Debt Rattle, September 11 2008: Confidence and perception

National Photo Co. Vest Test September 13 1923
W.H. Murphy of the Protective Garment Corp. of New York stands less than ten feet from Frederick County, Md. Deputy Sheriff Charles W. Smith in police headquarters and lets the deputy fire a .38 caliber revolver straight at his chest. When the bullet hit, Murphy never batted an eye. The bulletproof vest, which weighs about 11 pounds, is on the market for the protection of police and other officers in emergency cases. The bullet which Deputy Smith fired into the vest Wednesday was presented to him for a souvenir.

Ilargi: Bribery scandals, Wall Street-accomodated tax evasion, and assets that prove so utterly worthless that even the banks with the finest reputations can’t be sold anymore.

The US trade deficit just keeps on growing, and will do so until Americans simply have no money left to buy anything with. How about around Christmas time for that one?

Warnings of mass unemployment in Britain, where the central bank takes its hands off mortgage lenders and banks.

It's all gotten a bit beyond confidence and perception, I would think.

Lehman and to a lesser extent WaMu start to look like they may not survive till the afternoon close. Merrill, AIG and the monolines ain't exactly sitting pretty either. WaMu is on the verge of becoming a penny stock, and that is never good.

We may be nearing a point where so much goes astray at the same moment, that bail-outs are no longer an option. Which is not to say that Paulson, Bernanke and JPMorgan won't try.

Since this might be quite a day, I’ll do this early post and keep updating through the day. So do check back regularly.

PS Lehman's market capitalization: $3 billion
3rd quarter loss: $3.9 billion
3rd quarter writedowns: $5.6 billion
Remaining exposure to bad assets: $52 billion

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DJIA Sep 11 '08 10.20 AM EDT

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Lehman Pushed to Fire-Sale After Moody's Warning, Share Decline

Lehman Brothers Holdings Inc. was being pushed toward a sale as the shares plummeted and Moody's Investors Service said the firm must find a "stronger financial partner" or face a credit-ratings cut.

Without a "strategic arrangement" in the "near term," Lehman's ratings may be downgraded, Moody's said yesterday after the New York-based investment bank announced the biggest loss in its 158-year history. Lehman, led by Chief Executive Officer Richard Fuld, fell as much as 46 percent in New York trading today, ceding its spot as the fourth-biggest U.S. securities firm by market value to Raymond James Financial Inc. in St. Petersburg, Florida.

"While the number of potential acquirers at this point is very few, Moody's action certainly raises the specter of takeout, potentially at a very low price," said Merrill Lynch & Co. analyst Guy Moszkowski in a report today. He lowered his recommendation on the stock to "no opinion," saying a potential "take-under" makes it hard to gauge a price target.

Monique Wise, a Lehman spokeswoman, declined to comment on whether the firm was in talks with potential buyers. The shares fell $3.06, or 42 percent, to $4.19 at 10:34 a.m. in New York Stock exchange composite trading, the lowest since 1995, the year after firm was spun off from American Express Co. The drop reduced the company's market value to about $2.99 billion. Raymond James, a regional brokerage, is valued at about $3.6 billion.

Lehman said yesterday it's in the process of selling a majority stake in its asset-management unit, spinning off real- estate holdings and cutting the dividend in an effort to shore up capital and regain investor confidence. The announced plans failed to assuage investors' concerns and the shares sank 7 percent, after a 45 percent drop the day before.
HSBC, Deutsche Bank

Several of the largest European banks may be tempted to buy Lehman to bolster their presence in the U.S., analyst Richard Bove said earlier this week. Ladenburg Thalmann & Co.'s Bove speculated that HSBC Holdings Plc, Europe's biggest bank by market value, could be a suitor. London-based HSBC said yesterday it was "highly unlikely" to buy an investment bank.

Josef Ackermann, the CEO of Deutsche Bank AG, Germany's largest bank, said yesterday in Frankfurt that he wasn't interested in "parts or all of Lehman."

Lehman yesterday said it expects to report a $3.9 billion third-quarter loss on $5.6 billion of mortgage-related writedowns, worse than the $2.2 billion loss analysts had predicted. The company said it's auctioning off about 55 percent of the asset-management group, including fund-manager Neuberger Berman, and didn't name potential bidders. The real-estate spinoff is expected to be completed in the first fiscal quarter of 2009, according to yesterday's statement.

Pressure on Fuld, the longest-serving CEO on Wall Street, mounted after recent talks about a capital infusion from Korea Development Bank ended. Fuld, 62, is striving to convince investors that the firm will stem losses as housing prices decline. He and his management team also must keep clients and employees from leaving the company.

The restructuring "fell short of what was necessary to lessen the bear case on the stock," Goldman Sachs Group Inc. analyst William Tanona wrote in a note today, cutting his rating to "neutral" from "buy." "A downgrade would likely force Lehman to post additional collateral, increase short-term and long-term funding costs, and limit its ability to transact with partners which demand certain credit ratings," Tanona wrote.

Lehman was reduced to "hold" from "buy" by Citigroup Inc. analyst Prashant Bhatia. The third-quarter loss creates a "higher probability" of a cut in Lehman's credit rating, Bhatia said in a note to clients. "Confidence and perception issues are overwhelming Lehman's franchise value," Bhatia wrote. "We view raising capital in the very near-term as one of the most effective options to address the perception and confidence issues surrounding Lehman shares."

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U.S. stock futures point to sharply lower start, Lehman drops 39%

U.S. stock futures dropped sharply Thursday, with continued distress about the state of the world economy and of financials in particular tugging on sentiment.

S&P 500 futures fell 18.3 points to 1,215.00 and Nasdaq 100 futures dropped 27.75 points to 1,709.75. Dow industrial futures dropped 146 points. The dollar was sharply lower against the Japanese yen, frequently a sign of declining risk appetite. Oil futures fell 44 cents to $102.14, as the contract's fall toward the century mark continues.

