Dell Walks Away

Walking away is becoming increasingly popular. The practice has now spread to commercial real estate.

Michael Dell of Dell Computers is the latest walker. He is walking away from a sweetheart call centre deal in Edmonton Canada.

Dell Canada is closing its Edmonton call centre after only three years, putting more than 900 people out of work. The computer giant said the move was part of company-wide efforts to "increase the efficiency of its business, improve performance and provide better value for customers."

Dell was lured to Edmonton by a 20-year sweetheart lease deal at Edmonton Research Park, and has consistently touted the call centre as a top-performing global facility. The deal with Edmonton Economic Development Corp. included a $1-a-year lease on 15 acres of land, and a property tax rebate worth $1.1 million. It becomes void if the number of employees drops below 500.

Building a stand-alone facility was part of the deal with the city, and the building displaced the Norwesters rugby club and other sports groups using the clubhouse, fields and volleyball courts. At the time, EEDC said the concessions - a first for the organization - were worth the extra $30 million a year in economic activity generated by luring the Round Rock, Texas-based company here.

Alternatives For Walkers

In the Business Of Walking Away we explored You Walk Away and their business model of providing legal advice to prospects for a fee. That is a model I understand. When it comes to making a decision involving hundreds of thousands of dollars, the upfront fee of $995 seems reasonable.

Today I found another site called Walk Away Now. The business model of Walk Away Now is buying homes. I am not fond of this model because the only way it can possibly work is if they pay you far less than your home is worth. They also have a plan to buy your home with a leaseback. I am especially leery of the leaseback model. Should the buyer for any reason default on his mortgage, the lessee will be forced out of the house.

Harry Macklowe From Mogul To "Super"

The Daily Intelligencer is reporting Harry Macklowe Doesn't Own Those Seven Buildings Anymore.

Harry Macklowe got a little carried away last year: He bought seven midtown office buildings, including the General Motors Building, in ten days. He spent over $7 billion on the deal — but only $50 million of that was his own money.

My comment. The above paragraph is partially inaccurate. Macklowe purchased the General Motors Building for a then record $1.4 billion in 2003. That building is now reported to be worth as much as $3.8 billion.

Next week, his loans are coming due, and seeing as we're smack in the middle of a worldwide credit crunch, there's no way for him to refinance. Which is why this week, The Wall Street Journal has just reported, Harry has made a tentative agreement with his lender, Deutsche Bank, to turn the buildings over to them. No more buildings for Harry. Well, not exactly.

Even though Deutsche Bank would control the properties, "Macklowe would still retain the titles, to avoid triggering costly New York City transfer taxes, and Macklowe Properties would still manage the buildings." So basically, dude just went from being a mogul to being a super.

Poof $2.4 Billion Vaporized

Macklowe put up the General Motors Building as collateral on a foolish $7.6 billion real estate shopping spree with no money down and no cash on hand to make interest payments. Depending on the actual current value of the General Motors Building and terms of the workout with Deutsche Bank, he vaporized as much as $2.4 billion of personal wealth.

I am trying to understand the mentality of someone worth billions, willing to risk a huge portion of it, perhaps almost all of it, in an attempt to make more billions. What was it he thought he knew that Sam Zell didn't?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Jobless Claims Spike, Spending Slows, More Rate Cuts Coming

Still more evidence is pouring in that the economy is not only in a recession but is also rapidly weakening. Consumer Spending Is Slowing And Unemployment Claims Rise.

Purchases rose 0.2 percent in December after a 1 percent gain the month before, the Commerce Department said today in Washington. The Labor Department said jobless claims rose to a 27-month high last week, though the figures may have been distorted by adjusting for holidays, a spokesman said.

Initial applications for unemployment insurance rose 69,000 to 375,000, in a week when data may have been distorted by adjusting for the Jan. 21 holiday, a Labor spokesman said. The number of people staying on benefit rolls rose to 2.716 million in the week ended Jan. 19, from 2.669 million in the prior week.

"These are levels that are indicative of a recession," James Caron, global head of interest-rate strategy at Morgan Stanley in New York, said in a Bloomberg Television interview. "If the trend continues to be high jobless-claims numbers like this, it's going to really add some validity to the expectations that the U.S. is, in fact, in a recession at this time."

Rate Cut Probabilities On 2008-01-31

Curve Watchers Anonymous is watching the probability curve of Fed Funds Futures. Here is the chart.



click on chart for sharper image.
Above chart thanks to Cleveland Fed.

As you can see, the market is rapidly pricing in yet another half point cut at the March FOMC meeting. That would bring rates down to 2.50%. Bernanke now appears hell bent on matching Japan's ZIRP (Zero Interest Rate Policy) in a misguided attempt to prevent deflation, a deflation that I might add is badly needed. So much for anyone really wanting "affordable housing".

ADP National Employment Report

The ADP Employment Report for January 2008 is out.

Nonfarm private employment grew 130,000 from December 2007 to January of 2008 on a seasonally adjusted basis, according to the ADP National Employment Report™. The estimated change in employment from November to December was revised down 3,000 to 37,000.

January’s increase of 130,000 is consistent with nonfarm private employment growth that averaged 110,000 during the three-month period from October through December 2007. Employment in the service-providing sector of the economy grew 141,000, while employment in the goods-producing sector declined 11,000, the fourteenth consecutive monthly decline. Manufacturing employment in January was flat after eighteen consecutive monthly declines.

Payroll Playbook

I don't buy ADP's estimate and the Fed Fund Futures don't either. The BLS report is out tomorrow and I am looking for massive downward revisions that may point to out and out jobs contraction. We all know the BLS revisions are coming sometime, and if not tomorrow then my forecast may be way too cautious. But with consumer holiday sales a total flop, and in light of job cuts at banks and brokers, and with commercial real estate dramatically slowing, if by chance I am wrong then this will be the last hurrah.

Job Estimates

• ADP 130,000 Non-farm Private
• Economist Estimates 70,000 Total
• My Estimate -25,000 to -125,000 (with expected revisions)

These are the kinds of predictions that can make one look silly. Indeed they will, if the expected revisions do not come in. The only question in my mind is whether the BLS goes for the "big bang" revision or works it in over time. Regardless, the BLS is going to have to fess up sometime, and January and July are the months in which they typically do.

That said, it is not the backward revision that really matters, it is what happens going forward. In that regard, the trend towards higher unemployment has just started. Things are going to get worse, much worse with the service economy (the only bright spot outside of healthcare) about to take a massive hit as the overbuilding of retail stores comes to a grinding halt.

Pavlov's Dogs And Rate Cut Reactions

The market is rallying on the "good news" of more rate cuts. This is trained Pavlog's dog thinking. However, unemployed persons are not going to be paying mortgages, and capital impaired lending institutions are going to be stuck with more houses as People "walk away", some because they want to, many because they have no choice.


Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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The Battle for Consumer Discretionary Spending

Forbes is reporting Q4 GDP growth up 0.6 pct vs expected 1.2 pct, slowest since 2002 .

