Saturday, February 7, 2009

Steven Rattner's Car Czar Throne Denied By Wife's DWI?

As Detroit's automakers burn in the 7th circle of debtor hell, people have been wondering - where is Steve Rattner? A very interesting story has emerged that may explain not only his lateness in climbing to his appointed throne, but why he may never sit in it in the first place. As we noted, Steve's wife is Maureen White, a high profile democrat, who until 2006 was the finance chairwoman and top fund-raiser of the Democratic National Convention. More relevantly, however, on October 24, 2008, she was found drunk and catatonic behind the wheel of her Mercedes 350 as she was going thru an EZPass gate at the Throgs Neck Bridge. A detailed description of the night's events can be found in the Criminal Division of the Bronx Supreme Court:

Deponent states, that at the above time and places, deponent observed defendant seated behind the steering wheel of a 2006 Black Mercedes Benz 350, New York License Plate #CSL1498, with the keys in the ignition and the engine running. Deponent further states that said Black Mercedes Benz was stopped at the raised EZPass gate, failing to proceed through, with a line of vehicles honking behind said Black Mercedes Benz. Deponent further states that he approached the vehicle to inquire whether the defendant needed assistance at which time defendant stared blankly at deponent with glassy eyes and stated in sum and substance: WHERE DO I GO NOW? Deponent further states that he observed defendant to be disoriented and confused, and she was unable to follow directions.

Deponent further states that he observed defendant to be unsteady on her feet and to have a strong odor of alcoholic beverage emanating from her breath.

Deponent further states that he was present at the administration of a chemical test analysis of defendant's breath and defendant refused to take said test.

At least she has read DWI 101 which says to never agree to a breathalyzer at the scene of the crime. Subsequently, however, according to eCourts (docket # 64366C-2008) she relented, and on December 22 plead guilty to a misdemeanor DWI charge for which she had her license suspended for 90 days.

It does not end there. Michael Wolff presents an interesting case of an impressive conspiracy cover up. As Steve Rattner used to work at the New York Times and has been an advisor to Arthur Sulzberger on financial issues, and is also a friend of Rupert Murdoch's, the story never made either the New York Times, nor Murdoch's New York Post. Curiously, the story had been picked up by the Daily News, but subsequently was taken down, for reasons unknown.

Whether or not the potential car czar would want the story hidden is an open question. What is, however, pretty sure is that in its first three weeks, the Obama administration has seen more than its fair share of scandals, and an alcohol related bust for the wife of such a high profile posting would definitely not go well as a follow-up act to all the recent tax blow ups. We wait to see how this whole situation develops but would not be surprised if the next most likely candidate for the throne itself is Centerbridge's Steve Girsky, of Dana and Penn Gaming fame.
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Waiting For Godot... Or The Latest Government Bailout Scheme

This week's run up in the market was, without doubt, purely an exercise in front-running the government's pumping of more taxpayers' funds into financial "assets" and the pricing in of yet another rally (as well as some greater fool expectations thrown in for good measure) in light of continuing depression-worthy economic releases. The two main expectations for Monday's Treasury announcement revolve around an "aggregator" bank and toxic asset "ring-fencing." These are unique in that both perform crisis intervention before recognition of bank insolvency, or apriori triage. A key question is whether this rally, which caused a 5% rip in the market last week, will persist or fizzle? What have prior bailouts demonstrated in terms of market performance:

From 9 weeks post Bear Stearns, to 4 weeks post Paulson's GSE initiative, to no rally post TARP - the half-life of rallies is getting worse and worse, as if rallies are pricing in future rallies. So does the upcoming bailout have the makings of actually fixing the structural problems in the economy? Some thoughts on the various approaches, from BAC:

Aggregator Bank

This is an off balance sheet vehicle that pools multiple bank’s bad assets into one “Bad Bank” or “Aggregator Bank” that can both manage and dispose of the bad assets it buys from banks. To alleviate the pricing problem, the bad bank could focus on trading account securities and loans that have been most heavily marked down. By either taking these at the latest mark, or standardizing these marks across banks of the (relatively) more price transparent assets, the pricing issue – setting the correct price to protect taxpayers – could be avoided. The impact of this move would remove further downside uncertainty for the banks, freeing them up from those assets (while at the same time transferring all future upside to the government as well). However, that pool would be limited to those deemed sufficiently marked down to be able to avoid both price uncertainty and the potential that by setting too low of a price, further capital inadequacy issues would be exacerbated. These were the core problems of the first TARP program.

Ring fencing

This approach has two attractions. First, it avoids having to deal with the pricing issue. This is important for loans with no ready price and with limited loss provision against them but high potential cumulative loss. Second, the assets remain managed by the given bank leaving no requirement for a management or legal structure and funding remains the responsibility of the bank. The main drawback however lies in the provisions for loss sharing. To date these have taken the form of a first loss tranche and a contribution to a second loss tranche. The protection of taxpayers lies in setting the size of these tranches relative to the overall pool of assets. A “true up” provision or “claw back” provides further protection in the event losses develop beyond anticipated in setting the first and second loss tranche positions. However, the drawback to these provisions is they effectively would bring asset loss uncertainty back onto the “good bank”. This would inhibit the ability to raise private capital to buy out the government share of ownership as long as loss uncertainty remained higher than the first tranche of losses. Managing this trade off and the size and scope of the pool of assets insured will be critical points to look for on Monday.

Conditional Subsidization

This has gotten little attention, but may become a feature of the comprehensive program, especially for SME and residential mortgage loans. In this type of program, the bank write down of a loan is subsidized by the government. The amount of the subsidy is scaled by the amount of new loan creation and is conditional on borrower payment history. It was successfully applied during the Mexico Peso crisis.

Capital and Funding

Capital for the bank could come from the existing TARP with funding provided by the Fed through section 13(3) lending authority. Total TARP funds remaining of around $375bn (assuming $50bn of unallocated CPP funds are shifted to the bad bank) imply that based on “Leveraging the TARP”, a larger pool of assets could be handled. For the Aggregator bank, a 10% capitalization level implies that say $50bn of TARP funds could support $500bn worth of bad assets. For the insurance program TARP funds work in conjunction with first loss tranche absorption from the given bank. For example, a 10% first loss piece plus a 10% second loss tranche absorbed by TARP imply $100bn of TARP funds could support $1 trillion worth of asset insurance, providing the Fed with a total 20% loss protection (10% from bank, and 10% from TARP).

The attraction of such an approach is that both capital and funding could be more than sufficient based on existing authority to create an impression of “overwhelming force” with positive near term market implications.