U.S. stocks closed Wednesday with moderate gains, as a recovery for battered oil-sector shares and positive guidance from Texas Instruments and FedEx was offset by losses from financials after Lehman Brothers' $3.9 billion loss and a critical credit analysis of Washington Mutual. The Dow Jones Industrial Average rose 38 points, the Nasdaq Composite advanced 18 points and the S&P 500 added 7.5 points.

In a note dated Thursday, Banc of America Securities analyst Michael Hecht said there was lots of talk and not enough action at Lehman, estimating the brokerage will need an additional $6 billion of common equity. Citigroup separately downgraded Lehman to hold from buy, saying perception trumps fundamentals for now.

Lehman shares dropped 39% in pre-open trade on Thursday; Merrill Lynch fell 13%. The financial sector will face a new worry, as hearings are due on alleged tax shelters provided to hedge funds by investment banks including Citigroup and Merrill Lynch, according to a report in The Wall Street Journal.

There was a host of indicators, including figures showing falling import prices in August, a widening trade gap in July, and a moderate fall in weekly jobless claims.

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Lehman Shares Plummet After Three Analysts Cite Rating Risk

Lehman Brothers Holdings Inc., the worst-performer on the Standard & Poor's 500 Index this year, dropped 39 percent after three analysts said they lowered their recommendations because the firm's credit rating may be cut.

Lehman fell $2.85, or 39 percent, to $4.40 before the official open of the New York Stock Exchange. Shares of the New- York based firm dropped 89 percent this year before today. Lehman reported a record $3.9 billion loss for the third quarter yesterday and said it would sell a majority stake in its asset-management unit, spin off real-estate holdings and cut the dividend in an effort to shore up capital and regain investor confidence.

The restructuring "fell short of what was necessary to lessen the bear case on the stock," Goldman Sachs Group Inc. analyst William Tanona, who cut his rating to "neutral" from "buy," wrote in a note today. "A downgrade would likely force Lehman to post additional collateral, increase short-term and long-term funding costs, and limit its ability to transact with partners which demand certain credit ratings."

Lehman was cut to "hold" from "buy" by Citigroup Inc. analyst Prashant Bhatia and the firm was reduced to "no opinion" from "neutral" by Merrill Lynch & Co. analyst Guy Moszkowski. Goldman's six-month price estimate was reduced by two- thirds to $7, because of "significant uncertainty" surrounding management's measures to sell assets and support the balance sheet.

The third-quarter loss creates a "higher probability" of a cut in Lehman's credit rating, Bhatia said in a note to clients.
"Confidence and perception issues are overwhelming Lehman's franchise value," Bhatia said. "We view raising capital in the very near-term as one of the most effective options to address the perception and confidence issues surrounding Lehman shares."

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Can Lehman last the week?

With its stock down more than 40% in pre-market, I am getting the same sickening feeling I had during that week in March when Bear Stearns' stock made its swan dive into an empty swimming pool. As I said yesterday on CNBC's Power Lunch, investors seemed disappointed that Lehman Brothers Holdings Inc. had not actually closed any capital raising deals.

Now Lehman -- which lost 7% yesterday -- was down over 40% in pre-market. That's because four analysts "widened loss estimates and cut price targets for Lehman," according to Reuters. And Art Hogan of Jeffries & Co. said that Lehman's best hope -- its plan to auction 55% of Neuberger Berman, may not work.

"We are not even sure that the auction process for 55 percent of their asset management group is going to work because the people that win the auction need to find the money to buy it," he told Reuters.

I would not be surprised if Hank Paulson is now wondering why he ever took the job of Treasury Secretary. If Lehman stock keeps dropping 40% a day, there won't be much left by the end of the week. I have to believe that there are all sorts of people on Wall Street wondering whether they simply can't take the risk of continuing to do business with Lehman.

And if that happens, Paulson will need to decide whether to let it fail, force a merger or bail it out. Based on the logic of Paulson's previous bailouts, there's no reason it shouldn't. That's because Lehman's problem is that it holds billions in complex securities whose value could be as much as 95% overstated on its books.

It held them due to their former profits and now nobody wants them. If the government steps in to bail out every executive who makes a bad bet -- as it did with its Fannie Mae and Freddie Mac and Bear Stearns bailouts -- why not just let the government take over all money losing enterprises? And that's not just a moral hazard, it's a catastrophe for American capitalism.

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Lehman Plan Met With Skepticism By Credit Investors

Lehman Brothers Holdings Inc. on Wednesday trotted out plans for its future earlier than it had intended to quell market angst, but the troubled investment bank still left investors unimpressed. Indeed, uncertainty only seemed to deepen, and potential outcomes such as the firm's purchase by another company remained widely discussed after Lehman itself said it "remains committed to examining all strategic alternatives."

Lehman's credit default swaps, which measure a company's creditworthiness, deteriorated into record territory Wednesday. The privately traded contracts were quoted at 575 basis points, from 475 basis points Tuesday, according to broker Phoenix Partners Group in New York. That means it costs $575,000 annually to protect $10 million of Lehman senior debt against default for five years, compared with $475,000 before.

They moved as high as 600 basis points, a level more akin to a junk company multiple notches below the firm's actual rating of A2, according to Moody's Market Implied Ratings Service. But there are doubts that the contracts are actually being bought at those levels. Instead, the weakness is reflective of the uncertainty and wariness to enter into trades.

"It's a symptom of what happens when investors panic," said Michael Kastner, director of fixed-income at Sterling Stamos Capital Management in New York. Spreads continue to ratchet higher and "they'll remain there until there's some buyers out there," he said.

