The 0.37 percentage point increase from a month earlier is the biggest since October 2003. Nationwide Building Society's index of consumer sentiment dropped to the lowest level since the survey began in May 2004.
The U.K. is skirting a recession as house prices fall, oil costs rise to a record and lenders refuse to pass on the Bank of England's three interest-rate cuts since December. Policy makers, who make a rate decision tomorrow, said last month that they considered increasing borrowing costs after inflation accelerated to 3.3 percent, the fastest pace in at least a decade.
"The Bank of England's credibility is in question with the worst peak in inflation in its history, but there are a lot of reasons not to hike now," BNP's Clarke said. All but one of 49 economists in a Bloomberg News survey predict the Bank of England will keep the key rate unchanged at 5 percent tomorrow. Nationwide said there is a 20 percent chance that the bank will raise interest rates. Evidence of the economy's deterioration sent the pound lower against the euro today. The currency fell to 79.59 pence from 79.57 pence yesterday.
House prices fell the most since 1992 in June, Nationwide said July 1. Unemployment may rise 58 percent to 1.3 million by the middle of 2010, the Centre for Economic and Social Inclusion, a government-supported research group, predicted this week. Homebuilders Redrow Plc and Bovis Homes Group Plc today said they will cut their workforce by 40 percent as sales drop. Persimmon Plc said yesterday it eliminated 1,100 jobs after the housing slump lowered first-half sales by 34 percent.
"The state of the housing market is of grave cause for concern," Harriet Harman, deputy leader of the ruling Labour Party, said in Parliament today. She said the government and the Bank of England will fight inflation even as economic conditions threaten to "get tougher.'
Auction-Rate Probe Grows Over Clarity From Brokers
Federal prosecutors, ramping up criminal probes stemming from the credit crunch, are investigating whether two former Credit Suisse Group brokers lied to investors about how they placed their money into short-term securities, according to people familiar with the matter.
At issue is the $330 billion market for "auction rate" securities, which allow issuers such as municipalities and student loan companies, closed-end mutual funds or financial institutions to borrow money for the long term but at short-term, or lower, interest rates. Weekly or monthly auctions conducted by Wall Street firms reset those rates, but the market seized last February. When the auctions failed, investors were left without the ability to sell such securities.
The investigation, by the Justice Department's U.S. attorney's office for New York's Eastern District, represents the first known criminal matter stemming from the crumbling auction-rate securities market. The rout in this market has punished thousands of U.S. investors, who are now stuck paying high penalty rates, and it has raised questions about whether Wall Street firms adequately disclosed the risks in such auctions.
Until now, the fallout largely has been a civil-litigation headache for Wall Street firms and others, who have been hit with lawsuits seeking class-action status and more than 80 individual arbitration claims, according to the Financial Industry Regulatory Authority, a Wall Street self-regulatory organization.
The probe surfaces just weeks after prosecutors charged two former Bear Stearns hedge fund managers with securities fraud, the first criminal prosecutions in the year-long credit crunch. The Bear Stearns managers are contesting the charges.
In the auction-rate securities matter, two New York-based brokers, Eric Butler and Julian Tzolov, resigned from Credit Suisse on Sept. 7, 2007, amid accusations by clients that they were misled about the nature of the auction-rate securities they bought. Clients said they were told the securities they purchased were backed by student loans, according to a regulatory filing by the firm.
In fact, the securities were backed by risky collateralized debt obligations, or pools of bonds tied in part to subprime mortgages, according to people familiar with the matter. Such CDOs have plunged in value as the housing market deteriorated.
Credit Suisse issued the following statement Tuesday: "Nearly a year ago, we detected prohibited activity by two former cash management employees who were immediately suspended. These two employees, who resigned in September 2007, violated their obligations to Credit Suisse and to our clients. We promptly notified our regulators when this matter arose last year and we have continued to work closely with them." Credit Suisse isn't a target of the investigation, according to people familiar with the matter.
