Tuesday, March 4, 2008

Debt Rattle, March 4 2008

Gulf investors not enough to rescue Citigroup: Dubai
Gulf investment agency Dubai International Capital (DIC) said on Tuesday it would take "a lot more money" to rescue Citigroup Inc following investments from Abu Dhabi, Kuwait and Saudi Arabia's Prince Alwaleed.

Sameer al-Ansari, chief executive officer of the investment agency owned by the ruler of Dubai, was asked by Reuters what it would take to rescue the bank. Dubai International Capital, which manages about US$13-billion of assets, has invested in HSBC Holdings Plc and India's ICICI Bank. "It's going to take more than that to rescue Citi," he had earlier told a private equity financial conference.

The Abu Dhabi Investment Authority, a sovereign wealth fund owned by the world's fifth-largest oil exporter, last year bought a 4.9% stake in Citigroup, which has been hammered by write-downs linked to the U.S. subprime mortgage crisis. The Kuwait Investment Authority said in January it would invest US$3-billion in Citigroup. Citigroup suffered a record $9.83-billion fourth-quarter loss tied mainly to mortgage write-downs.

Citigroup Will Need A Lot More Money
The biggest question running around Wall St. is how much more cash is going to have to go into the sink hole of banks, brokerages, and insurance companies. The estimates for further subprime write-downs run into the tens of billions of dollars. The big wave of consumer credit card defaults is only starting to hit now. There are derivatives built around these pools of debt as well.

There is no guarantee that muni-bond insurers will make it. According to the FT, Ambac will not break into two pieces and put its troubled structured investment operation into a new shell. That puts paper held by big banks and institutions at risk. Ambac and MBIA could still be hit by the need to pay-off insurance on structured investments they have insured and their "Aaa" ratings could get whacked. LBO debt is being written down. Much of its is considered too leveraged and can't be pawned off to pension funds and hedging operators. Auditors will be crawling all over those obligations.

A no lesser figure than the head of Dubai International Capital says Citigroup is not out of the woods. He told Reuters it would take "a lot more money" to rescue Citigroup Inc following investments from Abu Dhabi, Kuwait and Saudi Arabia's Prince Alwaleed. With $13 billion in his pocket he has probably had a look at the balance sheet of every large US financial institution that has raised capital or may need to.

When Citi sold $7.5 billion of stock to Abu Dhabi Investment Authority the Telegraph wrote that an analysts at CIBC World Markets called the move “desperate”. That may be, but it was necessary. With Citi's exposure to most of the dangerous paper floating around the markets, the idea that it may have to raise another $7 billion after reporting its Q1 is certainly not out of the question.

What is open is whose ox will be gored. The bank's market cap is down to $120 billion. An investment that involves warrant coverage at some reasonable strike price could dilute current shareholders by 10%. If Citi is in real trouble and its stock is falling fast, that number could move to 15% or even 20%.

Citi could be a $15 stock by the spring.The excesses of the market have not been washed out of the system so the price of being a big bank is going to keep going up.

Banks may need an extra $143 billion to tide over crisis, says Barclays report
Western banks pulled down by the credit market turmoil that followed the US subprime mortgage crisis may have to raise an extra $143 billion (£77 billion) to weather the crisis, Barclays Capital said in a report. The banks will need extra money if bond insurers, who insure the products amidst the sub prime crisis, lose their credit ratings, the report said.

A lowering of credit rating would make it difficult for the bond insurers to pay out, which in turn would cause bigger losses to banks on sub-prime debt, Barclays said. Top banks have already reported losses exceeding $100 billion from mortgage bonds gone bad and analysts at Barclays Capital estimate total mortgage bond that banks own at $820 billion.

Citigroup's Job Cuts Could Total More Than 30,000
Citigroup's job cuts could reach 30,000 or more over the next year and a half because of increasing writedowns from subprime-related debt, CNBC has learned.

The layoffs would exceed the previously reported 24,000 job cuts that had been expected at the banking giant. Chief Executive Vikram S. Pandit is currently conducting a massive cost review and could cut as much as 10 percent of the bank's workforce of 370,000, according to people familiar with the situation.

In the past, Citigroup would lay off people  and then hire them back as consultants. But with more bad-debt writedowns looming, Pandit wants to make the cuts permanent, sources say. "They are asking managers if you have a task that takes six people, implement a plan where it only takes four people to complete," said one manager. The cuts are expected to occur over the next 12-18 months.

