Thursday, July 10, 2008

Debt Rattle, July 10 2008: In broad daylight

Walker Evans Lily Fields Summer 1936
Lily Rogers Fields and two of her children in their Hale County, Alabama, cabin
Husband is cotton sharecropper Bud Fields

Ilargi: I haven’t seen it phrased better than former Fed director Bill Poole now does: "[Congress] is allowing [Fannie Mae and Freddie Mac] to continue to exist as bastions of privilege, financed by the taxpayer".

But that is still not the whole picture. I think Poole may well know what is, but there’s no way he could go public with it.

It’s not just that the Fed, the Treasury, Congress and the Senate "allow" Fannie and Freddie to continue. They have been doing much more than that in the past 2-3 years, once it became clear that both the housing market and the mortgage-based securities market were in -deepening- trouble.

In that period, loan standards were lowering ever further, and nobody lifted a finger. At the same time, the pool of potential buyers for the loans and their securities dried up overnight. In order to keep as much as possible of the loan market, based on grossly overpriced properties, going, Washington, the Fed and Wall Street turned to Fannie and Freddie. They were told to accept jumbo loans, and their regulator, the Ofheo, allowed them to hold much less in reserve against their loan purchases than before.

As bond investor Jeff Gundlach puts it:"Fannie Mae and Freddie Mac are being encouraged by lawmakers and regulators to grab market share". And that is easy grabbing, because there is no-one else who wants any share of that market, because it's like throwing money down a pit.

Today, there still is a consensus that Fannie and Freddie will not be allowed to fall. (I’d like to see some more attention for the FHA, FHLB and Ginnie Mae in this context, but I’m sure that will come soon). What’s striking is that despite the implied guarantee by the US government for Fannie and Freddie’s losses, investors are running away as fast as they can, and in droves.

These investors realize something that doesn’t get a lot of press or "expert analysis": that is, the government may not let the GSE’s fall, but that doesn’t mean they have to guarantee the value of outstanding shares. We only need to look at what happened to Bear Stearns shareholders to understand the mechanism. Already, any additional share issues, which might be inevitable, would come at prices much lower than those paid a few months ago.

Present shareholders have decided not to wait for that. The Fed could orchestrate a Bear Stearns model takeover, or buy-out, at any time, and decide that shares are worth no more than, say, 25 cents.

Returning to Bill Poole’s definition of Fannie and Freddie as " bastions of privilege, financed by the taxpayer ", the reason I said that is not the whole picture is this: You have to look closer at what the "privilege" here consists of. And once you do that, it is of course simple: It is the privilege of profits, of money (in an industry that hemorrhages value, no less). Billions of dollars in fees and debt are being "whitewashed" which originate with mortgages on real estate that is losing value faster than the ink on the contracts can dry.

And while the privileged chosen few count their blessings and profits, the losses are transferred to the taxpayer, and not only does nobody try to stop the losses, Fannie and Freddie are actively encouraged to add more losses, basically as many as they can get away with.

That is where the whole picture emerges, the one Poole knows but dare not speak in starker terms than "bastions of privilege".

It’s the portrait of organized crime. Operating in broad daylight.

Fannie, Freddie 'Insolvent' After Losses, Poole Says
Borrowing at Fannie Mae, the U.S. government-sponsored mortgage company, has never been so expensive and it may not get better any time soon.

Fannie Mae paid a record yield relative to Treasuries on the sale of $3 billion in two-year notes yesterday amid concern the biggest provider of financing for U.S. home loans won't have enough capital to weather the worst housing slump since the Great Depression. The company's credit-default swaps show traders are treating the AAA rated debt as if it were five steps lower. Fannie Mae shares tumbled 13 percent yesterday in New York to the lowest level in almost 14 years.

Chances are increasing that the U.S. may need to bail out Fannie Mae and the smaller Freddie Mac, former St. Louis Federal Reserve President William Poole said in an interview. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules, he said. The fair value of Fannie Mae's assets fell 66 percent to $12.2 billion, data provided by the Washington-based company show, and may be negative next quarter, Poole said.

"Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer," Poole, 71, who left the Fed in March, said in the interview yesterday. Fair value accounting measures a company's net worth if it had to liquidate all of its assets to repay liabilities.

Fannie Mae and Freddie Mac, both of whom have the implicit backing of the government, make money by borrowing in the bond market and reinvesting the proceeds in higher-yielding mortgages and securities backed by home loans. Lawmakers in Washington may question Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson at a 10 a.m. hearing today about the financial health of the companies and whether they jeopardize the financial system.

"At some point we're going to reach that inflection, where the government is going to have to either guarantee explicitly or Fannie and Freddie are going to have be left to fend for themselves," Peter Boockvar, an equity strategist at Miller Tabak & Co. in New York, said in an interview with Bloomberg Television. "We're getting to that point where a decision has to be made by Washington."

The plunge in Fannie Mae and Freddie Mac yesterday in New York Stock Exchange trading led financial shares to their biggest decline in six years and sent the Standard & Poor's 500 Index into its first bear market since 2002. The government is counting on Fannie Mae and Freddie Mac, which own or guarantee about half the $12 trillion in home loans outstanding, to help revive the housing market.

Congress lifted growth restrictions on the companies, eased their capital requirements and allowed them to buy bigger "jumbo mortgages" to spur demand for home loans as competitors fled the market. Paulson said on July 8 he was pleased with Fannie Mae and Freddie Mac's efforts to raise capital. Bernanke said the same day the firms need to be "strong, well-regulated, well- capitalized" to provide credit "without posing undue risks to the financial system or taxpayer."

The Treasury has been discussing what to do if Fannie Mae and Freddie Mac fail for months as part of its contingency planning, the Wall Street Journal reported today, citing three people familiar with the matter. The government doesn't expect the companies to fail and it doesn't have a rescue plan in place, the Journal said.

"We are managing our business and maintaining a capital position that will allow us to fulfill our congressionally chartered mission now and in the future," Brian Faith, a spokesman for Fannie Mae, said. Poole is "a long-time critic," said Sharon McHale, a spokeswoman for McLean, Virginia-based Freddie Mac. "Freddie Mac is doing exactly what Congress intended when it chartered the company and, more recently, when it passed the Economic Stimulus Act," McHale said. "We are well capitalized and positioned to continue to serve our vital housing mission."

While leading the St. Louis Fed, Poole roiled markets in 2003 when he said the government should consider severing its implied backing of Fannie Mae and Freddie Mac and said the companies lack the capital to weather financial market disruptions. In 2006 and 2007 he called for lawmakers to strip Fannie Mae and Freddie Mac of their charters.

Congress created Freddie Mac and expanded Fannie Mae in 1970 to promote home buying in the U.S. The companies' charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default. The government will likely be forced to take over the companies because of the mortgage meltdown, Poole said.

"We know in a crisis the Federal Reserve tap would be open," said Poole, now a senior fellow at the Cato Institute. The bailout of Bear Stearns Cos. by JPMorgan Chase & Co., arranged by the Fed, demonstrates the government's unwillingness to allow "large, systemically important" financial institutions to fail, he said. Bear Stearns collapsed after customers fled amid speculation the company faced a cash shortage.

"I worry about those institutions," retired Richmond Fed President Alfred Broaddus said. "They are huge. They dwarf the Bear Stearns issue. In the very worst case scenario, I don't know how you do it other than extend money and the public takes the loss."

S&P 500 enters bear market
Credit jitters swept Wall Street again on Wednesday and pushed a key market index back into bear territory as financial shares fell and the appeal of government debt took a shine.

Oil pulled out of a steep two-day slide to end little changed after a U.S. government report showed a big drawdown in nationwide crude inventories and after Iran, a member of OPEC, conducted missile tests in a move that raised tensions with the West. Iran's testing of long- and medium-range missiles, including one that could reach Israel and U.S. bases in the Middle East, led the dollar to retreat and bolstered haven currencies such as the Swiss franc.

Banking shares tumbled and some investors worried that Fannie Mae and Freddie Mac might need a substantial capital injection, sending shares of the two major U.S. mortgage finance sources sharply lower. The KBW banking index fell 5.7 percent, while Freddie Mac shares dropped almost 24 percent and Fannie Mae's fell about 13 percent.

"The financials are not recovering. Some of the regional banks are showing signs of weakness and starting to crack a little bit," said Seth Plunkett, a portfolio manager for fixed income with American Century Investments in Mountain View, California. "Over all, we are seeing somewhat of a flight to quality and strength in Treasuries," he said.

