Wednesday, April 30, 2008

Debt Rattle, April 30 2008: We are all underwater

Tennessee 1936

Ilargi: I saw a headline today claiming that the US economy grew slightly in the 1st quarter, and jobs went up too. This kind of media reporting is getting so out-of-whack, deceiving, if not simply lying, that I don’t want to read it anymore, let alone report it here.

No matter what "positive" numbers come out of the rabbit-filled high hats, or what authority figure pulls them out of there, the reality is that it’s a slaughterhouse across the board. There’s not much need for me to comment on the list below, it paints a very clear picture. If there are still people who feel good about the economy, wherever in the world they live, and who think that we have reached "a bottom", any bottom, I strongly suggest seeking professional help.

It is now safe to say we have moved from "We are all subprime" to "We are all underwater".

Still, being underwater is by no means the most perverse consequence of our criminal finance system. Last week the UN said it had so far received $18 million of the -additional!- $750 million it says is needed for emergency food programs. Don't fool yourself: we will only feed the hungry if Monsanto and Cargill can make a profit off it. That's what food aid has been all about for decades.

Fed Lowers Rate to 2%, Seventh Cut Since Credit Squeeze Began
The Federal Reserve lowered its main interest rate by a quarter of a percentage point to 2 percent, the seventh cut since the onset of a global credit squeeze that's eroded economic growth. "The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time," the Federal Open Market Committee said in a statement after meeting today in Washington.

"The committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability." While a nine-month contraction in credit and soaring fuel prices have pushed the economy to the edge of recession, confidence has begun to return to financial markets. Inflation expectations are also picking up, driven by near record prices for oil and higher food expenses.

"Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters," Chairman Ben S. Bernanke and his colleagues said in the statement. Oil prices marched to another record high of $119.93 a barrel on April 28. The Fed said indicators of inflation expectations have risen.

"The committee expects inflation to moderate in coming quarters, reflecting the projected leveling- out of energy and other commodity prices and an easing of pressures on resource utilization," the Fed added. "It will be necessary to continue to monitor inflation developments carefully," the Fed said. Uncertainty about prices "remains high."

The Fed Board of Governors also voted to lower the discount rate, the cost of direct loans from the central bank, to 2.25 percent. Officials reduced the normal 1-point spread over the federal funds rate in August to a half point to ease liquidity constraints. They further narrowed the difference on March 16, in the first weekend emergency move since 1979.
Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser dissented from today's decision, preferring no change. They also objected to last month's reduction.

The Fed’s Dilemma: Rescue the Housing Market, or Feed the Poor?
At their two-day meeting that started [yesterday], U.S. Federal Reserve policymakers will have to grapple with a moral choice that is well beyond the pay grade of central bankers - choosing between the financial stability of U.S. homeowners and world hunger.

That’s not an exaggeration. Interest-rate policy normally only affects the world economy at the margin, but it has now been so expansionary for so long that the Fed’s interest-rate strategy has turned into a moral dilemma of sorts. In short, the central bank’s monetary policy will likely determine whether millions of U.S. homeowners lose their homes or millions of the world’s poor starve.[..]

While Americans consume only moderate quantities of raw commodities as a percentage of total consumption, for poor people in the Third World commodities still account for the bulk of their budget. While increases in energy and metals prices simply raise the cost of living, food-price spikes are much more serious, since they directly and significantly erode the living standards of the world’s poor.

Still more disturbing is the fact that the recent surge in food prices (which has been extreme, rice alone having trebled in price in the last year) has caused the beginnings of a breakdown in the world’s free trading system in food. Rice exporters such as Egypt, Indonesia and Vietnam are restricting, or even prohibiting, the export of certain kinds of rice, moves they’ve made to try and keep prices of that commodity down in their home markets.

Since many poor countries such as India also subsidize basic food prices to limit urban unrest, national budgets are being thrown out of kilter. At the margin, for the very poorest people in the least competently run countries, the result of this food-price surge is likely to be starvation. New crop plantings will alleviate the problem within a year, but for many, that will be too late: You can defer an automobile purchase until next year, but you can’t stop eating.

Bernanke no doubt hopes that he can keep interest rates low and thereby stimulate the U.S. economy and solve the housing problem, wringing out any inflationary results by pushing rates higher once housing has stabilized and the U.S. market has moved back onto a growth track. That appears excessively optimistic. A prolonged period of low interest rates will perpetuate the bubbles in energy and commodities, which will have two effects.

In the United States, it will firmly establish an inflation level of 10% or more, which will require a wrenchingly difficult recession to emerge from, as it did in 1979-82, thanks to a managerial miracle by then-Fed Chairman Paul Volcker. But in poorer countries, a long run of low interest rates will not only cause inflation and hardship, it will bring starvation as food prices soar well beyond the means of the poor. Hoarding will result, until finally all the world’s food-market mechanisms end up collapsing. So if the central bank does cut interest rates this afternoon, think twice before you cheer.

Caution: Mortgage Explosions Just Starting
In 2006 and 07, as the housing bubble was starting to burst, tremendous market share "gains" were made in the ALT-A space. "ALT-A" are loans where income was undocumented (so-called "liars loans") or otherwise contained "tricky" features such as "Pay Option" mortgages. These "ALT-A" loans constituted huge percentages of production - hundreds of billions of dollars - in 2006 and 2007. And every study done on them thus far on the production during those years has shown that half of these mortgages - or more - contain significant overstatement of income.

That is, fraud. Each and every one of these mortgages is subject to being "put back" on the originator. These loans will flow backward just as they flowed forward originally, continuing upward until they find a "home." Where's the "home"? When the firm that originated or securitized the loan is found.

What if the originator is out of business? Then the investment or commercial bank that securitized that debt is going to wind up stuck with it, because there is no way they will win an argument in court claiming that they had no ability (or obligation) to detect this fraud, when the products were designed to enable it, and it required only marginal investigation for them to be able to detect it (such as pulling the borrower's tax returns.)

Let this sink in folks - HALF of all ALT-A production from 2005-2007 is subject to being "put back" on the issuer, and current recovery on defaulted mortgages is about 50%. This means that the actual "expected damage" in money (that is, loss) terms is roughly 25% of all ALT-A production from the years 2005-2007.

If the equity markets were half-rational every single investment and commercial bank that had securitized mortgages (that would be basically all of them) in the ALT-A space would be getting hammered - right now - down to single digits.

Every one of these firms is on the hook for tens if not hundreds of billions of dollars worth of these mortgages, and the ones they will end up "eating" are the ones that are non-performing - not only are they the ones that contained fraud but they're also the ones that will prove to be uncollectable![..]

Countrywide reported a monstrous loss this morning. Now remember, Mozillo told us all in the third quarter that they would be posting earnings starting in 4Q. Guess what - he was not only wrong, he was WAY wrong - two quarters running. Yet BAC says they're "committed" to the merger? Huh?

Here's another prediction - BAC is intending to use CFC as a "dumping ground" for its toxic waste, will keep the firm as a wholly-owned sub so it is legally distinct, will dump their trash in there and then BK the "subsidiary" with some swansong about how things were suddenly "worse than anticipated", keeping the servicing platform.

Oh, and since I believe this is their intent that would make the entire transaction and subsequent bankruptcy fraudulent, but they won't get tagged for it, because once again, fraud, if you're a bank or other financial institution, is not an offense any more in the United States.

Defaults Rising Rapidly For 'Pick-a-Pay' (Option ARM) Mortgages
As the growth in subprime mortgage delinquencies appears to be slowing, lenders are seeing a rapid rise in defaults on a type of mortgage that gives consumers with good credit several different monthly-payment options. These mortgages, which are sometimes known as "pick-a-pay" or payment-option mortgages but are generically called option adjustable-rate mortgages, are turning out, in some cases, to be even more caustic than subprime loans, in part because the loan balance and the monthly payments on some loans is growing even as home prices are falling.

These loans have become the focus of investigations and a spate of lawsuits by borrowers who believe they were misinformed about the mortgages' complicated structure. Losses on option ARMs could be "in some cases close to subprime" mortgage levels, according to a recent report by Citigroup.

On Tuesday, Countrywide Financial Corp. said that 9.4% of the option ARMs in its bank portfolio were at least 90 days past due, up from 5.7% at the end of December and 1% a year earlier. Countrywide also reported that it had charged off $125 million of these loans in the first quarter, compared with $35 million a quarter earlier. Bank of America Corp. said last week that it will stop making option ARMs altogether after it completes the acquisition of Countrywide Financial, which in recent years has been the largest originator of these loans.

Washington Mutual Inc. reported earlier this month that option ARMs account for 50% of prime loans in its bank portfolio, but 70% of prime nonperforming loans. At Wachovia Corp., non-performing assets in the company's option ARM portfolio, which was acquired with the company's purchase of Golden West Financial Corp., climbed to $4.6 billion in the first quarter from $924 million a year earlier.

Nationwide, delinquencies on subprime loans -- at about 28% as of February, according to First American CoreLogic -- remain much higher than for option ARMs. But recent reports from mortgage securitizations suggest that subprime delinquencies have started going bad at a lower rate while delinquencies on option ARMs are speeding up.

Unlike subprime loans, which went to people with weak credit, option ARMs were generally given to borrowers considered to be lower-risk. But lending standards weakened in recent years and many borrowers now have little or no equity. Many lenders reduced the teaser rates on these loans as home prices climbed, making them appealing to borrowers looking to make the lowest monthly payment possible.

Now, with home prices dropping in California, Florida and other markets where option ARMs were popular, a growing number of borrowers with these loans now owe more than their homes are worth, one reason delinquencies are climbing, lenders say. Meanwhile, at FirstFed Financial Corp., 30% of borrowers whose loans recast to this higher level fell behind on their payments in the fourth quarter. Most other lenders won't see large numbers of resets until at least 2009 or 2010.

Many borrowers now say they didn't understand the features of the loan. For example, borrowers who make the minimum payment on a regular basis can see their loan balance grow and their monthly payment more than double when they begin making payments of principal and full interest. This typically happens after five years, but can occur earlier if the amount owed reaches a predetermined level -- typically 110% to 125% of the original loan balance.

"My sense is that many option ARM borrowers are in a worse position than subprime borrowers," says Kevin Stein, associate director of the California Reinvestment Coaliton, which combats predatory lending. "They wind up owing more and the resets are more significant."

Fannie And Freddie - Short To Zero?
Unbelievable. I have commented before that I believe Fannie and Freddie are woefully under reserved and potential "short to zero" candidates, simply because of the depth of their capital (or more specifically, the lack thereof) behind their credit book. Now we get something far more ugly - proof that what I have been told was in fact happening - that Fannie and Freddie were buying "Liar Loans" - is in fact true.

"A federal probe of Countrywide, the nation's largest mortgage lender, is turning up evidence that sales executives at the company deliberately overlooked inflated income figures for many borrowers, people with knowledge of the investigation say.
Both Countrywide and Fannie Mae, the government-sponsored company that bought many of the loans, classify the loans as "prime," meaning low-risk.
John Sipes, a former loan officer at Countrywide in Los Angeles, said sales agents loved the loan. "In the good old days, that was the best loan we had at Countrywide," he says. Borrowers were required to sign a form allowing Countrywide to verify their incomes with the Internal Revenue Service, but "they never really checked," he says."