Ilargi: The Pay Option ARM issue is back, and this time it’s here to stay. Hint: it’s a much bigger problem than subprime.

Countrywide sees pay-option loan risk
Countrywide Financial Corp. has seen mortgage defaults rise as the housing market went from boom to bust, but the nation's largest home loan provider says it could have more trouble ahead with a particularly risky slate of loans -- pay-option adjustable rate mortgages. Pay-option loans give borrowers the option to make a lower payment but can result in the unpaid portion being added to the principal balance. They also have the potential to provide high yields to investors who purchased the loans from lenders during the housing boom.

As of the end of December, Countrywide had nearly $29 billion in pay-option loans, with about $26 billion of the total having grown beyond their original loan amount, the company said in a filing late Friday with the Securities and Exchange Commission. 'Our borrowers' ability to defer portions of the interest accruing on their loans may expose us to increased credit risk,' the company said. It added that its risk could be greater because the amount of deferred interest on pay-option loans was on the upswing.

The company noted some 81 percent of the loans were made out to borrowers who provided little or no documentation on their income. As of the end of December, 71 percent of borrowers with pay-option loans were electing to make less than full interest payments. Even though borrowers with such loans had the option to just make interest payments, many were increasingly missing payments, the company said.

Ilargi: Game. Over.

Asset-Backed, Commercial-Mortgage Spreads Met 'Ebola'
The extra yields investors demand on bonds backed by assets from commercial mortgages to credit cards rose to records last week, as the debt-market slump prompted banks, hedge funds and other investors to shun the securities. The extra yields, or spreads, over benchmarks have surged since mid-2007 as a weakening U.S. economy erodes confidence in the bonds' credit quality and as losses on debt investments lead to forced sales and reduced demand.

The spread widening may herald more losses for the world's largest banks, which have reported more than $180 billion in mortgage-related losses. "People are calling it financial Ebola," Ed Steffelin, a senior managing director at GSC Group in New York, said in a telephone interview last week, referring to the deadly, contagious virus named after the Ebola River Valley in the Democratic Republic of the Congo.

Yields on three-year, AAA rated credit-card bonds with floating rates rose to 75 basis points over the London interbank offered rate, up from 40 basis points at the start of the year, according to Deutsche Bank AG data. Spreads over three-year swap rates for three-year, AAA rated fixed-rate auto-loan securities rose to 140 basis points, up from 75 basis points. The average spread over U.S. Treasuries on AAA rated commercial-mortgage securities climbed to 364 basis points, from 167 basis points on Dec. 31, according to Lehman Brothers Holdings Inc. index data.

Ilargi: News on Credit Default Swaps just keeps getting worse. Remember, this is a $45 trillion market.

CDS report: Unwind fears drive spreads to record highs
European credit derivatives indices hit new highs on Monday in a bearish session dominated by worries about forced liquidations of structured credit instruments. Analysts fear that structured products such as leveraged super-senior notes and constant proportion debt obligations are on the cusp of hitting market value triggers that would force them to be unwound.

The iTraxx Europe, which measures the cost of protecting 125 investment-grade credits against default, hit 138bp in early morning trade, about 11bp higher than late on Friday. This means it cost €138,000 annually to insure €10m of iTraxx Europe debt over five years. The iTraxx Crossover, an index of 50 mostly junk-rated credits, rose to about 621bp, against 600bp on Friday.

Willem Sels, credit strategist at Dresdner Kleinwort, wrote in a note: “We continue to believe that credit is in an ‘acceleration’ phase, where spread widening generates negative technical pressure, leading to these records.” Analysts are scrambling to work out how high spreads could go, but few are willing to make predictions with any confidence.

“How long is a piece of string?” asked one analyst. “I don’t think anyone has a clue how bad things could get.”

Bernanke Urges Banks to Forgive Portion of Mortgages
Federal Reserve Chairman Ben S. Bernanke, battling the worst housing recession in a quarter century, urged lenders to forgive portions of mortgages for more borrowers whose home values have declined. "Efforts by both government and private-sector entities to reduce unnecessary foreclosures are helping, but more can, and should, be done," Bernanke said in a speech in Orlando, Florida today. "Principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure."

Bernanke's call goes beyond the stance of the Bush administration and previous Fed comments. By comparison, the central bank's Feb. 27 report to Congress called for lenders to "pursue prudent loan workouts" through means such as modifying mortgage terms and deferring payments. "Delinquencies and foreclosures likely will continue to rise for a while longer," Bernanke said in the comments to the Independent Community Bankers of America.