A spokesman for the U.S. attorney's office and Paul Weinstein, a lawyer for Mr. Butler, declined to comment. Kenneth Breen, a lawyer for Mr. Tzolov, said his client is a well-respected broker who shouldn't be blamed for an unforeseeable market failure and that his clients were sophisticated investors who understood the risks. The securities clients purchased were triple-A rated, he says.
"Julian Tzolov deceived no one, and he had his clients' interests at heart at all times. We are confident that the U.S. attorney's office will make the correct decision and choose not to bring charges." Both brokers joined Morgan Stanley a few days after leaving Credit Suisse; a Morgan Stanley spokeswoman said they were fired on Monday and declined to elaborate.
The criminal investigation comes as the U.S. attorney's office for New York's Eastern District, based in Brooklyn, emerges as a primary inquisitor of Wall Street firms during the credit crisis. The office brought the recent Bear Stearns case.
"You can't tell a half-truth or lie about the nature of an investment -- that's criminal securities fraud," says Christopher Clark, a former federal prosecutor who is a defense lawyer in New York and isn't involved in the Credit Suisse case. "It's fairly common ground for criminal prosecutors because it goes to the heart of confidence in the markets; brokers can't lie about what you're giving them money to buy."
To Avoid Stalling Out, G.M. Plumbs Its Resources
Like a gas-thirsty S.U.V. crawling to the pump, General Motors needs to fill up fast with cash. Despite a broad overhaul since 2006, the nation’s largest automaker may soon have to raise new operating capital to offset a steep decline in United States vehicle sales.
Investors worried about its prospects, including the possibility of bankruptcy, have driven G.M.’s stock down to about $10, its lowest point in more than 50 years. G.M. executives privately dismiss the notion that they might someday be forced to seek Chapter 11 protection, but pressure is building on Wall Street for the company to raise cash in the equity and debt markets.
“The rapid change in the external environment, especially fuel prices and demand, has outpaced G.M.’s most aggressive restructuring timetable,” said John Casesa, managing partner of the consulting firm Casesa Shapiro Group in New York. “G.M. needs capital to finish the job.” G.M. has $23.9 billion in cash on hand, along with credit lines of $7 billion.
Rick Wagoner, G.M.’s chairman, has declined to comment on the automaker’s financing plans since announcing a series of plant closings last month. He and other senior G.M. executives will not be available for interviews until a course of action is made public, according to a spokesman, Tony Cervone.
Simple math suggests the automaker has enough cash to last through 2009, if analysts’ estimates are accurate that G.M. is spending $1 billion more each month than it is taking in. But G.M.’s cash cushion seems far from comfortable given the extraordinary drop in auto sales. Soaring gas prices and a weak economy sent new-vehicle sales down 10 percent in the first half of the year.
G.M. performed worse than the overall market, with its sales down 16 percent through June. And the market for big pickups and sport utility vehicles, which analysts say earn a profit of up to $10,000 each on models like the Chevrolet Suburban and Cadillac Escalade, dropped by 25 percent as consumers have fled to more fuel-efficient vehicles.
G.M., as well as rivals Ford Motor and Chrysler, have idled thousands of workers and shut plants that make S.U.V.’s and pickups. But closing plants won’t help G.M.’s balance sheet. One industry analyst, Himanshu Patel of JPMorgan Chase, forecasts that G.M. will burn through a combined $18 billion in cash this year and next.
While he discounts fears of bankruptcy, Mr. Patel said in a research note that “liquidity concerns” will require G.M. to borrow up to $10 billion before the end of this year. “G.M. is burning cash fast, but it still has many unencumbered assets that can be borrowed against,” he said.
The automaker is prepared to cut more white-collar jobs and is delaying some product programs to conserve cash. G.M. has also put its Hummer brand up for sale, and may consider eliminating, downsizing or selling off marginal brands such as Saturn and Pontiac.
Mark LaNeve, G.M.’s head of North American sales, tried to tamp down those rumors by circulating a letter to dealers Tuesday saying the company was not holding strategic reviews of any brands except Hummer.
