Thursday, February 28, 2008

Debt Rattle, February 28 2008

NOTE: today’s earlier post can be found here: 1 down, 10.000 to go

Ilargi: B-52 Ben is starting to choke on his web of crap. It’s hard to pick out the most blatant lie, there’s too many by now. But alright, how about this one: ”U.S. bank balance sheets are in strong shape.".

When he said that, someone in that Senate Committee should have interrupted him and asked for proof, for the sheets and the numbers in them. But they just play the same game, and even if they’d be tempted to, Ben is not under oath, so there’d just be more nonsense.

Just days after the FDIC announces that they expect over 100 bank failures in the near future, Bozo the Clown has the gutzpah to sit in front of your chosen representatives and say that the balance sheets of those same banks are in strong shape. You can call it what you want, a comedy, a tragedy, it makes no difference, but don’t ever again believe one single syllable of this play.

And by the way, the only thing that would lend any strength to those balance sheets is the money that you deposited with these banks. But don’t be too sure there’s much of that left either.

Bernanke: Stagflation Not Expected
Federal Reserve Chairman Ben Bernanke said Thursday that the current mix of slow growth and rising inflation is nowhere near the conditions of the 1970s, commonly referred to as "stagflation." "I don't anticipate stagflation," Mr. Bernanke said in response to questions from the Senate Banking Committee, where he delivered the second leg of his semiannual economic testimony to Congress.

He said the U.S. should return to strong growth and low inflation in coming years, and that the mix of fiscal and monetary stimulus should boost growth in the second half of this year. He also said that while oil prices remain a wild card, even if they stabilize at current high levels, that should reduce price pressures this year. Mr. Bernanke also said that there are some distinct differences between the current economic downturn and the previous one in 2001 that make it tougher for policymakers to respond to today's events. "Every period of economic stress has unique" circumstances, Mr. Bernanke said.

The housing correction that the U.S. now faces creates "a broader set of issues" than the bursting of the technology bubble at the start of this decade. The U.S. also has a "less advantageous" fiscal situation than a few years ago when the government ran a surplus, Mr. Bernanke said, and the dollar has weakened. Though there are more inflationary pressures than during the previous downturn, Mr. Bernanke said inflation expectations remain "pretty stable."

Mr. Bernanke also said U.S. bank balance sheets are in strong shape, and he doesn't anticipate major problems in the banking sector. Still, banks should continue raising capital, Mr. Bernanke said, adding he is worried banks might pull back from new lending.

Ilargi: In our ongoing course in “Expand your daily vocabulary”, we have an important new term. After subprime, counterparty risk, auction rate securities and credit default swaps, we proudly present: Margin Call. Soon coming to a town near you. If you have a mortgage, it may well come even closer than that.

Margin Calls Prick Thornburg
Thornburg Mortgage shares were plunging Thursday on news that the mortgage originator may be forced to sell assets in order to meet collateral requirements by its lenders.

The Santa Fe, N.M.-based company said that it has so far met $300 million in so-called margin calls since Feb. 14, and may be required to post more cash as its portfolio of Alt-A loans has fallen some 10% to 15% in value over the past few months. Alt-A mortgages are unconventional, nonprime mortgages that are provided to borrowers with insufficient documentation to prove their income.

Thornburg maintains a portfolio of some $2.9 billion in Alt-A mortgages. The lender described the drop in the value of those loans in a regulatory filing with the Securities and Exchange Commission as a "sudden adverse change in mortgage market conditions in general" that began on Feb. 14. Shares of the company were down as much as 22% in Thursday trading action, after seeing values plunge as much as 28% in premarket trading. More recently, shares were off 18.3% to $9.43.

Thornburg faced similar calls for additional capital to meet lender requirements during the summer when the mortgage crisis began to upend Wall Street firms and traditional mortgage lenders. Back in August, the mortgage originator sold $21.9 billion of assets to appease lenders and raised $500 million a month later to shore up its balance sheet. The West Coast mortgage lender specializes primarily in providing adjustable-rate mortgages known as jumbo loans, which are typically $417,000 or more.

Wachovia employees targeted in muni bond probe
The U.S. Department of Justice is investigating two Wachovia Corp. employees for improper conduct as part of the agency's investigation into competitive-bid practices in the municipal bond market.

In its annual report, Wachovia (NYSE: WB) disclosed it has received subpoenas from the DOJ and the U.S. Securities and Exchange Commission seeking documents and information from its municipal derivatives group. The two agencies told Wachovia they believe the employees engaged in improper conduct in the bond market.

In November, the DOJ notified the two employees, whom the bank did not identify, that they were targets of the investigation. Both employees are on administrative leave. The bank said it is cooperating fully with government investigators.

The investigation has involved other financial institutions, including Bank of America Corp. The bank (NYSE: BAC) recently disclosed the receipt of a Wells notice from the SEC on Feb. 4. The notice means SEC investigators may suggest the agency take legal action against employees. BofA agreed to cooperate with the DOJ, and in exchange the department will not seek criminal antitrust prosecution against the bank for matters it voluntarily reported to federal investigators.