The US economy slowed more dramatically than expected in the final three months of last year as housing posted its worst contraction in a quarter century, exports pulled back and inflation picked up steam, the Commerce Department reported today.

The economy grew at a 0.6 pct annualized pace in the fourth quarter, half the expected 1.2 pct pace of economists polled by Thomson's IFR Markets.

Business inventories were the big surprise in the GDP report. They went from being a major source of strength in Q3 to a major weakness in Q4, declining by 32.9 bln usd, after a 24.7 bln usd increase.

My Comment: After that 3rd quarter totally unwarranted buildup in inventory, the only surprise here is that everyone is surprised.

Briefing.com's Dick Green thinks the low GDP number is not unmitigated bad news. 'Even though the lower than expected number will give recession advocates some talking points, the swing in inventories actually sets up the first quarter numbers for a better reading,' he said. 'Inventories over time essentially net out, and it is now more likely that inventories will add to first quarter GDP or at least not subtract much. The sharp drop in fourth quarter inventories may actually lead to upward revisions to first quarter GDP.'

My Comment: Assuming the 3rd and 4th quarter balance out, there is no need to rebuild inventory in 1st Quarter of 2008. Look for another surprise when the 1st quarter disappoints again.

Exports, which had been among the biggest drivers of GDP growth in the third quarter, with what some economists saw as an unsustainable 19.1 pct increase, slowed to a much more moderate 3.9 pct increase in the fourth quarter.

My Comment: So much for both the decoupling theory and the theory that strong exports will prevent a recession.

Consumer spending, which makes up roughly 70 pct of the US economy, rose 2.0 pct last quarter, slower than the 2.8 pct rate in prior quarter.

'Looking ahead to Q1 GDP data, it is likely that consumer spending growth will slow considerably,' said Shapiro. 'The biggest question will be the degree of slowdown in consumer spending.'

My comment: Bingo. And with Wal-Mart Reducing Prices and Offering 0% Interest the preliminary signs are spending will be exceptionally weak. I am looking for prices wars across the board in the battle for consumer discretionary spending.

Housing's drag on the economy became more pronounced, with a 23.9 pct decline in the fourth quarter, the steepest drop since the recessionary fourth quarter of 1981.

Business construction, although strong with a 15.8 pct rise, was not enough to offset the housing and inventory contractions.

My Comment: Business construction will collapse. In the face of a strong consumer pullback, continued expansion would go beyond reckless. We simply do not need any more stores of any kind and rampant price cutting and 0% interest rates should be proof enough.

Final sales in the US economy also slipped last quarter to 1.9 pct growth from 4.0 pct in the third quarter, but because they exclude the inventory decline, final sales can be a better indicator of actual domestic demand.

My Comment: Final sales are not remotely keeping up with price inflation.

Those looking in the rear view mirror for price inflation and attempting to short treasuries with impunity are going to find the answer to the question Time To Short Treasuries? is not exactly what they thought.

Gross Domestic Product: 4th Quarter 2007 (Advance)

Looking ahead at official BEA GDP Release, one can find additional clues where things are headed in 2008. Let's take a look.

The major contributors to the increase in real GDP in 2007 were personal consumption expenditures (PCE), exports, nonresidential structures, and state and local government spending. These positive contributions were partly offset by decreases in residential fixed investment and in inventory investment. Imports, which are a subtraction in the calculation of GDP, increased.

The deceleration in real GDP primarily reflected a larger decrease in residential fixed investment, a downturn in private inventory investment, and a deceleration in equipment and software that were partly offset by a deceleration in imports.

Major Contributors To 2007 Growth

• Personal consumption expenditures
• Nonresidential structures
• State and local government spending

All of the above are going to contract in 2008.

Consumers are retrenching, Unemployment is Soaring as Private Sector Jobs Contract, and with Grim News For State Budgets states are tightening belts. California alone is facing an across the board 10% reduction in spending.

There are going to be some tough choices for California for sure but here is my California Budget Proposal. Regardless of how cutbacks are accomplished, the upcoming pullback in state and local spending cuts have nowhere near been factored into the equation by most economists.

European Retail Sales Contract

Things are not exactly booming in Europe either as European Retail Sales Drop a Fourth Month.

European retail sales fell for a fourth month in January as rising fuel, utility and food prices left shoppers with less money to spend, the Bloomberg purchasing managers index showed.

The gauge of sales in the euro region was a seasonally adjusted 48.1, compared with 46 in December. A reading below 50 indicates a decline. The index is based on a survey of more than 1,000 executives compiled for Bloomberg News by NTC Economics Ltd.

A 62 percent increase in oil prices over the past year is sapping spending power already hit by rising food costs, curbing demand for everything from Bang & Olufsen A/S televisions to Burberry Group Plc handbags.

Is Oil To Blame?

Blaming oil and/or food prices for the slowdown in retail sales makes little sense given that oil and food prices are components of retail spending. A better way of looking at things is that consumer attitudes towards consumption have changed.

Paying Tribute To Employees

One reason attitudes are souring has to do with how companies are treating employees. Here is just one small example. Consider Allergan, a US pharmaceutical company.

US pharmaceutical company Allergan will phase out work at its factory in Arklow, south of Dublin, over two years and transfer operations to Costa Rica.

General manager of the Allergan plant Paul Moody paid tribute to the workers and thanked them for their dedication.

Allergan is "paying tribute to employee dedication" by firing them for a job well done.

More and more companies seem to be saying: Don’t take it personal, it’s just business. Is it any wonder “The Business Of Walking Away” is booming? Have we now reached the point where everything we do is just a business decision?

While pondering the above, remember that Wal-Mart is not lowering prices out of the goodness of their hearts, they are lowering prices because supply outstrips demand at current prices. More businesses will be forced to do the same.

Look for price wars to commence and margins to shrink as the corporate battle for consumer discretionary spending begins.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Ripple Impact of $534 Billion Debt Downgrade

Bloomberg is reporting S&P Lowers or May Cut $534 Billion of Subprime Debt.

Standard & Poor's said it cut or may reduce ratings of $534 billion of subprime-mortgage securities and collateralized debt obligations, as home loan defaults rise. The downgrades may extend losses at the world's banks to more than $265 billion and have a "ripple impact" on the broader financial markets, S&P said.

The securities represent $270.1 billion, or 47 percent, of subprime mortgage bonds rated between January 2006 and June 2007, S&P said today in a statement. The New York-based ratings company also said it may cut 572 CDOs valued at $263.9 billion.

The downgrades may increase losses at European, Asian and U.S. regional banks, credit unions and the 12 Federal Home Loan Banks, S&P said. Many of those institutions haven't written down their subprime holdings to reflect their market values and these downgrades may force their hands, S&P said.

"It is difficult to predict the magnitude of any such effect, but we believe it will have implications for trading revenues, general business activity, and liquidity for the banks," S&P said. The ratings company will start reviewing its rankings for some banks, especially those that "are thinly capitalized."

