Sunday, March 2, 2008

Debt Rattle, March 2 2008

Ilargi: Earlier this week, I addressed the insanity of allowing Fan and Fred to get deeper into debt, just as they announced record losses. Of course I’m not the only one who noticed this. Under present market conditions, the two companies are now certain to fail, unless the government uses your tax money for a multi-trillion dollar bail-out. A dangerous game indeed. Bill Poole at the St. Louis Fed considers both endangered species, even without mentioning the OFHEO decision. As I wrote before, we’ll see a stunning amount of bad debt moving from the private (banks) to the public (GSEs) sector. And that means that you’ll effectively bail out the banks. How does that feel? This kind of action will not save the economy, it will murder it. And they all know it.

Sacrificing Fannie And Freddie
The Federal Reserve and the financial powers have thus far been classified as "creative" in their handling of the credit crisis.During this week's testimony from Federal Reserve Chairman Bernanke, a news item flashed across the wire: The Office of Federal Housing Enterprise Oversight (OFHEO) will be relaxing some of its operating restrictions for Fannie Mae and Freddie Mac. In particular, OFHEO said that it would remove caps on mortgage-portfolio growth and will gradually reduce its current requirement that both enterprises maintain capital reserves 30% above statutory minimums.

These capital requirements, initiated in 2004, are in place for good reason. Back then, it was found that these companies were not keeping their financial records in order while their executives were making millions. This move, essentially, will allow for additional money and credit to flow into the economy, but the timing of the OFHEO announcement is, at best, suspicious and very worrisome. It comes too close to the discussion by the Fed regarding their understanding of the current housing problem and the additional problems that lie ahead.

Remember, the reason why there were caps in the first place was that there was a significant breakdown in the way Freddie Mac and Fannie Mae were handling their financials. The penalty was a much greater capital requirement for each enterprise. "Since agreements reached in early 2004, OFHEO has had an ongoing requirement on each enterprise to maintain a capital level at least 30% above the statutory minimum capital requirement, because of the financial and operational uncertainties associated with their past problems," writes OFHEO Director James B. Lockhart in a statement. "In retrospect, this OFHEO-directed capital requirement, coupled with their large preferred-stock offerings means that they are in a much better capital position to deal with today's difficult and volatile market conditions and their significant losses."

Excuse me, but a release of the cap will help to keep their problems in check? Surely there are different problems now--and the 30% cushion helps to keep the stability of the quasi-agency companies during times when write-offs and write-downs are growing. The fact that Moody's is looking into downgrading these names is one of the few murmurs of sanity in this situation. It is clear that companies in dire need of credit expansion (builders, retailers) may be acting on a last-ditch-effort approach that will have them spin positive on any plan--no matter how detrimental it will be to our national financial health.

Freddie Mac holds 16% of subprime adjustable-rate mortgages 90 days or more delinquent or now in foreclosure. This is a far greater percentage of these types of loans in trouble this soon than at any time over the past 10 years. ARMs are considered hybrid mortgages, and as this category currently makes up such a large portion of Freddie's portfolio, there is reason to be cautious. Simply using debt-to-equity ratios as a proxy for loan-to-value will show that this is more of a creative mechanism for credit to flow that will have the near-term effect of throwing these two companies under the bus. We continue to warn investors that this type of gamble may lead to further solvency issues rather than balance sheet stability for Fannie and Freddie.

Any downgrade (hard to fathom?) will also create a greater problem, as the cost for asset-backed credit will eventually be need to be paid by ... you and me! These will take the form of a tax burden that will be left to be cleaned up by the "winners" of the upcoming election. The bottom line: Freddie and Fannie are being thrown under the bus in order to help the housing markets and in an effort to protect the credit markets. The removal of the mandatory cap is a dangerous gamble by regulators. In the end, there needs to be a sacrifice to save the rest of us. Freddie and Fannie may well be the burnt offerings to appease the credit gods.

Risks Seen for Growing Fannie, Freddie
Loosening the regulatory reins around Fannie Mae and Freddie Mac gives them the freedom to play a bigger role in trying to stabilize a worsening housing market. The danger, some analysts say, is that the government-sponsored mortgage titans will become saddled with too much financial risk. Fannie and Freddie this week reported fourth-quarter losses totaling $6.1 billion and predicted multibillion-dollar losses throughout 2008. Yet despite their financial troubles and the shakiness of the U.S. housing market, the government is making it easier for Fannie and Freddie to take on additional home-loan debt, something the companies have sought for months.

First they won the right -- as part of a bipartisan economic stimulus package -- to buy and guarantee mortgages above the traditional $417,000 limit. Then -- as a reward for filing timely financial statements following multibillion-dollar accounting scandals -- the companies were freed of a combined $1.5 trillion cap on their mortgage-investment holdings. Their regulator also raised the possibility of relaxing a mandated capital cushion Fannie and Freddie must keep in reserve.

While members of Congress and the Bush administration are hopeful these changes will enable Fannie and Freddie to help stem the housing downturn, some financial experts believe it is irresponsible to encourage the No. 1 and No. 2 mortgage finance companies to grow at this point in time. Asked about the potential risks from being allowed to expand, the companies point to their mortgage portfolios currently being tens of billions below the now-expiring $746 billion limit. Without an easing of the risk capital level, they say, it is difficult for them to purchase as many mortgages as desirable to help the market.