Lehman's bonds also saw very little trading activity, and the handful of trades that did go through pushed risk premiums out as wide as 98 basis points, according to MarketAxess. The company's stock also lost ground, falling 1% to $7.70, following a 45% plummet seen Tuesday.

On Wednesday, Lehman said it will spin off to its shareholders the "vast majority" of its commercial real-estate assets, sell a substantial interest in its investment-management division and slash its dividend 93%. Yet, while Lehman's plans are "steps in the right direction," they ultimately fall short, CreditSights analysts said in a a report.

The broker may still need another $3 billion to $4 billion in capital, according to CreditSights. And the most thorough way for the market's questions to be settled would be if Lehman were sold to a larger bank, the analysts said. Before Lehman's plans were announced, Standard & Poor's raised concerns about the impact of potential asset sales as it put the bank's single-A credit rating on watch for downgrade.

On Tuesday, S&P said the accelerating potential divestitures, like that of its commercial real estate portfolio, could exacerbate its capital-raising needs. Lehman's capital ratios appeared adequate at the end of its second quarter, according to S&P. Yet the agency said Tuesday it expected write-downs, difficulties in the investment-banking trading markets, and the deterioration of its mortgage portfolio, which could compromise that.

S&P reiterated Wednesday that Lehman's ratings remained on watch-negative. The struggle for investors is trying to figure out what Lehman will ultimately become, said Sean Egan, president of Egan-Jones Rating Co., an independent ratings agency.
Egan said there are two kinds of investment banks.

One is the broad-based, full-service kind like Morgan Stanley, Merrill Lynch and Goldman Sachs, which has deep trading operations, a number of brokers to support those operations, investment bankers and a money management arm. On the other hand, there are the smaller, boutique banks such as Lazard Ltd. and Allen & Co., which don't rely on their balance sheets, but rather relationships with influential figures, to secure business.

"Then there's Lehman Brothers that was fighting to be in the top tier of investment banks and in fact is considered a top-tier investment bank in selected business units such as parts of fixed income, but it didn't have a broad and deep franchise like a Goldman Sachs and arguably Morgan Stanley," Egan said. "It's not clear how they're going to go and that's the difficulty."

During the conference call Wednesday to report Lehman's plans, the firm's officials stressed the bank was going to focus on its core businesses. "While the market has undoubtedly changed, Lehman's core competencies remain as relevant as ever to the marketplace," said Chief Financial Officer Ian Lowitt.
For skeptical investors, that remains to be seen.

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Lehman still exposed to $52 billion in problem assets

Lehman Brothers said on Wednesday that it slashed mortgage and leveraged-loan holdings in recent months, but the brokerage firm still has at least $52 billion of exposure to these assets.

Lehman also unveiled plans to spin off most of its $25 billion to $30 billion of remaining commercial mortgage assets into a new company, Real Estate Investments Global, early next year. If that deal happens, the broker will be left with limited commercial mortgage exposure and roughly $25 billion of residential mortgage assets, other asset-backed securities and leveraged loans.

"The good news is that actual problem asset levels have been reduced by more than we expected," Jeff Harte, an analyst at Sandler O'Neill, wrote in a note to clients. "The bad news is that problem asset concentrations are still too high." Lehman, one of the largest underwriters of mortgage securities during the recent real estate boom, has been hit hard by slumping house prices and the broader credit crunch.

On Tuesday, shares of the firm slumped almost 45% on concern efforts to raise capital and sell assets were stalling. On Wednesday, the firm reported a fiscal third-quarter net loss of roughly $4 billion as it took more than $5 billion of new write-downs, mainly on soured mortgage exposures.

Lehman shares fell 6.9% to close at $7.25 after the results. Spreads on credit default swaps on the firm's debt widened by more than 100 basis points to 577, according to Credit Default Research. That's close to levels reached in the wake of the Bear Stearns bailout in March, CDR noted.

CDS are a common type of derivative contract that pay out in the event of default. When the difference, or spread, between rates on these contracts and rates on U.S. Treasury bonds increases, that suggests investors are willing to pay more to protect against defaults. "These are partial steps in the right direction," David Hendler, an analyst at fixed-income research firm CreditSights, wrote in a note to investors on Wednesday.

Still, Hendler cut his rating on Lehman debt because the firm's moves "may not be enough to satisfy skittish capital markets."
Lehman may need to raise more capital and there's uncertainty about the stability and level of future earnings that the firm can generate, he added. Lehman said it had $17.2 billion of residential mortgage securities and loans at the end of August. That's down from $24.9 billion at the end of May.

The firm has agreed to sell roughly $4 billion of U.K. mortgage assets to BlackRock. That deal is expected to close in the next few weeks and will reduce Lehman's exposure to $13.2 billion, the firm explained. Lehman had $24 billion of commercial mortgage securities and loans at the end of August. That's down from $29.4 billion on May 31. Other asset-backed securities totaled $4.6 billion, down from $6.5 billion. The firm also has $8.6 billion of real estate held for sale.

Lehman helped finance some big deals during the recent leveraged buyout boom, which also ended abruptly when the credit crunch hit last year. The firm still had $10.4 billion of leveraged loans at the end of August, but that's down from $18 billion at the end of May. In all, Lehman had $52.2 billion of real estate and leverage loan assets at the end of August, down from $78.8 billion on May 31. That doesn't include the $8.6 billion of real estate held for sale.

Lehman said it plans to spin off $25 billion to $30 billion of its commercial mortgage assets to shareholders in a separate company called REI Global. "The concentration of positions in commercial real estate-related assets has become a significant concern for investors and creditors," the brokerage firm said in a statement. "Therefore, Lehman Brothers believes that it is in the best interests of all its constituents to separate these assets from the rest of the firm."

Lehman said it will put capital into REI Global by transferring some of its common equity. The broker said it will also lend money to the new company. That debt may be sold off to other investors "as markets normalize," Lehman added.

