Wednesday, August 27, 2008

Debt Rattle, August 27 2008: Floating Rate Redemption

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J. Fred Huber Radio window, 1217 H Street NW in Washington
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Ilargi: The problems in the financial sector are about to become a lot bigger, and much more urgent. $500+ billion have been written down, and that was the easy part. The next $500 billion-$1.5 trillion will be far more hurtful. It's also inevitable.

I don’t know what shape they’ll all be in by Christmas, but it’s entirely possible that Wall Street four months from now will be hardly recognizable.

Every single one of the banks faces increasing and accumulating challenges, and it’s now impossible to even imagine that all of them will survive. On top of all the writedowns and losses that are still in the marked-to-fantasy pipeline, there are $100’s of billions in debt that need to be paid off and renewed.

This will result in steeply higher borrowing costs, and that is IF they can get access to loans. It will also lead to a whole new round, probably the biggest one by far to date, of asset fire sales.

But it’s by no means sure that they can find new credit, nor that they can find buyers for that next round of assets. Lehman Bros. is still out there looking for anyone that will give it a few pennies; no takers.

The FDIC may claim that it needs access to Treasury funds only to relieve "short-term cash-flow pressure", but the sign on the wall is clear. One large bank failure is now enough to shake the deposit insurance façade into a catatonic state.

The list of banks at risk of failure is all of a sudden 30% longer, but that in itself doesn’t even mean anything. If IndyMac can go beer-belly up without ever having made the list, anything goes.

The FDIC fund has shrunk to $45.2 billion. For comparison, the banks presently on the endangered list have $78 billion in deposits, while loans 90 days or more overdue soared 20%, to $162 billion, in just one quarter. Profits at FDIC member banks plunged 87%.

That is, if you believe they still make a profit at all. Which in these days of embellished statistics is a risky thing to do. Unemployment numbers "forget" to include people who have given up looking for work, just like housing stats ignore homes that have given up looking for a buyer.

Along those lines of logic, there’s little chance that the secret FDIC problem bank list would include the likes of Wachovia or Citigroup, if only because there’s no way deposits of that size could be guaranteed or handled by the agency. But that doesn’t mean these banks have given up looking for trouble.

New Credit Hurdle Looms for Banks
U.S. and European banks, already burdened by losses and concerns about their financial health, face a new challenge: paying off hundreds of billions of dollars of debt coming due.

At issue are so-called floating-rate notes -- securities used heavily by banks in 2006 to borrow money. A big chunk of those notes, which typically mature in two years, will come due over the next year or so, at a time when banks are struggling to raise fresh funds. That's forcing banks to sell assets, compete heavily for deposits and issue expensive new debt.

The crunch will begin next month, when some $95 billion in floating-rate notes mature. J.P. Morgan Chase & Co. analyst Alex Roever estimates that financial institutions will have to pay off at least $787 billion in floating-rate notes and other medium-term obligations before the end of 2009, about 43% more than they had to redeem in the previous 16 months.

The problem highlights how the pain of the credit crunch, now entering its second year, won't end soon for banks or the broader economy. The Federal Deposit Insurance Corp. said on Tuesday that its list of "problem" banks at risk of failure had grown to 117 at the end of June, up from 90 at the end of March.

FDIC Chairman Sheila Bair said her agency might have to borrow money from the Treasury Department to see it through an expected wave of bank failures. She said the borrowing could be needed to handle short-term cash-flow pressure brought on by reimbursements to depositors after bank failures.

As banks scramble to pay the floating-rate notes, they could see profit margins shrink as wary investors demand higher interest rates for new borrowings. They're also likely to become less willing to make new loans to consumers and companies, aggravating economic downturns in both the U.S. and Europe.

"It's going to be a bigger problem now than it was in the first half of this year, but it's going to continue on for probably at least a nine-month period," said Guy Stear, credit strategist at Société Générale SA in Paris. By the end of this year, big banks and investment banks such as Goldman Sachs Group Inc., Merrill Lynch & Co, Morgan Stanley, Wachovia Corp., and U.K. lender HBOS PLC must each redeem more than $5 billion in floating-rate notes, according to a recent report from J.P. Morgan.

Other big lenders such as General Electric Co., Wells Fargo & Co. and Italy's UniCredit Group also face big bills in coming months, the report says. Representatives of the banks said they're fully able to meet their floating-rate note obligations, either because they've already lined up the necessary funds or because they have ample customer deposits they can tap.

The rates they'll have to pay if they want to issue new debt will be much higher than they were back in 2006. In July 2007, the interest rates on banks' floating-rate notes were only about 0.02 percentage point above the London interbank offered rate, or Libor, a benchmark meant to reflect the rates at which banks lend to one another. Today, that "spread" is at least two full percentage points for some banks.

As many banks compete for funds to pay off their borrowings, or sell assets to raise cash, their actions could exacerbate strains in financial markets. Banks that turn to shorter-term loans will have to renew their borrowings more frequently, increasing the risk that they won't be able to get money when they need it.

The difficulties with the floating-rate loans can be traced to the onset of the credit crunch last year. At the time, bank-affiliated funds known as structured investment vehicles, or SIVs, were among the first to suffer. Those funds had been buyers of the banks' floating-rate notes. But when SIVs were unable to find investors for their own short-term debt, the SIV market largely collapsed, taking a big chunk out of demand for new bank floating-rate notes.

Most of the floating-rate notes are denominated in dollars. But redemptions of notes denominated in euros also loom for European and U.S. banks. In the final four months of this year, some €15 billion to €20 billion will come due every month, says Mr. Stear, the Société Générale strategist. That compares with some €7 billion to €15 billion that came due every month in the first half of 2008.

The crunch comes as problems in the markets on which banks rely to borrow money are showing no sign of abating. In one gauge of jitters about banks' financial health, the three-month dollar Libor remains well above expected central-bank target rates for the same period.

Even at the higher interest rates, banks are having a hard time getting cash. The securitization markets that had allowed banks to repackage loans and sell them to investors remain all but shut. Banks today rarely make loans to one another for periods of more than a week, and even some so-called "repo" loans -- in which the borrower puts up securities as collateral -- are becoming more expensive.

At the same time, the pressures on limited resources of banks and investment banks are growing. Companies have been actively tapping bank credit lines set up before the credit crisis began, forcing banks to increase their lending at a time when they're trying to reduce risk.

A number of big financial firms, including Citigroup Inc., Merrill Lynch, UBS AG, Morgan Stanley, J.P. Morgan, and Wachovia, have agreed to buy back some $42 billion of so-called auction-rate securities amid allegations that they misinformed retail investors about the securities' risks.

All the strains have made financial institutions increasingly dependent on central banks in the U.S., the U.K. and Europe for loans to make ends meet. Many banks have been packaging mortgages into securities to use as collateral for financing from the European Central Bank and the U.S. Federal Reserve. Questions are cropping up about how long central bankers should prop up financial markets, and whether banks in Europe are taking undue advantage of the central bank's lending facilities.

To be sure, some banks are finding plenty of buyers for new debt. In July, Spain's Banco Santander SA sold €2 billion of fixed-rate debt -- an issue that was increased from €1.5 billion because of investor demand. In July the bank also increased the amount of short-term IOUs, known as commercial paper, it could sell to €25 billion, from €15 billion.

If it sells the paper to pay off longer-term notes, that would significantly increase the frequency at which it would have to renew large chunks of its borrowings. A Santander spokesman said the bank is comfortable with its ability to meet its obligations. Some institutions, such as Morgan Stanley in New York, are issuing new debt months ahead of major redemptions to ensure they have the money when they need it.

In June, when Morgan Stanley reported second-quarter results for the period ended May 31, finance chief Colm Kelleher told investors that the investment bank had tapped the bond market to cover fiscal 2008 debt, meaning the firm didn't have to use company cash. Those bond proceeds also could be used to pay more than $1 billion coming due in December, when the firm's 2009 fiscal year starts.

UniCredit and San Francisco-based Wells Fargo said they had set aside money for the redemptions. HBOS said the debt repayment is "business as usual." A Goldman spokesman said that the firm is focused on using long-term debt, and that Goldman is comfortable with its funding. A General Electric spokesman said the company has access to multiple lending markets and has completed 83% of its 2008 funding goal.

Other firms, such as Merrill Lynch in New York and Wachovia in Charlotte, N.C., have said they can tap customer deposits. Merrill, one of those worst hit by write-downs tied to mortgage-loan securities, has increasingly focused on developing its bank unit, which had $101 billion of deposits as of June 27, compared with $82 billion a year earlier.

A spokeswoman for Wachovia, which was hit by losses tied to the acquisition of California lender Golden West Financial Corp., said that 55% of the bank's balance sheet is funded by core deposits and that the bank has the ability to "seamlessly handle the refinancing of short-term debt maturities as a result of our prudent liquidity planning."

FDIC Weighs Tapping Treasury as Funds Run Low
Federal Deposit Insurance Corp. Chairman Sheila Bair said Tuesday her agency might have to borrow money from the Treasury Department to see it through an expected wave of bank failures.

Ms. Bair said the borrowing could be needed to cover short-term cash-flow pressures caused by reimbursing depositors immediately after the failure of a bank. The borrowed money would be repaid once the assets of that failed bank are sold.

The last time the FDIC borrowed funds from Treasury came at the tail end of the savings-and-loan crisis in the early 1990s after thousands of banks were shuttered. That the agency is considering the option again, after the collapse of just nine banks this year, illustrates the concern among Washington regulators about the weakness of the U.S. banking system in the wake of the credit crisis.

"I would not rule out the possibility that at some point we may need to tap into [short-term] lines of credit with the Treasury for working capital, not to cover our losses, but just for short-term liquidity purposes," Ms. Bair said in an interview. Ms. Bair said such a scenario was unlikely in the "near term."

She said she did not expect the FDIC to take the more dramatic step of tapping a separate $30 billion credit line with Treasury, which has never been used. The FDIC said Tuesday its "problem" list of banks at risk of failure had grown to 117 at the end of June, compared with 90 at the end of March.

The FDIC's deposit insurance fund reimburses depositors who lost money in a bank failure, typically up to $100,000. The fund's balance fell in the second quarter to $45.2 billion. That is just 1.01% of all insured deposits, low by historical standards.

The biggest dent came from the July 11 failure of IndyMac Bank, which the agency now says is expected to cost $8.9 billion. Previously it had said losses would be between $4 billion to $8 billion.

In another move to bolster the insurance fund, Ms. Bair said the agency will propose in October charging higher premiums to thousands of U.S. banks. These contributions are one of the fund's major sources of income. The FDIC has been wrestling with how much to raise the fees because the extra expense would put stress on already struggling financial institutions.

Ms. Bair said the agency could charge higher premiums to banks that rely on high-risk deposits to fuel growth or have an "excessive reliance" on secured funding, such as advances from one of the 12 federal home-loan banks. Banks with less risky profiles would still likely have to pay more, but she said their fees shouldn't increase as much as high-risk banks. "We should reward behavior that reduces our costs," Ms. Bair said.

The FDIC was created during the Great Depression, and in 1990 it received the authority to borrow short-term funds from Treasury. It tapped that facility in 1991 and by June 1992 had accumulated loans of $15.1 billion. The money was repaid by August of the following year. This is just one of the sources of funding available to the FDIC, ensuring it can always pay depositors.

This time around, the FDIC would use the funds to bridge the gap between paying depositors and selling a bank's assets, which can take several years in the worst cases. In the FDIC's quarterly review, issued Tuesday, the agency unveiled a litany of data that shows banks reeling under the pressure of bad loans. It said the U.S. banking industry reported net income of $5 billion in the second quarter, the second-lowest level since the end of 1991.

