Saturday, March 21, 2009

Some More Thoughts On The FDIC And The "Systemic Risk Exception" Clause

As I dug a little more into the mystery of the amended Bloomberg headline discussing FDIC's travails, some interesting facts came up. On September 25, 2008, Bloomberg staff reporter David Evans (not to be confused with U2's The Edge) came out with a piece called "FDIC May Need $150 Billion Bailout as More Banks Fail." The article reaches its gloomy conclusion based on Chris Whalen's estimate that by the end of 2009, 100 U.S. banks will fail with collective assets of more than $800 billion, and quotes Richmond Fed director Mark Vaughan in saying "It's not going to be Armageddon. But it's going to be bad.'' Additionally, Evans discussed the potential fate of uninsured deposits, which he estimated at $2.6 trillion or 37% of the total $7 trillion in deposits held at U.S. FDIC member banks, and concluded that if "the government were on the hook " to protect these deposits as well, the FDIC's all in cost for failed bank rescues could swell "to more than $400 billion."

What is interesting, is that the very same day Evans came out with his FDIC critique, the agency immediately issued a rebuttal in the form of an open letter to Bloomberg News claiming David Evans "does a serious disservice to your organization and your readers by painting a skewed picture of the FDIC insurance fund." The letter, written by FDIC Public Affairs Director Andrew Gray, makes for a fascinating read as it discloses some curious, and previously undiscovered facts:
Let me be clear: The insurance fund is in a strong financial position to weather a significant upsurge in bank failures.
Even under an amended title, Sheila Bair's most recent public appearance on March 20, in which she claimed that "Without additional revenue beyond the regular assessments, current projections indicate that the fund balance will approach zero", does not make it sound like the insurance fund is "in a strong financial position" at all.
The FDIC has all the tools and resources necessary to meet our commitment to insured depositors, which we view as sacred. I do not foresee – as Mr. Evans suggests – that taxpayers may have to foot the bill for a "bailout."
Luckily for Mr. Gray "do not foresee" will not hold up in court as a determination of guarantees.
Let's look at the real facts about the FDIC insurance fund. The fund's current balance is $45 billion – but that figure is not static. The fund will continue to incur the cost of protecting insured depositors as more banks may fail, but we continually bring in more premium income. We will propose raising bank premiums in the coming weeks to ensure that the fund remains strong. And, at the same time, we will propose higher premiums on higher risk activity to create economic incentives for poorly managed banks to change their risk profiles. The fund is 100 percent industry-backed. Our ability to raise premiums essentially means that the capital of the entire banking industry – that's $1.3 trillion – is available for support.
At the time this letter came out, the TLGP did not exist. However now, in addition to having "the capital of the entire banking industry available for support", the FDIC, in a poetic flip of words, also has to issue capital to support the entire banking industry. The letter continues:
Moreover, if needed, the FDIC has longstanding lines of credit with the Treasury Department. Congress, understanding the need to ensure that working capital is available to the FDIC to provide bridge funding between the time a bank fails and when its assets are sold, provided broad authority for us to borrow from Treasury's Federal Financing Bank. If necessary, we can potentially raise very large sums of working capital, which would be paid back as the FDIC liquidates assets of failed banks. As per our authorizing statute, any money we might borrow from the Treasury must be paid back from industry assessments. Only once in the FDIC's history have we had to borrow from the Treasury – in the early 1990s – and that money was paid back with interest in less than two years.
Interestingly, Chris Dodd's Depositor Protection Act of 2009 legislation will make it possible for the FDIC not only to borrow from the Treasury but do so with some serious style - to the tune of $500 billion, up from the previous maximum borrowing limit of $30 billion. Somehow I think the FDIC will take a little longer than 2 years to repay that particular loan.

The last part of the letter is most interesting:
Finally, Mr. Evans' suggestion that the "government" could ever be "on the hook for uninsured deposits" demonstrates a misunderstanding of FDIC insurance. To protect taxpayers, we are required to follow the "least cost" resolution, which means that uninsured depositors are paid in full only if this is the least costly option for the FDIC. This usually occurs when a bidder for the failed bank is willing to pay a higher price for the entire deposit franchise. We are authorized to deviate from the "least cost" resolution only where a so-called "systemic risk" exception is made. This is an extraordinary procedure which we have never invoked. And again, any money we borrow from the Treasury Department must be repaid through industry assessments.
Just what is this Least Cost resolution? And even more so, the ominous sounding Systemic Risk Exception? Here is what a legal dictionary has to say about the former:
§ 360.1 Least-cost resolution.

