A new sidewalk in Washington, or the Maryland suburbs.
Ilargi: A lot of media attention these days for an article in Barron’s about the demise of Fannie and Freddie (which is at the bottom of this Debt Rattle).
Shares in both companies have fallen 15% so far this morning. Their combined market cap is now approaching a mere $10 billion, and that is supposed to support $5.3 trillion in debts and obligations.
The shares will keep falling, they’re beyond redemption; Barron’s includes the statement -which I’ve made here for ages- that common shareholders will be ceremoniously sacrificed. So will management. But they get to keep their pirated casino bonuses.
Since Barron’s estimates that Fannie and Freddie’s real value is negative $50 billion -each-, look for the Treasury and the Fed to figure out a way to pump $100 billion past the receding event horizon that envelops these companies.
And that will by no means be the last we hear of this. After all, $100 billion is still a far cry away from $5.3 trillion. If -make that when- US housing continues to falter, a lot more money will be needed. Long before Christmas.
The upcoming resets in Alt-A mortgages over the next few years provide an ironclad guarantee that US real estate, and hence Fan and Fred, will be hit hard. And the resets are but one in a long range of factors.
That makes all this not a financial, but a political issue. Whatever money will be used to buy out the two, will come from public coffers. And people will increasingly demand to know why the money should be used the way it is, especially as the whole economy starts contracting painfully later this year.
But it will be too late by then: the debts of the gambling community on Wall Street will have been transferred to your pockets, and you’ll be powerless to do anything about it. Fannie and Freddie will be nationalized in one form or another, so they will belong to you soon, debts included.
Both parties in Washington strongly support the biggest financial crime in world history, and there’s nobody else you can vote for. Really, it’s a closed system, it’s been thoroughly tested for leaks.
A good way to get an idea of what lies ahead for all countries comes from UK real estate: Asking prices for houses in London fell 5.3% in August, a $40,000 drop in value per home, in a single month.
I still see numbers floating around of a 30-40% drop in US real estate prices, peak to trough, and I’m starting to get annoyed at these numbers. They're wild guesses based on nothing much at all. Please someone explain what exactly it is that is going to stop the decline once it’s past 30%.
I don’t see anything that could do that. There is a fast and furious contraction of available credit going on, and no lender will be left to finance home purchases on any workable scale.
The only possibility left in that climate is this: Prices will keep on falling, and lose 80% or more. It’s a complete freefall, with no brakes, no safety net and no parachute.
Fannie and Freddie: Worth Negative $50 Billion Each
Fascinating piece in Barron's this week on our favorite junk paper: Phoney and Fraudy. A few interesting factoids about the GSEs, many of which you may have been unaware of:
- In the "1980s Fannie was effectively insolvent";
- These two GSEs currently have $5.2 trillion debt and guarantee obligations;
- Both balance sheets contain a tax credit entry called "deferred tax assets." These increase Fannie's net worth by $36 billion and Freddie's by $28 billion. They don't represent real cash, but are merely paper credits built up over the years. The worse shape the companies are in, the greater these credits are. To insolvent companies like FRE & FNM, they are meaningless accounting entries.
- The CEO claim that losses were due to being "forced to buy higher-risk mortgages to meet government affordable-housing targets" is provably untrue; The vast bulk of GSE losses came from mortgages where there was no attempt to verify borrowers' income or net worth. And, most of these mortgages were for principal balances much higher than mortgages made to low-income borrowers;
- It was the lack of lending standards -- LTV, Income verification, FICO scores, debt servicing abiloity, down payments, etc. -- that was the primary cause of losses, and not a "soft" government goal;
- A substantial portion of Fannie's and Freddie's credit losses ($337 billion and $237 billion respectively) comes from not sub-prime, but Alt-A. These mortgages were the real-estate speculation in the ex-urbs of Las Vegas and Los Angeles;
- Freddie CEO Syron has recently said they did not want to dilute current shareholders further.
US banks scramble to refinance maturing debt
Battered US financial groups will have to refinance billions of dollars in maturing debt over the coming months, a move likely to push banks’ funding costs higher and curb their profitability, say bankers and analysts.
The banks’ need to raise capital to offset mounting credit-related losses is forcing them to pay higher interest rates to entice investors. The rising funding costs are set to put pressure on earnings because, in many of their businesses, banks rely on the difference between borrowing and lending rates to make money.
“It is difficult to see how banks will continue to repeat the heady profit growth of the past few years if they borrow at these levels,” said a Wall Street banker. Banks could also be forced to raise lending rates, exacerbating the credit crunch felt by many businesses and individuals and further depressing economic activity.
Mohamed El-Erian, co-chief executive of Pimco, the asset management group, said: “If banks keep borrowing at these levels, you will get a repricing of credit for the whole economy.” Last week, financial groups including Citigroup, JPMorgan Chase and American International Group borrowed almost $20bn in new long-term debt, paying some of the highest interest rates ever in order to lock in funding.
The wave of refinancing is set to continue for several months as billions of dollars in bank debt come due. For example, Citigroup has more than $5bn of maturing bonds in August, but this climbs to $12.8bn in December, according to Dealogic data. Bank of America, with $7bn maturing in August, also faces higher refunding needs in December, with $9bn of maturing bonds.
Adding together 10 of the biggest bank borrowers, Dealogic said that maturing bonds total $27bn in August, $52bn in September, $23bn in October, $20bn in November and $86bn in December. The extent of the scramble for funds became clear last week when banks tapped central lending facilities, with strong demand for one- and three-month money lent by the Federal Reserve and the European Central Bank.
US commercial banks borrowed a record daily average of $17.7bn from the Fed last week. The lack of investor demand for structured finance products means that more short-term funding will need to come from traditional money market products, according to analysts.
Morgan Stanley Sees 2009 As The Year Of The Locusts
In the current age of financial pessimism, Morgan Stanley does not want to be bested. In a show of unusual courage, its president is predicting that the world of Wall St. will get progressively worse and not emerge from the current crisis for more than a year.
The financial crisis will probably not end until next year or even 2010, Germany's Handelsblatt newspaper quoted Morgan Stanley co-President Walid Chammah as saying. While a number of securities analysts and economists have predicted hard times for the next several quarters, Chammah's comments are at the cutting edge of financial executives willing to rat out their own industry.
Telling the truth may be back in vogue in the brokerage and banking industries. It is almost certain that when industry titans say their world is getting worse it means they have looked at the prospects for their future quarters and seen nothing but an abyss looking back at them.
The IMF has already said that mortgage-paper-related write-offs will hit $1 trillion. Only about 50% of that has been accounted for in financial company earnings. Barron's wrote that the common shareholders of Freddie Mac and Fannie Mae will be wiped out in a recapitalization by the government.
That may only be the beginning of resetting the value of large financial firms. The industry is now willing to accept a future it could not stand looking at as recently as a month ago.
Debt sales push US corporate bond risk to new highs
U.S. corporate bond yields have surged back to record levels relative to Treasuries after Citigroup and other financial firms sold a flurry of high-coupon debt last week, pressuring yields upward in the broader market.
The rising yields demanded by investors to buy corporate bonds are the latest sign that credit strains persist despite Federal Reserve moves to calm financial markets. Average investment-grade bond yields hit 3.05 percentage points over Treasuries on Friday, matching a record high hit on March 20 after the collapse of investment bank Bear Stearns, according to Merrill Lynch data.
"The momentum behind the move came from the financials index," fixed-income research service CreditSights said in a report on Saturday. Yields on financial companies' bonds rose by 9 basis points last week to 370 basis points over Treasuries, "wider even than at the time of the Bear Stearns bailout," CreditSights said.
Persistently high borrowing costs for banks could further curb their ability to lend, worsen a cash crunch at the sickest companies and extend an economic slump. Citigroup last week had to offer yields of over 6.5 percent, or 3.375 percentage points more than Treasuries, to entice investors to buy $3 billion of five-year notes.
In April, Citigroup sold $4.5 billion of five-year notes at a 5.6 percent yield, or 3 percentage points over Treasuries. Since then, deteriorating capital markets and a slumping economy have triggered massive write-downs at the bank. On July 18, it posted a $2.5 billion second-quarter loss, smaller than the market expected, amid $11.7 billion of write-downs and losses.
American International Group last week paid an 8.25 percent yield, a level more common on junk bonds, to sell $3.25 billion of 10-year notes. AIG is rated in the double-A range. "Increased new issuance is expected in the upcoming months, reducing demand for bonds in the secondary market," JPMorgan analyst Eric Beinstein said in a report on Friday.
Funding costs on new issues are pushing bond spreads wider, compared with credit default swaps, he said. A government rescue plan last month for mortgage giants Freddie Mac and Fannie Mae eased investor fears for a while, but the positive mood reversed amid more write-downs and analyst downgrades of financial firms.
