Slow Motion Train Wreck

Bennet Sedacca is asking Who Will Be Next Bear Stearns?

Without naming names quite yet, what would you think of a company that accomplished the following in 2007?

• Wrote down book value from $39 billion to $32 billion or from $41.35 to $29.34 per share.
  
• Increased shares outstanding from 868 million to 939 million.
  
• Increased Treasury Stock from 351 million to 418 million.
  
• Increased long-term borrowings from $147 billion to $201 billion.
  
• Increased preferred stock issuance from $3.1 to $4.4 billion.
  
• Increased Total debt to common equity to 2816.81%.

I could cite 20 or more similar financial ratios and they are all stunning.
Who is this firm? Merrill Lynch (MER)

Some statistics on another potential bad bank:

• Wrote down book value from $35 billion to $31 billion or from $32.67 per share to $28.56 per share.
  
• Increased long term borrowings from $127 billion to $160 billion.
  
• Increased total debt to common equity to 2496.53%.
  
• Maintains an $88 billion position in Level 3 assets, or 283% percent of shareholder equity.

Who is this firm? Morgan Stanley (MS)

There are only two solutions in my mind for what can happen to these firms. They can raise capital or sell themselves, perhaps for not very much.

The capital raises I foresee in the second quarter might be something for the record books. Fannie Mae (FNM) and Freddie Mac (FRE) may need to raise up to $20 billion this year through a combination of preferred, convertible preferred stock and equity to get their financial ratios into OFHEO compliance, as they are being asked to pick up the slack of the hundreds of mortgage lenders that have gone bad and the commercial banks that are now backing away from lending. I just read a news story where UBS (UBS) may need to raise upwards of $16 billion. Merrill, BankAmerica (BAC), Wachovia (WB), Morgan Stanley, HSBC (owner of Household Finance), and many others will not be far behind.

How long will market participants be available to buy all of this new paper? My general take is not for long.

Ouch! That's My ARS!

About a month back, I wrote an article entitled Pain in the ARS. ARS, or Auction Rate Securities are now beginning to make headlines and could prove extremely damaging to investors and the dealers that sold them to investors.

The securities yield a bit more than traditional money market funds and were considered "cash equivalents" when in reality they are very long term bonds that reset every so often, so long as there is a buyer and the auction doesn’t "fail" to attract enough buyers to reset the rate. What happens in a failed auction? The owner cannot get their money back from the brokerage firm—they simply have to stick it out until enough buyers are found to avoid failure.

When brokerage firms were flush with cash and making lots of money from traditional activities like investment banking, auctions never failed. The dealer simply stepped up and bought the remaining ARS and kept the auction from failing. These days, however, the dealers, like UBS (UBS), Merrill and Morgan Stanley are in dire need of capital themselves, leaving the investor to hold the security, perhaps for the entire duration, or 40 years.

This brings to light several important points. First, you are stuck in the security for possibly a long time, but failed auctions pay investors the "maximum rate" as defined by the prospectus, which on the surface sounds good. But in reality, most of the shares associated with closed end bond funds have a maximum rate of 110% of commercial paper.

Blackrock Muni Insured Floating Rate History

Blackrock Muni Insured Maturity Data

Note the "workout date" of 12/31/49. That is 41.75 years for those counting. And with the commercial paper index plummeting along with Fed Funds, I fully expect commercial paper rates to settle as low as 2%, which would net the ARS holder a whopping 2.2% and no liquidity.

So what is happening? UBS announced on Friday that it'll begin to mark the securities to market (as if there actually were a market). They haven’t yet disclosed their pricing methodology but I have one of my own. If someone asked me to buy this security, I would demand a yield of 10%. After all, I can buy agency preferred stock at 12% tax equivalent yield with loads of liquidity. Where would that bond trade? Yikes: something on the order of 23 cents on the dollar, as my table below shows.

Theoretical Price for a 2.2% ARS

There are actually some examples that are actually worse than this. Some student loan-backed ARS have reset to zero coupons. What would I pay for a forty year security with no yield? Zero.

The greedy are now being penalized. It's now possible that the good, the bad, the not-so-good and the ugly will all get hurt at once. Such is the unwinding of greed.

The above is just a portion of Sedacca's article, an article I consider a great read in entirety. Also covered in the article are ideas of how to play good banks, bad banks, and the in between banks. Those interested in income will welcome reading ideas on Fannie Mae and Freddie Mac debt.

How long the Fed can keep the train on the tracks remains to be seen but I agree with Sedacca that it might not be too long. Capital impairments are simply too high, and the combination of rising unemployment, imploding commercial real estate, and homeowners walking away will be too much for lenders to handle. One or more major banks and broker dealers in addition to Bear Stearns will not survive the coming train wreck.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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The Fed And The Henhouse

The GlobeInvestor is reporting Even on Wall Street, capitalism takes a hit.

Socialist-style Fed or financial saviour?

The cover of the latest issue of BusinessWeek shows Ben Bernanke in profile against a bright red and orange backdrop, pensively stroking his grey beard and looking remarkably like Vladimir Ilyich Lenin.

The imagery is intentional and pointed.

"Comrade Ben is determined that there will be no financial meltdown and no depression while he is in command," economist Ed Yardeni wrote to clients. "Given the initial reaction [on Wall Street], I suppose this means we are all financial socialists now."

Guaranteeing Bear Stearns' portfolio of troubled investments sets a bad precedent by transferring potential losses from the market to taxpayers, complained Allan Meltzer, a professor of political economy at Pittsburgh's Carnegie Mellon University.

"I do not believe the current system can remain if the bankers make the profits and the taxpayers share the losses."

Comrade Ben - Reluctant Revolutionary



Fed Calls Regulatory Overhaul "Timely"

Reuters is reporting Treasury regulatory overhaul plan "timely".

Upcoming Treasury Department proposals to make the Federal Reserve the chief regulator of U.S. financial markets and give it sweeping new powers won praise on Saturday from the central bank and the head of the Securities and Exchange Commission.

"The Treasury's report presents a timely and thoughtful analysis and is an important first step in the complex task of modernizing our financial and regulatory architecture. We look forward to working with the Congress and others to help develop a policy framework that will enhance financial and economic stability," a Federal Reserve spokeswoman said.

Let's Take a Look at "Timely"

• Housing is imploding.
• There are $500 Trillion in derivatives that no one can possibly understand the financial risks on.
• A huge portion of those derivatives are with JP Morgan (JPM).
• Bear Stearns stock went from $170 to $10 in a year in Shotgun Wedding between Bear Stearns and JP Morgan arranged by the Fed
• Questions Linger Over Lehman's Balance Sheet as Lehman Brothers (LEH) is leveraged 31.7 times.
• Citigroup (C) had to be bailed out by Abu Dhabi Deal Raises Questions About Citigroup's Health
• Merrill Lynch needed $6.6 Billion Bailout From Kuwait, Mizuho.
• Cost of Capital "Ratchets Up" at Citigroup and Merrill
• Morgan Stanley (MS) sold 9.9% of the firm to China after handing out huge bonuses.
• People are walking away from homes
• Businesses Are Advised To Walk Away from agreed upon deals.
• There is an open public debate on Moral Obligations Of Walking Away
• 1 in 10 of the entire state of Ohio is on food stamps.
• Florida, Ohio, and Michigan are in an economic depression.
• There is No market for Asset Backed Commercial Paper (ABCP)
• German Banks Fears Global Meltdown caused by US subprime debt
• There is a $1.1 Trillion HELOC Problem
• Unemployment is poised to soar.
• Commercial real estate is massively overbuilt and poised to plunge.
• Goldman Sachs (GS) is calling for another $460 billion in writedowns.
  
• The SEC Openly Invites Corporations To Lie.

Gee, that sure looks "timely" to me.

Who is to blame for the mess we are in?

And who is to blame? The Fed course, with help of Congress, and the SEC.

Congress passed legislation to create GSEs to foster affordable housing. Now the definition of "affordable" is over $700,000, and calls to reduce the role of the Fannie Mae are now calls to increase the role of Fannie Mae in the wake of the housing crisis. There were 300 some programs to create affordable housing and every program made the situation worse. All those programs really amounted to was handouts to the building industry and banks.

And if Congress would stop wasting money on needless programs the dollar would stop sinking. Of course the government is wasting trillions of dollars trying to be the world's policeman, a role we can no longer afford.