"We have consistently shown that we operate in a very safe and prudent manner," said Freddie spokeswoman Sharon McHale. Fannie spokeswoman Amy Bonitatibus declined to comment. Nobody is suggesting that Fannie and Freddie are on the verge of failure anytime soon. Some on Wall Street are even cheering the companies' efforts to gain market share at a time when smaller lenders are retreating. That said, there is concern among some experts that they have grown too large and could endanger the financial system if they were to totter or fail.

"Neither of these organizations has enough capital to cover their risk, and they know it," said Christopher Whalen, senior vice president and managing director of Institutional Risk Analytics, a firm based in Torrance, Calif. "I'm concerned about solvency for these entities." Congress created Fannie during the Depression and Freddie in 1970 to keep money flowing into the home-loan market by buying up mortgages and bundling them into securities for sale to investors worldwide -- thereby making home ownership affordable for low- and middle-income Americans.

Today the companies hold or guarantee around $4.9 trillion in home-loan debt, though under a 1992 law they are required to hold in reserve against risk only a fraction of what is mandated for commercial banks. While the Treasury Department isn't obligated to assist Fannie or Freddie in a financial emergency, there is a perceived notion on Wall Street that the government would bail them out in the event of a collapse. The idea that they are "too big to fail" enables the two companies to borrow relatively cheaply on global markets by issuing hundreds of billions of dollars in top-rated securities backed by mortgages.

How Important Is Moral Hazard?
WIlliam Poole is chairman of the St Louis Fed
We have known for many years that moral hazard is a potentially serious issue. If a firm believes that it will be bailed out if it gets into trouble, that expectation encourages excessive risk-taking and increases the probability of trouble.

There are two complementary ways to deal with moral hazard. First, firms in trouble ought not to be bailed out, unless the bailout takes a form that imposes heavy costs on managers and shareholders. Second, firms subject to government regulation ought to be compelled to maintain adequate capital to reduce the probability of failure. U.S. banks entered the period of turmoil last year pretty well capitalized and have been able to withstand large losses.

I am more skeptical of the financial strength of the GSEs, and believe that we could see substantial problems in that sector. According to the S&P Case-Shiller home value data released earlier this week, as of December 2007 average prices had declined by 15 percent or more over the past 12 months in Phoenix, San Diego, Miami and Las Vegas.

We can add Detroit to the danger list as the home price index for that city is down by almost 19 percent over the 24 months ending December 2007. With house prices falling significantly in a number of large markets, many prime mortgages issued a few years ago with a loan-to-value ratio of 80 percent may now have relatively little homeowner equity, which increases the probability of default and amount of loss in event of default.

As I emphasized some time ago, GSE losses will depend on the variance as well as the mean of changes in national home prices. Losses in markets with home prices falling more than the national average will not be offset by gains in markets with price changes above the national average. I do not have a new message here; we have known for a long time that advance preparation and a strong balance sheet are the keys to riding out a financial storm.

As I have emphasized before, the Federal Reserve can deal with liquidity pressures but cannot deal with solvency issues. I do not have any information on the GSEs that the market does not also have. Nevertheless, in assessing the risk of further credit disruptions this year, I would put the GSEs at the top of my list of sources of potentially serious problems. If those problems were realized, they would be a direct result of moral hazard inherent in the current structure of the GSEs.

Beware of Fannie's Help
Remember Ninja mortgages -- no income, no job, no assets? And "liar loans," with no check of borrowers' stated incomes? Staid old Fannie Mae and Freddie Mac, the U.S. mortgage titans, were supposed to have shunned such subprime excesses. Maybe they did. But Fannie now seems to be going out on a similar lending limb.

The company is offering borrowers who are behind with mortgage payments as much as $15,000 each to clear their arrears. The money comes -- get this -- as a 15-year unsecured personal loan, and "verbal confirmation of financial capacity" is considered acceptable. To be fair, there are a few other criteria. And it's billed as a way to help homeowners over a hump. But Fannie may benefit the most.

For Fannie, the "HomeSaver Advance" program should help reduce the need to modify mortgage loans formally, a complicated and expensive process, and to foreclose, a bad result all round. But as it happens, it will also reduce the number of delinquent loans Fannie buys back from the pools underlying mortgage-backed securities that it guarantees -- and the related losses it would otherwise have to take.

For borrowers, Fannie says, the program is a way to "bring delinquent mortgages current and keep their homes." That's true, provided they can afford the regular payments on their mortgage and those on the new loan, which kick in after six months. That may be fine for borrowers in truly temporary difficulty. But longer term, it's going to increase their debt burden.

The program might also upset investors in the company's MBS instruments. They like the idea that Fannie has to buy back troubled individual mortgages under certain conditions. If HomeSaver Advance makes formerly delinquent loans look pristine, even though the borrowers are actually still struggling, it undermines that comfort.

Overall, it could be Fannie that stands to reap the clearest benefits, at least in the short term. The company isn't saying how big the new program might get. But bruised shareholders -- and U.S. taxpayers, who are implicitly on the hook -- might wonder whether a collection of unsecured loans to demonstrably stretched borrowers could, before long, become a bit of a millstone.