Ilargi: As the OFHEO miraculously and irresponsibly allows Fan and Fred to get deeper into debt, it may not matter much: both are being downgraded. That’s a far more suitable prize for record losses.

Freddie Mac Posts Record Loss, Remains 'Cautious'
Freddie Mac, the second-largest source of money for U.S. home loans, posted a record $2.45 billion loss for the fourth quarter as rising mortgage defaults sent credit costs soaring. The net loss, which amounted to $3.97 a share, widened from $401 million, or 73 cents, a year earlier, the McLean, Virginia- based company said in a statement today. The loss compared with a $2.06 average estimate of 12 analysts in a Bloomberg survey.

Government-chartered Freddie Mac and the larger Fannie Mae, which account for 45 percent of the $11.5 trillion home loan market, are posting their biggest-ever losses as foreclosures and tumbling housing prices increase costs on the mortgages they buy and guarantee. Freddie Mac Chief Executive Officer Richard Syron said today the company remains 'extremely cautious' for 2008.

Credit losses 'are costing Freddie Mac valuable capital,' said Howard Shapiro, an analyst at Fox-Pitt Kelton Cochran Caronia Waller in New York. 'Losses won't bottom out until next year.' The fourth-quarter results included writedowns and other non-interest expenses of $2.1 billion primarily related to derivatives contracts, and $912 million of credit expenses. Credit losses will rise to $2.2 billion in 2008 and $2.9 billion in 2009, Freddie Mac said.

The company's regulator tried to provide a boost yesterday, removing limits on the combined $1.5 trillion mortgage portfolios of Fannie Mae and Freddie Mac, enabling the companies to increase financing for the slumping housing market. The Office of Federal Housing Enterprise Oversight lifted the constraints after the companies met a demand to resume timely reporting this month. 'Today's economy represents one of the most severe housing downturns in American history and our results reflect that difficult environment,' Syron, 64, said in the statement.

Fannie Mae yesterday posted a record net loss of $3.55 billion for the fourth quarter and increased its forecast for credit losses. Moody's Investors Service said it may cut Fannie Mae's financial strength rating because the losses are eroding the company's capital. Moody's is also reviewing Freddie Mac. Freddie Mac lost about 60 percent of its market value in the past year.

Door Could Open To Class Actions
A federal appeals court is nearing a decision on a battle between Chevy Chase Bank and a Wisconsin couple that could for the first time enable homeowners across the country to band together in class-action lawsuits against mortgage firms and get their loans canceled. The case is alarming Wall Street's biggest banks, which could bear the hefty cost of reimbursing all mortgage interest, closing costs and broker fees to groups of homeowners who uncover even minor mistakes in their loan documents.

After a federal judge in Milwaukee ruled last year that the Wisconsin couple had been deceived and other borrowers could join their suit, Chevy Chase Bank appealed to the circuit court in Chicago. Kevin Demet, the lawyer for the plaintiffs, said a decision by the appeals court is imminent, though others involved in the case said it could be a matter of weeks.

"It's one of the most important cases for the mortgage industry right now," said Louis Pizante, chief executive of Mavent, which provides consumer protection law services to major lenders. "The case was somewhat interesting a couple years ago when it started, but its ramifications and impact have completely changed given the current environment."

In recent years, home lending has boomed. But standards loosened at many mortgage firms and led to a rise of abuses, in particular predatory practices. Now, record numbers of people are finding themselves with loans that are more than they can afford and many want out.

Estimates vary widely on the number of homeowners who could benefit from the case. Those who have refinanced or hold a home equity loan are already eligible for a refund, while others can get monetary damages. The court's ruling won't change this. But by allowing plaintiffs to file class-action suits, the ruling would make it much easier and more affordable for groups of homeowners to get that relief, several lawyers and mortgage analysts said.

Dozens of class-action homeowner lawsuits have been filed in California and elsewhere against the nation's largest banks. The success of these claims could turn on the decision in the Chevy Chase case.

Americans Plan to Save, Not Spend, Tax-Rebate Checks, Poll Says
The stimulus plan Congress approved this month may provide less of a jolt to the U.S. economy than intended, as most Americans plan to save rather than spend their tax rebates, a Bloomberg/Los Angeles Times survey shows. Only 18 percent of respondents said they will spend their rebate on purchases, while slightly more than three in 10 said they prefer to use the money to pay off debt, and a third said they'll pocket it.

"People in Washington assume that about 40 percent of the money will be spent," said Douglas Elmendorf, a senior fellow at the Brookings Institution, a Washington-based research organization. "Much less would be disappointing." Respondents are increasingly gloomy about the economy's course. A majority said the U.S. is already in a recession and that President George W. Bush hasn't done enough to tackle the home-mortgage crisis.