The SEC in its infinitely poor wisdom, decided to give government sponsorship to Moody's, Fitch, and the S&P and this led to extremely risky garbage being rated AAA. I talked about this problem in Time To Break Up The Credit Rating Cartel.

But the Fed deserves the brunt of the blame for micro-managing interest rates like some central planners from the Soviet Union. The Fed does not know how to set the correct price for money (interest rates) any more than it knows how to set the correct price for orange juice. Only free market forces can properly set prices so that economic distortions do not occur.

Unfortunately, every problem Greenspan faced was an excuse to cut interest rates. Even non-problems like the silly Y2K (year 2000) scare was an excuse to cut rates.

When the dotcom bubble collapsed, the Fed slashed interest rates to 1% to get the economy moving again. The housing bubble was the result. Greenspan added more fuel to the fire along the way by openly praising ARMs and derivatives.

Greenspan May 5th 2005: "Perhaps the clearest evidence of the perceived benefits that derivatives have provided is their continued spectacular growth."

I compared Greenspan to Buffett in Who's Holding The Bag?

Buffett in stark contrast to Greenspan called the explosive use of derivatives an "investment time bomb".

It's perfectly clear now who was right. For those who have not pieced the story together properly, it was fear of a dominoes style chain reaction collapse of Credit Default Swaps starting with Bear Stearns that caused Bernanke to force a shotgun wedding between Bear Stearns and JP Morgan.

So what does the Treasury Department propose? The Orwellian answer of course is to give the Fed still more power to wreak havoc.

The Fed And The Henhouse

The New York Times is reporting In Treasury Plan, a Reluctant Eye Over Wall Street.

The Bush administration is proposing the broadest overhaul of Wall Street regulation since the Great Depression. But the plan, to be unveiled on Monday, has its genesis in a yearlong effort to limit Washington’s role in the market.

The regulatory umbrella created in the 1930s would grow wider, with power concentrated in fewer agencies. But that authority would be limited, doing virtually nothing to regulate the many new financial products whose unwise use has been a culprit in the current financial crisis.

The plan hands vast new authority to the Federal Reserve, essentially formalizing what has been an improvised process over the last three weeks. But some fear that the central bank’s role in creating the current mess will undercut its ability to clean it up.

“The Fed oversaw this meltdown,” said Michael Greenberger, a law professor at the University of Maryland who was a senior official of the Commodity Futures Trading Commission during the Clinton administration. “This is the equivalent of the builders of the Maginot line giving lessons on defense.”

The Fed’s former chairman, Alan Greenspan, for years praised the growth in the derivatives market as a boon for market stability, and resisted calls to use the Fed’s power to increase regulation of the mortgage market.

Inquiring minds can read through a 15 page Summary of Treasury’s Regulatory Proposal should they so desire. But here is the sad state of affairs:

The biggest, most reckless credit experiment in history has started to implode. It's far too late to stop a complete systemic collapse now. Granting new powers to the agency most responsible for the mess simply does not make any sense.

In the long run, the only solution is to abolish the Fed, end government sponsorship of the ratings agencies, and return to sound monetary policies in Congress with a currency backed by hard assets instead of promises.

Instead, the proposal is to give Fed increased authority to watch over additional henhouses. And if there's one thing worse than the fox watching the henhouse, it's the Fed watching the henhouse. A quick look at history should be enough to convince anyone of that.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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The $1.1 Trillion HELOC Problem

The New York Times is writing Home Equity Loans as Next Round in Credit Crisis.

Americans owe a staggering $1.1 trillion on home equity loans — and banks are increasingly worried they may not get some of that money back.

When borrowers default on their mortgages, lenders foreclose and sell the homes to recoup their money. But when homes sell for less than the value of their mortgages and home equity loans — a situation known as a short sale — lenders with first liens must be compensated fully before holders of second or third liens get a dime.

In places like California, Nevada, Arizona and Florida, where home prices have fallen significantly, second-lien holders can be left with little or nothing once first mortgages are paid.

Consider Randy and Dawn McLain of Phoenix. The couple decided to sell their home after falling behind on their first mortgage from Chase and a home equity line of credit from CitiFinancial last year, after Randy McLain retired because of a back injury. The couple owed $370,000 in total.

After three months, the couple found a buyer willing to pay about $300,000 for their home

CitiFinancial, which was owed $95,500, rejected the offer because it would have paid off the first mortgage in full but would have left it with a mere $1,000, after fees and closing costs, on the credit line.

“If it goes into foreclosure, which it is very likely to do anyway, you wouldn’t get anything,” said J. D. Dougherty, a real estate agent who represented the buyer on the transaction.

Underscoring the difficulties likely to arise from home equity loans, a Democratic proposal in Congress to refinance troubled mortgages and provide them with government backing specifically excludes second liens. Lenders holding a second lien would be required to write off their debts before the first loan could be refinanced. That could leave out a significant number of loans, analysts say.

People with weak, or subprime, credit could be hurt the most. More than a third of all subprime loans made in 2006 had associated second-lien debt, up from 17 percent in 2000, according to Credit Suisse. And many people added second loans after taking out first mortgages, so it is impossible to say for certain how many homeowners have multiple liens on their properties.

“This is turning out to be a real impediment to solving this problem,” said Mark Zandi, chief economist at Economy.com, “at least, solving it quickly.”

The article notes that 5.7 percent of home equity lines of credit were delinquent or in default in December 2007, up from 4.5 percent in 2006, according to Moody’s Economy.com. It's not unreasonable to assume with the the recession picking up steam that 10-15% of those $1 trillion in HELOCs and second mortgages will default. If so, add another $100-$150 billion in writeoffs. That number can easily be low.

The Latest Fad

Arizona Central is reporting about the latest fad: Hunting for foreclosure deals.

During the housing boom, investors flocked to metro Phoenix and climbed onto buses that took them to the Valley's fringes, where they checked out affordable new homes they could buy low and sell high.

Now, the bus tours to those edge suburbs are starting again. But this time, home buyers are looking for foreclosure properties they can flip for a fast profit.

My comment: Insanity never stops. Wake me up when flippers give up.

The Valley's foreclosure-buying spree started with auctions last fall. Late-night infomercials turned from buying homes with little down to foreclosure-investing. Daylong foreclosure-investing seminars in Valley hotel conference rooms, including sessions held by Trump University, began filling up in January. Smaller bus tours put on by local real-estate agents are going on most weekends now, and a national group called Foreclosure Bus Tours today will hold its first daylong event in the Phoenix area.

My Comment: There is no foreclosure buying spree. However, there are a bunch of "Trump Artists" making money promoting the idea.

"Foreclosure-investing is the real-estate buzzword now," said Eric Brown, a former Phoenix home builder who is a managing director of real-estate consulting firm Robert Charles Lesser & Co. "Huge investment companies and individuals are looking to pick up properties cheap."

My Comment: I would advise staying away from anything that becomes the "buzzword".

Foreclosure Bus Tours has shuttled investors around Detroit, Fort Lauderdale, Fla., and Boston, and it has tours planned in Dallas and Houston as well as Maryland and Connecticut. For $97, investors get lunch and check out several foreclosure properties. Usually, a local real-estate agent and mortgage broker is on the bus to get deals going.

My Comment: For $97 you get to listen to real estate shill pitch crappy deals to a captive audience.

"Last time around, it was the amateurs who believed the infomercials and used all the home equity in their own homes to buy rental properties," said Jay Butler, director of Realty Studies in the Morrison School at Arizona State University Polytechnic.

"Now, many of those houses are in foreclosure and selling to a similar group of investors."

My Comment: People flying in from Chicago or wherever and don't know the local conditions are going to get taken. The local professionals don't need a tour bus.

Most Valley homes in foreclosure don't have any equity left because of falling home values. More than 95 percent of the houses going into foreclosure are going back to the lender because no one wants to bid on the houses with upside-down loans, which are worth less than what is owed on them.

My Comment: That is another gotcha. Banks want their investment back no matter how unrealistic that is.

Some homeowners are trying to avoid foreclosure by doing short sales. But Brett Barry of Realty Executives said many lenders aren't willing to negotiate, particularly on home-equity loans or second mortgages, and that is forcing more people into foreclosures.

Lenders won't deal

"Lenders just won't deal, and it makes no sense because it's only going to cost them more money, particularly when the houses are going for so cheap at auctions," Barry said.