Also, the amount of loans and leases banks wrote off entirely jumped in the quarter to $26.4 billion, the highest level since 1991. The percentage of "noncurrent" loans and leases -- such as those more than 90 days past due -- hit 2.04% at the end of the second quarter, the highest level since 1993.

Firms set aside $50.2 billion to cover such loans, more than four times the amount of a year ago. Still, the FDIC said the reserves weren't keeping pace with higher delinquencies.

FDIC’s Banks 'Problem List' Rose 30% in Quarter, More to Come
The U.S. Federal Deposit Insurance Corp. said its "problem list" of banks increased 30 percent in the second quarter to the highest total in five years as more commercial real-estate loans were overdue.

The list had 117 banks as of June 30, up from 90 in the first quarter and the highest since mid-2003, the agency said today in its quarterly report without naming any institutions. FDIC-insured lenders reported net income of $4.96 billion, down 87 percent from $36.8 billion in the same quarter a year ago.

"More banks will come on the list as credit problems worsen," FDIC Chairman Sheila Bair said at a news conference in Washington. Regulators are adding to the list as bank assets, liquidity and other fiscal measures weaken. Nine banks have failed this year, including California-based mortgage lender IndyMac Bancorp Inc., which the FDIC is running as a successor institution, IndyMac Federal Bank FSB.

IndyMac's failure will cost the U.S. deposit insurance fund about $8.9 billion, exceeding a $4 billion to $8 billion estimate, said Diane Ellis, the associate director of financial- risk management. The FDIC discovered additional insured deposits and had time to value the assets, Ellis said.

Second-quarter earnings fell from $19.3 billion in the previous quarter, driven by higher provisions for loan losses, the FDIC said. It was the second-lowest net income reported since the fourth quarter of 1991 behind the $600 million reported in the fourth quarter of 2007, the agency said.

"The results were pretty dismal, and we don't see a return to the high earnings levels of previous years any time soon," Bair said. Funds set aside by banks to cover loan losses more than quadrupled to $50.2 billion from $11.4 billion in the year- earlier quarter.

Loans 90 days or more overdue, deemed troubled by the FDIC, jumped 20 percent to $162 billion from $136 billion in the first quarter, the FDIC said. Real-estate loans accounted for almost 90 percent of the rise in the past three quarters, the agency said. The deposit insurance fund fell 14 percent to $45.2 billion and the reserve ratio, or balance divided by insured deposits, was 1.01 percent. The FDIC is required to shore up the fund when the ratio falls below 1.15 percent.

The agency in October will consider a plan to replenish the account that will likely include an increase in the premiums charged banks, Bair said. A greater share of the increase will be shifted to "riskier institutions so that safer institutions won't be unduly burdened," she said.

Lenders on the "problem list" had assets of $78.3 billion at the end of the second quarter, triple the $26.3 billion in the first quarter, the agency said. The FDIC said IndyMac's assets represented $32 billion of the increase. Many banks on the list have high levels of commercial real- estate loans, especially in construction and development loans, said John Corston, the FDIC's associate director of large bank supervision.

The number of problem institutions will continue to rise, he said. "Problem institutions continue to be scattered across the country," Corston said. "However, we expect to see some migration to areas experiencing the greatest stress." Regulators rate banks based on their asset quality, earnings, liquidity and other fiscal measures.

FDIC says IndyMac failure costlier than expected
A U.S. banking regulator said the failure of mortgage lender IndyMac Bancorp Inc will deliver a bigger blow to its insured deposit fund than originally expected.

The Federal Deposit Insurance Corp said on Tuesday it now expects IndyMac's failure in July to cost its insurance fund $8.9 billion, compared with the previous expected range of $4 billion to $8 billion. The FDIC also said during its quarterly bank briefing that it will soon start widely marketing IndyMac's assets.

"We hope to market it certainly in the third quarter," FDIC Chairman Sheila Bair told a news conference. "I think we're going to be marketing it both as a whole bank as well as in pieces." Nine U.S. banks have failed this year, including IndyMac, which became the third-largest U.S. bank failure ever.

It was one of the 117 problem banks on the FDIC's second-quarter watch list of institutions with financial, operational or managerial weakness that threaten their financial viability. IndyMac accounted for $32 billion of the combined $78 billion in assets of problem banks on the FDIC's watch list.

The FDIC said its Deposit Insurance Fund fell in the second quarter to $45.2 billion, down from $52.8 billion at the end of the first quarter, due to an increase in bank failures. The agency oversees the industry-funded reserve used to insure up to $100,000 per deposit and $250,000 per individual retirement account at insured banks.

Diane Ellis, the FDIC's associate director of financial-risk management, said IndyMac's expected hit to the fund blossomed because analysts have had more time to value IndyMac's assets and have assigned some higher loss rates.

Also, some deposits that the FDIC originally thought were uninsured are actually insured, Ellis said.
The FDIC also said on Tuesday the decline in the insurance fund's balance caused the reserve ratio to fall to 1.01 percent as of June 30, from 1.19 percent the prior quarter.

Because the reserve ratio -- the fund's balance divided by the insured deposits -- fell below 1.15 percent, the FDIC is forced to develop a restoration plan to replenish the fund. The FDIC will consider such a plan in early October, it said, which will likely force banks that engage in riskier activities to pay more into the fund than other U.S. banks.

Bail-out of Fannie Mae and Freddie Mac should be last resort
The US Treasury should only take direct control of ailing mortgage giants Fannie Mae and Freddie Mac as a last resort, according to a detailed report on the pending fate of the pair written by Goldman Sachs.

The report - from the bank which US Treasury Secretary Hank Paulson led until May 2006 - argues that there are a number of steps the US government could take before taking full control of the pair. But the Goldman note, penned by US economist Alec Phillips, states that in spite of some of the doomsday scenarios in the public arena, aggressive government intervention should only be a last option.

If either of the pair's capital were to fall below the required level, Mr Phillips states that it "would put more pressure on the Treasury to explicitly back the liabilities of the GSEs". Mr Phillips sets out five different options for the US Treasury - ranging from "take no action" to a "more explicit government guarantee" - and argues that "the Treasury would opt for one of the earlier options to avoid" the government guarantee option.

The other possible suggested options include buying mortgage-backed securities, therefore buying the debt of Fannie and Freddie, as well as easing the capital requirements of the pair. Shares in the two mortgage giants rebounded somewhat, with Fannie 27 cents higher at $5.46 and Freddie Mac 57 cents at $3.86, in partial response to the Goldman note.

The companies' shares were also bolstered by a report from Citigroup analyst Brad Ball, who said the pair could withstand losses up until the end of the year.

But the marginal rebound looks unlikely to be enough for JP Morgan Chase, headed by Jamie Dimon, which disclosed it is facing a $600m-plus write-down on the value of its holdings in the preferred stock of the pair as their values continue to sink. JP Morgan held about $1.2bn of Fannie and Freddie's perpetual preferred stock and said it has lost some $600m in the current quarter.

Goldman sees options before Fannie, Freddie takeover
The U.S. Treasury Department could take several steps to buttress Fannie Mae and Freddie Mac before taking direct take control of the mortgage finance companies, according to a report released by Goldman Sachs on Tuesday.

Last month, the Treasury agreed to lend the companies money or give them a capital injection if either were to face collapse, and Wall Street has lately shunned the companies for fear that such a bailout would damage existing shareholders.

In a research note that outlined several scenarios for government aid, Goldman Sachs stated that an aggressive government intervention was a last option.If either company's capital were to dip below its required level, the report states that it "would put more pressure on the Treasury to explicitly back the liabilities of the GSEs."

Still, the report states, "the Treasury would opt for one of the earlier options to avoid such an outcome."
Common shares of the government-sponsored enterprises have sunk in recent days and even their relatively safe preferred shares have lost value as investors have turned their backs on Fannie Mae and Freddie Mac.

The Goldman report states that the Treasury might stand aside and hope that companies find their own footing. If the Treasury does intervene, it might first choose to ease capital demands on the two companies since many investors fret that Fannie Mae and Freddie Mac are bound to dip below the capital levels set by regulators.

If Treasury deems that the situation is worsening, it might either buy mortgage securities from the GSEs or directly inject capital. While any government intervention would likely cost the taxpayer money, the Goldman report states that any scenario for intervention "would be an entirely management event in the context of the federal budget."

How Long Can The Fed Last?
Cumberland Advisors has an interesting chart showing declining securities at the Fed.

Factors Adding to Reserves and Off Balance Sheet Securities Lending Program

click to enlarge

At the current pace, the Fed runs out of treasuries about a year from now. Things are about to get very interesting.

S&P Lowers Fannie Mae Ratings
Standard & Poor's Ratings Services lowered its preferred-stock and subordinated debt ratings on mortgage giant Fannie Mae, reflecting increased uncertainty about whether government support will extend to those securities in the event of further deterioration of the company's mortgage portfolio.

The moves mark the latest blow to the ailing mortgage giant and add to the worries of shareholders, who have been fretting ever since Congress last month gave the Treasury authority to make loans to Fannie Mae or smaller rival Freddie Mac or buy shares in them.

In cutting its preferred stock rating three notches to BBB- and its subordinated debt rating by one notch to BBB+, the ratings agency noted the long duration of the weak housing market and the rising severity of residential mortgage losses are driving credit costs higher and Fannie Mae's operating earnings lower. Both ratings indicate below-average credit quality.

The agency also reaffirmed Fannie Mae's AAA senior unsecured debt rating. S&P had warned about the potential for downgrades last month, while rival ratings firm Fitch Ratings cut Fannie Mae's preferred stock rating one notch to A+ and said more cuts were possible.

Last week, Moody's Investors Service also slashed its preferred-stock ratings for Fannie Mae and Freddie Mac to just above junk status as it increasingly expects the Treasury Department to directly support the firms "in an effort to thwart broader negative economic effects."

S&P further noted on Tuesday it expects peak mortgage losses to occur in 2009 at a level that could require further capital raising to maintain the cushion above the regulatory requirements and the company is facing more challenging market conditions to raise cost-effective capital.

In addition, S&P said the subordinated notes pose risk to investors because of an interest deferral feature with a trigger tied to Fannie Mae's regulatory capital levels that also states that a deferral of the subordinated-debt interest payment triggers the nonpayment of all preferred and common stock dividends.

During the past four quarters, Fannie and Freddie have posted combined losses of about $14 billion, eating deeply into their relatively meager capital holdings. Losses are turning out worse than generally forecast largely because home prices have fallen more steeply than expected. That means Fannie and Freddie recoup less money from sales of foreclosed homes.

The two companies acquire home loans from lenders and package them into securities. They keep some of those securities and sell the rest to other investors, earning fees for guaranteeing payments on those securities.

Abu Dhabi bank sues Morgan Stanley, Bank of New York Mellon,Moody’s and S&P over SIV fraud
A United Arab Emirates bank said on Tuesday it expected other Gulf Arab investors to back a lawsuit it has filed against major U.S. financial institutions over a fund that collapsed in the U.S. credit crisis.

Abu Dhabi Commercial Bank, which is majority owned by the Abu Dhabi government, filed a suit against Morgan Stanley, the Bank of New York Mellon and ratings agencies Moody’s and S&P on Monday, accusing them of fraud, the lawsuit showed. The lawsuit filed in U.S. district court in Manhattan said a complex deal known as the Cheyne Structured Investment Vehicle (SIV) was marketed by the defendants as highly rated and reliable, but that they had hidden the risks.

ADCB said in a statement on Tuesday it had also held talks with other banks and investors in the six-member Gulf Cooperation Council about joining its class action and expected more investors to either join or support the case. It did not name the other investors.