"It's time to circle the wagons and pay down debt," said Chris Danvers, 50, of Sacramento. He said he's noticed that business is slowing in the upscale steak house where he works as a waiter, so he will pay off the debt he recently incurred buying a refrigerator and a couch.

Bush and congressional leaders agreed on a $168 billion stimulus plan that has as its centerpiece tax rebates for most households. Taxpayers are expected to start receiving checks in May, ranging from $300 to more than $1,200 for some families.

Did the Rating Agencies Push the Monolines Into the Structured Finance Business?
A dirty little secret of the bond insurer mess is that the rating agencies not only aided and abetted their ill-fated entry into the structured finance business but apparently prodded them in that direction. Although I had been given this tidbit before, I hadn't gotten independent verification, but it now comes via a report in Bond Buyer of a speech by New York insurance superintendent Eric Dinallo.

First, the initial reports, February 3:
RK said...
There was an interesting interview today on CNBC with one of the principals of Egan Jones, the private ratings firm. Gasparino was on as well and made an interesting point. He said that S & P and Moodys were telling the municipal insurers for the last several years that they NEEDED to get into the structured finance business, to MAINTAIN their AAA rating, and that a prospective entrant into the business was told that to GET a AAA they would need to participate. While this is so far only heresay, Gasparino has done some good reporting in the past based on apparently good connections.

realty-based lawyer said...
Not hearsay - it happened in Oct/Nov 2005 or thereabouts. The prospective entrant was a financial guarantor being established by DEPFA, an Irish bank with German links that was recently acquired by Hypo Real Estate. CEO was Michael Freed.

Now for the independent sighting in Bond Buyer in its article, "New Regs for NY Insurers":
Insurance regulators did not stop hte financial guarantors from expanding their busineses out of the muni market, a dynamic that one of the moderators suggested could nevertheless play out in future business cycles. In response, Dinallo said his understanding of the current crisis was the the bond insurers were encouraged to expand into the structured finance by the rating agencies, who asked them to expand their books of business.

"From what I have learned so far, the bond insurers were encouraged by the rating agencies to improve their returns on equity and seek diversification through doing this structured business," Dinallo said.

The article notes that the Standard & Poor's has denied suggesting that the monolines increase their structured finance business; Moody's and Fitch so far are silent. It also begs the question of what sort of management would take strategic advice from experts in credit.

But again, one cynically has to wonder. Given how important and profitable the structured finance business was to the rating agencies at the time, they clearly (and naively) thought it was great business. And having the monolines involved no doubt facilitated getting deals done. Of course, this doesn't excuse either the companies themselves or the regulators. Nevertheless, given (as we have seen) that the threat of the loss of their AAA rating is a sword of Damocles over the monolines' heads, they'd have to think hard about ignoring a rating agency's recommendation.

Banks to report billions more in write-downs
Banks are likely to report more write-downs worth billions of dollars from exposure to leveraged loans and commercial-mortgage securities when they report first-quarter results, analysts at Citigroup said Wednesday. Bank of America Corp. could unveil $2.15 billion of write-downs, while JPMorgan Chase & Co.may report a $1.44 billion hit. Wachovia Corp. could see a $590 million impact, the Citi analysts estimated.

The mortgage-fueled credit crisis has hit banks and brokerage firms hard. As the real-estate boom ended, these companies were left holding mortgage-backed securities and more complex but related securities known as collateralized debt obligations, or CDOs. With delinquencies and foreclosures surging, the market value of these exposures slumped. That's already forcing banks and brokerage firms to take more than $100 billion of write-downs.

Fourth-quarter write-downs were mostly driven by a slump in the estimated market value of CDOs partly backed by residential-mortgage securities. This time around, leveraged loans and securities backed by commercial mortgages will likely be the main culprits, Citi analysts said. The credit crunch also torpedoed the corporate-buyout boom, leaving the same banks and brokers holding leveraged loans that were arranged to finance big acquisitions by private-equity firms.

New York Faces Double Whammy as Swaps Compound Failed Auctions
Local government officials from New York to Houston who followed the advice of their bankers and issued auction-rate bonds in combination with interest-rate swaps are now getting squeezed by both. States, cities and hospitals across the country expected yields on the debt to move in tandem with benchmark rates when they bought swaps to protect against rising interest costs.

Instead, the bonds' rates are up an average 3.1 percentage points since September, while the one-month London interbank offered rate -- what banks charge each other for funds -- has dropped 2.7 points. 'It's a universal problem,' said Debra Sloan, director of capital markets at Boston-based Partners Healthcare System Inc., which has interest-rate swaps on $450 million of its $600 million in auction securities. 'We try to structure them so that over time there is a match.'

The failure of the financial instruments compounds the pain for borrowers stuck paying record-high interest on auction-rate debt billed as a cheap alternative to traditional bonds. Investors got skittish last year, retreating from auctions that determine new rates every seven to 35 days. Now UBS AG, Goldman Sachs Group Inc., and other brokers are refusing to be bidders of last resort, and the $330 billion market is frozen. Municipalities and their taxpayers are paying for swap agreements that haven't worked for months.