"Supply-demand imbalances in many housing markets suggest that some further declines in house prices are likely." Subprime borrowers are about to see their mortgage rates increase more than 1 percentage point, he said. "Declines in short-term interest rates and initiatives involving rate freezes will reduce the impact somewhat, but interest-rate resets will nevertheless impose stress on many households."

U.S. Stocks Decline on Bernanke Plan
U.S. stocks fell, led by financial shares, on concern a proposal by Federal Reserve Chairman Ben S. Bernanke to increase mortgage writedowns will hurt bank earnings. Citigroup Inc., JPMorgan Chase & Co. and Bank of America Corp. led financial shares to the lowest since August 2003 after. Bernanke said banks should reduce the amount of principal owed on some home loans.

Bernanke urged lenders to expand mortgage writedowns for borrowers whose home values have declined, saying more must be done to stem foreclosures. His remarks were prepared for a conference in Orlando, Florida. Citigroup declined 87 cents to $22.22.

Merrill Lynch & Co.'s Guy Moszkowski said he expects $15 billion of writedowns related to the company's holdings of subprime mortgages and collateralized debt obligations and another $3 billion from leveraged loans, bad consumer debt, real-estate lending and other investments.

Ilargi: If there’s still people who are surprised by the following article, they should read us more often. It just can’t be that this is still being presented as something unexpected in the newsrooms of the nation. That’s nuts. 1000’s of banks will fail across the globe, and don’t believe anyone who says otherwise.

New recession worry: Bank failures
Construction loan problems threaten spike in smaller bank failures and add to worry over credit crunch.

As if the economy wasn't already fighting enough strong headwinds, the risk of capital shortfalls and outright failure of the nation's banks is rising. The Federal Deposit Insurance Corp., the federal agency that backs bank deposits, last week reported the biggest jump in "problem institutions" it has seen since the savings and loan crisis of the late 1980s. While the extent of the problem is still low by historic standards, it identified 76 banks as in trouble - a 52% increase from a year ago.

FDIC Commissioner Sheila Bair is among regulators set to testify Tuesday at a Senate Banking Committee hearing on the state of the banking industry. Experts say the 76 banks now under scrutiny are likely only a small part of the problems now looming over the banking sector. Jaret Seiberg, the financial services analyst for policy research firm Stanford Group, said it appears that regulators are expecting about 200 bank failures in the coming year or two.

If that occurs, it could rival the flood of bank failures seen during the S&L crisis. In 1989, the nation saw a post-Depression era record of 206 bank failures. And Seiberg says even more than 200 troubled banks are likely to be purchased before they reach the point of failure. "Many of these banks are highly dependent on construction lending, and that's the area of lending that is likely to come under the most stress," he said.

The FDIC stresses that not all those banks will fail. In fact in 2007 only three banks failed, even though 50 were on the watch list at the end of the previous year. So far this year, one bank - Douglass National Bank in Kansas City, Mo. - has failed.

Still, the head of the FDIC is looking to hire 25 staffers to deal with an anticipated increase in failures, a move that would increase its staff by 11%. Among those it hopes to hire are recent retirees who worked through the S&L crisis. The banks most at risk for failure are generally smaller ones, not the huge global banks hit by billions in writedowns from subprime mortgage problems.

Smaller banks are big players in the business of construction loans made to homebuilders - loans that were backed by new homes now worth a fraction of the original estimated value. In the past six months, the number of construction loans that are 30 days or more delinquent has spiked, according to Foresight Analytics, an Oakland, Calif., economic- and real-estate-research company. Its figures show 7.5% of single-family construction loans were delinquent in the fourth quarter of 2007, more than double the 3.1% rate as recently as the second quarter.

Ilargi: And then there’s the ideas that are dead in the bathwater. Covered bonds are on a bank’s balance sheet. Has Ms Bair looked at US banks’ balance sheets lately? They have no space for additional bonds. “Backed by a pool of collateral”. What collateral?

Could Covered Bonds Replace Securitization?
Sheila Bair, chairman of the Federal Deposit Insurance Corp., said Monday that the U.S. bank regulator is pushing ahead with a plan to clear the way for a housing finance tool popular in Europe. The move at the FDIC comes as the structured finance market for U.S. mortgages has essentially ground to a halt amid the worst housing crisis in at least 50 years.

Bair wants to make it easier for U.S. banks to issue so-called covered bonds — essentially an on-balance-sheet alternative to the off-balance-sheet treatment that has been the norm with most securitizations.