“This is the next step in a process aimed at recouping the losses ADCB has already incurred, and additionally, this is an important step in paving the way for other GCC investors to ensure they are provided an opportunity to recover their own losses,” ADCB Chief Executive Officer Eirvin Knox said. “ADCB has taken a proactive early lead to protect itself and other investors.”

SIVs, which once held some $350 billion in assets, have played a major role in the U.S. credit crisis, after proving unable to refinance their short-term debts. A series of SIVs are now selling off bank debt and assets such as asset-backed securities to try to pay back investors, a move that many see as further pressuring credit markets.

A deal was announced last month to restructure Cheyne, which at receivership was a $7 billion fund. A spokeswoman for Morgan Stanley and a spokesman for Bank of New York Mellon in the United States declined to comment on Monday. A spokesman for S&P parent McGraw-Hill declined comment on Monday, saying the company had not yet been served with the complaint. A spokesman for Moody’s was not immediately available for comment at the time.

SIVs used short-term funding, such as asset-backed commercial paper, to buy longer-term assets such as bank debt and asset-backed securities. The bank brought the action on behalf of all investors who bought investment grade Mezzanine Capital Notes issued by Cheyne Finance and its wholly owned subsidiary Cheyne Finance Capital Notes from October 2004 to October 2007.

Record drops in U.S. home prices continue
Although U.S. home prices fell faster than ever in the second quarter, the rate of acceleration slowed in June, according to a closely watched index released Tuesday. Experts hailed the slight deceleration as a harbinger of an eventual recovery in the dismal real estate market.

The Standard & Poor's/Case-Shiller U.S. National Home Price Index plunged by double digits in the second quarter, falling a record 15.4 percent compared with the previous year. The index covers all nine U.S. census divisions. A 10-city composite index fell a record 17 percent, while a 20-city index fell 15.9 percent, also a record.

However, observers seized upon a sliver of good news: Those indexes posted a rate of decline for June that was only slightly more than the May decline of 16.9 percent and 15.8 percent, respectively. "I consider it good news that you're seeing price declines decelerate," said Terrin Griffiths, economist and industry analyst with the California and Nevada Credit Union League.
"While the markets haven't reached bottom, we're getting closer to there."

Maureen Maitland, vice president of index services at New York's Standard & Poor's, which publishes the indexes, concurred. "You need to see something slow down before it turns back up," she said. Still, she added: "We cannot declare that we've hit the bottom and are on our way back up."

Another positive sign: Nine of the 20 regions tracked showed slight month-to-month increases in June. In comparison, six months ago, every single region was in negative territory on both a month-to-month and year-to year basis. "Boston and Denver's monthly increases were in excess of 1 percent, and both were up three consecutive months," Maitland said. "Charlotte (N.C.) and Dallas were both up for four consecutive months."

The San Francisco metropolitan region did not share in that positive news; in fact, it was among seven regions in the country where prices fell more than 20 percent. Case-Shiller uses the U.S. Census Bureau definition of the area, counting it as the counties of Alameda, Contra Costa, Marin, San Francisco and San Mateo. Prices in that broadly defined region have fallen about 27 percent during the past two years. Prices in June were down 23.7 percent compared with a year ago.

"It is still the case that California metro areas are among the worst in the country," said Jed Kolko, a research fellow at the Public Policy Institute of California. "The situation is essentially as bad as in Las Vegas, Phoenix and Miami." And that's even though Case-Shiller only tracks three regions within California - San Francisco, Los Angeles and San Diego - omitting some of the hardest-hit areas, such as Stockton.

While lumping counties beleaguered by foreclosures, such as Contra Costa and Alameda, in with the relatively stable markets of San Francisco, Marin and San Mateo, does not give a truly detailed snapshot of the region, Maitland said it fulfills the index's mandate of providing a broad picture of metropolitan areas as well as a comprehensive snapshot of the nation as a whole.

Kolko cautioned that no single report gives a complete snapshot of the market. Case-Shiller calculates changes by comparing the sales price with previous sales prices for the exact same home, generally considered the most reliable method. But the current preponderance of bargain-price foreclosures being sold drags down the numbers.

"The index doesn't necessarily tell you what has happened to the value of your average home that did not sell," Kolko said. "It is really affected by the characteristics of those homes that are actually selling." Also on Tuesday, the Office of Federal Housing Enterprise Oversight released a report based on repeat sales of homes mortgaged through Fannie Mae and Freddie Mac. It showed that home prices fell a seasonally adjusted 1.4 percent in the second quarter, a slower decline than 1.7 percent in the first quarter.

OFHEO shows the price decline for the past year as a record 4.8 percent. It tracks a smaller - and healthier - market segment than Case-Shiller because Fannie and Freddie deal only with conforming loans and had stricter underwriting than the subprime loans now rampantly going into foreclosure. For instance, borrowers had to show proof of income.

The borrowers whose homes are tracked by OFHEO "had to have all their I's dotted and t's crossed so they didn't have some of the (problems) we've seen in the broader market," Griffiths said.

Fidelity hit hard by Fannie, Freddie downfall
FMR LLC, the parent of Fidelity Investments, held more than $1.5 billion in the common stock of Freddie Mac and Fannie Mae before their shares plunged in recent weeks, leaving the mutual fund giant with large potential losses.

FMR held 22.39 million shares of Freddie Mac that were worth $367.2 million at the end of June, according to recent regulatory filings. The stock was then trading at $16.40 a share, but on Tuesday morning Freddie shares were trading at $4.05 a share. FMR was Freddie’s 11th largest institutional shareholder, Securities and Exchange Commission filings show.

FMR was the fifth largest shareholder in Fannie Mae at the end of June when it held 60.29 million shares worth $1.18 billion. The Fannie stock, then trading at $19.51 a share, was at $6 Tuesday morning.

At the end of June, Fannie’s largest three institutional investors were Axa (134.3 million shares), Capital Research Global Investors (116.9 million shares) and mutual fund Dodge & Cox (69.4 million shares), SEC filings show.

Freddie Mac’s largest three institutional investors were Capital Research (64.9 million shares), Legg Mason (53.3 million shares) and Axa (41.1 million shares), SEC filings show. Fidelity Investments operates a regional center in Covington, with more than 2,900 employees. Another 900 work at a call center in Blue Ash.

Auction Rate Securities Inquiry Looks at Fidelity-Goldman Ties
The New York attorney general's office is probing the relationship between Fidelity Investments and Goldman Sachs Group Inc. as part of its investigation into Fidelity's sale of auction-rate securities to individual investors, according to a person familiar with the investigation.

Investigators are looking at whether Fidelity's relationship with Goldman may have given Fidelity an incentive to sell the instruments, also called ARS's, this person said. The attorney general started focusing on the relationship after it learned that most of the auction-rate securities sold by Fidelity were underwritten by Goldman, this person said.

In recent months, many retail investors have been unable to cash out of auction-rate securities, debt instruments that some brokers compared to safe, easy-to-sell money-market funds. New York, Massachusetts and other states have been conducting a widespread investigation of the market.

Goldman declined to comment on the probe. Anne Crowley, spokesman for Fidelity, the Boston mutual-fund titan, said she wouldn't comment on a regulatory issue, but added, "There was no incentive for Fidelity to promote auction-rate securities." She said 600 Fidelity accounts held the auction-rate securities.

The attorney general's office is probing whether Fidelity may have marketed Goldman-underwritten ARS's because it was getting other services from the investment bank, said a person familiar with the matter. This person said the services include possible Goldman underwriting of private offerings that Fidelity develops for "accredited," or wealthy, investors, and financial-counseling services that Goldman's Ayco unit provides to Fidelity executives.

Fidelity's Ms. Crowley said she didn't know whether Goldman had underwritten any private offerings for Fidelity. She said Fidelity's relationship with Ayco predates Goldman's purchase of that company in 2003. Wall Street firms sold some $330 billion in auction-rate securities before the market collapsed in February, when Wall Street firms stopped supporting it with their own bids, leaving customers unable to cash out.

Regulators have been forcing Wall Street firms to repay customers. So far, a variety of firms have agreed to buy back $50 billion of the securities, and to pay $525 million in penalties. Last week, in a settlement with regulators representing 49 states, Goldman agreed to a $1.5 billion buyback from retail investors, and to pay a $22.5 million penalty to states. No firms have admitted wrongdoing in the settlements.

Goldman's agreement does not cover customers who bought auction-rate securities from Fidelity. Massachusetts's top regulator, William F. Galvin, has called on Fidelity to buy back all the securities it sold.

In a response to Mr. Galvin, Fidelity President Rodger Lawson said companies that underwrote the securities and oversaw the auction process should be "held responsible to provide liquidity for all purchasers of auction-rate securities, not just their own customers." The letter did not mention Goldman. Goldman declined to comment on the letter. Mr. Lawson's letter said that only a "very small percentage of investors bought auction-rate securities from Fidelity."

Ilargi: Apparently, most questions in the ARS/Cuomo issue center around the fact that larger investors haven’t been promised their money back.

But that’s not my question, and neither is it Mike Morgan’s. We would like to know why Cuomo settles for slap-on-the-wrist fines in what he himself has labeled fraud cases, and why he lets the banks and their employees get away with that fraud without admitting their guilt.

Those are far more interesting questions.

The ARS saga: Wider and wider….
There’s no stopping him: the office of New York attorney general Andrew Cuomo is now probing the relationship between Fidelity Investments and Goldman Sachs as part of its investigation into the sale of auction-rate securities, the Wall Street Journal reports. The implications of this latest widening of Cuomo’s investigation are significant.

As the FT noted last Friday, Cuomo is already investigating the role of brokerages that sold the offending securities, including Fidelity, Charles Schwab, TD Ameritrade, E-Trade Financial and Oppenheimer, as well as underwriters including Bank of America.

But the fresh angle is the examination of whether Fidelity’s relationship with Goldman may have given Fidelity “an incentive” to sell the instruments to individual investors, according to the Journal. The investigators began focusing on the relationship after learning that most of the ARS sold by Fidelity were underwritten by Goldman.

The question, according to the Journal, is whether Fidelity may have marketed Goldman-underwritten ARS because it was getting other services from the investment bank, including possible underwriting of private offerings that Fidelity develops for “accredited,” or wealthy, investors, and financial-counselling services that Goldman’s Ayco unit provides to Fidelity executives.

A Fidelity spokesman wouldn’t comment on regulatory issues, but she did tell the Journal that Fidelity’s relationship with Ayco predates Goldman’s purchase of that company in 2003, and that 600 Fidelity accounts held the auction-rate securities. Oh, and there was “no incentive for Fidelity to promote auction-rate securities,” she added. Wall Street firms sold some $330bn in ARS before the market collapsed in February, when banks stopped supporting the market with their own bids, leaving customers unable to cash out.

So far, a mini “who’s who” of Wall Street firms, including Citigroup, JP Morgan Chase, Merrill Lynch, Morgan Stanley, UBS, Wachovia, Goldman Sachs and Deutsche Bank, have agreed to repay - mainly retail - customers on their ARS investments.
In a key settlement, Merrill, Deutsche Bank and Goldman agreed to buy back $50bn of the securities, and to pay $525m in penalties.

Last week, in a settlement with regulators representing 49 states, Goldman agreed to a $1.5bn buyback from retail investors, and to pay a $22.5m penalty to states. Goldman’s agreement does not cover customers who bought ARS from Fidelity, notes the Journal, adding that Massachusetts’s top regulator, William F. Galvin, has called on Fidelity to buy back all the securities it sold.