(a) General rule. Except as provided in section 13(c)(4)(G) of the FDI Act (12 U.S.C. 1823 (c)(4)(G)), the FDIC shall not take any action, directly or indirectly, under sections 13(c), 13(d), 13(f), 13(h) or 13(k) of the FDI Act (12 U.S.C. 1823 (c), (d), (f), (h) or (k)) with respect to any insured depository institution that would have the effect of increasing losses to any insurance fund by protecting:

(1) Depositors for more than the insured portion of their deposits (determined without regard to whether such institution is liquidated); or

(2) Creditors other than depositors.

(b) Purchase and assumption transactions. Subject to the requirement of section 13(c)(4)(A) of the FDI Act (12 U.S.C. 1823(c)(4)(A)), paragraph (a) of this section shall not be construed as prohibiting the FDIC from allowing any person who acquires any assets or assumes any liabilities of any insured depository institution, for which the FDIC has been appointed conservator or receiver, to acquire uninsured deposit liabilities of such institution as long as the applicable insurance fund does not incur any loss with respect to such uninsured deposit liabilities in an amount greater than the loss which would have been incurred with respect to such liabilities if the institution had been liquidated.

[58 FR 67664, Dec. 22, 1993, as amended at 63 FR 37761, July 14, 1998]

And here is an interesting tidbit on the Systemic Risk Exception:

To get a grip on the too big to fail problem, Congress established a difficult-to-trigger systemic risk exception. A least-cost resolution can be foregone - and by implication a resolution method selected that results in uninsured depositors and other creditors being protected - only if the Board Of Directors of the FDIC, The Board of Governors of the Federal Reserve System, and the secretary of the Treasury, in consultation with the president, determine the least-costly approach "would have serious adverse effects on economic conditions or financial stability."
Personally, I have never encountered any legislative loopholes that need a quorum of these four most critical pillars of the U.S. economy. It is obvious the FDIC and lawmakers realized that there is something of huge value to be protected here in case there is a "systemic risk event." And while it is likely not deposits over and above the insurance maximum, it might potentially have to do with "other creditors" rights. Which is where, if one were to get conspiracy theory minded, it would be possible to presume that in certain cases bank creditors (maybe even foreign investors who own this debt) would receive a least-cost resolution exemption. But even without that detour, in the case of a consensus that we have crossed the threshold of "systemic risk" (a phrase thrown around a little too freely these days), it is prima facie the case that U.S. taxpayers would be on the hook to bail out not only failed banks' uninsured depositors but also creditors.

Now while the implications of this very fine print could be potentially staggering to the blissfully ignorant American public, the immediate change in the Bloomberg headline seems to be the least Bloomberg could do to avoid receiving additional angry letters, and to bring the public a step closer to these disclosures. Curiously, all this comes on the heels of Friday's announcement that the NCUA is putting two massive credit unions into conservatorship after stress-tests disclosed "an unacceptably high concentration of risk from mortgage-backed securities" and the agency's insurance fund will see a loss of $1.2 billion from the closures, according to spokesman John McKechnie.

Maybe the FDIC was a little early in its allegations that Bloomberg and Evans were doing anyone a disservice, as the reporter's grim forecast is slowly starting to become reality.


Didn't even finish typing this, and the FDIC's troubles are already growing. This just out:

Washington Mutual Sues FDIC for over $13 Billion
In a complaint filed with the U.S. District Court for the District of Columbia, the thrift's former parent accused the FDIC of having on January 23 made a "cryptic disallowance" of its claims, prompting the lawsuit.

It also accused the FDIC of agreeing to an unreasonably low price in arranging the a $1.9 billion sale of the banking business to JPMorgan on September 25, when regulators seized Washington Mutual and appointed the FDIC as receiver.

JPMorgan did not buy the parent holding company, which filed for Chapter 11 bankruptcy protection the following day.

In its complaint, Washington Mutual seeks to recover as much as $6.5 billion of capital contributions it said it made to its banking unit from December 2007 through the seizure.

Washington Mutual also seeks the return of $4 billion of trust preferred securities it said were wrongfully transferred to the banking unit, and said it may be entitled to as much as $3 billion of tax refunds. It also seeks damages of $177.1 million related to unpaid loans made to the banking unit.