REI Global will be able to account for these commercial mortgage assets on a hold-to-maturity basis, which means the new company won't have to mark the value of the assets to market prices regularly. That means it will avoid big write-downs each quarter, leaving it to manage the assets without that pressure, Lehman explained.

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U.S. Trade Deficit of $62.2 Billion Exceeds Forecast

The U.S. trade deficit widened more than forecast in July as oil imports soared to a record, overshadowing gains in exports.

The gap grew 5.7 percent to $62.2 billion, the largest in 16 months, from a revised $58.8 billion in June that was bigger than previously estimated, the Commerce Department said today in Washington. Total imports and exports were the highest ever.

Americans paid a record $124.66 a barrel for foreign crude oil, more than offsetting increases in shipments of automobiles, aircraft and machinery to buyers overseas. While a weak dollar has made U.S. goods more affordable, shrinking economies in Europe and Japan may stifle export growth in coming months.

"Exports will take a little bit of a hit, but I'm not terribly worried about it right now," Nariman Behravesh, chief economist at Global Insight Inc. in Lexington, Massachusetts, said in a Bloomberg Radio interview yesterday. "We still have a dollar that's quite competitive, even though it's appreciated a little bit in the last couple of months."

Economists forecast the gap would widen to $58 billion from an initially reported $56.8 billion in June, according to the median of 75 estimates in a Bloomberg News survey. Projections ranged from deficits of $54.6 billion to $62.5 billion. Imports climbed 3.9 percent to $230.3 billion in July, reflecting a record $42.6 billion in purchases of crude oil that swelled the deficit with the Organization of Petroleum Exporting Countries. Excluding oil, the trade gap shrank.

The imported-oil bill probably came down in August as prices retreated. A barrel of crude oil on the New York Mercantile Exchange cost an average $117.02 last month, down from $133.77 in July. Exports increased 3.3 percent to $168.1 billion, led by a $1.4 billion jump in shipments of autos and parts.

In August, prices of goods imported into the U.S. fell by the most in almost two decades of record-keeping as the cost of oil and natural gas dropped, indicating slower economic growth may be starting to calm inflation, according to another report. The import price index decreased 3.7 percent, more than forecast, after rising a revised 0.2 percent in July, the Labor Department said today in Washington. Outside of oil, costs fell 0.3 percent following a 0.7 percent increase the prior month.

Overseas shipments have received a boost from the 7 percent decline in the dollar against a trade-weighted basket of currencies of major trading partners in the 12 months ended in July. The dollar began to recover in April after dropping 27 percent from February 2002.

After adjusting for inflation, the trade deficit grew to $41.2 billion from $40.1 billion in June that was larger than previously estimated. The figures, which are used to calculate gross domestic product, indicate the government may lower the second-quarter growth estimate when the final data is reported later this month. July's price-adjusted deficit was smaller than the average for last quarter, indicating trade will again boost growth in the third quarter.

The smallest trade deficit in eight years was the biggest contributor to the 3.3 percent pace of economic expansion last quarter. The narrower gap added 3.1 percentage points to growth, the most since 1980, the Commerce Department said Aug. 28. Excluding trade, the economy would have expanded at a 0.2 percent pace after growing 0.1 percent in the first three months of the year.

The trade gap with China widened to $24.9 billion from $21.4 billion in the prior month. The deficit with the OPEC jumped 34 percent to a record $24.2 billion. Some U.S. manufacturers have taken advantage of the competitive dollar. Boeing Co., the world's second-biggest aircraft maker, received bookings for 70 new planes in July, up from 62 placed in June. Fifty of the Chicago-based company's July orders came from abroad.

A machinist's strike this month could prevent Boeing from filling those orders in coming months, further threatening U.S. export growth. In the past, work stoppages by members of the company's largest union, the International Association of Machinists and Aerospace Workers, have lasted four to 10 weeks.

As economies in Europe and Japan contract, the outlook for exports has softened. FedEx Corp., the world's largest air-cargo carrier, foresees weak demand both in the U.S. and abroad. "While sustained declines in fuel prices could improve our full-year outlook, the slowing economic growth trends in the U.S. are now extending to other areas of the global economy," Alan Graf, chief financial officer of the Memphis, Tennessee-based company, said yesterday in a statement.

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WaMu Falls on Concern Accounting Will Deter Suitors

Washington Mutual Inc., the largest U.S. savings & loan, failed to interest suitors in a purchase this year because new accounting rules for devalued loans are driving away buyers, two bankers involved in the talks said. The stock fell 30 percent to an 18-year low.

At least three potential acquirers ended negotiations to buy either Seattle-based WaMu or Cleveland's National City Corp., the bankers said. One sticking point, they say: a rule change that will force acquirers to compute a target's assets at market prices instead of deriving values from measures including the purchase price.

WaMu is in "a tough place," said Jaime Peters, an analyst at Morningstar Inc. in Chicago. "The revised rules will create additional hurdles for WaMu, and there are already plenty of hurdles." WaMu fetched $2.32 at 4 p.m. in New York Stock Exchange composite trading, the lowest since Nov. 27, 1990. Credit- default swaps indicate there's an 80 percent chance WaMu will default in five years. WaMu and National City are the worst- performing stocks in the 24-member KBW Bank Index this year.

The Financial Accounting Standards Board's change, effective in December, may delay consolidation in an industry saddled with more than $500 billion in writedowns and credit losses. "The new rule will curtail M&A by making it too expensive," said Robert Willens, a former Lehman Brothers Holdings Inc. accounting analyst and executive who teaches at Columbia Business School.

"With loans fetching their greatest discounts since the Great Depression, it sharply reduces the value of a target's assets. That will force an acquirer to raise additional capital in this very difficult environment." Loan prices may drop by about 30 percent from their valuation at maturity, said Willens, who also runs a tax consulting firm in New York. The new rule isn't the only obstacle to bank mergers. Plunging home prices and rising defaults have punctured mortgage securities, forcing lenders to conserve cash.