My Comment: There's the home equity/second mortgage trap again. It is preventing deals from getting done. Second lien holders want something. Why should they approve a deal and get nothing out of it? First lien holders are being too stubborn. Bankruptcies will result instead of short sales. Everyone loses.

Diane Drain, a Phoenix bankruptcy and foreclosure attorney, is seeing the same thing. She said she is working with two to three investors a day who are going to lose homes to foreclosure because lenders won't negotiate with them.

She cautions people investing in foreclosures to spend only money they can afford to lose.

"If it's money you would take to Vegas and drop on a table, then invest it in foreclosure properties," Drain said. "But if it's your retirement account or home equity, don't touch it. I am seeing too many people now who are losing everything because they invested in homes they thought they could flip for a profit."

My Comment: Finally, we see some practical advice.

Key Points

• The idea that one can buy foreclosures and flip them quickly for a profit is complete silliness. There is simply to much inventory. Exactly who is the flipper going to flip to?
  
• Banks are still holding out for too much money on foreclosed properties.
• Second mortgages are preventing deals from getting done.
• Refusal to deal is hurting all the parties involved and increases losses on the first lien holder.
• Refusal to work out short sales will increase bankruptcies.
• Bills to alleviate this mess will fail because Congress excluded second liens. Actually, no matter what Congress does it will fail. The best thing Congress can do is nothing.
  

The home equity problem is two fold. The easily seen is the $100-$150 billion (or more) in future writeoffs. Beneath the surface is the damage caused by all these loans originated with 0% down, and/or HELOCs involving multiple companies with multiple liens. The latter is slowing down deal making and will eventually result in more personal bankruptcies.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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SEC Openly Invites Corporations To Lie

The Securities and Exchange Commission sent out a Letter On Fair Value Measurements, (Financial Accounting Standards No. 157) that is tantamount to being an open invitation to lie. Let's take a look at what some are saying about that letter.

Floyd Norris at the New York Times writes If Market Prices Are Too Low, Ignore Them.

The Securities and Exchange Commission is out today with a letter to companies that own a lot of financial instruments whose current market value must be reported to shareholders. For more than a few companies, disclosing market values is neither easy nor convenient.

The issue is the application of SFAS 157, which governs the way companies compute fair value of assets. The rule sets out three categories of assets, with different ways to value them. Category 1 includes assets with easily observable market values. I.B.M. stock closed today at $114.57, and it is not easy to justify a different value if your quarter ended today. Category 2 is a little fuzzier, where there are observable markets that provide a good guide to prices of your asset, even though there is no direct market. And then there is Category 3, which is essentially mark to model.

But one part of the letter stood out to me, providing an excuse for companies to ignore a market value if they don’t like it (italics added):

“Under SFAS 157, it is appropriate for you to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, unless those prices are the result of a forced liquidation or distress sale. Only when actual market prices, or relevant observable inputs, are not available is it appropriate for you to use unobservable inputs which reflect your assumptions of what market participants would use in pricing the asset or liability.”

That sounds to me like an invitation to fudge. Some people on Wall Street think that nearly every sale today is a forced sale. There are entire categories of collateralized debt obligations where most, if not all, of the trades, occur because a holder has received, or expects, a margin call.

Naked Capitalism wrote an excellent piece on this today called SEC Gives Permission to Fudge Mark-to-Market.

In the last couple of months, there has been increased worry that mark-to-market accounting leads to the operation of a destructive "financial accelerator." As prevailing values go down, banks have to lower the value of their holdings. This leads to a direct hit to their net worth, which will lead them to contract their balance sheets, either by withholding credit or selling assets. More sales in a weak market lead to further declines in the prices of financial instruments, leading to more writedowns and sales of inventory.

Funny how no one had a problem with mark-to-market when asset prices were rising.

But now the SEC has given banks and brokers a huge out. No matter how small or easily absorbed by the market a forced sale might be (think of a hedge fund hit by a margin call), a financial institution can ignore the price realized. In fact, they get to determine what trades constitute a forced sale.

Moreover, we've seen plenty of unintended consequences, or worse, backfires, as regulators intervene trying to alleviate the credit crisis. Banks have been reluctant to extend credit to each other precisely because they don't trust their creditworthiness. That's tantamount to saying they already don't trust their public financial statements, since according to their public filings, virtually all major financial institutions have more than the required statutory capital.

So this move, to stem the balance-sheet-shrinking impact of mark-to-market accounting in a falling price environment, may further undermine liquidity. Companies will less able to judge whether their published financials are telling the whole story, And where the numbers are in doubt, rumors are taken more seriously.

To paraphrase Winston Churchill, it has been said that mark to market accounting is the worst form of financial accounting except for all the others that have been tried. But it looks like we are going to try them anyhow.

Let's sum this all up. Corporations were happy to mark to market as long as asset prices were going up. This led to more loans on top of loans as corporations were making huge profits, at least on paper. Enormous bonuses were handed out based on those paper profits and corporations leveraged up loans.

Now we see those profits were nothing but a mirage.

Of course everyone knew those earnings were a mirage even at the time, but as long as the party was going on, no one wanted to spoil it, especially the Fed and the SEC. So the SEC looked away, and so did the Fed, and so did investors who were happy with everything as long as stock prices were going up.

In the asymmetrical world of the Fed and the SEC bubbles are never prevented, but everything is done to prevent them from busting. Now the SEC is openly inviting corporation to lie.

Disclosure that was fine on the way up is somehow not fine on the way down.

In the end all this does is create more mistrust and suspicion about what is real and what is imaginary. That suspicion may be more damaging than actual disclosure and may also create big temporary inequities between corporations that decide to come clean vs. those who keep sneaking more garbage into Category 3 assets, while pretending those assets are worth more than they are.

Nonetheless, if there was a futures market on pretending, "pretending futures" would be a screaming buy. To paraphrase Martha Stewart "That's not a good thing".

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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ABCP Catch 22 In Canada

The asset backed commercial story in Canada takes a new twist every few weeks. I last wrote about the crisis on March 1, 2008 in Bank of Montreal Misses Margin Calls.

A short synopsis is that Canadian investors thought they were buying short term high quality commercial paper were actually buying subprime mortgage garbage from the US. In a complicated sets of twists and turns, the paper has been frozen since last August, as the value of the paper plummeted.

Bailout plan after bailout plan missed deadlines. All of the bailout plans have revolved around converting short term paper to long term paper, and even then with a loss. The amount frozen is approximately $33 billion. Following is a report on just one piece of the frozen debt.

On March 20, the Vancouver Sun reported Investors face a Catch-22 on ABCP.

Investors in British Columbia who put their money - and faith - in a Vancouver brokerage house, are now caught up in a financial nightmare. Canaccord Capital Inc. put about 1,400 clients, many of them from B.C., in ill-fated asset-backed commercial paper. Those investors, and their almost $270 million worth of savings, have been stuck in a legal limbo since the paper was frozen last August.

And now with a proposal to resolve the ABCP freeze expected to be sent to note-holders next month, the investors are faced with a Catch-22.

Under the plan, reached March 17, the short-term paper would be converted into new notes maturing as late as 2017. Once trading resumes, the new notes will likely trade at 60 cents to 80 cents on the dollar, according to analysts. For that discount, investors may have to give up the right to sue the banks, rating agencies and investment dealers who got them into the mess in the first place.

Or they could hold what were supposed to be short-term investments for eight years and hope to regain the full amount of their investment at that time.

The alternative is to vote against the plan, see the value of the notes drop even further, yet retain the right to spend thousands of dollars in legal fees, and years in court, to try to get their money back.

It's a lose-lose situation for investors who thought they were in risk-free, conservative investments.

The interesting twist is that the plan requires voter approval and it's one vote per person affected. The Sun notes that "retail investors hold only a small portion of the total amount in jeopardy, they outnumber the approximately 100 institutional investors at least 15 to one."

I can't help but laugh at this: "Last week, Canaccord hired an ABCP expert to advise its clients on the proposal."

Gee... Any idea what that "expert" is going to say? I think I do, and here it is with my translation as to the real meaning at the same time.

Expert Statement: "We recommend taking this deal as a fair and honest solution. It's the best we can do under the circumstances and it's time to put this behind us and move forward."

Translation: "You are damned if you do and damned if you don't. Either way you are damned. However, we recommend you take this deal right away because it protects us from further liability. Please sign on the dotted line now and we will throw in a free toaster."

Question: Why is Canaccord hiring an ABCP expert now instead of before investing in this stupid scheme?