Yeah, right. Remember now, we were told last spring and summer this was a "Subprime" problem. Then that there were some "liar loans" but they were not considered "prime" paper, and that the "prime" mortgages that were written over the years were in fact safe - even from "bubble" vintages. Now, as the FBI digs into the matter, we get down to what appears to be the truth. Let's lay it out here, assuming that the FBI investigation proves out:
  • Countrywide (and presumably other lenders) wrote mortgages to people on "stated" income, allegedly with the right to verify income against tax returns, but in fact they never did.
  • These loans were then packaged up and sold to various channels, including the GSEs Fannie and Freddie, contaminating their "prime" credit book with garbage paper that is at high risk of default. These loans were bought by Fannie and Freddie despite both of those firms representing to its investors that they buy only "safe, prime" mortgage paper.
  • This was allegedly hidden from investors (In the stock? In the paper? From Fannie?), thereby inducing those investors to purchase things (stock, bonds, mortgages) they would not have otherwise bought.
  • Either Countrywide's folks in the corner office were incompetent (unaware) or complicit (worse) - so how is it that Sambol has been given a job by BAC?

Oh, and now that the firm has been gutted Countrywide lacks the ability to "buy back" the defaulted paper, so the buyers - including Fannie and Freddie - are going to wind up eating it. Is this the only instance of this sort of outrageous behavior and misrepresentation in the system, which now appears to have been promoted and enabled by the very same GSEs that are supposed to "help" Americans buy and own homes? Care to take a bet on it? I wouldn't.

More Subprime, Alt-A Mortgages May Head 'Underwater'
About half of recent subprime and Alt-A borrowers may soon owe more on their mortgages than their houses are worth or hold minimal equity, putting $800 billion of debt at greater risk of default, according to Barclays Capital. Subprime loans from 2006 and 2007 that exceed the value of the homes jumped 5 percentage points to 19.8 percent in the fourth quarter, and may reach 26 percent by midyear if prices drop at the same pace, Barclays analysts wrote in a report yesterday. Alt-A loans, a grade better than subprime, would grow to 23 percent from 16.3 percent.

Many of the loans are in areas where prices are falling faster than the U.S. average, so the size of the shift is underappreciated, New York-based analysts Ajay Rajadhyaksha and Derek Chen wrote. The odds that a borrower will default, saddling lenders and bond investors with losses, rises when a homeowner owes more on a property than it can sell for, they wrote. "Mortgage loans are moving underwater at a very sharp pace, far more than suggested by aggregate home price data," they wrote. Home mortgages held by households totaled $10.5 trillion on Dec. 31, according to Federal Reserve data.

Defaults on Insured Mortgages Rise 37% in U.S. From a Year Ago
Defaults on privately insured U.S. mortgages rose 37 percent in March from a year earlier for their 15th straight increase, according to an industry report released today. The number of insured borrowers more than 60 days late on payments rose to 58,131 last month from 42,362 a year earlier, the Washington-based Mortgage Insurance Companies of America said.

Mortgage insurers pay lenders when homeowners default and foreclosures fail to cover costs. The new data show the U.S. housing slump isn't over. Foreclosure filings more than doubled in the first quarter as payments rose for subprime adjustable mortgages and falling home prices left property owners unable to sell or refinance without losing money, according to RealtyTrac Inc., a provider of foreclosure data.

The number of new policies issued to homeowners in the month rose to 138,782, a 2.5 percent increase from a year earlier, as lenders sought protection against further losses. Mortgage insurers say they've tightened underwriting standards and raised prices as demand for the coverage grows.

Congress, the Bush administration and regulators have urged lenders to renegotiate terms for borrowers so they can stay in their homes, easing a glut of empty houses. Almost 650,000 properties were in some stage of foreclosure during the quarter, Irvine, California-based RealtyTrac said yesterday. That's 112 percent more than a year ago.

Crisis Catches Up to Deutsche Bank
Deutsche Bank won praise and envy in financial circles for appearing to weather the credit storm better than most of its peers, but its luck finally ran out on Tuesday. The bank reported a pretax loss of 254 million euros ($396 million) for the first quarter, its first loss in five years, after writing down $4.2 billion in tainted loans and mortgage-backed securities.

Deutsche Bank had warned about the write-downs earlier this month, so they stirred less concern among analysts than the effect of the financial crisis on the bank’s day-to-day sales and trading business. Revenues were down sharply in traditional Deutsche Bank franchises like credit- and equity-derivatives trading. The bank’s chief financial officer, Anthony Di Iorio, declined to reconfirm the bank’s earnings forecast for 2008, saying there was too much turbulence in the markets.

Deutsche Bank’s loss, analysts say, is less evidence of a bank that blundered into risky, poorly understood markets than a sign of how far this crisis has spread beyond its roots in the American mortgage market. The loss would have been even worse if Deutsche Bank had not booked gains from selling shares in Daimler, Allianz and Linde — part of a long-term strategy to divest itself of stakes in German companies. “Today’s numbers were disappointing,” said David Williams, head of banking research at the London office of the investment bank Fox-Pitt Kelton Cochran Caronia Waller. “Deutsche’s core business, their day-to-day, bread-and-butter operations have been affected.”

With the likelihood of further write-downs and the possibility that its trading business may not recover soon, some analysts have concluded that Deutsche Bank did not avoid the subprime crisis after all. It is merely suffering its effects six months later than Merrill Lynch, UBS and Citigroup. “Deutsche Bank did much better than its peers because it was less exposed to the subprime areas,” said Simon Adamson, an analyst at CreditSights, a research firm in London. “But now the focus of the write-downs has shifted, and Deutsche has a large leveraged loan book.”

Citigroup Sells $3 Billion of Stock to Boost Capital
Citigroup Inc., the U.S. bank hit with writedowns on subprime mortgages and bonds, is selling $3 billion of stock two weeks after reporting its second straight quarterly loss. The shares are being sold in a public offering, New York- based Citigroup said today in a statement. Citigroup already has raised more than $30 billion of capital since December. A weakening U.S. economy and rising consumer delinquencies forced Chief Executive Officer Vikram Pandit to rescind assurances earlier this year that the bank didn't need to raise more funds.

"This was extremely disappointing," William Fitzpatrick, an equity analyst at Optique Capital Management in Racine, Wisconsin, said in a Bloomberg Television interview. "We were hoping they wouldn't have to go the equity markets like this." Companies usually try to avoid forced stock sales because they dilute the earnings power of current shareholders. Citigroup, the biggest U.S. bank by assets, earlier this month sold $6 billion of preferred shares, a bond-like security that isn't dilutive to common shareholders.

Citigroup fell about 3.8 percent to $25.32 in extended trading after the stock sale was announced this afternoon. It fell 49 cents to $26.32 earlier today in New York Stock Exchange trading. Both Pandit and Chief Financial OfficerGary Crittenden had said earlier this year that Citigroup may avoid the need to raise more capital. In January, Crittenden said the company had "stress-tested" its assumptions under "multiple recessionary scenarios."

Then, on April 18, the bank posted a first-quarter loss of $5.1 billion. Crittenden, on a conference call with Wall Street analysts, was asked if the bank might seek more capital. He said, "You can never say never."

Citigroup Increases Stock Offering to $4.5 Billion
Citigroup Inc., seeking to bolster capital depleted by mounting losses, raised $4.5 billion in a stock sale, 50 percent more than it planned after "strong demand" from investors. Citigroup, the biggest U.S. bank, sold 178.1 million shares at a price of $25.27 each, it said in a statement today. Shares of the New York-based company fell 2.9 percent in New York trading.

The sale represents about 3 percent of Citigroup's shares outstanding as of March 31. The world's biggest banks, grappling with more than $300 billion of losses on mortgages, bonds and loans, have sought new capital to stave off credit-rating downgrades that might jeopardize client relationships and access to financing. Companies usually try to avoid forced stock sales because they dilute the earnings power of current shareholders.

"They need the additional capital," said Ben Wallace, an analyst at Grimes & Co. in Westborough, Massachusetts, which manages $800 million including Citigroup shares. "The dilution factor is a secondary concern these days."
Citigroup fell 76 cents to $25.56 as of 10:04 a.m. in New York Stock Exchange composite trading. They've fallen 52 percent in the past year.

The bank already has raised more than $30 billion of capital since December, including the sale of equity to investment funds controlled by foreign governments in Abu Dhabi, Singapore and Kuwait. Last week Citigroup sold $6 billion of preferred shares, a bond-like security that isn't dilutive to common shareholders, after it reported a $5.1 billion first- quarter loss and cut 9,000 jobs.

Countrywide Reports $893 Million Loss From Bad Loans
Countrywide Financial Corp., the mortgage lender that Bank of America Corp. plans to buy, reported a third straight quarterly loss as late payments and home foreclosures escalated. The net loss was $893 million, or $1.60 a share, compared with a profit of $434 million, or 72 cents, in the year-earlier period, the Calabasas, California-based company said in a statement today. Countrywide's losses aren't enough to prompt Bank of America to abandon its bid, said Credit Suisse Group analyst Moshe Orenbuch.

Countrywide trades for about 15 percent less than shareholders would get if the stock swap were completed today, reflecting investor concern that Bank of America may demand a better price or cancel the sale, valued at about $4 billion. "It's not likely to deteriorate enough to derail the deal," said Orenbuch. Countrywide gained 2 cents to $5.85 at 4:01 p.m. in New York Stock Exchange composite trading. The lender has declined about 85 percent in the past 12 months, with Chief Executive Officer Angelo Mozilo, 69, presiding over the company's first annual loss in more than 30 years.

U.S. foreclosure filings more than doubled in the first quarter as payments rose for subprime adjustable mortgages, according to data vendor RealtyTrac Inc. Bank of America, the nation's second-biggest bank by assets behind Citigroup Inc., said April 21 that the sale, announced in January, remains on course for completion in the third quarter. The Charlotte, North Carolina-based bank dropped 32 cents to $37.86 and has slumped about 25 percent over the past year.

The combination would make Bank of America the biggest U.S. mortgage lender, handling about one out of every four home loans. The bank ranked fifth in 2007, according to trade publication Inside Mortgage Finance. Countrywide, the biggest mortgage lender by value of loans last year, posted a $703.5 million loss for all of 2007 because of higher loan losses and writedowns of securities backed by home loans.

"The problem with Countrywide is that it comes with this portfolio that was not underwritten correctly and is very sloppy," said Paul Miller, an analyst at Friedman Billings Ramsey & Co., in an interview with Bloomberg Television. Miller expects Bank of America to end up buying Countrywide at a lower price than originally negotiated.

Bank of America plans to assist troubled borrowers holding $40 billion in mortgages
Bank of America said it plans to refinance or modify terms on $40 billion of mortgages for troubled borrowers over the next two years, after acquiring Countrywide Financial later this year. The bank expects the moves to aid 265,000 borrowers who are at risk of losing their homes. "No one benefits from a foreclosed home," said Liam McGee, BofA's president of global consumer and small business banking, said at a Federal Reserve hearing in Los Angeles Monday.

The Fed held the hearing as part of BofA's plans to buy Countrywide. BofA also plans to employ almost 4,000 people for a year to work out problem loans at Countrywide. BofA's plans to mop up the Countrywide mess suggest the scope of the problems afflicting Countrywide and its customers in the wake of the historic housing boom's bust. In a similar Fed hearing in Chicago, the bank disclosed that it will eliminate Countrywide's subprime lending operations and limit the menu of mortgages that contributed to Countrywide's spectacular downfall.