Under accounting rules, many smaller banks haven't been required to write down their holdings until the credit ratings fell, enabling them to avoid the losses that have crippled Citigroup Inc., Merrill Lynch & Co. and UBS AG. The world's largest banks have reported losses exceeding $133 billion related to mortgages, CDOs and leveraged loans.

Who's Holding The Bag?

The key questions now are "Who's Holding The Bag?" and "How severe will the downgrade be?" Judging from the article it may be smaller regional banks that are hit hardest. Given that Bank Reserves Are Negative already this is going to trigger more borrowing from the Term Auction Facility or more mad scrambles to raise capital from the oil producers, China or Singapore. I expect many smaller banks to go under.

Ackman's Letter to Moody's and the S&P about Ambac (ABK) and MBIA (MBI)

On January 18th 2008 Bill Ackman wrote a letter to Moody's and the S&P regarding the monolines. Here is point #8 of Bill Ackman’s Letter to Rating Agencies Regarding Bond Insurers.

I encourage you to ask yourself the following question while looking at your image in the mirror:

Does a company deserve your highest Triple A rating whose stock price has declined 90%, has cut its dividend, is scrambling to raise capital, completed a partial financing at 14% interest (now trading at a 20% yield one week later), has incurred losses massively in excess of its promised zero-loss expectations wiping out more than half of book value, with Berkshire Hathaway as a new competitor, having lost access to its only liquidity facility, and having concealed material information from the marketplace?

Can this possibly make sense?

New Ackman Letter On Monolines

On January 30th Ackman wrote another letter regarding Bond Insurer Transparency. This one was addressed to The Honorable Eric E. Dinallo Superintendent of Insurance State of New York, The Honorable Sean Dilweg Commissioner of Insurance State of Wisconsin, and 5 directors at the Securities and Exchange Commission .

Click here to read Ackman's Letter On Bond Insurer Transparency.

Merrill Lynch Throws In The Towel On CDOs

Bloomberg is reporting Merrill Plans to Cut Back on CDOs, Structured Finance.

"Opportunities in many areas" of structured finance and so-called collateralized debt obligations "will be minimal for the foreseeable future and our activities will be reduced accordingly," New York-based Merrill said in an e-mailed statement. The firm will continue packaging corporate loans and derivatives into securities.

Merrill issued the statement after Chief Executive Officer John Thain told investors at a conference in New York earlier today that the firm planned to exit its CDO and structured credit businesses.

"We are not going to be in the CDO and structured-credit types of businesses," which generated 15 percent of the firm's fixed-income revenue, Thain said at the conference.

Anyone in the CDO or structured credit positions at Merrill Lynch has a job that is in jeopardy.

FGIC Loses AAA Rating

After missing a deadline Fitch strips FGIC of AAA rating.

Financial Guaranty, a unit of New York-based FGIC Corp., was cut two levels to AA, New York-based Fitch said today in a statement. The company had been AAA since at least 1991. Moody's Investors Service and Standard & Poor's are also reevaluating their ratings.

"This announcement is based on FGIC's not yet raising new capital, or having executed other risk mitigation measures, to meet Fitch's AAA capital guidelines within a timeframe consistent with Fitch's expectations,'' the ratings company said today.

Fitch was pretending that FGIC deserved an AAA rating for years. Now it is pretending the rating deserves to be AA.

Moody's, Fitch, and the S&P are a disgrace for the way they have pandered to the monolines.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Fed Fears Deflationary Debt Collapse

Today's action smacks of a classic bear trap rally.

A friend going by the name KodiakBear had this comment today. "A bear market rally is like a shark – it has to keep moving or else it dies."

S&P 500 5-Minute Chart



Click on chart for sharper image

Inquiring minds might be interested in the text of the FOMC announcement.

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 3 percent.

Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets.

The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

Today's policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.

Actions Speak Louder Than Words

As you can see, the Fed did not really say much of anything other than risk was to the downside, something that any thinking person could figure out on their own accord. Fed actions however, are another matter. Cutting interest rates from 4.25 to 3.0 in less than two weeks tells the real story. This is what Fed actions say: "We are scared to death about a deflationary debt collapse".

Amazon Clobbered After Hours

MarketWatch is reporting Amazon earnings double on strong holiday sales.

For the quarter ended Dec. 31, Amazon (AMZN) reported earnings of $207 million, or 48 cents a share, compared with earnings of $98 million, or 23 cents a share, for the same period the previous year.

The bottom line results were in line with expectations from analysts, according to consensus forecasts from Thomson Financial.

However, expectations for operating profits disappointed. The company expects operating income to come in between $785 million and $985 million for the full year. The mid-point of that range - $885 million - is below the $958.4 million in operating income that was expected by analysts for the year.
"The argument against this stock for years has been that Amazon is great at selling things but not great at making good money," said Tim Boyd of American Technology Research. "Basically, it looks like they are back to their old ways here."

Amazon A Wile After Hours Ride

After hours, Amazon fell from $74 to $70, then rose to $77 and is now trading at $65 and change. This is just another indication that Tech Has Topped.

Heading into a consumer led recession there are simply not going to be many places to hide out. However, one would never know that listening to the analysts on Bloomberg after the FOMC announcement. Several analysts actually predicted the Fed will be hiking rates within a year and this is all going to blow over by the fourth quarter.

Faith in the Fed remains in bubble territory. That faith will eventually be shattered.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Wal-Mart Reduces Prices & Offers 0% Interest

CNN Money is reporting Wal-Mart chops prices in bid to lure shoppers.

Wal-Mart announced Tuesday that it will chop prices between 10 to 30% this week on groceries, electronics and other home-related products in an effort to keep its cash-strapped consumers excited about shopping.

While its rivals, including Target (TGT), have seen sales decelerate dramatically in recent weeks from a consumer spending slowdown, Wal-Mart (WMT) has been benefiting from more shoppers trading down to its discount stores.

"We all know economic times are tough so our plan is to help with added savings throughout the year, focusing especially on what people want, when they need it," said John Fleming, Wal-Mart's chief merchandising officer.

My Translation: We are reducing prices because we have to. There is little demand at current pricing.

"The extent to which Wal-Mart can use these extra discounts to drive [store] traffic and pick up market share is a good thing," he added.

Wal-Mart spokeswoman Melissa O'Brien told CNNMoney.com that this month's week-long additional price cuts are "the first of more to come."

"We will have more of these during the busier shopping periods of the year like Valentine's Day and Easter," O'Brien said.

My Translation: Get ready for price wars. This will not be good for profits at Target, at Wal-Mart, or anywhere else.

In addition to the extra discounts on "thousands of products," the retailer said it will offer no interest for 18 months on purchases of $250 or more with a Wal-Mart Credit Card.

Wal-Mart Stimulus Program To Fail

The problem with 'Wal-Mart stimulus' is tax rebates won't do much to lift consumer spending.