The contracts typically require buyers to pay fixed rates in exchange for variable payments from the banks arranging them. These variable rates, based on Libor, roughly matched the cost of auction bonds for more than five years, making the fixed rates -- still far lower than what borrowers would have paid on traditional bonds -- well worth it. Then, when a crisis in the subprime mortgage market began to shake investor confidence in September, they started to diverge.

The annualized rate on $63 million of auction bonds the city of Buffalo, New York, sold in 2005 jumped 7.7 percentage points when a Feb. 14 auction failed, triggering the penalty rate of 11 percent proscribed in the terms of the deal. That's almost 9 percentage points more than the floating rate it got from a swap with New York-based Citigroup Inc. Adding in the fixed rate of 3.17 percent, the city paid more than 12 percent that week.
'It hasn't always been like that,' said Anthony Farina, executive assistant comptroller in Buffalo.

Pennsylvania Student Loans Halted on Auction Failures
The Pennsylvania Higher Education Assistance Agency, the second-largest seller of auction-rate debt for the past seven years, will stop making student loans next month after paying $24 million in extra interest. The agency services and buys existing obligations and makes about $500 million in new loans annually, chief financial officer Tim Guenther said. Officials, who made 140,000 student loans in the 12 months through June 30, said they will halt making new ones on March 7.

'The decision was taken because with the auction rates resetting where they are, bringing on new loans is a guaranteed loss at this time,' Guenther said. 'Basically, since Feb. 13 every auction has failed.' The agency is telling its client schools to deal with banks with which it normally deals to arrange new loans for students. Those banks will charge the same amount for interest and fees as the agency. The effect of the disruption on students for now is 'probably nothing,' Guenther said.

The agency sold $8.4 billion of auction-rate bonds from 2000 to 2007 and was the second-largest issuer during the period, according to Thomson Financial. Problems may occur if the agency can't buy the loans that Pennsylvania banks make. If the institutions must retain those obligations, they may exit the market, Guenther said. 'We don't think that danger is imminent, but we don't know when that happens,' Guenther said. The failures are occurring as investor confidence wanes in the creditworthiness of insurers backing auction-rate debt of the type Pennsylvania authorities issued.

The failures have cost the agency about $24 million in additional interest costs over the last three weeks, Guenther said. Their auctions are conducted by banks including New York- based Citigroup Inc. and Morgan Stanley, Minneapolis-based RBC Dain Rauscher Inc. and Zurich-based UBS AG. The agency hasn't sought a refund of fees paid to the banks that ran the failed auctions. 'We haven't been going after them on getting out of contracts so much as trying to figure out a way to fix the problem,' Guenther said.

Ilargi: We’re getting used to this stuff, right? Another day, another downgrade. Note, though, that this is not a subprime story: much of it is much higher rated.

Fitch Places $97B of SF CDOs on Watch Negative on Worsening Mortgage Performance
Following continued deterioration in the subprime and Alt-A RMBS markets, Fitch Ratings initiated a global review of 430 structured finance collateralized debt obligations (SF CDOs) with exposure to residential mortgage-backed securities (RMBS). Fitch has placed $97 billion of rated notes, comprised of 902 tranches, across 197 transactions on Rating Watch Negative.

This action reflects the continued credit deterioration in U.S. subprime mortgage as recently revealed in heightened loss expectations and resultant rating actions. The combination of declining home prices and high risk mortgages are principal drivers of increased loss expectations for subprime RMBS. In light of this on-going deterioration, Fitch's RMBS group announced increased loss expectations of 21% and 26% of initial securitized balances for subprime RMBS from the 2006 and 2007 vintage, respectively. Accordingly, Fitch placed $139 billion of 2006 and 2007 subprime RMBS on Rating Watch Negative.

As of Feb. 25, 2008, Fitch completed rating actions on approximately 80% of these tranches with 1,913 RMBS bonds being downgraded an average of 8.6 notches, 366 RMBS bonds affirmed and 91 RMBS bonds remained on Rating Watch Negative. A detailed list of the RMBS rating action summary is available on the Fitch Ratings web site at

In placing SF CDO transactions on Rating Watch Negative, Fitch primarily considered exposure to subprime RMBS and other SF CDOs with underlying exposure to subprime RMBS. Fitch notes that credit deterioration of the underlying subprime RMBS securities may be amplified at the SF CDO-level due to the use of leverage as well as structural features, such as overcollateralization (OC) haircuts and OC-based event of default (EOD), which may adversely impact certain rated notes and CDOs containing these notes.

Further, Fitch's higher loss forecasts are expected to result in widespread and significant downgrades among the subprime RMBS bonds still on Rating Watch Negative, and may affect all levels of the subprime RMBS capital structure. This was taken into consideration in identifying Rating Watch Negative candidates, especially with respect to high grade SF CDOs (i.e. underlying collateral originally rated 'AAA', 'AA' or 'A'), which tend to be thinly capitalized.