A year-long credit crisis may be only half over at best and banks may face more write-downs from soured mortgage debt and problems at bond insurers, Standard & Poor's said last week.
Four of Wall Street's biggest investment banks were downgraded last Wednesday by Merrill Lynch & Co analyst Guy Moszkowski, who said conditions have deteriorated significantly since July. Analysts at Oppenheimer & Co, Lehman Brothers and Deutsche Bank Securities also lowered earnings forecasts for various banks last week.
Bernanke Tries to Define What Institutions Fed Could Let Fail
Ben S. Bernanke is still trying to define which financial institutions it's safe to let fail. The longer it takes him to decide, the tougher the decision becomes.
In the year since credit markets seized up, the 54-year- old Federal Reserve chairman has repeatedly expanded the central bank's protective role, turning its balance sheet into a parking lot for Wall Street's hard-to-finance bonds and offering loans through its discount window to investment banks and mortgage firms Fannie Mae and Freddie Mac.
The lack of clearly defined limits may put the Fed's independence at risk as Congress discovers that its $900 billion portfolio can be used for emergency bailouts that might otherwise require politically sensitive appropriations and taxes.
"There is some hard thinking that needs to be done," Philadelphia Federal Reserve Bank President Charles Plosser said in an interview last week. "The Fed has a terrific reputation as a credible institution. We have to be cautious not to undertake things that put that credibility at risk."
The expanding role of central banks will be the hottest topic in the room when Bernanke addresses his counterparts from around the world at the Kansas City Fed's Jackson Hole, Wyoming, symposium Aug. 22. Since taking on $29 billion in Bear Stearns Cos. assets to facilitate the failing firm's takeover by JPMorgan Chase & Co., Bernanke has made several moves that imply further expansion of the central bank's mission.
He granted a congressional request to accept bonds backed by student loans as collateral for Fed securities loans. And he didn't object when Congress inserted a provision into the housing bill signed into law last month that makes it easier for the Fed to lend to failed banks under government control.
"They want to placate the Congress and the financial markets," says Fed historian Allan Meltzer; doing so sets a "terrible precedent." Policy makers are aware of the concern. The Federal Open Market Committee has ordered a formal study of the implications of the Fed's broader role in fostering financial stability, drawing on research from throughout the Fed system.
Under Bernanke's predecessor Alan Greenspan, the Fed drew a clear line against using its portfolio to influence specific markets. An internal study published in 2002 warned that "the favoring of specific entities" might "invite pressure from special-interest groups."
Just three days after the Fed approved a loan against Bear Stearns securities, Pennsylvania Democratic Representative Paul Kanjorski and 31 other lawmakers sent Bernanke a letter asking him to open the discount window to nonbank education-loan companies. Bernanke refused.
The 2002 study said such pressures "could pull the Fed into fiscal debates" and "compromise its objectives" for monetary policy: keeping employment high and inflation low. "How can you be independent on one score and dependent on another?" asks Vincent Reinhart, former director of the Fed's Monetary Affairs Division, who advised both Bernanke and Greenspan.
Officials "are overburdening the Federal Reserve, and that sets up the potential for multiple conflicts," he says. "They use up their credibility on nonmonetary issues, they lose their independence and they dilute their expertise."
Reinhart, now a resident scholar at the American Enterprise Institute in Washington, is one of several Fed alumni who say they are concerned the central bank will next face requests to rescue hedge funds or insurance companies whose failure might damage the financial system.
"It is much harder to say no when you have the precedent," says J. Alfred Broaddus Jr., former president of the Richmond Fed. "Congress needs to find a way to structure something else to take the Fed out of this." The Fed chairman's decisions are a decisive break with Greenspan's aversion to government interference in markets, a conviction that even permeated the central bank's day-to-day operations.
On Aug. 10, 2005, when Greenspan was chairman, 94 percent of the Fed's $24 billion in outstanding repurchase agreements with Wall Street were in U.S. Treasury notes. On Aug. 10, 2008, only 14 percent were in Treasuries, with the rest in mortgage bonds and agency securities, according to Wrightson ICAP LLC in Jersey City, New Jersey. The New York Fed says agency and mortgage-backed securities "became more attractive."
"They have had to abandon all principles that guided their earlier debates," says Lou Crandall, chief economist at Wrightson. The objective now is "how you get the most market impact." To Bernanke, the decisions of the past 12 months may well have protected the Fed's independence from far greater erosion that might have occurred if the central bank had stood aloof while financial markets melted down.
The former Princeton University scholar views the Great Depression as a fiasco that compromised the Fed's credibility, bringing an onslaught of regulation and a congressional review of the Federal Reserve Act. If the Fed had walked away from Bear Stearns, it would have led to higher unemployment, a deeper downturn and a longer recovery, all of which would have brought even greater political pressure on the Fed, the chairman's defenders argue.
"It is not an easy sell," Bernanke told Senator Evan Bayh, an Indiana Democrat, during an April 3 hearing on the Bear Stearns rescue. "But the truth is that the beneficiaries of our actions were not Bear Stearns and were not even principally Wall Street. It was Main Street."
Bernanke added that "the financial system has been under a lot of stress and that has affected our ability to grow. It's affected employment. It's affected credit availability." Bernanke's actions have been informed by his own research with New York University's Mark Gertler showing that damaged banks accelerate economic downturns.
That threat has multiplied in a new financial system where mortgage lenders may not even be banks, and mortgages are warehoused in funds off the books of banks. "We are in a new environment, and the Fed had to do something different," Gertler says. "Moving forward, the regulatory structure has to adjust."
Fed officials have been cautious about suggesting what new supervisory powers they would like or how their lender-of-last- resort powers should function in the future. Bernanke said in a July 8 speech that a "strong case can be made" for expanding the Fed's authority over the U.S. payment system, the complex network of financial plumbing that handles the exchange of money from such transactions as options trades in Chicago and stock sales in New York.
The Fed also is pushing for better settlement and trading systems for securities that aren't bought and sold on exchanges. Beyond that, the Fed chairman has expressed wariness over the U.S. Treasury's recommendation that the Fed become the "market-stability regulator." "Attention should be paid to the risk that market participants might incorrectly view the Fed as a source of unconditional support," he said in the July 8 speech.
Even so, the Fed has already expanded its supervisory reach. It has become a temporary consulting regulator of Fannie Mae and Freddie Mac, working with the Office of Federal Housing Enterprise Oversight. An agreement with the Securities and Exchange Commission allows the Fed to make recommendations on the capital and liquidity positions of investment banks.
The Fed is also more actively using its authority to supervise nonbank consumer-finance subsidiaries of bank holding companies, such as the CitiFinancial unit of Citigroup Inc. To "a large degree," it appears the Fed " is going to become a major regulator of financial institutions," says Ross Levine, a Brown University economist who has written a book on bank regulation.
With that comes the danger that measures the Fed has to take to enhance stability may end up restraining economic growth, Levine says. "That can come at a very big cost to innovation and the welfare of the country," he says. Plosser, the Philadelphia Fed president, says the central bank is struggling internally with such concerns.
"What has been put on the plate is the broader role of central banks in their effort to promote or ensure financial stability," he says. "We have to face up to the potential risks to the conduct of sound monetary policy from acquiring these other responsibilities."
Mean Street: Fannie and Freddie–They Shoot Horses Don’t They?
One of these mornings, we will wake up, turn on CNBC and watch Treasury Secretary Hank Paulson announce the nationalization of Fannie Mae and Freddie Mac. At least, that is what should happen.
Fannie and Freddie are mortally wounded institutions and need to be dispatched as cleanly and quickly as possible. If politics would only allow it, we would all be better off. Of course, Hank need not call it “nationalization.” Call it a “pre-emptive government sponsored investment” into a GSE, or government-sponsored entity.
There would be, of course, some prickly legal issues involved in taking over these companies and wiping out the common shareholders. One popular scenario posits the Treasury would put roughly $15 billion of preferred equity into each institution. The common equity would be erased. And the board members of the GSEs would be replaced with representatives from the Treasury, Federal Reserve and the new GSE regulator.
Naturally, free-market disciples will shudder at the idea of a government takeover. But it would simply be the formal acceptance of realities that already are well understood by the stock market. These realities: Fannie and Freddie are “bankrupt” institutions. The housing market is a mess. And it is only a matter of time before the “implicit” guarantee of the U.S. government becomes “explicit.”
The government’s current strategy to backstop Fannie and Freddie, rather than overhaul them, is a politically expedient way to buy time. But at some point in the next few months, given the dour trends in the housing market, time will run out. And then what? This is Paulson’s choice.