No firms have admitted wrongdoing in the settlements, a fact that commentator Dan Solin on Huffingtonpost describes as “lawyer speak for permitting them to defend private lawsuits by third parties who would otherwise be entitled to use the settlement as evidence of liability”.
This escape hatch is meaningful, because the settling defendants have agreed to purchase back only ARS sold to their clients. Why not do the right thing and purchase back all the ARS that were sold to all investors who were harmed because these firms perpetuated the myth of a legitimate auction?

These investors, who make up the bulk of the $330bn ARS market, will need to prove their claims in private arbitration proceedings, before industry panels, where they are unlikely to be awarded any meaningful damages.

Solin’s response is similar to other commentary in the blogosphere - although the reasons for criticism range from outrage about the “little guy” to the kind of criticism from Risk News, which complains in a (subscription only) comment that Merrill’s deal, just like Goldman’s, “leaves the larger purchasers uncovered”. Inevitably, the probe, as it widens and becomes uglier, promises to yield something for everyone to bitch and moan about.

US retail space gets mauled by slowdown
A rash of bankruptcy filings by major retail chains and planned store closings by a host of others have property owners scrambling to negotiate lease-termination deals and find tenants that will bring in traffic for the holiday shopping season.

The International Council of Shopping Centers expects that nearly 144,000 stores will close their doors by the end of 2008, a 7% increase over last year. “Property owners should brace for rougher times ahead,” said Lawrence Yan, chief economist with the National Association of Realtors. “They may see lower rents, and they will have more trouble leasing vacant properties.”

Among the high-profile bankruptcies leaving stores vacant are mid-priced department stores Mervyn's and Steve & Barry's; specialty retailer Sharper Image; Linens "n Things; and casual-dining chain Bennigan's. While not every store owned by a bankrupt chain will close its doors, companies are asking for lower rents and other concessions as part of their reorganization plans.

Property owners are hearing bad news even from companies far from bankruptcy, such as ubiquitous coffee chain Starbucks, which in July announced plans to shutter 600 stores by the first half of 2009. Ann Taylor and Talbots have also told investors this year that they'll be closing underperforming branches.

The vacancy rate for U.S. neighborhood and community shopping centers spiked in the second quarter to 8.2%, a 50-basis-point increase over the previous quarter and the highest rate since 1995, according to real estate research firm Reis. Regional and super-regional mall vacancy rates increased 40 basis points during the quarter, to 6.3%, the highest level since 2002.

As shopping centers lose large anchors like Mervyn's and chief traffic drivers like Starbucks, smaller tenants are seeing their sales drop along with the number of shoppers frequenting the malls, said Gary Glick, retail development practice chair at the law firm Cox Castle & Nicholson.

“The smaller tenants are all approaching developers and telling them that they're not doing well, and they need rent relief,” Mr. Glick said. “Some developers are working with them, and some aren't.”

The retail outlook has contributed to the decline in retail property prices, already suffering from the credit crunch. Retail property prices fell 7.7% in the second quarter, compared with the same period in 2007, according to the Moody's/REAL commercial property price index.

“If you are an investor that doesn't have to spend, you are sitting on the sidelines waiting for prices to soften even more,” said Bernard Haddigan, senior vice president and managing director of the national retail group at Marcus & Millichap Real Estate Investment Services.

Mr. Haddigan expects another surge in retail bankruptcies in the spring, following the dismal holiday shopping season predicted by many retailers. “I think we're going to see continued softening,” he added. “I don't see any reason this would turn around before the summer of '09.”

Ilargi: Don’t look now, but your entire community is being sold off. Good luck with that democracy.

Running Out of Money, Cities Are Debating the Privatization of Public Infrastructure
Cleaning up road kill and maintaining runways may not sound like cutting-edge investments. But banks and funds with big money seem to think so.

Reeling from more exotic investments that imploded during the credit crisis, Kohlberg Kravis Roberts, the Carlyle Group, Goldman Sachs, Morgan Stanley and Credit Suisse are among the investors who have amassed an estimated $250 billion war chest — much of it raised in the last two years — to finance a tidal wave of infrastructure projects in the United States and overseas.

Their strategy is gaining steam in the United States as federal, state and local governments previously wary of private funds struggle under mounting deficits that have curbed their ability to improve crumbling roads, bridges and even airports with taxpayer money. With politicians like Gov. Arnold Schwarzenegger of California warning of a national infrastructure crisis, public resistance to private financing may start to ease.

“Budget gaps are starting to increase the viability of public-private partnerships,” said Norman Y. Mineta, a former secretary of transportation who was recently hired by Credit Suisse as a senior adviser to such deals. This fall, Midway Airport of Chicago could become the first to pass into the hands of private investors.

Just outside the nation’s capital, a $1.9 billion public-private partnership will finance new high-occupancy toll lanes around Washington. This week, Florida gave the green light to six groups that included JPMorgan, Lehman Brothers and the Carlyle Group to bid for a 50- to 75 -year lease on Alligator Alley, a toll road known for sightings of sleeping alligators that stretches 78 miles down I-75 in South Florida.

Until recently, the use of private funds to build and manage large-scale American infrastructure assets was slow to take root. States and towns could raise taxes and user fees or turn to the municipal bond market.
Americans have also been wary of foreign investors, who were among the first to this market, taking over their prized roads and bridges.

When Macquarie of Australia and Cintra of Spain, two foreign funds with large portfolios of international investments, snapped up leases to the Chicago Skyway and the Indiana Toll Road, “people said ‘hold it, we don’t want our infrastructure owned by foreigners,’ ” Mr. Mineta said.

And then there is the odd romance between Americans and their roads: they do not want anyone other than the government owning them. The specter of investors reaping huge fees by financing assets like the Pennsylvania Turnpike also touches a raw nerve among taxpayers, who already feel they are paying top dollar for the government to maintain roads and bridges.

And with good reason: Private investors recoup their money by maximizing revenue — either making the infrastructure better to allow for more cars, for example, or by raising tolls. (Concession agreements dictate everything from toll increases to the amount of time dead animals can remain on the road before being cleared.)

Politicians have often supported the civic outcry: in the spring of 2007, James L. Oberstar of Minnesota, chairman of the House Committees on Transportation and Infrastructure, warned that his panel would “work to undo” any public-private partnership deals that failed to protect the public interest.

And labor unions have been quick to point out that investment funds stand to reap handsome fees from the crisis in infrastructure. “Our concern is that some sources of financing see this as a quick opportunity to make money,” Stephen Abrecht, director of the Capital Stewardship Program at the Service Employees International Union, said.

But in a world in which governments view infrastructure as a way to manage growth and raise productivity through the efficient movement of goods and people, an eroding economy has forced politicians to take another look.

“There’s a huge opportunity that the U.S. public sector is in danger of losing,” says Markus J. Pressdee, head of infrastructure investment banking at Credit Suisse. “It thinks there is a boatload of capital and when it is politically convenient it will be able to take advantage of it. But the capital is going into infrastructure assets available today around the world, and not waiting for projects the U.S., the public sector, may sponsor in the future.”

Traditionally, the federal government played a major role in developing the nation’s transportation backbone: Thomas Jefferson built canals and roads in the 1800s, Theodore Roosevelt expanded power generation in the early 1900s. In the 1950s Dwight Eisenhower oversaw the building of the interstate highway system.

But since the early 1990s, the United States has had no comprehensive transportation development, and responsibilities were pushed off to states, municipalities and metropolitan planning organizations. “Look at the physical neglect — crumbling bridges, the issue of energy security, environmental concerns,” said Robert Puentes of the Brookings Institution. “It’s more relevant than ever and we have no vision.”

The American Society of Civil Engineers estimates that the United States needs to invest at least $1.6 trillion over the next five years to maintain and expand its infrastructure. Last year, the Federal Highway Administration deemed 72,000 bridges, or more than 12 percent of the country’s total, “structurally deficient.” But the funds to fix them are shrinking: by the end of this year, the Highway Trust Fund will have a several billion dollar deficit.

“We are facing an infrastructure crisis in this country that threatens our status as an economic superpower, and threatens the health and safety of the people we serve,” New York Mayor Michael R. Bloomberg told Congress this year. In January he joined forces with Mr. Schwarzenegger and Gov. Edward G. Rendell of Pennsylvania to start a nonprofit group to raise awareness about the problem.

Some American pension funds see an investment opportunity. “Our infrastructure is crumbling, from bridges in Minnesota to our airports and freeways,” said Christopher Ailman, the head of the California State Teachers’ Retirement System. His board recently authorized up to about $800 million to invest in infrastructure projects.

Nearby, the California Public Employees’ Retirement System, with coffers totaling $234 billion, has earmarked $7 billion for infrastructure investments through 2010. The Washington State Investment Board has allocated 5 percent of its fund to such investments.

Some foreign pension funds that jumped into the game early have already reaped rewards: The $52 billion Ontario Municipal Employee Retirement System saw a 12.4 percent return last year on a $5 billion infrastructure investment pool, above the benchmark 9.9 percent though down from 14 percent in 2006.

“People are creating a new asset class,” said Anne Valentine Andrews, head of portfolio strategy at Morgan Stanley Infrastructure. “You can see and understand the businesses involved — for example, ships come into the port, unload containers, reload containers and leave,” she said. “There’s no black box.”

The prospect of steady returns has drawn high-flying investors like Kohlberg Kravis and Morgan Stanley to the table. “Ten to 20 years from now infrastructure could be larger than real estate,” said Mark Weisdorf, head of infrastructure investments at JPMorgan. In 2006 and 2007, more than $500 billion worth of commercial real estate deals were done.

The pace of recent work is encouraging, says Robert Poole, director of transportation studies at the Reason Foundation, pointing to projects like the high-occupancy toll, or HOT, lanes outside Washington. “The fact that the private sector raised $1.4 billion for the Beltway project shows that even projects like HOT lanes that are considered high risk can be developed and financed privately and that has huge implications for other large metro areas,” he said .

Yet if the flow of money is fast, the return on these investments can be a waiting game. Washington’s HOT lanes project took six years to build after Fluor Enterprises, one of the two private companies financing part of the project, made an unsolicited bid in 2002. The privatization of Chicago’s Midway Airport was part of a pilot program adopted by the Federal Aviation Administration in 1996 to allow five domestic airports to be privatized.

Twelve years later only one airport has met that goal — Stewart International Airport in Newburgh, N.Y. — and it was sold back to the Port Authority of New York and New Jersey. For many politicians, privatization also remains a painful process. Mitch Daniels, the governor of Indiana, faced a severe backlash when he collected $3.8 billion for a 75- year lease of the Indiana Toll Road. A popular bumper sticker in Indiana reads “Keep the toll road, lease Mitch.”

Joe Dear, executive director of the Washington State Investment Board, still wonders how quickly governments will move. “Will all public agencies think it’s worth the extra return private capital will demand?” he asked. “That’s unclear.”

Goldman third-quarter outlook cut at Morgan Stanley
An analyst at Morgan Stanley cut his third-quarter outlook for Goldman Sachs Group Inc citing broad-based market weakness, but expects the market to look past a disappointing quarter if it found no evidence of a material breakdown in risk management.

Analyst Patrick Pinschmidt expects Goldman, the largest U.S. securities firm, to incur $1 billion in net residential and commercial mortgage write-downs, in addition to $500 million from its leveraged buyout portfolio.

"While Goldman Sachs is less exposed to mortgage write-downs, industry-wide decline in flow business coupled with vulnerability to equity market directionality stemming from principal investment activities has exacerbated exceedingly difficult market backdrop," Pinschmidt said.

He cut his third-quarter earnings outlook on Goldman to $1.65 a share from $3. According to Reuters Estimates, analysts on average expect the company to earn $2.62 a share.