The bottom line is that while the government does have the capacity to leave a potential favorable impact on the financial system overall, it is contingent on i) a proper execution which, as we have seen, has been a huge problem for the administration in the past, even for a much more experienced Secretary of the Treasury than Geithner, and ii) while the financial system may end up being propped up yet again (temporarily) it would involve further incremental leverage, exponentiating the underlying reliance on less and less unencumbered capital, and thus putting the house of cards (as we like to call the global financial system) at even more risk of fat tail events. All this while the underlying economic deterioration is still an open question.

While one may argue that we are currently living the aftermath of the residential real estate collapse, Zero Hedge believes that the second leg to the current recession-cum-depression will become evident once the full impact of the crash in global commercial real estate, via the associated $3 trillion + in global CMBS and whole loan varieties, funnels through the world's economy. Upcoming major downgrades in senior and super senior CMBS tranches (note the AAA-BBB spreads below, implying either BBB is very cheap, or AAA is very rich) will incite an additional firesale of related securities that none of the proposed government programs will be able to compensate for, leading to yet another major bail out overhaul requirement.

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Weekend Reading

More on the commercial real-estate bubble pop as vacancies skyrocket and rents plunge (NYT)

Soldiers open fire on anti-government protesters in Madagascar (Sky News)

Barron's takes on Cramer in battle of worst media stock pickers (Barron's)

IMF joins Merrill Lynch: "Advanced economies already in depression" (Bloomberg)

Pessimistic insight from Bridgewater's Ray Dalio (Barron's)

We will go through a giant debt-restructuring, because we either have to bring debt-service payments down so they are low relative to incomes -- the cash flows that are being produced to service them -- or we are going to have to raise incomes by printing a lot of money.

There will be substantial nationalization of banks. It is going on now and it will continue. But the same question will be asked even after nationalization: What will happen to the pile of bad stuff?

Buying equities in late 2009, or more likely 2010, will be a great move because equities will be much cheaper than now.

U.S. Attorney General's office leaks secret memorandum to Washington Post (NRO)
The reason why the government will not destroy Wall Street is because it needs Wall Street's advice as it rebuilds Wall Street, or something comparably convoluted (Bloomberg)

Pay disparity in US exceeds France under last king, and no guillotines to be found (Naked Capitalism)

Dry bulk shipping surge to be shortlived (Lloyd's List)

Everthing about the Cash 4 Gold scam (OptionArmageddon)

Bank of America "absolutely does not need any more money"... until it does (NY Post)

Weekly Chartology
  • Q4 2008 negative earnings surprises rise despite dropping guidance
  • Recent S&P trading volume
  • Prior week best and worst performing sectors

  • Equity: Investors confident growth stocks will outperform
  • Equity: Volatility persisting
  • Credit Indices: CDS outperforming Cash (250 bps index negative basis)
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Three More U.S. Banks Shut Down

While the markets keep chugging along, bank failures continue to accelerate (all FDIC recorded bank failures listed here). Two banks in California (County Bank of Merced, and Alliance Bank) and one in Georgia (FirstBank Financial Services) were shut down by the FDIC this week, bringing 2009's total to nine. Indicatively, in 2008, it took until August to hit 9 failed banks. The three banks had $2.5 billion in assets and $2.9 billion in deposits. The three failed banks will see their deposits assumed by Westamerica Bank, California Bank and Trust of San Diego, and Regions Financial Bank, and acquire assets at a substantial discount.

“We do expect there to be more stress on banks, which could result in an increase in commercial bank failures,” said Comptroller of the Currency John Dugan in a Feb. 2 interview. A deepening recession that adds stress may lead to “significantly more losses,” said Dugan, regulator of national banks.

The FDIC is expecting an unprecedented rise in bank failures this year, recently requesting a tripling in its borrowing power to $100 billion which may or may not be sufficient to guarantee deposits. Additionally, as we reported, the FDIC has hired Joe Perella to advise on "stabilization" strategies, and we still believe it is the taxpayers' utmost privilege to understand just how Perella Weinberg is compensated as the company proceeds to recommend ongoing bank closures.
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Verizon Takes A Page Straight Out Of Office Space

This is unbelievable. Verizon thinks math is a matter of opinion.

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End of Week Major Corporate CDS Movers

from Markit Sphere: Related Content

Industrialized Countries CDS Levels

France, Germany and Japan all less risky than the U.S.

from Markit
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Friday, February 6, 2009

Bob Corker: "Stimulus" Package Is Nothing Short of Disaster

Senator Bob Corker is likely the smartest member of Senate currently. While on a relative basis this is not saying much when one juxtaposes him with the intellectual fortitude (or lack thereof) of his 99 peers, Bob, unlike the entire current administration, will actually think before he condemns future generations of Americans to a miserable hyperleveraged and hyperinflated existence.

We agree with everything contained in the press release that was just released from his office. For the lazy among us, there is also a youtube clip.

This should be mandatory reading for everyone who has even remote political, economic or financial aspirations.

Some of the highlights:
Again, I appreciate those folks who are trying to work together to make this bill, which is a disaster in my opinion, slightly better. But, I wonder if it wouldn't make more sense for us as a country to just wait for a week or two to hear the rest of the administration's plans as it relates to solving this problem. I think for us to rush out and put forth $1 trillion in spending on top of a projected $1 trillion deficit without fully understanding the other issues that our country and the way that the administration plans to deal with these other issues is incredibly imprudent.
I would just urge people on both sides of the aisle to think about this, to vote their conscience, to not just go along, but in fact, to stop and pause and let's look at all the issues we're going to be dealing with. Let's ask the administration to come forth and talk to us about the price tag of dealing appropriately with the credit markets, with housing, and with maybe some directed spending on infrastructure or something that is not programmatic and doesn't disrupt the way that state government is run.

I feel like our country is getting ready to do something that we will regret and generations after us will regret. I am so concerned about where we are as an economy. I feel like we are using resources today so inappropriately when we're going to need those resources down the road.
It is actually enlightening to realize that there actually are some, very few unfortunately, truly intelligent people in power. Sphere: Related Content

The Rapid Rise and Blistering Fall Of Boaz Weinstein

As we wrote two weeks ago in detail, the massive unwind of basis trades in the post-Lehman world was a crushing blow to numerous hedge funds, Merrill Lynch's prop desk, the reason why Citadel has to post a 100% return this year just to be able to pocket any incentive fees, and cost Boaz Weinstein his investing career (contrary to his aspirations to start a new fund). Today the WSJ picks up on the 35 year old's very interesting story, and covers in detail how the card-counter, who in the heyday of Wall Street was getting paid $40 million a year, fell from grace with a counterparty-risk induced thud, after basis trades gone wrong cost his SABA group at Deutsche Bank a $1.8 billion loss. By the way, what is it with these 30 year olds and their hubris: Nick Leeson, Jerome Kerviel, Boaz... Could companies such as Soc Gen and Deutsche Bank not afford some more experienced "risk managers" to run checks and balances on net portfolio risk?