Other factors considered in the Rating Watch Negative process included the worse-than-expected and still rising level of negative credit migration of Alternative-A (Alt-A) mortgage loans. In fact, a significant number of Alt-A transaction has been downgraded, placed on Rating Watch Negative or 'Under Analysis' by either Fitch or the other rating agencies.

Saudi real estate giant calls on UAE to drop dollar peg
The UAE should drop its dirham currency's peg to the dollar to help fight soaring inflation, the chief executive of a Saudi Arabian real estate firm said. Abdulraman Al-Tassan, chief executive of Rakaa Properties, is the latest business leader to call on the second-largest Arab economy to sever its link to the dollar as it tackles inflation which hit a 19-year peak of 9.3% in 2006.

"The long-awaited decision on whether to de-peg the GCC currencies from the dollar is one possible effective solution" to combat inflation, Al-Tassan said in a statement issued on Wednesday on the impact of a regional real estate boom on inflation. Rakaa Properties, the real estate arm of Riyadh-based conglomerate Rakaa Holding, is developing a $272 million project on Abu Dhabi's Reem Island.

UAE business leaders - including Khalaf Al-Habtoor, chairman of conglomerate Al-Habtoor Group, and Dubai Properties Chief Executive Mohammed Binbrek - made calls for an end to the dollar peg in December in a report in the daily Emirates Business 24/7. Surging inflation in the Gulf has fuelled speculation that some countries may either revalue their currencies or drop their pegs to the dollar, which hit a record low against the euro on Wednesday.

UAE inflation probably accelerated to 10.9% last year on surging rents, National Bank of Abu Dhabi (NBAD) said this week. "Al-Tassan agreed with the call to de-peg the dirham from the dollar," the Rakaa statement said.

Bets on revaluation grow on Greenspan remarks
UAE dirham forwards widened on Wednesday after former US Federal Reserve chairman Alan Greenspan commented in favour of currency reform, renewing bets on Gulf Arab currency revaluations.

Speaking at conferences in Saudi Arabia and the UAE on Monday, Greenspan said near-record Gulf Arab inflation would fall "significantly" were the oil producers to drop their dollar pegs and float their currencies freely. "When Alan Greenspan talks, people listen to him," said Jason Goff, head of group treasury and market sales at Emirates Bank International.

"A good part of speculation on Gulf currencies is outside of the Gulf. What Greenspan says carries weight in the market," he said. Dollar pegs restrict the Gulf's ability to fight inflation by forcing them to shadow US monetary policy at a time when the Fed is cutting rates to ward off recession. The dollar slumped to a record low against the euro on Wednesday

UAE being held back by dollar peg
The UAE's booming economy is being held back by its currency peg to the weak US dollar, the Asia editor of The Economist magazine told on Monday. Speaking on the sidelines of a conference in Abu Dhabi, Pam Woodall said it was no longer economically viable for the UAE and other Gulf states to continue with their dollar peg as the US economy was spiralling into recession.

“All countries pegged to the dollar are suffering rising inflation. Abu Dhabi is growing at an amazing rate, it does not make economic sense for booming economies to peg their currencies to a country that is about to go into recession,” Woodall said. Woodall predicted the issue of the dollar peg would continue to dog Gulf states over the next year as further rate cuts by the US Federal Reserve fuelled inflationary pressure.

[Inflation in the UAE probably hit 10.9% in 2007, the National Bank of Abu Dhabi (NBAD) said, revising up its forecast for price rises by almost three percentage points on rising rents.

Inflation is rising rapidly across the world's top oil-exporting region, where economies are surging on a near five-fold rise in oil prices since 2002. UAE inflation hit a 19-year peak of 9.3% in 2006, according to official data. "Indicators continue to point to unabated inflation," NBAD said in a note on Sunday in which it raised its inflation forecast from 8.1% because of faster than anticipated rent increases]

Paulson Says No Go on Housing Bailouts
Treasury Secretary Hank Paulson has thrown a bucket of cold water on a number of proposals being floated in Washington to rescue troubled borrowers via the explicit use of public funds, such as the idea of reviving the 1933 Home Owner's Loan Corporation to buy underwater mortgages and renegotiate them.

In some respects, Paulson's tough stance is welcome, because many of these proposals would do more for banks and investors than borrowers. Many homeowners, including ones who are capable of servicing their mortages, are walking away because they deem them an unattractive investment. There is now a large class of nominal homeowners who in fact are more akin to renters with a home ownership option that is now deeply out of the money. And they can often rent more cheaply too.

But unfortunately, what is driving Paulson isn't a pragmatic assessment of what measures might be cost effective and not involve undue moral hazard. Instead, he is guided primarily by the ideological imperatives of this Adminsitration, which is to favor so-called private sector solutions. But that construct is dishonest and limiting. For instance, the Journal reports that Paulson maintains that "market-based approach will be enough to keep the situation under control."