Newly installed WaMu Chief Executive Officer Alan Fishman, who sold the last bank he ran, said in an interview that a sale isn't in the bank's future. "You don't build a company to sell it," the 62-year-old lifelong New Yorker said in a Sept. 8 interview. Fishman, who replaced ousted predecessor Kerry Killinger, 59, was CEO of Brooklyn's Independence Community Bank Corp., which was sold to Sovereign Bancorp in 2006. Others aren't so sure.

"The market will likely view the removal of WaMu's former CEO as the last remaining hurdle for the board to consider pursuing a possible sale," Merrill Lynch & Co. analyst Kenneth Bruce wrote in a Sept. 8 note to investors. Complicating a potential sale: "the poor quality of WaMu's loan portfolio." WaMu yesterday had its credit-rating outlook cut by Standard & Poor's, which cited concern losses may extend beyond the company's $19 billion forecast.

The rule may create a situation where a bank that seems well-capitalized on its own wouldn't meet liquidity requirements if it were acquired because its loan values would fall, Peters said. "In that case, the target's capital might not support the marks, and the acquirer could be forced to put in additional capital," she said.

As industry takeovers sputter, the tweaks to FASB Statement No. 141 couldn't come at a worse time. U.S. banks reported 51 takeovers, valued at $6.1 billion, in the year through Aug. 27, data compiled by Bloomberg show. That's down from 150 deals valued at $55.2 billion in the same period a year ago, and 175 worth $63.6 billion in 2006.

Loans are hard to ignore. The $4.6 trillion of loans held by the 24 companies in the KBW Bank Index make up half their assets, data compiled by Bloomberg show. At WaMu, the percentage is even higher: $240 billion of loans are 77 percent of assets. It's much the same at National City, where $113 billion of loans are 74 percent of assets, according to data compiled by Bloomberg.

As potential acquirers steer clear, financial companies may be forced to seek capital from investors burned by earlier rounds of fundraising. Shares of U.S. banks that raised money have declined by an average of 45 percent after capital infusions, Goldman Sachs Group Inc. said in a July report. Both WaMu and National City raised $7 billion in April by selling shares at a discount to their market price.

FASB, which sets U.S. accounting rules from its headquarters in Norwalk, Connecticut, says the new rule will bring U.S. standards in line with those overseas. The board first decided on its implementation last December, giving companies a year to incorporate the new standard into accounting procedures. Investors have mostly been supportive because the rule promised enhanced disclosure, said Sue Bielstein, a FASB director.

"We had calls broadly for common standards in this area because it caused significant headaches," Bielstein said. "An element of the international standards leapfrogged ours and that's where we were playing catch-up."

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Carnage continues for Washington Mutual

Washington Mutual shares plummeted to a 17-year low on Wednesday, hammered by investors who fear its metastasizing home loans could inflict lethal damage. "They are a company with fundamental problems that is getting the worst of the brunt of the market," said Jaime Peters, an analyst with Morningstar in Chicago. "That is scary because finance is all about confidence."

The worst-case scenario would be WaMu failing - or coming to the brink, if Uncle Sam swooped to the rescue a la Bear Stearns. A collapse of the nation's largest S&L would be devastating. But Peters and others said they don't think the situation is that dire yet.

While Washington Mutual has appeared troubled for months - its shares have plunged more than 90 percent the past year - recent events have brought it to the forefront of Wall Street's concerns. Since Monday, the stock price has been halved. On Wednesday it closed at $2.32 per share, down 30 percent. Among the recent events:

CEO ousted; regulator steps in. On Monday, it took a one-two punch. It sacked CEO Kerry Killinger, replacing him with Alan Fishman, chairman of Meridian Capital Group, a New York commercial mortgage broker. While Killinger had led a dramatic expansion into a $300 billion institution with more than 2,200 branches, he also marshaled WaMu's move into subprime and other risky mortgages that has resulted in $6.3 billion in losses the past three quarters.

At the same time, the company said its regulator, the Office of Thrift Supervision, has put it under special supervision, requiring it to improve risk management and compliance procedures, and provide a multiyear business plan, including a forecast for earnings, asset quality and capital. Washington Mutual said the plan will not require it to raise capital, boost liquidity or cut products and services.

Credit-default swaps soar. On Wednesday, the cost to protect Washington Mutual's debt hit a record high, according to Bloomberg News. Credit-default swaps are a way to hedge against the risk of a borrower defaulting on its debt. Bloomberg said WaMu's credit-default swaps are trading at a price "that implies a more than 90 percent chance the company will default within five years." Protecting $10 million of WaMu's bonds for five years now costs $4.3 million up front and $500,000 per year.

Selling company becomes harder. An accounting change on the horizon makes the company a less-attractive acquisition target. Potential buyers will have to calculate an acquisition's assets at their market price, instead of using other data such as the purchase price - which means purchasers would have to cough up more capital or experience more dilution.

"That diminishes the chance of having a company like JPMorgan come in and buy them," Peters said. "It's another downside."
Still, a shotgun wedding is a possibility. If the S&L's situation deteriorates, regulators "could encourage a merger with another institution, a purchase and assumption transaction, sales of branches, further injections from private equity or some other public-private partnership," wrote CreditSights Inc. analyst David Hendler.

Who are potential suitors? JPMorgan Chase, with $1.7 trillion in assets, is well positioned to absorb WaMu's $300 billion. While Wells Fargo, which has remained relatively above the mortgage fray, seems like a suitable banking partner, its $600 billion in assets might make it too small. "That would be a 50 percent increase (in size) for Wells; that's a pretty big deal," Peters said.
One plus for a purchaser: Washington Mutual's retail banking business. "Their core business is making money, which will help offset losses from loans in the future," Peters said.