The article presents an interesting picture of the trader in his final days:

Brooding in his office overlooking Wall Street, Mr. Weinstein remained outwardly calm as markets went haywire, traders say. The value of his group's holdings of corporate bonds and loans began to slide as other investors, needing to raise money, sold such securities.

At the same time, trading in credit-default swaps was curtailed because market players were concerned about entering trades with banks that potentially could collapse. This left Mr. Weinstein's group increasingly unprotected against losses in corporate bonds and loans, because it used swaps to hedge those positions.

Mr. Weinstein wasn't alone. Similar positions held by banks and hedge funds across Wall Street fell apart amid the seismic dislocations after the Lehman collapse.

As prices of corporate bonds and loans slumped to new lows and stocks plunged too, Mr. Weinstein wanted to buy more swaps to protect his positions, traders say. He told traders that in such a trading environment, "the primary objective is to get as flat as possible to the market" -- not betting on either a rise or a fall -- according to a person familiar with the conversation.

But in contentious conference calls, risk managers at Deutsche Bank told Mr. Weinstein to scale back positions or sell them entirely, traders say. Mr. Weinstein's stock-trading desk was instructed to sell nearly every holding, effectively shutting it down.
Good reading, and presents some interesting, although not quite correct, perspectives on why the basis trade went from cash cow to guillotine in a span of 24 hours. And, by the way, we are kidding that Boaz will never get a job - Bill Ackman has said he would likely hire him in a heartbeat. Maybe Boaz can go and run the PSIV fund... We are hearing it has some PM openings and doesn't believe in diversification either. After all basis trades and Target calls are pretty much the same thing.
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250 West 55th Street Office Building Construction Abandoned

One of the first major casualties of the hibernation in the NY commercial market is Boston Properties, which announced today after market close that it is suspending construction of what would have been a lovely 39 story glass building on 8th and 55th, and in its place will leave a gaping hole and some construction equipment to the enjoyment of Carnegie Hall goers. Mort Zuckerman, who yesterday was on CNBC extolling the virtues of the NY office market, and is owner of Boston Properties (which had a nice 10% pop in stock price today for reasons unknown) has announced Boston Prop will suspend construction of the project because it was unable to close a lease with major unnamed law firm.

We presume that the unnamed firm is either Gibson Dunn or Proskauer Rose who had previously been in consideration for 220,000 and 600,000 square feet, respectively, and likely decided to amend their lease agreements. Suspension of the project will lower the real estate investment trust's capital commitments through 2011 by about $450 million. What was not mentioned is that it will dramatically slash future revenues and earnings by a substantial amount, although BXP did note that "the company is currently evaluating the impact of the suspension of construction on its guidance for earnings per share and Funds From Operations for fiscal 2009, and the Company intends to publish updated guidance for fiscal 2009 as soon as practicable." Sphere: Related Content

Commentary On The Payroll Number

Straight from the mouth of the people who can't wait to pay you back your TARP money (Goldman of course). For what it's worth the masters of the universe have been surprisingly objective lately.
Nonfarm payrolls -598K in Jan vs. GS -475K, median forecast -540K
Unemployment rate up 0.4 points in Jan to 7.6% vs. GS and median at 7.5%.
Average hourly earnings +0.3% in Jan (mom, +3.9% yoy) vs. GS and median +0.2%.

1. Job losses were in the larger end of the range of expectations for this report, with nonfarm payrolls down nearly 600K and the household survey showing job losses of 1.239 million in the month. Revisions to the immediately preceding months were down, as has been the pattern lately, though somewhat less substantial than in recent months -- a total of 66K for November and December combined.

2. This is the month when benchmark revisions are applied, and while the revision to the benchmark reference month -- March 2008 -- was as small as BLS had advertised (-17K vs. a preliminary estimate of -21K), the monthly changes through 2008 now show a much larger and steadier decline in payrolls than before. On average, the monthly changes from January through October were -32K; with the new numbers, payrolls have dropped at least 100K per month since January 2008 (that's the last one with less than 100K).

3. In January 2009, the job losses were even more widespread than in prior months, especially in manufacturing. The diffusion index for this sector -- measuring the percentage of industries reporting job gains -- fell to 7.8%, the lowest on record since these numbers were published beginning in 1991. This means that more than 11 of every 12 industries was laying off workers in a sector that, while barely one-tenth of the work force, counted for just over one-third of the job losses.

4. While losses were concentrated in manufacturing, they were fairly pervasive elsewhere as well. Almost 3 out of 4 industries (counting those in manufacturing) reported declines in payrolls. Only government, education, and healthcare showed gains among the main categories.

5. The rise in the unemployment rate occurred despite a large exodus from the labor force (-731K), reflecting the huge job losses already mentioned in the first item. With the unemployment rate starting the year at 7.6% and rising several tenths of a percentage point per month, our year-end call for a 9% rate looks like it could have upside risk.

6. Reflecting both the sharp cutback in payrolls and further shortening in the manufacturing workweek, the index of hours worked fell 0.7% in January. On a fully trended basis (i.e., assuming similar declines in both February and March), this would imply a setback in total hours worked on the order of 8.5% at an annual rate for the first quarter, implying downside risk to our estimate of -4.5% for the annualized decline in real GDP. The assumption of ongoing declines does not look so outrageous when stacked against the fact that this index has fallen between 0.6% and 0.9% in each of the last five months.

7. Wages were the bright spot in this report, as they rose 0.3% in the month to a year-to-year increase of 3.9%. This is somewhat at odds with the wage index of the ECI, raising the possibility that changes in the mix of workers and/or the shortening workweeks may be boosting the hourly average. Nonetheless, at a time when prices are flat (in core) to falling (in headline), this may provide a modest cushion to a falling economy.
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Apollo Investment Outlook Cut To Negative by Fitch

Oh no she didn't.
Fitch Ratings-New York-06 February 2009: Fitch Ratings has revised the Rating Outlook on Apollo Investment Corporation's(Apollo) ratings to Negative from Stable as follows:

--Long-term Issuer Default Rating (IDR) 'BBB'; and

--Senior secured debt 'BBB'.

Approximately $1.2 billion of debt is affected by this action.

The Outlook revision reflects the uncertainty surrounding the recognition of further unrealized depreciation on Apollo's portfolio, which, if material, could pressure the company's ability to maintain compliance with asset coverage requirements. Fitch recognizes Apollo's more conservative leverage strategy, relative to peers, and its plans to preserve capital and liquidity over the near-term; however, unpredictable movements in market valuation could quickly negate the current equity cushion. Similar to other Business Development Companies (BDCs), Apollo has a tangible net worth covenant in its debt facility, but Fitch does not believe the company has an impending need to seek relief under the covenant because its required equity is a function of asset size; meaning minimum equity requirements decline as assets are written down. BDCs which have sought covenant relief recently have minimum equity requirements which do not vary with asset size.