If Paulson considers the worst housing market since the Depression to be under control, I shudder to think what an unmanaged situation would look like.

However, a grey area in "private sector solutions" is a willingness to rack up government contingent liabilities. The portfolio ceilings on Fannie Mae and Freddie Mac were lifted Wednesday, and OFHEO's James Lockhart had said earlier this month that the two GSEs could add $100 billion in mortgages in the next six months without running into capital limits. The plan now in place is to keep Fannie and Freddie in remediation mode, setting aside reserves 30% higher than the usual minimum. However, if the GSEs come under increasing pressure to take on weaker mortgages to salvage the housing market, even those higher reserves may prove insufficient.

Similarly, the Treasury has not nixed some proposals to increase the role of the FHA. The FHA is the historical source of mortgages to middle and lower income borrowers, so an increased role for the FHA could well make sense. But again, it may be subject to pressures to relax its standards and become a warehouse for mortgages on the brink.

CIBC tables a $1.4-billion loss
Canadian Imperial Bank of Commerce reported a first-quarter loss of $1.456-billion on Thursday, compared to a profit of $770-million a year earlier, as the bank took a slew of charges related to its subprime mortgage exposure.

The writedowns and paper losses included a $2.28-billion (pre-tax) charge because of the bank's exposure to troubled bond insurer ACA Financial Guaranty Corp.; a $626-million charge on exposure to other financial guarantors; $473-million of paper losses on securities tied to the U.S. mortgage market; and a $108-million loss on the sale of some of the bank's U.S. business to Oppenheimer Holdings Inc. as well as management changes and the restructuring of some other businesses.

Those items, amounting to $3.49-billion, were partially offset by two much smaller gains; $56-million on tax-related items, and $171-million on the changing value of credit derivatives on corporate loans.

“Our losses related to the U.S. residential mortgage market are a significant disappointment and are not aligned with our strategic imperative of consistent and sustainable performance,” stated CEO Gerry McCaughey. The bank cautioned that “market and economic conditions relating to the financial guarantors may change in the future, which could result in significant future losses.”

BMO-sponsored ABCP trusts downgraded by DBRS
Bank of Montreal is one step closer to a writedown of as much as $495-million after failing to reach an accord to head off the potential collapse of two asset-backed commercial paper trusts that the lender sponsors.

Credit rating agency DBRS downgraded the notes of Apex Trust and Sitka Trust on Thursday after BMO failed to negotiate a restructuring proposal with a party owed collateral by a deadline of last night, and after Apex failed to roll over all its notes that came due that day. A spokesman for Bank of Montreal had no immediate comment.

“Several levered super-senior transactions entered into by the trusts with several swap counterparties face outstanding calls for additional collateral,” DBRS said. “The total amount of collateral that is due is significant.”DBRS declined to comment on what it meant by “significant.” The result of the failure to roll and meet collateral calls would likely be a wind-up of the two trusts after a short grace period of two days in which BMO will have a chance to scramble for a solution.

If one isn't found, BMO warned last week that it could end up writing off its $495-million net exposure to the trusts. That would be in addition to $210-million in losses the bank has already booked resulting from the trusts. Normally, the plan for an ABCP trust facing a collateral call is to sell more notes to raise money, but with the market not buying ABCP from Apex that is going to be difficult.

Toronto-based BMO could fund the collateral calls on its own, and it said last week that it could offer further support. However, doing so would mean doubling down on a bet that credit markets will recover in a meaningful way, which they show few signs of doing.

Speculative Onslaught. Crisis of the World Financial System: The Financial Predators had a Ball
When CDO holders around the world last summer suddenly and urgently needed liquidity to face the market sell-off, they found the market value of their CDOs was far below book value. So, instead of generating liquidity by selling CDOs, they sold high-quality liquid blue chip stocks, government bonds, precious metals.

That simply meant the CDO crisis led to a loss of value in both CDOs and stocks. The drop in price of equities triggered contagion to hedge funds. That dramatic price collapse wasn’t predicted by the theoretical models built into quantitative hedge funds and led to large losses in that part of the market, led by Bear Stearns’ two in-house hedge funds. Major losses by leading hedge funds further fed increasing uncertainty and amplified the crisis.

That was the beginning of colossal collateral damage. The models all broke down.

Lack of transparency was at the root of the crisis that had finally and inevitably erupted in mid-2007. That lack of transparency was due to the fact that instead of spreading risk in a transparent way as foreseen by accepted economic theory, market operators chose ways to "securitize" risky assets by promoting high-yielding, high-risk assets, without clearly marking their risk. Additionally, credit-rating agencies turned a blind eye to the inherent risks of the products. The fact that they were rarely traded meant even the approximate value of these structured financial products was not known.[...]