Wall Street research analysts have been projecting yet another tough quarter for U.S. investment banks marked by additional writedowns across a series of fixed-income assets amid an already weak operating environment. Since the start of this month, analysts at least seven brokerages, including Merrill Lynch, Banc of America Securities and Bernstein, have cut their view for Goldman and Morgan Stanley.

At least four have forecast a quarterly loss for Lehman Brothers Holdings Inc. Pinschmidt maintained his "overweight" rating on the stock, saying Goldman shares "...undervalue prospect of significant return on equity outperformance over next 18 to 24 months."

Pimco Seeks as Much as $5 Billion for Distressed Debt
Pacific Investment Management Co., the biggest manager of bond funds, is seeking as much as $5 billion to buy mortgage-backed debt that plunged in value after the subprime market collapsed, according to two investors with knowledge of the matter.

The Distressed Senior Credit Opportunities Fund will invest in "senior" and "super-senior" securities backed by commercial and residential mortgages, said the people, who asked not to be identified because the fund is private. Senior debt is first to be paid off in a default.

Pimco, based in Newport Beach, California, and money managers such as BlackRock Inc. and TCW Group Inc. have opened funds to buy securities they consider cheap based on the underlying value of the assets or the borrower's ability to repay the debt. Investors have pulled back from all but the safest government-backed debt as the foreclosure rate on U.S. subprime- mortgage loans doubled to a record 10.7 percent in March from a year earlier.

"There's a handful of firms out there, Pimco being one of them, that are well-positioned to deal with this credit crisis and the fire sales going on in mortgage-backed securities," Geoff Bobroff, a mutual-fund consultant in East Greenwich, Rhode Island, said in an interview.

Pimco, a unit of Munich-based insurer Allianz SE, oversees $830 billion, including the $129.5 billion Pimco Total Return Fund, the largest bond mutual fund. Last year, it raised almost $3 billion to invest in distressed mortgage assets, the investors said. Mohamed El-Erian, Pimco's co-chief executive officer, declined to comment. El-Erian shares the position of co-chief investment officer with Bill Gross, while Bill Thompson is the co-CEO.

The firm has sought to boost mutual-fund returns in the past year by buying more mortgage-related assets. The investments generally target high-quality mortgage debt, such as those guaranteed by government-chartered agencies Fannie Mae and Freddie Mac.

Gross's Total Return Fund advanced 9.4 percent in the past year to beat 99 percent of competing bond funds, according to data compiled by Morningstar Inc. in Chicago. The fund had 61 percent of its assets in mortgage securities as of June 30, up from 53 percent a year earlier.

"One of the most extraordinary things we've seen with Pimco over the past year is that they've invested in high-quality mortgage-backed securities across the board," said Lawrence Jones, a mutual-fund analyst at Morningstar. "They've been calling for a housing slowdown before the term `subprime' became popular in cocktail-party conversations."

The new Pimco fund, dubbed Disco, will focus on commercial loans as well as residential debt that doesn't carry explicit government guarantees or the implied backing of securities issued by companies such as Fannie Mae or Freddie Mac, the investors said. It also will seek investments in securities backed by home- equity, credit-card and auto loans, they said, and can invest in debt secured by collateral outside the U.S.

The Disco fund has a 15-month investment period and a 5-year life. It will be jointly managed by Pimco's credit teams in the U.S. and Europe, the investors said.

BlackRock, the second-largest U.S. bond manager, with $527 billion in fixed-income assets, has several funds aimed at profiting from the credit drought. It teamed up with Boston-based hedge-fund firm Highfields Capital Management LP to start a company and raise $2 billion to buy delinquent home mortgages. Since the subprime crisis began last year, New York-based BlackRock has raised more than $5 billion to buy mortgages, distressed debt and loans.

Prices of non-agency mortgage securities have tumbled to record lows. AAA fixed-rate prime-jumbo securities typically fetch a record 12 cents per dollar of principal less than similar securities backed by government agencies, according to an Aug. 20 report by Credit Suisse Group analysts. Jumbo loans are those over $417,000.

The commercial-mortgage bond market hasn't faced the same rate of late payments as debt tied to subprime home loans. The percentage of all commercial mortgage loans that were delinquent increased 2 basis points in July to 0.43 percent, according to Fitch Ratings. A basis point is 0.01 percentage point. Delinquencies for subprime loans in 2006 bonds climbed to 41.7 percent, based on July reports from trustees, from 34.2 percent in February, Standard & Poor's said Aug. 21.

Yields on commercial real-estate securities relative to benchmarks have surged on concern that defaults will increase. For AAA-rated commercial mortgage-backed bonds, yields have widened to 284.43 basis points more than 10-year swap rates as of Aug. 22, up from 55 basis points a year earlier, according to data from Bank of America Corp. The swap rate is what borrowers pay to exchange fixed-rate interest payments for floating ones.

ECB Overpricing Asset-Backed Debt May Hurt Market
The European Central Bank may be delaying the recovery of the region's $1.3 trillion mortgage- backed bond market by distorting prices on the debt, according to former Bank of England policy maker Willem H. Buiter.

"There is almost certainly an overpricing of the bonds," Buiter, now a professor at the London School of Economics, said in a telephone interview yesterday. "By artificially supporting the market the ECB may be crowding out private purchasers."
Europe's banks stepped up their borrowing from the central bank after the credit crisis sapped demand from investors a year ago.

They can raise cash by handing over assets or pledging mortgage-backed securities to the ECB as collateral. The ECB values the assets at a discount to face value and the borrowing bank keeps the debt on its balance sheet. Banks have created 434 billion euros ($640 billion) of mortgage bonds in the past year to put on their balance sheets which can be used as collateral, four times the amount they sold to investors, according to UniCredit SpA.

The ECB may be accepting the debt at a price at least 4 cents higher than in the open market, giving banks little incentive to sell the debt to investors, Buiter said. Eszter Miltenyi, a press officer at the Frankfurt-based ECB, declined to comment.

Spanish mortgage bonds are being valued at 95 cents on the euro or higher, Buiter said. The debt trades at about 91 cents, according to data compiled by Societe Generale SA. The ECB will soon announce changes to the rules that determine the collateral it accepts, council member Yves Mersch said in an Aug. 23 interview. Officials are concerned banks will dump securities they can't sell on the ECB and become overly reliant on central-bank funds.

"The collateral that we take must also be traded in the market because only then is it priced accurately," Axel Weber, a council member and the head of Germany's Bundesbank, said in an interview in Frankfurt yesterday. "We aim at taking final decisions in autumn which will be communicated immediately."

The ECB may make it harder for banks to use as collateral bond backed by loans they themselves made, Buiter said. The amount of asset-backed bonds deposited with the ECB accounted for 16 percent of total collateral deposited with the ECB at the end of 2007, compared with 15 percent of government debt, considered the safest.

Ilargi: I don’t know what’s worse, journalists that keep talking of Nobel economists, or the economists that keep claiming they have a Nobel Prize. It’s fake.

ECB slammed by "Nobel economist" as European slump deepens
Almost the entire region of Western Europe, Scandinavia and the Baltics is on the cusp of fully fledged recession, raising fresh fears about the health of Europe's banking system.

Germany's IFO confidence index of future business crashed in July to levels last seen in the post-unification bust of the early 1990s. Over the past three months the index has suffered the steepest decline since the 1973 oil shock. "Everything is coming to a head at the same time," said Julian Callow, Europe economist at Barclays Capital.

"The euro's surge over the past two years has caught up. We've seen a hollowing out of the euro area's industrial sector, an oil shock, and tightening credit conditions, made worse by the European Central Bank's decision to raise rates in June," he said. Nobel economist Robert Solow said the ECB had made a bad mistake and was now moving far too slowly to stop the downturn engulfing the region.

"I get the feeling that the mandate of the ECB is based on the notion that controlling inflation in a modern industrial economy is enough, with no further need for anything else. This not a view that is accepted any longer in economic circles. Central banks should not try to reverse oil supply shocks," he told The Daily Telegraph.

Prof Solow, an expert on growth theory, questioned whether the eurozone is capable of responding to a crisis given the lack of a single economic government to co-ordinate policy. "You could say that every political entity gets the central bank it deserves," he said, speaking at a Riksbank gathering of Nobel laureates.

The dramatic downturn in Europe's core economy appears to have taken the currency markets by surprise. The euro has plummeted by almost 10pc against the US dollar since early July, inflicting heavy losses on hedge funds with big "short" positions on the greenback.

Denmark is already in a fully fledged recession and now appears to be sliding deeper into trouble. Danish industrial orders collapsed by 22pc in June compared to a month earlier, Eurostat revealed yesterday.
The country suffered its own Northern Rock-style debacle on Monday when the central bank had to launch a rescue of Roskilde Bank after a run of withdrawals by depositors.

The state is now guaranteeing $8bn (£4.3bn) of debts. It is the biggest bank rescue in Scandinavia since the financial crisis of the early 1990s. Nils Bernstein, the Danish central bank's governor, said the authorities were left with no choice once Roskilde, the country's eighth biggest bank, had lost the confidence of the capital markets and was unable to roll over loans following disastrous losses on the Danish property market.

Attempts to find a private buyer had failed. Mr Bernstein said a collapse of the bank would have posed "a significant threat to financial stability in Denmark". Roskilde has, in effect, been nationalised, leaving the shareholders with nothing, in accordance with the strict tradition of Scandinavian bank rescues.

"The presumption is that holders of capital have lost their money," he said, adding that the bank was "not fit to survive" after abusing the credit system to pursue breakneck growth without proper regard for social duty. Denmark's economy has been destabilised by its membership of the European Exchange Rate System (ERM), which forced it to import interest rates that were much too low for the country.

The result was a wild credit boom that pushed Danish household debt to 260pc of disposable income, the highest level in the world. This is worse than Britain (159pc) and America (135pc). The property boom has now turned to bust. House prices have fallen by 10.7pc over the past year in Copenhagen.

The abruptness of the bank collapse in Roskilde - a sleepy town in central Denmark best known for its rock festival - is a reminder that Nordic lenders are heavily exposed to the downturn.

Sweden's economy ground to a halt in the second quarter. There are now concerns that Swedish banks could face a squeeze as the Stockholm property market deflates and the losses mount on heavy exposure to the Baltic states. House prices in Latvia have fallen 28pc this year.

The International Monetary Fund said that Swedbank dominates lending in Latvia and Estonia, where it has more clients than in its home base in Sweden, and it is the biggest lender in Lithuania. It warned that the Baltic operations of the Swedish banks "could cause a credit crunch in Sweden itself" if the funding dries up in the wholesale capital markets.

Fitch Ratings warned yesterday that the Baltic trio of Latvia, Estonia and Lithuania face a high risk of a hard landing after years of blistering credit growth, mostly funded by foreign funds. It warned of a "risk of a loss of confidence in the Baltic currencies and their banking systems, triggering widespread conversion and withdrawal of deposits".

Latvia's current account deficit is 18pc of GDP, and external financing needs have reached 158pc of reserves. Financing needs in Estonia are now 218pc of reserves. Danske Bank fears a severe crisis if these countries are forced to devalue. The property booms have been funded by euros and Swiss francs mortgages, creating a major exchange risk.

Upbeat U.S. census report masks economic plight
Wages for working Americans increased, the number of people without health insurance decreased and the poverty rate was essentially unchanged in 2007, according to census figures released today. Experts cautioned, however, that the new data don’t capture the effects of the economic slump that began late last year and has caused massive job losses, increased unemployment, high inflation and falling wages.

In 2007, though, median household income rose by 1.3%, from $49,568 in 2006 to $50,233. The portion of Americans in poverty increased slightly, from 12.3% to 12.5%. The number without health coverage fell from 47 million in 2006 to 45.7 million last year. It was the first annual decline in the uninsured population since President George W. Bush took office in 2001.