He can either continue to muddle along and inject a few billion dollars of preferred equity into Fannie and Freddie on an “as needed” basis until the end of the Bush administration in January. Or he can go full steam ahead with a pre-emptive government takeover of Fannie and Freddie. Ironically, this radical step would make Fannie and Freddie an election issue. And perhaps only that would create momentum for true GSE reform.
The unfortunate reality is that politicians won’t embark voluntarily on a GSE overhaul a few months before an election. It isn’t a vote-winning issue. They would rather throw money at Fannie and Freddie and pray for a housing rebound. So why bring it up? Well, because Fannie and Freddie desperately need to be overhauled. They stand at the center of the multitrillion-dollar U.S. mortgage system. They are failing and taking the system down with them.
As Alan Greenspan argued in this week’s Wall Street Journal, Fannie and Freddie need to be broken up into a half dozen or more units and, eventually, privatized. But that requires a fight in Congress and legislation, neither of which will happen before the election.
So let us give the American voter his due. Put the issue of overhauling the GSEs front-and-center as an election issue by nationalizing Freddie and Fannie. Do it sooner rather than later. Of course, the doomsayers will tell you that to nationalize would be crazy. It would set bad precedent. Hugo Chavez, anybody? It would increase the nation’s liabilities by $5 trillion, weaken the dollar and fuel inflation.
That all seems unlikely. A creeping nationalization of Fannie and Freddie already is priced into the markets. The dollar has been rallying on the notion that things may be bad here, but are worse overseas. On the morning of the Treasury’s announcement of its “investment,” the Dow will rise 500 points. The market likes certainty–even if it doesn’t like what it is certain about.
Hot, and Not
Those preaching inflation simply do not understand the Implications of the Slowing Global Economy. Let's take a look at this from a second angle; What's Hot and What's Not.
• Walking Away
• The Frugality Reality
• Raising Capital At Any Price
• Small Cars and Driving less
• Camping Close To Home
• Collapsed Trade Talks
• Tightening Lending Standards and Peak Credit
• Home Cooking
• Rising Corporate Bond Yields
• Rising Risk Spreads vs. Treasuries
• Layoffs And Rising Unemployment
• Rising Savings Rate
• Leverage Buyouts
• Toggle Bonds
• Covenant Lite Agreements
• The Securitization Model
• The Shopping Center Economic Model
• Hummers, Trucks, And SUVs
• Private Jets
• Flaunting Wealth
• The Idea That Housing Always Goes Up
• Whole Foods
• Eating Out
• Expensive Vacations
Of course inflation and deflation are not about prices at all but rather about money supply and credit, and credit (especially credit marked to market) is plunging. That is restricting bank lending, business expansion, etc. Consumers now finally realize they cannot depend on rising home prices as their retirement. The Savings rate in the US is soaring.
Finally, "price inflation" which is what Castle is talking about is a lagging indicator. So even from a "price inflation" standpoint, I am willing to take the other side of the bet. Year over year CPI comparisons are going to be easy to beat for quite some time to come.
Lehman Faces Another Loss, Adding Salt To Its Wounds
Lehman Brothers Holdings Inc. has been taking its time as it wrestles with how to escape the problems haunting the investment bank. It probably can't wait much longer.
With the end of the New York company's fiscal third quarter less than two weeks away, some analysts are girding for a loss of $1.8 billion or more, instead of the modest profit they previously expected. If the dour projections come true, Lehman's losses since the start of March would total at least $4.5 billion -- or more than the firm churned out in profit during fiscal 2007.
The likelihood of back-to-back quarterly losses, fueled by widely anticipated write-downs in a portfolio saddled with more than $50 billion in risky real-estate and mortgage assets, puts even more pressure on Lehman Chairman and Chief Executive Richard S. Fuld Jr. to show that the losses won't keep piling up. If they do, Lehman could need to raise additional capital beyond the $6 billion it got in June.
In the past few months, Lehman officials have examined an array of options to bolster the company's financial position, ranging from selling troubled real-estate assets at a discount to divesting a piece of profitable asset-management unit Neuberger Berman, according to people familiar with the matter.
Another stock offering would be hard to pull off without angering existing shareholders, largely because the tidal wave of common shares floated in June has since plunged in value by 42%. Lehman shares slipped three cents, or 0.2%, to $16.17 each in New York Stock Exchange composite trading at 4 p.m. Friday.
Lehman has been working hard to reduce its exposure to assets causing it big headaches, and the firm's balance sheet shrank 19% to $639 billion in the fiscal second quarter ended May 31. Lehman is aiming to further winnow its exposure to risky assets by at least 20% a quarter, two Wall Street analysts said last week.
But those moves aren't coming fast enough to offset the misery caused by continuing stress in the housing market, where prices are falling with no end in sight. For example, Lehman holds $10.2 billion of Alt-A mortgages, or loans made to borrowers who didn't fully document their income. The firm has an additional $11.5 billion in exposure to leveraged-buyout financing.
David Trone, an analyst at Fox-Pitt, Kelton, predicts that Lehman will write down its Alt-A portfolio by about $1.7 billion, or 17%, at the end of the current quarter.
J.P. Morgan Chase & Co.'s write-down of $1.5 billion in Alt-A and other mortgages, disclosed in a securities filing last week, also prods Lehman to take its own haircut on home-loan exposure. Mortgage write-downs also might be triggered by price levels in sales related to the recent restructuring of structured investment vehicles such as Cheyne Finance PLC.
Mr. Trone expects Lehman to pile up overall write-downs of $3.6 billion, offset by $800 million in hedging gains. While that obviously would be painful, it is "not meaningful enough, in our view, to necessitate additional capital raises," Mr. Trone concludes. He expects Lehman to post a net loss of $1.8 billion, far worse than his previous estimate of a $250 million profit.
Guy Moszkowski, a Merrill Lynch & Co. analyst who last week more than doubled his loss projection to $2.6 billion, predicts that Lehman will take a $4.5 billion hit from write-downs, with about 35% of that offset by hedging. He also cut his estimates for Goldman Sachs Group Inc. and Morgan Stanley.
An additional markdown of as much as 20% related to the firm's remaining $64 billion in mortgage and commercial real-estate exposure "seems like a lot but can't be ruled out," Mr. Moszkowski argues. If that were to happen, Lehman might need to raise more capital.
Morgan Stanley and Goldman Sachs change approach to lending
Morgan Stanley and Goldman Sachs are responding to the credit crisis with systems that use the market's view of their own creditworthiness as a basis for lending decisions, according to people familiar with the matter.
These arrangements for determining the size of lending commitments to hedge fund clients were being put in place before the collapse of Bear Stearns. But implementation has gathered pace as investment banks seek ways to guard against the sudden loss of confidence - and resulting withdrawal of market funding - that crippled Bear.
The message is that "if our firm is in trouble, we would rather fund ourselves than fund you [hedge funds]", said a brokerage executive with knowledge of the arrangements. He added: "We would only use it if there were a real issue."
Morgan Stanley is essentially tying its promise to provide financing to hedge fund clients to the prices of credit insurance on its own debt. If the cost of the protection rises to a certain level, that would trigger a reduction in Morgan Stanley commitments to hedge funds. Goldman Sachs is understood to have a similar arrangement that uses its bond prices as a reference point for credit commitments to hedge fund clients.
The shift in lending systems is significant because investment banks are powerful forces in prime brokerage, the business of providing loans and other services to hedge funds.
Morgan Stanley's use of the credit insurance market as a basis for lending decisions underscores the extent to which the derivatives market has replaced rating agencies as the final word on creditworthiness. It could lead to more scrutiny of the reliability of the credit insurance market.
Mortgage insurers spent $1.1 million lobbying government on housing issues in second quarter
The trade group for mortgage insurers spent more than $1.1 million lobbying in the first quarter on issues dealing with the housing market slump, according to a recent disclosure form.
The Mortgage Insurance Companies of America lobbied on a bill to mandate tougher oversight of government-sponsored mortgage finance companies Fannie Mae and Freddie Mac, as well as efforts to prevent foreclosures and modify home loans.
President Bush last month signed sweeping housing legislation that strengthens regulation of Fannie and Freddie.
The bill, which had the mortgage industry's support, also aims to prevent foreclosures by allowing homeowners to swap their mortgages for more affordable loans, but only if their lender agrees to take a loss on the initial loan.
Members of the mortgage insurance group include: American International Group Inc.'s AIG United Guaranty, Triad Guaranty Inc., PMI Group Inc., MGIC Investment Corp., Genworth Financial Inc. and Old Republic International Corp.
Besides lawmakers, the trade group lobbied the Department of Housing and Urban Development in the April-June period, according to a July 18 filing with the House clerk's office .