Answer: They had no idea what they were doing then. They know full well what they are doing now... trying to protect their own hide. So they hired an expert that is all but guaranteed to give the answer they want to hear.

Coastal Community Credit Union Woes

On March 22 the Vancouver Sun wrote about Worried Investors at Coastal Community Credit Union.

Baumel, of Qualicum Beach, is one of an unknown number of credit union members across Canada who were put into ill-fated asset-back commercial paper through Credential Securities Inc., the credit unions' investment dealer. Yet now that the paper has gone bad, Baumel said the credit union is not willing to give him his money back.

Baumel is in real estate, so he has enough risky investments. That's why he wanted his savings to be in something 100-per-cent safe. At first it was in an account at the credit union, but that earned no interest, so the credit union -- Coastal Community Credit Union -- advised him to go to Credential. There he put his money in what he believed was a high-interest savings account.

But when Baumel went to withdraw $100,000 of his $365,000 portfolio last August to lend to a colleague as part of a business deal, he was given the bad news -- the money had been frozen.

Baumel had never heard of commercial paper, but if he had been told he was in asset-backed or mortgage-backed investments, he says he would have turned it down. He already had enough exposure to that risk with his real estate investments, Baumel said.

What makes Baumel "profoundly disappointed" is that despite the fact he told Credential to invest in something that was 100-per-cent safe, he ended up with ABCPs. And the credit union has refused to assure him he won't be out of pocket when the issue is resolved, Baumel said.

Other than Credential, Canaccord is the only investment dealer known to have not yet made a deal to indemnify its clients. While it is unknown how much Credential customers hold, Baumel was told that his credit union has about 12 clients in his situation, with a total of between $2 million to $3 million invested.

New Plan For Small ABCP holders

On March 28 Reuters reported Plan in works to help small Canadian ABCP holders.

A relief plan to assist individual owners of frozen Canadian asset-backed commercial paper is in the works, but it is moving more slowly than participants hoped, Canaccord Capital Inc Chief Operating Officer Mark Maybank said Friday.

"A lot of people are working very diligently ... we continue to work with others to put together that plan," Maybank said in an interview. "It's not finished, it's certainly taking longer than we or anyone else would like, but we think we're getting closer."

Some retail investors are upset with a proposal to restructure C$32 billion ($31.4 billion) of asset-backed notes that were issued by various non-bank-sponsored trusts. This segment of the commercial paper market collapsed last summer.

Retail noteholders, most of them Canaccord clients, outnumber institutional investors with big holdings, so they could kill the seven-month-long ABCP restructuring effort next month if a majority votes against the proposal.

The relief plan could offer extra liquidity to small ABCP investors who receive new, restructured notes. But it is "doubtful" the plan will be finalized before public information meetings on the main restructuring proposal begin next week, Maybank said. He declined to name the other parties in the talks. The Globe and Mail newspaper said "a group of Canadian financial institutions" was involved.

Small investors face tough choices as they ponder the restructuring proposal: receive new notes and wait years to recover their funds; sell the new notes at potentially steep discounts in a secondary market; or vote against it and try to recover their money through litigation.

Some 1,400 of an estimated 1,800 retail noteholders are clients of Canaccord. The investment dealer has said it cannot afford to buy out their ABCP positions, totaling about C$270 million.

Another 335 investors, who are with Credential Securities Inc., an investment dealer for various Canadian credit unions, collectively own C$48 million of the seized-up paper.

Credential said this week that it is exploring avenues to ensure that its investors "receive the maximum possible value from their investments." One option under discussion calls for retail investors' holdings to be bought for a set percentage of their initial investments.

"It depends a bit on the type and nature of the client, different clients have different needs, but we would be able to guarantee a certain percentage," Canaccord's Maybank said. "That would certainly be one of our preferred ways to go forward."

The cost of settling with individual ABCP investors is low in the grand scheme of the restructuring, so large stakeholders will probably step up, a bank analyst said Thursday. "We believe that small investors have less than C$500 million of the total balance but the majority of the votes," BMO Capital Markets analyst Ian de Verteuil said in a research note.

Assuming that a successful ABCP restructuring allowed 85 percent recovery on the paper, the cost of settling with small investors would only be C$75 million, de Verteuil said."We have no idea who will bear the costs of settling this situation but are confident that some of the larger stakeholders will," the analyst wrote.

Canaccord promises to make a deal with angry investors

On March 28 Canaccord promises to make a deal with angry investors.

Canaccord Capital Corp. said it's willing to come to an agreement with clients who were told the asset-backed commercial paper they bought was guaranteed. And for any other clients, the Vancouver brokerage is trying to set up a pool of funds that will enable investors to sell their notes at a set price.

Canaccord has 1,400 clients who have invested almost $270 million in the ABCPs. Last week a number of those clients complained to The Vancouver Sun that they had been sold the investments as equivalent to guaranteed investment certificates.

Mark Maybank, Canaccord's chief operating officer, said to suggest the notes were sold as GICs was "patently untrue."

"It's a higher yielding money market product," he said. "It does not have the word 'guaranteed' in it."

But if clients were told it was a guaranteed investment then that's a breach of the rules governing brokerage houses and Canaccord is willing to talk about possible remedies with them, he said.

Ron Lawley, a 72-year-old retiree from Nanaimo, has more than $200,000 tied up, which he says he told his broker to put into Canadian treasury bills. He's been writing and telephoning Canaccord compliance since December, without any resolution to date, though he remains hopeful.

But he won't take anything less than all his money back plus interest, he said.
"And if I don't get that, I am definitely going to be voting no on this accord," he said.

Angela Speller, who has her life savings in ABCPs at Canaccord, said she has not received a response from Canaccord to her complaint earlier this month.
"[But] I would like the entire sum of money," Speller said. "After all I didn't put my money in anything that was risky. I was told it was triple A."

Magic Words

Ron Lawley used the magic words: "T-Bills". If it can be proven that is what he said, his broker should be in deep trouble for not doing what was stated. The question is whether or not it can be proven what Lawley said. Nonetheless, I suspect Lawley will be believed unless a phone recording proves otherwise.

On the other hand, Angela Speller used the wrong words: "AAA". There is no guarantee on "AAA" and that may prove to be a very expensive lesson depending on what Canaccord decides to do with "small investors".

85% Recovery Rate Doubtful

Odds of an 85% recovery rate that was mentioned earlier are extremely doubtful. Besides, 85% "recovery" some 7-9 years down the road in 2015-2017 is simply not 85% recovery no matter how much whitewashing is done.

It will be interesting to see just what is offered to small investors and in what timeframes. To secure the necessary votes to unfreeze this mess some concessions do appear likely for "small" investors. "Small" may simply mean just small enough to secure enough votes to get this deal passed. Anyone too big, is likely going to be very unhappy with the result.

No matter what the offer, this setup seems more like a No Win Situation or a Hobson's Choice (accepting the offer or eventually getting nothing after years of legal fees), than it does a Catch 22.

Thanks to Deb Wot, a teacher in the Canadian Northwest Territories, for helping compile links used in this article. Deb's blog is Making Sense of my World.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Eye on Commodity Prices

There was an interesting "buzz" on Minyanville on Thursday about commodity prices. Here goes from Minyan Peter:

Three things that caught my eye this morning:

• The WSJ reporting that Valero (VLO) is cutting back refining output because of a surplus of supply.
• Oil trading flat/down despite the announcement of a terrorist bombing of a major Iraqi pipeline.
• The CME announced an increase in commodity trading marginrequirements.

While discrete events, all again raise the question of peaking consumer
commodity prices. Two things to keep in mind:

First, commodity price inflation has been cited repeatedly by the Fed as a concern. And given the view of many that the most recent price rises are a function of rampant speculation (versus fundamental demand) I would not underestimate

a) the pressure placed on the CME to increase margin requirements by banking regulators to curtail speculation

b) how stability in commodity prices (let alone price declines) opens up the Fed's ability to drop short term rates further without pummeling the dollar.

Second, while everyone will likely cheer commodity price declines as the savior of the US consumer, asset deflation, whether in housing, commodities or anything else is like Kryptonite to the banking industry. And don't forget, too, how much lending (particularly M&A related) has been done in the past five years in support of commodity related companies - particularly in Asia.

At least to me, commodity price deflation eliminates any notion of decoupling.

Death Spiral Becomes Born-Again Experience

Bloomberg is writing about a Born-Again Experience at Red Kite.