Cutting jobs or dumping brands will reduce costs, but those actions will not replace revenue lost in the slumping vehicle market.
“Plant closings, elimination or sell-offs of some product lines, and further white-collar cuts will only slow the agony,” said Louis Lataif, dean of Boston University’s School of Management and a former Ford executive. “These actions cannot restore profitability.”
Ilargi: I was surprised and amazed seeing the reactions to the "leaked" report from Bridgewater. Some folks never learn to tell real life from hubris.
1/ I’d want to see Bridgewater’s -a hedge fund, after all- short positions; what do they stand to gain from their report?
2/ I don’t feel that $1.6 trillion is such a crazy number, it’s just big.
3/ What deserves much more attention is that -and why- the IMF official total credit crunch loss estimate still stands at $400 billion; that numbers now looks downright deceptive. It’s been there for a long time, while things get worse every day. People won’t believe reality till it gets confirmed by the Fed, the ECB or Wall Street, but they will NEVER give you their real thoughts: It’s don’t ask, don’t tell, all across the board.
4/ It’s been at least half a year since the first estimates of $1 trillion and more came out; they were hardly addressed at all, and certainly not in ways that would require serious reporting.
5/ All in all, it’s once again the awe that BIG numbers inspire (remember the empty hot-air ruckus over $100 oil?), but I’ve seen little in the way of actual analysis.
6/ Most striking, for all those who have mentioned the report, there has been almost no attention to what the $1.6 trillion in losses, if they are correct, would mean for the US and global economy: there’s a good chance it would basically need to stop functioning. Ambrose Evans-Pritchard draws the conclusion that large-scale nationalization of banks would seem inevitable, but I doubt that governments would be willing, never mind able, to stop the bleeding. It’s very possible that trying to do so would deplete their capital positions, their credit ratings and more. It’s not as if governments of nation states in a globalized economy have some sort of endless flexibility. There are no bottomless printing presses today.
Bank losses from credit crisis may run to $1,6 trillion
Bridgewater Associates has issued an apocalyptic warning to clients that bank losses from the worldwide credit crisis may reach $1,600bn (£800bn), four times official estimates and enough to pose a grave risk to the financial system.
The giant US hedge fund said that it doubted whether lenders would be able to shoulder the full losses, disguised until now by "mark-to-model" methods of valuing structured credit.
"We are facing an avalanche of bad assets. We have big doubts as to whether financial institutions will be able to obtain enough new capital to cover their losses. The credit crisis is going to get worse," said the group in a confidential report, leaked to the Swiss newspaper SonntagsZeitung.
Bank losses on this scale would have far-reaching effects. Lenders would have to curtail loans by roughly 10-to-one to preserve their capital ratios. This would imply a further contraction of credit by up to $12,000bn worldwide unless banks could raise fresh capital.
It would be almost impossible to attract or even find such sums from investors. While sovereign wealth funds command roughly $3,000bn in funds, this money is mostly committed already. The funds have grown extremely wary of Western banks with sub-prime exposure after burning their fingers so many times already.
Bridgewater said true losses would mushroom if the banks were compelled to use "mark-to-market", which foretells a much crueller haircut for investors in the outstanding pool of structured debt from mortgages, credit cards, car loans and such like, together worth $26.6bn.
The International Monetary Fund has estimated bank losses of roughly $400bn. A chunk has already been covered by fresh infusions of capital, allowing the lenders to continue lubricating the global financial system without having to squeeze credit too hard.
The great unknown is whether this is the end of the debacle. A number of hedge funds believe the alleged losses - typically measured by the ABX index - may overstate the likely level of defaults. They are buying the spurned securities for as little as eight cents on the dollar.
If Bridgewater is anywhere near correct, governments alone have the wherewithal to rescue the system. This would mean the de facto nationalisation of the banking systems in the US, Britain and Europe.