Ilargi: The ABCP farce in Canada does not stop. They've delayed the deadline again, must be the 10th time by now.... It must be getting hard for these guys to keep a straight face while going to the press. The non-bank commercial paper in Canada has been frozen since August 14 2007, when it became clear there was no market for it anymore. None. As the would-be rescuers stumble along from deadline to deadline, the paper loses ever more of what little value it had left, and the banks that are supposed to finance the bail-out get into deeper trouble. To wit: The Bank of Montreal said this week they are out of the game altogether. The longer it takes, the smaller the chance of anything positive coming from this.

A reminder: Canada's no 1 pension fund, Québec's Caisse de Depôt, is stuck in this doodoo for close to $20 billion.. Another large pension fund, Ontario Teachers, meanwhile, is pushing through a highly leveraged purchase of phone company BCE, at a point in time when leveraged buy-outs everywhere else in the world have followed the dodo into the sweet beyond. And while Canada is smug about its energy riches, it stunningly and unbelievably ran its first current account deficit in a long time. This will not end well.

ABCP fix to be delayed until end of April
The investor group that's seeking a restructuring plan for $33-billion in frozen asset-backed commercial paper confirmed that the fix will be delayed until the end of April, as details of the plan, such as participation by Canadian banks, have yet to be nailed down amid crumbling credit markets.

The so-called Crawford Committee that represents holders of the moribund paper said that investors will now get information packages “before March 14,” rather than this week as planned, and the proposed swap of ABCP for new bonds will occur “toward the end of April.”

The committee said it is still working to get Canadian banks to support the restructuring with a commitment to fund a $2-billion line of credit have yet to conclude. Sources told the Globe and Mail Thursday that Bank of Montreal is wavering on its plans to participate, as it confronts troubles with ABCP trusts of its own.

“Negotiations with Canadian banks on the definitive terms of their participation in the margin funding facility are continuing,” Purdy Crawford, the lawyer who heads the committee, said in a statement late Friday. “We remain optimistic that they will support our restructuring plan as participants in this facility.” In the meantime, a standstill that protects the trusts from meltdown remains in place, the committee said.

Leveraged funds rush to sell debt
"Just less than $100bn, or 65 per cent, of the existing medium-term note [MTN] debt is due to be repaid in 2008, leaving around $50bn of MTN outstanding at the end of the year," Birgit Specht at Citigroup said. "This looks like a good proxy for both the magnitude and the pace of a potential wind-down this year."

SIVs have been at the centre of the credit crunch in the past six months as fears about potential losses from subprime mortgages have sent prices down on all kinds of structured bonds and led investors to flee the short-term debt markets that SIVs relied on.
Since Dresdner Kleinwort and Bank of Montreal joined other banks to pledge full support to their SIVs this month, all but one of the vehicles have either been bailed out by bank sponsors or have defaulted on their debt.

The final independent vehicle still standing, Gordian Knot's $41bn Sigma Finance, was put on watch for downgrade by Moody's on Wednesday. "While the SIV crisis may have few surprises left, we remain firmly of the view that bank bail-outs are unlikely to stem the flow of asset sales," said Ganesh Rajendra, head of securitisation research at Deutsche Bank. He added that recent weeks had already seen a notable pick-up in selling pressure.

It is not just SIVs that are being forced to sell such bonds. Yesterday, news arrived about the collapse of Peloton, a London-based hedge fund specialising in asset-backed bonds, and there is rising concern about who might be next.

Of the $100bn due in MTN repayments, Citigroup estimates that almost $85bn is due by the end of September. There will also be repayments due on short-term commercial paper and repo facilities with other banks. In addition, there is about $25bn-$30bn of debt that defaulted SIVs have already failed to repay.

The Buck Has Stopped
Ben S. Bernanke, the Federal Reserve chairman, told Congress last week that fighting off a possible recession in the United States was Job 1 for his crew. But a consumer-led recession has already begun, according to a new index that reflects how much money Americans can actually spend right now. The new indicator comes courtesy of Charles Biderman, the founder and chief executive of TrimTabs Investment Research, a proprietary research firm in Santa Rosa, Calif. “The big picture is: the amount of money people have to spend, which includes money on real estate transactions, is plummeting, and it started to break down in October,” he said.

Consumer spending, don’t forget, accounts for about two-thirds of gross domestic product. Naturally, all eyes are on what consumers are doing with their money. Mr. Biderman said his data, in contrast to the indicators the federal number crunchers produce, are contemporaneous and offer much more insight into what is happening in the economic here and now.

He said data from the Bureau of Labor Statistics and the Bureau of Economic Analysis rely on outdated figures and outmoded methods. (Both agencies have been roundly criticized for years about these problems. They defend their practices by saying that, among other things, certain data segments that they ignore are insignificant and that their models are — of necessity — focused on past data.)

Mr. Biderman’s assessment of current employment and personal income pictures, for instance, is gleaned from sources that include daily deposits of withheld income and employment taxes reported to the United States Treasury. This compares with the monthly employment analyses put out by the Bureau of Labor Statistics, which are preliminary and, Mr. Biderman says, based on flawed surveys and extrapolation of historical data.
No surprise, he says, that the initial figures from the bureau are so often adjusted significantly later on.