A closer look at the numbers also reveals some troubling trends, however, including that the inflation-adjusted median income for working-age households was $1,100 lower in 2007 than it was in the recession year of 2001. Last year’s poverty rate was also higher than the 11.7% rate in 2001.

“Never before on record has poverty been higher and median income for working-age households lower at the end of a multi-year economic expansion than in the previous recession,” said Robert Greenstein, executive director of the Center on Budget and Policy Priorities, a liberal research center. “The data are now clear that for poverty and median income, this was the worst economic expansion on record.”

Experts credit an increase in government-funded coverage for reducing the number of uninsured Americans. The number of people younger than 65 who are publicly insured jumped from 46.3 million to 48.6 million last year, according to Lynn Blewett, director of the State Health Access Data Assistance Center at the University of Minnesota.

Children accounted for nearly half that increase, as the number of youngsters in government health programs grew from 22.1 million in 2006 to 23 million last year. “Programs like SCHIP and Medicaid are lifelines for providing Americans with the health care they need, especially during times when the economy is soft and more people feel vulnerable to losing employer-sponsored health insurance,” Blewett said.

Ron Pollack, the executive director of Families USA, a liberal health-advocacy group, saw irony in the growth of public coverage. “At the very time the Bush administration tried to cut back Medicaid and twice vetoed legislation to extend children’s health coverage, the public safety net cushioned the loss of employer-sponsored health coverage,” Pollack said.

Most researchers and economists say federal measures are a poor tool to gauge poverty’s complexity. The numbers don’t factor in assistance from government anti-poverty programs, which help pull people out of poverty. Alternative poverty measures that account for these shortcomings typically deflate poverty statistics.

Devon Herrick, a health economist at the conservative Dallas-based National Center for Policy Analysis, said government figures on the uninsured were “somewhat overblown” because they included up to 14 million people who qualified for government coverage but weren’t enrolled and nearly 18 million people who earned more than $50,000 and chose to forgo coverage.

He also said the uninsured figures provided only a snapshot because respondents are questioned only when the survey is taken, rather than over a year. A 2004 census report found that three-fourths of uninsured people get coverage within a year, Herrick said.

Median household income — the level at which half of U.S. households earn more and half less — increased for the third straight year. Men who worked full time saw their median earnings increase nearly 4% to $45,113. Median income for full-time working women rose by 5% to $35,102.

Median incomes for black and Hispanic households increased for the first time since 1999, but black households still had the lowest median income, at $33,916. They were followed by Hispanics at $38,678. Asian households had the highest median income — $66,103 — while non-Hispanic whites came in at $54,920.

The poverty rate increased by only a small fraction; 816,000 more people lived in poverty in 2007 than in 2006. But the rate and number of children in poverty increased from 17.4%, or 12.8 million, in 2006 to 18% and 13.3 million last year. Nationally, children account for nearly 36% of Americans in poverty, though they make up only about 25% of the population. Other findings include:
•Full-time working women earned 78% of what full-time working men earned in 2007, an all-time high.
•The income of foreign-born households headed by noncitizens dropped 7.3% to $37,637 after increasing 4.1% in 2006.
•Last year’s poverty rate for the South was 14.2%. It was 11.4% in the Northeast, 11.1% in the Midwest and 12% in the West. All were statistically unchanged from 2006.

Thousands more in West Michigan hit 'extreme poverty' as state woes continue
More people in West Michigan are bottoming out.

The U.S. Census Bureau shows the number of Grand Rapids residents in extreme poverty -- at $10,325 or less for a family of four and half the federal poverty line -- climbed from 13,957 in 2000 to 22,497 in 2007, a 65 percent increase. That number represents 12.3 percent of the city's population.

In Kent County, 78,198 people were in poverty in 2007, or 13.2 percent, compared to 49,832 in 2000, or 8.9 percent. The number in extreme poverty jumped from 22,061 in 2000 to 36,597. Chico Daniels, president and CEO of Mel Trotter Ministries, sees this bleak reality each day at the Grand Rapids shelter for homeless men and families. Some come because of substance abuse. But others are simply out of money, out of work and have no place to stay.

"With the highest unemployment rate in the nation, I'm not surprised. Some of these are people who counted on those assembly-line jobs," Daniels said of Michigan's economy. "They staked their entire future on the auto industry. The decline of the auto industry has sent shock waves through the entire community."

Year to date, the shelter has taken in 3,889 women, up 35 percent from the same period in 2007. The number of children in the shelter is up nearly 20 percent. "I think poverty doesn't go on vacation," Daniels said. "Poverty tends to hit women and children hardest. My definition of poverty is a lack of options. People come to Mel Trotter because they are out of options."

In Wyoming, the poverty rate declined slightly, from 14.3 percent in 2006 to 12.2 percent in 2007. But those in extreme poverty increased from 2,594 in 2006 to 4,339 in 2007, a 67 percent rise. While the overall poverty rate in Ottawa County was about half that of Kent County, at 6.8 percent, those in poverty climbed more than 5,000 from 2006 to 2007, to 16,909.

The number in extreme poverty reached 7,176, nearly double the number in 2006. Michigan's rate of extreme poverty jumped from 6 percent in 2006 to 6.5 percent last year. Eight years ago, the rate was 4.8 percent. The number of people in poverty increased by 45,000 during 2006-07. The child poverty rate increased from 17.8 percent to 19 percent between 2006-07, while the national rate stood at 17.6 percent.

Amy Rynell, director of the Chicago-based Heartland Alliance Mid-American Institute on Poverty, said Michigan continues to lead even the hard-hit Midwest in bad news. Its poverty rate stood at 14 percent in 2007, up from 13.5 percent the year before -- and a full percentage point above the national rate, which was virtually unchanged during the same period.

"Michigan, relative to the nation, appears to be doing the worst. The only state in the nation where poverty actually increased was Michigan." Rynell said the rising number of those in extreme poverty is sobering. "These are people who are spreading out their food so they are only eating once a day. They are people who are living in houses that are unsuitable for living. "These are really dire conditions where people are making decisions that are really untenable."

Beyond the layoffs and plant closings that have rocked the Midwest in recent years, Rynell said, states such as Michigan are paying the price for social service cutbacks. Four Michigan cities -- Kalamazoo, Flint, Pontiac and Detroit -- were among the 20 poorest in the nation. "We have seen over the last decade a whittling away of our safety net. The programs that were in place to help people in economic downturns have been whittling away."

The news is little better for middle-class households. Median incomes in West Michigan remain sharply down from 2000, declining in Kent County from $57,217 in 2000 to $49,354 in 2007. In Ottawa County, income dropped from $65,140 in 2000 to $53,881 in 2007.

The 2007 median income in Michigan was $47,950, down 1.2 percent or $596 from the 2006 median of $48,546. The state's nationwide ranking slid from 24th to 27th. Locally, there was one ray of hope in the Census report released Tuesday. Median income in Grand Rapids climbed to $38,272 in 2007, from $35,676 in 2006.

In another report released Tuesday, the Census Bureau said 11 percent of Michigan residents had no health insurance coverage in 2007 -- up from 10.4 percent in 2006 and 9.1 percent at the beginning of the decade. But that was one category in which Michigan fared better than most states. The national average of uninsured citizens was 15.5 percent, and Michigan ranked 11th best nationally in providing health coverage

Northern Rock defaults leave taxpayers facing bill
Fears that taxpayers may end up footing an even bigger bill for Northern Rock intensified yesterday after it emerged that the nationalised bank was suffering dramatically high default rates.

Northern Rock borrowers falling more than 90 days behind on mortgage payments were rising at much faster rates than the overall mortgage market, Standard & Poor's (S&P) said. Repossessions of Rock mortgagees were also rising at a far higher rate.

The problem was identified in Granite, the £40 billion offshore trust that holds many of Rock's mortgages and provides monthly performance figures to its bondholders. Granite was performing substantially worse than similar securitisation vehicles set up by Barclays, HBOS, Abbey, Alliance & Leicester and Standard Life, S&P said.

Andrew South, S&P's senior director for structured finance, said that any financial pain of a major blowout in defaults would be shared between Granite bondholders and Rock. “The deteriorating book increases the chances that taxpayers, ultimately, might have to shoulder some of the cost,” he said.

Arrears of 90 days or more in mortgages held by Granite soared by two thirds between this year's first and second quarters, with £508 million of loans turning sour. By contrast similar trusts run by rival banks saw relatively small increases in delinquencies in the quarter, S&P noted. Repossessions of properties in the Granite porfolio soared from 134 a month in the first quarter to 353 a month in the second, again a much worse deterioration than in the industry generally.

S&P also alerted investors to another potential risk of mortgages in Granite. Average loan-to-value ratios (LTVs) were 77 per cent for Granite, as against 60 per cent typically in other trusts. Just under 30 per cent of Granite loans were at LTVs of 90 per cent or more. That means a large proportion of borrowers would be in negative equity if house prices fall further.

A Rock spokesman said: “At this stage Granite is performing within its parameters. Investors [bondholders] are well aware of this and are protected by the reserve fund [a cushion that protects bondholders in the event of default].” The spokesman said that the arrears figures in Granite were consistent with figures issued by Rock with its half-year results on August 5.

At the time, Rock said that arrears levels, including Granite loans, had doubled since the start of the year to 1.18 per cent of the total residential mortgage book. Repossessions were up from 2,215 at the start of the year to 3,710. On top of the £40 billion Granite book, Rock holds £37 billion of mortgages on its own balance sheet, which it says are of similar quality to Granite's loans.

S&P said that Granite's relatively poor performance on credit quality remained even after allowing for the fact that it was shrinking its book as mortgages matured or borrowers took their business elsewhere. The Granite book is down from £46 billion at the start of the year. Rock suffered a cataclysmic depositor panic last September, forcing the Government to guarantee deposits and later to nationalise it after failing to orchestrate a private sector rescue.

It emerged this weekend that at the time of the nationalisation, in February, when the Government was assuring voters that Rock could ultimately be sold back to the private sector for a profit, it was being privately advised by Goldman Sachs that the saga was most likely to lead to a loss of between £450 million and £1.28 billion.

Since being nationalised, Rock has repaid £9.4 billion of government loans, reducing its outstanding debt to £17.5 billion. It is negotiating with the Treasury to swap up to £3 billion of government loans for fresh equity to strengthen its balance sheet.

• Granite is a special-purpose vehicle set up in 1999 by Northern Rock in Jersey. It was used by Rock to make extra cash from the mortgages that the bank had sold to homeowners
• Northern Rock transferred mortgages to Granite, which packaged them together. Investors bought these securities, which provided them with regular interest payments
• Rock does not own or run Granite, which is a separate legal entity
•Many other banks have these vehicles, including Halifax, Bank of Scotland and Barclays. They are particularly common in the United States, where almost all mortgages are held within special-purpose vehicles similar to Granite

UK homebuilder says Government can't fix the housing market
Taylor Wimpey has warned that the Government is unlikely to be able to offer a quick fix for the country's ailing housing market, as the housebuilder reported a plunge in first-half profits.

One of Britain's biggest housebuilders saw first-half profits drop 96pc to £4.3m in the first six months of the year. Taylor Wimpey also revealed a total write-down of £1.5bn in the period, including £690m on its landbanks in the UK, North America. Including the write-down the company slumped to a loss of £1.4bn.

The end to Britain's decade-long housing boom has savaged profits at housebuilders and estate agents and pushed the country to the edge of its first recession in almost two decades. The speed of the reversal has left Gordon Brown trailing in the opinion polls and prompted calls from many in the housebuilder industry for the Government to step in.