"There's still a lot of uncertainty out there, so it's going to be hard for the market to make any real progress," said Alan Lancz, president of Alan B. Lancz & Associates, an investment advisory firm in Toledo, Ohio. "Real estate prices are going down, and the earnings power that financial stocks had is going to be gone forever.".

Fannie Mae Pays Record Spreads on Two-Year Note Sale
Fannie Mae paid a record yield over benchmark rates on $3 billion of two-year notes amid concern that the U.S. mortgage-finance company doesn't have enough capital to weather the biggest housing slump since the Great Depression.

The 3.25 percent benchmark notes priced to yield 3.27 percent, or 74 basis points more than comparable U.S. Treasuries, the Washington-based company said today in an e-mailed statement. That's the biggest spread since Fannie Mae first sold two-year benchmark notes in 2000 and triple what it paid in June 2006.

Investors and traders are overlooking the government's implied guarantee of Fannie Mae and Freddie Mac debt as credit losses grow. The companies have raised more than $20 billion since December as their combined losses grew to more than $11 billion. Credit-default swaps tied to their $1.45 trillion of AAA rated debt are trading at levels that imply the bonds should be rated A2 by Moody's Investors Service, according to data compiled by the firm's credit strategy group.

"There's tremendous fears in these two," said Andrew Brenner, co-head of structured products and emerging markets in New York at MF Global Inc. "Look how they're trading in credit- default swap land." In the stock market, Freddie Mac dropped $3.20, or 24 percent, to $10.26 in New York. Fannie Mae fell $2.31, or 13 percent, to $15.31. Both are down more than 60 percent so far this year.

Fannie Mae last month sold $4 billion of 3 percent benchmark notes maturing in 2010 that priced to yield 3.036 percent, or 65 basis points more than U.S. Treasuries of similar maturity. A basis point is 0.01 percentage point. Bank of America Corp., Merrill Lynch & Co. and JPMorgan Chase & Co. managed the sale. Benchmark notes are Fannie Mae's largest type of debt issue, with a minimum size of $3 billion.

Fannie Mae's spread relative to interest-rate swaps are not at their widest ever, said Jim Vogel, the head of agency debt research at FTN Financial Group in Memphis, Tennessee. "That will explain 80 to 90 percent of what's going on in agency spreads at the short-term part of the market right now," Vogel said. "The swaps market is large and liquid and not necessarily concerned specifically with Fannie and Freddie on any given day."

The Fannie and Freddie doomsday scenario
Here's a scary, and relevant, question to ponder as the housing market continues to slide: What would it take for the government to step in and help Fannie Mae and Freddie Mac, and how would a rescue affect you, the taxpayer?

A Lehman analyst's note on Monday sent shares of both companies plunging. Though they've recovered some, the fall, and Fed Chairman Ben Bernanke's downbeat outlook for housing issued Tuesday, is forcing investors to consider what would happen if a bailout is needed.

Fannie Mae and Freddie Mac are government sponsored enterprises that help the mortgage market function by purchasing pools of loans and packaging them into securities. If one or both couldn't function, the result would be chaos. At the end of last year, Fannie alone had packaged and guaranteed about $2.8 trillion worth of mortgages, approximately 23% of all outstanding US mortgage debt.

And these securities are highly rated and sold to investors all over the world. "If Fannie or Freddie failed, it would be far worse than the fall of [investment bank] Bear Stearns," says Sean Egan, head of credit ratings firm Egan Jones. "It could throw the economy into depression or something close to it."

Clearly, investors remain concerned. Credit default swaps - a kind of insurance against the possibility of Fannie and Freddie defaulting on their corporate bonds, are at their most expensive levels in 14 weeks; both companies are expected to report steep losses for the second quarter; and their main business, mortgage securitization, is under pressure as home price values decline and foreclosure numbers rise.

"The major issue is that these are very leveraged financial institutions, leveraged much more than any other bank, and they have lots of mortgage assets. As real estate values decline every day, the value of [the mortgages that it bundles, guarantees, and sells] are called into question," says Dalton Investments co-founder Steve Persky, who has been focused on distressed mortgage assets.

The possibility of government aid looms because it's hard to see how the private market can help the companies. Their stock market values have dropped so low that it would be difficult for them to raise money. For example, Egan estimates that Freddie alone will need to raise $7 billion over the next two quarters due to writedowns and losses. But the company's market capitalization - the number of outstanding shares times the share price stands at $8.7 billion.

"An investment banker would be hard pressed to raise an amount of money nearly equal to the value of the entire company," Egan says. What's more, both companies have already raised a total of $13 billion by issuing preferred stock at the end of 2007; and they reduced their dividend payments to conserve cash.

The Federal Reserve and the Treasury have taken great pains to point out that the government is not obligated to bail out either Fannie or Freddie if they face insolvency. It's debatable where the legal obligations lie, but as a practical matter, the government can't let these institutions fail because they are being counted up on to help fix the mortgage mess.

If Fannie and Freddie were unable to buy and back loans, banks would stop originating them and the pool of homebuyers would shrink, causing home prices to fall even further. "If the government believes the companies serve an essential role in the market, which they do, they cannot let them fail," says Joseph Mason, an economics professor with the University of Louisiana who focuses on the mortgage markets.

So what would force the Treasury and Fed to step in? Fannie and Freddie are among the most highly-leveraged companies around, meaning the amount of capital they have on hand is nowhere close to the level of assets they control. Fannie and Freddie must constantly borrow money in order to operate; if for any reason borrowing costs rose sharply they would not be able to make good on their guarantees or even fund their day to day operations.

This is when the government would feel intense pressure to step in and, at the very least, pay contracts in a timely manner. In an April report, Standard & Poor's said an Armageddon scenario whereby Fannie and Freddie are insolvent is unlikely, but that the mere possibility of failure at either is a greater threat to the economy than the actual collapse of any investment bank.

So what might it look like if the government had to lend a hand? Outright nationalization is an unlikely option given that neither the current administration nor the presidential candidates could afford to support such a move in an election year.

More likely, the Treasury Department or the Federal Reserve would come in and provide a liquidity backstop, in the form of a loan or guarantee to bondholders that they will be paid. Fannie and Freddie could even do a preferred stock deal with the government, much like the deal forged by Citigroup with the Abu Dhabi Investment Authority, says Egan.

That would allow give officials the ability to argue that they weren't bailing out the companies, but rather making an investment that would pay off in the long run. Mason has a diffferent twist on a possible intervention. If either were to face insolvency, he says the government should purchase a large voting block of equity in the institution and use that as a tool to eliminate any dividends, replace officers and manage the firms back to solvency.

"But [a rescue] would be a political situation, so it would be messy," says Mason. "Fannie and Freddie would fight against having officers replaced. They would want to keep the dividend."

The doomsday scenario could cost taxpayers more than $1 trillion, says the S&P report. The report went so far as to say that a government bailout of Fannie or Freddie could force the agency to lower its rating on the creditworthiness of the United States. 

Fannie, Freddie stock, bond investors face off
Bond holders and stock holders of Fannie Mae and Freddie Mac are rooting for different teams. Fixed-income investors want the two U.S. home finance companies to issue shares to shore up capital. But for equity investors, diluting their investment is the last thing they desire, given the spectacular drops in the shares in the last year.

The companies, which have been given a central role by Congress in restoring the U.S. housing market to health, may have to seek more capital under tougher conditions in coming months, escalating the strife between shareholders and bondholders.

Investors have watched Fannie and Freddie shares plummet more than 60 percent this year after soaring delinquencies on home loans resulted in billions of dollars of losses. The predicament for Fannie Mae and Freddie Mac has produced a chasm between shareholders and bond holders, including those in the mammoth $4.5 trillion "agency" mortgage bond market.

Money managers are not turning their backs on Fannie Mae and Freddie Mac fixed-income securities -- as many have with their shares -- on belief their money is safe. Further deterioration in housing will harshly test the balance sheets of the companies, leaving them little choice but to ask for money from the very investors who made losing bets on previous capital-raisings.

"Their profitability is not assured," said Andrew Harding, chief investment officer of fixed-income at Allegiant Asset Management, noting that is the reason their shares are "really challenged." It's a different story for Fannie's and Freddie's fixed-income securities. Their agency debt and mortgage-backed securities they guarantee are "protected in the sense that they are going to pay their bills," Harding added.