The race to the bottom has begun in earnest
Two alerts landed on my desk this weekend from the elite markets team at Goldman Sachs. One was entitled "The Dollar Has Bottomed!". Those betting on an imminent disintegration of American economic and political power may have to wait another cycle. Rival hegemons are falling like ninepins.
The US dollar index hit an all-time low in March. It crept slowly upwards in the early summer before smashing through layers of resistance over the past month. The surge against sterling, the euro, the Swiss franc and the Australian dollar is one of the most spectacular currency shifts in half a century. "Something fundamental has changed," said the bank. Indeed.
US industry is now super-competitive, if small. Mid East funds are drawing up shopping lists of Wall Street takeover targets. Airbus and Volkswagen are shifting plant to America to escape crushing labour costs.
US exports have risen 22pc over the past year, outstripping Chinese growth. The US non-oil trade deficit has shrunk by two fifths since 2002. It is now running at $300bn a year. This is 2.1pc of GDP.
The other note advised clients to "Take Profit on Globalization Basket", especially on Eastern Europe currencies. Goldman Sachs has quietly dropped its talk of $200 oil. Even Russia's petro-rouble is now deemed suspect.
The twin missives more or less sum up the dramatic change in mood sweeping financial markets since it became evident that the entire bloc of rich OECD countries has succumbed to the delayed effects of the credit crisis.
Japan contracted by 0.6pc in the second quarter, Germany by 0.5pc, France and Italy by 0.3pc. Spain recalled the cabinet last week for an emergency summit. New Zealand and Denmark are in recession. Iceland contracted at a catastrophic 3.7pc in the second quarter.
"The whole decoupling thesis has started to come apart at the seams," said David Bloom, currency chief at HSBC. "Canada is frozen over. We have Arctic conditions in Sweden, and the UK is falling off the white cliffs of Dover."
The UK economy is not my brief, but I see that hedge funds are circulating a report from the US guru Jeremy Grantham predicting a very bad end to Gordon Brown's debt experiment. "The UK housing event is probably second only to the Japanese 1990 land bubble in the Real Estate Bubble Hall of Fame.
UK house prices could easily decline 50pc from the peak, and at that lower level they would still be higher than they were in 1997 as a multiple of income," he said. "If prices go all the way back to trend, and history says that is extremely likely, then the UK financial system will need some serious bail-outs and the global ripples will be substantial."
For months the exchange markets ignored this impending train crash, just as they ignored the property bust in Europe's Latin Bloc, or the little detail that UBS alone had just lost the equivalent of 8pc of Switzerland's GDP. All they cared about in the currency pits was the interest rate gap: US low, Europe high.
Now the paradigm has flipped. The Fed may have been right after all to slash rates to 2pc. The European Central Bank may have panicked by tightening in July. Note that the elder Swiss National Bank did not do anything so rash.
Bulls now believe America is turning the corner. Financial stocks are up 20pc since early July. Some "monoline" bond insurers have risen 1,200pc in a month as fears of Götterdämmerung give way to sheer intoxicating relief, and a "short-squeeze". Such are bear-trap rallies.
Regrettably, I remain beset by gloom. The US fiscal stimulus package that kept spending afloat in the second quarter is running out fast. There is nothing yet to replace it. The export boom cannot keep adding juice as the global crunch hits. My fear is that the US will tip into a second, deeper leg of the downturn, setting off a wave of savage job cuts. This will start to feel more like a real depression.
The futures market is pricing a 33pc fall in US house prices from peak to trough, based on the Case-Shiller index. Banks have not come close to writing off implied losses on this scale. Daniel Alpert from Westwood Capital predicts that a mere 28pc fall would alone lead to a $5.4 trillion haircut in US household wealth, and leave lenders nursing $1.25 trillion in losses. So far they have confessed to less than $500bn.
Meredith Whitney, the Oppenheimer's bank Cassandra, predicts a gruesome 40pc fall in prices. If so, expect prime borrowers facing negative equity to start throwing in the towel en masse. "I do not think we are near the end of writedowns. I continue to see capital levels going lower, and stocks going lower," she said.
So no, this painful ordeal is far from over. We are not witnessing a dollar rally so much as a collapse in European and commodity currencies. The race to the bottom has begun in earnest.
Fox-Pitt cuts Goldman Sachs Q3 outlook
Fox-Pitt, Kelton lowered its third-quarter earnings estimate on Goldman Sachs Group Inc by 40 percent to $1.95 a share, to reflect weaker-than-expected results across the board and bigger write-downs than projected.
"Goldman is particularly vulnerable to more recent downturns in global equity markets, given its large position as a principal equity investor, equity flow franchise, Asian market participant, and proprietary trader," analyst David Trone said in a note to clients.
Trone, who cut its price target on the stock to $195 from $210, said he expects Goldman's total net write-downs at $2.1 billion. The analyst said he expects a decline in the bank's businesses including equity trading and commodities, principal investment portfolio, securities services, rates and currencies, fixed income and investment banking.
Trone lowered his fourth-quarter earnings estimate to $4.40 from $5.25 a share, and cut his 2009 estimate to $16.01 from $17.19 a share, reflecting a "presumed extension of capital markets weakness."
"While our investment bank and brokers universe looks quite oversold to us, as a practical matter, we continue to recommend caution for now, given continued negative momentum in the macro-economic backdrop," Trone said.
Citigroup, AIG Lead Most U.S. Bond Sales Since June
Citigroup Inc. and American International Group Inc. led the busiest week of corporate bond sales since June as financial companies lured investors with record yields over benchmark rates.
Borrowers raised $15.5 billion of debt, after selling $7.6 billion last week. Citigroup, the largest U.S. bank by assets, sold $3 billion of five-year notes at the highest spread over U.S. Treasuries since it was formed from the merger of Travelers Group Inc. and Citicorp in 1998. AIG of New York, the biggest U.S. insurer, sold $3.25 billion of 10-year notes at more than double the spread offered on similar debt in December.
Financial companies are making concessions to investors after posting $107 billion in second-quarter credit losses on plummeting mortgage-linked securities. The credit crisis is "far from over" and the global economy will slow as lending tightens further, a Merrill Lynch & Co. analyst said this week.
"Investors still believe that these are historic wides and two to three years from now, they're going to be rewarded for having purchased these securities at these levels," said Anne Daley, the co-head of U.S. syndicate at Barclays Capital in New York.
Financial companies with investment-grade ratings raised $10.7 billion of debt this week, compared with $6.9 billion in all of July, even as the average spread on bank debt rose to a record 399 basis points, according to a Merrill Lynch index for the industry.
"Many of the financials have been out of the market for months and need to finance," Daley said. "Nobody likes to be the first one out with the wide spread, but once it's done, it opens the door for others to follow."
Overall sales were the highest since borrowers issued $24.5 billion of debt during the week ended June 27. Foreign investors bought a net $4.7 billion of corporate bonds in June, compared with a net of $59.8 billion a month earlier, the Treasury Department said today.
Citigroup sold its 6.5 percent senior notes at a yield of 337.5 basis points more than Treasuries, almost 50 basis points more than what the New York-based bank paid on similar debt four months ago, according to data compiled by Bloomberg. Moody's Investors Service gave Citigroup's notes a rating of Aa3, its fourth-highest level of investment grade, and Standard & Poor's ranked them an equivalent AA-.
AIG sold the 8.25 percent notes after reporting its third- straight quarterly loss. The debt paid a yield of 433 basis points over benchmark rates. On Dec. 7, AIG sold $2.5 billion of 10-year notes at a spread of 180 basis points.
AIG debt this week was cut to "neutral" from "overweight" by JPMorgan Chase & Co., which said further writedowns tied to mortgage-backed securities may trigger ratings downgrades and force the insurer to raise more capital. The AIG notes are rated Aa3 by Moody's and AA- by S&P.
American Express Credit Corp., a unit of the largest U.S. credit-card company, sold $2 billion of five-year notes with a 425 basis point spread, 62 percent more than what it paid on similar debt three months ago. New York-based JPMorgan sold $1.6 billion of 8.625 percent perpetual preferred securities following a $1.5 billion credit writedown. Wells Fargo & Co., the biggest bank on the U.S. West Coast, sold $600 million of 8.625 percent trust preferreds after boosting the size from $250 million.
The extra yield investors demand to own investment-grade debt rose 4 basis points this week to 305 basis points, matching the record set on March 20, according to Merrill's U.S. Corporate Master index. A basis point is 0.01 percentage point.
Industrial issuers found a window to sell debt as last week's drop in commodity prices encouraged investors that falling energy costs would ease pressure on corporate earnings, said Tom Farina, a director at Deutsche Bank AG's insurance asset management unit in New York.