If successful, this lawsuit will not help out FDIC's increasingly troubled financial state. Sphere: Related Content

The True State Of The CMBS Market, And Why Billions In New Writedowns Are Coming

In response for requests for information on where the capital markets objectively evaluate commercial mortgage backed securities, and also to demonstrate the recent knee jerk reaction of how CMBX spreads ripped wider once it became clear older vintage, sub-AAA would not be eligible for TALF 1.0 participation, I am presenting the recent trading levels of CMBX 1 through CMBX 5, segregated by tranching (rule of thumb: the higher the chart line, the lower the underlying value, the more MTM pain for sellers of the CMBX tranche i.e. banks). The mid-to-late February explosion was a result of the market realizing these securities would not be eligible for taxpayer support in the TALF 1.0 version, and thus indicative of the true, and very sad, state of the commercial mortgage backed real estate market (some good intro material on CMBX here).

The annihilation in CMBX (for lack of a better word), explains the recent urgency behind the Treasury's moves to provide an iteration of TALF that will return some sense of normalcy to the CRE securitization market. The majority of CMBX tranches trade at levels which imply vast losses at low recovery values on the underlying loans.

As there are hundreds of billions in underlying notional behind the various 1 thru 5 vintages, the mark to market pain experienced by major banks and financial institutions (who would sell CMBX risk to willing purchasers) in the recent widening sprint is likely to generate another round of massive write-downs at all TARP recipients.

Also, for an indication of just how bad bank writedowns will be this quarter, a good proxy is the average levels of the various CMBX indices at Dec 31 and where they are trending now. If the current price levels persists, it will be a bloodbath.






hat tip to JP Morgan for chart data. Sphere: Related Content

Will Somebody Remove Geithner From The Poker Table Please?

As Zero Hedge wrote previously, the TALF in its current formulation is merely a lot of hot air as it provides an incentive to buy assets that nobody really cares about (AAA-backed, newly issued "securitized" equivalents). It would seem that the Treasury also glances at this website occasionally, as next week's newsflow is likely to be dominated by discussions over the revamped and expanded TALF 2.0 that Geithner will soon be unveiling. And just what an expansion it is! Instead of providing back stopped, leveraged, non recourse incentives to hedge funds and asset managers to participate in a relatively safe piece of the securitization market, the Treasury Secretary is pulling out all stops: according to press reports, TALF 2.0 will include "older, illiquid and lower-rated securities." These could subsequently be re-packaged by the primary purchasers and then resold to a wider investor audience (those who remember the long, long time ago days of 2007 will recall that this kind of "repackaging" in the securitization market is what got us into this mess, and led to the bankruptcy of such previous tourist traps as Iceland). Not surprisingly, Stephen Myrow, a former Treasury official under Bush who helped create the TALF was caught saying "opening the TALF to legacy assets is the most effective and efficient way to purge troubled assets from the financial system." And in order to guard against losses, the Fed would take "so-called haircuts, or discounts on the loans, for the collateral it accepts." And to top it all off the FDIC (yes, the same people supposed to protect deposits at all costs), will start an aggregator-entity (bad bank) to purchase non-securitized whole loans, which would get a government guarantee and be re-sold to investors.

As ZH regulars can divine, what all this verbiage means, is that hedge funds will be allowed to establish investment positions, levered up to 10x with the government's aid, on which the funds will have only a stop loss of a certain percentage, and all incremental losses will be borne by you, dear (American) reader. And while this risk was "somewhat" acceptable for TALF 1.0, now that Geithner is opening it up to the whole morass of uber toxic and even more uber illiquid garbage floating on banks' balance sheets, the Treasury has just gone all in with taxpayer money in its bet that the market will recover. Geithner's Put has just been transformed to Geithner's All In. Is this vaguely reminiscent of what the rating agencies were doing: excel models which would crash if one tried to assume a reduction in housing values?

So in a nutshell:

1. The government is opening up the tax money spigot for market intermediary vehicles (hedge funds and other PPIFs or public-private investment funds) to buy up virtually all toxic assets with no accounting for default risk or loss assumptions, on the bet asset prices (i.e.the market) will go nowhere but up from this point onward. This is a huge gamble as macro economic conditions indicate we are nowhere near a bottom.
2. PPIFs use taxpayer provided leverage to agree with the Treasury that this is, indeed, the market bottom.
3. If this, gasp, is not the real bottom, hedge fund losses are limited as the TALF is non-recourse and non-remargining in nature and PPIF first-loss downside is at worst roughly in the 10% ballpark (of course they get to keep the spoils if the ploy succeeds), all the while no collateral has to be posted.
4. Banks and other companies offload all their toxic assets to these leveraged vehicles.
5. In the meantime the FASB is adjusting accounting rules to make sure that whatever assets remain can take advantage of Hummer-size FAS 115 loopholes and mark them at par.
6. Also in the meantime, the FDIC is buying up non-securitized toxic products (whole loans), and providing government backstopped capital to banks via the TLGP, all the while Sheila Bair is complaining that the Deposit Insurance Fund (DIF) is at or near zero.
7. Investors, whose deposits currently have no statutorily-required insurance as per the above point, are supposed to believe that banks are healthy, the accounting opacity is the new transparency, that the soon to be $15 trillion in total new bailout-related government debt and guarantees is sustainable as China bails and the Fed is left to purchases it own treasuries, that the FDIC will restore its DIF from fees banks pay for TLGP issues (even though banks will soon be able to issue debt cheaper in the Eurodollar market, until such time as LIBOR spikes again), and are expected to buy up equities and fixed income securities
8. As more and more buy into this all is good "new-age bull market" rally, the PPIFs will suddenly decide to sell off their resecuritized toxic garbage at a profit to themselves, people will ask just what these toxic legacy assets are really worth (again) and the whole system will crash once more, this time with the implicit guarantee of tens of trillions of US debt.