Rating stability will be driven by stabilization of market spreads and valuation multiples, the ability to de-lever incoming quarters in order to build the cushion on asset coverage, and the company's ability to access the debt and equity markets to raise capital when market conditions improve.Conversely, a reduction in asset coverage below 205% could prompt a ratings downgrade.
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Data Is Out: Consumers Have No Desire To Borrow

Confirming our expectations that the government's stupid idea of forcing consumers to borrow is, well, stupid, the latest release from the Federal Reserve indicates that consumer credit for December has in fact dropped by $6.6 billion to to $2,562.3 billion, after having dropped $11 billion in November. Both numbers were lower than consensus. And while Bloomberg spins this again to indicate that banks aren't lending, we think the flip side is true, in that consumers have no desire to borrow, and the core focus of all governmental programs, which is to stimulate lending and loosen lending standards yet again which is what got us in this mess in the first place, is flawed by extension.

Add Image
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Are April WTI Crude Futures Going to Skyrocket Today

Curious note: the US Oil Fund, which is an ETF, holds 20% of the outstanding March futures contracts, and these have to roll by the end of NYMEX trading today from March to April. The ETF holds 81,050 March contracts as of February 5 according to its website, which is 4x the amount it held in December. It is possible that the 1-2nd months contango could exhibit some very odd behavior today as USO rolls. The only way the contango won't explode is if there are buyers on the other side of the trade. Although with recent rampant rumors about GS selling vol into the commodity market and other comparable trickeries, we fully expect some fireworks before market close.

Bloomberg link pending Sphere: Related Content

Comic Relief Moment

For a good overview of Obama's first month on the job: Sphere: Related Content

Midday Factoid: Market About to Hit 22x Forward P/E

The S&P will likely hit 880 today. Based on a conservative 2009 S&P earnings projection of 40, this implies a 22x forward multiple, which is a realistic 80% premium to the past 130 years' historical average of 12x. If only the economy could now just jump right to 2017 when the depression is hopefully over and the mutiple has some sort of vaguely remote credibility.

Just saying. Sphere: Related Content

Moody's Continues Dismantling CMBS Market

Moody's just laid down the law and downgraded 12 classes, or $2.4 billion worth, of Bank of Countrywide Lynch's CMBS 2006-6 Series (that's Bank of America for you Bono fans)

Warren Buffett's rating agency said the reasons for the downgrade were "higher expected losses for the pool resulting from increased leverage, reduced debt service coverage, and anticipated losses from loans in special servicing. Moody's also affirmed nine classes."

Due to the current economic recession, Moody's expects a significant overall decline in future property cash flows as a result of a higher incidence of tenant defaults and bankruptcies and a sharp decline in lease renewal rates. This drop in cash flows is likely to lead to a marked increase in term defaults on commercial mortgage loans from the 2006 through 2008 cohort of conduit/fusion loans because many of these loans were underwritten with significant upside at a peak point in the real estate cycle and valued using historically low capitalization rates. Moody's review of all deals from these vintages is to ensure that the ratings reflect our expectation of their weaker future performance in an adverse economic climate.

As of the January 12, 2009 distribution date, the transaction's aggregate certificate balance has decreased by less than 1% to $2.5 billion. The Certificates are collateralized by 118 mortgage loans ranging in size from less than 1% to 12% of the pool, with the top 10 loans representing62% of the pool.

Moody's weighted average conduit loan to value ("LTV") ratio is 136% compared to 108% at securitization. Moody's actual debt service coverage ratio ("DSCR") is 1.12X compared to 1.33X at securitization. Moody's actual DSCR is Moody's estimate of net cash flow divided by actual debt
*** Reference point: chart of recent prices of the various tranches in CMBS 5.
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Ackman's Target Fund Gets a Royal -40.1% Beatdown in January

Despite Target stock being down only 9.6% in January, Bill Ackman got 4x the beating as he was using options instead of stock to express his bullish bet. Pershing Square IV, which is how The Target fund is formally known, is down a whopping 89.5% since inception.

Ackman writes in his Feb 5 investor letter: "While PSIV and Target stock have declined materially, we still believe our fundamental investment case for Target stock will ultimately be realized, although not within the original time frame we had initially estimated.”

The fund which was started in 2007 with $2 billion in capital, and currently has only $210 million left, will get a personal injection from the hedge fund whiz of $25 million.

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Is Fraud Discovery Institute Looking at Allstate?

We used to be huge fans of president Palmer, so we are very troubled by the fact that instead of standing for all that is shady in CTU's interrogation techniques and making sure Jack Bauer lives yet another season, he keeps on steadfastly peddling Allstate's insurance business. Thanks to reader Marty who pointed out this distributing story about more potential accounting shenanigans at the troubled insurer.

Today's trading action at Hartford Financial, which was down 35% last we checked, shows just how precarious insurers' balance sheets due to all the risk insurance they have underwritten. A report by the WashingtonPost claims that accounting changes in Allstate's books, specifically focusing on deferred tax assets, boosted its financial appearance by a total of $712 million, while clouding its true liquidity picture. One of the issues is that while insurance companies' lobbies for loosened regulatory requirements and thinner financial cushions had been rebuffed by industry regulators, Allstate found a loophole with its home regulator in Illinois, which approved on of the company's accounting changes during Q4, which was retroactive to Sept. 30.

According to Allstate Controller Sam Pilch, who noted the company already had the broader regulatory body's blessing, "[Regulators] look at it favorably because it's indicative of the strength of the company," when an analyst asked about the approximately $700 million of capital the company generated through accounting changes. Additionally, CEO Tom Wilson added "I think, as Sam said, regulators are involved in it and aware of it and approve it."

Some more from the Post:
Insurers are regulated at the state rather than the federal level, and the NAIC, which has only limited power to influence state regulations, helps coordinate standards among the states. The NAIC tries to prevent a "race to the bottom" in which insurers move to states with weaker regulations, New York Insurance Superintendent Eric Dinallo said last year in testimony to Congress.

Now, it's every state for itself. The result could be that some companies have to measure and report their financial strength differently from state to state, regulators said. Changing the accounting rules for particular companies or companies based in particular states could make it harder to compare insurers or to track changes in their financial condition.

The day after the NAIC executive committee voted not to endorse industry-wide relief, Iowa Insurance Commissioner Susan E. Voss announced that she would allow Iowa-based insurers to count more so-called deferred tax assets in their reported capital for last year, much as the insurance lobby had requested. The tax benefits could someday help the companies reduce their tax bills -- or they could eventually expire with no value to the insurers. Unlike cash or other liquid investments, they do not increase a company's ability to pay claims in the meantime.

"Let's face it," Voss said. "This is an unusual time."

Inclusion of the added tax benefits "can be a tool for appropriate financial reporting, or it can be a weapon to mislead investors," said Donald Thomas, an accounting analyst with Gradient Analytics. "It all gets back down to the character of the people making the judgments and the quality of their estimates."