Consumers will spend more, but not that much more, and they will do it over a brief period. "Since the rebate checks to individuals likely won't be mailed out until May or June, the lift to consumer spending is probably going to be a shortlived third-quarter event," [Merrill Lynch chief economist] wrote.

In what has to qualify as one of the more absurd headlines for a press release in recent memory, Wal-Mart announced what it called its "Economic Stimulus Plan for U.S. Shoppers."

I can only hope that this is meant to be tongue-in-cheek but Wal-Mart actually said in its press release that "against a backdrop of continued talk of a credit squeeze, Wal-Mart is concentrating on savings on the items customers need to buy at this time of year - unbeatable prices for the big game."

So rest assured, consumers. You don't need to wait for your tax rebate check. Go splurge today on Pepsi 12-packs, Tostitos Scoops and Hillshire Farms Cocktail Smokies.

I am not sure what Wal-Mart is smoking, but you cannot spend your way out of a recession when you are broke. US consumers are broke, so broke they are walking away from their homes.

Mortgage Forgiveness Act Revisited

Flashback October 2, 2007
Mortgage Forgiveness Act - The Seen and Unseen

Here was my prophesy:

The winner in the debt forgiveness provision (if there is a winner) is the struggling homeowner. The unseen loser is the mortgage holder, the NAR and the NAHB. Prior to this legislation, a homeowner had to worry about tax liabilities of just handing over the keys and walking away. If debt was forgiven prior to bankruptcy, there was also a tax liability. Such considerations have been removed. At the margin, more people will be tempted than before to hand over the keys and walk away.

The debt forgiveness provision of this bill has the ability to cascade into all sorts of things mortgage holders would not want to see. Specifically, any housing relief measure that rewards bad behavior (not paying the mortgage or handing over the keys) is likely to fail miserably.

Congress will no doubt be back amending and re-amending this very bill in years to come on behalf of lobbyists who did not foresee the consequences of the bill as it was written today.

And so it was. A law supported by the NAR, the NAHB, and the president all thinking this would somehow be a boon to housing was anything but. Instead we see 60 Minutes Legitimizing Walking Away and The Business of Walking Away is now booming.

Attack On Big Mac

Investors hammer McDonald's stock after No. 1 fast-food chain reports slowing U.S. sales in December.

Don't assume that McDonald's is recession proof simply because it's a cheap place to eat. McDonald's (MCD) stock fell 7% in midday trading Monday after the No. 1 fast-food chain said slowing consumer spending was partly responsible for flat December same-store sales, a measure of sales at its U.S. restaurants open at least a year.

"There really is no safe harbor in retail right now," Flickinger warned, adding that McDonald's U.S. sales slowdown should be a bleaker sign that American consumers may be in even worse shape.

During a conference call with analysts to discuss its fourth-quarter results, CEO Jim Skinner addressed McDonald's past performance during a recession. Skinner also said McDonald's would be making a [menu] "slight shift" to more value-priced offerings in 2008. The company's value meal items currently account for up to 14% of total revenue.

Yahoo to Cut Jobs

CEO Jerry Yang says Yahoo faces 'headwinds' this year.

Search engine Yahoo announced it would lay off 1,000 employees by mid-February, even as it reported fourth quarter earnings Tuesday that beat expectations.

During the company's conference call with analysts, chief executive Jerry Yang warned that the company faces "headwinds" this year and confirmed the upcoming layoffs, which had been rumored for the past week. Yang said the company would make the job cuts as part of a "workforce realignment."

The stock plunged more than 10% after-hours on the news.

From bad to worse at Countrywide

Thing are heading From bad to worse as Countrywide posted a $422 million loss and revealed that a third of its subprime loans are delinquent.

Countrywide on Tuesday reported a loss of $422 million in the fourth quarter and revealed that an astounding one-third of its investment portfolio's sub-prime mortgage loans are delinquent.

The loss threw cold water on Countrywide chief operating officer Steve Sambol's confident assurances to investors in October that, "We view the third quarter of 2007 as an earnings trough, and anticipate that the company will be profitable in the fourth quarter and in 2008."

The home lending giant reserved $924 million for credit-related losses in the fourth quarter - over a dozen times more than what it set aside in the fourth quarter of last year.

Countrywide's eye-popping 33% delinquency rate on its sub-prime mortgage book also represents a decline from the third quarter, where "only" 29.6% of sub-prime paper was delinquent.

The figures obscure a central fact, however: Countrywide's portfolio of sub-prime loans consist of those that were not previously written down, or could not be sold or securitized. In other words, this portfolio is likely to get much, much worse.

Countrywide also said it shifted $7 billion of "prime non-agency" loans to the portfolio - out of the held-for-sale inventory - because it appears that there were no buyers likely to be found for this paper.

The economy is rapidly slowing on all fronts. Tech which nearly everyone claimed to be immune, is obviously not immune. Wal-Mart slashing prices again, and rising unemployment and delinquencies are going to further restrict bank lending.

There is simply no way to get inflation out of this mix. The Fed Fund rates is headed to 2% or lower and the 10-year treasury yield will likely make a new all time low yield. Those shorting treasuries with impunity, will have their heads handed to them.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Bank Reserves Go Negative

I have been watching a chart of Borrowed Bank Reserves for several weeks. The action is unprecedented.

Borrowed Reserves of Depository Institutions



click on chart for sharper image.

The NFORBES Chart above is courtesy of St. Louis Fed.

Here's an interesting excerpt from the book Investing Public Funds by Girard Miller about borrowed reserves.

"Another useful indicator of the Federal Reserve's relative monetary policies can be found weekly in the Federal Reserve data. A key statistic is the net free reserves or net borrowed reserves line item. This statistic measures the degree to which depository institutions have found it necessary to obtain funds in the Fed Funds market and through the Fed discount window in order to obtain required reserves.

During periods of central bank credit-tightening operations, the depository sector might find it necessary to borrow funds to meet reserve requirements. This practice results in net borrowed reserves, which shows as a negative number. Conversely, if ample funds are available through the banking system to meet reserve requirements, banks can become net lenders of reserves through the Fed Funds markets"

Given that the Fed is not in a credit tightening mode, we must look for a better explanation. Here it is: Banks in aggregate have now burnt through all of their capital and are forced to borrow reserves from the Fed in order to keep lending.

Detail comes from the Federal Reserve H3 Release.

Table 2 Not Seasonally Adjusted Reserves in Millions of Dollars



Click on chart for sharper image.

Total Reserves for two weeks ending January 16th are $39.988 billion. Inquiring minds are no doubt wondering where $40 Billion came from. It's a good question. The answer is the Term Auction Facility. You can see that figure in Table 1 of the H3 release (not shown).

Were it not for the Term Auction Facility, banks would have had to raise $40 billion in capital by selling assets or some other means. We will look at "other means" in just a moment.

For now, the Fed is not disclosing who is borrowing under the Term Auction Facility, probably out of fear that people just might find out what banks are capital impaired and by how much.

January 29 TAF Auction

Forbes is reporting Fed's TAF auctions 30 bln usd 28-day loans at 3.123 pct.