Rising prices for industrial metals and other commodities have pulled thousands of new investors into what were once illiquid markets. Money invested in commodity hedge funds surged 83 percent to about $55 billion in 2007 from $14 billion in 2005, according to estimates by Chicago-based Cole Partners Asset Management. Mutual funds tracking commodity indexes held $125 billion at the end of 2007, compared with $25 billion in 2003, according to Barclays Capital.

"The world is going through the biggest industrial revolution it has ever seen, and it's affecting the largest part of the human population ever," they [Michael Farmer, co-founder of hedge fund Red Kite Metals and his partner, David Lilley] wrote in an e-mail. "This is bringing a combination of millions of new consumers and cheap manufacturing capacity. The implications for raw materials are dramatic, and the world has to learn to value them more highly."

Not everyone agrees that commodity prices will keep rising, especially at a time when economists are predicting a U.S. recession and global slowdown.

"I think where we're really at in the commodity business - - and I've been at this since the 1970s -- is we're overvalued in a number of areas,'' says Don Roose, president of West Des Moines, Iowa-based brokerage U.S. Commodities Inc. "We're nearing a commodity bubble that is very similar to the dot-com bubble.''

Donald Selkin, director of equity research at Joseph Stevens & Co. in New York, says the commodities boom has little to do with supply and demand.

"Massively Misguided"

"The near-record prices that we are seeing come from speculators -- it's massively misguided bullishness," he says. "All economic data we have seen -- durable goods data, economic growth -- are quite negative. It will backfire one day, though I don't expect a market collapse in copper."

Though it also trades aluminum, nickel and tin, Red Kite Metal's main business is copper. It buys the metal from producers in North and South America and sells it to companies that turn the metal into wires and pipes for home and office builders and carmakers. The fund trades copper futures on the LME and buys the physical metal, holding it in warehouses around the world until Farmer and Lilley are ready to sell.

Red Kite moves markets via the huge trades it executes. According to a prospectus sent to potential investors in 2006, Red Kite Metals at that time was borrowing an average of six times its investment pool, which an investor estimated at about $1 billion.

At the March 20 price, that would buy about 750,000 metric tons of copper, or almost four times the combined total metal stockpiles currently held at warehouses registered with the Comex division of the New York Mercantile Exchange, the Shanghai Futures Exchange and the LME.

"If you buy a million tons of copper, that's guaranteed to get the market up," says David Threlkeld, president of metals trading firm Resolved Inc. in Scottsdale, Arizona. Threlkeld was the man who blew the whistle on Tokyo-based Sumitomo Corp.'s illegal effort to corner the copper market in the 1990s.

"RK holds physical stocks of metal as part of its investment strategy," Farmer and Lilley said in a February e-mail. "As a matter of policy, we don't comment on specific positions."

The kings of copper continue to believe that as long as China and India keep building, an investment in the red metal can't lose.

Commodity Speculation

When one points to commodity inventories being at record lows, those inventories do not take into account all the speculative inventories. Red Kite admits being leveraged 6 times. And Red Kite is just one such company. How many more hedge funds are stockpiling metals and/or leveraging futures? In what amounts?

Regardless of what China and India are doing, in light of a slowing economy combined with pressure on the CME to do something about speculation, it's quite a leap of arrogance to believe "investment in the red metal can't lose". With enough leverage, anything can lose, even in mostly favorable conditions.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Germany Fears Global Meltdown

Here is an interesting tale of central bankers working deep into the night last weekend, with Bundesbank President Axel Weber repeatedly in touch by telephone and via videoconferencing with Ben Bernanke in an attempt to orchestrate a bailout of Bear Stearns.

The issues are many: What constitutes too big to fail, who should pay the price for bank failures, what to do about the US dollar, and whether there should be a formal statement on the above.

The issues are still not resolved of course. Nor can they be. Too many banks are insolvent both in the US and abroad.

Let's pick up more of the story in Germans Fear Meltdown of Financial System.

Germany and other industrialized nations are desperately trying to brace themselves against the threat of a collapse of the global financial system. The crisis has now taken its toll on the German economy, where the weak dollar is putting jobs in jeopardy and the credit crunch is paralyzing many businesses.

For some time, there has been a tacit agreement among central bankers and the financial ministers of key economies not to allow any bank large enough to jeopardize the system to go under -- no matter what the cost. But, on Sunday, the question arose whether this agreement should be formalized and made public. The central bankers decided against the idea, reasoning that it would practically be an invitation to speculators and large hedge funds to take advantage of this government guarantee.

So, what does apply? Should the state use taxpayer money to help greedy bankers repair the damage caused by their unscrupulous speculation? Should it invest billions to save ailing financial institutions, thereby engendering new risks and side effects? And should the government, to use the words of a Frankfurt investment banker, "treat a drug addict with cocaine"?

How does one explain to honest taxpayers that they should pony up their hard-earned money for a bank like Bear Stearns, whose long-standing CEO forked out $28 million (€18 million) for a 600-square-meter (6,500 square-foot) duplex apartment on New York's Central Park shortly before the collapse of his company? Or that UBS, the crisis-ridden, major Swiss bank, fired three of its senior executives for poor performance only to turn around and pay them roughly 60 million Swiss francs (€38 million/$59.2 million) in golden parachutes?

The central banks and governments of the major industrialized nations are still dodging the answers to these questions.

"I no longer have faith in the ability of the markets to heal themselves," Deutsche Bank CEO Josef Ackermann confessed in a speech delivered last Monday in Frankfurt. Ackermann said that the American example shows that governments and central banks must now play a stronger role.

Even his counterpart at Commerzbank, Klaus-Peter Müller, agreed, saying that the current situation has the potential to develop into "the biggest financial crisis in postwar history" as long as "the markets are allowed to continue operating unchecked." According to Müller, "It would make sense to permit the banks -- retroactively to Jan. 1 -- to account for securities differently by eliminating the daily revaluation requirement." He argues that this would stop the downward spiral on the banks' financial statements.

The German Finance Ministry promptly rejected such calls, saying: "We see no need to become active at the national level." But this assertion is far from the truth. The ministry has become a place of nonstop crisis meetings, the chancellery is kept constantly apprised of the latest developments, and the Federal Financial Supervisory Authority (BaFin) has already set up a task force to address the issue. No one in the government has the slightest doubt that it will intervene the minute another bank begins to falter.

Germany's state-owned banks, which have been especially careless in recent years about investing in American securities backed by subprime loans, are considered greatly at risk. One of them, Bayerische Landesbank, is currently considering writing off €1 billion ($1.54 billion) -- or possibly even more -- in bad debt. In the first two months of 2008 alone, the Bavarian bank's troubled securities portfolio has lost €1 billion in value, and it has fallen even further since. "There could be another billion in losses on top of that," says one banker.

At another state-owned bank, Dusseldorf-based WestLB, €5 billion ($7.7 billions) in government bailout funds are apparently not enough. The bank is already losing its next billion.

If other banks run into trouble, Finance Minister Peer Steinbrück plans to come to their aid with fiscal tools, even if it gets expensive for the government. "Preventing a bank crash," say officials at the finance ministry, "takes precedence over budget consolidation."

US Subprime Market Sinks IKB Bank

Bloomberg is reporting IKB Supervisory Board Denies Fault for Near-Collapse.

The supervisory board of IKB Deutsche Industriebank AG, the first German casualty of the U.S. subprime market collapse, rebuffed shareholder allegations that it could have averted the near-collapse of the German bank.

"We had no chance to recognize the risks and to avoid the life-threatening crisis," Ulrich Hartmann, head of IKB's supervisory board, said today at the annual general meeting in Dusseldorf.

IKB received an emergency bailout last summer after a finance affiliate that invested in mortgage-backed securities couldn't raise funding amid the credit crunch. The German lender has received financial aid of more than 8 billion euros ($12.6 billion) from Germany's development bank KfW Group, the government and the country's banking associations to stave off insolvency and cover writedowns and losses.

"Apparently, there wasn't a soul in the entire bank who had a grasp of risk management," said Hans-Richard Schmitz of the DSW association, which represents German private investors including IKB shareholders. "Shareholders have been left with a shattered bank and no one wants to take responsibility."

IKB has lost about three-quarters of its market value since July 30, when it cut its full-year forecast and received emergency funding less than two weeks after saying the subprime crisis wouldn't affect it. The bank is currently worth 406 million euros. IKB rose 3 cents, or 0.7 percent, to 4.19 euros in Frankfurt trading after dropping 16 percent yesterday.