Ilargi: Let’s let Bill Bonner do a little Bridgewater do-over.
Huge, Stupid, and Probably Fatal
Americans came back from their Independence Day holiday…and found their Empire of Debt in worse shape than ever - $1.6 trillion in potential losses from the credit crunch! Freddie Mac and Fannie Mae are to America's great empire what the East India Company was to the British Empire in the 19th century…and the Louisiana Company was to France in the 18th. Huge, stupid, and probably fatal.
Freddie and Fannie are huge government-chartered mortgage lenders. In 18th century France, speculators bet on the riches of Louisiana, through the government-chartered Louisiana Company. In the 19th century, they wagered their money on the riches of India, through the government-chartered East India Company. And in the 20th century, they gambled on rising housing prices through Fannie and Freddie.
Yesterday, the twins got spanked hard. Freddie lost 18%. Fannie took a 16% hit. The stock fell to its lowest level since 1995, wiping out every penny of gain from the housing bubble. Sic transit gloria pecunaria. Or something like that. The immediate problem is that the mortgage lenders are running out of money. They need to raise $75 billion.
A few years ago, that would have been no problem. Everybody was ready to put money into America's go-go, securitized housing market. But then, housing went. Yesterday's news tells us that housing prices are falling in 23 out of 25 U.S. metropolitan areas. That, according to Case/Shiller. Foreclosures are still rising at a faster and faster pace. Etc. Etc.
So now, Freddie and Fannie have a problem. They need to raise money - a lot of it. And now it has become "very difficult," say the experts, to raise that kind of dough. Investors are slowly putting two and three together. The pair of mortgage lenders needs more cash. Their industry is in full flight. Their capital is disappearing. Their collateral gets marked down every month: "Hey, maybe we should sell the stock!"
The result of these deliberations was a bad day on Wall Street for the twins, bringing total losses into the billions for remaining stockholders, who were too slow or too dull to sell their shares. Overall, the Dow lost 56 points…and oil sold off $3.48, but remained above $141. Commodities fell…with the CRB down 19 points. And gold, too, got whacked for a $4.80 loss, bringing an ounce of gold to $928.
Everyone is waiting for the top in the oil market. We don't know where it is, anymore than anyone else. Our only advantage is that we know it is there somewhere. Oil is a useful commodity. It responds to the laws of supply and demand. Every roughneck with a rig is now drilling down and trying to get more oil to sell. And every motorist, industrialist and householder is looking for ways to not buy it. Somehow, somewhere they'll bring the price down.
Wait…oil also responds to money. We saw an estimate yesterday that 25% of oil's price increase since 2003 was because of the dollar falling against foreign currencies. What about the other 75%? That too, is probably largely a feature of a dollar that is losing its purchasing power against consumer goods and raw materials. All paper currencies are going down; prices rise. For the last 100 years, the oil price has tracked - more or less - changes in money supply growth.
As M3 increased, so did the price of oil. Currently, the money supply - as measured by M3 - is increasing at an annual rate of about 18%. Oil is going up - on a 10-year moving average basis - about 23% per year. Looked at another way, from 1974 to the present, the price of oil has gone up a bit more than 14 times. M3, meanwhile, has gone up a bit more than 11 times.
What does this mean? Please don't get us mixed up with someone who knows, dear reader. We're just guessing. But our rough guess is that oil is a bit overpriced anyway you look at it. And as it responds to normal market signals, it is bound to be beaten down. But let's return to our story. Poor Freddie and Fannie! They need to raise money.
And if a report leaked from Bridgewater Associates turns out to be correct, so will a lot of other businesses…and governments. Bridgewater's confidential memo - which got out to the Swiss press and then made its way to Ambrose Evans-Pritchard at The Telegraph in London - says that losses from the credit crunch could go as high as $1.6 trillion…four times as high as official estimates from the IMF. And it only gets worse…
*** One trillion, six hundred billion dollars is a lot of money. If Bridgewater is right, the whole financial sector will be gutted. You'll remember, dear reader, after manufacturing pulled out of America, the financial industry was left. And retail. Housing. Services. And not much else. The center of economic power shifted from Detroit and Trenton - where they made things - to Manhattan, where they financed them.