Long-held views that the companies, chartered by Congress, have the implicit backing of the government has steeled the nerves of bond investors as well. "There is a big mortgage problem out there. Fannie and Freddie are the biggest in mortgages. Fannie and Freddie have a big problem," said Jeffrey Gundlach, chief investment officer at Los Angeles-based bond manager Trust Company of the West.

He added: "It's like everything else, there's too much leverage in the system. In this case, it's not hedge-fund type of leverage. With Fannie and Freddie, there are too many guarantees against the capital base -- end of story." In that regard, Gundlach sees the companies tapping the markets again for capital to boost their balance sheets.

"That is a disaster for the existing shareholders," he said. "The stock is probably going effectively to the single digits." Bond investors will do "very well" if an infusion of capital occurs, Gundlach said. That is because Fannie and Freddie are "going to still be around to guarantee," he added. Lawmakers and regulators want to make sure that happens, and investors know it.

Fannie Mae and Freddie Mac are being encouraged by lawmakers and regulators to grab market share, since many Wall Street programs that fueled the housing bubble have been frozen for nearly a year. Even the Bush administration, which spent most of the past seven years trying to shrink the companies, has been underscoring their importance to the economy.

But fuel for that growth has to come from somewhere, and revenues, while strengthened, are no where near enough to offset the losses from housing, analysts say.

U.S. Mulls Future of Fannie, Freddie
The Bush administration has held talks about what to do in the event mortgage giants Fannie Mae and Freddie Mac falter, according to three people familiar with the matter, as the stock prices of both companies continue to fall sharply.

These discussions have been going on for months and are part of normal contingency planning that the Treasury Department and other financial regulators regularly undertake. The talks have become more serious recently given the financial woes of the shareholder-owned, government-chartered companies, whose stability is vital to the functioning of the nation's housing market, these people say.

The government doesn't expect the entities to fail and no rescue plan is imminent, these people said. Government officials and market analysts expect both companies will be able to raise large amounts of capital relatively easily. Treasury officials are nonetheless talking about what the government could -- or should -- do if Fannie and Freddie become so pressed that they are unable to borrow money and continue operating.

The shares of the two companies have plummeted for several reasons. Investors are worried they will suffer bigger losses as housing prices continue to fall and mortgage defaults rise. Stock-market investors are also worried they will need to raise significant amounts of capital to cover those losses. For stock investors, that means the value of their ownership stakes in the company will be cut. Bond investors continue to lend to both companies, though they are also demanding slightly higher interest rates.

Fannie and Freddie's health is of deep concern to policy makers because of the critical role they play in the housing market. The two companies own or guarantee about $5 trillion of mortgages or nearly half of all U.S. home-mortgage debt outstanding. The government has increasingly leaned on the companies to provide critical stability to a housing market crippled by falling home prices and banks too nervous to lend.

If a loss of confidence among investors made it impossible for Fannie and Freddie to continue supporting the mortgage market, "the government would have to step in," said Douglas Elmendorf, an economist at the Brookings Institution in Washington.

"They can't be allowed to fail," said Peter Wallison, a former Treasury Department general counsel. "The losses would extend through so much of our economy, and so much of the world economy. There is simply no way that the United States government can let it happen."

It's unclear what the government might do to either forestall or mitigate any potential problems. Treasury Secretary Henry Paulson has said in the past the government will not back the debt of Fannie and Freddie. Options mentioned by analysts include a credit line from the Federal Reserve, an equity investment by the government or an explicit federal guarantee of the mortgage companies' $1.5 trillion in debt.

The most likely scenario is that Fannie and Freddie will raise capital from private investors, even though that will dilute the interests of current shareholders, said Josh Rosner, an analyst at Graham Fisher & Co., a New York research boutique. In case they are unable to attract sufficient private money, though, the government needs a contingency plan to shore them up, Mr. Rosner said.
There is at least one precedent for the government making concrete a financial obligation that was previously only assumed. During the crisis caused by the failure of savings-and-loan institutions in the 1980s, Congress passed the Competitive Equality Banking Act of 1987, making the government legally liable for obligations of the Federal Deposit Insurance Corp. Congress had previously adopted a joint resolution that the government would support the deposit insurance fund if necessary, but the pledge wasn't binding.

Wachovia Gets Worse
Wachovia named a new boss late Wednesday and saddled him with an unenviable situation: he must either stanch a tide of subprime-related red ink or find somebody to buy a bank in a market chock full of banks for sale.

Robert Steel, 56, most recently a U.S. Treasury official and for nearly three decades a Goldman Sachs executive, was appointed to fill the shoes of Ken Thompson, who was fired last month, no doubt largely due to his ill-timed, $23.9 billion purchase of mortgage lender Golden West Financial in 2006.

Wachovia is still paying for that deal. It said Wednesday evening that it was adding $3.3 billion to its reserves for bad loans related to its former Pick-a-Pay mortgage product, acquired with Golden West. Pick-a-Pay was the perfect product for the housing bubble: borrowers could choose from a smorgasbord of options each month, ranging down from the regular monthly payment to minimal levels that led to increases in the principal values of their mortgages.

In a spate of post-spring cleaning, Wachovia also said it was increasing its loan-loss reserves by a total $4.2 billion--Pick-A-Pay isn't its only problem, though the new boss, Steel, said "most areas of the company continue to perform well." The provision and a few other items will lead to a second-quarter loss of $2.6 billion to $2.8 billion, or $1.23 to $1.33 a share.

That loss is not counting a further goodwill impairment charge of an as-yet to be determined amount. Wachovia didn't say, but goodwill impairment is what happens when a company overpays for an acquisition, so you could guess that it's related to the Golden West deal. Wall Street analysts had been expecting Wachovia to earn 15 cents a share, according to

Yet perhaps on hopes of a sale, Wachovia's shares gained a bit in after-hours trading: the stock was up 26 cents, or 1.8%, to $14.65, after losing 7.4% in the regular trading session's rout, which was rooted in housing-bubble concerns. Wachovia's market value is currently $30.8 billion.

Analyst slashes Wachovia target
An RBC Capital Markets analyst slashed his price target on Wachovia Corp. Thursday, predicting shares will remain pressured until at least 2009 and cast doubt on whether its new CEO was up for the challenges ahead.

Gerard Cassidy lowered his target to $13 from $20, implying he expects shares to decline 9 percent from Wednesday's close of $14.29. Cassidy predicted in a note to investors that Wachovia, under its new chief executive, Robert Steel, will "incur a significant charge to 'clean up' its problems once and for all, eliminate its dividend and raise additional capital."

The nation's fourth-largest bank named Steel, 56, a former Treasury Department undersecretary, to its top post on Wednesday. Wachovia also said it has set aside $4.2 billion pretax to cover bad loans for the quarter, leading to an estimated second-quarter loss of about $2.6 billion to $2.8 billion, or between $1.23 and $1.33 per share, excluding a goodwill writedown.

Cassidy said Steel has a "strong pedigree and a strong resume," but said he would have favored an executive with more commercial banking background. "We believe the Wachovia ship is sinking and if the financial hurricane it is trying to navigate through intensifies to a category 5, the company will need extraordinary leadership to make it through safely," Cassidy wrote. "Hopefully CEO Steel is the right person for this job because the margin of error is very small, in our opinion."

Cassidy said Wachovia will incur a "monster charge" to build up loan loss reserves, will raise between $10 billion and $20 billion in capital, eliminate its dividend and purge all senior management responsible for leading the bank "into the mess they are in at this time." He also foresaw further downsizing.

Foreclosure Activity Up 53 Percent From June 2007
RealtyTrac, the leading online marketplace for foreclosure properties, today released its June 2008 U.S. Foreclosure Market Report(TM), which shows foreclosure filings -- default notices, auction sale notices and bank repossessions -- were reported on 252,363 U.S. properties during the month, a 3 percent decrease from the previous month but still a 53 percent increase from June 2007. The report also shows one in every 501 U.S. households received a foreclosure filing during the month.

RealtyTrac publishes the largest and most comprehensive national database of foreclosure and bank-owned properties, with over 1.5 million properties from over 2,200 counties across the country, and is the foreclosure data provider to MSN Real Estate, Yahoo! Real Estate and The Wall Street Journal's Real Estate Journal.