The Federal Reserve's latest loan auction through its Term Auction Facility (TAF) produced the lowest interest rate, lowest bid-to-cover ratio and fewest bidders yet. The lower demand suggests an improved liquidity situation in financial markets.

Yesterday's auction of 30 bln usd 28-day loans came in at a 3.123 pct interest rate, a 1.25 bid-to-cover ratio and 52 bidders. This was the fourth auction under the new TAF program designed to relieve pressure in the short-term, inter-bank funding market.

The Role Of The Monolines

What Happens if Ambac (ABK) and MBIA (MBI) are downgraded? That too is a good question. Let's take a look.

MarketWatch is reporting Banks may need $143 billion in fresh capital.

If bond insurers are downgraded a lot, banks will need as much as $143 billion in fresh capital to absorb the impact, Barclays Capital estimated Friday. Citigroup Inc. (C), Merrill Lynch & Co. (MER) Bank of America Corp. (BAC), and Wachovia Corp. (WB) are among U.S. banks most exposed to bond insurers, or "monolines" as they're also known, Barclays Capital wrote to investors.

The Telegraph is reporting Banks 'face a further $300bn sub-prime hit'.

The world's financial institutions will have to write down a further $300bn (£152bn) of US sub-prime losses before the crisis is over, according to a study by consulting firm Oliver Wyman.

"While governments, central banks and regulators scramble to address the aftermath of the sub-prime fallout, several other crises are mounting."

Tumbling property prices - especially in the UK and Spain - a weakening dollar, a possible collapse in commodity prices, and a fall in Chinese and Indian stocks will "disrupt" the global economy, the report claimed.

As noted in Banks Attempt To Freeze Balance Sheets “Large money center banks have virtually frozen their balance sheets, reluctant to lend even to good credit,” according to Scott Anderson, a senior economist at Wells Fargo.

However, rising numbers of foreclosures are forcing assets on to bank balance sheets in spite of that desire to freeze. It's no wonder banks are spooked by those walking away from debt. See 60 Minutes Legitimizes Walking Away for details.

Banks Raise ATM Fees to $3.00

One method of raising capital is to increase fees. $3 ATM Fees are one such method.

"They're looking for ways to make up for the losses and nickel and diming appears to be the only way they can do it," Consumer Affairs analyst Joseph Enoch said. Today, the average ATM fee is $1.78, while five years ago it cost a little more than a $1 to retrieve money from a bank with which you didn't have an account.

In some areas, JP Morgan Chase, Bank of America and Wachovia fees have hit $3 for non-customers. Some banks now charge their own customers a fee for the convenience of using an ATM to the disdain of some.

Another way to raise cash (and a very expensive one at that) is to offer way above market rates on savings deposits and CDs. Let's take a look at some current offers on savings accounts.

Savings Deposit Rates



Click on chart for sharper image.
Chart courtesy of Bankrate.Com.

Any bank paying those rates on savings accounts is desperate for cash. Those looking for candidate banks liable to go under need only look at the price banks are willing to pay for capital.

I cannot stress this enough: If you accept these offers, please make sure you never go above the FDIC limit.

$3.00 ATM Fees Will Backfire

As for banks charging $3.00 ATM fees, I think the strategy will backfire in several ways.

• Some customers will stop using anything but their own bank's ATMs. Instead of getting $1.50 banks will get nothing.
  
  
• Some customers will opt to max out the cash they take on each transaction to minimize the number of transaction fees.
  
  
• Banks charging their own customers will find many switching banks out of resentment.

In the grand scheme of things, $30 Billion or $40 billion is not a lot of money. However, when lack of reserves would otherwise prevent lending, it certainly is a lot of money. Imagine a major bank telling customers: "We have no cash reserves so we can't give you a loan." With that in mind, banks are scrambling to raise cash.

Borrowing reserves is expensive, paying 5% on CDs and Savings Deposits is expensive, and in the end, attempting to extract more blood out of consumers by raising ATM fees to $3.00 is going to prove expensive. There are simply no good ways to raise capital. And the problem is going to get far worse before it gets better.

A deepening recession, a falling stock market, plunging commercial real estate, and social acceptance of walking away are all going to exacerbate the problems Bernanke and lending institutions face. A Crash Course For Bernanke on academic theory is coming. It will be interesting to watch how he reacts to it.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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The Business of Walking Away

Previously I discussed the psychology of walking away in 60 Minutes Legitimizes Walking Away, Changing Social Attitudes About Debt, and a Crash Course For Bernanke.

This post will address the business of walking away. Professor Depew was talking about Business Decisions in point 3 of Monday's Five Things.

Last night, CBS' "60 Minutes" took a look at the "subprime loan crisis." You can find the full transcript here, but the following exchange between "60 Minutes" correspondent Steve Kroft and homeowner Stephanie Valdez is a highlight worth examining a bit closer; it's significant both from an economic and, more importantly, a socionomic point of view.

STEPHANIE VALDEZ: Why pay a $3,200 payment on a 1200-square-foot home? It makes no sense.

STEVE KROFT: That's what you agreed to do when you bought the house.

STEPHANIE VALDEZ: Fine. If the value is going up. But we're not going anywhere. The price or the value is going down. It makes no sense because we will never be able to refinance and get a lower payment. There's no way.

STEVE KROFT: You're saying, essentially, that you're going to stop making payments on it? You're just gonna let it go into foreclosure?

STEPHANIE VALDEZ: You know, that's the only advice we've gotten so far is walk away from the home. We don't want to do that to our credit. Why can't our mortgage company work with us?

Kevin Depew:
The issue Kroft is alluding to here is what one might call "the morality of contractual obligation." Without saying it explicitly, Kroft implies ("That's what you agreed to do when you bought the house,") that Valdez and her husband, by walking away from the house, are engaging in some vaguely immoral behavior. It's a promise. They are breaking their promise. Left dangling for the viewer to arrive at is the conclusion that people who break promises are immoral.

But Valdez is outlining a perfectly rational economic argument for exiting the mortgage contract and is willing to accept the full penalty - credit impairment - for her actions. Still, Kroft carries the vague morality objection a bit further in the segment.

"Nobody seems to be saying, 'Look, I made a contract with you. I borrowed money from you. I'm gonna do everything I can to pay off that obligation.' People just seem to be saying, 'Look, take the house. Good-bye. I'm leaving,'"

Kroft observes to real estate agent Kevin Moran. "There was a time, I think, when people felt really bad about not paying off a debt."

"Yeah, I think in those days, loans were made by your local banker or building and loan associations or savings and loan," Moran replies. "They were guys you saw in the grocery store. They were on the little league team with you, the PTA, the school. And I think as mortgages became securitized and Wall Street became involved, they became very transactional and there was no relationship built with the borrower and the lender. And I think that makes it easier for someone to see it as an anonymous party at the other end of the transaction and just walk away from it."

"Just a business decision," Kroft says.