TrimTabs calls its new measure the Consumer Spendables Indicator, and it sensibly includes these crucial sources of consumption cash: after-tax wages; after-tax income from nonwage sources, like capital gains, dividends, pensions, partnerships and self-employment; and net equity extraction from consumers’ homes, either through property sales or mortgage refinancing. For the first time since the fourth quarter of 2003, TrimTabs estimates, consumers will have less money to spend this quarter on a year-over-year basis. The firm expects this figure to fall 0.6 percent from the same period in 2007.

While that may not seem like a meaningful decline, it becomes more significant when compared with the increases the index showed during the real estate boom. Back when homes were everybody’s favorite A.T.M., mortgage equity extraction propelled the TrimTabs consumer indicator. Beginning in late 2004, quarterly comparisons with year-earlier periods shot up; they peaked at a growth rate of 17 percent in the first quarter of 2006. During that period, consumers had $1.69 trillion to spend; equity extraction accounted for $191 billion then, TrimTabs said, its peak amount.

Markets Fall on Drumbeat of Grim Reports
An outpouring of negative economic and financial reports soured the mood on Wall Street Friday as banks and other lenders further tightened credit in their struggle to contain damage from losses on mortgages, business loans and related debt. Shares sank, and investors fled to the safety of Treasuries as the Standard & Poor’s 500-stock index fell 2.71 percent and the Dow Jones industrial average dropped 315.79 points, or 2.51 percent, to 12,266.39. Both indexes capped their worst four months since 2002.

Prices of municipal bonds, bank loans and high-yield debt all fell as well. The markets for ultrasafe debt backed by the federal government and other nations were alone in posting gains. Some commodities, including gold, were also up. “The drumbeat of economic news has been unrelentingly bad,” said Edward Yardeni, a normally upbeat investment strategist. “The recession scenario is looking more and more credible.”

Like so many days since the credit troubles erupted in August, Friday dawned on the East Coast with ominous financial signals. A.I.G., the large insurer, had reported its worst loss ever the evening before. Reports out of London overnight suggested that a large hedge fund, Peloton Partners, was being forced to sell nearly $2 billion in mortgage-related securities after it lost the backing of its lenders.

By the time traders in New York were at their desks, economic reports issued in Washington showed consumer spending was flat in January after adjusting for inflation. Then a bellwether report on Midwestern business activity unexpectedly fell to its lowest level in more than six years, and a survey showed consumer confidence declined to a 16-year low.

If that was not pessimistic enough, Wall Street’s attention was soon riveted by a report from analysts at UBS that estimated losses to the financial system from securities backed by mortgages and other debts would total $600 billion. Until recently, many analysts had been forecasting losses in the neighborhood of $400 billion — a figure that the dwindling band of optimists in the financial markets once dismissed as vastly overblown.
“There is not any one news item that I can point to,” said Douglas Peta, chief investment strategist at J. W. Seligman & Company in New York. “We know that there is paper out there that we can’t trust. We don’t know exactly who owns it and how much. And we don’t know how they are valuing it.”

A Rerun, Maybe, but of What Show?
IS it 1989 all over again? Or 2001? Or, for those old enough to remember, a replay of 1973-74? On Wall Street these days, leading strategists are citing these and other periods to help explain what lies ahead for the stock market in 2008, even as market indexes and the broader economy seem to be following divergent paths.

On the one hand, leading strategists like Byron Wien of Pequot Capital and Tobias Levkovich of Citigroup are predicting a recession. Ben S. Bernanke, the Federal Reserve chairman, sounded a pessimistic note in Congressional testimony last week, saying that the economy was looking “distinctly less favorable” than it did last summer, while the government reported anemic growth in gross domestic product of just 0.6 percent, at an annual rate, in the final quarter of 2007.

On the other hand, even after Friday’s losses, the Dow Jones industrial average is still hovering around 12,250 while the broader Standard & Poor’s 500-stock index is down only about 5 percent from a year ago, when economic expectations were much rosier.

At first glance, it may seem either that the fears are overdone or that the market hasn’t fully priced in the likelihood of a recession. Mr. Wien, who sees similarities between now and 1973-74, is in the second camp. Along with $100-a-barrel oil today, he points to price increases for other commodities, like wheat, which has surged recently. Inflationary pressures are rising, he says, even as the economy slows.

Citigroup Underwrote $6.9 Billion of Ambac's Most Troubled CDOs
Citigroup Inc. helped create at least $6.9 billion of securities insured by Ambac Financial Group Inc. that have tumbled in value and may require the insurer to pay claims, according to research by Tavakoli Structured Finance Inc.
Of the $22 billion of collateralized debt obligations linked to the mortgage market and insured by Ambac, about $7.5 billion were underwritten by Citigroup, which is among banks seeking to help Ambac raise capital. Of those CDOs, $6.9 billion, or 92 percent, are experiencing so-called events of default, Tavakoli said. Such events signal the most-senior classes may not be paid in full.

Ambac of New York is in talks with banks to raise money to satisfy Moody's Investors Service and Standard & Poor's that it has enough capital to remain top-rated after posting more than $5 billion of losses related to guarantees on CDOs, which package pools of debt and slice them into new pieces. New York-based Citigroup is among a group of banks in discussions to help Ambac.

"Given the deterioration in these deals, Ambac may experience substantial principal losses, and capital suppliers may view the portfolio as financial guarantees on non-investment grade products," Janet Tavakoli, president of Tavakoli Structured Finance, wrote in a Feb. 18 research report. "It is no surprise that the major underwriters of the CDO deals on Ambac's books are participating in the rescue."