This is, of course, just one perspective. What is certain is that between Bernanke's TSY actions earlier this week, and Geithner's launch into TALF 2.0 (which is essentially stopping short of outright purchasing of bonds and equities), the administration has gone all in on selling its vision for the future to the U.S. taxpayer-cum-investor. If the pitch is unsuccessful, look out below. Sphere: Related Content

Madoff Victim Letters

Sphere: Related Content

The Week In Review

As next week's news is likely to be consumed by Geithner's redesign of the TALF, it is useful to summarize the events of the prior week. An overview of the ten most notable events that have occurred, compliments of BofA:

1) Fed’s moves impact Treasury notes and the dollar

The move towards buying Treasuries outright and the sharp expansion in mortgage and agency paper support was indeed very bold action by the Fed. We would expect to soon see the narrow money numbers such as M1 and the monetary base accelerate sharply. The questions have been, and will remain, whether we will see renewed credit growth, what will happen to money velocity and whether the ratio of non-liquid assets to total assets will begin to rise in the commercial banking sector.

The only obvious impact from the Fed’s intervention is on Treasury notes since that is what the central bank is actively purchasing, and on the dollar, since the growth in the money supply can be expected to accelerate – though keep in mind that other central banks are also pursuing aggressive policies so it is unclear how long the dollar bear market will really last. But since commodities and gold are priced in dollars, and because reflation expectations can be expected to be on the front burner, basic materials should also be beneficiaries.

The real aim of the Fed here was to drag down the entire yield curve out to 10-years, in our view, and this in turn will help ease debt-service strains for households and businesses as they roll over their obligations. Mortgage rates, in particular, should come way down and we anticipate could well touch historic lows of 4-1/2%. Refinancing risks should also be alleviated somewhat for corporates, at least at the margin.

2) Fed is not buying equities and not buying real estate

But beyond Treasuries, mortgages, the dollar, commodities and gold, we do not see much in the way of lingering benefits for equities or for corporate bonds outside of, say, tertiary or secondary impacts. We believe the fact that the Fed is going this far is testament to the view that the plethora of other policies thus far have fallen short. We do not feel that the contours of the business cycle, primarily the timing of the end of the recession, are going to hinge on the Fed’s move any more than was the case in Japan.

The Fed’s actions, while helping to achieve lower interest costs and perhaps unclog the arteries in the mortgage and asset-backed market, do not address the reality of corporate earnings declining again this year to an estimated $40 (on operating EPS). The Fed is not buying equities. The actions will do little to bring the unsold new housing inventory down from its record high 13.3 months’ supply, so despite the cash-flow benefits from a refinancing standpoint, we do not see the demand side being strong enough to bring this inventory below 8 months any time soon and until that happens, we believe home prices will continue to deflate.
The Fed is not buying real estate.

It was interesting to see the tepid reaction in the corporate bond market after the Fed announcement. Then again, the Fed is not buying investment grade or highyield corporate bonds, either.

3) Not obvious that demand for borrowing will be there

While the Fed can do all it can to put the financial system into a situation where it is able to extend credit again, it is not at all obvious to us that the demand for borrowing is going to be there as households in particular continue to focus their attention on climbing out of their record debt burdens. By the time the fourth quarter had rolled around, the Fed and the Treasury had already expended plenty of resources to rekindle the credit cycle, including the central bank move to cut rates to 0% effectively – and even with that effort, households cut their liabilities by over $300 billion, or at over an 8% annual rate. This marked the second time
in the past three quarters that the household sector moved, on net, to reduce their overall indebtedness, and for the first time ever, household liabilities have contracted on a year-to-year basis. This is what happens in a deleveraging phase, and it is highly deflationary and as we saw in Japan, requires time and massive doses of fiscal and monetary stimulus to even partially offset.