"June was the second straight month with more than a quarter million properties nationwide receiving foreclosure filings," said James J. Saccacio, chief executive officer of RealtyTrac. "Foreclosure activity slipped 3 percent lower from the previous month, but the year-over-year increase of more than 50 percent indicates we have not yet reached the top of this foreclosure cycle.

Bank repossessions, or REOs, continue to increase at a much faster pace than default notices or auction notices. REOs in June were up 171 percent from a year ago, while default notices were up 38 percent and auction notices were up 22 percent over the same time period."

Warburg Takes Bath On MBIA Stake
Warburg Pincus' $800 million investment in troubled monoline insurer MBIA is teaching private-equity firms and hedge funds alike a valuable lesson: Bottom fishing can be risky business.

What more than six months ago was greeted with applause on Wall Street is proving to be anything but praiseworthy for Warburg these days. According to its most recent quarterly performance report, which was obtained by The Post and covers the three months ended March 31, Warburg took a $215 million writedown on its MBIA stake.

That's a far cry from the total of $800 million that Warburg invested in MBIA in exchange for a 25 percent stake in the insurer, whose business it is to guarantee the performance of various debt securities, ranging from municipal bonds to esoteric instruments backed by mortgages. The MBIA position accounts for the single-largest investment in Warburg's investment vehicle known as Warburg Pincus Private Equity X.

At the time that Warburg made its first investment in December, MBIA shares were trading at $30. Since then, a collapsing debt market and persistent questions about MBIA and its competitors' financial health have sent the sector reeling, with MBIA shares cratering nearly 90 percent. Yesterday, MBIA shares closed at $3.91, down 3.5 percent.

Warburg's experience with its MBIA stake is a stark reminder to private-equity and hedge-fund players consumed with trying to bottom fish for investments that have been battered during the mortgage-inspired credit crisis. Insurance firms such as MBIA and Ambac Financial were once a little-known cottage industry on Wall Street, but have come into the spotlight over their ability to make good on policies that they have underwritten to protect against losses in mortgage-tainted securities.

However, MBIA has been whipsawed by worries sparked primarily by activist hedge-fund investor Bill Ackman, who runs hedge fund Pershing Square Capital, and has bet the company will go bankrupt - even as the company boasts of its ability to raise capital to build up reserves against losses.

Fitch says may cut Merrill Lynch debt rating
Fitch Ratings said on Wednesday it may cut Merrill Lynch & Co Inc's debt rating due to expected ongoing write-downs and diminished prospects for earnings.

Merrill's rating was the only one placed on review for downgrade as Fitch completed its evaluation of investment banks, affirming the ratings of Lehman Brothers, Goldman Sachs and Morgan Stanley. Fitch now rates Merrill "A-plus," the fifth-highest investment grade and the same as Lehman's rating, while Goldman Sachs and Morgan Stanley are rated one notch higher at "AA-minus."

Fitch said Merrill's exposure to mortgage-backed debt and downgraded bond insurers at the end of the first quarter was significant relative to its peers and expressed concerns about the level of the brokerage's long-term debt maturing over the next 12 months.

The rating firm said it expects the No. 3 Wall Street investment bank to report a fourth consecutive quarterly loss on July 17. It cited losses in fixed income, currency and commodities operations, which may "overwhelm" income from the better-performing retail brokerage, private client and equities businesses.

Just like its rivals, Merrill faces declining investment banking business opportunities due to the current negative credit environment, Fitch added. "These reduced revenue opportunities, coupled with Merrill's ongoing negative mark-to-market adjustments, significantly constrain the company's earnings prospects," Fitch said in a statement.

The world's largest brokerage has recorded more than $30 billion of write-downs since the third quarter of last year and Wall Street analysts forecast up to $6 billion of additional charges in the second quarter. To offset those write-downs, Merrill Chief Executive John Thain is widely expected to raise capital by selling assets, which could include the company's stakes in BlackRock Inc and Bloomberg LP.

Fitch said monetizing these assets could generate "incremental capital," adding that current market conditions also limit attractive sales opportunities for other assets. Although Merrill has over $80 billion in excess liquidity at the parent company level to cover unanticipated cash needs and has broad access to retail and institutional investors, Fitch expressed concerns about its funding profile.

Merrill faces $73 billion of long-term debt maturing over the next 12 months, according to Fitch. "Fitch believes the investor base may be becoming saturated and financial flexibility may be more limited in the future. Satisfying additional capital needs with more equity or unsecured term debt may prove costly," the rating firm said.

Another rating firm, Standard & Poor's, has already cut Merrill's rating to "A" and Moody's has had its "A1" rating on review for downgrade since mid-April. Healthy ratings are crucial for investment banks because they determine the cost and availability of funding and impact their ability to trade credit derivatives.

Fitch said the rating outlook on Lehman and Morgan Stanley is negative, while Goldman's is stable. The outlook indicates the likely direction of the rating in one to two years.

Bank of America may assume all Countrywide debt
Bank of America Corp is primed to assume all debt of the former Countrywide Financial Corp, independent research firm CreditSights Inc said, a move that would alleviate worries of Countrywide bondholders.

CreditSights analyst David Hendler issued his assessment on Wednesday, the day after a regulatory filing that showed how the second-largest U.S. bank was treating some of Countrywide's debt obligations. Bank of America bought the largest U.S. mortgage lender last week for about $2.5 billion.

"Countrywide's bank credit facilities have been repaid and its outstanding debt has been assumed by an indirect subsidiary, created and wholly owned by B of A," Hendler wrote. "Our view continues to be that B of A will ultimately honor the outstanding indebtedness from (old) Countrywide, based on our discussion with the company following this filing, as well as our prior analysis."

In late April, Charlotte, North Carolina-based Bank of America had said it was examining options for Countrywide debt, estimated at around $40 billion, and that there was "no assurance" it would redeem, assume or guarantee the debt.

Whistling Past the Graveyard: Paulson’s misleading numbers
It is natural for a government official to look for signs things are getting better. So we should not be surprised that Treasury Secretary Henry Paulson yesterday pointed to the few signs there are of improvement in the housing market.

I’ve done my share of looking for signs of such improvement. At some point there has to be a bottom, but it is not easy to find evidence that the housing market is improving. One statistic he cited particularly struck me as whistling past the graveyard:
“We are working through the excess new home inventory – the inventory of new single family homes is down 21 percent from its 2006 peak.”

Well, actually that is not the way it looks to homebuilders. The statistic he relied upon includes new homes that builders are offering for sale even though construction has not even begun. Those homes are typically in new subdivisions, and there are not very many of them these days. The number of unstarted new homes being offered is down 36 percent since June 2006, the month the overall figure he points to hit its peak.

Part of that decline came because builders dropped plans to build, not because buyers appeared. The number of partially completed new homes being offered is down 40 percent. What sales are being made are in the more desirable developments, and even there prices must be cut to make sales. (One California builder was offering a buy one, get one free sale on new homes.)

The inventory of new homes that have been completed and are available for sale is up 35 percent. In June 2006, there were 135,000 such homes. This May, the latest figure available, there were 182,000 such homes. And the median age of those completed but unsold homes has gone up 136 percent over that period, from 3.6 months to 8.5 months.

That later figure is the highest since the government started keeping that statistic. Some of those homes are in subdivisions where foreclosures are already climbing, and may be hard to unload at any price. The actual number of completed but unsold new homes peaked in January at 199,000 homes, and is now down 9 percent. Unfortunately, sales of such homes are slower than ever, relative to the inventory.

May was the first month ever that sales of completed new homes totalled less than 10 percent of the number of such homes that had been available for sale at the beginning of the month. Builders have largely stopped building, so the inventory must eventually fall. But what is noteworthy is how slowly that process is proceeding.

Extending the mortgage-crash pain
Mortgage debt backs a lot of the bad bonds that are wreaking balance-sheet havoc, and mortgage relief has been suggested as a cure - both for homeowners and Wall Street. But a closer look suggests that modifying homeowners' loans may simply be pushing losses into the future.

Since the turmoil in the credit markets began a year ago, investment banks have had to write down the values of all sorts of securities, but the bonds that sparked the crisis were those backed by mortgages granted to borrowers who could ill afford the payments.

New foreclosure data due out Thursday should show even more homeowners underwater, so it's clear that mortgage debt is still toxic for investment banks, hedge funds and other institutional investors. For them, loan modification holds out a ray of hope. Even though principal and interest payments will likely go down, that's better than foreclosure and no money at all coming into the bond.