"Although deferred tax assets represent real economic benefits, such assets are of limited use in meeting policyholder obligations in a time of stress," Standard & Poor's, a corporate rating agency, said in a recent report. "Although such a change would increase reported statutory capital and surplus, we are aware that the quality of this capital could be lower," S&P wrote.

Where have we seen this before: regulators constantly loosening regulatory requirements for one reason or another to pretend companies are in good shape when in fact their liquidity is likely in shambles, while using the deferred tax asset strawman as a "repository of value". Didn't the GSEs (Fannie and Freddie) allegedly have billion in deferred tax assets right up until they day the government decided to nationalize them?

The Post concludes rhetorically:

In a news release last week reporting on its financial performance in 2008, Allstate said Illinois gave it permission during the fourth quarter of last year to change the way it accounts for certain annuities. The change blunted the effect of deteriorating market conditions, increasing the Allstate Life Insurance Co. subsidiary's financial cushion by $347 million as of Sept. 30.

Though Allstate reported that the Illinois Division of Insurance approved that change during the fourth quarter of 2008, a spokeswoman for the regulator said the change wasn't approved until Jan. 28 -- the same day Allstate issued the earnings report for last year. Illinois spokeswoman Anjali Julka provided a copy of the letter from the regulator to Allstate approving the request, which was dated Jan. 28.

Allstate spokeswoman Thielen declined to comment on the discrepancy.

In its news release last week, Allstate said it also changed the way it accounts for deferred tax assets, contributing $365 million to the Allstate Insurance Co. subsidiary's estimated regulatory surplus of $13.4 billion as of Dec. 31. The company reported that the $365 million involved a practice "we have submitted for approval." That change has not been approved, Julka said.

Asked how that squared with Allstate executives' statements to the contrary during last week's conference call, Thielen declined to comment.

Zero Hedge has no position in any Allstate securities, but cautions anyone who does, to be very, very careful. Sphere: Related Content

Citi Preferred Stock Junked by Fitch

You were expecting an upgrade? Only Dick Bové has good things to say worthless piles of toxic asset heaps these days.

The report below.

Fitch Ratings-New York-06 February 2009: Fitch Ratings has downgraded the following ratings for Citigroup Inc. (Citi):

--Individual to 'C/D' from 'C'

--Preferred to 'BB' from 'BBB'.

These ratings are on Rating Watch Negative by Fitch. At the same time, Fitch has affirmed Citi's Long-term and Short-term Issuer Default Ratings (IDRs) of 'A+' and 'F1+', respectively,given Citi's systemic importance and the magnitude of support measures from the U.S. government. The Outlook for the Long-term IDR remains Stable. A list of Citigroup entities affected by rating changes is listed below.

Fitch's downgrade of Citi's Individual Rating reflects current and expected financial performance challenges. Citi recorded massive losses in fourth quarter-2008 (4Q'08) and faces the
prospect of surging asset quality problems globally. Fitch recognizes Citi's efforts in building up its loan loss reserves and reducing problematic exposures across many different categories (including subprime ABS CDOs, Alt-A securities,leveraged finance, CMBS, monolines, and SIVs, among others).Nevertheless, global economic difficulties are causing the inflow of new problems ranging from U.S. and international consumer exposures to large corporate exposures. Consequently,provisioning needs are expected to remain quite elevated for2009. The U.S. government's loss cap guarantee reduces the long tail risk on a U.S. portfolio of approximately $300 billion.That said, Citi's first loss exposure of $30 billion (above existing reserves) remains sizeable.

In addition to performance challenges, the following factors drove Fitch's decision to downgrade the Preferred Rating:

--a very high level of preferred in the capital structure;--large servicing costs on preferred;

--the potential for the deferral to conserve capital.

Following the U.S. government capital injections, preferred and trust preferred instruments now total over $100 billion versus tangible common equity of $29 billion at year-end 2008. The cost associated with preferred and trust preferred is considerably higher in 2009 when compared to 2008. Quarterly costs associated with preferred and trust preferred instrument snow total $1.8 billion including the new government preferred issues. When combined with a weak performance outlook, the magnitude of these ongoing costs raises the probability for deferral. (Please see commentary: Fitch Sees Elevated Risk of Bank Hybrid Capital Coupon Deferral in 2009 dated Feb. 4, 2009 available on Fitch's web site at '').

The Individual Rating and Preferred Ratings could face incremental pressure depending on the scope of future losses by Citi. On the other hand, a return to profitability and positive internal capital generation are key factors towards stabilizing Citi's Individual and Preferred Ratings.
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Brits Stampeding To Pay Bonuses Fast in Merrill's Footsteps

You knew it was coming. First Merrill realized that the bonus spigot was going to be shut down so they paid out bonuses asap when they should have been selling office furniture, and now the slightly slower cousins across the pond are realizing they need to cash out now before the U.S. populist anger focuses on their interior decorating... oh and get exactly 0 bonuses after being nationalized.

As the TimesOnline reports:

Banks dependent on taxpayer support are planning to rush out hundreds of millions of pounds in bonuses to senior bankers and traders before a threatened crackdown.

As ministers prepared to curb excessive remuneration, it emerged that Barclays and Lloyds Banking Group were poised to follow Royal Bank of Scotland (RBS) by paying bonuses within weeks.

Barclays, which has tapped the Bank of England for billions of pounds in loans and guarantees, is believed to be planning even larger payouts. According to the terms of its purchase of the North American division of the collapsed Lehman Brothers, Barclays is due to pay $2.5 billion (£1.7 billion) in bonuses to traders and dealmakers on Wall Street in the next few days.

Ministers reacted angrily to reports in The Times that RBS was preparing to give bonuses to thousands of senior bankers and traders. Banks applying for government insurance to underwrite toxic assets and free up cash for lending are likely to have to meet conditions preventing them paying excessive remuneration, officials said.
While total payouts seem rather small time compared to recent U.S. precedent, what does seem surprising is that ironically, former employees of liquidated Lehman may get the best deal after all. However, as we are betting people, we see the chances of these bonus payments occurring now as rather slim. The Brits didn't learn from the U.S. precedent, and should have kept all their comp schemes under deep wraps.

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Early Feb 6 Headlines

  • Jobless rate at 7.6%, futures spike on doomsday expectations (Bloomberg)
  • Julius Baer confirms "minor trading accident" relating to hiding trading losses (Reuters)
  • Nomura needs $3.3 billion following Lehman gluttony leads to indigestion (Reuters)
  • Ford on verge of begging after "unexpected" 4$ billion pension shortfall (Bloomberg)
  • Hartford hosed on missed capital target (Bloomberg)
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Thursday, February 5, 2009

Zero Hedge Exclusive: Topographical Representation of Madoff Accounts

After fooling around with the Madoff account data, I decided to geocode some of it. As there is a lot of addresses, I focused on some of the core areas: NY, California, Connecticut, Palm Beach, and the rest of the world. Below are the mapped results for all accounts in any one given region. With some skill these addresses can be ported to Google earth and likely seen in all their 2 feet resolution splendor. Make sure to click on the hyperlinks for interactive maps (take a few seconds to load), the graphics are fixed snapshots.