Investment-grade companies overall sold $13.4 billion of bonds, compared with a weekly average of $18 billion for 2008. Investment-grade issuance is still on pace to reach a new high this year, even after a lull in issuance last month, according to a report Aug. 13 from CreditSights Inc.
Investment banks are bad taxpayers
The penny has dropped in London and New York that banks are not reliable sources of tax revenues. Losses from the credit crisis means that some investment banks may not pay taxes, as Michael Bloomberg, mayor of New York, gloomily phrases it, “for years”.
The most spectacular example is Merrill Lynch, which has booked $29bn of losses from its rash involvement in trading collateralised debt obligations, in London. Although many of the deals in question were struck by bankers in New York, Merrill booked them to its London subsidiary.
As a result, London and the UK can forget Merrill paying any tax on its local profits for a very long time. Merrill Lynch International has accumulated tax losses that it will be able to carry forward indefinitely. The investment bank has become the institutional equivalent of a “non-dom”, a foreign banker who escapes UK tax.
For Merrill and for the UK, this is an unintended consequence of the low rate of corporate taxation. The UK corporation tax rate of 28 per cent meant it made sense for Merrill to book the deals in London rather than the US, where the federal rate is 35 per cent and state taxes add a few percentage points.
Low taxation has now become zero taxation, which will further add to the incentive for Merrill to do (or to book) business in London. That has some benefits for the City of London in terms of employment but is unlikely to warm the hearts of the tax-paying British, or other UK-based businesses.
More broadly, it could prompt a reassessment of the benefits to cities such as New York, London, Dubai, Frankfurt and Hong Kong of competing to become international financial hubs. If a country gains some skyscrapers and local jobs, but few fiscal benefits, it will become a less pliant host.
New York and London have depended heavily on banks to fill the coffers. Banks provide about 20 per cent of New York’s state revenues and 9 per cent of the city’s funds. Banks such as Goldman Sachs have been able to exploit that status to obtain significant tax breaks on building and occupying skyscrapers in Manhattan.
After a period in disgrace with their shareholders and changing their senior executives, investment banks will be able to get on with business. But the hangover from the credit crisis will affect cities for years to come. They will have to find other sources of revenue to make up for the absence of taxes from financial institutions.
Financially based cities are facing the same challenges as others that were heavily dependent on single industries did in the past. The decline of western coal-mining, shipbuilding, steelmaking and car manufacture have afflicted cities such as Leeds, Glasgow, Sheffield, Pittsburgh and Detroit.
Investment banking is not dead but it is in a cyclical downturn. It has occupied an outsized role in western economies in the past decade and is now shrinking. This cyclicality, and its tendency to make losses every few years, make it an unreliable financial partner. Let the taxman beware.
British property prices plummet, sales head for new lows
Having previously tried to resist market forces, property sellers have begun aggressively to cut the asking prices for their homes, according to the online estate agency Rightmove.
After months where asking prices moved down by much less than the actual prices agreed on property deals, householders slashed the asking price of the average British home by 2.3 per cent last month – a drop of £5,403.
In London, the discounting has become even more marked, with asking prices down by 5.3 per cent last month alone, representing a reduction of £21,000 in the four weeks to 9 August, said Rightmove in its latest survey of the housing market.
The 2.3 per cent fall in asking prices represents a significant quickening of pace on the 1.8 per cent and 1.2 per cent drops in the preceding months, and is the largest fall Rightmove has ever measured in August.
Miles Shipside, commercial director of Rightmove, said: "Sellers coming to the market in the middle of the summer holiday season tend to be more motivated. London, in particular, appears to be having its own special summer sale." Prices in the capital are 3.8 per cent lower than last year, compared with 4.8 per cent nationally.
Rightmove said that national asking prices reached a peak for the year at £242,500 in May, compared to selling prices, as measured by the Halifax and Nationwide indices, which peaked last autumn. The catch-up is attributed to "some discretionary sellers choosing not to enter the market, leaving a higher proportion of forced sellers who price more aggressively", said Rightmove.
Such anecdotal evidence is supported by the most recent survey of the housing market by the Royal Institution of Chartered Surveyors, which also detected an increasing number of distressed sales, especially in the south and East Anglia. The number of new mortgage approvals, says the Bank of England, is down 70 per cent on last year.
The latest survey also confirms that business is extremely slow for estate agents. Rightmove says that the average unsold stock of property per estate agency branch has increased again to new record levels: in spite of the low supply of new instructions, it now stands at 78, up from 77 last month: Mr Shipside said this indicates that the number of transactions will continue to be at historical lows.
"The number of transactions this year is in danger of being the lowest since 1959. This raises serious questions as to whether any short-term incentives by the Government or the Bank of England would be effective in speeding up the market recovery against the backdrop of the global problems of the credit crunch."
Meanwhile, a separate survey published today found that more than £18bn of equity tied up in buy-to-let properties will be cashed in over the next few years, as Britain's private landlords sell out of the sector in their droves.
The insurance giant Skandia said the total buy-to-let mortgage stock will reduce to just £44bn within the next few years, as thousands of landlords sell up and pay off their loans. Last year, buy-to-let mortgage balances topped £120bn – a rise of more than 20 per cent on the previous year and some 60 times greater than the £2bn which was outstanding a decade ago. By the end of 2007, private landlords represented one in 10 of all UK mortgages, up from well under 1 per cent back in 1998.
Nick Poyntz-Wright, chief executive of Skandia UK, said: "Higher mortgage rates and falling property prices will cause investors to reconsider their exposure to residential property, and many will choose a more diversified approach."
UK residential building land value drops 20 percent
Residential building land, one of the core assets of most housebuilders, plummeted in value by 20pc in the first six months of the year and could fall by up to 50pc before the current slump is over.
Research by estate agent Savills shows the value of brownfield sites, down 19.8pc, and greenfield sites, down 22.5pc, fell by roughly four times the rate of the housing market as investors deserted the sector. With development land a key part of most housebuilders' asset bases, the valuations will be a major concern for the struggling sector.
Savills' director of research, Yolande Barnes, said: "There are two ways that falling land values affect housebuilders. The first is in pushing down share prices, but the more worrying issue is for those that are heavily indebted and are under pressure from their banks to repay debt. "At the moment you have to sell development land at fire-sale prices."
The news comes at a sensitive time for housebuilders. Persimmon, Taylor Wimpey and Barratt - the three most indebted - are all due to update the market in the next three weeks. They have already seen their share prices fall by as much as 85pc over the past 12 months.
Analysts are widely expecting some companies to follow the lead set by Taylor Wimpey last month in writing down the value of their land banks to reflect the falling market. However, Ms Barnes says the plummeting value of development land is presenting opportunities for those with the money to invest.
She said: "There are people with funds that are getting ready to invest. You can start bottom-fishing in the current market. This is the point in the market where development fortunes are lost but also made."
The research shows that the decline in development land values has accelerated over the first half of the year. A fall of around 7pc in the first quarter was followed by a drop of up to 17pc in the second quarter.
Things will get worse: you can bet the house on it
Nav Sharma is listening, downcast, to the sound of silence. At the once-bustling Ruxton's estate agency in Solihull, a suburb on the southern outskirts of Birmingham, househunters have all but disappeared.
'Have you heard one phone ring since you've been in here?' the agency's senior partner asks repeatedly. 'Most agents have written this year off. I have never seen a downturn like it and I have been in this business for 25 years.' Prices have already dropped by 5 to 10 per cent, he says, as buyers pull out of chains.
He blames Gordon Brown for the housing squeeze which is hitting this relatively affluent suburb. 'The government has been shockingly incompetent, they have pulled the rug from under our feet, they should start showing some leadership.' He adds that perceived hesitation over a proposed stamp duty 'holiday' is a making a bad situation worse.
'Their dithering has led to chains collapsing. All we need is stability. The bottom has fallen out of this market.' He says mortgage applications are taking twice as long as usual, compounding the problem. Elaine Brookes, Sharma's colleague, interjects plaintively: 'Can you please go and knock on Number 10 and ask them to give us some help?'.
This sorry tale is being repeated up and down the country as the property boom which began to gather pace in the mid-1990s, and more than tripled house prices in a decade, turns to bust. The estate agents on the front line of the slowdown may not be among the best-loved professionals, but the fallout is likely to spread far beyond them. As homeowners everywhere rethink how much their property may be worth, spending patterns are being reined in, and buy-to-let entrepreneurs have their calculators out.