BofA is also tackling the problem of tenants residing in foreclosed homes head on. McGee said BofA will let tenants stay in a property 60 days after a foreclosure and will actually give them $2,000 under a "cash for keys" program for those vacating a property within 30 days. Some tenants have found themselves out on the street -- often without their security deposits -- because they had no idea their landlords were behind on their mortgage payments. The Charlotte, N.C,, bank also said it will double its community development investments to $1.5 trillion over the next decade. That money will help build affordable housing and expand mortgage financing for low-income and minority borrowers.

The bank also plans to make "concentrated efforts" in Southern California's hard-hit Riverside and San Bernardino counties, Janet Lamkin, president of Bank of America California, told those attending the Fed hearing. BofA will also make $30 million in charitable contributions to California nonprofits this year. "We have a significant stake in the economic vitality and quality of life in this state," Lamkin said.

GMAC Feels the Drag From Its Struggling Mortgage Unit
GMAC LLC's first-quarter loss illustrates how tightly the company is being choked by its mortgage-lending unit, Residential Capital LLC. That the broader economy is faltering adds to its woes. GMAC, the financing arm of General Motors Corp., said its first-quarter loss widened to $589 million from $305 million a year earlier, pressured by persistent weakness at Residential Capital. Cerberus Capital Management LP owns 51% of GMAC.

GMAC's results will affect those of GM -- which owns the other 49% of the company and includes its share of GMAC's figures in its data -- as the auto maker also attempts to return to profitability. Cerberus has also taken a hit on the investment, having marked down its GMAC stake by roughly 20% as of March 31, according to a person familiar with the situation. A Cerberus spokesman declined to comment. ResCap had a first-quarter net loss of $859 million, narrower than last year's $910 million loss. Its recent loss included a gain of $480 million from debt retirement.

ResCap, once a major U.S. subprime-mortgage originator, has been reporting losses for more than a year as a result of the blowup of the risky-mortgage market and the subsequent credit crunch. ResCap lost $4.3 billion in 2007, and GMAC spent much of the year restructuring the company, including job cuts and an overhaul of the business model.

In spite of GMAC's efforts to support ResCap, many credit-market investors suspect ResCap will become too much of a burden for its parent and ultimately will fail to meet its debt obligations. Within the coming year, ResCap has about $4 billion of unsecured debt and $13 billion of secured debt coming due. The company currently has a $4.2 billion cash cushion.

Opec head sees oil price hitting $200 a barrel
The president of Opec has warned that the price of oil could hit $200 (£100) a barrel, spelling more pain for the major crude-consuming economies. Chakib Khelil said there was nothing that the oil producers' cartel could do to bring down the high price, which he blamed on geopolitical tensions and market speculators.

His comments, coming as oil touched a record $120 a barrel on Nymex at one stage yesterday, are seen as rejecting pleas from America and Europe for Opec to turn on the taps and help rein in the price. Mr Khelil, Algeria's energy minister, said there is no evidence of a shortage of oil on world markets. He told El Moudjahid, Algeria's state-owned newspaper, that oil stocks in the US were at a five-year high.

The price is being pushed up by the weak dollar, investment funds speculating on a higher price, and fears over supply shortages created by events such as the Grangemouth strike in Scotland and another at ExxonMobil's operations in Nigeria. In such circumstances, Mr Khelil said he could not rule out oil going to $200 a barrel. While the power of Opec, which supplies about 35pc of the world's needs, is no longer as great as in the 1980s and 1990s, critics within the US government argue that its members could do more to increase supply.

The rising price of crude is not hurting the oil companies, however. Royal Dutch Shell is today expected to report record first-quarter profits, while BP should turn in one of its best quarterly performances for two years. During the quarter being reported, oil reached $100 for the first time. Shell's Q3 profits are forecast to rise 5pc to around $6.88bn, with BP's rising about 32pc to $5.26bn. Profits from refinery operations will fall, however, as the cost of crude oil rises.

In February, BP estimated that output will rise 13pc during the next five years to about 4.3m barrels a day. Tony Hayward, the chief executive, said BP will sustain production of at least 4m barrels a day until 2020 even without new finds.

Worst UK house price slide since 1996 raises negative equity fears
House prices across the nation are now falling year-on-year for the first time in more than a decade, Nationwide Building Society said today. The average price of a home in April dropped 1pc from a year earlier, and by 1.1pc compared with March. The prospect of property values falling below what they were worth this time last year raises fears that many homeowners may be pushed into negative equity - as the amount owed on their mortgage exceeds the price of their home.

The weakness in the housing market will only add to pressure on the Bank of England to reduce interest rates from their current level of 5pc. Danny Blanchflower, one of the nine people at the central bank who votes on interest rates, warned yesterday that prices could tumble by as much as 30pc in the next two to three years and, that without a sharp reduction in rates, the UK economy risks a recession.

Howard Archer of Global Insight said: "The longer the credit crunch goes on, and the deeper and longer the UK economic slowdown is, the greater the danger will be that an even sharper housing market correction will occur." The state of the housing market, which until this year enjoyed a decade-long boom, will add to the worries for Prime Minister Gordon Brown. Mr Brown said that he is “very worried” about the impact of rising fuel prices on families and pensioners.

Bank of England 'must act to avoid recession'
Britain faces the threat of a significant recession, with house prices at risk of falling by a third, a senior Bank of England policymaker has said. David Blanchflower, a member of the Monetary Policy Committee, said Britain was facing a US-style economic downturn and urged the Bank to take "aggressive action" to prevent it.

It came as the Bank of England reported a sharp fall in the number of new mortgages taken out, with the housing market entering its toughest period since the early 1990s. Prof Blanchflower, who teaches economics in the US as well as being one of the nine members on the Bank committee that sets interest rates, said: "We face a real risk that the UK may fall into recession, and aggressive action is required to prevent this from occurring.

"For some time now I have been gloomy about prospects in the United States, which now seems clearly to be in recession. I believe there are a number of similarities between the UK and the United States that suggest that in the UK we are also going to see a substantial decline in growth, a pick-up in unemployment, little if any growth in real wages, declining consumption growth driven primarily by significant declines in house prices. "The credit crunch is starting to hit and hit hard."

Bank of England policy?makers are usually quick to dismiss the prospect of a recession or a housing slump. However, Prof Blanchflower used his speech at the Royal Society to provide an explicit warning about home values. "In my view a correction of approximately one third in house prices does not seem implausible in the UK over a period of two or three years if house price-to-earnings ratios are to be restored to more sustainable levels," he said. Although many forecasters suspect house prices will drop in the coming years, few have issued forecasts quite as dramatic as Prof Blanchflower.

Spanish banks' negative outlook reflects weakened credit environment - Moody's
Moody's Investor Service said the negative rating outlook for the Spanish banking system reflects a weakening of the country's real-estate market, high levels of exposure and concentration to this sector and a more challenging funding market. Moody's expects to witness a further increase in delinquencies in 2008, in view of a weakening labour market and expected house price correction.

The outlook also takes account of the ongoing global credit crisis and an uncertain macroeconomic environment, particular as the construction and real estate segment -- which accounts for a significant portion of banks' books -- also accounts for a sizeable part of the domestic labour force, 13.2 percent as of the fourth quarter of 2007. 'The negative outlook for Spain's rated banks -- comprising commercial banks, savings banks and credit co-operatives -- is based on a sizeable proportion of property and construction companies in Spanish banks' balance sheets,' Moody's noted.

Moody's said that after several years of strong growth in lending, fuelled by relatively cheap access to market funding -- particularly securitisations and covered bonds -- the turmoil in the financial markets has translated into a sudden deceleration of business growth for Spanish banks.

Fed looks to extend debate on liquidity
Federal Reserve policymakers will discuss paying interest on bank reserves in a closed door meeting on Wednesday. Such a move could in theory allow the Fed to expand its liquidity support operations without limit. The discussion will take place alongside the Fed’s regular meeting on monetary policy, at which officials are expected to agree to cut rates another quarter point (25 basis points) to 2 per cent and hint at a possible pause in June.

Under a law passed in 2006, the US central bank will gain the authority to pay interest on reserves in 2011. The meeting on Wednesday is based on that timeframe and will not be followed by any announcements. However, the meeting could spark an internal debate as to whether the Fed should consider asking Congress to bring forward this authority to help it deal with the current credit crisis. Many experts think that would be a good idea. Vincent Reinhart, former chief monetary economist at the Fed, said paying interest on reserves would allow the Fed to “expand their liabilities to support more asset purchases”.

A number of other central banks already have the authority to pay interest on reserves, as well as the authority to lend banks money. In normal times they can use these deposit and lending rates to put a corridor around the main policy rate, and prevent it from being buffeted too far away from the level they aim to set.

But at times of financial market stress, the ability to pay interest on reserves takes on added significance. Currently, the Fed cannot expand or contract its balance sheet without altering the overall supply of reserves and changing its main policy rate, the Fed funds rate. All it can do is change the composition of its balance sheet – absorbing more duration risk, liquidity risk or credit risk from the private sector. But if the Fed was able to pay interest on deposits, it could use that rate to put a floor under the Fed funds rate.

Fed's Bailout Is Questioned by Ex-Staffer
The Federal Reserve's rescue of Bear Stearns Cos. will come to be seen as its "worst policy mistake in a generation," a former top Fed staffer said. The episode will be seen as comparable to "the great contraction" of the 1930s and "the great inflation" of the 1970s, Vincent Reinhart said Monday at a panel organized by the American Enterprise Institute, a conservative-leaning think tank where he is now a scholar. Until mid-2007, Mr. Reinhart was director of monetary affairs at the Fed and secretary of its policy-making panel, the most senior position on the Fed's Washington-based staff.

His appraisal is one of the harshest yet by a high-profile observer. The Fed last month lent Bear Stearns money to prevent a bankruptcy filing and then financed $29 billion of its assets to facilitate a takeover by J.P. Morgan Chase & Co. Former Fed Chairman Paul Volcker has said the move went to "the very edge of [the Fed's] lawful and implied powers," although he has since said that that wasn't meant as a criticism. Congress and analysts have deferred to the Fed's judgment.

Mr. Reinhart said the bailout "eliminated forever the possibility the Fed could serve as an honest broker."

In 1998, the Fed coaxed private creditors of Long-Term Capital Management to bail out the hedge fund but didn't have to put up its own money. If it ever tries a similar maneuver on a Wall Street cohort, he said, "The reasonable question any person in the room will ask is, 'How much will you contribute to the solution?'"

Mr. Reinhart said the Fed's move may have been justified if the alternative was a chain-reaction run on many other investment banks. But he asked if other options were available, such as taking a "tougher line" with J.P. Morgan, seeking other suitors, removing certain assets from Bear's portfolio or quickly implementing its previously announced offer to temporarily swap Treasury securities for dealers' less liquid assets. "All those things were possible but not pursued," he said.

What the Fed Could Learn from Europe's Central Bank
Never before have the central banks of the United States and Europe pursued such divergent strategies when it comes to dealing with a financial crisis. The increased value of the euro against the dollar reveals which strategy is working.

Trichet runs the ECB thoughtfully and with circumspection. The Fed, under Bernanke's leadership, is hands-on and decisive. But which approach is more successful during an acute global financial crisis? And is it possible that the two key central bankers are in fact fueling the seemingly unending banking disaster?