Chief Executive Officer Guenther Braeunig today called on shareholders to approve a 1.5 billion-euro stock sale that is "vital to continue running the bank."

"IKB should be shut down," said private investor Hans-Wilhelm Voeller at the congress center in Dusseldorf, where IKB is based and more than 1,000 shareholders were in attendance. "Better a miserable ending than misery without end."

Now there's the quote of the month: "Better a miserable ending than misery without end." We need to apply that thinking here in the US instead of attempting to make debt slaves out of homeowners and zombies out of banks.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Dear Citigroup Customer ....

I have a friend "SK" who is a Certified Mortgage Planning Specialist in California. He has clients in existing ARMs with Citigroup. Those ARMs are about to reset and Citigroup has been sending out "Dear Customer" letters warning them of increases in loan rates.

This is where it gets interesting.

Citigroup has been warning customers of higher rates and is offering existing customers fixed rate mortgages at "special rates". The problem with the offer is the rates in question are about to reset lower, not higher. Yes I have proof.

Exhibit A



click on chart for sharper image

The above document shows a letter that was sent out on March 21, 2008. The small red oval says "The rates in this example were current as of 2/27/2008".

Exhibit B



Exhibit B is simply a blowup of a portion of Exhibit A.

Key Points

1) The area at the top states "Projected Loan After Next Reset"
2) The projected rate of 2/27/2008 is 6.303%.

Exhibit C



click on chart for sharper image

Exhibit C states the loan in question is based on one-year LIBOR + 2.25%

Exhibit D



click on chart for sharper image

Exhibit D shows the LIBOR rate as of February 27, 2008.
Let's be generous to Citigroup and call the rate 2.85

Now let's add the index amount from Exhibit C to the base rate from Exhibit D (2.85 + 2.25) to arrive at a projected customer rate for this loan.

My math says 2.85 + 2.25 = 5.1%
Citi's math (from exhibits A and B) says 2.85 +2.25 = 6.303%

LIBOR (and therefore the projected loan rate) is even lower today.

Exhibit E

Exhibit E is from another client of "SK". It is an Email is discussing correspondence between "SK's" client and Citigroup, as well as an actual conference call between "SK", his client, and Citigroup.

Hey "SK",

Sorry for the delay and thank-you for your help with Citi.
The following is a re-cap our March 17th, 2008 correspondence with Citi,:

As a preferred customer of Citi Mortgage, we called to inquire about our options on our 3/1 arm that has a fast approaching anniversary. We received the following information.

Question 1. What happens to our loan on the anniversary? Will it go down?
Answer: It is very unlikely that it will go down. Would you like to refinance?

Question 2. If we refinance should we stick with an arm or go to a fixed mortgage?
Answer: You do not want an arm you want a fixed. We used a 15 yr. fixed as a example;

We were quoted: 15 yr fixed-5.5 with an Apr of 5.65 and a $4400.00 fee.
We asked for a good faith FAX and she said they do not give those.
We said thank you but we are going to shop.

That is when we called you for help.

We did not know if we were tied to the Libor or the Treasury. A call was placed to Citi and after much reluctance, they reveal we were tied to the T-bill with a 2.75 pt. spread and again we received a higher percentage rate quote.

A conference call was then made between you, a Citi loan officer and myself. Again they were quoting a percentage rate higher than 4.75 which it should have been on that day. We then asked for a supervisor and we were transfer to another loan officer of the same level. When asked if he was a supervisor, he said "no" and another request was made for a supervisor and they hung up on us.

We are seriously questioning Citi Mortgage's ethical practices.
Thank you for your help. We do appreciate doing business with you.

Let's look at Q&A #1 again.

Question 1. What happens to our loan on the anniversary? Will it go down?
Answer: It is very unlikely that it will go down. Would you like to refinance?

By the way the existing rate on the loan in the Email above is 6.00%. That rate is based on the one-year treasury rate plus an index of 2.75. On March 17, the one-year T-Bill rate was 1.53 as quoted during the conference call. Let's do the math. 1.53 + 2.75 = 4.28 (rounded to the nearest higher 1/8 would be 4.375). Citigroup told the client the new rate would be above 6.00%

The above conversation, in conjunction with the documented hard evidence above, suggests a pattern deceit by Citigroup. I am wondering how many Citigroup customers have refinanced to a higher rate and payment based on inaccurate rate quotes from Citigroup mortgage specialists.

I am not a lawyer. I do not know if any of this violates truth in lending laws, fair lending practices laws, or any other laws. However, I do know this is a mess, and if I was a customer of Citigroup I would be questioning whether or not I could believe anything they say.

In the sake of fairness, if Citigroup has a different explanation for the above examples, I will post it.

Addendum 3:

Inquiring minds may wish to read Operational Risk – Improper Disclosure By Citigroup Mortgage. The article discusses a potentially serious breach of fiduciary responsibility by Citigroup, possible RESPA violations, potential violations of Reg. Z, and likely violations of internal procedures.

Addendum 2:

Anyone who feels aggrieved by the actions of Citigroup may contact http://www.consumergripes.net/

This addendum is not associated with Addendum 1 posted previously.

Addendum 1:

I received an Email from a lawyer who writes:

I am a lawyer. And, you don’t need to be a lawyer to KNOW fraud when you see it, and I’d say that what you describe – deliberately misquoting rates, etc. is fraud (there are two types of fraud – fraud in fact and fraud in the inducement, but we don’t have to get in to that, and you may well know the difference (and I suspect you do)).

Most law is “common sense” and if something screams “fraud” it most likely is – under whatever particular law – whether statutory law or common law.

If Citi KNOWS the rate is going lower, but says “it is most likely to go higher” and doesn’t give a straight answer, and is stupid enough to have third party witnesses listen to the misrepresentations and/or put them in writing and or have them recorded (and I assume Citi records a lot of stuff by law or company policy), then they deserve to be sued by a lot people.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Liquidity Battle Moves To Different Universe

Bloomberg is reporting Fed May Emerge From Crisis With More Influence at SEC Expense.

America's financial system faces its biggest overhaul since the Great Depression as officials weigh lessons from the credit-market rout and the near collapse of Bear Stearns Cos.

Federal Reserve policy makers are redefining which companies are vital to the flow of credit, an area once the sole domain of commercial banks, and which institutions pose risks to the entire economy if they fail. Treasury Secretary Henry Paulson said in a speech yesterday that the Fed should broaden its oversight to include Wall Street investment firms, now regulated by the Securities and Exchange Commission.

"This is tectonic," said Ralph Ferrara, a former general counsel at the SEC, and now a partner at Dewey & LeBoeuf LLP in Washington. "We no longer want to have a balkanized response to a national crisis." The SEC will be so diminished that it "will be given a nice view of the Potomac from whatever floor of the comprehensive financial services regulator they are given," said Ferrara.

"Because of financial innovation, we have lots of these financial firms that started to look like banks," said Mark Gertler, a New York University professor and visiting scholar at the New York Fed. "Any institution that may need to go to the discount window directly or indirectly ought to be under the supervisory control of the Fed."

Legislators are already considering a new regulatory structure. House Financial Services Chairman Barney Frank said last week Congress should consider creating an agency to monitor market risk or give that authority to the Fed. The Massachusetts Democrat also said he will seek less duplication. Currently, there are five separate regulators of banks, thrifts, and credit unions.

Lovely. Let's give the most guilty party in creating the mess, more power to make an even bigger mess. Not to be outdone, the Bank of England and the ECB join the battle.

BOE and ECB Join Liquidity Battle

Things are so bad that the BOE Will Take Revolutionary Action.

The Bank of England is poised to take revolutionary action to find a “resolution” to the problems faced by British banks unable to sell or refinance portfolios of mortgage-backed debt, Mervyn King, the governor, signalled on Wednesday.

Mr King also suggested that the Bank was becoming more open to interest rate cuts. His comments came as Hank Paulson, US Treasury secretary, offered strong support for the Federal Reserve’s handling of the Bear Stearns crisis.

In a statement to the British parliament, Mr King said the Bank of England’s existing lending against mortgage-backed securities was “a useful bridge to a longer-term solution”, but can “be only a temporary measure”.

He said a longer-term resolution was needed to deal with the “fragility” of financial markets and to relieve the “overhang on banks’ balance sheets of assets in which markets have closed”.