Risk and its pricing did not behave like a bell-shaped curve, not in financial markets any more than in oilfield exploitation. In 1900 an obscure French mathematician and financial speculator, Louis Bachelier, argued that price changes in bonds or stocks followed the bell-shaped curve that the German mathematician, Carl Friedrich Gauss, devised as a model to map statistical probabilities for various events. Bell curves assumed a mild form of randomness in price fluctuations, just as the standard I.Q. test by design defines 100 as "average," the center of the bell. It was a kind of useful alchemy, but still alchemy.

That assumption that financial price variations behaved fundamentally like the bell curve allowed Wall Street Rocket Scientists to roll out an unending stream of new financial products each more arcane and complex than the previous. The theories were modified. The "Law of Large Numbers" was added to say that when the number of events becomes sufficiently large, like flips of a coin or rolls of die, the value converges on a stable value over the long term. The Law of Large Numbers, which in reality was no scientific law at all, allowed banks like Citigroup or Chase to issue hundreds of millions of Visa cards without so much as a credit check, based on data showing that in "normal" times defaults on credit cards were so rare as not to be worth considering.

The problems with models based on bell curve distributions or laws of large numbers arose when times were not normal, such as a steep economic recession of the sort the United States economy today is beginning to experience, a recession comparable perhaps only to that of 1931-1939.

Zogby Poll: 67% View Traditional Journalism as "Out of Touch"
Internet is the top source of news for nearly half of Americans; Survey finds two-thirds dissatisfied with the quality of journalism

Two thirds of Americans - 67% - believe traditional journalism is out of touch with what Americans want from their news, a new We Media/Zogby Interactive poll shows. The survey also found that while most Americans (70%) think journalism is important to the quality of life in their communities, two thirds (64%) are dissatisfied with the quality of journalism in their communities.

Meanwhile, the online survey documented the shift away from traditional sources of news, such as newspapers and TV, to the Internet - most dramatically among so-called digital natives - people under 30 years old.

Nearly half of respondents (48%) said their primary source of news and information is the Internet, an increase from 40% who said the same a year ago. Younger adults were most likely to name the Internet as their top source - 55% of those age 18 to 29 say they get most of their news and information online, compared to 35% of those age 65 and older. These oldest adults are the only age group to favor a primary news source other than the Internet, with 38% of these seniors who said they get most of their news from television.

Overall, 29% said television is their main source of news, while fewer said they turn to radio (11%) and newspapers (10%) for most of their news and information. Just 7% of those age 18 to 29 said they get most of their news from newspapers, while more than twice as many (17%) of those age 65 and older list newspapers as their top source of news and information.

Web sites are regarded as a more important source of news and information than traditional media outlets - 86% of Americans said Web sites were an important source of news, with more than half (56%) who view these sites as very important. Most also view television (77%), radio (74%), and newspapers (70%) as important sources of news, although fewer than say the same about blogs (38%).

”This is the new face of hunger”
Huge budget deficit means millions more face starvation

The United Nations warned yesterday that it no longer has enough money to keep global malnutrition at bay this year in the face of a dramatic upward surge in world commodity prices, which have created a "new face of hunger". "We will have a problem in coming months," said Josette Sheeran, the head of the UN's World Food Programme (WFP). "We will have a significant gap if commodity prices remain this high, and we will need an extra half billion dollars just to meet existing assessed needs."

With voluntary contributions from the world's wealthy nations, the WFP feeds 73 million people in 78 countries, less than a 10th of the total number of the world's undernourished. Its agreed budget for 2008 was $2.9bn (£1.5bn). But with annual food price increases around the world of up to 40% and dramatic hikes in fuel costs, that budget is no longer enough even to maintain current food deliveries.

The shortfall is all the more worrying as it comes at a time when populations, many in urban areas, who had thought themselves secure in their food supply are now unable to afford basic foodstuffs. Afghanistan has recently added an extra 2.5 million people to the number it says are at risk of malnutrition.

"This is the new face of hunger," Sheeran said. "There is food on shelves but people are priced out of the market. There is vulnerability in urban areas we have not seen before. There are food riots in countries where we have not seen them before."


Bigelow said...

Thanks for the excellent Engdahl piece!

“The degree of lending fraud and abuse that ensued in the new era of asset securitization was staggering to the imagination.”

Engdahl names names, Fed Chairman Alan Greenspan, Treasury Secretaries Robert Rubin, Lawrence Summers, Henry Paulsen and Chairs of the Agriculture Committees [Bob Smith and Richard Lugar].

“The very system they worked over decades to create was premised on fraud and non-transparency.”

None will be prosecuted or go to jail; I’d bet they will all get even more power.

Anonymous said...


Back in August Stoneleigh put up a "primer" on TOD Canada.

When I finally discovered TOD and the Financial Roundups, I asked a question or two and it was probably obvious that I needed basic information, so he/she directed me to his/her primer.

It was a great help, even though I did not understand everything. A few weeks of intensive study around the internet and a second reading put me in a position where I had a limited, but at least not erroneous, grasp of the situation.

My point here is this. Would it be possible to draft a second document that looks at the current situation with a wide-angle lens (like the primer), but assuming that the basic knowledge is in place. I.e. for someone who has read the primer and been assiduously reading since.