Implicit in this segment is that families are not entitled to make "business decisions." But you know who is entitled? Why, businesses of course. When businesses laid off 1.5 million workers in 2007, it was purely a "business decision." When Wall Street banks "wrote down" more than $100 billion in losses in 2007, it was purely a "business decision."

Look for families to become more comfortable making "business decisions" of their own in 2008.

Banks vs. Consumers

If banks can make "business decisions" to ignore risks, to lend money with no down payment, and fire people at at the first sign of trouble without any remorse, why shouldn't consumers be able to do the same?

Take a look at previous values on homes now being auctioned. Did not lenders make a business decision to ignore insane valuations placed on those homes?

Indeed they did, and one reason was they could securitize the garbage and sell it to pension plans and foreign investors as far away as Norway (see Citibank SIVs Hit Norway Townships). Is Citigroup about to refund Norway townships for the mess it created?

Another reason banks ignored insane valuations is they thought lucrative fees would more than make up for losses on foreclosed properties. They thought wrong.

As a result, lenders became home owners and are now in hock with the auction business.

You Walk Away

There is an interesting new business that just started up January 1, 2008. The business is called You Walk Away.

Is Foreclosure Right For You?

• Are you stressed out about your mortgage payments?
• Do you have little or no equity in your home?
• Have you had trouble trying to sell your house?
• Is your home sinking under the waves of the real estate crash?
• What if you could live payment free for up to 8 months or more and walk away without owing a penny?

Unshackle yourself today from a losing investment and use our proven method to Walk Away.

I spoke with John Maddux a "senior advocate" with You Walk Away (YWA) about the business. As one might expect it is booming. For $995 one receives a half hour of legal counsel where individual strategies are mapped out and all the laws pertaining to recourse vs. non-recourse loans as well as judicial procedures are explained to the customer. YWA also files the necessary legal papers to stop mortgage companies from calling and informs you immediately of how many days you will be able to stay in the house for free. Should the lender take longer to process the documents, YWA will keep you informed of any extra time.

With the amount of money at stake, the fee seems reasonable for the services provided.

Maddux informed me that YWA is currently operating in the state of California only, but Nevada and Florida will soon be coming online. Eventually they expect to be nationwide.

Walking Away In Ohio

One in ten homes in Cleveland, Ohio had been repossessed. Deutsche Bank Trust, acting on behalf of bondholders, is the largest property owner in the city. I discussed this situation in a Beautiful Model For Fraud.

Cleveland is suing 21 of the nation’s largest banks and financial institutions, accusing them of knowingly plunging the city into a financial crisis by flooding the local housing market with subprime mortgage loans to people who could never repay.

City officials hope to recover hundreds of millions of dollars in damages, including lost taxes from devalued property and money spent demolishing and boarding up thousands of abandoned houses.

"To me, this is no different than organized crime or drugs," Jackson said in an interview with Plain Dealer reporters and editors. "It has the same effect as drug activity in neighborhoods. It's a form of organized crime that happens to be legal in many respects."

Will Deutsche Bank and the other 20 lenders attempt to walk away from this mess as a business decision? You bet. The business of walking away is going to be booming for a long time to come. This is yet another reason why Things That "Can't" Happen are about to.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Crash Course For Bernanke

I am reading an interesting article from October 2000 called A Crash Course for Central Bankers. The following excerpt seems strikingly pertinent.

There’s no denying that a collapse in stock prices today would pose serious macroeconomic challenges for the United States. Consumer spending would slow, and the U.S. economy would become less of a magnet for foreign investors. Economic growth, which in any case has recently been at unsustainable levels, would decline somewhat.

History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.

The Japanese Experience

Here is another paragraph from the article.

The downturn following the collapse of Japan’s so-called bubble economy of the 1980s was not as severe as the Great Depression. However, in some crucial aspects, Japan in the 1990s was a slow-motion replay of the U.S. experience 60 years earlier. After effectively precipitating the crash in stock and real estate prices through sharp increases in interest rates (in much the same way that the Fed triggered the crash of 1929), the Bank of Japan seemed in no hurry to ease monetary policy and did not cut rates significantly until 1994. As a result, prices in Japan have fallen about 1 percent annually since 1992. And much like U.S. officials during the 1930s, Japanese policymakers were unconscionably slow in tackling the severe banking crisis that impaired the economy’s ability to function normally.

It's amazing that anyone could possibly think that if only Japan had started cutting rates in 1992 instead of 1994 that it would have made any difference. Unfortunately for the world, we now get to test out Bernanke's theories in real life.

The Great Fiscal Stimulus of 1929

Consider The great fiscal stimulus package ... of 1929

Herbert Hoover -- only nine months into his presidency -- assembled leaders from the public and private sectors to create an economic-stimulus package. Among the measures, Time magazine reported at the time, was a promise from Congress to offer bipartisan support for a tax-cut package. Also on the table was an assurance from the Federal Reserve that it would provide cheaper credit.

Of course, there were a litany of public-works projects, plans for new corporate investments, and even a promise by Henry Ford to raise wages at his auto plants.
None of this worked.

Certainly, our economy now has far more differences than similarities with the economy of 1929, and few expect a new depression for the decade ahead. But it's also worth remembering that the best laid plans of presidents, chief executives and senators can sometimes come to nothing.

Like the fiscal stimulus of 1929 the Fiscal "Stimulus" Of 2008 Is Doomed To Fail.

Yes, there are differences between 1929 and 2008. However, many similarities are striking.

Similarities Between 2008 and 1929

• In the 20's, there was a massive overexpansion of manufacturing capacity. Today there is a massive overexpansion of productive capacity in China and a massive overexpansion of retail stores in the US.
  
  
• In the late 1920s, bank credit propelled a massive real estate boom in New York City, in Florida, and throughout the country. We now have the biggest housing bubble in history.
  
  
• In late 20’s credit was expanding at a rapid pace but there was no need for additional productive capacity. Today GDP is rapidly falling but credit is still rising (for now).
  
  
• In 1929 there was no pent up demand for manufactured goods, especially autos. Today there is no pent up demand for homes, restaurants, retail stores, strip malls, autos, trucks, or anything else.
  

In 2008 as in 1929, the ability and willingness of consumers to borrow and banks to lend is under attack not only in the US but Europe as well. For more on the latter please see Financial Crisis Poised To Hit Europe.

Four Reasons Bernanke Will Fail

• Changing Social Attitudes About Debt (People willing to walk away from homes, save more and spend less)
  
• Commercial Real Estate Crash Underway
  
• Unemployment Soaring as Private Sector Jobs Contract
  
• Global wage arbitrage
  

For more on changing social attitudes please see 60 Minutes Legitimizes Walking Away From Homes.

Ludwig von Mises: "There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved."

Final analysis will show that Bernanke can change interest rates but not attitudes, and attitudes are far more important. Indeed, changes in attitudes will render all of Bernanke's academic theories about the Great Depression meaningless.