Covered bonds are much more common in Europe, where they constitute of $1.8 trillion euro market and have been widely used for many years. The first U.S. issue of such a bond took place in Sept. 2006, with Washington Mutual as the issuer.

Reuters reported late Monday that Bair expects the FDIC to issue a statement on covered bond issuance within the next 30 days, opening the issue to comment from U.S. market participants.
“The thinking at this stage is we will draft a policy statement and go out for comment,” Reuters quotes her as saying.
The FDIC chairman sees covered bonds as a way to jump-start the frozen secondary market for mortgages, and has suggested since early February that the regulator will consider how to better accomodate their use. Per an earlier Reuters report:
“My sense is to try and accommodate it, but do it in an incremental way, so we get some experience with it before we open the door,” Bair told the Reuters Regulation Summit. … “Because you are holding on balance sheet perhaps you don’t get the same dilution of underwriting standards that you can get when you move them completely off,” she said. In the words of the industry source, covered bonds “force the banks to eat their own cooking.”

Despite the interest at the FDIC, secondary market participants appear less enthused about the prospects of keeping mortgage debt on their balance sheets. Reuters reported on reaction to Bair’s proposal at last month’s ASF 2008 conference in Las Vegas:
… issuers’ desire to protect their credit ratings and a lack of liquidity in covered bonds mean they will not pose serious competition for the type of mortgage securities that raised the bulk of funds for housing loans in the past decade.
Covered bonds are bank obligations, and overuse of them could hurt issuer ratings, which in turn are important for other debt funding, said Paul Baalman, a Bank of America Corp structured finance executive. “You are never going to load up on this because you have the rating agencies looking at your secured debt,” Baalman said at the American Securitization Forum meeting in Las Vegas.

Canada Cuts Rate a Half Point, Signals More Is Needed
The Bank of Canada cut its benchmark interest rate a half point, the first such move since 2001, and said it will again to offset a slump in exports to the U.S. Mark Carney, in his first decision as governor, cut the target rate for overnight loans between commercial banks to 3.5 percent, the lowest since March 2006. Thirteen of 26 economists surveyed by Bloomberg News predicted the move.

"Further monetary stimulus is likely to be required in the near term," the central bank said today in a statement from Ottawa. Signs of economic slowdown in Canada are "materializing and, in some respects, intensifying." Tumbling exports to the U.S. will limit 2008 economic growth to a seven-year low of 1.8 percent, the central bank says, and have erased the country's broad trade surplus for the first time since 1999. The bigger rate cut today also helps catch up with moves this year by the U.S. Federal Reserve, and may slow the Canadian dollar's advance that has battered manufacturers.

"The risks emanating from the U.S. are really serious and threatening Canada," said Meny Grauman, a senior economist at CIBC World Markets who correctly called today's move. "We see possibly another 50 basis points as early as the next meeting." The bank's next decision is April 22.

Ilargi: Color me surpised, nay, shocked... Canada ABCP is dead!

Uncertainty builds over ABCP fix
Storm clouds are once again gathering over the restructuring of Canada's frozen asset-backed commercial paper market amid reports that the backers have been unable to agree on a key standstill deal because of the unfolding crisis in the credit markets. The decision to extend the standstill "is just rolling day by day," said a source close to an investors committee overseeing the restructuring.

International banks and others involved in the talks are reluctant to commit themselves any longer than that because of unprecedented volatility in the debt markets. According to Andre-Philippe Hardy, an analyst at RBC Capital Markets, spreads on North American investment grade debt have jumped to 165 basis points, more than triple since August when the ABCP market seized up. "The destruction value since this thing began has been massive," said Colin Kilgour, a securitization expert in Toronto.

Meanwhile, Purdy Crawford, the Bay Street lawyer heading up the investors committee, has predicted that the new restructured notes investors would receive in exchange for their ABCP will likely trade "at a significant discount to par." In an email to an a group of retail investors on the Facebook social network website, Mr. Crawford said that while investors will likely get their money back if they hold the notes for the seven years it takes them to mature, trying to sell them in the interim will probably result in losses.

The $35-billion market for ABCP fell apart in August after issuers failed to roll maturing notes and the banks that has undertaken to provide emergency liquidity declined to step in. Seven months later the negotiations are still on going. On Friday, Mr. Crawford's committee revealed that the completion of the restructuring has been delayed until the end of April. Many observers are skeptical even that date can be met.