Tavakoli based her research on data released by Pershing Square Capital Management. Pershing Square, led by hedge fund manager Bill Ackman, has a short position on Ambac and Armonk, New York-based MBIA Inc. The firm released a list of MBIA- and Ambac-guaranteed CDOs backed by subprime mortgages along with a model that allows investors to forecast possible losses by the companies. Ackman's model has been criticized by Ambac and MBIA as exaggerating the likely losses, which Ackman put at about $12 billion each.

Ambac-insured CDOs originated by Citigroup that are experiencing an event of default include Diversey Harbor ABS CDO, Ridgeway Court Funding I and II, 888 Tactical Funding, Class V Funding III and Adams Square Funding II, according to an S&P report dated Feb. 22. Ambac's bailout hit a snag this week after ratings companies demanded more capital, CNBC reported today, citing people familiar with the situation.

Treasury Tells a Very Scary Story
When the U.S. government's official 2007 financial report was released last December, the response could hardly have been worse. Not only were its ratios worrisome enough to make corporate shareholders blanche, but its results were so full of "serious material weaknesses" that the Government Accountability Office could not even audit it.

In the absence of an audit, the Treasury Department and the Office of Management and Budget heeded the GAO's advice and released a more informal report titled "The Federal Government's Financial Health: A Citizens Guide to the 2007 Financial Report of the United States Government."

Some of the language in the eight-page summary document — boiled down from a dense 186 pages — is scalding, and the projections border on the terrifying. The first such guide, it was produced in hopes of helping the public understand America's long-term financial predicament. But what it is that's to be understood is distinctly scary.

Ilargi: Here's to creative thinking: in order to get your attention away from the fact that we lose your money hand over fist, we'll give you some extra. Of your own money.

HSBC to hike dividend as crunch bites
HSBC will tomorrow reveal a record $16bn (£8.1bn) of bad debts at its full year results but seek to reassure investors that it is containing the sub-prime crisis by lifting its dividend in line with its banking peers. HSBC, which is expected to increase its dividend by about 10 per cent, will stress that its Asian and emerging markets businesses are performing strongly as it tries to fend off the attentions of activist fund manager Knight Vinke.

The bad debt charge, which tops the £10.6bn that last year led to its first profits warning in 142 years, will be roughly £3.4bn higher than anticipated at the half year. For the final three months of 2007, write-offs in its North American consumer finance division are expected to have jumped to $4bn - from $3.4bn in the previous three months and double the $2bn quarterly run rate predicted in June.

Group write-offs will amount to almost a quarter of total income, forecast at $73bn. Chief executive Mike Geoghegan has said the crisis will take three years to work through. The problems were caused by aggressive sub-prime mortgage selling at its US arm HSBC Finance Corporation.

Investors now fear HSBC's sub-prime woes are spreading to other asset classes such as credit cards and personal loans. Abigail Webb, an analyst at Credit Suisse, warned that there are already "clear signs of contagion" as the economic impact of sub-prime spreads.

Sub-prime disaster sours HSBC's Eastern promise
When HSBC alerted the world to problems in its subprime mortgage business in the United States in late November 2006, it was the first admission by a major bank that it had been stung by bad loans to lower income customers. Investors initially punished HSBC, but - as more sub-prime problems flowed from other major lenders in the US - the British bank was given grudging respect for being upfront about its difficulties.

As HSBC admitted that the picture was deteriorating and it had to issue its first ever profit warning in February last year, Mike Geoghegan, the bank's straight-talking chief executive, attempted to reassure investors by taking personal responsibility, saying: "I'm in the engine room driving the ship."

Geoghegan was careful to stress that sorting out the problems at the business, rebranded HSBC Finance from its original name of Household International, would take two or three years to sort out. HSBC's shares have been the best performer among UK banks after Standard Chartered in the past year, with both benefiting from an explosion of growth in Asia. However, the upbeat picture from the East at HSBC's results tomorrow is likely to be overshadowed by more grim findings in the West, centring on its US sub-prime portfolio.

Analysts are pencilling in a loss of more than $1bn (£503m) for just the three months to December????31 from HSBC Finance. They expect the bad debts to have spread from the most toxic areas, such as broker-originated business and mortgages known as "second lien " - which are taken out on top of an initial home loan and are the first to be hit if the house price falls - into more mainstream areas of subprime. Abigail Webb, at Citigroup, said: "HSBC was ahead of the curve taking provisions. The question now is not whether they have to take further provisions, but how much. Loans are getting written off a lot quicker than they thought they would."

Investors are becoming impatient. Knight Vinke, the activist investor, built up a stake in HSBC last year and has been noisily pressing for change. It has a long list of criticisms, but top of its list is HSBC's huge exposure to sub-prime. HSBC Finance has a $180bn loan book and is among America's top 10 sub-prime lenders. In the five years since HSBC bought the business it has, at times, been a top three player.

UK: Financial Services Authority turns to insurers as it looks for the next crisis
The Financial Services Authority has turned the spotlight on the insurance industry as it tries to seek out the next problem waiting to explode in the financial industry following the sub-prime mortgage crisis. The City regulator has written to insurance companies asking for details of their illiquid assets and credit derivatives as it tries to uncover where the risks lie in the financial system.