Map 1: New York (or is it Upper East Side) snapshot (for interactive NY map click here)

Map 2: Los Angeles snapshot (for interactive CA map click here)

Map 3: Greenwich snapshot (for interactive CT map click here)

Map 4: Palm Beach snapshot (for interactive Palm Beach map click here)

Map 5: Europe snapshot (for interactive non-U.S. map click here)

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Late Thursday Headlines

  • $10 billion slipped between cracks... New demand from autosuppliers is for $25.5 billion (Bloomberg)
  • US explores converting stakes in banks to common shares (FT)
  • Geithner's window to halt capital flight from US Banks may soon close (Bloomberg)
  • The banks' recent lobbying spree (NY Post)
  • Yen about to be right back where it was (Bloomberg)
  • Great bailout rap while you wait in the unemployment line and curse Paulson (youTube)
  • Madoff list in excel format (Unknown contributor with lots of free time)
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Overview Of Refinancing Considerations For Credit Investors

Credit investors have been riding a high wave in the past few months. We have been sceptical of the breadth and duration of this exuberance for three main reasons:

1) The collapse of the shadow finance system. While issuers were historically allowed to offload capital needs to synthetic structures such as securitization and off balance sheet vehicles, companies now, more than ever, are forced to meet financing and refinancing needs in traditional pathways, involving convincing the investor pool of fundamental investment suitability.

2) Limited availability of capital and increasing near term maturities. With the industrial strength Treasury issuance ramp up only just starting, $350 billion of investment grade maturities over the next two years, as well as a more limited investor universe due to the viral redemptions at hedge funds and woeful performance at mutual funds, many companies will be forced out due to the simply physical lack of access to refinancing dollars.

3) Exploding IG - HY spreads and other fundamental considerations. As the cost of capital grows exponentially the lower on the rating agencies' totem pole a company lies, perfectly executed business plans will be a necessity and credit investor vigilance will become a prerequisite. Once a downgrade succession starts, it will become next to impossible for a company to avoid the double whammy of worsening leverage metrics and investor sentiment, especially in the recessionary environment over the next 2-3 years.

So as accounts evaluate new opportunities and consider the refinancing risk of new candidates, they should keep in mind the following key considerations: i) debt issuance prospects, ii) current liquidity, and iii) borrowing alternatives.

Debt Issuance Prospects

Maturity Schedules: Focus on upcoming notional and date of maturities, market price and maturing debt's features over the next 3 years. Also important is whether maturities coincide with deeply subordinated issuance or fall in big maturity years: what will bondholders realistic bargaining options be? Lastly, is the future refi event also a possible default event?

Market Access Risk: Where in the subjective preference universe of investors does a company fall? Is it from a tainted sector (autos) or preferred (utilities and healthcare)? Will there be major industry risks ahead? Some industries such as consumer and retail will be more prone to defensive issuance while the IG window is open, as downgrade threats will escalate refis to the point of impossibility. From an equity stand point, the inability to access unsecured debt markets will be a major threat to expansion plans, and other shareholder friendly events. Implicitly this means that equity valuations of debt-laden companies will become more and more credit-nuance dependent, as the credit market access variable will define an increasingly more critical cost of capital and its impact on the balance sheet and cash flow statement.

Repricing Risk: A safe generalization is that for HY names, refinancing bonds will be a Sisyphean task at the unsecured level due to prohibitive spreads (Landry's just priced new issue with a 14% coupon at an 88 price is a pipe dream: we predict it will drag the company into bankruptcy within 1-2 years max). Additionally, new issues have been pricing at negative basis to CDS recently, and thus CDS levels are a good indication of where to expect new issue pricing given a specific discount. Some very risky IG names from this perspective would be BBB-rated automotive names such as BorgWarner and JCI, as due to their tainted nature they will need to price at an abnormally high yield, thereby pushing a self-referential downgrade in implicit and explicit credit risk.

Current Liquidity

Liquidity Snapshot Analysis: Simply stated this means whether cash on hand + undrawn credit facilities + free cash flow are sufficient to handle a longer or shorter lock out from the primary markets? How about total lockouts or just CP lockouts? While this kind of check has been routine for HY analysts, it is becoming de rigeur for Crossover names and even standard IG names (it was what many people did on AAA rated GECC).

Bank Line Capacity: Bank lines backstop everything from seasonal W/C swings, letters of credit, debt maturities and commercial paper. Two main questions here are: how much is available for draw down now and can new lines be established. Recent market actions have indicated banks' willingness for cash collateralization of numerous cross over names, as well as increasing securitization of previously uncollateralized bank lines at names such as Gannett. When considering existing credit lines, it is important to evaluate maturities and sizes, what are covenants (maintenance and incurrence tests), how much is committed to international operations, if there is a revolver draw down, is it due to unforeseen circumstances or to proactively address systematic threat in the banking system, and from a covenant stand point: how much asset pledging carve out room is there, what is the reference pool of assets, and what is are reference assets for lien baskets. Lastly, an important question is who is in the lending group: many bank deals in which Lehman, Bear or Merrill were administrators or lead lenders were in jeopardy as investors did not know how to approach a lack of clear cut successor situation.

Is there a Government Backstop Program Available: As we wrote earlier, there are numerous government programs available to subsidize virtually all parts of the balance sheet and provide liquidity. With programs such as the TLGP, TALF and CPFF springing up at a moment's notice upon regulatory contemplation, these can be game changing events: AAA-rated GECC may have been bankrupt now if the Fed had not stepped in at the 11th hour to provide immediate CP assistance.

Borrowing Alternatives

Security/Structural Subordination: A concern for borrowers migrating down the capital structure is being structurally subordinated. As most IG bonds and pre 2007 bank lines are covenant lite, they carry a large risk of being layered. If bank lines have springing liens which upon a downgrade become secured (again ala Gannett), existing bondholders will end up with proratedly lower recoveries due to their collateral pool becoming notably smaller. As more banks try to follow GCI's example, issuers will resist ratings triggers driving liquidity events but may not have choice but to acquiesce to asset pledging. A concentrated bank system with less competition will only makes this a more distinct reality for borrowers.

Investment Grade Indenture Analysis: The same holds true for bondholders of investment grade securities. The question will be how the asset mix of any given issuer could get encumbered based on the carve-out language in the limitations-on-liens covenants.