Chief executive Peter Redfern said: "Of course we'd like to see the Government help the market, but our view is slightly different to some other companies," he said. "Even if it did intervene, through measures like a stamp duty holiday or a fall in interest rates, we still think the market would be in a difficult position. It's not something the Government alone can fix."

Mr Redfern, who helped mastermind the merger of George Wimpey and Taylor Woodrow last year, said that the builder was now focussed on revising its debts covenants with its banks and would not be relying on the Government to rescue the sector.

Yesterday rival builder Bovis called on Gordon Brown to support the troubled sector. Taylor Wimpey said it was in discussions with its lenders, however he said the company did not expect to have to raise new capital.
The new homes specialist, which has already given warning that it will breach its banking arrangements over the full year, insisted there were no fundamental obstacles in the way of a deal with its bankers.

Mr Redfern also said the company had received approaches, but had not entered into formal discussions. "It's not something we have ruled out, but we are focussing on sorting out our covenants," he said. He added that the company did not expect to have to make any further redundancies or office closures, following an announcement in April that it would close 13 of its 39 regional offices with an anticipated loss of 900 jobs.

As expected, the company said it had scrapped its interim dividend, arguing the payment was inappropriate given the current trading conditions. The shares slumped by over 13pc to 45p in early trading.

Canada job losses hide behind government hiring binge
Weakness in the labour market that has been masked by strong public-sector job growth could soon be laid bare as softening government finances put the hiring frenzy on hold.

Employment in all levels of government rose 3.1 per cent to 3.4 million in the second quarter, creating a total of 70,000 jobs so far this year, Statistics Canada reported Tuesday.

The quarterly numbers continue a trend that has been in place since 2000, when public-sector hiring began to rebound after years of budget-balancing declines. Since then, when employment stood at 2.8 million, another 563,108 jobs have been added.

Despite sharp declines in Canada's manufacturing sector in recent times, the country's labour market has been buffeted from overall losses - with 55,000 jobs eliminated from the economy in July - by gains in the public sector.

"We look at the overall quality of employment and were surprised to see that it has improved despite the weakening economy," said CIBC World markets senior economist Benjamin Tal. "One of the reasons for that was the fact that a lot of the new jobs were in the public sector, which has relatively high-quality jobs.

"This probably will not last. The days that governments run high surpluses are over. In fact, I would expect government hiring to slow down significantly over the next two to three years," Tal said. "That means you will not see government jobs offsetting losses in the private sector . . . so the Canadian market will be exposed to its weakness this time. Both quality and quantity of jobs will go down because of the softening in hiring by governments.

Yet government hiring is not without its costs, says Fraser Institute senior economist Niels Veldhuis, and at current levels Canada's ability to compete is damaged by that. According to the Statistics Canada report, the proportion of public sector workers among the total employed in the workforce has remained stable at 19 per cent since 2001.

"This number is quite concerning," Veldhuis said. "The public sector as a percentage of employment is critical in terms of how that impacts our economy and our labour market, and we need to be focusing on reducing that further than 19 per cent rather than being pleased with 19."

As jurisdictions with higher rates of public sector employment tend to attract less investment and suffer slower rates of economic growth, it is imperative to make ourselves comparable to competitors, Veldhuis said. But we are a long way off from that, as Canadian provinces have much bigger public sectors than most U.S. states.

"When you look at place like Nevada, Wisconsin and Massachusetts, they're all sitting at 10 or 11 per cent of employment. Alberta has Canada's smallest public sector at about 15.5 per cent. But when you start looking at places like Newfoundland and Saskatchewan, Saskatchewan has the highest (proportional) public sector in North America, at 27.4 per cent."

Veldhuis said government hiring should not be seen as a bromide for troubled times, as the increased government spending could force the economy into deficit and the government to raise taxes. The statistics included hiring in federal, provincial and municipal governments as well as educational, health and social services institutions and government business enterprises.

No bottom in Canada either. Not even close
Another condo project was cancelled last week in mid-town Toronto. No headlines here. The media did not even notice. Just a letter sent to the unhappy people who wanted to live there. Many of them, in reality, did not understand how lucky they were.

Two thousand miles away, the average price of a detached home in Burnaby took a plunge, according to last weekend’s paper. A nondescript detached home you’d drive by without noticing now sells for $705,000, which is $42,000 less than about a month ago. Yeah, that was an 8% decline in a few weeks.

In this Van burb, listings are up 24%. Sales are down 44%. Back in southern Ontario, listings have also exploded higher, while realtors are desperately trying to cling to the fiction that sales are flatlining and prices are stable. Of course, the trend line is clear. The market is in trouble.

As in Burnaby, so it is in Mississauga. The number of days on market has about doubled in the past year, which means homeowners – a great many of them first-time sellers – are learning the hard way that supply and demand has more of an impact on prices than squeezing hard and hoping.

Listings in the GTA area started to really rise in April and May, which means many sellers are just coming up to the 90-day mark for their listings. They are now being told that to have any chance of selling in the hotter autumn season, prices will have to be reduced. Thus, officials numbers for sales closing from November through to February will show average and median prices taking a haircut.

This, in turn, will set the backdrop for the Spring, 2009 market, which will be one of reduced activity, substantially lower house values and a worsening economy. That’s just a reality, now that bank profits are tumbling, commodity prices have turned hugely unstable, and both Canada and the United States are in the middle of regime change, or at least political upheaval.

Then, natch, we have the looming Oct. 15 death of the 0/40 generation, the immediate consequences of which are uncertain. But not good. Already new home sales have taken it on the chin. Huge Mattamy Homes – now the nation’s largest builder – has slashed prices by up to $50,000. At the same time some banks who shall remain nameless (like TD) have found ways of turning a cash-back mortgage into a zero-down loan, which only extends the miserable adjustment period a while longer.

Of course, opportunity will emerge from all of this. There will be a bottom. Prices will correct too far, and then profits will lie there for the courageous to scoop up.

But, we’re not there yet. In fact, we’re not even close. Remember, the US market started to tank in September of 2005 and now – the autumn of 2008 – foreclosures are growing, prices are falling and middle-class homeowners are being destroyed in even greater numbers. There will be many siren calls of relief in the coming months from the real estate community. Heed not a one.

State injection for Fannie and Freddie will offset pain
Most of the time, the path to survival in financial bureaucracies is through company-party-line on-message bullishness. That’s particularly true in the US, where pessimism about the future is not just bad business, but unpatriotic.

Not true today. More than sufficient electric shocks have been administered to the rats. Now, the corporate rodents know that PowerPoints projecting trees growing to the sky are going to get you fired, not promoted. Short-sellers are no longer bad people, but prophets. That’s part of the reason why the optimistic case for equities is still generally dismissed.

There are, however, substantive points made by the equity bears. The most coherent come from the credit people, who point out, grimly, that you can’t have a recovery if you don’t have the bank lines or fixed income buy side to support the spending. The damage done from write-offs and shaken confidence is so severe, they say, that it will be impossible to finance growth in any kind of demand, at least in the visible future.

No bank capital, and no securitisation markets, mean we will all be reduced to post-apocalyptic bands of looters, hunter-gatherers, and, I suppose, bankruptcy lawyers. Since the more cautious credit people saved their clients some of their capital, they deserve a listen.

Greg Peters, the Morgan Stanley credit strategist, says: “Once the banks and credit institutions pull back their reins, they keep them pulled back for a long time. The more optimistic consumer economists don’t understand this because this is very different compared to any other experience they have gone through. It is impossible to calculate the impact of the breakdown of securitisation.”

That’s true. Of course, we did have some economic activity even before the securitisation of subprime and alt-A mortgages, and before collateralised loan obligations replaced actual corporate loans. We survived on iceberg lettuce and coleslaw before we knew there were such things as arugula and cilantro.

Still, to the point raised by Peters and the other cautionary voices, there are answers. First, Fannie Mae and Freddie Mac need to be nationalised, in the sense that the federal government injects capital in the form of preferred equity and direct credit support, wiping out the existing common.

I believe it is critical that that takeover leaves the privately held preferred stock of the government-sponsored enterprises in place. Preserving the value of GSE preferred issues is very much in the taxpayers’ interest, as it makes possible the recapitalisation of the rest of the banking system.

Most of the discussion of the need for a federal takeover of the GSEs has concerned their credit losses on subprime and Alt-A paper. However, even if a private recapitalisation could be done to offset those, the GSEs would not have sufficient capital to handle the long-term risk of the maturity mismatches on their highly leveraged balance sheet.

Let’s say there’s a great economic recovery, housing prices stabilise, and the interest rate curve becomes more normal. The rise in long-term rates would lead to an extension of the maturity of mortgage portfolios, which would need to be offset by hedging activities. Significant declines in the long end would also need to be hedged, as homeowners refinanced.

I don’t believe the interest rate swaps market will have the capacity or willingness to take on that risk at any payable price. One way or another, these institutions will spend a considerable time with negative equity. Again. The only way to handle that is with government ownership.

No doubt there are bankers and lawyers explaining all this to the Washington “leadership”, in the respectful, but urgent, tones trust and estate lawyers use when telling dim heirs that they need to sign a document lest Mummy’s bequest become valueless. It could take a little while for the political managers to accept that they need to shred yet another set of talking points.

Then, all of those fiduciaries worried about making that 8 per cent return assumed in their actuarial pro formas will have a way to keep their jobs: buy new issues of bank cumulative preferred stock. How could they have confidence in the banks? Because the banks will be able to put a lot of their housing paper to those newly recapped GSEs. On the other hand, they may want to hold on to at least some of that paper.

There are a lot of housing-related securities that will take real losses on foreclosures and steeply discounted liquidation sales. There is also a lot of paper that was marked to a very illliquid market. Away from Florida, Nevada, Arizona, parts of the Rust Belt, and California, there is a lot of solidly financed property in the US, and a significant part of the paper it supports will be marked up in value. That will be another source of additions to bank capital.

We won’t be getting another consumption-led boom for a long time. The US will recover, though, and sooner than the credit tribe thinks. There will be exports, import substitution from transplanted factories, cheaper oil and government-financed infrastructure spending. Capital flight from Europe will help finance the construction of our next perpetual motion machine.
When everyone regains their confidence, I’ll get bearish again.

Ilargi: The last bits of good news that can be wrung out of the economy... Unfortunately, the report is outdated before it’s released: the rise in the dollar guarantees a drop in exports.

Orders for Durable Goods in U.S. Unexpectedly Gain
Orders for U.S. durable goods unexpectedly increased in July, indicating that growing demand from abroad is still helping companies weather a slump in domestic spending.

The 1.3 percent gain in bookings of goods meant to last several years matched the previous month's rise, which was larger than previously estimated, the Commerce Department said today in Washington. Excluding transportation equipment, orders rose 0.7 percent after a 2.4 percent increase a month earlier.

The boost to the U.S. from trade, which was the biggest in almost 28 years last quarter, may wane after figures this month showed shrinking economies in the euro region and Japan. "Many" Federal Reserve officials anticipate export gains will fade, minutes of their Aug. 5 meeting showed yesterday.

"The impact from global weakening so far on U.S. manufacturers remains modest," Aaron Smith an economist at Moody's, said in an interview with Bloomberg Television. Because of domestic weakness, the economy may still slow or contract "while simultaneously still having very modest weakness in manufacturing and capital spending," he said.

Treasuries fell after the report and stock futures gained. The benchmark 10-year note yielded 3.82 percent as of 8:40 a.m. in New York, up 4 basis points from yesterday. Economists projected orders would be unchanged after a previously reported 0.8 percent increase in June, according to the median of 76 forecast in a Bloomberg News survey. Estimates ranged from a drop of 2.1 percent to a gain of 2.2 percent.