Of all the mortgages that will go into delinquency over the next 12 to 18 months, as many as two thirds could be modified, Joseph Mason, an economics professor with the University of Louisiana who focuses on the mortgage markets, wrote in a report last fall. About 1.7 million homeowners have received help negotiating with lenders through a government program called Hope Now; and the need for modifications is growing.

Treasury Secretary Henry Paulson said recently that 1.5 million home foreclosures were started in 2007 and that an estimated 2.5 million more would take place this year. Congress is now debating an expanded federal role in the modification process. Unfortunately, modification often isn't the end of the story. A survey by the Mortgage Bankers Association based on foreclosure information from the third quarter of 2007 shows that 29% of modified loans end in foreclosure anyway.

Predictably, the numbers are much higher for poorer states such as Arkansas (41%), Louisiana (42%), and North Dakota (47%). Before it filed for bankruptcy last year, loan originator New Century Financial stated that between 40% and 60% of loans it modified eventually ended up in foreclosure.

The housing stimulus bills working their way through Congress try to address this problem by providing a safe harbor for loan servicers that create "qualified loan modification or workout plans." A qualified plan is one that is scheduled to remain in place until the borrower sells or refinances, or for at least five years, and does not result in the borrower paying additional fees.

These measures should make loan servicers more careful about which loans they will modify. The servicers also would agree to take a 15% haircut on the value of the mortgage before selling the loan (and its risk) to the Federal Housing Authority (and the taxpayer).

For now, loan servicers are not regulated and historic data has not been compiled to see which companies have a better or worse track record when it comes to modification, points out Josh Rosner, managing director at research firm Graham Fisher. Rosner says that, on average, a homeowner who had a loan modified only to lose the house in foreclosure paid the new loan for two years "Clearly the homeowner would have been better off renting and rebuilding his credit".

But in the meantime, the mortgage payments help support the value of mortgage-backed bonds. "You can imagine that if some of these mortgages are retooled, and especially if some are eventually given a Federal Housing Authority wrapper, they will rise in value," says Joe Patire, head of fixed income trading and managing director at YieldQuest.

He adds that in 2009 and 2010, many of the current write downs could become "write ups" as the market value on all that paper rises. However, if 30% or 40% of these modifications end in foreclosure anyway, the losses will come, they'll just show up later. "There might be an initial pop in price when these securities initially look like they will perform better," Patire says.

"In reality, the holders of these securities will still be in the same place they were before. But something that has been written up is a lot easier to sell." Wall Street, no doubt, would welcome any measure that allows it to get rid of these bonds for more than their current fire-sale prices, even if the bonds won't perform well down the road. It's just a matter of finding a sucker to buy. Recent history has shown that to be a surprisingly easy feat to accomplish.

Commodities: A bad place for pensions
With oil selling for more than $140 a barrel recently, I'm worried about the speculators.

I'm not alone. Last week, I returned from vacation to several e-mails about commodity experts who told a House subcommittee late last month that speculators are driving up energy prices. One insisted that if Congress reined in such speculation, oil would drop as low as $65 a barrel, according to CNN.

As I've written before, speculators have been the convenient scapegoat of every commodity bubble since the first agriculture markets in the 1920s. The rise in energy prices has more to do with changing market conditions — demand outpacing supply — than speculation, but the reaction to higher prices is the same: blame someone other than us.

That's not always easy. We'd like to believe that speculators are market demons — shadowy hedge funds, super-rich private equity investors, scurrilous billionaires feasting on our suffering like economic vultures. The truth hits closer to home. The surge in energy prices has turned millions of average folks into speculators, even though they may not realize it.

Some of the nation's biggest pension funds have been pouring money into energy futures and other commodity investments, seeking an inflation hedge and bigger returns than they can get in stocks and bonds. Lehman Bros. recently estimated the amount of assets under management invested in commodities more than tripled since 2006, to more than $230 billion.

The California Public Employees Retirement System, or Calpers, the nation's largest public pension fund, has more than $1 billion invested in oil and other commodities, and its investment has soared 68 percent since last year. Closer to home, the Texas Teachers Retirement System is holding about $4.4 billion in energy-related commodities contracts, while the University of Texas Investment Management Co. has some $500 million.

In other words, the surge in oil prices is fattening the retirement plans of millions of workers who've become, in essence, secondhand speculators. While it may seem encouraging that energy investments are boosting returns for pensions, they're seeking bigger gains to close funding from earlier bets that soured. That's why I'm worried.

Historically, pension funds have avoided direct investments in commodities because they're too volatile. In the past decade, though, many pensions have liberalized their guidelines and have brought in advisers and managers who are more interested in posting impressive gains than managing returns over the long haul.

"They're looking for short-term returns, and they're following trends," said Houston investor Charles Miller, a former manager of public pension funds and the former chairman of the UT board of regents. "Direct commodity investments are inappropriate for large pension funds."

Unlike private investments or even mutual funds, pensions aren't required to maximize returns. They merely have to generate returns that cover their obligations to retirees. "Pensions should be invested in fixed-incomes with the same maturities as the future beneficiaries," said Roger Lowenstein, author of While America Aged, which chronicles problems facing U.S. pensions.

By chasing the latest investment fad, funds inevitably miss them or hold onto them too long, he said. Often, they fail to understand the markets for such securities. "Do they think they know anything more about the price of oil, the price of tungsten, or the price of fine silk yarn than the market does? It's irresponsible to be playing with it," Lowenstein said.

In many cases, commodity investments still represent a small piece of pensions' overall portfolio. At TRS, for example, it's only about 3 percent of the fund's total assets. But Dallas investor Shad Rowe, who chairs the Texas Pension Review Board, which oversees all public retirement systems in the state, sees a more disturbing problem.

He believes the flood of pension investments into the commodity markets is contributing to the rise in prices. The money invested for retirement is feeding inflation, which reduces the amount of money people have to spend now.

"They're making life difficult for the people whose money it is," Rowe said. In other words, the rush to commodities is likely to be bad for pensioners in the long run, and it's not doing them any favors now, either.

Investors fight speculation charges
Pension funds, university endowments and other large investors are striking back at congressional proposals to curtail their ability to invest in lucrative oil and agricultural commodities. Over the past few weeks, institutional investors have become the newest group to be scapegoated by oil producers, trucking companies, farmers, airlines and others eager to shift the blame for skyrocketing food and fuel prices.

Now the investors, labeled speculators by anxious lawmakers, are starting to play defense. Organizations representing a diverse set of financial interests are lobbying against measures that would hamper their commodities investments. Lobbyists fear that, as prices continue to rise, the investors will be subjected to increasingly intense scrutiny.

“This came up pretty fast, and there was an immediate concern,” said Judy Schub, managing director of the Committee on Investment of Employee Benefit Assets, which represents private pension funds. The investors are an attractive target for politicians desperately trying to convince voters before the November elections that they’re acting to lower spiking prices. All the attention is making investors, who are already working in a difficult market environment, even more nervous.

Large investors are pouring more money into the commodities futures markets to hedge against inflation from the falling dollar. But unlike airlines and other traditional market players that have locked in oil at set prices, the speculators have no use for the actual fuel. Their paper barrels are financial bets that the price of oil will either rise or fall. Whether speculators are actually affecting oil prices is debatable.

“One of the themes from the testimonies on Capitol Hill is that people don’t really have a good grasp on to what degree commodities investment is a factor in the rise of oil prices,” said a financial services lobbyist who represents pension funds. Even so, investors in the commodities market have been targeted in at least eight hearings and a dozen bills.

“We were in the market when oil was $30 a barrel and no one was suggesting then that our investment strategy was manipulative or driving up costs,” said Richard Baker, head of the Managed Funds Association.

Speculation is not illegal. But the Organization of the Petroleum Exporting Countries, the International Monetary Fund, Democratic congressional leaders, the presidential candidates and some economists say speculation is having negative effects on the economy. They argue that because the investors do not actually use the oil, their influx into the market is artificially inflating normal supply-and-demand pricing.

“The steady upward climb of the cost of food and energy in recent months is not simply the result of natural market forces at work,” said Sen. Joseph I. Lieberman (I-Conn.). “Our government must step in as soon as possible to protect our consumers and our economy because, against the forces of the speculative markets, the average person simply cannot protect himself or herself.”