4) Fed policy does not operate in a vacuum

What many pundits seem to be missing is that Fed policy does not operate in a vacuum. The Fed is responding to what we can only refer to as severe trauma on the US household balance sheet. The aggregate loss in household wealth is an eye-popping $12.9tn (and now roughly up to $20 trillion in 1Q): This constitutes a 20% decline in household wealth since the peak was put in back in mid-2007. Wealth destruction of this magnitude is unprecedented since the Great Depression. At the rate it is going, the personal savings rate could be north of 10% within a year – that is a hugely deflationary event unless personal incomes are somehow shored up at the same time (though this is much more effectively addressed via fiscal policy). Yes, indeed, the Fed’s balance sheet and the balance sheet of the federal government are both expanding at record rates. That is what makes the headlines and that is what analysts, strategists and economists will be consumed with today – the latest operation technique by the surgeons.
But the reality is that patient is still in sickbay.

These massive reflationary efforts should be seen, in our view, as a partial antidote, not a panacea, to the deflationary effects brought on from the unprecedented contraction in the largest balance sheet on the planet: The $55 trillion US household balance sheet. Based on what house prices and equity valuation have been doing this quarter, we are likely in for a total loss of household net worth approximating $7 trillion this quarter alone, which would bring the cumulate decline in consumer wealth to $20 trillion. This wealth loss exceeds the combined expansion of the Fed’s and government balance sheet by a factor of more than five, which should put the reflation-deflation debate into perspective.

5) Overall inflation still heading lower

Overall CPI rose by a higher than expected 0.4% M/M in February led by 3.3% gain in energy prices (gas prices were the key culprit, up 8.3% M/M). Energy added 0.2 ppt to the headline. Core CPI was up 0.2% over the month with persistent increases in several core goods categories including apparel 1.3%, new cars 0.8%, tobacco 0.7% and drug prices 0.6% M/M.

Both apparel and car prices are likely to reverse in upcoming months as retailers continue aggressive discounting tactics to lure customers given the depressed state of demand. Higher tobacco prices continue to reflect higher state and local tax increases as governments attempt to capture higher revenues. Higher wholesale prices for tobacco products are also likely a factor. Elsewhere, core service prices eased (up 0.1% M/M) with a similar increase in owners equivalent rent. Higher medical care services (0.3%) and tuition (0.5%) costs were partially offset by declines in hotels (-1.8%) and airfares (-2.1%) – declines in these latter two
categories are clearly reflecting the falloff in demand and resulting easier pricing.

Relative to year-ago levels, overall CPI rose 0.2% versus a flat reading in January. We anticipate that by 2Q the headline will begin to head into negative Y/Y terrain and that by 3Q we could be looking at declines of 3.0%. Easy and significant year-ago comparisons for energy are a key driver in falling headline prices. Ore prices, up 1.8% Y/Y in February versus 1.7% in January, are also expected to ease toward sub-1% by 3Q with more competitive pricing for a broad array of consumer categories at its back.

6) Broad-based declines in output; new lows in utilization

We saw a 1.4% slide in industrial production in February, and how broadly based the declines were. The level of the index, at 99.7, is at its lowest since April 2002. Over the past six months, production has sunk at a 17.6% annual rate – underscoring how the pain has spread from the homebuilders to the consumers and now to the manufacturers. Tech production was cut 3.4% last month and has fallen now for seven months in a row, a losing streak not seen since the 2001 “wreck”. But the YoY trend has sunk to -13.8% and this took out the -12.8% low
posted in the last cycle when tech was the major culprit behind the recession, not an innocent bystander as is the case today. Note that the widening in the supplydemand gap is global and underscored by the reversal in the price of steel – which had rebounded in the aftermath of the Chinese fiscal stimulus plan to $490/ton in February from $360 in November but has since declined back to $415.

Manufacturing capacity utilization rates fell to a new all-time low of 67.3% from 67.8% in January and 69.7% in December. These are highly deflationary numbers. Much of the excess capacity is for finished product – 61.6% for machinery, 60.2% for tech, 49.1% for wood products, 68.2% for fabricated metal products, 43.6% for motor vehicles. But look at the resource sector – CAPU rates are holding up rather well: 88.2% in mining, and 88.3% in the energy patch, as examples.

7) ISM manufacturing index heading lower in March

The Philly Fed manufacturing index came in markedly better than expectations at -35.0 in March versus -41.3 in February (the market was braced for -39). Still, at this level, activity in the region contracted at a rapid pace with ongoing declines in practically every component. The leading new orders index plunged 10.4 points over the month to -40.7, suggesting that bigger declines in shipments and production lie ahead. Further supporting an ongoing recession was a record low in capex spending intentions over the next six months. And look at prices received – still flirting near record deflation lows of -32.6 (second lowest ever!) – and prices-paid at -31.3, which indeed was a record low. Together with the new lows reported in the March NY Empire survey, the national ISM index is expected to decline from the 35.8 print we saw in February.