Equity-Linked Market Alternatives: If dislocations in the credit market persist, it would make sense for companies to raise capital via convertible and other equity-linked products. The last time this occurred was in 2002 when the IG and HY markets again were on the verge of collapse. The problem now is that hedge funds are getting the short end of the stick regarding funding lines as well as collateral and counterparty risk, exacerbating cash to synthetic aberrations. Hedge funds are still facing redemption risk and convert arbs players who came to the rescue of the HY market in 2002 have not been around for several years and are unlikely to comr back at all. A recent name that took advantage of the cvt market to the surprise of investors was Radioshack, while more erudite historical examples in the 2001-2003 period include Lucent, Nortel, Tyco and Gap. The CDS market needs to be deep and liquid to overcome the absence of pure-play convert players, and must consist of entities that are not merely hedging but actively trading. So as regulators consider how to abolish the CDS market (an issue we most recently wrote about here), they should realize that CDS are likely integral in pulling the credit market out of its existing near-comatose state.

Financing Options: the ability to sell assets has saved many troubled companies in the past, and thus it is critical to keep an eye on the asset sale market to evaluate potential sources of last-ditch liquidity available. It is no secret that, in terms of market influences, strategic buyers will be more active than financial buyers in coming months, while private equity will be dormant for fears it may enter the market at high valuations yet again while faced with increasingly weary LPs. Additionally, industry segregation will continue with some industries, such as pharma, healthcare and energy much better positioned for asset sales compared to auto, homebuilders, and consumer cyclical. And of course, the strategic acquiror universe will be much smaller as well and potential purchasers will likely have unlevered balance sheets with lots of disposable cash. An interesting case here is Louisiana Pacific, which investor are virtually convinced will file for bankruptcy soon, however the belief is that some imaginary strategic will pay for their assets a hefty price of 70 cents on the dollar even in liquidation (when all close comps are on the verge themselves), which is why LPX CDS trades incomprehensibly tight.


This is merely a partial attempt at quantifying the refinancing risks which investors should be aware of as they consider investing in credit opportunities. Undoubtedly the near term (2009 and 2010) presents significant risks, which is why we caution credit funds from rushing blindly into opportunities that aside from a technical run up have very little else going for them. And again we welcome comments and insight. Sphere: Related Content

United States Capital LP Beginning To Force Legacy Investors Out

In surprising news, David Bonderman's TPG has announced it is dramatically scaling down its distressed financial investing strategy. The company, which recently raised $6 billion to invest in distressed financial opportunities, has announced it will return 25% of that amount to investors. "Distressed" has long been the capital raising straw man for both private equity companies and hedge funds, as it is broad enough not to define a specific approach (a great ploy when previously failed "narrow" strategies such as merger or convertible arbitrage would hinder new efforts in comparable fund raising campaigns). In a 180 degree turn, TPG told investors it was scaling back distressed financial investing as it was concerned the government's expanded role in the financial sector meant fewer opportunities for private sector firms.
Another PE titan, Carlyle, does not agree with TPG's view yet. According to a senior partner "Carlyle's view is that the government doesn't have enough money and will have to rely on private capital." While the second part is likely true, the first section is patently wrong in our opinion, as the Treasury has demonstrated just how worthless it thinks the off switch on the dollar printing presses is. Carlyle co-founder Bill Conway said "Would-be competitors, including many of the world's largest banks, may have trouble competing due to ongoing risk exposures associated with pre-existing assets."

A third point of view was presented by Chris Flowers, whose JC Flowers recently had some remarkable flame downs in the financial investment arena.

Mr Flowers has said he sees benefits in government involvement. In purchasing the assets of IndyMac a few weeks ago as part of a consortium, he said: “The downside is limited due to loss sharing with the government.”
Carlyle is currently raising a financial focused fund with a rumored $3 billion target, however the fundraising is allegedly so complicated, the offering memorandum does not list a hard target.

In our view, as the largest hedge fund in the world now is the U.S. government, whose cost of funding is zero, TPG 's scale-down example will likely be followed by more and more PE and HF firms, initially in the financial industry and subsequently in more verticals, especially as the government migrates out of financials and starts investing in other "critical" industries such as autos, airlines, and possibly moves to energy and consumer names.

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Lawyers, Bankers Getting Paid To Work on Unsolvable Problem

The latest news from Detroit is that the U.S. Government has hired Cadwalader as bankruptcy counsel to the Distressed-3 sans Ford. Confirming that the government is known to throw away money first and ask questions later, Cadwalader is supposed to work with Chicago-based Sonnenschein to evaluate restructuring scenarios, including possible bankruptcy. Rothschild, which is the group's financial advisor, has been hard at work cranking away on 13 week cash flow schedules and DIP preparation already.

According to Bruce Clark from Moody's, the Obama administration "certainly needs sound advice on the complicated area of bankruptcy and implications for the economy." Cause heaven forbid they are bailed out first only to realize subsequently that the industry is completely unviable at sub 10 million SAARs. Too bad this is exactly what happened - according to Bloomberg:

When the government loaned the $17.4 billion in December, it didn’t work out an inter-creditor agreement that would determine its rights relative to past lenders. Cadwalader is working on such an agreement, as well as on related labor and environmental matters, the people said.

Cadwalader is also advising the government on how it might become a so-called “debtor-in-possession” or DIP lender, the people said. DIP loans fund a company’s operations as it reorganizes in bankruptcy. DIP lenders get repaid before pre-bankruptcy lenders and creditors.
The D-2 owe the U.S. government a viability progress report by February 14, and on March 31 the government has the option of putting them in bankruptcy. It will be a shame if the $20 billion of taxpayer money the government has spent so far in another crescendo of rash decisions is all for nothing.
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Did Anyone In Obama's Administration Ever Pay Taxes?

Hilda Solis, labor secretary nominee, apparently shares not only the last name of Carlos from Desparate Housewives (don't ask why I know this), but also his penchant for tax evasion. In what is becoming a daily occurrence, another tax-scandal in Obama's camp has been uncovered. Granted, it was not so much Hilda, as her husband, who apparently just paid $6,400 to settle a tax lien.

White House secretary Gibbs said Solis wasn’t involved in the liens and shouldn’t be blamed. “We’re not going to penalize her for her husband’s mistakes,” Gibbs told reporters at the White House. “Her tax returns are in order.”

Oh good, so only her husband doesn't believe in taxes. All is well.

Honestly, this is not even surprising anymore. Obama's sterling reputation is already in tatters, the coolness factor has worn off as all those unemployed during Bush are somehow still unemployed, and one can only hope that the next scandal involves at least something more juicy than some small-time IRS scammery.