But the investors, the Bush administration and Wall Street blame the price spike on increased demand from China and other developing economies, the falling dollar, and political uncertainty, particularly in Nigeria, Iraq and Iran.

“Some have confused speculation with manipulation or other abusive market practices,” six groups representing traders, funds and large financial services banks wrote in a June letter to Congress. “Blaming speculation or any specific trading practice for rising or falling commodity and energy prices, without real evidence of wrongdoing, is misguided.”

CFTC's New Enforcement Head to Face Political Unrest
The U.S. Commodity Futures Trading Commission named Stephen Obie acting director of enforcement as the agency faces political pressure to ensure energy and agricultural markets are not being manipulated as prices soar.

Obie will take over from Gregory Mocek, who will be leaving within 60 days after heading the enforcement division since 2002, the Washington-based agency said today. Obie, regional counsel for the CFTC's New York office, helped investigate manipulation cases against Amaranth Advisors LLC, Enron Corp., and American Electric Power Company Inc., experience that may be needed as Congress reacts to record gasoline and oil prices.

"There's an enormous amount of scrutiny and pressure on the agency with regard to the rise of commodity prices, oil being the greatest," said Geoffrey Aronow, former CFTC enforcement director who hired Mocek at the agency. "That is not likely to end anytime soon."

Record prices for crude oil, gasoline, soybeans, wheat, copper and other commodities have focused attention on the CFTC in recent months. Lawmakers are weighing about a dozen proposals to limit speculation and strengthen oversight of foreign exchanges offering U.S.-based futures contracts. The U.S. House of Representatives last month passed a bill requiring the CFTC to "eliminate excessive speculation" in energy markets.

The regulator said in May it has been investigating the oil market since December for signs of manipulation, a rare public disclosure of an ongoing probe. The agency last month imposed limits on the number of U.S. oil futures contracts a trader can hold on Intercontinental Exchange Inc.'s London-based ICE Futures Europe market after U.S. politicians charged that excessive speculation, not supply and demand, is behind record prices for crude oil.

Mocek, 46, said in June there is no evidence speculators are manipulating U.S. oil prices on foreign exchanges. He oversaw more than 100 investigators and staff members who monitor futures markets for manipulation and fraud. Obie's challenge in the current price environment is to conduct fair and thorough investigations, Aronow said. "The pressure to `do something' when there may not be anything to do" will be "the greatest challenge in the coming year," he said.

Britain's economy is coming unglued quickly
Britain, one of the big winners from the free flow of capital and services globally in the last decade, is rapidly becoming one of globalization's losers because of its reliance on property and finance.

With financial services contracting and the international flow of capital that financed a debt binge in an almost total freeze, the British economy, housing and financial markets are in a headlong race lower. Britain's famously open economy has had a stunning run of uninterrupted growth over 15 years as it successfully transformed itself into a services and consumer society.

London's financial center boomed, arguably winning pre-eminence over New York, while international capital from Russia, Asia and the Middle East found a base in London. At the same time, Britain's regions enjoyed smaller-scale but still buoyant growth, much of it connected in one way or another with a near tripling in property prices over a decade.

Now the shutdown of the flow of international capital to its banks and borrowers has brought that growth to a halt, while a spike in the cost of energy and food hurts consumers. It is really rather difficult to give a sense of exactly how quickly Britain's economy is coming unglued. According to Nationwide, the British mortgage lender, house prices fell by 2.5 percent in June alone, and some economists are forecasting multiyear falls of as much as a third.

Mortgage lending is down by 64 percent year on year in May as banks recoil from lending into a falling market and also because of the simple fact that Britons collectively don't deposit enough to cover their borrowing needs. John Lewis, a British retailer, said sales at its department stores dropped 8.3 percent in the week that ended June 28, compared with the same week a year earlier, while a rival, Marks & Spencer, also reported disappointing results.

The banking sector is racing to recapitalize, not entirely successfully, with shares of the mortgage specialist Bradford & Bingley well below the level at which a new offering of stock was underwritten. Construction activity fell at its fastest pace in at least 11 years in June, while the crucial services sector shrank at its sharpest rate since just after the Sept. 11, 2001, attacks in the United States.

Even manufacturing contracted in May, though to be fair it would almost take an industrial revolution for Britain's small sector to make up for shortfalls in property, consumption and finance. Britain is very likely already in recession, and its financial markets have further to fall. So how will the British experience of a property bust stack up against the United States?

Karen Ward, chief British. economist at HSBC in London, estimates that the construction, real estate and related sectors account for 10 percent of employment. The U.S. comparison is not exact, but is something on the order of 7 percent or 8 percent. Britain, in effect, concentrated on those things in which it had a comparative advantage, notably finance, and it outsourced the rest.

Whereas productive industries are essentially flat in growth since 2003, financial intermediation has grown by 50 percent and real estate activity by 35 percent. Britain's openness and its willingness to adopt innovation, especially financial innovation, allowed it to finance a consumption and property bubble that could persist only so long as money flowed to its consumers from abroad. Its banks, notably Northern Rock, borrowed from abroad, and its house buyers did so, too, through securitized mortgages. That all ended last summer.

Don't get me wrong. I don't blame Britain's problems on perfidious foreigners. It was a free contract that people across the country grasped with both hands. Now globalization, too, will limit Britain's ability to respond to the end of cheap money. Financial markets have the power to punish sterling and government bonds if official borrowing becomes more aggressive.

That leaves the government in a poor position to stimulate the economy with additional spending, given that even on its own now optimistic forecasts it will only narrowly avoid breaching its sustainable debt rule.

As for the Bank of England, its ability to soften a downturn with official interest rate cuts is constrained by global food and energy prices that have driven inflation to 3.3 percent, well above its 2 percent target. Its commitment to that target, and all it implies, will be tested as the year unfolds.

Ilargi: The Canadian government never met a barndoor it didn’t like. The damage that the present government does to the country can not easily be overestimated; it will take many years for people to realize the extent. When they do, it’ll be too late. Previous governments, run by other parties, have paved the way for this to happen: the neo-cons have taken over, and they have an iron grip on the nation, facilitated by an "opposition" that is as effective as the Democrats have been in the US in the past 8 years. In my book, this is defined as "complicity". The fact that the entire population has been on a media-induced valium trip for the past 20 years only serves to complete the picture. Canadians want beads and mirrors and other shiny objects, and they’ve sold their voices in order to get them. It’s a dysfunctional country.

Ottawa tightens mortgage rules to avoid 'bubble'
The federal government is cracking down on the mortgage industry in a move that could help protect against a U.S.-style housing bubble, but will also make it tougher to borrow money to buy a home. The Finance Department said Wednesday it will stop backing mortgages with amortization periods longer than 35 years as of Oct. 15.

It will also start demanding a down payment equal to at least 5 per cent of the home's value, rather than guaranteeing mortgages where they buyer has borrowed the total amount. “Today's announcement marks a responsible and measured approach by the government to ensure Canada's housing market remains strong, and to reduce the risk of a U.S.-style housing bubble developing in Canada,” the Finance Department said in a statement.

Existing 40-year mortgages will be grandfathered, a Finance Department spokesman said. In 2006, the maximum amortization period was extended to 40 years from 25, and longer-term mortgage products have become increasingly popular with buyers looking for lower monthly payments as the price of Canadian homes soared.

Last year, 37 per cent of new mortgages were for terms of longer than 25 years, according to the Canadian Association of Accredited Mortgage Professionals (CAAMP). But while longer amortizations stretch out monthly payments, they also greatly increase the cost of a mortgage over its lifetime.

For example, the total interest on a $300,000 mortgage can soar from $286,161 over the life of a 25-year mortgage to $498,416 over a 40-year amortization period – adding more than $200,000 to the cost of the home. This, combined with the fact that these mortgages are often combined with little or no equity, raised alarm bells with policy makers looking at the turmoil that took place in the U.S. when house prices started to fall.

“We've seen an inclination now, a trend, toward longer-term amortizations and smaller down payments, and that is a matter of some concern,” Finance Minister Jim Flaherty said in a speech in May. Mr. Flaherty was not available for comment Wednesday. Jim Murphy, president and chief executive of CAAMP, said in talks with him the government expressed concern about the risky lending products that collapsed the U.S. housing market.