Insurers are being asked for details of their exposure to credit derivatives - complex financial instruments that have been at the heart of the current financial turmoil. They are also being told to outline how they are valuing these assets at a time when financial markets have frozen up, making it difficult to be confident about their precise value. Stung by criticism of its handling of the Northern Rock affair, the FSA is emphasising the liquidity of assets held by financial institutions. While the regulator issued a discussion paper on liquidity in banks and building societies in December, it has also been trying to establish more details about the assets held in the insurance industry.

The explosion in the use of credit derivatives - which encompasses products such as credit default swaps and collateralised debt obligations - has led to uncertainty about where these products are being held. Investment banks that created the products have sold them to other financial firms such as insurers. Clive Briault, managing director of retail markets at the FSA, disclosed the regulator's interest in insurers in a speech this week. He said: "We have ... written to all life insurers asking for details of their illiquid assets and credit derivatives, and their approach to valuing those assets."

Consumer sentiment, regional factories sound recession bell
The alarm bells of U.S. recession rang louder on Friday as reports showed business activity in the U.S. Midwest plummeted in February and consumer sentiment slumped to a 16-year low. More grim news poured in from the inflation front, with government data indicating consumers were struggling in January to keep ahead of robust price growth, which remained uncomfortably high by standards normally associated with the Federal Reserve.

The National Association of Purchasing Managers-Chicago said its index of regional business conditions tumbled to 44.5, its lowest since December 2001, from 51.5 in January. The result was well below the level of 50 that separates growth from contraction.

"It looks like there's been a reversal of fortune for the manufacturing sector from last month and the economy appears to have fallen off a cliff," said Chris Rupkey, senior financial economist, Bank of Tokyo/Mitsubishi, New York, referring to the Chicago PMI report. "This is just the latest piece of evidence that the U.S. economy is teetering on the edge of recession."

Dollar: It will only get worse
Despite all the pain the U.S. dollar has endured in recent days, the greenback may still have further to fall before seeing any sort of relief, according to currency experts. Driving much of the dollar's decline this week were tepid remarks about the U.S. economy by Federal Reserve Chairman Ben Bernanke, who hinted that the central bank would cut interest rates once again at the Fed's March meeting.

Those comments, combined with a number of troubling signs about the strength of the U.S. economy, helped send the dollar tumbling to multi-year lows against a host of currencies including the Swiss franc, the Malaysian ringgit and Japanese yen.
"It all points towards a weaker U.S. economy and currency traders don't want to be exposed to that kind of risk," said Gareth Sylvester, senior currency strategist and self-described "dollar bear" at HFIX Plc in San Francisco.

But perhaps the most notable move of the week was the dollar hitting successive all-time lows against the euro, breaking the key psychological barrier of $1.50 for the first time since the 15-nation currency was launched in 1999. Currency experts, however, argue that the dollar will remain under pressure at least through the next month or longer. If next Friday's February employment report is as bad as economists are anticipating, argues Joe Francomano, manager of foreign exchange with Erste Bank in New York, the greenback could possibly hit rock bottom at that point.

How far could it fall? The prevailing forecast lately is that the dollar will hit a ceiling of $1.55 against the euro in the near term and fall further against the yen, sinking as low as ¥101 or ¥102. Even the most bearish currency experts agree that the pressure on the dollar should abate some time around the middle of 2008, after the Fed winds down its rate-cutting campaign and as the sluggish U.S. economy starts to perk up. But where the dollar heads after that is anyone's guess.

U.S. called a house of cards just on brink
A former White House adviser for four U.S. presidents says America is on the verge of financial and political upheaval unless the country makes substantial changes in the very near future. Speaking Wednesday at the Hinckley Institute of Politics at the University of Utah, Stephen M. Studdert, author of the book "America in Danger, What You Must Know to Protect Yourself," said the country is facing economic threats on various levels, including growing government and corporate debt.

"I think the debt level in this country is enormous and dangerous and frightening," said Studdert. "If the government of this country were a business, they would have to declare bankruptcy." Studdert, who served as adviser to Ronald Reagan, Gerald Ford, George H.W. Bush and Bill Clinton, said the U.S. comptroller general has described the U.S. as "bankrupt as a nation." "Today the United States of America is a house of cards that could tumble at any time," he said. "The elements of a perfect storm of destabilization and crisis are all about us.

As for possible solutions to our national economic problems, Studdert said the citizens of the country must use the power at the polls to make the changes necessary to improve the future. "We have to demand of those who we send to public office at every level some accountability," he said. "It's time for a little less political correctness and a little more political courage."

"I was appalled to see the United States Congress spending so much time, resources and energy over the issue of steroid use by professional ballplayers, when there are weighty issues that affect not only the country today but the country's existence for generations to come," he said. Studdert said the American political system today is rife with problems.

"It is rife with politicians who are not statesman; it's rife with politicians who stand for nothing but their own re-election," said Studdert. "There is irresponsibility and intellectual dishonesty." Studdert blamed much of the dishonesty on the amount of money involved in the nation's political system.

Swiss bank Baer denies Web site tax scheme claims
Swiss bank Julius Baer denied on Saturday claims by a Web site that its Cayman Islands branch was used for tax avoidance schemes, one day after a U.S. judge lifted an order that had shut down the site. republished claims by a former Baer employee and self-proclaimed whistleblower that the Zurich-based bank used its international network to help clients avoid taxes after the federal judge lifted the lockdown on free-speech grounds.