A report from RBC's Mr. Hardy speculated that one of the foreign banks that is a major creditor to the frozen ABCP trusts "has apparently become more nervous" and is no longer supporting the restructuring. If that is the case, "it could derail the restructuring," he said in a note last week.

BMO fails to reach restructuring deal on 2 trusts
Credit-rating agency DBRS placed the notes of Apex Trust and Sitka Trust, which are sponsored by BMO, "under review with negative implications," as the bank's negotiators continued talks with several banks that are counterparties to the trusts. In total, the trusts face more than $500-million in potential collateral calls. One counterparty to Sitka is now allowed to seize collateral, while a counterparty to Apex will be in a similar position Tuesday as grace periods to make payments expire.

"Counterparties to several additional transactions will be in a position to seize collateral before the end of this week if the trusts fail to fund outstanding margin calls or otherwise reach an agreement" with the counterparties, DBRS warned.

Bank of Montreal, which is holding its annual meeting in Quebec City Tuesday as it reports its first-quarter results, cautioned last month that it faced a $495-million writedown if the trusts were not restructured. More recently it added that there is also the risk of lawsuits. Combined, investors including BMO hold $1.9-billion worth of paper from Apex and Sitka.

The bank has already taken $210-million in charges because of the trusts, which have become BMO's most pressing credit crunch-related problem. The bank has also disclosed that it will be taking a $160-million writedown Tuesday because of its exposure to beleaguered bond insurer ACA Financial; a $25-million hit due to structured investment vehicles and a further $175-million charge due to other issues related to the credit crunch.

BMO's credit troubles have pushed the bank to re-examine whether it can provide support to a backup line of credit for the restructuring of the $32-billion third-party asset-backed commercial paper (ABCP) market. That market has been frozen since it seized up in August as a result of the credit crunch, and a committee led by Toronto lawyer Purdy Crawford is still working to salvage it.

In early February, the committee announced that BMO, Canadian Imperial Bank of Commerce, Royal Bank of Canada and Bank of Nova Scotia had each agreed in principle — subject to certain conditions — to join National Bank and other investors and asset providers who were providing support to a $14-billion backup credit line that's critical to a successful restructuring of the market. Canada's big banks were asked to contribute $2-billion in total.

The committee, which has repeatedly missed its self-imposed deadlines, was struggling to get firm commitments from the big banks in December as a key date loomed and so its financial adviser, JPMorgan Chase & Co., promised that if the banks didn't come through it would canvass the market for financing and, as a last resort, step in itself. As the talks drag on, pressure is now mounting for the committee to turn to that alternative.

"The time is now to reassure the market and have JPMorgan come forward publicly with support and liquidity," said Ross Hendin, chief executive officer of Hendin Consultants. "If a bank like BMO is ready to suffer the public embarrassment of letting its conduits melt down, this is a clear indication of a very tough time in the market." His associate Daryl Ching, managing partner of Clarity Financial Strategy, said that there's a growing chance the entire third-party ABCP committee will disband, given the problems.

BMO warns of more losses as profit falls 27%
Bank of Montreal reported first quarter profits fell by more than a quarter from last year. The bank earned profits of $255-million, down $93-million or 27% from a profit of $348-million in the first quarter of 2007, when results were restated for charges related to a natural gas trading.

BMO's performance was hit by a previously announced $490-million charge related to the credit crunch, as well as a $60-million increase in the general provision for loan losses, which was also announced early.

The bank also gave additional information regarding two troubled asset-backed commercial paper conduits which it sponsors. Both Apex and Sitka trusts were previously downgraded by DBRS last week, and the bank has said that if a restructuring of the trusts is not successful BMO will take a charge of approximately $500-million. On Monday, Apex and Sitka were placed on review by DBRS, which stated swap counterparties to both trusts would be in a position to seize collateral by Tuesday morning.

The bank also revealed that it faces an additional risk should Apex not successfully be restructured. "One noteholder of Apex is disputing BMO's demand for the return of a $400-million funds transfer," the bank said. "In addition, a swap counterparty is disputing its obligations of up to $600-million to BMO under an agreement and with respect to a total return swap transaction that the counterparty had previously confirmed."

Ilargi: Spain’s real estate market is set for a very big fall, and the unraveling has now started for real. We wonder how much ECB credit is involved, the sort backed by worthless collateral.