The ECB remains calm -- sometimes to the point of doing nothing. Since the turbulence in the financial markets began last summer, it has left European key interest rates unchanged. The Fed, on the other hand, seems to take action to show it is doing something, sometimes to the point of hysteria. Since August of 2007, it has brought down the key interest rate at record speed, from 5.25 percent to 2.25 percent, to avert a recession in the United States.

But now it seems that all of the Fed's efforts have been in vain. Testifying before the US Congress, Bernanke was forced to admit that he expects the US economy to grow very little, if at all, in the first half of 2008. It "could even contract slightly," he said.

If a currency's value is a measure of confidence in an economy and its central bank, then the Europeans and their ECB are clearly emerging as the winners in the current crisis. Last week the euro climbed to a new record high of $1.60.
This has damaged confidence in both the Fed and its chairman. "Bernanke and his Fed are well on their way toward gambling away their credibility," says Thorsten Polleit, chief economist at Barclays Capital in Frankfurt.

"Bernanke is making himself a slave to the stock markets," said Willem Buiter, a monetary policy expert at the London School of Economics. Trichet, on the other hand, has opted for a hands-off approach. Interest rates in the euro zone are still where they were before the crisis, despite a considerably worsened economic outlook for Europe.

The Pentagon Strangles Our Economy: Why the U.S. Has Gone Broke
By Chalmers Johnson
60 years of enormous military spending is taking a dramatic toll on the rest of the economy.

The military adventurers in the Bush administration have much in common with the corporate leaders of the defunct energy company Enron. Both groups thought that they were the "smartest guys in the room" -- the title of Alex Gibney's prize-winning film on what went wrong at Enron. The neoconservatives in the White House and the Pentagon outsmarted themselves. They failed even to address the problem of how to finance their schemes of imperialist wars and global domination.[..]

The pioneer in analyzing what has been lost as a result of military Keynesianism was the late Seymour Melman (1917-2004), a professor of industrial engineering and operations research at Columbia University. His 1970 book, Pentagon Capitalism: The Political Economy of War, was a prescient analysis of the unintended consequences of the U.S. preoccupation with its armed forces and their weaponry since the onset of the cold war.

Melman wrote: "From 1946 to 1969, the United States government spent over $1,000bn on the military, more than half of this under the Kennedy and Johnson administrations -- the period during which the [Pentagon-dominated] state management was established as a formal institution. This sum of staggering size (try to visualize a billion of something) does not express the cost of the military establishment to the nation as a whole. The true cost is measured by what has been foregone, by the accumulated deterioration in many facets of life, by the inability to alleviate human wretchedness of long duration."

In an important exegesis on Melman's relevance to the current American economic situation, Thomas Woods writes: "According to the U.S. Department of Defense, during the four decades from 1947 through 1987 it used (in 1982 dollars) $7.62 trillion in capital resources. In 1985, the Department of Commerce estimated the value of the nation's plant and equipment, and infrastructure, at just over $7.29 trillion ... The amount spent over that period could have doubled the American capital stock or modernized and replaced its existing stock." The fact that we did not modernize or replace our capital assets is one of the main reasons why, by the turn of the 21st century, our manufacturing base had all but evaporated. Machine tools, an industry on which Melman was an authority, are a particularly important symptom.

In November 1968, a five-year inventory disclosed "that 64% of the metalworking machine tools used in U.S. industry were 10 years old or older. The age of this industrial equipment (drills, lathes, etc.) marks the United States' machine tool stock as the oldest among all major industrial nations, and it marks the continuation of a deterioration process that began with the end of the second world war. This deterioration at the base of the industrial system certifies to the continuous debilitating and depleting effect that the military use of capital and research and development talent has had on American industry."

Nothing has been done since 1968 to reverse these trends and it shows today in our massive imports of equipment -- from medical machines like proton accelerators for radiological therapy (made primarily in Belgium, Germany, and Japan) to cars and trucks. Our short tenure as the world's lone superpower has come to an end. As Harvard economics professor Benjamin Friedman has written: "Again and again it has always been the world's leading lending country that has been the premier country in terms of political influence, diplomatic influence and cultural influence.

It's no accident that we took over the role from the British at the same time that we took over the job of being the world's leading lending country. Today we are no longer the world's leading lending country. In fact we are now the world's biggest debtor country, and we are continuing to wield influence on the basis of military prowess alone."

The Black Hole of Debt
In recent weeks, Haiti has been gripped by violent protest yet again. And yet again the inhabitants of this impoverished country are suffering the most brutal consequences of the fallout of the global economic crisis. This time it is the rise in global food prices, which has sparked riots in Port au Prince, Haiti's capital, where UN peacekeepers used rubber bullets and tear gas against protesters attempting to storm the presidential palace. Days later the prime minister was fired.

It is therefore particularly appropriate that on Tuesday this week -the anniversary of the death of Haiti's dictator, Francois "Papa Doc" Duvalier - hundreds of debt campaigners fasted for Haiti's debt to be cancelled. Haiti's fate has been tied up with the issue of international debt more than any other country. Despite the fact that it's debt is illegitimate by any standards and despite Haiti's sorry position as the poorest country in the western hemisphere, it still owes $1.3bn. Every year debt repayments flow from Haiti to multilateral banks, just as its resources once enriched the French empire.

Haiti became the world's first republic to outlaw slavery, after the slave population led a struggle for independence which they won in 1804. However, in 1825, in return for recognition, the new state promised to pay its former French overlords compensation amounting to $21bn in today's money. It did not finish paying this debt until 1947. Calls for restitution have been consistently rejected by French governments.

Some 40% of Haiti's current debt was run up by the Duvalier dictators - better known as Papa Doc and Baby Doc - who between 1957 and 1986 stole parts of these loans for themselves, and used the rest to repress the population. When the Americans flew Baby Doc out of Haiti in 1986, he is estimated to have taken $90m with him. The Duvaliers were anti-communist and all too happy to follow the economic policies prescribed by the west, so their misdemeanours were overlooked.

In the 1980s and 90s, like all indebted countries, Haiti had to follow structural adjustment policies designed by the World Bank and International Monetary Fund (IMF) - including cuts in government expenditure on health and education, privatisation and the removal of import controls. Indigenous Haitian industries were wiped out as American imports flooded into the country. In 1995 the IMF forced Haiti to slash its rice tariff from 35% to 3%.

According to Oxfam, this resulted in an increase in imports of more than 150% between 1994 and 2003, the vast majority from the US. Certainly this meant lower prices for Haitian consumers, but it also devastated Haitian rice farmers. Traditional rice-farming areas of Haiti now have some of the highest concentrations of malnutrition and a country that was self-sufficient in rice is now dependent on foreign imports, at the mercy of global market prices.

Today, 80% of Haiti's population live in poverty as defined by the World Bank (under $2 a day). Average life expectancy is just 52 years. Half of all Haitian adults cannot read or write. Yet Haiti failed to qualify for debt relief under the heavily indebted poor country initiative (HIPC), established in 1996 to make the debts of the most severely indebted poor countries more sustainable - surely the clearest proof of the arbitrary nature of the HIPC scheme.

Ilargi: Talk about a perfect storm: in order to feed themselves, people will increasingly destroy their living environment. Monsanto and Cargill are laughing in the background.

Shortages Threaten Farmers’ Key Tool: Fertilizer
Truong Thi Nha stands just four and a half feet tall. Her three grown children tower over her, just as many young people in this village outside Hanoi dwarf their parents. The biggest reason the children are so robust: fertilizer. Ms. Nha, her face weathered beyond its 51 years, said her growth was stunted by a childhood of hunger and malnutrition. Just a few decades ago, crop yields here were far lower and diets much worse.

Then the widespread use of inexpensive chemical fertilizer, coupled with market reforms, helped power an agricultural explosion here that had already occurred in other parts of the world. Yields of rice and corn rose, and diets grew richer. Now those gains are threatened in many countries by spot shortages and soaring prices for fertilizer, the most essential ingredient of modern agriculture.

Some kinds of fertilizer have nearly tripled in price in the last year, keeping farmers from buying all they need. That is one of many factors contributing to a rise in food prices that, according to the United Nations’ World Food Program, threatens to push tens of millions of poor people into malnutrition. Protests over high food prices have erupted across the developing world, and the stability of governments from Senegal to the Philippines is threatened.

In the United States, farmers in Iowa eager to replenish nutrients in the soil have increased the age-old practice of spreading hog manure on fields. In India, the cost of subsidizing fertilizer for farmers has soared, leading to political dispute. And in Africa, plans to stave off hunger by increasing crop yields are suddenly in jeopardy. The squeeze on the supply of fertilizer has been building for roughly five years. Rising demand for food and biofuels prompted farmers everywhere to plant more crops. As demand grew, the fertilizer mines and factories of the world proved unable to keep up.

Some dealers in the Midwest ran out of fertilizer last fall, and they continue to restrict sales this spring because of a limited supply. “If you want 10,000 tons, they’ll sell you 5,000 today, maybe 3,000,” said W. Scott Tinsman Jr., a fertilizer dealer in Davenport, Iowa. “The rubber band is stretched really far.” Fertilizer companies are confident the shortage will be solved eventually, noting that they plan to build scores of new factories. But that will probably create fresh problems in the long run as the world grows more dependent on fossil fuels to produce chemical fertilizers. Intensified use of such fertilizers is certain to mean greater pollution of waterways, too.

Click to enlarge

Monday, April 28, 2008

Debt Rattle, April 29 2008: Questions Over Bailouts

The Shrinking Pie Effect
It seems to me that predominating now in the markets is something that could be called the “shrinking pie effect” (as I try my hand at my own version of Winterisms…) : basically this is the propensity of the credit bubble in the widest sense to continue deflating even as various bailouts and pumping schemes (i.e. by the central banks) enjoy some measure of success (with predictable cheers by the financial media). While these schemes may stabilize certain corners of the credit markets and avert near-term major money center bank failure, they cannot bring the markets back to their recent glory days of even a year ago. Too much “bid” is now gone, never to return, and the amount of such bid goes down with each passing month. Hence “shrinking pie.”

EU threat to U.K. rescue
In a striking warning of the loss of national sovereignty that comes with EU membership, Britain's $100 billion bailout plan for its banks and mortgage market is threatened with a ban from Brussels.

EU competition officials are frowning on the scheme for giving "unfair" preference to British over European banks, and because it may also breach rules against state aid. Legal experts on EU rules say the Bank of England's rescue plan has little chance of survival with EU bureaucrats.

"It seems to me that this is prima facie state aid because this scheme gives banks operating in the United Kingdom an advantage over other European banks operating outside the UK," said Anthony Woolich, head of competition for the London-based LG law firm.

The scheme, devised by Bank of England Gov. Mervyn King, allows banks to swap some of their troubled mortgages at a discount for state-backed treasury bonds. It is aimed at restoring liquidity to the London financial markets by giving the banks the safe and easily sold treasury bonds, in return for the mortgages that they cannot sell in the current troubled markets.

The irony is that the British scheme is similar to one long used by the European Central Bank, custodian of the euro, that lets European banks use their mortgage bonds as collateral to borrow ECB-issued Eurobonds. That policy has not been questioned by EU officials, and the threat of a ban on the Bank of England plan underlines British fears that the EU is determined to sabotage London's dominant role in financial markets in the name of competition.