Capital tightness continues. Another factor that has investors worried: Money is expensive and hard to get nowadays, most of all for a firm that is stigmatized by its association with the toxic housing market. "If they don't have enough capital right now, the credit markets are pretty closed to problem investments," Peters said.

WaMu declined to comment for this story, other than pointing to a Standard & Poor's report from Tuesday that said the thrift is well capitalized. (The same report downgraded its outlook to negative from stable.) "The strong regulatory capital cushion of over $10 billion above regulatory capital measures is considered quite solid," S&P wrote.

"Also deposit funding trends have been stable and there has been no adverse change to the holding company liquidity profile. WaMu continues to downsize its mortgage exposures and balance sheet growth has been restrained." In April, the company raised $7.2 billion from investors, led by private-equity firm TPG Inc.; that brings to $11.2 billion the amount of equity it's raised since the fourth quarter of last year.

Home loan portfolio struggles. In July, WaMu said soured home loans could cause it to lose as much at $19 billion over the next 2 1/2 years. The company has about $180 billion worth of home loans on its books, according to Peters: $105 billion in mortgages, $60 billion in home-equity loans and $16 billion in subprime (both home equity and first mortgages). Morningstar thinks it can absorb losses of about $25 billion before it would be in serious trouble.

John Lonski, chief economist at Moody's Investors Service in New York, said Washington Mutual's battering on Wall Street reflects ongoing concerns about soured home loans. "It's a reminder that the losses arising from mortgage repayment difficulties have yet to become fully known," he said. "As long as the housing market slides, as long as home prices decline, the ultimate cost of the mortgage meltdown remains unknown. There is not convincing evidence of an impending bottom for housing."

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Wall Street Firms Involved in Tax Dodge, Probe Says

Lehman Brothers Holdings Inc., UBS AG and Merrill Lynch & Co. are among Wall Street firms that concocted derivatives and stock-loan deals to help offshore hedge funds dodge hundreds of millions of dollars in U.S. taxes, according to a U.S. Senate committee investigation.

The Internal Revenue Service looked the other way while securities firms sold complicated financial products designed to skirt a law requiring them to withhold U.S. taxes on stock dividends paid to offshore investors, said Senator Carl Levin, chairman of the Permanent Subcommittee on Investigations.

Levin, a Michigan Democrat, said he wants the IRS to pursue back taxes or penalties against Wall Street firms and their hedge-fund clients that got around a 30 percent dividend tax. "We are going to press the IRS to go after what is obviously a scheme," Levin said, while briefing reporters yesterday about the committee's yearlong probe. "The IRS should be going after this. They are not. They have been pussyfooting around this."

Citigroup Inc., Morgan Stanley, and Deutsche Bank AG also profited by creating and selling "dividend-enhancement" products with no legitimate investment purpose besides letting investors avoid taxes, the committee report said. Morgan Stanley's dividend-enhancement products generated $25 million of revenue for the company in 2004 alone, and cost the U.S. government more than $300 million in unpaid taxes from 2000 through 2007, the report said.

Lehman Brothers, in an internal document described in the Senate report, estimated that it helped clients avoid $115 million in taxes in 2004. Lehman spokeswoman Monique Wise declined to comment on the report. Dividend-enhancement transactions earned about $5 million of profit for UBS in 2005, and $4 million for Deutsche Bank in 2007, the report said.

Levin said he plans to introduce legislation making it harder to structure swaps and stock loans for the sole purpose of avoiding taxes. The dividend tax applies to offshore investors who don't pay U.S. taxes on interest or capital gains. The 30 percent rate generally only applies to investors based in countries that don't have a tax treaty with the U.S., Levin said.

Tax authorities have "a number of investigations under way" involving issues cited in the committee report, IRS spokesman Frank Keith said. "The IRS intends to aggressively pursue transactions that it believes to be abusive."

Citigroup, aware the IRS might deem its so-called dividend- uplift transactions to be illegal, voluntarily disclosed them and paid $24 million in withholding taxes for 2003 through 2005, the report said. Citigroup spokesman Daniel Noonan said the bank treated the transactions properly. "The report recognizes that there are ambiguities in how the law should be applied," Noonan said in an e-mail statement. "We support efforts by the IRS, Treasury and Congress to clarify the proper tax treatment."

In one kind of dividend-enhancement product, offshore hedge funds would sell stocks to Wall Street firms near the time for a dividend payment. At the same time, the securities firms entered into swap contracts in which, for a fee, they agreed to pay investors the equivalent of the dividend plus any stock gains.

The swaps changed the definition of the income under IRS rules, letting offshore funds claim they didn't earn dividends subject to the 30 percent withholding tax. The Wall Street firms, in turn, might owe taxes on the dividends -- at the lower, 15 percent rate for U.S. taxpayers -- while claiming even larger deductions for the swap payments to investors.

Some firms helped clients avoid the tax through stock-loan transactions that used more steps and more complex structures to make it harder to trace any wrongdoing, according to the report. The dividend-enhancement business got a boost in 2004, when Microsoft Corp. announced a special $3 dividend. Securities firms, including Morgan Stanley and Lehman, saw a huge business opportunity, according to e-mails quoted in the Senate report.

A Morgan Stanley e-mail called Microsoft's dividend "a great opportunity," the report said. Another e-mail said Morgan Stanley employees shouldn't enter into swaps too close to the date of Microsoft's payment. "We do not want to put on trades close to record date. Tax risk increases dramatically," the e-mail said, according to the report. Morgan Stanley spokesman Mark Lake said the company "fully complied and continues to comply with all relevant tax laws and regulations."

Firms marketing the products and hedge funds buying them knew they risked being accused of tax evasion, the report said. Lehman instituted a "tax risk" cap permitting only $25 million of such transactions per year, the report said. That limited the company's additional tax liability if the IRS determined the transactions were illegal.