Sovereign wealth’s Colonial ambitions fall through
It turns out sovereign wealth funds can walk away from deals - and swiftly. Less than a week after it tabled an offer for troubled Spanish property group Inmobiliaria Colonial, the Investment Corporation of Dubai has turned on its heel. The offer, pitched at €1.85 a share in cash or paid in ICD’s zero coupon bonds worth €2.25 at maturity, valued the group at just below €3bn.

Some come-down for the group, worth €9.5bn a year ago but which hit trouble as Spanish property valuations came under pressure, prompting its main shareholders to build up large debts increasing their stakes in the business. The share price slumped in December after forced selling amongst investors, who backed an equity issue last summer through a complex swap arrangement that has since unravelled. It seems that those shareholders, Luis Portillo, former chairman, and the Nozaleda family, couldn’t reach agreement with the ICD.

ICD also wanted the approval of Colonial’s creditor banks, RBS, Eurohypo, Calyon and Goldman Sachs, which last year arranged a €7.2bn syndicated credit to allow Colonial to acquire two other real estate groups in Spain. The group has already breached its covenants. Those banks now need to find another buyer for the business - and sharpish. They face the prospect of having the Spanish property mess reflected on their books.

Update: Colonial share trading suspended
Trading in the shares of Inmobiliaria Colonial SA has been suspended, Spain's stock market regulator CNMV said. Earlier, Investment Corporation of Dubai (ICD) said the exclusive bid period it had for studying a possible offer for the beleaguered realtor expired yesterday, with no agreement having been reached.

ICD said that talks on the details of the bid failed despite the 'best efforts' of all the parties involved, namely Colonial core shareholders Luis Portillo and Nozar. ESR analysts called the ICD news 'negative, but not surprising,' and said that the most likely next step will be for Colonial's creditor banks to find a new buyer, a move slated by some of today's press.

Ambac decides against splitting
Ambac, the troubled bond insurer, has decided against splitting in two as it completes a $2bn-$3bn recapitalisation, insiders said. Under a recent proposal, Ambac, the second biggest bond insurer, or monoline, would have split its operations into a triple-A-rated municipal bond insurance business and a structured finance business with potentially lower ratings. A lower rating on the structured part of its business could have forced banks to reduce the value of guarantees on collateralised debt obligations and on derivative trades.

There was also the possibility of lawsuits by banks and other groups that bought insurance on CDOs and other structured products. Eight banks, led by Citigroup and UBS, which between them bought the most guarantees from Ambac, are together preparing to inject $2bn or more into the monoline, which has been racing to come up with fresh capital to avoid a sharp cut in its triple-A rating.

The capital infusion, which is likely to include other investors beside the banks, could be announced as early as Wednesday, people involved in the talks said. The deal is expected to result in Ambac remaining a single entity with a triple-A rating.
Although Ambac’s past guarantees are expected to remain together, its future business is likely to be different. Ambac announced late last week that it had slashed dividends and would stop providing insurance on structured finance deals for at least six months.

The moves, similar to those announced by MBIA, the biggest bond insurer, which has been grappling with a lack of investor confidence in its financial strength, are designed to preserve capital. Ambac said halting its structured business for six months would free up $600m in additional capital, for example. Bond insurers have for decades provided triple-A stamps of approval to hundreds of billions of dollars of municipal debt.

In spite of efforts by regulators to prevent downgrades of monolines, municipal bond yields have risen to historic highs compared with US Treasuries in the past week. This could lead to sharply higher borrowing costs for municipalities across the US.

Ambac bailout may cause crisis
One risk that few talked about until recently is counterparty risk. Your insurance is only as good as your insurance company. Your credit default swap is only as good as the party you contract with to setup the agreement.

And that's where we are: the banks are scared that a significant part of their reserves may be downgraded. In practice, the market trades these securities as if they had been downgraded; but for the purpose of preserving capital ratios, an AAA rating on paper continues to satisfy the banks' top regulator, the Federal Reserve (Fed). Selling these securities is not a preferred option for the banks, as many are - even in good times - illiquid; and in the current environment, a fire sale would cause serious harm to the banks holding the securities.

However, banks are on an increasingly shaky foundation. Add a few ingredients to set the stage for more volatility in financial markets. Maybe most vocal have been the municipalities that have seen the cost of borrowing surge as the ARS market has vanished. Municipalities have to learn the same lesson as holders of mortgage-backed commercial paper: the buyers of short-term securities tend to be risk-averse investors. They like the extra bit of interest they get from exotic instruments, but as soon as they realize that the securities they have been buying are risky, they walk away.