Mr King was not specific about the mechanisms that might be used. But possibilities are understood to include the purchase or the swapping of asset-backed securities for liquid assets or cash – ideas that have been discussed with other central banks, as the FT reported last week.

To ensure taxpayers were not left with banks’ bad debts, Mr King insisted that the government would have to be insured against any credit losses. Insisting that the big problem in the UK was liquidity, not irresponsible lending, he added: “The banks neither need nor want the taxpayer to insure them against these losses.”

[My comment: Excuse me but insured by who? Ambac? MBIA? Northern Rock?]

Meanwhile, Jean-Claude Trichet, European Central Bank president, told the European parliament that the ECB was committed to easing financial market tensions, but the rescue of banks facing solvency difficulties would be “in a different universe” and require taxpayers’ money.

A Different Universe

Now there's an interesting admission by Trichet: Easing financial tensions will be in a different universe requiring taxpayer money. Meanwhile, the Bank Of England wants guarantees from the tooth fairy that taxpayers will not be at risk. And back in the US, Congress is investigating into how the Fed and the Treasury department handled Bear Stearns while looking into giving the Fed more still power to wreak havoc.

Does anyone else want to join this mad hatters tea party? There seems to be plenty of room at the table for Japan.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Fed Drains Again: 9 Straight POMOs

Every day I hear from someone how the Fed is "printing". My typical reaction is to ask for proof. I never see any. I just looked again. I still don't see any. Oh sure, people point to various Fed sponsored facilities like these as printing.

Recap Of Fed Sponsored Facilities

• The TAF (Term Auction Facility) failed to restore liquidity.
• The TSLF (Term Securities Lending Facility) failed to restore liquidity. See The Fed's Swap Meet for more on the TSLF.
• The PDCF (Primary Dealer Credit Facility) will be the next "facility" to fail. See Fed Fails To Halt Debt Meltdown for more on the PDCF.

However, none of the above is printing. Others point to rate cuts, but rates cuts sure are not printing. Still others point to the $30 billion (now $29 billion) guarantee of the JP Morgan take under of Bear Stearns as printing. However, as bad or illegal as that idea may have been (see Debate Over Bear Stearns: Hussman vs. Mauldin) that is not printing either.

Perhaps one can argue they expect the Fed to start printing, or the Fed will have to start printing once the crappy collateral the Fed is taking for the above swaps and bailouts heads south, but until that happens, let's not say the Fed is printing when in fact they are doing the opposite, at least on a permanent basis.

The last 9 Permanent Open Market Operations, all this month, have been "draining" actions (the opposite of printing). A "printing" action is an Outright Purchase. A "draining" action is an Outright Sale.

Permanent Operations

Operation Date: 03/26/2008
Operation Type: Outright Bill Sale
Release Time:   10:45 AM
Close Time:   11:10 AM
Settlement Date: 03/27/2008
Maturity/Call Date Range: 05/01/2008 - 05/15/2008
Total Par Amt Accepted (mlns) : $9,000
Total Par Amt Submitted (mlns) : $30,285

Operation Date: 03/25/2008
Operation Type: Outright Bill Sale
Release Time:   10:30 AM
Close Time:   10:55 AM
Settlement Date:03/26/2008
Maturity/Call Date Range: 05/22/2008 - 06/12/2008
Total Par Amt Accepted (mlns) : $11,999
Total Par Amt Submitted (mlns) : $41,194

Operation Date: 03/24/2008
Operation Type: Outright Coupon Sale
Release Time:  10:45 AM
Close Time:   11:10 AM
Settlement Date:03/25/2008
Maturity/Call Date Range: 06/30/2011 - 09/30/2011
Total Par Amt Accepted (mlns) : $5,001
Total Par Amt Submitted (mlns) :$12,289

Operation Date: 03/20/2008
Operation Type: Outright Coupon Sale
Release Time:  10:44 AM
Close Time:    11:05 AM
Settlement Date:03/24/2008
Maturity/Call Date Range:02/15/2011 - 05/31/2011
Total Par Amt Accepted (mlns) : $4,957
Total Par Amt Submitted (mlns) :$9,884

Operation Date: 03/19/2008
Operation Type: Outright Bill Sale
Release Time:   10:18 AM
Close Time:   10:45 AM
Settlement Date: 03/20/2008
Maturity/Call Date Range: 06/12/2008 - 07/31/2008
Total Par Amt Accepted (mlns) : $14,999
Total Par Amt Submitted (mlns) : $53,672

Operation Date: 03/17/2008
Operation Type: Outright Coupon Sale
Release Time:  10:55 AM
Close Time:  11:30 AM
Settlement Date: 03/18/2008
Maturity/Call Date Range: 09/30/2009 - 01/31/2010
Total Par Amt Accepted (mlns) : $5,000
Total Par Amt Submitted (mlns) : $13,015

Operation Date: 03/17/2008
Operation Type: Outright Bill Sale
Release Time:   10:04 AM
Close Time:    10:30 AM
Settlement Date: 03/18/2008
Maturity/Call Date Range: 08/07/2008 - 09/11/2008
Total Par Amt Accepted (mlns) : $17,999
Total Par Amt Submitted (mlns) : $56,605

Operation Date: 03/12/2008
Operation Type: Outright Bill Sale
Release Time:   10:45 AM
Close Time:    11:15 AM
Settlement Date: 03/13/2008
Maturity/Call Date Range:05/08/2008 - 06/05/2008
Total Par Amt Accepted (mlns) : $15,001
Total Par Amt Submitted (mlns) : $57,065

Operation Date: 03/07/2008
Operation Type: Outright Bill Sale
Release Time:  10:31 AM
Close Time:   11:15 AM
Settlement Date: 03/10/2008
Maturity/Call Date Range: 05/08/2008 - 06/05/2008
Total Par Amt Accepted (mlns) : $10,000
Total Par Amt Submitted (mlns) : $52,595

Of course the Fed conducts temporary open market operations as well. On that score, a repo is a temporary injection of cash and a reverse repo is a draining action. "Temporary" is typically overnight to 28 days while "Permanent" is months or longer.

Every time there is a huge repo the conspiracy crowd goes gaga because they forget to include expiring repos. Here is a table of Temporary Open Market Operations.

I am not going to add it all up even though some meticulously keep track of such changes. Instead I am going to point to a chart of base money supply.

Base Money As Of 2008-03-12



click on chart for sharper image
The above chart courtesy of the St. Louis Fed

Someone wake me up when the Fed starts printing to a significant degree. In the meantime let's not say the Fed is printing when it is perfectly clear the Fed is printing at close to a 0% rate.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Citigroup Freezes HELOCs

Here is an interesting article on QueerCents about Citibank Freezing Home Equity Lines of Credit. Nina writes...

“Remember that credit is money.” – Benjamin Franklin

As many readers know, I’m a proponent of keeping an untapped home equity line of credit (HELOC) at my disposal for major emergencies. This isn’t my emergency fund. It’s what I call my catastrophe fund.

I’ve always believed that keeping a HELOC readily available is the best insurance policy and the back-up plan for if / when the emergency fund runs empty. Think about it… being able to tap this money could buy us time in the event of job loss or illness. And time is money.

Immediately after we bought the house, our mortgage broker had us refinance and get a line of credit from Citibank for $168,000. We have never used it.

I list all the financial details to support my belief that we’re responsible borrowers. The HELOC is there strictly as a backup plan. For a catastrophe. Period. End of story. But with that said, I’ve always looked at that line of credit as my money. Money I could access at any time.

So it came as a surprise yesterday when we got the letter from Citibank about our $168,000 line of credit: "We have determined that home values in your area, including your home value, have significantly declined. As a result of this decline, your home’s value no longer supports the current credit limit for your home equity line of credit. Therefore, we are reducing the credit limit for your home equity line of credit, effective March 18, 2008, to $10,000. Our reduction of your credit limit is authorized by your line of credit agreement, federal law and regulatory guidelines."

Reduced to $10,000!? Hello!? Please don’t f-ck with my house in Newport Beach…

Of course, I’m calling them today to dispute it. Why? Because unlike the Phoenix property, I believe I can prove our home has retained its value and hasn’t declined. But Newport hasn’t declined with any significance and if we compare current comps in our zip code, we can prove to the lender that our home has retained its value. Or so that’s my plan. I’m going to fight this one and I’ll write a follow up post about my success or failure with regards to the dispute.