Merrill Lynch, promoting a product it called "Gemini," offered Olayan Group a tax-indemnification agreement and estimated that Olayan could save $7 million a year just on its Occidental Petroleum Corp. stock. Olayan, a Saudi Arabia-based fund with an office in New York, didn't buy, saying such a transaction "would provide a strong case for the IRS to assert tax evasion," according to the Senate report.

Olayan spokesman Richard Hobson confirmed that the company declined to make dividend-related transactions with Merrill. Merrill Lynch spokesman Mark Herr said the firm "acted in good faith when we advised our clients and acted appropriately under existing tax law."

Ted Meyer, a Deutsche Bank spokesman, said the firm's business "operates within the letter and spirit of the law."
UBS spokeswoman Rohini Pragasam said the company has cooperated with Levin's committee. She declined to comment on specific information in the report, which said UBS ended a Cayman Islands stock-lending program in November 2007.

Citigroup's lawyers had warned employees that they couldn't buy stocks from offshore funds and promise to sell them back after the dividend payment because the IRS might see that as a tax-avoidance maneuver. An internal Citigroup audit found that some employees arranged such transactions anyway, the committee report found. In a memo to the IRS that was quoted in the committee report, Citigroup said it paid the tax "even though liability was uncertain."

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Sex, drugs, gifts uncovered in government oil probe

U.S. government employees received improper gifts from energy industry representatives, and engaged with them in illegal drug use and inappropriate sexual relations, according to a report issued Wednesday.

The report was issued by the Interior Department's inspector general after a $5.3 million investigation "uncovered recreational marijuana and cocaine use" by "a handful" of Interior Department staff, and found two federal employees "engaged in brief sexual relationships with representatives from companies doing business" with the department.

Two Interior Department employees "received combined gifts and gratuities on at least 135 occasions from four major oil and gas companies with whom they were doing business -- a textbook example of improperly receiving gifts from prohibited sources," Inspector General Earl Devaney says in a letter to Interior Secretary Dirk Kempthorne accompanying the report.

Randall Luthi, head of the Minerals Management Service at the Interior Department, said the public had not suffered financial losses as a result of the employees' behavior. Some of the government employees tried to hide their close association with the industry they were supposed to be regulating, the report says.

The investigation turned up e-mails in which MMS employees "preparing to attend industry events used such language as 'this trip is to be kept quiet,' or were asked to RSVP 'in private' by their supervisor," the report says. "When we asked one of these employees why they needed to avoid discussing their social activities with industry, he responded with a slight chuckle, 'They might have, you know, contacted the [inspector general],' " the report says.

The investigation appears to have been prompted by an internal whistle-blower's report in 2006, and concerns activity from 2002 to 2006 by the department responsible for selling the oil and gas the government collects as rent from companies drilling on federal lands. The report alleges inappropriate behavior by 19 members of the Royalty in Kind program -- about one-third of the department. Some have since left the department, making it unclear what kind of disciplinary action they could be subject to.

The Department of Justice declined to prosecute two former employees named in the report, the inspector general said, without saying why. Another pleaded guilty to a criminal charge. Department of Justice spokeswoman Laura Sweeney said the department did receive "one or more referrals related to matters referenced in the Department of Interior inspector general reports," but she declined to comment further.

MMS head Luthi said only "six or seven" employees named in the report still work for the department. He vowed appropriate action by the time he leaves office in January. Democrats used the report to accuse President Bush's administration of being too close to the oil industry.

"The Bush administration put an 'America for Sale' sign on the White House lawn from day one and has been courting Big Oil ever since," Rep. Louise Slaughter, D-New York and chairwoman of the House Rules Committee, said in a written statement. "Democrats have been saying it for some time, but this proves it. This administration is literally in bed with Big Oil. Little did we know they were such a cheap date."

Sen. Bill Nelson, a Florida Democrat, said the report should make Congress reconsider plans to expand offshore drilling. "The rest of the United States government doesn't need to jump in bed with" the oil industry, he said. "Offshore drilling will not solve our energy crisis nor will it bring down prices at the pump," Nelson said. "Instead, it will enrich the oil companies and reward the culture of corruption that has been fostered, funded and now exposed by the inspector general."

House Speaker Nancy Pelosi, D-California, said in a statement: "This report documents the 'pervasive culture of exclusivity' that has cheated the American taxpayer out of the billions of dollars owed them by the oil companies," Pelosi said. Sen. Dianne Feinstein, D-California, called the allegations in the report "unacceptable."

House Minority Leader John Boehner, a Republican from Ohio and an advocate of easing drilling rules, said that in 2006, "our members on the Government Reform Committee were investigating this problem in the department." "Our members of the last two years ... have been pushing [current] Chairman [Rep. Henry] Waxman to continue this investigation and to have hearings and he's refused to do it," Boehner said. Waxman is a Democrat from California.

Two oil companies mentioned in the report, Shell and Chevron, declined to comment, saying they still needed to review it. A third, Hess, said in a statement: "We do not believe we are the focus of the investigation and we will cooperate with any further requests from the inspector general's office that may arise."

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‘A Culture of Substance Abuse and Promiscuity’ at Oil & Gas Agency

The DOJ’s inspector general’s office, run by Glenn Fine, has had one heckuva busy summer, throwing much of its resources at investigations into the legacy of political meddling at the Department.

But the Interior Department’s inspector general, Earl Devaney, has been busy too. The big news today, via the WSJ: Employees of the federal agency that last year collected more than $11 billion in royalties from oil and gas companies broke government rules and created a “culture of ethical failure” by allegedly accepting gifts from and having sex with industry representatives.