Greenspan had the wind of consumers' willingness and ability to go deeper in debt at his back. Bernanke has the wind of boomers fearing retirement in the midst of falling home prices and impaired bank balance sheets blowing stiffly in his face. There is no cure for what ails us other than time and price. And with the aforementioned attitude changes, the biggest, most reckless, global credit expansion experiment the world has ever seen is coming to an end. Central banks are powerless to do anything about it.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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60 Minutes Legitimizes Walking Away

There was a nice expose on CBS 60 Minutes this weekend called House Of Cards. I seldom watch TV but happened to catch it.

Steve Kroft reports on how the U.S. sub-prime mortgage meltdown, in which risky loans drove a housing boom that went bust, is now roiling capital markets worldwide.



Click here to play video.

Steve Kroft: "It sounds complicated but it's really very simple. Banks lent hundreds of billions of dollars to homebuyers that can't pay them back. Wall Street took the risky debt, dressed it up as fancy securities and sold them round the world as safe investments. If it sounds a little bit like a shell game or a ponzi scheme, in some ways it was".

...

"Matt and Stephanie Valdez say they knew exactly what they were doing when they bought this small two bedroom house for $355,000."



....They cannot refinance because the value of the house fell below the existing mortgage. They say they can afford the higher payments but see no point in making them.

Matt: The value of the house keeps going down and the payments keep going up. Where's the logic in that?

Stephanie: Why make a $3200 a month payment on a 1200 square foot home? It makes no sense.

Steve Kroft: But that's what you agreed to do when you bought the house.

Stephanie: Fine if the value was going up. The value is going down.

Steve Kroft: You are saying essentially you are going to stop making payments.

Stephanie: The only advice we've gotten so far is to walk away.

60 Minutes Legitimizes Walking Away

What 60 minutes described was a Beautiful Model For Fraud. That model is now imploding as all fraudulent schemes eventually do. And for those on the fence, 60 Minutes may just have legitimized it walking away.

The LA Times is writing A tipping point? "Foreclose me ... I'll save money"

A homeowner who can't sell his house tells the L.A.Times, "Foreclose me. ... I'll live in the house for free for 12 months, and I'll save my money and I'll move on."

Banks and lenders fear this kind of thinking -- that walking away from a house could be the smart economic move -- appears to be on the rise. Wachovia, in a conference call yesterday, warned investors that increasing numbers of homeowners are walking away from their homes by choice: "... people that have otherwise had the capacity to pay, but have basically just decided not to because they feel like they've lost equity, value in their properties..."

Intentional Foreclosure: The New Trend

CBS13 is talking about the New Trend in Sacramento: 'Intentional Foreclosure'.

This is how it works. Bob paid $420,000 for his home. Then he notices the house across the street, with more upgrades, and is selling for $315,000.

So Bob, who has pretty good credit, decides to buy the cheaper house. He can't afford both, so then he walks away from his original home, letting it fall into foreclosure. That will hurt his credit, but he's willing to take the hit for a more affordable home.

Changing Social Attitudes At Forefront Of Crisis

Changing Social Attitudes About Debt have clearly moved to the forefront of the housing crisis. Even those who can afford to pay are walking away with no regrets. And with people walking away in mass, Banks Attempt To Freeze Balance Sheets is destined to fail.

This is what happens when you give people free money. Unfortunately, Bernanke, Congress, and Paulson are intent on giving away more free money to fix the problem. On the surface this might appear inflationary. However, credit destruction and bank impairments are happening far faster than Bernanke and Congress are acting.

Welcome to Deflation American Style. At the current rate of progression, Deflation American Style figures to be far worse than anything Japan ever saw.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Financial Crisis Poised To Hit Europe

Three more nails in the were driven into the European decoupling myth coffin this past weekend. Let's take a look.

Reuters is reporting Financial crisis to hit 20,000 London jobs.

As many as 20,000 jobs in London's financial district are likely to be wiped out due to the financial crisis, a survey showed on Sunday.

The Sunday Telegraph reported that Experian, which provides data and forecasts to government and private bodies, had slashed its predictions for job growth in the City of London and Canary Wharf to a fall of up to 5 percent from its previous forecast of flat net employment this year.

Experian expects between 10,000 and 20,000 jobs to be lost over the year, with the majority going from the financial sector.

With up to 400,000 people employed in London's financial district, a fall of this scale could severely affect the economy, dragging commercial property prices down and hitting related industries such as IT and telecoms, it said.

European Hedge Funds Freeze Redemptions

The TimesOnline is reporting Crisis grips European hedge funds.

Up to 10 European hedge funds have suspended redemptions after investors clamoured for their cash when the managers made severe losses.

A London prime broker told The Sunday Times that even before last week’s extreme gyrations, nearly two-thirds of London-based hedge funds had lost between 4% and 10% of their value. A "significant number" had lost much more, he said.

The manager of one of Britain’s biggest hedge funds said: "It’s been an extraordinary week. Even in the crash of 1987 I don’t remember so much carnage."

The problems have been exacerbated by the fact that prime brokers, the arms of investment banks that finance hedge funds, have tightened lending policies.

One manager said: "Since market losses are magnified by leverage in a hedge fund, there can be a sudden need for a cash injection. But this time, the banks can’t lend as easily. Funds are then forced to sell, which causes even more problems."

Freezing Funds A Huge Mistake

I see European hedge funds have learned nothing from their US counterparts at Bear Stearns. Halting redemptions is a very poor decision. All it does is create a pent up demand for more investors to leave as net asset values sink.

I talked about the Redemption Trap in relation to Bear Stearns back in July. "An investor in Europe, who didn't want to be identified, says he's been trying to get his money out of the hedge fund since February."

The Bear Stearns High-Grade Structured Credit Strategies Enhanced Leveraged Fund eventually went to zero while the High-Grade Structured Credit Strategies Fund went for something like 12 cents on the dollar. Had redemptions been allowed in February, investors wanting out would have gotten more than that for sure.

More Subprime Bank Troubles In Germany

Reuters is reporting Landesbanks' subprime exposure 80 billion euros.

Four German state banks have a combined exposure of almost 80 billion euros ($117.2 billion) to risky assets and the state bank of Bavaria, BayernLB, could need an over 2 billion euro write-down, FOCUS magazine reported.

Germany's Landesbanks are financial institutions owned by regional government and local community savings banks.

The banks are considering whether to transfer their U.S. subprime debt-related instruments to a special-purpose vehicle, the weekly magazine reported without citing its sources.

SIV Madness

With everyone else trying to reduce SIV exposure, what the heck are Germany's Landesbanks doing considering creating a new SIV? Hasn't anyone learned anything from this mess yet?

Mike "Mish" Shedlock
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Faith In System Erodes Brick By Brick

Bloomberg is reporting SEC to Rework Rules After Funds Struggled With Subprime Prices.

The U.S. Securities and Exchange Commission is updating rules for how mutual funds value holdings after they struggled to price mortgage-backed investments during the subprime-lending crisis.