Mothers ceased wanting their babies to grow up to be CEO of General Motors; they wanted them to go to Wall Street. That's where the real money was. Finance was the key not only to huge profits itself, but also to the growth of the retail and housing sectors. People bought durable goods and consumer goods on credit. No credit; no purchases. No purchases; no consumer economy. Well, now GM has lost 75% of its value…and the financial industry is not far behind.
Well, Bridgewater goes on to say that a $1.6 trillion loss in the financial industry will mean a loss of $12 trillion in credit to the economy as a whole. When the lenders don't have capital, they can't lend it out. Typically, they lend $10 for every dollar of capital. So if a dollar of capital is wiped off their balance sheets, as much as $10 of credit is erased from the economy.
Here at The Daily Reckoning headquarters in Europe, we're used to high prices. One billion? Heck, we spend much that on lunch. But $12 trillion begins to sound like real money. And $12 trillion taken out of the U.S. consumer economy begins to sound like the Great Depression. Like Japan, 1990-2006…only worse. Collapsing asset prices. Rising unemployment. Bankruptcies. Defaults.
Of course, no central bank or government will go into that good night without a fight. The Fed will cut rates…and lower reserve requirements…and probably intervene directly in markets. Banks will be effectively nationalized…as has already happened with Northern Rock in Britain. The federal government will increase borrowing and spending to try to offset the money disappearing from the markets and the economy. Yesterday, we mentioned $1 trillion deficits. Think $2 trillion deficits. Maybe more.
Here's the truth folks:
- You can't run a credit book with well under 1% of its total value held in capital base. The reason should be obvious - even in "good times" you're likely to see 1% default rates, and in bad ones, history says you could see ten times that much. You WILL go bankrupt doing this if you HONESTLY report what's on your books.
- The banks and other financial institutions are NOT adequately capitalized when you pull all the off-balance-sheet crap back on their books and force an honest accounting of the payment capacity of the "protection" they hold via the unregulated swap market.
- Bernanke and Paulson know the above is the case.
- They are desperate to hold the ball of string together without forcing the banks to take their medicine, which would sink a significant number of them and force many of the rest to divest themselves of assets at whatever price they can get and thus become smaller and less powerful.
- Its not working nor can it, because the underlying problem is the valuation of the "assets" behind the debt is deficient by up to half of the outstanding loan balance.
- Nobody in their right mind who is upside down to a significant degree (10% or more) and cannot be attached for the deficiency (either because they don't have it to take or are in a "no-recourse" situation) should sit still for this. Contract law recognizes a thing called "efficient breach" for a reason! Businesses do this all the time and you should too if it makes sense in your particular set of circumstances. Under absolutely NO circumstance should you EVER touch 401k, IRA or other tax-sheltered retirement money in an attempt to keep your house as in virtually all cases such assets are one of the few things that creditors cannot attach and seize in a bankruptcy!
- This problem is NOT limited to a few "small banks" as you may have been told or led to believe. Have a look at the stock prices of any of the regionals with exposure in California and Florida - the big regionals. WaMu, Wells, Wachovia, Downey, First Federal and of course IndyMac. These firms did not get in trouble writing subprime loans, they got in trouble by writing negative-amortization "pay option" ALT-A paper that nobody in their right mind with a hint of common sense would have EVER written.
Absolutely NOBODY outside of the blogosphere such as myself, Mish, Roubini and a few others is talking about this. We, on the other hand, have been talking about it for more than a year and in fact, I documented WaMu's horsecrap during their first quarter earnings report last year when a quick look at their 10Q showed that they were paying their dividend from capitalized interest which, of course, is not real money that has actually been received. The regulators have not done jack about this. Still. A year later.