The Finance Department was also worried about the future impact of competition between mortgage insurers, which led to the introduction of 40-year mortgage in 2006, Mr. Murphy said. “I think you have a clear case of the government sitting down and looking at its risk exposure and wanting to review that. They have financial guarantees in place for the CMHC and private insurers, and they were saying, ‘What is our risk, and what is the risk to the Canadian taxpayer?' ” he said.

Reaction from the industry was mixed. “CMHC supports the new parameters … . We also support their efforts to maintain the strong Canadian housing market,” said spokesperson Stephanie Rubec, adding CMHC will stop insuring 40-year and zero down payment mortgages in October.

“It's the right move,” said Nick Kyprianou, president of Home Capital Group Inc., whose principal subsidiary, Home Trust Co., provides alternative mortgages. “Why get people overextended? Nobody wins by getting people right to the end of the cliff.” Others, however, say home buyers and banks have been prudent with their finances, and are being punished for the more lax approach south of the border.

“Things here are not like they are in the U.S. where they had those NINJA loans, no income, no job, no assets. … It's only going to hurt the consumer,” said John Panagakos, owner of Toronto brokerage Mortgage Centre. The move actually comes at a time when the housing market has moved on to other concerns, the most pressing of which is chilling consumer sentiment due to high fuel prices, said Douglas Porter, deputy chief economist at BMO Nesbitt Burns Inc. “It's a bit like closing the barn door after the horse has already run down the road.”

Ilargi: Nice writing, but I’m not sure the author understands the issues.

Economic chill looms heavy over Ireland, Vancouver
"You guys should stop spending money on gadgets," said my father to my brother and me last week. My brother was examining my sleek, video and wireless-enabled MP3 player. "You're going to need your money for gasoline and food."

My father, in his 80s, doesn't understand why my brother and I are interested in sleek, video and wireless-enabled MP3 players. But he also went through the Depression, the unimaginably bleak 1930s which as far as post-millennial public collective memory goes might as well have been the 1830s. Having grown up on a farm where the family at least had food but no cash, Dad is intimately acquainted with scarcity.

His warning about an impending need for thrift, a notion also long disappeared from collective memory, is part of an increasing unease in the land about our economic future. Canadians are wondering if they should be scared. Gas has gone up dramatically, with signs home heating fuel will follow. Food is more expensive. Last week, I noticed at least two local restaurants near my office had raised prices and, I suspect, cut back on portions.

Car sales are plummeting. Transportation fees for taxis and ferries are going up. Frequent Courier contributor Michael McCarthy, our resident prophet of doom who's been writing about energy issues for years, likes to hammer home the point that this is just the beginning. It's going to get worse. Oh joy.

I sensed similar unease while visiting Ireland last month. The Irish, a pleasant people who live on a rainy flat bog ringed by mountains and overrun with what seem like hundreds of millions of sheep, are experiencing a hangover after years of partying as the Celtic Tiger. They beat up economically just about everyone for nearly a decade and a half, building up high-tech industry by day while downing gallons of Guinness and Jameson by night.

Things were so good that Ireland's traditional population loss through migration reversed itself. E.U. citizens, especially from Eastern Europe, came in droves to take service jobs the locals no longer wanted or needed, which is one reason why many of the servers in restaurants during my trip were Polish, Slovakian or Italian.

Now, the Irish told me, the party is over, and after spending a couple of nights in County Mayo pubs, I believe when the Irish finally leave a party, it really is over. A recession has emptied the kegs and reduced the construction cranes over Dublin to a fraction of their number a few years ago. But is it a recession, and perhaps merely part of a regular economic cycle, or is it something more profound? And is anyone paying attention to the warning signs?

In Westport, a tourist town of 4,000 near Ireland's west coast, the word "bustling" was the only description that fit. The place was alive with pedestrians, cars, trucks, tourist buses and cadres of German, American, and French visitors. The French perpetually smoked, the Americans filled shopping bags and the six Germans at breakfast when I entered the dining room one morning in my B&B looked at me like they'd just committed a major crime.

I asked no questions. If they'd done anything, maybe it was simply to dare enjoy themselves at a time when the economic wheel is turning. Or perhaps their denial was showing. The Irish, too, appear to be in denial. Gas is well over $2 a litre, and has always been pricier than here, but the Irish drive everywhere, and quickly, which is something considering their roads are little wider than the shoulders on the No. 1 Highway.

The local newscasts and newspapers were dominated by Ireland's stinging rejection through referendum of greater integration with the E.U. But there was little official talk of economic uncertainty, whereas some of the locals I met were nervous about what lies ahead. This year, the Irish and other Europeans are still going on vacation, moved forward by past financial momentum. But next year, as jobs go, household budgets tighten and prices rise, all bets are off. The Irish might soon want those service jobs back from the immigrant Poles.

We have similar or even greater denial here. In Kelowna last weekend, where everyone is highly pleased with the expensive new bridge spanning Lake Okanagan, I was shocked by the luxurious new condo towers going up. The ambition is to create a Yaletown-like neighbourhood along the waterfront north of the city's downtown.

This is hardly the stuff of food riots. If we're headed to a peak-oil meltdown and a reduced standard of living my father would recognize from 70 years ago, no one--from Galway to Gibsons--is preparing for it.

Canada home energy bills may be highest ever
Total spending on energy by Canadian households likely hit an all-time high as a percentage of disposable income in the second quarter of this year – and those home-heating and electricity bills will head even higher this winter, says Bank of Montreal economist Douglas Porter.

Mr. Porter calculated that roughly 7 per cent of disposable household income went toward gasoline, natural gas, fuel oil and electricity in April, May and June. “While raging gasoline prices have been hogging the headlines, natural gas has been quietly rising every bit as fast as crude oil in the past year (doubling in that period), and this will wallop household heating bills this winter,” Mr. Porter wrote in a research report issued Wednesday.

“With many of the energy input costs for hydro companies on the march, it is only a matter of time before electricity prices also lurch higher in many provinces,” Mr. Porter said. The dramatic rise in energy costs has dampened consumer confidence and is expected to push the inflation rate higher. The Consumer Price Index report for June, to be released July 23, “could hit the 3 per cent barrier, and threatens to push above the top end of the Bank of Canada's comfort range in the next few months,” Mr. Porter said.

He noted that the latest Bank of Canada business confidence report, issued earlier this week, found that almost half of Canadian companies plan to increase prices to consumers over the next year to cover soaring costs of energy and other commodities. There is a widely-held view that the Canadian economy benefits from higher oil prices, as a significant net energy exporter, Mr. Porter said.

But with crude oil hitting record highs, “there is a strong case to be made that the surge in oil and gas prices crossed the tipping point this spring from providing some economic ballast for the domestic economy to acting as a heavy anchor.”

Although the trade surplus on energy goods has reached an all-time high of nearly 5 per cent of gross domestic product, “the negative hit on the prospects of Canada's major trading partners and consumers looms much larger,” he said, adding that a sustained moderation of energy prices would provide a welcome respite to the Canadian economy at this stage.

Investment managers turn bearish on Canadian stocks
There's been a turnaround in North American market sentiment with investment managers turning bullish on the U.S. stock market but more bearish on Canada's, according to survey results released Wednesday. "The U.S. and Canadian markets could be going in opposite directions," the latest Russell Investment Manager Outlook said.

The U.S. market had been considered the world's economic Achilles heel for the better part of the past year, yet bullishness towards U.S. equities climbed to 45% in late spring from 33% near the end of the winter quarter while bearishness towards the U.S. market plunged to 13% from 31%, it said. In contrast, it said bullishness towards Canadian stocks has fallen to 33% from 43%, while 44% remain bearish.

"After several consecutive quarters of strong Canadian economic performance, a soaring loonie, record energy and materials prices, and seemingly modest inflation, it appears that investment managers have begun to doubt the continued upside potential of the Canadian market," said Sadiq Adatia, chief investment officer with Russell Investments Canada Limited.

The report comes in the wake of a series of steep drops in the Canadian benchmark stock index which by early this week had wiped out all the gains of this year. Digging deeper, bullishness towards the materials sector -- dominated by gold stocks -- plummeted to just 32% from 62%, it noted. And, while 51% remain bullish on the energy sector, bears have surged to 41% from 23%. Further, more than 95% say the Canadian market is either fairly-valued or overvalued, as opposed to undervalued.