Money markets fund have no interest in holding risky securities; many were foolish to buy these securities in the past, but those days are gone and won't return. Municipalities, however, are political beasts. In their view, monoline insurers have betrayed them by risking their credit rating through recklessly veering into riskier lines of business; they believe that insurers have a contractual duty to try to preserve their credit ratings. And they have a point; not only do they have a point, the municipalities exert influence over attorneys-general and over insurance licensing, amongst others.

When CEOs are threatened with jail time - and we are not suggesting that this has been done yet, nor that fraud has been made public to date that would warrant that - they listen to the requests of municipalities. Hence the calls to have these insurers split up into their traditional and their riskier businesses. Such calls are difficult to implement as the holders of insurance on mortgage products also have rights.

Ilargi: MBIA raises fees for key personnel, while it has no idea how much those same people "acquired" in losses. Wouldn’t you just love to own stock in a company like that?

MBIA, Ambac Filings Show Subprime Losses Continued
MBIA and New York-based Ambac said they have written little new insurance since their ratings came under scrutiny. The companies plan to salvage their business of insuring municipal bonds after expanding into CDOs, which package pools of debt and slice them into pieces with varying ratings.

MBIA said in its Feb. 29 filing that losses on mortgage- backed securities will probably increase this year. The company recorded $3.7 billion in market-value losses on its guarantees of asset-backed debt last year, mostly from mortgage debt. MBIA raised $3 billion to help offset the losses and convinced Moody's and S&P that it should keep top ratings. MBIA said has seen "deterioration" in prime or near-prime home-equity loan securities it backed and loss payments may erode a "significant portion" of reserves by year-end. MBIA probably will have to pay as much as $800 million this year, before the effect of reinsurance contracts, mostly for bonds backed by mortgages and home-equity loans.

The company approved the lowest annual bonuses in its history last year, at 40 percent of its target, according to a filing today. Credit-default swaps tied to MBIA's debt soared 168 basis points to 767 basis points on Feb. 29, according to London-based CMA Datavision, a sign of eroding investor confidence in the company's creditworthiness. Contracts on its insurance unit, which investors and banks have been using to hedge against the risk the company loses its top ratings, climbed 112 basis points to 540, the highest in two months, CMA prices show. A basis point is 0.01 percentage point.

A decline indicates improvement in the perception of credit quality; an increase, the opposite. An estimate for losses through Jan. 31 "is not available at this time," MBIA said. The company said it "observed further widening of credit market spreads," indicating the value has declined.

Dollar Close to Record Low Versus Euro on Slumping U.S. Economy
The dollar traded close to the weakest ever against the euro on speculation the slumping U.S. economy will cause banks to report more losses from the collapse of the subprime-mortgage market. The U.S. currency also traded near a three-year low against the yen before a private report tomorrow that may show companies in the U.S. added fewer jobs in February.

Losses against the euro were limited after European finance officials including Luxembourg Prime and Finance Minister Jean-Claude Juncker voiced concerns about dollar weakness. "It's unlikely that we see good U.S. economic data," said Yuji Saito, head of foreign-exchange sales in Tokyo at Societe Generale SA, a unit of France's second-largest bank by market value.

"The dollar-bearish trend will persist. The market consensus is that the Federal Reserve isn't unhappy about a weaker dollar to support the economy.""The sentiment is to sell the dollar against the yen and the euro," said Hidetoshi Yanagihara, a senior currency trader at Mizuho Corporate Bank in New York.

Traders yesterday raised bets the Fed will cut interest rates by 0.75 percentage point at its March 18 meeting. Futures on the Chicago Board of Trade show traders see a 74 percent likelihood the Fed will lower the main rate to 2.25 percent from 3 percent. A week ago, traders saw no chance of such a deep cut this month. The balance of bets is on a half-point reduction.

Sydney homeowners lose $450 every week since early 2004
Homeowners in Sydney's outer suburbs have been losing as much as $450 a week every week since early 2004 on the value of their properties as the real story of mortgage belt misery begins to emerge. With the Reserve Bank likely to announce yet another interest rate hike tomorrow, a Daily Telegraph investigation reveals hundreds of streets in Sydney's outer suburbs now have houses that have been bought and sold at a loss - in rare cases more than 40 per cent in value.

Since the peak of the boom in early 2004, Sydney's southern suburbs has dipped the most in value, with the median price falling $82,750 over the ensuing 15 quarters, according to Australian Property Monitors figures. Other areas where the Australian dream is souring include Canterbury Bankstown which has registered $65,000 in losses, Sydney's south west $44,500 and Sydney's west $25,000.