Excluding transportation equipment, orders were projected to fall 0.7 percent, after an originally reported 2 percent gain in June, according to the Bloomberg survey. Estimates ranged from a decline of 2.9 percent to an increase of 0.6 percent.
Bookings for non-defense capital goods excluding aircraft, a measure of future business investment, increased 2.6 percent, the most since April. Shipments of those items, used in calculating gross domestic product, rose 0.6 percent following a 0.4 percent gain that was smaller than previously estimated.

Today's revisions will probably have little impact on economists' forecasts for growth in the second quarter. Revised gross domestic product figures from the Commerce Department, due tomorrow, may show the economy expanded at a 2.7 percent annual rate from April through June, up from an advanced estimate of 1.9 percent reported last month as exports jumped, according to a Bloomberg survey.

Business spending on new equipment and software dropped at a 3.4 percent annual pace last quarter, the second consecutive decline and the biggest since the first three months of 2004, according to the government's advance estimate issued last month.

Growth in coming quarters probably will slow as the effects of the federal tax rebates wear off and consumer spending weakens. Retail sales in July fell 0.1 percent, the first decline in five months, the Commerce Department reported Aug. 13. "An increasingly strained consumer, deepening woes for the housing sector and a desire to pare inventories will all weigh on manufacturing output," Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York, said before the report.

Factories are faring better than in past downturns, helped in part by a weak dollar that has helped boost exports. The Institute for Supply Management's manufacturing index for July fell to 50, the dividing line between growth and contraction, from 50.2 a month earlier. During the 2001 recession it averaged 43.5.

Manufacturing "declined or remained weak in most districts," even as "demand for exports remained generally high," the Fed said last month in its regional economic known as the Beige Book. Bank lending "was generally reported to be restrained."

Regional reports this month offered mixed impressions. The New York Fed's general economic index rose in August to 2.8, the highest level since January, from minus 4.9 a month earlier. The Philadelphia Fed said last week that manufacturing in the region shrank in August for a ninth straight month.

Gains in orders for metals, machinery, communications gear, automobiles and aircraft all contributed to the increase in demand last month. Orders for transportation equipment rose 3.1 percent, led by a 28 percent jump in airplane bookings. Demand for automobiles climbed 1.2 percent.

The gain in autos may have reflected a continued rebound following the end of a strike at American Axle & Manufacturing Holdings Inc., the largest axle supplier for General Motors Corp. GM said June 16 it had returned to full production. Such gains are unlikely to continue as sales slump. Auto- industry figures this month showed purchases of cars and light trucks in the U.S. fell in July to a 12.5 million annual rate, the lowest level since March 1993, as consumers faced record gas prices.

Some manufacturers are trimming staff to offset high energy costs. Alcoa Inc., the world's third largest aluminum producer, said last week that it will lay off 300 employees in Texas starting Aug. 31. The cuts come as a result of "uneconomical power prices," the New York-based company said in a statement. Commodity costs have subsided since mid-July, easing cost pressures. Crude oil futures dropped below $112 a barrel on Aug. 15 after peaking at $147 on July 11.

Rapid rise of dollar may endanger U.S. and world economies
The dollar is enjoying its strongest rally in three years largely because of bad news outside the United States rather than good news at home. Just as the dollar's swift decline earlier this year set off alarm bells with world policy makers who were worried that it was contributing to inflation, a swift rise that hurts U.S. exports would not be welcome, either.

Currencies are typically viewed as proxies for their underlying economies, and the dollar is no exception. What makes it somewhat unusual is that it is the dominant currency of global trade. And its movements are intricately linked to the price of oil, which in turn has vital importance for the world economy.

Most economists think that the second quarter was the high-water mark for the U.S. economy this year, and that a contraction in the fourth quarter is not out of the question. If anything, the outlook has worsened in recent weeks as credit concerns have spread and investors worry that the U.S. government may have to bail out the mortgage finance giants Fannie Mae and Freddie Mac.

So why has the dollar climbed 7 percent against a basket of currencies since July 15? It is all relative. The outlook for the American economy may be grim, but that of the rest of the developed world is deteriorating rapidly. "This spreading weakness abroad - and it is worse now in Europe and Japan than it is in the U.S.A. - is the primary reason for the dollar's recovery," said David Rosenberg, an economist at Merrill Lynch.

Data released Friday showed that Britain's economy did not grow at all in the second quarter. The euro zone recorded its first-ever contraction during that period. Revised figures due Thursday are expected to show that the U.S. economy grew at a solid 2.7 percent annual rate in the second quarter, according to economists polled by Reuters, well ahead of the 1.9 percent pace that was initially reported.

But don't expect much of a celebration on Wall Street, because few investors believe this pace can be sustained. Ironically, the recent resurgence in the dollar is part of the reason why. For the global economy, a strengthening dollar is a mixed blessing. It is good news for European exporters, who have long complained that an expensive euro was hurting their business. It is not such great news for the U.S. economy, which has relied on export demand to compensate for sluggish domestic spending.

Indeed, foreign trade added 2.4 percentage points to second-quarter U.S. gross domestic product, its largest contribution in nearly 28 years, according to calculations from the research firm Global Insight. The revised data Thursday may show that it provided an even stronger kick of 3.2 percent. In other words, without trade, the second-quarter GDP figure could very well have been negative.

In a speech Friday, Ben Bernanke, the chairman of the U.S. Federal Reserve, called the dollar's stabilization and the recent cool-down in the oil market "encouraging." But currencies, like economies, can rise too quickly for comfort, and in ways that are not healthy.

To the extent that the strengthening dollar has helped to lower oil prices, it has clearly helped the global economy. Oil is down more than $30 a barrel from a July peak of just above $147. But if the dollar's strength reflects weakening in Europe and Asia rather than an improvement at home, that does not bode well for the U.S. or world economy.

Even if a weaker euro make European exports more competitive on the global market, that does not mean much if a weak global economy saps demand. Global Insight thinks it will be 2010 before the world economy rebounds. "World economic growth in 2009 is likely to be the slowest since 2003," said Nariman Behravesh, its chief economist. "Every world region's growth is expected to slow next year, and the list of countries in or near recession is expanding."

Edward Leamer, director of UCLA Anderson Forecast, said U.S. economic data still suggested a weakening economy rather than a full-blown recession, but the stronger dollar posed a threat. "If this is a symptom of potentially weaker exports going forward, then we're in another high-risk period," he said.


Anonymous said...

Hi ilargi,

Is there any, more or less, simple way of keeping track of how Canadian banks are holding up or rated? I don't think a Canadian bank has ever failed but that was then and I guess this is now. Neat the simplicity of some thoughts isn't it? I wish all the rest were as simple. I think I will find a nice closet and spend the day going OM!


Anonymous said...

How long may the dollar financial system stay alive?

I do agree with Ilargi as he said that the wheels of capitalism are about to stop soon.

I do believe that this is the begin of the end of the economy as we know it today.

Anonymous said...

"the wheels of capitalism are about to stop soon."

How soon is soon? Halloween? January?

I know things are hard to predict, but some people have been seriously talking about a financial meltdown since the beginning of the year. While there are some signs that there is a crisis, to most people, the wheels are still going round and round.
Anonymous Reader

Anonymous said...

Not just since the beginning of the year. I know people who have predicted a big crash most years for the last 25 years. Apparently no man knoweth the hour or the day.

Farmerod said...


None since 1985, AFAIK. Two failures in AB due to real estate and oil collapses.

Facing Failure

FWIW, my own personal rating of the big banks in order of worst to best based on recent headlines and general character (don't know about National):

CIBC, BMO, RBC, TD, Scotia, Sealy, Simmons (don't lose any sleep over which of the last two to park your cash)

Anonymous said...

A propos the crash prediction thread going on just now, here's an article on Doomerism by permaculturist Toby Hemenway may be of interest to some readers here:


Ilargi said...

Hemenway may be able to help you plant pickles, but he's useless as a thinker. I don't think he even understands the bias he exhibits in words such as catastrophism and doomerism. There are a zillion summaries of end of the world movements, and the only reason I can think of for him to add yet another is being ignorant of what's already out there. Other than that, studying the human mind might be an idea for him. Why someone would post a link to such drivel on my site, you tell me.

Anonymous said...

If Sir Isaac Newton couldn't predict when, knowing the market would crash (, how do you people expect Ilargi to give you any useful dates? Throw your own dice...

Anonymous said...

Really good podcast with Mish and two other guys as to whether the bankster f*ckup will lead to deflation or hyperinflation. Mish thinks we are going into serious deflation. He thinks eventually we will get into hypeinflation, but it's going to take a while. He doesn't think the Fed can bring us to HI but thinks the Congress might if it goes totally batshit. About 40 minutes. Definitely worth the listen. They asked Mish where he would invest his money right now. He sheepishly said short term trearuries. He was embarrassed.

Greenpa said...

"Hemenway may be able to help you plant pickles, but he's useless as a thinker."

Why, how can you say that? He has a bibliography!


Anonymous said...


Mattresses aside for now,why would you consider BNS safer than TD right now? I'm interested in any info you came across or may know.

Thanks, FF

Anonymous said...

Fannie Replaces Top Managers Amid Capital Concern

Bloomberg LINK

Farmerod said...

FF - please take that ranking with a shaker of salt. It was meant more as a setup to a joke than as advice. However, I do think CIBC is the worst because of their known exposure to 'level 3' -like assets. BMO has some too and likes getting into trouble, whether it's from natural gas bets gone awry or whatever else. I can't recall specifically why I don't particularly like RBC; I just don't. BNS and TD are a toss-up. I think one of them just saw some opportunity to expand into the states (WTF?!) and the other, probably BNS, further into Central America. Expansion in general seems like a silly idea when the whole house of cards is about to fall. Or I could be completely making all of that up. It doesn't matter to me what happens to any particular bank, though, assuming the ones I use keep their doors open until October when this year's batch of Canada Savings Bonds come out. In the future, I just have to hope that there's some financial institution whose doors are still open to cash by bonds when I need them.

(This whole conversation suddenly seems surreal. I can't believe I'm advocating CSB's!)

Anonymous said...

"Hemenway may be able to help you plant pickles, but he's useless as a thinker."

...How about John Michael Greer for ya?


Stoneleigh said...

Snoo et al,

I like John Michael Greer, although I disagree with him that we're currently facing a slow catabolic collapse. I would argue that catabolic collapse began at least about 30 years ago, around when energy per capita peaked globally. It hasn't looked like a collapse so far as it's effects have been obscured by credit expansion, but the kind of economic hollowing out we've seen is catabolic virtually by definition.

Far from facing a slow collapse now as Greer would suggest, I think the slow phase is behind us and we're about to face a frighteningly rapid decline. The South Sea bubble is the best example of such a rapid collapse (1720-1722 if memory serves), although this event will be larger as the excesses that preceded it have been larger.

Our economic system has been consuming its own foundation in order to drive what looks outwardly like a huge burst of wealth creation. By analogy one might imagine a supernova that briefly expands and burns as brightly as a galaxy, but then implodes to a fragment of its former self.

As for timing, I think we face the first of what will probably be several cascading events this autumn. The recent rally appears (on balance of probabilities) to have topped on August 11th, meaning that the next phase of the decline would already be underway (although alternatively it is still possible that we could see a larger retracement, as the rally up to August 11th was fairly shallow as retracements go). My guess is that the coming decline should last perhaps 3 months and should at least take out the October 2002 low (DJIA about 7500). There will be far more downside potential to follow the next temporary rally as well.

Anonymous said...

Thank you, Stoneleigh.

Yes, the slow collapse started a long time ago. Nothing was done to mitigate the coming precipitous collapse.

I remember reading "Limits to Growth" and "Small is Beautiful" in the 70s. Now it's over ...