"Looking at the big picture, it's likely that investment managers are simply finding better relative values in the weaker U.S. market than elsewhere in the world, and may be looking to shift profits from Canada and other markets back into American stocks," said Adatia. "In our view, this illustrates the increasing divide between those who believe Canadian natural resources are in the midst of a long-term secular growth trend driven by a fundamental shift in the global economy, and those who believe we are merely witnessing a classic bubble."

The outlook for Canadian sectors wasn't entirely negative, however. Despite the widespread view that the Canadian economy is heading for a slowdown, the level of bullishness towards industrials -- such as airlines and railways -- climb significantly to 42% from 22%, it said. Similarly, bullishness towards the consumer discretionary sector rose to 32% from 19%.

Information technology also saw bullishness rise considerably to 69% from 40%, it said, adding, however that sector is largely a proxy for Research in Motion, Canada's best-known growth stock.

RBC's writedowns to double to more than $3 billion
Royal Bank of Canada's writedowns could double to more than $3-billion as ongoing deterioration in U.S. credit markets takes its toll on Canada's largest bank, a report warned Wednesday.

Worsening conditions in the U.S. may force RBC to take another $1.5-billion hit to add to the $1.6-billion in credit-crunch losses it has disclosed, said the report from Genuity Capital Markets analyst Mario Mendonca. The potential losses would likely wipe out the entire quarterly profits at RBC, and would put a big dent in any hopes the worst of the credit crunch is behind Canada's banks.

Mr. Mendonca's warning comes a day after Bank of Canada governor Mark Carney signalled a better outlook for credit markets here by saying he is closing an emergency fund set up to help the banking sector. But most of the recent trouble for the Canadian banks has come from their involvement in U.S. markets, where Federal Reserve chair Ben Bernanke said earlier this week he will keep the door open for emergency Fed funding into next year if market turmoil persists.

The announcement soothed the nerves of cash-strapped Wall Street banks but fuelled fears that the credit crunch is far from over. Mr. Mendonca said his forecast of more writedowns at RBC is based on a further slide in the U.S. subprime mortgage market, plus weakening of mortgage backed securities values and worsening conditions on a variety of structured products since late June. Another key driver is a recent fall in the credit rating of monoline insurer MBIA Inc., a counterparty to some of the RBC's U.S. investments.

"We re-examined RBC's exposures in this light and we estimate that [the bank] will take a third quarter pretax charge ranging from $900-million to $1.5-billion," Mr. Mendonca said. The bank's stock fell almost 4% on the Toronto Stock Exchange Wednesday, down $1.84 to close at $44.16. RBC's share price has fallen 28% in the past year, and is down 14% since the start of June.

Mr. Mendonca noted that the potential writedowns would not undermine RBC's strong capital position. But he also said the bank, which reports its third quarter results on August 28, is facing a variety of additional issues including exposure to U.S. builder finance and tough conditions for generating profits from its significant capital markets group.

RBC's total credit-crunch losses are the second largest of any bank in Canada. Canadian Imperial Bank of Commerce has recorded $6.7-billion in credit-crunch charges since last summer, and a number of bank industry analysts say the bank could take another $1-billion to $1.5-billion in charges when it reports third quarter results on August 27. Bank of Montreal and Bank of Nova Scotia have recorded about $1.2-billion in writedowns between them, while Toronto-Dominion Bank has avoided similar writedowns.


Anonymous said...

Okay, at the risk of being hammered by fellow readers, I'll try and float one more flag of hope... or at least a question(please keep in mind that I, too, think 'the end is near'...)

The financial industry is a dead-man-walking, no doubt, the Hanna-Barbera cartoon character running in space/place over a 1000 foot cliff...

BUT, is that all that's left? Are we truly just a FIRE (Finance, Insurance, Real Estate) economy now? The CEO of Dow Chem. was on CNBC this morning and it led me to think about the OTHER sectors of the economy... How big a chunk of the economy is the FIRE section?


Anonymous said...

Within a self-directed IRA, people can buy short term Treasuries whereby they own them directly. But what if this IRA is held at Fidelity or Vanguard which are big holders of mutual funds.

If the mutual funds end up being wallpaper, couldn't that be the end of Fidelity and Vanguard who manage all these mutual funds? How safe is that IRA containing Treasuries directly?

Is it too mind-boggling to think that Fidelity and Vanguard could dissolve similarly like the banks?

Anonymous Reader

Anonymous said...

"[Congress] is allowing [Fannie Mae and Freddie Mac] to continue to exist as bastions of privilege, financed by the taxpayer".

That seems to cry out for Dickens and "are there no prisons are there no work houses?"

One person will see tragedy, poverty and skinned taxpayers, another will see opportunity for investment ... concrete and rebar!

Anonymous said...


The Poole statement is hitting Europe too.

Für Druck sorgten die Aussagen des ehemaligen Fed-Gouverneurs, William Poole, dass die US-Hypothekenfinanzierer Fannie Mae und Freddie Mac "bankrott" seien.

The next to last word is pretty clear, even if your German is not great.


Anonymous said...


Illargi, you write:
And once you do that, it is of course simple: It is the privilege of profits, of money (in an industry that hemorrhages value, no less). Billions of dollars in fees and debt are being "whitewashed"...

Sorry to be slow, but I still do not understand. It is clearly not the shareholders of F+F who are profiting. So who is it? The mortgage brokers and banks who sold to F+F?


Bigelow said...

”And while Katrina may be seen as an opportunistic event, it is not the blueprint, that is all about planning these events, not waiting for them to happen. In that light, Katrina is a very poor example for what the doctrine means.”

Correct. All about preparing the crisis and the aftermath, then causing the disaster to benefit from it; not above benefiting from free earthquakes and floods when they can get ‘em though.

People just don’t believe there are sociopaths capable of this, which is another part of why it works

Anonymous said...

"If [Fannie Mae and/or Freddie Mac] couldn't function, the result would be chaos."

Would it? For the average American? Or for the bankers and investors?

If houses weren't mortgaged, if people had to pay cash, would they not be cheaper?

Thanks for the excellent blog.


Ilargi said...


It is clearly not the shareholders of F+F who are profiting. So who is it? The mortgage brokers and banks who sold to F+F?

That's correct. Since mortgage backed securities are no longer viable in their former shape, and no lender can afford to have (the risk for) the loans in their books, F+F are/were the savior of the industry. Brokers and lenders could still get the fees, and sell off the loans. This also kept prices higher than they otherwise would have been.

Ilargi said...


Without finance and real estate, the economy as we know it can't function properly. The levels of leverage we see in the FIRE section will make sure that, when it plunges for real, most of the rest of the economy will go down with it.

Ilargi said...


Would it? For the average American? Or for the bankers and investors?

If houses weren't mortgaged, if people had to pay cash, would they not be cheaper?

The average American is so beholden to the finance industry that for all intents and purposes both are two sides of the same coin.

If people had to pay cash they'd find out they have none.

Anonymous said...

I'm confused, Ilargi. Was it "while we were sleeping?" or "in broad daylight"??? Or just 24/7??

Ilargi said...

I'd say most of us sleep through our entire lives. It's the only reason I can think of why we let others rob us blind and make our children's lives living hell.

Ilargi said...


As per your question yesterday (apologies) about Lehman's: I have until now been cautious about Lehman's demise because of the place the company occupies in the ownership structure of the Fed.

But I have to admit they get hit very hard these days, -11.36% yesterday, -12.36% today, standing at $17.30 with a 52week high of 74.09. It ain't pretty.

Still, I don't know, I think owning the Fed counts for something. Quite a lot, really.

You can survey the entire Fed ownership set-up here.

If Lehman goes, I'm thinking it's because it's been decided to let it go. Why, I don't, and I can't, know.

The Lizard said...

"I'd say most of us sleep through our entire lives."

A correct and ancient realization.

Buddha means "awakened one".

Anonymous said...

Question about the Canadian mortgage market: how much do those of us, without mortgages, have to worry about impending economic doom? Would you put any more faith in the Canadian mortgage market than the American?

Ilargi said...


We're not facing a subprime crisis, or a mortgage crisis. They're there, of course, but focusing on them makes people blind to the fact that they are just symptoms, small facets, of a much larger credit crisis. Mortgages are nothing but the more or less accidental first phase to blow up.

And Canada will no more be spared any part of it than the US will, or France or Japan. There'll be differences in the reactions to the new found poverty in different parts of the world, but Canada looks assured to go wherever the US goes.

jim said...

Anyone have thoughts about what happens to Fannie and Freddie preferred stocks if the govt takes them over?