Mervyn King, governor of the Bank of England, presenting its quarterly assessment of the economic outlook last week, offered little reassurance to Sharma, or anyone else in the housing market hoping for a helping hand. Chancellor Alistair Darling and other government ministers have floated various plans for reinvigorating the market over recent weeks, and former HBOS boss Sir James Crosby has been set the task of coming up with potential solutions; but King made it crystal clear that he believed government should avoid meddling.
'We're in a period where house prices are clearly adjusting to a new level, and buyers and sellers are struggling to find out what that new level is,' he said. 'The market will determine it, not us or the government. Once we've reached that level, prices should normalise. But that does not mean back to levels seen early last year that were clearly excessive.'
For several years, analysts had warned that property had begun to look much too expensive, relative to incomes - and lenders were becoming increasingly lax, giving prices an artificial boost. Karen Ward, chief UK economist at HSBC, says the value of housing has a natural limit, set by people's incomes; and 'what drives house prices away from this is over-optimistic expectations, and credit which is willing to follow that trail.
Now, both those things are working in reverse.' She believes that part of the reason house prices have turned so quickly since last autumn is that, deep down, we all half knew the market had gone mad.
Already, Nationwide calculates that the average home is worth £15,000 less than it was a year ago, and has slipped back to its value in August 2006. Now, analysts are scrambling over each other to increase their predictions of how far prices could fall from their peak. Many say 20 per cent; some up to 35 per cent, or even more.
George Buckley, of Deutsche Bank, points out that house prices in the United States have been falling since 2006, with only tentative signs that the downturn is coming to an end - and the boom in the UK was much bigger.
In its quarterly inflation report, the Bank of England warned that the outlook for the housing market was 'highly uncertain.
Some factors underpinning past increases in the house price-to- earnings ratio, such as the growth in the demand for housing due to demographic changes, may persist. But others, such as the increased availability of credit for borrowers with little or no deposit, have reversed, and are unlikely to return to the levels seen in recent years'.
Many of the arguments used to justify rising prices, and reassure optimistic investors in recent years, are likely to reverse as the economy turns. The UK has welcomed a rapid influx of migrants, especially from the eastern European accession countries, such as Poland and the Czech Republic, attracted to the UK's strong job market.
But with unemployment rising, the flow of arrivals has already slowed and analysts believe many of these often highly mobile workers may choose to return home, or move elsewhere to seek work. Other demographic forces apparently boosting prices could also suddenly appear weaker as the market turns.
Seema Shah, property analyst at consultancy Capital Economics, points out that when prices are rising rapidly, people tend to buy a larger home than they really need, betting that it will turn out to be a good investment, and stretch themselves to 'get a foot on the ladder' as early as possible. This artificially boosts demand for living space and pushes up prices.
As the market slides, she predicts that many more buyers will instead opt to buy a smaller property, or share with others. 'Expectations of falling house prices will convince many to defer their property purchase, or sell their property. As more people choose to share with friends, family or strangers, a key source of demand for property at the lower end of the market will be hit, intensifying the downward pressure on prices.'
She says this increase in sharing could reduce the demand for the one-bedroom properties these people would otherwise have bought by 10 to 20 per cent. These and other factors suggest the downturn could still have a long way to run.
There is a heated debate among experts about how much falling house prices matter for consumers' spending patterns and the wider economy. The Bank of England argues that when prices fall, some people become worse off, but others - putative first-time buyers who had been struggling to save for a deposit, for example - become better off, and the two effects cancel each other out.
However, other economists believe the aggregate effect of falling house prices on spending is likely to be negative. Michael Saunders, of Citigroup, points out that as banks adjust to falling house prices, they tend to increase the cost of borrowing, demanding higher deposits, pushing up arrangement fees and so on.
Saunders calculates that, despite falling prices, those first-time buyers who managed to get a mortgage paid an average £17,300 deposit in June, up from £13,160 a year ago. With mortgage rates sharply higher than a year ago for risky borrowers, the total cost of buying a home - a year's repayments plus the deposit - is now 69 per cent of the average first-time buyer's income, the highest proportion since records began in 1974.
'Not only home owners, but also first-time buyers, probably react to the housing slide by feeling impoverished [in the short term], saving more and spending less.' And without the extra fuel of cheap mortgage rates, it could be a long time before homes begin to look affordable again, and the market 'normalises', as King calls it.
The house price-to-income ratio, a measure of how expensive property has become, had shot up to more than seven times income by last year, when the market peaked. Since prices turned, it has begun to slip, but remains very high by historical standards - and well above the five and a half hit at the peak of the 1980s boom.
From the point of view of the estate agents at the sharp end - and anyone in a hurry to sell - the worst problem is the fact that so few homes are changing hands in the current market. Unsurprisingly, given the problems of raising finance, many buyers are struggling to raise cash.
Financial website Moneyfacts calculates that there are fewer than 4,000 mortgage products now available, compared with more than 13,000 last August. With the prospects for prices looking so uncertain, many thousands of other potential buyers are simply sitting back and waiting to see what happens next. Data from the Council of Mortgage Lenders suggests there were just 36,000 sales in June - a third of the level 12 months ago.
That certainly chimes with the experience of industry veterans in Solihull. Maureen Miller, branch manager of estate agency John Shepherd, says she would normally be expecting to sell 40 houses a month, but now achieving 20 is becoming a challenge. 'There are no first-time buyers. Deals are taking a lot more time to complete,' she says.
Miller and her colleague look up hopefully as a customer comes in, but Paula Parker, a mother of three, has already sold her house. 'It took me a year,' she says, 'I had to lower the asking price from £320,000 to £250,000'. A short walk along the high street reveals that Sharma at Ruxtons and Miller at John Shepherd are actually the lucky ones.
The collapse in sales has taken a heavy toll on other local property businesses. A branch of Countrywide surveyors has already closed down, and estate agent Shipways is also shut. Russell Patterson, local branch manager of estate agency Hunters, reflects the sentiment of the majority of agents in Solihull when he says there is no confidence in the market.
'People are holding off buying because they are expecting a cut in the price,' he adds. 'We are now having to accept lower offers on houses. We expect a very quiet winter.' Like many estate agents in the region, he says that the frequency of deals falling through has increased as chains involving first-time buyers began collapsing.
Simon Rubinsohn, chief economist at the Royal Institution for Chartered Surveyors, says there is likely to be much worse to come for estate agents.
'I sense that people are still hanging back,' he says. 'They're not actually panicking. They're nervous about it, because transactions are what's driving the industry, but I don't get the impression that people are slashing and burning just yet. If we move into 2009 and it's the same story, then you really do worry about how agents will respond.'
UK homebuilders urge government help for first-time buyers
Homebuilders are lobbying the government to set up a tax-free savings scheme for first-time buyers as a way of improving liquidity in the beleaguered mortgage markets, writes Lucy Barnard.
David Pretty, the chairman of trade body the New Homes Marketing Board, urged Chancellor Alistair Darling to introduce a national Home Deposit Savings Scheme offering tax breaks worth up to £5,000 to help buyers afford the rising costs of housing deposits as credit conditions tighten.
Savers would be given up to five years to save a maximum of £20,000. To this would be added a 25pc tax-free bonus, pushing their savings to £25,000, which would be used to cover a deposit, stamp duty, legal fees and removal costs. The scheme would be administered by banks and building societies.
The NHMB first proposed a scheme in March but Mr Pretty, former chief executive of Barratt Homes, said the housing market downturn made the need for one “urgent and immediate”.
Gloom deepens among UK firms
Two separate surveys today reinforce the gloom enveloping UK businesses, as they face the toughest trading environment since the early 1990s.
The Lloyds TSB Business Barometer found that in July companies' confidence in trading prospects plummeted to its lowest since the survey began in 2002, while the Institute of Chartered Accountants (ICAEW) also revealed tumbling confidence in the last quarter.
Lloyds TSB said that the balance of firms who believe their trading activity will increase, rather than decrease over the next 12 months, has fallen to +22 per cent – a 10 per cent drop on June and well below the average of +51 per cent since 2002.
Trevor Williams, chief economist at Lloyds TSB Corporate Markets, blamed the rising cost of raw materials and weakening export prospects in the slowing European market, despite a weaker pound. He said: "There's a strong balance between business confidence and the actual performance of the economy.
And, with so many firms remaining downbeat, we can expect UK economic growth to remain weak well into next year." Firms in the services sector suffered the biggest monthly drop in confidence, down by 24 per cent to +27 per cent.
The ICAEW's Business Confidence Monitor revealed a drop to -25.7 per cent for the three months to 30 June from 19.7 per cent in the previous quarter, in terms of companies which are "slightly less" or "much less" confident about their prospects.
Robin Fieth, ICAEW's executive director of operations and finance, said: "We are seeing a new realism among businesses ... with projected staff and capital investment both significantly down on this time last year."