Morgan Stanley see big bank woes just beginning
Morgan Stanley analysts on Monday told clients to "sell the rally" in financial stocks, slashing forecasts for big bank earnings and warning that the current credit crunch is only just beginning.

In aggregate, Morgan Stanley reduced its estimates for 2008 large bank earnings by $17 billion, or 26 percent, and reduced 2009 forecasts by $13 billion, or 15 percent. The analysts expect higher loan losses and expenses, offset by higher net interest income, though profits could fall further still if the Federal Reserve stops lowering interest rates.

"More capital hikes and dividend cuts (are) coming as our credit deteriorates and forward earnings decline," analysts led by Betsy Graseck wrote in a report. "We think we are only in the third inning of the credit cycle and expect this credit cycle will be worse than (the slump in) 1990-91."

Ratings Extortion? Maybe. And Yet More Fraud
Our capital markets have become one gigantic scam. The SEC won't investigate, the FBI won't prosecute and both political parties claim to be "concerned" about the impact this has had on Americans, but neither will get off their duffs and start insisting that existing law be enforced.

Every day I am treated to a new disclosure on the utter depravity of these people on Wall Street, Congress and The Federal Reserve who have taken truly extraordinary steps to rob every American, up and down Main Street.

And we wonder why the market "goes up" when the economic news "goes down"? I'm not surprised at all. Wall Street has become convinced that so long as a greater bagholder can be found, no matter what has to be done to make it happen, legal or not, nothing evil can occur in the markets. Therefore, there is no risk. We thus must buy, because prices will rise since we'll never be held to account for our lies, fraud and rape of the American public.

My Confession: “Approve and Move” - A Million Tiny Compromises
Let me set this up for you, briefly. As I’ve said, at any point in the process there is culpability for the crisis, rooted in greed. There is the borrower who wants that loan and that big dream home, which is too much for him to afford, but he wants it so bad he will do anything to get it, including stretching the truth of his financial situation. There’s the appraiser who wants to gain the favor of real estate agents, mortgage brokers and sales people at the bank, so he stretches that value; if even just a *little bit. There’s the politician that wants campaign contributions, or a seat on the board at a major bank someday, who knows our trade policy is wrong, but who votes for that free trade deal anyway, outsourcing thousands more jobs. There’s the mortgage broker who knowingly put together a loan with fraudulent documents and information; because he just has to get that commission; *just this once to get out of debt, and then he won’t do it again. Until the next time that is. And of course, the Wall Street banking executive, securitizing those loans and pushing the mortgage companies for more; even if the credit scores are lower, even if the LTV is higher, even if the documentation is less, because they just have to issue more securities, to keep up with their peers and hit those earnings projections. The love of money at all levels in the process.

But it could have been stopped, and the best place to stop it, if not on Wall Street, was at my desk. I was an underwriter, and yes, my confession is: this mess is my fault too.

It’s a tall order to expect a person to lodge a personal protest against this machinery of cowboy capitalism. But everyone makes decisions every day. Everyone has to face his own conscience everyday. Everyone has a role to play and even one cog in the wheel can stop the process, at least temporarily. And after all, it is the underwriter who, at the fundamental level, is paid specifically for his judgment and accuracy of decision making. They pay you to make good decisions. But 99% of the time what did I do?

Approve and move.

Will They Call FHA A Predatory Sub Prime Lender Too?
FHA reform is being “debated” in the House of Representatives. Even though the private sector managed risk better than FHA (where default rates are higher than in subprime, and rising), the House is prepared to increase FHA’s mandate and allow more loans to be made to borrowers currently in foreclosure. If that isn’t scary enough, the “debate” is currently centered not on the cost to taxpayers, not on credit quality, not on the role of limited government in a market economic system, not on our budget deficits and the need to keep government lean; no, the debate is on whether or not the taxpayers should pay for the legal fees of the borrowers in foreclosure.

Can someone give me ONE REASON that ANY AMERICAN should continue paying their mortgage? The election year Congress is falling all over itself to reward you for not paying your bills.

U.K. House Prices Decline the Most in Three Years
U.K. house prices fell the most in more than three years in April as a dearth of credit and concern that the property slump is deepening deterred prospective homebuyers, Hometrack Ltd. said.

The average cost of a home in England and Wales dropped 0.6 percent, the most since December 2004, to 173,100 pounds ($344,000), the London-based research company said today in a statement. Prices declined 0.9 percent from a year earlier.

A surge in borrowing costs has prompted banks to withdraw their best mortgage offers, worsening the housing decline. Falling home prices are sapping consumer confidence and held economic growth to the slowest pace since 2005 in the first quarter.

``Weak confidence is effectively resulting in a `buyers strike,''' Richard Donnell, director of research at Hometrack, said in the statement. ``The current downward pressure on prices will only start to be reversed once there is a turnaround in buyer confidence'' that will ``revolve around greater stability in the financial markets and an improved economic outlook.''

CRE Bust: How Deep, How Fast?
A key historical investment pattern is for non-residential investment in structures to follow residential investment by about 4 to 7 quarters (both up and down). See Investment Matters for some graphs on this subject.

Clearly the CRE slump is here. Now the questions is how deep and how fast will CRE investment fall. One way to think about this is to look at previous declines in non-residential investment....

....My guess - based on these two previous busts - is that non-residential investment will decline about 15% to 20% over the next four quarters, from a $501 billion seasonally adjusted annual rate (SAAR) in Q4 2007, to about $400 billion to $425 billion in Q4 2008 - and that most of the bust will happen during 2008.

Drinks? DJs? See Realtor Inside
n February, throngs of people gathered at a $100,000 poolside party in Miami, downing Roberto Cavalli vodka, sampling food from local restaurants and dancing to a DJ blasting hip-hop and house music. Nearly 1,000 more people showed up than expected, sending the hosts scrambling to provide extra booze and triggering noise complaints from neighbors.

It wasn't a wedding or a birthday bash. The swanky event -- designed with a film theme, with a red carpet and a giant movie screen -- was hosted by the Related Group, a luxury developer, to get people to see, and eventually buy, apartments in its new 1,000-unit complex....

....Welcome to the open-house on steroids. Home-baked cookies are out. Designer drinks, opera singers and Cinco-de-Mayo theme parties are in. Despite sluggish home sales in most of the country, some Realtors and developers are sinking money into open-house parties that they hope will draw crowds -- and an eventual buyer.

Fifty Ways To Leave Your Lender
Several speakers used expressions such as "I have never seen anything like this in my 25 to 30 years in the markets" or, "This sell-off in the mortgage market was unparalleled in the last 25 years." Obviously, the recent events are not seen as just another normal market correction.

One of the reasons for this was explained in a masterful and highly entertaining speech by Paul McCulley, the senior economist of PIMCO, the largest bond manager in North America. He used Paul Simon's 1975 classic song "Fifty Ways to Leave Your Lover" to illustrate the problem with the "NINJA" borrowers in the U.S.--"NINJA" stands for borrowers with No Income, No Job or Assets).

As Mr. McCulley pointed out, the song lyrics might also be interpreted as 50 ways to leave your lender, with the most important point being the last couplet: "Just drop off the key, Lee, and get yourself free." Lax lending practices that had allowed people with no assets or proof of income to borrow far more than they could ever hope to service, let alone repay, had effectively given the NINJAs a free call option on the increase in house prices as well as--and this is the vital point--a free put option back to the lender if the house did not go up in price.

With no down payment and therefore no "skin in the game," the NINJA borrower could walk away from his or her depreciating house and "send in the keys" to the lender. As Mr. McCulley pointed out, in most U.S. states, lenders can either pursue the borrower or the asset, but not both. As the NINJA borrower, by definition, has no assets, there is no downside to walking away.

Fed's Bailout Is Questioned by Ex-Staffer
The Federal Reserve's rescue of Bear Stearns Cos. will come to be seen as its "worst policy mistake in a generation," a former top Fed staffer said.
Vincent Reinhart: An ex-Fed player's Monday-morning quarterbacking.

The episode will be seen as comparable to "the great contraction" of the 1930s and "the great inflation" of the 1970s, Vincent Reinhart said Monday at a panel organized by the American Enterprise Institute, a conservative-leaning think tank where he is now a scholar. Until mid-2007, Mr. Reinhart was director of monetary affairs at the Fed and secretary of its policy-making panel, the most senior position on the Fed's Washington-based staff.

His appraisal is one of the harshest yet by a high-profile observer. The Fed last month lent Bear Stearns money to prevent a bankruptcy filing and then financed $29 billion of its assets to facilitate a takeover by J.P. Morgan Chase & Co. Former Fed Chairman Paul Volcker has said the move went to "the very edge of [the Fed's] lawful and implied powers," although he has since said that that wasn't meant as a criticism. Congress and analysts have deferred to the Fed's judgment.

Mr. Reinhart said the bailout "eliminated forever the possibility the Fed could serve as an honest broker." In 1998, the Fed coaxed private creditors of Long-Term Capital Management to bail out the hedge fund but didn't have to put up its own money.

U.S. Home Vacancies Rise to Record on Foreclosures
A record 18.6 million U.S. homes stood empty in the first quarter as lenders took possession of a growing number of properties in foreclosure.

The figure is 5.7 percent higher than a year ago, when 17.6 million properties were vacant, the U.S. Census Bureau said in a report today. The vacancy rate, the share of homes empty and for sale, rose to 2.9 percent, the highest since the bureau started keeping count in 1956. About 2.3 million empty homes were for sale, compared with 2.2 million a year earlier, the report said.

The worst U.S. housing slump in more than a quarter century is deepening as falling values encourage buyers to delay purchases in hopes of getting a better deal. The median U.S. home sale price may drop 5.8 percent in 2008, the most on record, followed by another 4.7 percent decline next year, Fannie Mae, the world's largest mortgage buyer, said April 7.

``We think it unlikely that prices begin to stabilize until vacancy rates start declining,'' Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York, said today in a report for clients.

Loan Industry Fighting Rules on Mortgages
The mortgage industry, facing the prospect of tougher regulations for its central role in the housing crisis, has begun an intensive campaign to fight back.

As the Federal Reserve completes work on rules to root out abuses by lenders, its plan has run into a buzz saw of criticism from bankers, mortgage brokers and other parts of the housing industry. One common industry criticism is that at a time of tight credit, tighter rules could make many mortgages more expensive by creating more paperwork and potentially exposing lenders to more lawsuits.

To the chagrin of consumer groups that have complained that the proposed rules are not strong enough, the industry’s criticism has already prompted the Fed to consider narrowing the scope of the plan so it applies to fewer loans.

So many Florida housing scams, so few watchdogs
Earlier this month, FBI director Robert Mueller described a "tremendous surge"' in mortgage fraud investigations that has diverted agents from other cases.

"I'm not sure at this point we can see the extent of the surge,'' he told a U.S. Senate hearing.

Few places have had more fraudulent activity than Florida, where buyers flooded into a booming real estate market in 2005 and 2006, only to be stuck with properties they couldn't afford or couldn't resell when prices plunged. That led to a torrent of shady transactions aimed at unloading unwanted homes and condos.

By last fall, the problem had grown so bad that Florida Attorney General Bill McCollum created a Mortgage Fraud Task Force with 26 investigators, attorneys, paralegals and an economist. They complemented Roseneau's 51-member investigative team. But spread across a state of 18-million, that's not many, given the prevalence and complexity of what they're dealing with.