Baer, however, said it hadn't broken any rules and that the republished claims that the bank used its Cayman Island branch for tax schemes were false. "We reject that entirely. This is untrue," said spokesman Martin Somogyi. "We have a subsidiary there and it acts according to local law and is fully regulated." The Baer case has received attention in Europe because of Germany's assault on the tax haven Liechtenstein, the tiny principality that shares a border and extensive financial ties with Switzerland, home to many private banks that cater to the very wealthy.

Many countries say secrecy laws in Liechtenstein -- which is on the black list of countries that do not comply with transparency guidelines compiled by the Organisation for Economic Cooperation and Development, or the OECD -- helps their citizens to evade taxes. Baer said on Thursday that the documents posted on alleged tax and money laundering schemes involving Cayman Islands accounts. The bank said the documents were falsified and it denied the claims made in them.

Hedge Funds' Fire Sales Send Muni-Bond Yields To Historic High Levels
Months of turmoil in the municipal-bond market, long a placid haven for individual investors, reached a boiling point Friday -- as hedge funds were forced to unwind complicated bets and in the process dump billions of dollars of the securities. As a result of that surprising forced selling, yields on debt from municipalities and other tax-exempt issuers jumped to their highest levels in history, when compared with safe debt issued by the U.S. government. The average AAA-rated, 30-year municipal bond yielded 5.14% Friday afternoon, compared with 4.42% on a U.S. Treasury 30-year bond.

In normal times, municipal-bond yields are much lower than Treasurys, because investors don't have to pay taxes on municipal bonds. Among the hedge funds being forced to sell off securities when their trades went awry were Pennsylvania-based Duration Capital Management and New York-based 1861 Capital Management, according to people familiar with the matter. Investment brokers on Wall Street scrambled Friday to circulate long lists containing billions worth of securities on offer from these funds.

Duration declined to comment. Meantime, 1861 Capital Management met its margin calls, said people familiar with the matter. For hundreds of municipal-bond issuers -- ranging from the Port Authority of New York and New Jersey to the North Texas Tollway Authority -- the turmoil could mean that the cost of borrowing will soar, a problem at a time when tax revenues are coming under strain from a slowing economy.

The spike in rates caused the cancellation of one bond offering planned for the coming week. The Houston Independent School District said that it had withdrawn a planned $385.4 million municipal-bond issue, saying the rapid rise of interest rates had made the cost of such an offering prohibitively expensive. Other issuers, including the North Texas tollway, the state of California and Puerto Rico's sewage authority, were scheduled to issue nearly $5 billion worth of municipal bonds in aggregate, in what seems sure to be a difficult environment.

Markets Go Down On Bad News
Everyone who has no idea what is going on, is aghast at the stock markets of the world all going down as the US Titanic sinks. The Bernanke rate cuts aren't cutting it anymore.

Oh my god. The investors holding these AAA, AA and A bonds were supposed to make a profit if it rose above 100. If it fell, their losses accumulated very rapidly. Losing is very dangerous in this derivative game! And they lost. Big time. The plunge was very rapid from the end of July till the end of October. Then, Bernanke stepped in first, with the usual magic wand waving of rate cuts. Then he went in for a massive injection of funds to stop this decline. Incidentally, the stock market's nightmare ride downwards had barely begun at this point! After all, it reached its all-time high [excluding inflation, of course] of 14,100 in early October, 2007.

So basically, we went from a record market to a complete melt down in less than three weeks. The fact that these funds started floating or rather, deflating rapidly in July when the DOW was at 12,000, is a sign to us that the fall here isn't due to commerce ending or even slowing down. Consumer spending was still forging ahead, after all. The only things that were different were all banking-related. The Basel II Accord rules were taking effect and the banks, who were pretending for the previous year to have great equities in their vaults had to suddenly expose all of this to the cruel light of day. They had to open the books. And all the 'off the books' accounts had to be put on the books. This was the doom that cast everything into the depths of despair!

The banks cannot give more loans if they have no reserves and if their existing equities are losers, they have to add reserves, not make more and more loans. They cannot make money totally out of thin air. They have to have a pay-back system somewhere. As well as some savings. Once they were forced to start telling the truth, the whole thing has been impossible. Look at those charts! The losses are staggering. All the AAAs, AA and A ABX CDOs are all moving towards the same place: zero.

The BBB papers are now at slightly higher than 10¢ to the dollar. But the others are barely better. All but the AAA papers are now below 30¢ to the dollar. They stabilized briefly from the Bernanke money injection day in mid-November and desperately clung to life until the second half of February. This is when all systems, the Stock Markets, the muni bond markets, the interbank lending markets, you name it, all have decisively turned downwards. The news that the Federal Government was going to hand out a bundle of goodies temporarily buoyed up the markets, the financiers, the bankers, but now that has faded. Even the Japanese are now accepting the idea that the $150 billion Xmas gift from Santa won't save the global economy.

So the ABX funds fell. I give them another month, maybe two, but probably less, to hit zero once and forever.

Ilargi: Mish reports on what goes on in the trenches, away from the big money boys. The story of America's future is this:budget shortfalls, pink slips and fast deteriorating service levels, across towns, counties and states.. Get used to it, it can't be stopped.