China's Battered Property Stocks Require Rigorous Value Appraisal
China's property market is sputtering through its roughest patch in a decade, and developers' share prices have suffered a prolonged drubbing. Is it finally time to go bargain hunting? Maybe, analysts say, but proceed with caution.
Few experts question China's long-term growth story and strong trends such as urbanization and rising income levels, which offer good reasons to stay interested in China property. But the length and depth of this year's market beating has confounded buyers looking for a bottom -- and a meaningful recovery may be a way off.
The Hong Kong-listed shares of many of the biggest and most prominent listed developers in China have shed more than 50% of their market capitalization since the beginning of the year. The Hang Seng Index is down 23% in 2008.
The property tumble is rooted partly in a series of tightening measures from Beijing aimed at cooling housing prices that central authorities feared were rising too quickly.
Also, broader stock-market pain -- the Shanghai Composite Index is down 54% this year -- has cut potential homebuyers' purchasing power. During the first half, Chinese developers clocked in apartment sales that accounted for only 30% to 35% of their full-year revenue targets. That means cash flow is tight at a time the developers are being squeezed on bank lending and outside sources of funds.
Home sales in July were lackluster, and this month's Olympic Games are expected to be a quiet time, leaving a lot of pressure on the autumn for a pickup in the pace. Many developers say they can sell two-thirds of their full-year targets in the second half. But analysts say that to drive sales, the companies will likely slash prices, which could widen the gap between their actual 2008 revenue and how much they targeted.
More bad news is on the way for property developers. At the bottom end of the market, a wave of low-income housing the government will be making available could prove a further drag, particularly for mass-market developers. Some investors and analysts say there are still plenty of good reasons to get into the market, though they caution that timing will be important.
"We think in the long term that the fundamentals are very healthy, but in the short term, the dynamics are changing quickly," says Victor Yeung, Hong Kong-based senior securities analyst for LaSalle Investment Management Securities, which has a $9.5 billion global property-stock portfolio.
He and others warn there is still room for stocks to fall as analysts lower ratings in response to weak interim earnings and downward sales revisions for full-year 2008 and 2009. Still, there are reasons for optimism. Macroeconomic measures are unlikely to further tighten this year, economists say, pointing to falling inflation that could give central leaders more room to shift to pro-growth measures -- or at least less tightening.
Raymond Cheng, a sector analyst at Credit Suisse in Hong Kong, argues that Beijing's concerns about falling home prices might spur measures to aid the sector, which could "trigger a strong rebound" in stock prices. "The market is overly pessimistic," he wrote in late July.
Justin Pica, who manages an Asia-Pacific real-estate stock portfolio for ING Investment Management in Hong Kong, says some developers are "looking oversold," a view that Mr. Cheng shares. Nonetheless, Mr. Pica warns that significant downside risk could still be lurking as developers announce interim earnings. "I wouldn't say I'd be aggressively buying at this point, but valuations are looking attractive," he says. "I'm just concerned there is still a lot of negative news out there."
Washington's ultimate solution
These are the dog days of summer, the height of our national vacation season. But instead of hitting the beach, people in Washington and on Wall Street are spending their days all atwitter with ideas of what new regulations and rules and controls we need to deal with our financial market meltdowns, the worst since the Great Depression almost 80 years ago.
But let me tell you a little secret, folks. Even though they're scurrying around like everyone else in this game, I think the crisis managers at the Federal Reserve Board and the Treasury have quietly adopted a technique that has helped us deal with previous financial crises - what I call the "play and pray" approach.
They don't teach it in Economics 101, and none of the players dealing with the current meltdown will talk about it on the record. But it's a time-tested strategy - think of the mortgage crisis of the late 1970s and early 1980s, the bank problems in the early 1990s, and the Asian contagion of the late 1990s. The idea: You play for time by keeping things afloat long enough for your prayers to be answered by the markets' turning in the right direction.
The theory is that if you give stricken financial institutions like Fannie Mae enough time, profits from their basic operations can help them dig out of the capital pit into which they've fallen. A few years of nice profits will help offset the big losses from past blunders, provided the company stays alive long enough.
In fact, Fannie Mae's underlying business - using borrowed money to buy mortgages - is showing increasing profitability. That's because while the Fed has cut the short-term Federal funds rate that it controls to 2% from 5.25% since September, rates on long-term mortgages have risen.
HSH Associates says fixed-rate 30-year mortgages cost 6.70% in early August, up from 6.47% when the Fed first cut rates. The reason: There are far fewer sources of long-term mortgage money than before the market meltdown started last year, because falling house prices and fear of inflation have spooked lenders. Another factor is the dollar's decline, which has unnerved the foreigners who had been major mortgage investors.
I suspect that playing for time and praying for a break is also how crisis managers hope to keep financial insurers like MBIA and Ambac alive, to forestall what they fear could be catastrophic failures. The idea: The firms' basic business of insuring municipal securities that rarely default will over time help cover their losses from insuring collateralized debt obligations and mortgage-backed securities that they didn't understand.
Play-and-pray isn't a particularly fair policy - among other things, it means giant institutions aren't allowed to fail, while smaller ones are left to the tender mercies of the market. But given time and regulatory leeway and some good luck, this policy has a chance of working out if we can get past the hair-raising losses many big financial institutions are currently reporting.
The idea of regulating hitherto-unregulated institutions like investment banks in return for having Uncle Sam stand behind them is a good idea. So is giving regulators more power over Fannie and its sibling, Freddie Mac. Those are long-term objectives. For now, though, goal No. 1 is to get through this mess. But once things have stabilized a bit, let's cram through tough regulations before memory fades. We didn't do so after the last mortgage crisis abated, and we're paying for that mistake now.
Prayers are occasionally answered. Oil prices have been falling, and if that continues, it will be enormously helpful. However, mortgage defaults among nonjunk borrowers are rising, and house prices are still falling. Air-conditioning bills in places where electricity is generated with natural gas are horrendous, and home heating bills promise to be horrendous too.
But for now, if you'll excuse me, I'm heading for the beach. If you can, I suggest you do the same. The world may not feel better when you get back - but at least you will.
The Endgame Nears For Fannie and Freddie
It may be curtains soon for the managements and shareholders of beleaguered housing giants Fannie Mae and Freddie Mac. It is growing increasingly likely that the Treasury will recapitalize Fannie and Freddie in the months ahead on the taxpayer's dime, availing itself of powers granted it under the new housing bill signed into law last month.
Such a move almost certainly would wipe out existing holders of the agencies' common stock, with preferred shareholders and even holders of the two entities' $19 billion of subordinated debt also suffering losses. Barron's first raised the possibility of a government takeover of Fannie and Freddie in a March 10 cover story, "Is Fannie Mae Toast?"
Heaven knows, the two government-sponsored enterprises, or GSEs, both need resuscitation. Soaring mortgage delinquencies and foreclosures have led the companies to gush red ink for the past four quarters, and their managements concede the outlook is even grimmer well into next year. Shares of Fannie Mae and Freddie Mac have lost around 90% of their value in the past year, with Fannie now trading at $7.91, and Freddie at $5.88.
Similarly, the balance sheets of both companies have been destroyed. On a fair-value basis, in which the value of assets and liabilities is marked to immediate-liquidation value, Freddie would have had a negative net worth of $5.6 billion as of June 30, while Fannie's equity eroded to $12.5 billion from a fair value of $36 billion at the end of last year. That $12.5 billion isn't much of a cushion for a $2.8 trillion book of owned or guaranteed mortgage assets.
What's more, the fair-value figures reported by the companies may overstate the value of their assets significantly. By some calculations each company is around $50 billion in the hole. But more on that later.
Bringing Fannie and Freddie to heel will be difficult for the Bush administration, despite the GSEs' (Government-Sponsored Enterprises') parlous financial condition. Consider their history. In the early 1980s Fannie was effectively insolvent, but the government allowed it to continue operating.
Eventually long-term interest rates dropped, bolstering the value of the company's mortgages and bringing it back from the brink. Earlier in the current decade Fannie and Freddie successfully fought a full-scale attempt by the White House and some brave Republican legislators to clamp down on their operations, after they were caught perpetrating accounting frauds.
Note, too, that Fannie and Freddie have nonpareil lobbying operations and formidable political strength, owing to their hefty donations and penchant for hiring former political operatives. Besides, the agencies claim they've landed in their current predicament through no fault of their own.
As Freddie Mac Chairman and CEO Richard Syron recently put it, the GSEs have been hit by a "100-year storm" in the housing market, accentuated by some higher-risk mortgages that they were forced to buy to meet government affordable-housing targets.