"Mortgage fraud cases tend to be extremely document-intensive,'' says Sandi Copes, a spokeswoman for the attorney general's office. "The documents in possession of the complainants do not necessarily match the documents provided by potential defendants, necessitating a time-consuming comparison.''

In a legitimate real estate transaction, all parties are supposed to have identical documents with the same sale price and closing costs. With mortgage fraud, however, the lender may have closing statements showing a sale price of, say, $500,000 while the buyer and seller have statements showing the property actually went for $300,000. The other $200,000 — earmarked for "repairs'' or "renovations'' — ends up in someone's pocket.

"It's not uncommon to have three completely different sets of documents from three different sources,'' says Roseneau, the financial investigations chief. "Then you've got to run the dog to the ground.''

Complicating the process is that closing statements and appraisals, unlike mortgage documents, are not part of the public record. If fraud is suspected, investigators are often forced to subpoena reams of paperwork and bank records. And then they need to link up with a prosecutor who may or may not consider the evidence sufficient.

Good credit can't protect borrowers from bad loans
A good credit score doesn't mean you can't end up in foreclosure.

Many now troubled borrowers had excellent credit when they got their mortgages. But they took out loans that they couldn't afford to buy homes that were too expensive. Credit scores alone are no guarantee that borrowers will be able to keep up with their payments.

In September 2007, the most recent month for which data is available, more than 20% of subprime mortgage borrowers with scores of between 840 and 900 were 60 days or more delinquent, according to First American LoanPerformance. That default rate was roughly equal to that of borrowers with much lower scores, in the 540 to 599 range....

....In the runup to the bubble, underwriting standards eroded just as much for people with high FICO scores as they did for people with bad credit, said Bitner.

Vancouver residential property tax up 3 per cent
"The average home is about $940,000. So what the residents will be paying is $77 more in the year. Businesses will be paying $88 less," said Annette Klein, the director of budget services for the city.

Opposition councillors were quick to point out the tax increase for 2009 could be much higher.

Vision Vancouver Coun. Raymond Louie said last year's municipal strike saved the city millions of dollars, and the full cost of expanding Vancouver's police force won't be felt until next year.

"We're talking about potentially an 11 per cent tax increase right out of the gates [in 2009]," said Louie.

Forced out by the Olympics
Roy Van Hest owns the Art Knapp Plantland on Minoru Boulevard at Alderbridge Way with his family. When his store opened in 2005, his tax bill was $59,625. He estimates his 2008 bill will be $269,070.

“There’s no way that we can stomach it. Basically my taxes will be 400 per cent greater than they were three years ago.”

He said it will be hard to compete with other businesses when he’s paying taxes “astronomically more” than competitors elsewhere in Richmond.

Even non-profit groups have been hit hard. The Richmond branch of the Canadian Mental Health Association is facing a tax bill of $43,335 this year—a 119 per cent tax increase over last year.

Robert McCullough, senior property manager for properties in the area owned by Richmond Holdings Ltd., said it’s not unusual to see 100 to 200 per cent increases in taxes this year.

“It’s unfortunate. We all understand the needs of the city to move and to change and to redevelop, but there has to be some consideration to the people who are already a part of this neighbourhood, because within a year, they’ll all be driven out. No business can afford to bear that kind of tax hit.”

McCullough predicts the neighbourhood will become “an empty industrial ghetto” before 2010 on the doorstep to the Olympic oval.

Brazil Oil Trapped by 500-Degree Heat, Salt Barrier
Brazil's plan to become one of the world's biggest oil exporters hinges on exploiting crude 6 miles below the ocean surface in deposits so hot they can melt the metal used to carry uranium to nuclear plants.

Tapping what may be the biggest oil finds in the Western Hemisphere in three decades will require equipment that can withstand 18,000 pounds per square inch of pressure, enough to crush a pickup truck, pipes that can carry oil at temperatures above 500 degrees Fahrenheit (260 Celsius) and drill bits that can penetrate layers of salt more than one mile thick.

Petroleo Brasileiro SA, the state-controlled oil company, is betting on the Tupi and Carioca fields to become one of the world's seven biggest crude exporters. Until the tools needed to exploit the reservoirs are invented, the crude will remain locked under the sea, said Matt Cline, a U.S. Energy Department economist.

Move over, energy and food crises
The South African fuel industry is facing a crisis that is going to make Eskom's problems look like a picnic, the Fuel Retailers' Association (FRA) says.

This is because the pipelines used to get fuel from refineries along the coast to inland distribution points are crumbling and refineries past their lifespan are unable to cope with increasing demands.

Imported fuel has to be transported by road, because of the dire state of the pipelines, and the inability of the country's rail network to deliver.

"Nobody is building stockpiles, which is something we need as demands increase," says Peter Morgan, the director of the FRA.

He says South Africa has imported fuel for years because the country's refineries are unable to make enough for local needs.

Once the petrol or diesel is imported, the ability to transport it inland is limited "because the pipelines cannot cope, the rail system cannot cope".

Also unable to cope with the large volumes demanded by motorists and industry through fuel retailers are the tanker companies, which run hundreds of tankers from refineries to petrol stations every day.

Morgan says one of the most serious problems is that there are no strategic fuel supplies in South Africa. The country's refineries are already working to full capacity and any power outage, fire or other failure in the system will lead to shortages.

Rearming the world
Last summer, AS Americans focused on the surge in Iraq, most ignored a military exercise with a potentially more far-reaching impact. In a remote location in the Ural Mountains, Russia, China, and several Central Asian nations gathered for a massive war game, ironically dubbed "Peace Mission 2007."

Thousands of troops, armored vehicles, fighter-bombers, and attack helicopters stormed a town in a mock battle that was supposed to simulate fighting a terrorist takeover. Beneath its antiterror veneer, Peace Mission 2007 was a classic display of military readiness: When it was over, the troops paraded before their assembled defense chiefs, and the whole event laid the groundwork for a closer military alliance among the participating nations.

That such an exercise was held at all might seem shocking. Despite the global war on terrorism, and a steady drumbeat of civil conflicts, no war involving a major power like Russia has occurred in decades, and no external enemy threatens any of the Central Asian nations.

But the exercise highlighted an alarming new reality. With much less fanfare than the early days of the Cold War, the world is entering a new arms race, and with it, a dangerous new web of military relationships. According to the Stockholm International Peace Research Institute, which tracks international armed forces spending, between 1997 and 2006 global military expenditures jumped by nearly 40 percent. Driven mainly by anxiety over oil and natural resources, countries are building their arsenals of conventional weapons at a rate not seen in decades, beefing up their armies and navies, and forging potential new alliances that could divide up the world in unpredictable ways.

Debt Rattle, April 28 2008: Risk, Secrecy and Perverse Incentives

Stoneleigh: The British like their secrecy. The Official Secrets Act always covered the most ridiculously trivial things. I remember an episode of the series Yes, Minister which referred to 'open government', from the point of view of the civil service, as an oxymoron - "Either you can be open, or you can have government."

It's hardly surprising then that bank rescues would proceed in secret, when the alternative is probably more bank runs along the lines of Northern Rock. Such a dynamic would probably pick up momentum, with the market picking off apparently weak banks one by one and the public sector having to choose between full bailouts and banking chaos. Full bailouts are not an option once a banking crisis becomes systemic, just as deposit insurance in other jurisdictions wouldn't be worth the paper it's written on in a systemic banking collapse.

Unfortunately, that leaves depositors in the dark as to where the risks lie, without actually removing those risks. The bravado meant to buy time in the hope that confidence will return is a desperate gamble. If institutions and individuals can be convinced that the whole system will be bailed out if necessary, maybe they won't try to cash out and bring the system down in the process, or so the thinking goes.

It also creates a huge moral hazard problem, tempting the banks to play 'double or nothing' while the public sector carries the risk. Northern Rock made even riskier mortgages after they were handed a blank cheque than they had done before. This increases both the size and the likelihood of an eventual meltdown. Postponement is not prevention.

However, in the current climate, the Bank of England is probably 'damned if they do and damned if they don't'. Secrecy itself creates the appearance of heightened risk and reduces the very trust that must be restored if the credit crunch is to be resolved. As the issue is solvency rather than liquidity, resolution through hollow gestures is simply not realistic. At some point the Bank of England's bluff will be called and the systemic crisis will be triggered. Depositors and others will then be out of luck.

Bank bail-outs to be kept secret
The Bank of England has imposed a permanent news blackout on its £50bn-plus plan to ease the credit crunch.

Ferocious and unprecedented secrecy means taxpayers will never know the names of the banks that have been supported through the special liquidity scheme, which was unveiled by Bank Governor Mervyn King last week.

Requests under the Freedom of Information Act are to be denied. Details will be kept secret even after 30 years - the period after which all but the most sensitive state documents are released....

....Even a figure for the overall amount advanced will not be published until October. Meanwhile the Bank is expected to issue at least £50bn of Treasury bills to banks in exchange for their mortgages - entirely in secret.

This hypersensitive official stance is thought to be a response to the events of last year when a huge stigma was attached to any lender suspected of going to the Bank for cash help....

....The scheme, drawn up by King and approved by Chancellor Alistair Darling, aims to improve banks' liquidity by temporarily swapping bundles of mortgages and credit card debt for Treasury bills, which are short-dated Government debt that matures within nine months.

The scheme will run for three years so these bills will be replaced by new ones when required.

Stoneleigh: What's going on here amounts to trying to cure a hangover by having a few more drinks. The Keynes quote does not mean that central bankers an fix the credit system - it means that even if they could, it may not be enough, hence the oft-quoted 'pushing on a piece of string' analogy. The measures taken by central banks have spawned a rally, which is unlikely to last for much longer, but to say that the system is fixed is laughable.

Relief on Wall Street unlikely to bring universal joy
The key text here – much quoted of late – is from John Maynard Keynes: “Whilst the weakening of credit is sufficient to bring about a collapse, its strengthening, though a necessary condition of recovery, is not a sufficient condition.” In other words, central banks can fix the credit system, but getting lending back to normal may be another matter.

Is the system really fixed? If so – and it feels like it – the turning point may have been not the Bear Stearns rescue, as often claimed, but the flood of liquidity from the central banks.

According to Tim Bond of Barclays Capital, in the months to the end of February assets held by US banks rose by $960bn. But deposits rose by only $293bn (£147.7bn), leaving a record gap of $667bn.

Normally, that would have been filled by the money market funds. They had liquidity to spare – in the same 12 months their cash inflow was $893bn.

But in a version of Northern Rock writ large, they no longer wanted to know. As recently as January 2006, all their monthly cash flow had gone into commercial and corporate paper. By February this year, that figure had shrunk to 11 per cent. Instead, the cash was going into safe havens such as Treasury bills.

This was all to do with the collapse of the shadow banking system – in particular, of off-balance sheet structures designed to hold mortgage-backed securities. As Mr Bond puts it, the banks had outsourced their assets and liabilities. The assets were now coming back on to their books, but the liabilities were not.

This is precisely the problem which the central bank rescues were designed to address. If the banks can swap those assets for Treasuries, then borrow against the Treasuries, they can plug the funding gap themselves.

Partly in consequence, equity funding becomes a lot easier, as shown by Royal Bank of Scotland’s £12bn ($24bn) rights issue last week. Deposits, too show signs of recovering. Much more of this, and the money markets will be open to the banks as usual.