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Apollo Investment Corp. Cuts Dividend, May Raise Capital

We wouldn't expect anything else from Leon Black's mezzanine investment vehicle. The Drexelite knows how to raise capital when an efficient market (monkeys) is going against him in all his investments (throwing feces). And the market sure is not helping his book of "assets" in Apollo's Mezzanine Fund. While the fund's common stock (AINV) hit an all time low today, the earnings release expects investors to presume that its investments have only gone down by 20% in value (from $3 billion at March 31, 2008 to $2.4 billion). As the portfolio consists of every imaginable illiquid second lien loan and junior-most bond tranche (including large positions in such recent bankruptcies as Eurofresh) color us skeptical when we look at these numbers.

Somehow AINV managed to score management and incentive fees of $28 million in the quarter and $86 million for the 9 months running, compared to $32 million and $63 million for the prior year period... We are not quite sure what these were an incentive to, but we'll let that slide. At least Apollo assures its investors that the company "was in compliance with all financial covenants on its credit facility", and with a debt-to-equity ratio of 0.83x, was in compliance with its regulatory asset coverage. The company has $1.16 billion borrowed on its credit facility and has a comfortable $540 million available to be used for further Fortunoff-type investments. The company warns it may need to raise equity off its curent shelf. Whether or not selling equity at the current all time low stock price makes sense is irrelevant: hungry Apolloers need to eat too.

The investor call tomorrow at 11am should be entertaining.
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Rating Agency Downgrade Smackdown Continues

As Moody's was getting took much media attention today with assorted blurbs about worthless CMBS here and potential US downgrade there, S&P decided to strike right back with another wholesale downgrade, this time of the retail space after last week's energy whack. Six names were put on creditwatch negative:

Nordstrom: A-
JC Penney: BBB-
Macy's: BBB-
Sears: BB-
Dillards: B+
Neiman Marcus: B+

As usual S&P had to be really sure that nobody bought anything at all at any of these retailers over the holiday season before they decided to get proactive. Sphere: Related Content

Moody's On U.S.: AAA Stable.... For Now

Moody's noted earlier that the U.S.' AAA rating is stable for now, although it is not clear how the government's interventions in the financial markets and economic stimuli will affect the deteriorating financial position. U.S. Treasuries issued to the public are "most certain" to be paid, wrote Steven Hess, Moody's senior credit officer, in a research report. If that isn't a good example of diplomacy and watching out for one's career, nothing is.

The government had $5.8 trillion in debt held by the public at the end of 2008, the rating agency said, which seems a tad low for the real figure which is in the $10 trillion + range, but you can't go from abacus to excel in a day... The government's ratio of debt to gross domestic product, and debt and interest payments to federal revenue, will rise to levels that are high for a country rated Aaa-rated. "Whether in 2010 or after, interest rates are almost certain to rise from their current low levels and the affordability of the federal government debt will deteriorate," analysts said. Additionally, it's difficult to determine the impact of purchases of preferred stock of housing agencies Freddie Mac and Fannie Mae, any purchases under the Troubled Asset Relief Program or other capital provided to banks.

Actually guys, it really is not that difficult, but last thing you want to do is have to call the NY unemployment hotline right now, so we'll all read between the lines.

The Moodyfolk added "structural fundamentals, political stability, and still favorable post-crisis economic prospects support the stable outlook for the Aaa ratings of the United States."

In other news, Bill Gross keeps pounding the table that unless the U.S. buys several trillion of assets (again preferrably bonds that he owns), there will be a mini-depression. Sphere: Related Content

Bank Run Prevention 101, And The Recent Band-Aiding By the Government

A few days ago the Fed had to (was forced to) postpone the expiration date of virtually all liquidity facilities designed to stop and prevent the mother of all bank runs, which followed the Reserve Fund's breaking the buck after Lehman's collapse. As few people pointed out, the removal of these contingencies would likely have brought the liquidity crisis back with a vicious bang. Furthermore, it reminds us once again of the truly bad shape the liquidity component of the U.S. economy is right now (in addition to all the other crutches the government is using to make sure the financial system does not collapse).

This chart summarizes all the liquidity facilities currently in use as well as which ones had their maturity dates extended (virtually all).

A reminder of last September's events: When the Reserve fund "broke the buck", investors withdrew several hundred billion from other prime money market funds. As prime funds invest in ST instruments such as commercial paper (CP), that lead to partial withdrawal of a key provider of ST funding for corporations, and the CP market ended up having to borrow overnight at much higher rates. The Fed intervened by setting up the CP Funding Facility (CPFF) which buys 3 months CP from tier 1 issuers, filling the gap left by the collapse in prime fund assets. The recent $100 billion decline in outstandings under the CPFF implies issuers are weaning off the facility and using the private CP market again, as well as leeching off other programs such as TLGP government guaranteed term debt issuance.

So whereas recent trends were a somewhat positive data point, the maturity extension raises more fundamental questions about what the Fed may be seeing (that others can't or are not allowed to see).

A prophetic policy paper written by the Cleveland Fed in June 2007, before the bubble had burst, entitled "On the Resolution of Financial Crises, The Swedish Experience" provides good philosophical insight into what is currently going on in the market. To nobody's surprise the government is doing all it can (whether in the form of the above mentioned liquidity guarantee extensions or otherwise) to mitigate the shock to the system in the near-term; however, the long-term impact gets exponentially worse the more the administration cushions the blow today and tomorrow. The fact that our children's lives will be adversely impacted so that we can purchase on credit for a few more months, live in an upside down mortgaged house, and general hang on to the last traces of an uber-leveraged lifestyle which will become extinct soon enough, is representative of a phenomenal form of egotism, which in my opinion is much more worthy of a populist crusade than Al Gore's attempt to turn everyone's attention to global warming (although that is also a noble cause).

The third trait of a successful resolution strategy is the maintenance of market discipline. Without it, the stage is set for future crises. For example, extending blanket guarantees during a crisis weakens the market discipline exerted by uninsured creditors in the postcrisis period. Uninsured depositors and nondeposit creditors have strong incentives to monitor and discipline financial institutions by raising their cost of funding when their risk increases. At some point, as the probability of default increases, uninsured claimants will threaten to liquidate their claims. If market discipline is to be effective, these investors must be credibly exposed to loss; that is, they must suffer the consequences of ignoring or failing to detect signs of trouble. An explicit blanket guarantee of all the liabilities of problem institutions in the throes of a crisis reduces the credibility of claims that defacto guarantees will not be extended in future bank failures.

Similar incentive problems arise when regulators and policymakers respond to the crisis by bailing out banks’ creditors through a policy of capital forbearance and unlimited liquidity support. Although bailouts tend to alleviate pressures on the financial system, forbearance and unlimited liquidity support allow uninsured investors to take their money out of the bank, shielding them from loss and reducing their incentive to monitor in the future. In essence, capital forbearance and unlimited liquidity support provide an implicit blanket guarantee and serve as a taxpayer-funded rescue package for sophisticated investors who purposely took on risk and were compensated for bearing it.

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