"Funds seem to be relying on stale pricing on several occasions," Scheidt said in an interview today. "They were continuing to value the securities at prior levels" even though "facts would suggest that the price would have gone down."

The new rules, which will be binding for companies registered under the Investment Company Act, mark the agency's "first comprehensive" revision in four decades, Scheidt said.

When prices don't exist because an exchange is closed or an asset is infrequently traded, funds base valuations on prices for which they can reasonably expect to sell. In such cases, fund managers rely on quotes from brokers and pricing services.

Inaccurate asset prices may prompt mutual-fund managers to overestimate a fund's net value and overpay when shareholders sell back their stakes. That can shortchange long-term investors.

When demand for subprime-backed debt dried up last year, more than 80 percent of investment managers had difficulty obtaining prices for mortgage-related investments, according to a September survey by Greenwich Associates.

Brokers stopped providing quotes out of concern they might have to honor the prices and buy back securities that had plummeted in value, said Timothy Sangston, a managing director at Greenwich Associates, a financial-services consultant based in Greenwich, Connecticut.

To prevent investor losses, Baltimore-based Legg Mason has arranged $1.47 billion in financing for its money-market and cash funds since November. In December, Atlanta-based SunTrust injected $1.4 billion into two money funds, and Bank of America, the second-largest U.S. bank, said it would wind down a $12 billion cash fund. Cash funds, which are sold to institutions and wealthy individuals, offer higher yields by investing in riskier assets.

Within the $12.1 trillion U.S. mutual-fund industry, the biggest subprime-debt investors are taxable bond and money-market funds, which managed a combined $3.93 trillion of assets as of November, according to the Investment Company Institute.

In November GE's "enhanced" cash fund broke the buck. GE was an institutional money fund not a retail money market operation, and it is now closed.

In December, Bank of America shut its $12 billion cash fund.

The so-called enhanced-cash fund, which was only offered privately to institutional investors, saw its net asset value dip below $1 recently. Big investors that want to redeem are being paid "in kind," which means they get their share of the fund's assets put into a separately managed account, according to Jon Goldstein, a spokesman for Bank of America.

"It's in the best interests of the fund and investors to start unwinding," Goldstein said. "Unprecedented conditions in short-term debt markets have weakened the performance of private cash funds like this one."

Such disruptions have sparked concerns that money-market funds could drop into negative territory. These types of funds are supposed to return investors' principal -- so if they "break the buck," as it's called, that would be bad news.

However, the $12 billion Columbia fund that's shutting down is not a money-market fund, according to Goldstein. As an enhanced-cash fund, it was supposed to take more risk to generate higher returns.

More Cash Injections Needed

Not wanting to break the buck further, Bank of America decided to hand over securities to any pension plan or large investor and essentially said "It's your problem now". That cannot be too inspiring for future business relationships. One of the results of what has transpired so far is bound to be reduced trust in institutions peddling all kinds of products.

These new rules all but insure more cash infusions will be required by institutional money funds and other funds that still have not marked assets to market. Etrade was caught holding client cash in illadvised debt instruments, and it may yet result in bankruptcy.

Douglass National Bank, Kansas City, MO Goes Under

The Kansas City Star is reporting, Douglass National Bank Fails.

The bank's failure is the first in the nation this year and the first in the area since Superior National Bank failed in April 1994.

Douglass has struggled with mounting loan problems and operated under March 2006 orders from regulators to improve its dwindling capital strength. In the last two years, losses had reached $5.6 million, and more than 20 percent of the bank's remaining loans were still considered problems as of the end of December.

The Office of the Comptroller of the Currency, which regulates nationally chartered banks, closed Douglass after its regular business hours Friday and appointed the Federal Deposit Insurance Corp. to be receiver. The FDIC said it sold $55.7 million of Douglass' assets to Liberty Bank and Trust at book value, less a discount of $6.1 million.

Depositors' accounts transferred automatically to Liberty Bank and Trust. The FDIC said customers could access their money this weekend by writing checks and using debit or automated teller cards.

Faith in the system is slowly but surely eroding, brick by brick. Failing banks will add to the worry. Investors have every right to be wondering "What's Next?"

I am expecting many more bank failures coming up. This is a warning call to anyone over the FDIC limit at any bank anywhere.

Mike "Mish" Shedlock
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Real Estate Auctions Booming

The real estate auction business is booming. Real Estate Disposition Corp is auctioning 2,000 homes in California and 575 in DC, Maryland, and Virginia. More states are coming up.



click on image for enhanced view.

Following is a random sampling of listings.
Some are "real beauties".

Item 247A



Item 252B


Item 240


Item 20


Item 249


Item 250


Item 272


Item 327


Item 600B


Item 604B


Item 664A


The only way some of those houses could have sold at the previous value is out and out fraud. Many of the opening bids are preposterous. Even still, there are going to be enormous losses if the homes go for the opening bid. Some won't sell for half the opening bid. They will be back on the auction block again, hopefully with more realistic opening bids.

FirstFed hit by delinquent loans

The LA Times is reporting First Federal Bank of California Net Income Plunges.

FirstFed Financial Corp., parent of First Federal Bank of California, reported that net income plunged 75% to $8.41 million in the fourth quarter because of delinquent home loans.

FirstFed shares slumped $2.93 to $36.07.

Net income was 61 cents a share, compared with $33.4 million, or $1.97, in the same period a year earlier, the Santa Monica-based company said.

Single-family home loan delinquencies led to an increase in the provision for losses to $21 million, compared with $3 million a year earlier. Adjustable-rate mortgages contributed to the higher level of delinquent loans, the company said.

California Defaults Soar



The above chart from DQNews.

California Foreclosure Activity Still Rising

The number of mortgage default notices filed against California homeowners jumped last quarter to its highest level in more than fifteen years, a real estate information service reported.

Lending institutions sent homeowners 81,550 default notices during the October-to-December period. That was up by 12.4 percent from 72,571 the previous quarter, and up 114.6 percent from 37,994 for fourth-quarter 2006, according to DataQuick Information Systems.

Last quarter's number of defaults was the highest in DataQuick's statistics, which go back to 1992.

"Foreclosure activity is closely tied to a decline in home values. With today's depreciation, an increasing number of homeowners find themselves owing more on a property than it's market value, setting the stage for default if there is mortgage payment shock, a job loss or the owner needs to move," said Marshall Prentice, DataQuick's president.

Of the homeowners in default, an estimated 41 percent emerge from the foreclosure process by bringing their payments current, refinancing, or selling the home and paying off what they owe. A year ago it was about 71 percent. The increased portion of homes lost to foreclosure reflects the slow real estate market, as well as the number of homes bought during the height of the market with multiple-loan financing, which makes 'work-outs' difficult.

Bottom Fishers Beware

As go defaults so goes auctions. The auction business is going to be booming for a long time to come and prices have much further to drop.

Note: I am doing a live radio show every Wednesday on the Charles Goyette show KFNX. Those interested can click on the MP3 player on the upper right of the blog to hear an audio recording.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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