A report by Devaney describes a party atmosphere at the Denver office of the Minerals Management Service, a bureau of the Interior Department. Some employees of the office, which houses the department’s royalty-in-kind program, “frequently consumed alcohol at industry functions, had used cocaine and marijuana, and had sexual relations with oil and gas company representatives,” the report says, adding that “sexual relationships with prohibited sources cannot, by definition, be arms-length.”

The report also says that between 2002 and 2006, 19 employees in the agency’s royalty-in-kind program, roughly a third of the program’s total staff, had “socialized with and had received a wide array of gifts from oil and gas companies with whom the employees were conducting official business.” Devaney’s report said: “We discovered a culture of substance abuse and promiscuity.”

We know what you’re thinking: What’s the Minerals Management Service? As the WSJ notes, it oversees the nation’s natural-gas, oil and other mineral resources on the outer continental shelf. Its duties include drawing up leases for drilling in offshore waters. Through the royalty-in-kind, or RIK, program, the government receives oil instead of cash payments from energy companies in exchange for drilling rights.

The IG’s report named four companies — Chevron, a U.S. unit of Royal Dutch Shell, Gary-Williams Energy Corp. and Hess Corp. — as gift givers. In a written statement Wednesday, the Shell unit said it cooperated fully with the investigation, but that it would be premature to comment on the report “until we have an opportunity to review the content.”

A spokesman for Hess said the company had cooperated with the inspector general’s inquiry, and that the company’s own investigation “indicated no wrongdoing” by employees. In July, a former aide to the agency’s associate director of minerals revenue management pleaded guilty in U.S. District Court to violating conflict-of-interest laws. The employee, Jimmy W. Mayberry, 65 years old, acknowledged helping create a consulting position that he later took after retiring from government.

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'Tens of thousands to be laid off every week' as UK falls into recession

Tens of thousands of people could be laid off every week in the run-up to Christmas as the UK economy falls into recession, David Blanchflower of the Bank of England's monetary policy committee warned today.

Blanchflower told MPs to expect "a large increase in unemployment", and warned that a "horrible surprise" could be just around the corner. The gloomy assessment sent shares in London falling, and also weakened sterling yet further against the dollar.

Blanchflower, who has repeatedly tried and failed in recent months to persuade the MPC to cut interest rates, predicted that the unemployment count will rise by 60,000 a month for several months in a row, probably starting in October.

"I believe we will see a deeper economic decline than other people think," Blanchflower told the Treasury select committee, ruling out the possibility that the UK GDP will not shrink. He added that the employment market will come under extra pressure this autumn when school leavers look to join the workforce.

The claimant count has already risen for the last six months. In July it increased by 20,100, the fastest rate since the early 1990s. Those who hold onto their jobs through the downturn should also brace themselves for difficult times, Blanchflower warned. "Employees in the private sector are not in a position to ask for higher wages, and employers are not in a position to pay it either."

The FTSE 100 index was down by 64 points following Blanchflower's comments at 5302.2, while sterling fell again today to $1.75. The MPC has held UK interest rates at 5% for the last five months, as it tries to juggle rising inflation and falling economic growth. While Blanchflower has argued for a cut, other members of the committee believe that soaring inflation poses too much of a threat.

Blanchflower was appearing before the committee as part of a five-man delegation answering questions on the MPC's quarterly inflation report. During the hearing, governor Mervyn King revealed that the Bank will launch a new funding scheme for banks to try to keep the mortgage market afloat.

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Bank of England warns of no quick fix to mortgage crisis

There is no quick fix for the mortgage crisis blighting the British economy, the Governor of Bank of England has warned.

The Bank will continue to support lenders, but will not help them to offer more generous mortgages, Mervyn King told the Treasury Select Committee, adding that households would also continue to feel a squeeze from falling incomes and higher prices for a range of basic goods.

The Bank plans next week to unveil its successor to the emergency funding scheme, known as the Special Liquidity Scheme, which since April has allowed ailing banks to keep lending by swapping risky mortgages for cash from the Treasury. Some analysts reckon banks may have tapped the scheme for as much as £200bn.

Mr King said that while the new plan would be important, it could not provide a long-term answer to the credit crisis. "I hope everyone will understand that the proposals to be published next week, important though they are, will not and cannot solve the shortage of funding to finance bank lending, including mortgage lending," Mr King said.

The drought in the mortgage market has ended the decade-long boom in the house prices. The number of home loans approved in July - 33,000 - was down 71pc on the year before, while pruse prices are now 13pc lower than they were a year ago.

The weakness in the housing market is having a crippling effect on the wider economy, with the Organsation for Economic Co-operation and Development and the European Commission both forecasting that Britain will be in recession by the end of the year.

The Bank's Monetary Policy Committee (MPC) last week refused to cut interest rates from 5pc, a move many in British business are calling for. Its hands are tied by inflation sitting at a 16-year high rate of 4.4pc thanks to a surge in oil, food and energy prices. Admitting that he is expecting inflation to continue exceeding the Government's 2pc target, Mr King said the UK faced "testing times".

"In the UK we face a difficult, but temporary, period during which inflation will remain high for a while and output growth at best weak," he told MPs on the Treasury Select Committee. "Perhaps of even greater significance for demand, real take-home pay has been squeezed by rises in energy and food prices, so holding back household spending."

David Blanchflower, the MPC member who has been regularly outvoted in his call for a deep rates, has warned that sharp rises in unemployment are in store as the economy grinds to a halt. "My view certainly is that we are going to see a large increase in unemployment. The October numbers are going to start to see a big kickthrough and that is going to be an unpleasant shock," he said.

Mr King told MPs that the Bank's new liquidity plan could not provide long-term insurance of mortgages. "We will not be able to provide finance for the lifetime of a mortgage. We will only provide liquidity for a shortish period," he explained. More details of the plan, which was named by John McFall, the chairman of the committee, "Son of the Special Liquidity Scheme", will be announced next week

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Jim Rogers speaks his mind

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