On a per week basis, the changes in median prices to late last year equate to $444 a week losses for the south, $349 for the Canterbury-Bankstown area, $239 for the south west and $134 for west. The decline in median price values are despite a mini-boom in real estate in the more affluent eastern half of the city. But while these changes are based on median movements, a new report by MVS Valuers analysised hundreds of case studies of resold homes to offer more detail on how homeowners are hurting.

The MVS Valuers analysis shows that anyone who has bought as long ago as January 2002 and resold recently in Sydney's west and south west is likely to have copped a loss. Prime Minister Kevin Rudd is today expected to unveil a plan to help families battling housing stress in a move designed to take the heat out of the latest Reserve Bank rate hike.

California enters frayed muni market, protection-free
California's upcoming $1.75 billion issue will join a growing number of municipal bond deals notable for what's missing -- bond insurance. This insurance was widely used by municipalities in years past as a way of securing higher credit ratings or sweetening the appeal of a bond issue, allowing the issuer to sell the bonds at lower interest rates.

The insurance is supposed to act as an additional buffer against defaults. For investors in the $2.6 trillion municipal bond market, insurance helped them choose these tax-free bonds without knowing much about the issuers' underlying financials. But financial troubles at MBIA Inc., Ambac Financial and other companies that provide this insurance have, in many cases, made the bond insurance irrelevant or even a handicap.

California, for instance, has not paid for bond insurance on its last two big deals -- a $3.3 billion economic recovery bond, sold in February, and a $1 billion general obligation bond, issued in November. The state doesn't plan to pay for insurance on its upcoming general obligation bonds either, which are available to retail investors Monday and Tuesday and are set for institutional sales and pricing Wednesday.

That's a change from the past. California spent $102 million insuring general obligation bonds between 2003 and 2007. "The value of bond insurance is not what it was a half-year ago," said Tom Dresslar, a spokesman for the California state treasurer's office. He said the state continues to do the math on whether to buy bond insurance, comparing the interest rates it would pay on insured bonds with those on uninsured issues.


Anonymous said...

I keep waiting for this whole thing to start, to hit the mainstream.

Then it dawned on me that I could be called in for the Pink Slip today and it will have started for me.

It is starting for people all over the place the second they get laid off. What can they do?

The safety net is so thin and frayed...

Anonymous said...

Traders yesterday raised bets the Fed will cut interest rates by 0.75 percentage point at its March 18 meeting

Just heard this repeated on the CBC afternoon business report. Either way, happens or not, should be an interesting. One way cries of fear the other of hair pulled out.

Farmerod said...

I wonder whether we'll make it to March 18th without a rate cut. Lots of stock market volatility recently. It might be time for a surprise cut of, say, 50bp. Then leave 25bp for March 18. That will theoretically leave 225bp in the gun but, really, somewhat less than 225bp.

How long can this continue? May? June? Stoneleigh, please say June. The house goes on the market in 10 days...

Crystalradio- if memory serves, you're from western Canada somewhere. Mind if I ask where, more specifically?

Ilargi said...


I've posted more Canada lately, quite a bit actually.
Today: BMO profit down 27%, with stern warnings about more to come, Scotiabank 16% profit loss, $40 billion of ABCP can be flushed down the loo, housing sales are falling across the nation, and the Bank of Canada cuts the interest rate.

You'd think that all that would get a reaction, but I have yet to see one critical question about the reason for that rate cut, and the mood in the media remains jubilant. I saw some RBC chick on TV saying that at least half the people think this is a great time to buy real estate.

Since nobody has a clue what's going on in this country, I wouldn't be too worried about selling your home.

Anonymous said...

Sheese! With a nom de guerre like outtacontrol you expect me to tell you where I am? Hey musashi I got a ripe one here, bring those friends of yours, the ones that you posted pictures of yesterday!

More seriously, I live in B.C. on Vancouver Island, now it's my turn to be curious, if you feel like it let me know why you wish to know and just how near you are:)

Farmerod said...

Hey CR

The handle refers to the occupation I plan not to occupy within a few years, or possible a few weeks (air traffic control). Stoneleigh will shoot you my email and vouch for my non-psychoticness. I checked out your blog. What's the story with those concrete abodes?

goritsas said...

I thought this was an interesting development:

The ultimate sell signal
Commentary: Resignation of top GAO official directly impacts your portfolio