Big Banks Levering UP UP UP!
Well, isn’t this cute. While spewing ‘de-leveraging’ every chance they get, apparently the big banks are levering up faster than ever before. reports that “according to Tim Bond of Barclays Capital, in the months to the end of February assets held by US banks rose by $960bn but deposits rose by only $293bn (£147.7bn), leaving a record gap of $667bn.”

The very same banks that have all said the financial system’s problems are due to the massive leverage and lack of capital are back on the crack pipe and in rare form. This story is infuriating but just goes to show the peril the banks have put themselves in.

Hedge funds take extra risk to lift targets
Hedge fund managers in danger of missing out on lucrative performance fees routinely raise their exposure to risk in a gamble to meet their performance targets, according to new research.

The study* raises questions as to whether hedge fund managers are acting in the best interests of their investors - who may want a consistent approach to risk - or are more interested in maximising their own bonuses.

"The investor wants them [hedge fund managers] to carry on doing what they mandated them to do from day one. Maybe performance fees don't provide the right incentives," said Nick Motson, one of the authors of the report. "The initial finding was this does not look good."

Academics Discover Two Plus Two Equals Four
I'm always amazed at how naive academics are about the real world of trading and investing.

Aside from such obvious delusions as the assertion that markets are efficient, they seem to have no real grasp of the human side of the business and its impact on investment decision-making.

Anybody who has ever traded for a living, or who has worked in close proximity to those do, will tell you that people who are losing money invariably have the urge to go for broke, and those who are underperforming targets will want to take on more risk, when some sort of deadline -- bonus time, the end of an evaluation period, a prospective margin call, you name it -- is approaching.

Not everyone yields to these feelings, of course, but skewed incentives -- like when the upside is unlimited but the downside is not -- boosts the odds that they will do what underlying investors and risk managers fear most.

Wall Street, Run Amok
First, Maestro Einhorn points out that the fellows who run big investment banks have a strong incentive to maximize their assets and leverage themselves into deep trouble because their pay is a function of how much debt they can pile on. If they can use relatively low-interest debt to generate slightly higher returns, the firm earns more revenue and executive pay increases. Often, an astonishing 50 percent of total revenue goes to employee compensation at Wall Street firms.

NOW, you may ask, what kind of assets were they acquiring with that debt? Well, sometimes, as with Bear Stearns, the leveraged assets are mostly government agency debt, which used to be regarded as fairly safe.

Sometimes, as Mr. Einhorn notes, those portfolios also hold stocks, bonds, loans awaiting securitization, and pieces of structured finance deals. They also hold heavy exposure to derivatives that have stunning risk profiles and can produce astounding losses in bad circumstances. They might also contain real estate assets and have exposure to private equity deals.

In other words, they can hold some scary “assets.” What do they hold as capital against such risks? You would think it would be cash or Treasury bonds, wouldn’t you? But no.

Under an interesting set of rules promulgated by the Securities and Exchange Commission in 2004, called “Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities,” the amount of capital that had to underlie assets was reduced substantially. (Mr. Einhorn rightly says that this set of rules should have been called the “Bear Stearns Future Insolvency Act of 2004.”)

Through the act, the S.E.C. — acting as one of Wall Street’s chief regulators, mind you — also allowed such things as “hybrid capital instruments” (much riskier than cash or Treasuries), subordinated debt (ditto) and even deferred return of taxes, to be counted as capital. The S.E.C. even allowed the banks to hold securities “for which there is no ready market” as capital.

“These adjustments reduced the amount of required capital to engage in increasingly risky activities,” Mr. Einhorn says....

....It looks to me as if the inmates are running the asylum. One truth, that deregulation is sometimes a good thing, has been followed down so long and winding a road that it has led to an immense lie: that deregulation carried to an extreme will not lead to calamity.

Deutsche Bank planning major capital increase: report
Deutsche Bank, the biggest German bank, is planning a capital increase to raise up to 17 billion euros (27 billion dollars), news weekly Der Spiegel reported in its Monday issue.

The bank will seek approval for the move at a shareholders' meeting at the end of May, the report said, citing a copy of the agenda for the meeting.

Some four billion euros are expected to be raised by the sale of 55 million new shares.

UBS to cut 8,000 jobs; announcement expected May 6 - report
UBS AG. plans to cut about 8,000 jobs and will likely announce the move when it presents its first-quarter financial results on May 6, Swiss weekly newspaper Sonntag reported, without saying where it got the information.

Some 3,000 cuts will initially affect the company's operations in the United States and in western Europe, with the remaining 5,000 jobs to be eliminated this autumn, primarily in administrative functions, the newspaper said.

Company Credit Deteriorating in Europe, Moody's Says
European corporate credit quality is sinking at an ``alarming'' rate as rising oil prices, the possibility of a U.S. recession and the euro's strength restrain the region's economic growth, Moody's Investors Service said.

Moody's assigned 32 negative outlooks to European companies in the first quarter, almost triple the 11 that were positive, the New York-based ratings firm said in a report today. The gap is the widest since 2001 and indicates deteriorating credit quality in 12 to 18 months, Moody's said.

``The negative outlook gap is quite alarming,'' Moody's economists Christine Li and Kimberly Forkes wrote in London. ``Uncertainty about the U.S. recession, nervous financial markets, higher input costs for business and an appreciating euro are restraining the euro-zone economy.''....

....Losses at banks are hampering lending and will have a ``greater and more prolonged'' impact on non-financial businesses, Moody's said. Banks reported $308 billion of writedowns and credit losses tied to the collapse of the subprime mortgage market, according to data compiled by Bloomberg.

The bloody knife used to gut Bear Stearns
JP Morgan had a credit exposure/capital ratio of 419% as of 12/07.

The average ratio is 83%, excluding JPM it is 49%. HSBC is the only bank with the level of exposure and they have had some of largest writedowns.

But there are more than a few crackpots making this assertion. Professor Solomon from NYU is one of those making the charge.

Specifically, I believe that JP Morgan acquired Bear because they stood to lose the most from a Bear Stearns bankruptcy. For example, as Barry Ritholtz of the Big Picture points out (see here), JP Morgan has the greatest derivative exposure of any of the I-Banks. Now, I do not know how much of that exposure was to Bear Stearns as the counterparty, but I bet it was a fair amount (in fact, see Jesse’s Cafe Americain for information on Bear’s credit derivative exposure).

If Bear were the counterparty (insurer) to JP Morgan on much of its mortgage-backed security portfolio, it then becomes transparent why JP Morgan had to step in. They would have had to step in to avoid a Bear bankruptcy so that they would not be forced to take toxic assets back onto their own balance sheet and avoid massive write-downs. Were JP’s exposure to Bear large enough, then JP Morgan itself could have been left significantly impaired.

This might also explain the Fed’s interest in Bear. For example, if it were only Bear at risk and their exposure was spread relatively evenly across counterparties such that many of the big, primary banks were not at risk as a result, the Fed would have had no interest in this event. Instead, it would have just let Bear fail. But the Fed could not let Bear bring down JP Morgan with it. So it stepped in to orchestrate an orderly wind-down of Bear while facilitating its acquisition by JP Morgan.

(see original for chart)

Danger Ahead: Fixing Wall Street Hazardous to Earnings Growth
Wall Street's money-making machine is broken, and efforts to repair it after the biggest losses in history are likely to undermine profits for years to come.

Citigroup Inc., UBS AG and Merrill Lynch & Co. are among the banks and securities firms that have posted $310 billion of writedowns and credit losses from the collapse of the subprime mortgage market. They've cut 48,000 jobs and ousted four chief executive officers. The top five U.S. securities firms saw $110 billion of market value evaporate in the past 12 months.

No one is sure the model works anymore. While Wall Street executives and regulators study what went wrong, there is no consensus solution for restoring confidence. Under review are some of the motors that powered record earnings this decade -- leverage, off-balance-sheet investments, the business of repackaging assets into bonds through securitization, and over- the-counter trading of credit derivatives. Without them, it will be difficult to generate growth.

``Brokerages will have a tough time for a while,'' said Todd McCallister, a managing director at St. Petersburg, Florida-based Eagle Asset Management Inc., which oversees $14 billion. ``The main engine of its recent growth, securitization, will be curtailed. Regulation will be cranked up. Everything is stacked against them.''

Last month's collapse and emergency sale of Bear Stearns Cos., the fifth-largest of the New York-based securities firms, demonstrated the perils of Wall Street business practices developed after the 1999 repeal of the Glass-Steagall Act. The change allowed investment banks and depository institutions to compete with each other.

Are Low Interest Rates Fueling Price Inflation?
The idea that the credit crunch is over is pure fallacy. The Fed Funds Rate is 2.25%, LIBOR is 2.91% and Citigroup is raising money at 8.4%, Merrill Lynch is raising money at 8.625%, and Bank of America is raising money at 8.125%....

....If one looks at what banks and brokerages have to pay for debt, what spreads junk bonds are yielding, and what jumbo mortgages are costing, the widely held idea that "Interest rates are low" is easily debunked....

....The easily seen and often quoted interest rate is the Fed Fund Rate. However, the Fed Funds Rate is not a valid perspective from which to state "low interest rates are fueling price inflation".

On the other hand, if one wants to state that past interest rate actions by the Fed and past monetary printing by the Fed are still causing current economic distortions, I can embrace that. The Fed, by its very nature, causes economic distortions including price inflation.

But the key rates now are the rates it takes to get a deal done. And those rates have been climbing since last Summer. Clearly it's harder and harder to get a deal done. Credit has dramatically tightened. There are no more liar loans, covenant lite agreements, huge commercial real estate deals, etc.

Nonetheless, the market has been cheering lately simply because deals are getting done, even thought the cost (excluding the last week or so) has been rising. But don't be fooled, there is no bottom in sight. As professor Bennet Sedacca suggests, the bottom will come when the deals can't get done. That could be quite a long ways off. Economic Winter is setting in.

Inside the Liar's Loan
The term is mortgage-industry slang for what's more formally called a "stated income" mortgage—a mortgage that a lender gives without checking tax returns, employment history, or pretty much anything else. Many of the loans that are in trouble now, or will be in trouble soon, fall into this category. But the term gives only the barest hint of the pervasive failure involved.

The original idea of the stated income mortgage was that it would benefit salespeople who work on commission, people who own their own businesses, and others for whom predicting next year's income isn't just a matter of looking at last year's.

At the height of the mortgage boom, however, especially in pricey markets, the liar's loan became a routine way of doing business; for some lenders—both smaller ones like IndyMac and WMC as well as big ones like Countrywide and Washington Mutual—it was the main way. In 2006 in some parts of the country, these loans made up as much as half of new mortgages, for both subprime borrowers and for homebuyers with high credit scores.

Under ordinary circumstances, we think of lying as something that a few people do. But the nickname "liar's loan" is stunningly apt. The vast majority of the people who took these loans out exaggerated at least a little. Most lied a lot. And it's likely that most of the liar's loans—including those given to people with excellent credit histories—will go bad.

Three Reasons Why a Mortgage Bailout Is a Terrible Idea
1. Home Prices Should Fall

Every time a bailout is mentioned, there is talk about slowing the decline in prices. Everyone wants to keep the bubble inflated, keep the good times rolling. But it's time to face facts: home prices are too high and need to come down.