8) Weather could be factor in housing starts jump

Builders broke ground on 583,000 homes in February, above consensus and Banc of America Securities-Merrill Lynch expectations. We do not see this as a positive factor for the housing market given the massive 6 million unoccupied homes for sale or rent that still need to be absorbed by the market. Weather may have played a role in boosting homebuilding activity. Rainfall was significantly lower than normal in February and national temperatures were a bit warmer as well, although only 1/2 a standard deviation above normal. It was multi-family
units that were the main driver of the upside surprise, posting 226,000 units started in February, up by more than 100,000 from January’s activity. Single family starts were a more moderate 357,000, about even with January’s pace. Building permits also rose in February to 547,000 (3.0% m/m), with multi-family up by 6.6% and single down by 11.0%.

Homes completed rose to 785,000 in February, a 2.3% rise from January. Single family
completions were 505,000, an 8.2% drop from January. Still, this is about 200,000 above the current pace of sales; therefore, we expect months’ supply to remain near a multi-decade high of 13.3 months in February.

9) Current account narrows for second straight quarter

The current account deficit narrowed from $181.3 billion (revised from $174.1 billion) in the third quarter to $132.8 billion in the fourth quarter. The actual current account deficit came in below the median of analysts’ projections of $137.1 billion. The BAS-ML estimate was for a deficit of $130 billion. Between the third and fourth quarters, the current account deficit improved a record $48.5 billion dollars. Versus the third quarter current account deficit to GDP share of 5.03%, the fourth quarter deficit was 3.74% of GDP. Looking ahead, we anticipate the current account is likely to continue its sharp narrowing path as the slowdown in exports exceeds the decline in imports. After posting a current account deficit of $673 billion in 2008 (4.7% of GDP), we expect the deficit to narrow to about $250 billion (or 1.8% of GDP) in 2009.
The deficit on goods and services fell $40.5 billion, to $140.4 billion in the fourth quarter. The deficit on goods decreased $42.2 billion, to $174.1 billion while the surplus on services fell $1.7 billion, to $33.7 billion. The surplus on income increased from $29.6 billion in the third quarter to $36.5 billion in the fourth quarter. Income receipts on US-owned assets abroad fell $25.7 billion, to $165.9 billion as direct investment receipts and other private receipts (dividends and
interest payments) fell. Income payments on foreign-owned assets in the US declined $32.6 billion, to $130.2 billion as direct investment payments and other private payments fell. Net transfers to foreigners were $28.9 billion in the fourth quarter, down from $30 billion in the third quarter.

10) We remain bullish on gold

We were bullish on gold before the Fed’s latest balance sheet maneuver, and we remain bullish thereafter: Bullion is a traditional hedge against uncertainty – financial, economic, and geopolitical. See below for more evidence of such uncertainty:

“Mexico Issues Tariff List In U.S. Trucking Dispute” (WSJ, March 19th, 2009).
“Australian Panel Rejects $529.5 Million Coal Merger (WSJ, March 19th, 2009).
“Beijing Rejects Coke’s Juice Deal” (WSJ, March 19th, 2009).
“Europe Warned to Unite Or Risk Being Last to Exit Recession” (FT, March 19th, 2009).
“Export Fall Hits China Growth Forecast” (FT, March 19th, 2009).
“Increases in Cash Hoards Prompt Fears of Stifling Economy” (FT, March 19th, 2009).
“Downturn Heightens China-India Tension on Trade” (WSJ, March 20th, 2009)

If gold is positively correlated with fear, we don’t expect this bull market in bullion
to subside anytime soon. Sphere: Related Content

Friday, March 20, 2009

DE Shaw On The Basis Monster That Ate Wall Street

DE Shaw's quant Ph.D. geniuses are focusing on the topic de jour: the Basis Trade (to Boaz Weinstein's chagrin they are 6 months off). Always good to get one more perspective on the issue. Great bedtime reading for hardcores: enough new concepts here to find at least 5 brand spanking new ways to blow up the world. Particularly interesting section:

What's critical here is that the two risk factors most responsible for driving cash -synthetic basis-namely, the availability of financing and the positioning (long or short cash relative to synthetic) of levered players - inconveniently also two of the least desirable risk factors for a levered instrument vehicle like most hedge funds. Those factors' combined impact literally describes the terms of a classic common-investor liquidation crisis. By incurring heavy exposure to financing risk and the portfolio of other levered investors, a levered hedge fund is effectively selling a gigantic put option on its ability to finance its own positions. Moreover, this put option has characteristics that greatly increased the probability that the option will move in the money at the worst possible moment. If a levered investors suddenly finds itself facing heavy losses, it's not a stretch to suppose that, at the same time and for largely the same reasons, that investor's equity capital base is under pressure from redemptions, its financing position is weakening because of a credit crunch, and other similarly positioned investors are liquidating. Worse still, all of these phenomena lend to self-reinforce in pernicious ways. In such circumstances, it's imprudent to count on financing and trading counterparties to provide help because, as already noted, they're likely to be deleveraging at the same time.

Also, a great discussion on Berkshire abnormally positive basis. Hat tip purearb

DEShaw - Free Legal Forms Sphere: Related Content

Mary Meeker's Latest Convergence Piece

Some internet convergence optimism from the ever cheerful Morgan Stanley lifer Mary Meeker, to dispel the recent FDIC hatin' on ZH. Hat tip to Paul Kedrosky.

Meeker Tech '09 - Get more Business Plans Sphere: Related Content

FDIC Closes Three More Banks

This brings the 2009 total to 20 banks down and counting. The latest three are:

  • FirstCity Bank of Stockbridge, GA, had total assets of $297 million and total deposits of $278 million. At the time of closing, the bank had approximately $778,000 in deposits that exceeded the insurance limits. In English this means tomorrow some people will realize they are $778,000 poorer.
  • Colorado National Bank, Colorado Springs, CO, had total assets of $123.5 million and total deposits of $82.7 million. The FDIC will share 80/20 percent in the losses with Herring Bank (who assumes Colorado Natl's deposits) on approximately $62 million in assets covered under the agreement.
  • TeemBank, National Association, Paola, KS, had total assets of $669.8 million and total deposits of $492.8 million. The FDIC will share 80/20 percent in the losses with assuming bank Great Southern Bank on approximately $450 million in assets covered under the agreement.

And thanks to vigilant readers who pointed out this new twist: the U.S. placed two credit unions under conservatorship: U.S. Central Federal Credit Union (Lenexa, KS) with $34 billion in assets and Western Corporate Federal Credit Union (San Dimas, CA) with $23 billion in assets...

The two corporate credit unions were placed into conservatorship to protect retail credit union deposits and the interest of the National Credit Union Share Insurance Fund (NCUSIF), as well as to remove any impediments to the Agency’s ability to take appropriate mitigating actions that may be necessary. Service continues uninterrupted at both U.S. Central Corporate Federal Credit Union and WesCorp, and members are free to make deposits and access funds.

The Federal Credit Union Act authorizes the NCUA Board to appoint itself conservator when necessary to conserve the assets of a federally insured credit union, preserve member assets and protect the NCUSIF.

$57 billion in assets? This is more than all FDIC-seized bank assets in 2009. Has the FDIC been merely attempting to distract from the real troubles at the National Credit Union Administration?

Sphere: Related Content

Delayed Bloomberg Editorializing To Avoid Panic

Hat tip to reader Camila for pointing out that Bloomberg's earlier editorial mistake in reporting the truth was subsequently mitigated substantially. The title of the original Bloomberg article was "Bair Says FDIC Reserves May Hit Zero Without New Fees", which was subsequently moderated to the current "Bair Defends Fee To Build Deposit Reserves Amid Bank Opposition."

The image below is a snapshot of the current Bloomberg article which is referenced by the Bair link disclosed earlier.

The original title was eliminated and the only remnant in Bloomberg's cache shows up in the title of the Bloomberg TV Interview with Bair that the article was supposed to reference, and that originally hit at 14:36:11.

And to all who say that the Treasury has this all under control, I would only interject that this is the kind of problem that can not be dealt with reactively, like the blow ups of Lehman and AIG. It will be amusing to see the Treasury print $6 trillion to cover the deposits as they get all electronically pulled... Which is why this is a proactive i.e. confidence problem. Once the train gets rolling it can not be stopped. As such, the prudent after-the-fact Bloomberg editorializing makes all the sense in the world. Sphere: Related Content

More Leaked Citi Memos

Vik is freaking out again ergo leaked memos... This time it is potential employee defections and bonus refunds... And some not so good news for distress causing people.
To: All Citi Colleagues

From: Vikram Pandit

Date: March 20, 2009

Re: Washington Update

Our industry has recently seen a tide of negative sentiment rising in Washington, D.C. regarding compensation. Of course, some of it is warranted. But I take exception when there is a discussion about spreading the blame to each and every employee in the financial services industry. At our company, we removed the people responsible for Citi’s financial distress and acted fast to strengthen and streamline the business, and install new risk processes and new risk personnel. You have been invaluable in our collective efforts to put the company on solid footing.