- You want the really bad news? The FDIC only has $50 billion in actual assets. Now most of the time they don't eat much on a bank closure, as they get another solvent bank to "eat" the dead one's deposits and thus their actual "pay out" is quite small. BUT, in a real "oh crap!" scenario the government would either have to disavow them or backstop them. In the former case you lose your money. In the latter the yield curve ramps higher and borrowing costs go to the moon.
Assuming that The Government calculates that telling "insured" depositors to piss off would result in an immediate deployment of torches and pitchforks, you must therefore expect that if you're in debt or NEED access to credit to function and the failures start to get ugly that you will be absolutely screwed even if you're so-called "insured", as your borrowing costs will skyrocket.
Ilargi: Meanwhile, Canadians are actively encouraged to stick their heads in the -oil- sand. Good luck with that. The Canadian dollar is “undervalued”, say the experts, while the prime minister says inflation in under control. The same genius now blames developing nations for greenhouse emissions, not Canada, where per capita energy use is the highest in the world, and where the oil sands guarantee huge increases in emissions.
Oh, by the way, as it goes with ostriches, your ass is sticking out, Carney!
Bank of Canada ends emergency lending
Canada is emerging as an oasis of calm in global credit markets that are otherwise beset by caution and doubt.
The Bank of Canada said yesterday that it is ending a $2-billion emergency lending program it started at the height of the credit crunch to make liquidity available to cash-starved banks.
Governor Mark Carney's assessment that Canadian lenders no longer need the central bank to secure funds stands in stark contrast to his U.S. counterpart's view of credit conditions south of the border. As Mr. Carney signalled the coast was clear, Federal Reserve Board chairman Ben Bernanke told a conference in Arlington, Va., that "short-term funding markets remained strained" and that he may extend some of the Fed's extraordinary liquidity measures.
The difference reflects Canada's relatively stronger economy, which is getting a lift from rising incomes and higher commodity prices. Canada's banks also are healthier than U.S. institutions because Toronto-Dominion Bank and others limited their exposure to securities backed by U.S. subprime mortgages. Those assets have become essentially worthless in the wake of the collapse of the U.S. housing market.
"U.S. banks will likely need access to more liquidity, and for longer, than the Canadian banks," said Dustin Reid, a currency strategist at ABN AMRO in Chicago and former trader at the Bank of Canada. "The worst appears to be over domestically for Canada."
Easier lending conditions will give Mr. Carney and his fellow policy makers on the governing council more freedom to raise interest rates if they sense inflation is getting out of hand, since one of the reasons they slashed interest rates aggressively through the first half of the year was to encourage banks to lend.
The Bank of Canada left its benchmark lending rate at 3 per cent last month, saying worries over faster-than-expected price increases outweighed concern over weaker U.S. demand for exports. Along with lowering the cost of money, the Bank of Canada sought to fight the credit crunch by making 28-day loans available to banks at an auction, transactions it referred to as term purchase and resale agreements, or term PRAs.
The central bank issued separate batches of the short-term loans, worth $1-billion apiece, in December and rolled over the funding agreements as each came due. The Bank of Canada ended the original $1-billion PRA when it matured on June 26.
"This decision reflects the continuing improvement in market conditions since the end of April, including funding conditions out three months," the Bank of Canada said in a statement yesterday explaining its decision.
Ilargi: Let’s contrast the happy tidings blowing from Carney and Harper’s derrières (their heads are busy elsewhere, remember?) with the latest post from Garth Turner at greaterfool.ca. Garth has a book out with the same name, and he is one of the lone voices -as a Member of Parliament, no less- who have a well-documented, non-cheerleading overview of what’s about to befall Canada.
Canada: 'There is no market'
A follow-up to the last post on the future of suburbia: Last summer, on my political blog, I said the big story, then on nobody’s radar, would be real estate. My bleatings continued with little effect, so I decided to write a book about it.
“Greater Fool” was published three months ago and is now into its second printing. My premise was simply that the US real estate correction would come to Canada, and it took me 200 pages to explain why. Trust me, subprime mortgages have little to do with it.