Misconceptions vs. Reality

There are many amazing misconceptions in this story but let's start at the top.

Ben Franklin is wrong. Credit is not money. Credit is credit. Nina in fact proves why credit is not money. Credit lines can be withdrawn while cash in the bank (below the FDIC limit) is cash in the bank.

Above the FDIC limit cash in the bank may soon not be cash in the bank. For more on this idea please see Treasuries Safer Than Cash and Yield Curve Twilight Zone. Anyone above the FDIC limit at any bank needs to take action now.

For a quick look at the idea that credit is money and homes are safe credit please consider WaMu Alt-A Pool Revisited.

Since May of 2007, on a credit pool rated 92.6% AAA, 22.69% is now 60 days delinquent or worse, with 11.62% in foreclosure and 3.56% already in REO status. Clearly credit is not cash. Although that is just one pool, not necessarily representative of overall market conditions, but with that kind of action going on it's no wonder banks are cutting back credit lines.

Declining Housing Markets

As far as overall conditions go, let's consider the Case-Shiller Housing Index from my post Chicago Area Foreclosures On Record Pace.

Chicago is one of the cities that Calculated Risk plots. Let's take at his latest chart from Real Case-Shiller House Price Index.



click on chart for larger image

Note the decline in the composite 10 and composite 20 market areas. The chart is inflation adjusted which arguably makes the chart look a bit worse, but the reality is home prices are declining in all major markets.

Furthermore, housing has not yet bottomed. Please see Housing - The Worst Is Yet To Come and When Will Housing Bottom? for details. For an updated look at Florida, ground zero of the housing bubble bust, please read Grown Men Are Crying In Florida. It's a pretty shocking composite.

"It's My Money"

Anyone making a statement "I’ve always looked at that line of credit as my money." should not be advising anyone on money matters. Borrowed money is not one's money. Once borrowed, the amount is debt owed to the lending institution or person making the loan.

Nina is calling Citigroup to dispute. Good luck. Nina writes "When we bought our home three years ago, we put $300,000 down on the $1,100,000 purchase price. .... One reason why we bought in Newport is because we believed that property values would retain their value over time".

I have a message for Nina:

Wake Up!

It is highly likely that you are underwater on your house or soon will be. California is getting hammered. Anyone depending on "comps" is likely hearing what they want to hear. If by some miracle, your area is a pocket of strength it likely will not be soon. Home prices have dramatically outstripped affordability and have only one way to go and that is down.

You can believe in the tooth fairy just as you can believe in your house, but that does not make it real.

Look at this from Citigroup's point of view.

• You have decreasing home equity, most likely no equity.
• California is in decline with a long way to go before houses can be considered affordable.
• The US is in recession.
• People are losing jobs.
• You do not know the difference between money and credit.
• You do not understand the difference between your money and someone else's money.
• You spent $55,000 trying to "make a baby" (mentioned in the article).
• You are about to adopt a child instead (also mentioned in the article).
• Your cash went down and your expenses are clearly going to rise as a result of the last two points.

The frightening thing to Citigroup and other lenders has to be the cavalier attitude of people who still do not see the freight train coming their way. Yes, you want the cash for "emergencies" but should an emergency arise (such as a huge loss in income) that forces you to sell your home after you deplete a $168,000 equity line, Citigroup would be on the hook for it.

Most importantly, the "E" in HELOC stands for equity, (it is likely that you have none or far less than you think) and the "C" in HELOC stands for credit as opposed to your money.

I suggest Citigroup is acting quite reasonably.

Corporations Tapping Equity Lines

Ironically, one reason lending institutions are looking to reduce credit lines elsewhere is corporations are in a mad scramble to tap their lines.

Please consider Porsche, Sprint Unsettle Banks With Rush for Credit.

Citigroup Inc., JPMorgan Chase & Co. and the rest of the banking industry face a new drain on their capital.

Borrowers from Sprint Nextel Corp. to Porsche Automobil Holding SE to MGIC Investment Corp. are drawing on credit lines. JPMorgan analysts say it's the start of a trend that may force banks to raise as much as $40 billion to keep an adequate cushion against potential losses.

Companies are scrambling for cash at one of the worst times for the financial services industry. The world's biggest firms have taken $195 billion in writedowns and losses on securities tied to subprime mortgages, and the 10 biggest U.S. banks have the lowest capital levels in at least 17 years, according to Credit Suisse Group. The tapping of credit lines may be enough to grind new lending to a halt, said David Goldman, a senior portfolio strategist at London-based hedge fund Asteri Capital.

Banks had more than $1.4 trillion in untapped loan commitments as of September, the most since data became available in 1989, according to the Shared National Credit survey by four U.S. regulators including the Federal Reserve and Office of the Comptroller of the Currency.

New York-based Citigroup had $471 billion at yearend, more than any other U.S. bank, according to regulatory filings. Charlotte, North Carolina-based Bank of America disclosed $406 billion of undrawn loan agreements and New York-based JPMorgan had $251 billion. Merrill Lynch & Co. had $59.3 billion.

The added demand from borrowers comes as banks rein in lending to everyone from hedge funds to homeowners in an attempt to preserve capital. A mortgage fund run by David Rubenstein's Carlyle Group collapsed after creditors withdrew financing and Peloton Partners LLP liquidated a fund after demands from banks to repay loans. Leveraged buyouts have slowed to a trickle.

Borrowers will be more inclined to tap credit lines as banks tighten their lending standards, according to Kevin Murphy, a money manager who oversees investment-grade and emerging-market bonds at Boston-based Putnam Investments, which has $65 billion in fixed-income assets.

"It's a vicious cycle," he said. "The more that they tighten the lending standards, the more there will be certain stresses in the financial market. Any sort of unfunded commitments they've put out are likely to be called on."

Sprint, which lost $29.5 billion last quarter, borrowed $2.5 billion in February from a $6 billion credit line arranged by JPMorgan and Citigroup, according to a regulatory filing. Sprint has $1.25 billion in bonds due in November and $400 million of commercial paper.

"If they are short of capital at some point, banks may stop offering credit to borrowers that would normally qualify for a loan," said Anil Kashyap, a professor at the University of Chicago Graduate School of Business, and a former economist for the Federal Reserve. "That's the definition of a credit crunch."

Nina may (or may not be) a good credit risk. I actually suspect she is. But plenty of so called good credit risks will no longer be good credit risks should an emergency arise.

The prudent person needs to have a cash cushion of their own as opposed to a credit line should an unfortunate situation such as the loss of a job happen. Given that unemployment is extremely likely to soar, a sad day of reckoning is coming for the "credit generation".

Those who lose their job and have little or no savings are in for a rude awakening: Cash is not trash but credit sure is.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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WaMu Alt-A Pool Revisited

About a month ago, in Evidence of "Walking Away" In WaMu Mortgage Pool, I wrote about a particular Washington Mutual (WM) Alt-A mortgage pool "affectionately" known as WMALT 2007-0C1 .

Many inquiring minds have been asking for an update of this pool. I am pleased to present a new screen shot of the same Alt-A pool. Once again, thanks go to "CS" for the screen shot.

New chart of WMALT 2007-0C1



click on chart for sharper image

The pool data just keeps getting uglier and uglier.

Month      REO     60+

10-2007   0.00%   11.53%
11-2007   0.04%   13.30%
12-2007   0.64%   16.83%
01-2008   1.83%   19.32%
02-2008   3.56%   22.69%

60 day delinquencies or greater has been rising at a nice steady pace of 2.5% to 3.5% or so every month since August 2007. The Real Estate Owned (REO) number is now a whopping 3.56% of the pool.

Inquiring minds may be asking about lines 7 and 8 as well as the GEO lines at the bottom of the screen shot.

• Line 7 is the sum of lines 3 through 6 (anything 60 days late or greater plus all previous foreclosures and REOs)
• Line 8 is the sum of lines 4 through 6 (anything 90 days late or greater plus all previous foreclosures and REOs).
• The GEO lines (geographic distribution) show this pool is 48% California and 14% Florida.

Cesspool Bottom Line

22.69% of a pool that was 92.6% rated AAA is 60 days delinquent or worse. 3.56% of that pool is REO. That's an amazing performance for an AAA pool whose issue date was May, 2007. At the current rate of progression it would not be surprising to see 30% of this pool get to REO status.

Repeating what I said last month....

Washington Mutual was the underwriter. If you bought a slice of this cesspool from WaMu, are you going to buy their next offering?

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