I would bet that such a document would be of immense service to many people.

Any chances ?

Thanks for all the good work.

François Bartsch

Anonymous said...

Any thoughts on the new tax-free savings accounts the Canadian Conservative government introduced in their latest budget? Will anyone even have the money to invest when they come online in 2009?

Ilargi said...


"Would it be possible to draft a second document that looks at the current situation with a wide-angle lens (like the primer), but assuming that the basic knowledge is in place. I.e. for someone who has read the primer and been assiduously reading since.

That's a good idea. I'll email poke Stoneleigh to get that done.

Ilargi said...


i haven't read up on the "new tax-free savings accounts" in Canada, I must admit. What are the parameters here? They'd involve depositing money with Canadian banks, I presume? And tax free but not "fee-free"? What are the yearly limits? This is Flaherty's new shiny budget? I need more info.

Anonymous said...

From this

"A key feature of Flaherty's document is the introduction of a new investment vehicle for Canadians, dubbed a Tax-free Savings Account.

Individuals will be able to put up to $5,000 a year into one of the accounts. Capital gains earned on investments in the account will be exempt from tax, even when withdrawn. Account holders will be able to withdraw money at any time without restriction. Unlike an RRSP, contributions to the new account will not be tax-deductible."

Anonymous said...

More details at the Budget 08 website:

"How the Tax-Free Savings Account Will Work

* Starting in 2009, Canadian residents age 18 or older will be eligible to contribute up to $5,000 annually to a TFSA, with unused room being carried forward.
* Contributions will not be deductible.
* Capital gains and other investment income earned in a TFSA will not be taxed.
* Withdrawals will be tax-free.
* Neither income earned within a TFSA nor withdrawals from it will affect eligibility for federal income-tested benefits and credits.
* Withdrawals will create contribution room for future savings.
* Contributions to a spouse’s or common-law partner’s TFSA will be allowed, and TFSA assets will be transferable to the TFSA of a spouse or common-law partner upon death.
* Qualified investments include all arm’s-length Registered Retirement Savings Plan (RRSP) qualified investments.
* The $5,000 annual contribution limit will be indexed to inflation in $500 increments."

Anonymous said...

The dollar tumbled to 104.65 yen, its lowest since May 2005, after a slide in the U.S. currency towards the key 105 yen level triggered a wave of stop-loss orders.

ilargi, very sorry, please pardon this ignorant white savage's all encompassing ignorance but what makes 105 yen a key level and for what?

Stoneleigh said...

Crystal Radio,

Different levels are considered key for different markets based on various kinds of technical analysis (looking at market trends, channels, patterns and momentum). Those levels would be referred to as support (underneath) or resistance (above). If support, or resistance, levels are broken, then traders assume that the market is breaking in one direction or the other.

My favourite kind of technical analysis is Elliottwave, which regards markets as exhibiting fractal behaviour - Fibonacci patterning at different degrees of trend. If you're interested you could also check out Kondratieff waves (long cycles), Dow Theory, TRIN etc. Next time they have a free week at, I'll let you know, if you'd like to check out an example of what technical analysts do.

Edgy said...

Recall earlier my comment about our parent's estate - well, we have a buyer who, according to sister, was preapproved conventional but changed to FHA financing. They've been approved and hopefully we'll close before any further collapsing of the mortgage industry. Is FHA related to Fred/Fan?

Also, I have two FNMA (7.0% & 7.5%) and one GNMA (6.5%)holdings of about $7500. Am I at risk here of losing value/principle?

Thanks for all your reporting... I can't believe the mess we're in. I started watching Dr. Zhivago(sp?) last night and wondered how long we the sheeple will go before we demand a revolution.

Anonymous said...

Thanks Stoneleigh, Sounds interesting! I take it that is what Genesis is doing in his 'technical'. Too bad he doesn't do Canadian stocks as it looked quite interesting, though rather confusing.

BTW, have you looked at the education saving changes in the Flattery budget? Extending the saving period from 21 to 31 years for contributing. To me it sounded like a way making political points while avoiding increasing the amount one would be able to put tax free into savings during that 21 years. But then maybe I just have a bit of bias against anything fostered by a warmongering sleaze ridden Harper led government. What do you think?:)

Stoneleigh said...

Hi Crystal Radio,

I actually don't pay much attention to government programs that have such a long time horizon, because so much is set to change drastically in that timeframe. I can't see the rules for anything financial staying the same over the next 30 years. I also think savings of that kind are likely to be derailed sooner rather than later by a systemic banking crisis, which would be a significant deterrent to going that route.

Stoneleigh said...


Glad to hear you have a buyer.

I wouldn't own holdings in Fannie, Freddie or Ginnie Mae as I think the risk is very high. Those entities are being set up as the bag holders for a lot more dodgy mortgages, on top the ones they already have.

Stoneleigh said...


I'll see what I can do for you. An update to Resurgence of Risk does seem to be called for.