But, it’s academic now. Because it’s arrived. At least the start of the beginning has arrived. And I will say it again: This is the biggest story to impact the middle class, especially combined with our current, and mounting, energy crisis. In fact, the political party which comes up with an agenda of action for that beleaguered middle class will have a potent advantage in the next federal election.
Remember, after all, that it was the housing collapse in the US which brought that economy to its knees, devalued the greenback, goosed oil prices, created a global financial crisis, and cost Canadian banks about $10 billion. This, of course, is not over yet. American real estate prices have declined every month for 16 months; year-over-year values are down 15% nation-wide with some markets off 40%; and it’s estimated the bottom is at least a year away.
Over 3,000,000 families have negative equity and there are over a thousand foreclosures a day. This is the worst housing crisis since the Depression, and it has spurred similar retreats from Europe to Australia.
Canada is not immune from this contagion. For a year I’ve been warning the policies of the federal government would exacerbate this situation, and it’s happened. Ottawa has continued to milk stressed-out middle-class families, refusing to cut income taxes. Government spending’s been out of control, and we’re perilously close once again to deficit.
Over 400,000 manufacturing jobs have been erased, some because of the hollowing-out of national industry, others because Ottawa helped talk up the dollar and smash our competitiveness. The income trust decision wiped out much-needed private savings and nuked too much investment in oil and gas. And, of course, the government paved the way for 40-year mortgages which have coaxed so many young couples into buying too much house with too much debt.
But don’t just take my word for it. The pattern is always the same. First, sales volumes drop for resales homes, and months later prices start to tumble. Right now, as has been pointed out on this blog, Calgary and Edmonton are in the price-decline stage, with the average home in the Albertan capital down 11% over the past year, or a whopping $44,000.
In Toronto and Vancouver, sales are falling off a cliff, which likely means prices will deteriorate by the end of the year. Home sales in the GTA are down 18% over this time last year, and crashed 9% last month alone. In Vancouver, despite the hype of the 2010 Olympics, the situation is even more dire. Sales have crumbed by 43% in a year, and the number of people trying to bail has grown steadily, with listings up 18%.
Again, don’t take my word for it. Talk to a neighbour or a friend about home sales in their communities. You will find selling a home right now is a nightmare in most places, an impossibility in some. Too many young couples who bought at the limit of their financial ability, and thought they could always sell for a profit in a weekend, are devastated.
I spoke with a realtor friend two days ago – a guy I’d warned about this last December – and he was in shock. “It’s like a light switch was flicked off,” he said. “Suddenly people who need to sell are asking me how cheap they have to go, and people who wanted to buy two months ago are too afraid to make an offer.There is no market.” He specializes in cottage properties, and swears the value of an average $400,000 property dropped by a hundred grand last month.
Don’t be fooled. This is not just an economic story. It’s not about a natural cycle in the housing market. This is a societal tidal wave, since over 80% of entire family net worth is in residential real estate. We’ve all had three years to watch this unfold in slow-motion south of the border. Now it’s here.
Australia: economic gloom deepens
Bad economic numbers are coming in thick and fast, with home-loan approvals falling sharply and consumer sentiment hitting a 16-year low. Home-loan approvals fell to an 8-year low in May as the Reserve Bank's 7.25% interest rate turns consumers away from buying houses.
The number of home loans, seasonally adjusted, dropped 7.9% in May, the lowest since June 2000, according to data from Bloomberg. The May figure is down from 3% in April. Analysts polled by Bloomberg expected the number of home loans to fall 2% in May.
"The numbers are pretty hideous," said George Worthington, chief Asia Pacific economist for Thomson IFR. "The combined effect of the RBA's rate rises and the commercial banks interest rate increases have really slammed the market." "I would have thought the effect (of the rate rises) would have been close to finishing though it looks like it's got more to play out," he said.