Grim News in Arizona State Budget and Sacramento City Budget
The city of Sacramento announced Friday it is trimming its work force by more than 9 percent and, in an effort to avoid massive layoffs, it is offering buyouts to as many as 200 employees. Assistant City Manager Gus Vina said the city has eliminated 204 jobs through a hiring freeze, attrition, layoffs and other measures. But to stanch its fiscal hemorrhaging, the city intends to eliminate about 300 more jobs and make cuts in service.

Now, with the potential of more layoffs looming, the city and labor unions have proposed an employee buyout plan, hoping up to 200 workers will voluntarily give up their jobs. In the fiscal year beginning July 1, the capital city is facing a $58 million budget shortfall in its $450 million general fund, Vina said.

The city's financial crisis is caused by unexpectedly low revenue and escalating costs, budget officials said. Sales tax revenue is below estimates. Also, the downturn of the housing market and rising unemployment are likely to mean a significant slowdown, or even a loss, in property and utility users tax revenue.

I have news for Sacramento: This is round one. More layoffs will be coming.

Layoffs cannot be good news given the Sacramento region's unemployment rate is the highest in 11 years.
The Sacramento region's unemployment rate shot up a half-point in January to 6.4 percent, the Employment Development Department reported Friday. Although the increase was due mainly to seasonal cutbacks, it was also clear that the Sacramento area is getting clobbered by the soft real estate market.

Unemployment in greater Sacramento is nearly a point higher than a year ago, and the highest it's been since the 6.6 percent rate recorded in January 1997. Back then the region was shaking off the lingering effects of the early 1990s recession.

Vallejo Unions Agree To Cut Wages

In Vallejo, cops, firefighters agree to cut raises. Vallejo police and firefighters have tentatively agreed to forgo raises amounting to millions of dollars in savings as part of concessions aimed at staving off bankruptcy for the cash-strapped city.

The best thing for Vallejo taxpayers would be bankruptcy and compete renegotiation of union contracts.

Dramatic Drop In Arizona Revenue

The Arizona Joint Legislative Budget Committee report shows grim January data.
Total January General Fund revenue collections were $849.3 million, or (16.1)% below January of last year. This amount was $(226.2) million below the forecast based on the June enacted state budget.

For the first 7 months of FY 2008, General Fund collections are down (3.5)% when compared to last year, and are $(619.2) million less than the enacted forecast. When factoring in Urban Revenue Sharing, year-to-date collections are (5.1)% below last year. City by city, state by state there are going to be budget shortfalls. These shortfalls are going to get worse over time. Unions are not going to like it, but contracts are going to have to be renegotiated.

Russia is emerging as a global economic giant
Hillary Clinton is a highly-educated woman. But this was her response last week when asked to name the front-runner in Russia's presidential election. The New York senator and White House hopeful seems to wear her ignorance of the world's largest country as a badge of honour. She is not alone.

In the run-up to today's Russian vote, the Western press has been full of insinuation, slur and downright disinformation about a nation which has risen from the ashes and is now emerging as a global economic giant. I lived in Moscow for several years during the mid-90s - the roughest period of Russia's "transition" from state-planning to capitalism. I've paid regular visits ever since. I now work for a company that manages foreign investments in emerging markets - including Russia.

So, feel free to sniff at my motives. But please don't sniff at the facts, which show that Russia, over the last ten years, has achieved possibly the most incredible economic turnaround in human history.
When the Soviet Union imploded in the late 1980s and the planned economy collapsed, Russian growth sunk deep into negative territory.

For the next decade, the country lurched from crisis to crisis. Then, amid signs of recovery in 1998, Russia's fragile post-Communist economy collapsed again - caught in a financial melt-down affecting all emerging markets. Trying to defend its currency, the country defaulted on its sovereign debt.

Since then, Russia has grown at a real terms average of 7 per cent a year. In 2007, growth hit 8.1 per cent - higher than the year before, despite the US-originated sub-prime crisis that has hobbled much of the world. Russia's reserves have ballooned from practically zero in 1998 to $480bn (£242bn) today - the third largest haul on earth. The country is now almost debt-free - with a budget surplus of 6 per cent of GDP, and a trade surplus almost twice as much again.

Goldman Sachs describes Russia's economic performance as "remarkable". UBS calls it "awesome". Russia, India, China and the other large emerging markets are upending the world economic order. Their resurgence has created hundreds of billions of dollars of wealth and lifted tens of millions from poverty.

Three years ago, Russia overtook Saudi Arabia to become the world's largest crude exporter [Ilargi: they are the no 1 producer, not exporter]. And the country's post-Soviet recovery was initially built on a 50 per cent rise in annual crude production. Had that increase not happened (had Russia chosen to join OPEC, for example), oil would now be way above $150 a barrel, rather than close to $100. Imagine how much that would now be hurting oil importers like America and the UK.

But Russia is now far more than "just an oil and gas economy". Retail sales are growing at around 13 per cent a year in real terms - one reason why leading multi-nationals are now piling into Russia. Construction is expanding by 16 per cent a year, and domestic investment by 20 per cent - as Russia rebuilds its shattered post-Soviet infrastructure. Again, this trend is now attracting massive - and welcome - foreign investment.

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