Home prices in the U.S. increased 85 percent when adjusted for inflation from 1997 through 2006, according to Yale economist and noted bubble expert Robert Shiller. Income increases came nowhere near this figure. Since mid-2006, home prices have fallen only 15 percent, leaving potential buyers priced out of the market.

Incomes are not going up. They are going down. In order for people to be able to reasonably afford a home, prices need to come down too. It's simple math. A bail out won't change that. In fact, it could make it worse by delaying the inevitable correction.

2. Some Borrowers Should Be Renters

Bailout supporters argue that a bailout is needed to 'keep people in their homes.' Let's think about this for a minute. What is the point of keeping someone chained to a depreciating asset that they can't afford?

Data has shown that people aren't defaulting in increasing numbers because their payments are readjusting. Most of the defaults are occurring before a reset. The fact is that there are hundreds of thousands--if not millions--of people who bought more house than they could reasonably afford because home prices were too high.

Giving these people a prime rate instead of a subprime rate or a fixed rate instead of an adjustable rate isn't going to change that fact. These homeowners would be better off getting rid of their dead weight ASAP and renting a comparable home for less money for the next few years.

3. There Should Be Consequences

A mortgage bailout that utilizes taxpayer money or any other money that would be better spent elsewhere is downright unethical. While there are people who are struggling with default because of job loss, a death in the family or some other tragedy, most are in trouble because they made a poor financial decision.

Bailing them out at the expense of others is just plain wrong. Poor financial decisions get made every single day. People charge too much on credit cards, they gamble their grocery money away at the slots, they buy a brand new SUV when they should have bought a used Chevette and they spend their daycare fund on crack. Do we bail these people out? Of course not.

The same philosophy should be applied to housing. While it's true that not everyone was a speculator--some people just wanted a home for their family--they all had a chance to weigh their decision and READ the contract they were signing. If a poor decision was made, it should be no surprise that there are consequences that must be faced.

By the way, this 'consequence theory' also applies to the lenders, builders and others in the housing industry that made bad business decisions. They are the last people who should be helped by a bailout.

The Housing Market is Nowhere Near Bottom
Housing is what started the current mess me are in. Thanks to record low interest rates from the Federal Reserve, the US consumer went on a debt-induced home buying binge. That binge is now coming home to roost. And it's not going to let up for the foreseeable future.

Let's start with supply. First, there are a ton of existing homes on the market -- right around 4 million.

This translates into a little under a 10 months supply. Also note that this number -- months of supply -- has been increasing.

So -- we have a ton of supply on the market. Unfortunately that has not translated into a big enough cut in prices to stimulate demand.

Prices increased about 90% in 6 years, yet have barely dropped in comparison to the massive run-up they had during the early 2000s. Simply put, we have a long way to go before we start seeing prices hit an inventory clearing level.

(see original for charts)

Bernanke May Have to Follow Volcker to Avoid Being Tagged Burns
Federal Reserve Chairman Ben S. Bernanke may have to start talking and acting more like Paul Volcker if he wants to avoid being remembered as another Arthur Burns.

With oil and food prices surging, Volcker told the Economic Club of New York on April 9 that ``there are some resemblances between the present situation and the period in the early 1970s,'' when then-Fed Chairman Burns let an inflation psychology take hold. ``There was some fear of recession, the oil price went skyrocketing up, the dollar was very weak.''

It took Volcker's effort as Fed chief to push the overnight lending rate to 20 percent in 1980 and drive the economy into its deepest decline since the Depression to break the inflation he inherited. To avoid squandering the gains Volcker made, Bernanke may need to stop his all-out effort to prop up the weakening economy and start paying more attention to countering price pressures.

Jefferson County bond interest payments climb another $700,000 per week
Interest rates on some Jefferson County sewer bonds have more than doubled this month, adding $700,000 each week to the $2.5 million in extra weekly interest expenses the county was already paying on its failed auction-rate bonds.

The development means the county's financial situation has continued to deteriorate as its leaders attempt to negotiate terms with creditors that would avert a default.

The county now faces additional monthly interest payments totaling $12.8 million - money county officials say they don't have the ability to pay over an extended period. It has more than doubled the $10 million in monthly interest Jefferson County was paying on its auction-rate bonds before the crisis hit.

"The county has taken the position that the current circumstances are not entirely of its own doing," said James H. White III of Birmingham investment firm Porter, White & Co., the county's top financial adviser. "We had lots of help.

"The immediate cause of the failure was the downgrade of the insurance companies. Our auctions didn't start failing until the insurance companies were downgraded."

Earlier this year, Fitch Ratings downgraded the credit rating of bond insurer Financial Guaranty Insurance Corp., starting a cascade of cuts over fears the companies might not be able to cover guarantees on losses tied to subprime mortgages.

The downgrades triggered a chain reaction that ended up wiping out demand for the auction securities issued by the county to pay for a massive sewer repair and expansion program.

Middle class taps nest eggs to keep homes
Trapped by rising mortgage payments and falling house values, a growing number of squeezed middle-class homeowners are tapping into their treasured retirement nest eggs to ward off foreclosure.

"This is definitely an issue we've been hearing about from our members," said Kevin Stein, associate director of the California Reinvestment Coalition, which represents 250 nonprofit groups and public agencies in the state.

"It does seem the crisis is impacting a broader segment of America, and it clearly calls for broader solutions than what we have so far," Stein said.

Apart from being a fresh sign that the housing crisis has spread up the U.S. income ladder, tapping tax-deferred savings accounts like 401(k) plans could have profound effects on taxpayer welfare, social security and employment patterns, economists and financial advisers said.

"I think this means we'll see some baby boomers having to work well into their 70s to make ends meet," University of Maryland economist Peter Morici said.

Wall Street Grain Hoarding Brings Farmers, Consumers Near Ruin
Commodity-index funds control a record 4.51 billion bushels of corn, wheat and soybeans through Chicago Board of Trade futures, equal to half the amount held in U.S. silos on March 1. The holdings jumped 29 percent in the past year as investors bought grain contracts seeking better returns than stocks or bonds. The buying sent crop prices and volatility to records and boosted the cost for growers and processors to manage risk....

....The divergence between CBOT futures and the underlying commodity is so great that some grain merchants have stopped bidding for new crops, said Niemeyer, a member of the National Corn Growers Association board. Others won't guarantee a price for more than 60 days.

``We have a fundamental problem with the markets,'' said Kevin McNew, president of researcher Cash Grain Bids Inc. in Bozeman, Montana, and a former Montana State University economist. ``It is very difficult to operate a grain business when the cash prices are below the futures'' by such a wide margin, he said.

The price gap should converge when futures contracts expire and deliveries are settled. Instead, the average premium for CBOT wheat has quadrupled in two years to 40 cents a bushel, compared with 10 cents the prior five years, McNew said.

Stoneleigh: Will Steel producers be any happier with the effects of speculation than farmers?

Steel screams on LME despite recession talk
The London Metal Exchange is today launching a futures contract for billet steel, the semi-finished fungible variety. The first batch of July-dated lots of 65 tonnes each - the size of a Russian-Ukrainian rail car, the industry norm - will be sold by open outcry this morning at 11.40....

....The steel contract is a big play, second to oil in the raw materials firmament. World steel output hit a record $660bn last year. If the venture succeeds - Dubai and New York's Nymex are angling for a share - it may double the LME's turnover in five years.

Steel futures are a boon to the world's army of small producers. They can at last sell their product into the forward market, hedging risk.

It eliminates the punitive "haircut" imposed by banks to cover wild price moves. The cost of credit will fall. "This is the first time they have been able to manage their risk and guarantee cash flow," said Liz Milan, the LME's commercial director. This is creative City capitalism at its best.

The steel lords sniff a threat. Hedge funds will run amok, they mutter. Look what they did to nickel contracts last year - pushing prices up and down like a yo-yo.

"We do not believe financial institutions speculating on steel pricing will bring any benefit to our industry," said Arcelor-Mittal, top dog with 10pc of world steel.

Dollar Slide Drives Budget as Japan Shuns Treasuries
Add another ailment to the U.S. misery index of soaring gasoline and wheat costs and falling home values: a federal deficit that is burgeoning as foreign investors led by the Japanese recoil from the slumping dollar.

The Japanese, who own $586.6 billion, or 12 percent of U.S. government debt, had their worst quarter in Treasuries this decade, losing 7 percent in the first three months of the year as the dollar fell to the lowest since 1995 versus the yen, Merrill Lynch & Co. indexes show. Dai-ichi Mutual Life Insurance Co., Meiji Yasuda Life Insurance Co. and Sumitomo Life Insurance Co., three of the nation's four-biggest insurers, would rather accept the world's lowest bond yields in Japan than buy U.S. debt.

``It's too early to say the dollar will stop falling,'' said Masataka Horii, head of the investment team in Tokyo for the $53.1 billion Kokusai Global Sovereign Open, Asia's biggest bond fund. ``The U.S. economy will be slow for a while.''

Japan owns more Treasuries than any other nation. After raising their holdings by $9.2 billion to $620.6 billion between March and July 2007, Japanese investors trimmed that stake by $34 billion through February, the Treasury said April 15.

For half of India Inc economic scenario worsens: FICCI
As much as half of Indian corporates, surveyed by industry body FICCI, have said the overall economic conditions have deteriorated in the last six months with high interest, appreciating rupee and rising cost of raw materials playing the spoilsport.

The survey found that many firms are faced with no choice but to increase their prices. Stabilisation of the rupee to around Rs 40 to a US dollar has helped some companies in their export business but a majority 56 per cent feel that currency appreciation has dented their competitiveness.

Cars and kitchens tempt Indian housebuyers
Free cars and mortgage-free living are being dangled in front of house-hunters in Bangalore as developers battle to halt a property slump in India's Silicon Valley.

House prices have fallen by as much as 20 per cent this year in the sub-continent's IT capital on the back of a building boom and fears that the US sub-prime crisis will stall the huge recruitment plans of the city's flagship outsourcing companies.

After the meltdown on Wall Street, the Indian software industry's most important client, similar declines are being reported in technology hubs across the country. Vincent Lottefier, head of the Indian operations of Jones Lang LaSalle, the property consultant, said: “We are definitely seeing pricing pressures and corrections in areas where outsourcers are putting on the brakes.”

Freebies commonly thrown in by increasingly desperate developers include complimentary fitted kitchens, extra parking spaces and relief from stamp duty. Some, however, have been more generous. Orange Properties, a Bangalore company, has promised a free Maruti SX4, a four-door family car, with every 1,500 sq ft flat. The saloon costs up to 800,000 rupees (£10,120), representing a discount of 20 per cent on the 4 million rupee apartment.

Scholar Threatened for Warning of Housing Bubble in Taipei
An academic who warned of a property bubble in Taipei in a letter to a newspaper editor April 12 has received a threatening letter telling him to "shut up" or a contract killer will be sent to murder him.

The Wenshan police station in Taipei confirmed Thursday that its officers were investigating the intimidation case.

Chang Chin-oh, a professor of land economics at National Chengchi University, warned property hunters in his letter to the editor that the property market in Taipei is showing signs of a bubble and that although the market is no longer flourishing, housing prices are still being maintained at abnormally high levels.

After the letter was published, Chang received a computer-printed letter from the "Greater China Real Estate Alliance," warning him to keep his mouth shut or his life will be in danger.

Chang told reporters that the caution he set forth in his letter to the editor was well-intentioned, as he felt he has a duty to share the findings of his research with the public.