Mr Worthington noted the number of new mortgages hit a three-and-a-half year low and that the purchases of newly built homes has been falling steadily for 11 months. Loans for new homes lead the fall, plunging a seasonally adjusted 13.5% in May, followed by loans for existing homes, which dropped 8% as consumers showed an unwillingness to take on home purchases amid signs of a slowing economy and higher inflation. Credit extended for the construction of new homes dropped 5%.
The declining home loan market provides further evidence that the RBA's inflation fighting efforts are having their desired effect. The RBA ratcheted up the cash rate to a 12-year high in March in the hope of triggering an economic slowdown that avoids a recession. High petrol prices and food prices are complicating the RBA's inflation battle even while giving consumers more reason to stay at home and spend less.
The surprisingly sharp drop in home-loan approvals comes as consumer sentiment fell to a 16-year low in July, as rising petrol prices erode confidence about the economic future. The monthly Westpac-Melbourne Institute survey shows consumer sentiment fell 6.7% in July to 79 points down from 84.7 points in June, well below the 100 points mark indicating that pessimists outnumber optimists.
The reading is down for the sixth straight month as consumers grapple with runaway petrol prices, and is now at its lowest level since January 1992, when consumers were still shaking off the effects of a two-year recession. "The most probable explanation for the sharp fall in the index is likely to be petrol and oil prices," Westpac chief economist Bill Evans said in a statement.
"Average petrol prices rose by 3.4% since the last survey to be up 15.3% over the last three months. Crude oil prices were reported to have increased by 11.5% since the last survey." Consumers can expect little immediate relief as the effects of soaring oil prices flow through to the Australian market. Crude oil has surged to above $US140 a barrel in recent weeks. Fuel prices are also contributing to the cost of bringing food to market.
"There is historical evidence to support petrol prices as the key explanation behind this recent fall in sentiment," said Mr Evans, who noted that interest rates remained steady over the past three months. The Reserve Bank's flat 7.25% cash rate is being overshadowed by the 15.3% rise in petrol prices over the same period, he said. Over the same three months, the consumer sentiment index has dropped 9.6%
Climate change report like a disaster novel, says Australian minister
· Scientists predict 10-fold increase in heatwaves
· Greenhouse gases blamed for half of rainfall decrease
A new report by Australia's top scientists predicts that the country will be hit by a 10-fold increase in heatwaves and that droughts will almost double in frequency and become more widespread because of climate change.
The scientific projections envisage rainfall continuing to decline in a country that is already one of the hottest and driest in the world. It says that about 50% of the decrease in rainfall in south-western Australia since the 1950s has probably been due to greenhouse gases. Yesterday, Australia's agriculture minister, Tony Burke, described the report as alarming and said: "Parts of these high-level projections read more like a disaster novel than a scientific report."
The analysis, commissioned by the government as part of a review of public funding to drought-stricken farmers, was published days after another report, by Professor Ross Garnaut, warned that Australia had to adopt a scheme for trading greenhouse gas emissions by 2010 or face the eventual destruction of sites including the Great Barrier Reef, the wetlands of Kakadu and the nation's food bowl, the Murray-Darling Basin.
The prime minister, Kevin Rudd, who swept to victory on a green agenda last November, said the analysis by the Bureau of Meteorology and the Commonwealth Scientific and Industrial Research Organisation was "very disturbing". The reports will put pressure on him to act swiftly on his pledge for Australia to lead the world in tackling polluters.
However, the rising cost of living has dented his government's popularity and his plans for a carbon trading scheme have begun to unnerve voters and industry. Rudd has acknowledged that tough debate lies ahead and has said the government will map out its policy options this month.
Yesterday's report revealed that not only would droughts occur more often but that the area affected would be twice as large as now. The proportion of the country having exceptionally hot years could increase from 5% each year to as much as 95%, according to the projections.
The report says rainfall in Australia has been declining since the 1950s and about half of that decrease is due to climate change. It says the current thresholds for farmers to claim financial assistance are out of date because hotter and drier weather will become the norm.