The latter contention is more than disingenuous. A substantial portion of Fannie's and Freddie's credit losses comes from $337 billion and $237 billion, respectively, of Alt-A mortgages that the agencies imprudently bought or guaranteed in recent years to boost their market share. These are mortgages for which little or no attempt was made to verify the borrowers' income or net worth.
The principal balances were much higher than those of mortgages typically made to low-income borrowers. In short, Alt-A mortgages were a hallmark of real-estate speculation in the ex-urbs of Las Vegas or Los Angeles, not predatory lending to low-income folks in the inner cities.
In the current bailout the Bush administration is playing from strength. Not only have the GSEs' stocks been decimated, but trading in their debt -- whether the $1.6 trillion of corporate obligations or $3.6 trillion of mortgage-backed securities the two have guaranteed -- would have been in disarray had the recent housing bill not made explicit the U.S. government's backing of that debt. Even so, GSE debt spreads are starting to widen, relative to Treasury yields.
An insider in the Bush administration tells Barron's Fannie and Freddie are being jawboned by the Treasury Department and their new regulator, the Federal Housing Finance Agency (FHFA), to raise more equity. But government officials don't expect the agencies to succeed. For one thing, only a "capital raise" of $10 billion or more apiece would have any credibility.
Yet, what common-stock investors would advance that kind of money to entities that have market capitalizations of $8.5 billion (Fannie) and $4 billion (Freddie), especially as the FHFA will use its new powers to boost dramatically the regulatory capital the GSEs must have in coming years?
Just as disconcerting for prospective shareholders, all but $300 million of the $7.2 billion in equity Fannie raised in the second quarter was lost in the very same quarter, according to its fair-value balance sheet. With credit losses surging at both agencies, $20 billion in new common equity wouldn't last long.
The cost of selling new preferred stock, meanwhile, would seem to be prohibitive for Fannie and Freddie. The dividend yields on their preferreds have soared to around 14%, in part because of a recent rating downgrade by Standard & Poor's. Yields that high would blight the future earnings prospects of both concerns.
Should the agencies fail to raise fresh capital, the administration is likely to mount its own recapitalization, with Treasury infusing taxpayer money into the enterprises, according to our source. The infusion would take the form of a preferred stock with such seniority, dividend preference and convertibility rights that Fannie's and Freddie's existing common shares effectively would be wiped out, and their preferred shares left bereft of dividends.
Then again, the administration might show minimal kindness to preferred shareholders; local and regional bankers have been lobbying the Bushies not to wipe out the preferred since the bankers own a lot of that paper and rely on the bank preferred-stock market for much of their own equity capital.
An equity injection by the government would be tantamount to a quasi-nationalization, without having to put the agencies' liabilities on the nation's balance sheet, and thus doubling the U.S. debt. Treasury would install new management and directors at both, curb the GSEs' sometimes reckless investment and guarantee operations, and liquidate in an orderly fashion the GSEs' troubled $1.6 billion in on-balance-sheet investments. Then the companies could be resold to the public without their explicit government debt guarantees, or folded into government agencies like Ginnie Mae or the FHA.
Should the Bush administration lose its nerve and kick the GSE bailout forward to the next administration, a similar scenario still might unfold.
In a column last month in the Financial Times, Lawrence Summers, Treasury Secretary in the Clinton administration and an important economic adviser to Democratic presidential candidate Barack Obama, opined that in view of the sad financial condition of Fannie and Freddie, both should be thrown into government receivership to protect the U.S. taxpayer.
Republican presidential contender John McCain, for his part, fulminated in a recent op-ed in the Tampa Bay Times that if a dime of taxpayer money is used to bail out the companies, "the managements and the boards should immediately be replaced, multimillion-dollar salaries should be cut, and bonuses and other compensation should be eliminated."
The white house began to worry about Fannie's and Freddie's solvency in February, when both agencies reported capital-shredding losses for the fourth quarter of 2007. Adding to the official concern was the deepening turmoil in the residential- mortgage market, and the need for the agencies to keep mortgage money flowing.
The White House dispatched Treasury's then-Undersecretary for Finance Bob Steel to cut a deal with both Fannie and Freddie. In return for the pair doing its best to raise $10 billion each in new equity, the administration would eliminate the cap on mortgage paper the agencies could put on their balance sheets, and lower the increased minimum regulatory capital requirements imposed on the GSEs after their previous accounting scandal.
According to our source, both agency managements seemed amenable to the March deal, though they demurred on raising new capital immediately. They thought, and Treasury agreed, that any share flotation would have to wait until May, when first-quarter earnings were scheduled to be announced, providing investors with material information. Come May, Fannie kept its side of the bargain by raising $7.2 billion in mostly common equity. But Bush officials were shocked when Freddie failed to follow suit on an announced $5.5 billion equity raise.
According to our source, Freddie's Syron offered a variety of excuses. He said neither he nor several senior board members wanted to dilute current shareholders since the stock had fallen from 67 in the summer of 2007 to around 25 in May. He also insisted Freddie could do nothing on the core capital front until it had completed its formal corporate registration with the SEC under the 1934 Act.
That argument seemed fishy, since Freddie had raised $6 billion in preferred capital the previous November, and like Fannie has an exemption from registering stock issues with the SEC. A Freddie Mac spokesperson says the company was acting according to legal advice.
Freddie succeeded in exploiting the Prague Spring of regulatory forbearance. Monthly statements show it bought even more mortgages, gunning the growth in its retained, on-balance-sheet portfolio by 11% in the second quarter. By reducing its hedging costs, it also doubled its vulnerability to loss from interest-rate moves. It appears Freddie was hoping a Hail Mary Pass with the portfolio would somehow reduce its spiraling operating losses.
In retrospect, the agency meltdown seemed inevitable as the housing crisis deepened and credit losses mounted. On July 7 an analyst report claimed both agencies might have to raise substantially more capital because of a change in accounting regulations. Both stocks went into free fall, tumbling nearly 50% on the week.
The Bush administration feared the stock collapse would signal that the companies were heading for insolvency, and thus call into question the safety of their $5.2 trillion debt and guarantee obligations, despite the government's implicit guarantee of that paper. The impact of a failed GSE debt auction would be global and catastrophic, since foreigners, including many Asian central banks, owned $1.5 trillion in Fannie and Freddie paper.
After a frantic weekend meeting, Treasury Secretary Paulson announced on July 13 a rescue plan under which the Fed, and ultimately the Treasury, would backstop all Fannie and Freddie debt, and buy equity in the companies should that be necessary to bolster them. The omnibus housing bill passed and signed into law several weeks later codified all this in addition to establishing a new regulator for the GSEs with strong receivership powers.
In the weeks since, Freddie has continued to put off raising capital, even though it finally completed its registration as a corporation with the SEC. Syron said when second-quarter earnings were released Aug. 6 that the company was waiting for a more "propitious" time. One might argue it came in May, when the stock was 25, not 6.
Both GSEs continue to note their so-called core or regulatory capital levels remain comfortably above the minimum required by federal regulation. This ignores what would happen, however, if their balance sheets were marked to fair value -- or if their fair-value estimates were hugely inflated, as indeed may be the case. Both balance sheets, for one, contain an entry called deferred tax assets that bulks up Fannie's fair-value net worth by $36 billion and Freddie's by $28 billion.
These assets don't represent real cash but tax credits the agencies have built up over the years that can be used to offset future profits. But, since the tax assets can't be sold to a third party, or disappear in a receivership or sale of the company, they are disallowed in the capital computations of most financial institutions. Ironically, the worse a company does, the more capital cushion this asset creates.
The companies also appear to have boosted their capital ratios by sharply curtailing their repurchase of soured mortgages out of the securitizations they've guaranteed. In the fourth quarter of last year, for instance, Freddie Mac took a loss of $736 million on loans repurchased. In this year's first quarter that figure dropped to $51 million -- a stunning decline in view of the continued deterioration of the housing and mortgage markets. Instead, the company made the interest payments to bring the mortgages current -- a much smaller outlay, but a tactic that only pushes an inevitable loss forward into future quarters.
In Fannie's case, by postponing the buyback of bad loans the company avoided more than $1 billion in second-quarter charge-offs and a hit to its net worth. Other numbers also give pause. Less generous marks to Freddie's $132 billion investment holdings in private-label subprime and Alt-A securities would lop another $20 billion off its net worth. And, more than likely, Fannie's credit reserves of $8.9 billion won't fully protect it from future losses on $36 billion of seriously delinquent mortgages on its $2.8 trillion book.
After accounting for deferred tax assets and generous asset marks, Fannie and Freddie each may have a negative $50 billion in asset value, and little prospect of digging themselves out of the hole. Whether Fannie and Freddie are liquidated or nationalized as a prelude to privatization, in their current form they won't be missed.