The work we have all done to try to stabilize the financial system and to get this economy moving again would be significantly set back if we lose our talented people because Congress imposes a special tax on financial services employees. It would affect countless number of people who will find it difficult, if not impossible, to pay back the bonuses that they earned.

I want you to know that we are working in every appropriate way with policymakers in Washington, and with other financial institutions and industry associations, to come to agreement on a constructive industry compensation system that is good for the company, the financial system and the country. We will continue to do everything we can to ensure that we can pay our employees fairly, reflecting their market value and hard work, especially during these challenging times.

I know it is difficult, but no matter what happens in Washington our prospects will be best served if we all continue to work hard helping clients and customers around the world and improving the performance of the business and speeding our return to profitability.

So while you continue to focus on our clients and quality execution, please rest assured that senior management and experts in Washington are focused on these developments and trying to address issues raised in the debate with clarity about the real facts.

Thank you for your unwavering commitment and dedication.

(bjh) NY
Sphere: Related Content

Goldman's Co-Head Of Fixed Income Goes To Fidelity

It has been confirmed that Chris Sullivan, (curiously still with a green light on his Bloomberg profile) is taking the Ironclad parked in the dodecatuple secret bottom basement of 32 Old Slip, and will sail the East River all the way up to Boston where he will be joining Fidelity as president of its bond fund. Sullivan is moving on up in the world, not just in a purely magnetic north sense, as at Fidelity he will oversee more than $170 billion in bond assets.

Zero Hedge hopes for Chris' sake, that Fidelity has learned the novel and arcane concept of shorting, which his now former employer has always been so good at. Sphere: Related Content

Sheila Bair: FDIC Reserves To Hit Zero

When I wrote about this issue a week ago, I thought I was going to be called out for prognosticating gloom and doom as usual...Well, no such luck, in fact quite the opposite. Sheila Bair came out with some very scary words for depositors everywhere:
“Without additional revenue beyond the regular assessments, current projections indicate that the [depositor investor] fund balance will approach zero,” Bair said.
In the words of Lewis Black, I will repeat that, because it bears repeating:

“Without additional revenue beyond the regular assessments, current projections indicate that the fund balance will approach zero."

This is actually one of the most terrifying news I have heard in forever, as it goes to the heart of depositor confidence problem, with a next step being the global bank run that Kanjorski was fuming about.

The reason for Bair's statement is to attempt to explain the need for the recently instituted fee increases for TLGP participants.
"Even though this increase comes at a difficult time, I strongly believe that keeping deposit insurance industry-funded will be better for you and your customers when this crisis is over."

“I’m optimistic that Congress will soon act on the borrowing authority increase,” Bair said. “This should give us the breathing room we need to reduce the special assessment, while covering all projected losses, with industry funds.”
Oh yes, let's not forget that Chris Dodd of such recent fame as the AIG bonus scandal, is trying to plough even more taxpayer money into a cause worthy of... saving taxpayer money... Still not too sure I understand how that works. But let the law of unintended consequences strike as it may.

Bair also had some very favorable things to say of the recent accounting changes proposed by the FASB which I wrote about yesterday (of course Bair will be a proponent of opacity: last thing depositors need to know is that DIF is negative among other things).

There is a minor light at the end of the tunnel.
Bair said she wants to “end too-big-to-fail” models that have shaped U.S. policy and wants financial firms to reduce systemic risk by “limiting size” and “complexity.” She said regulators “need to impose higher capital requirements” to ensure banks have enough capital to withstand worsening economic scenarios.
In the meantime, Bair is praying that nobody realizes that there is no money left to insure America's deposits, and that everyone absorbs the optimism spewing forth from the lips of CNBC's Steve Liessman like a wet sponge.

The only appropriate ending to this post are the following words:
"I cannot imagine any condition which would cause a ship to founder. I cannot conceive of any vital disaster happening to this vessel. Modern ship building has gone beyond that."

Captain Edward J. Smith, Commander of Titanic
Sphere: Related Content

Don't Bounce GM's Check Just Yet

One-time potential auto czar and now merely actual auto cheerleader, Steve Rattner, said GM may need "'considerably' more government aid than their request for as much as $21.6 billion."

GM, which recently was beaming after it had said everything is cool and no more cash will be needed in the short-term must have finally figured out how to scroll down on the excel-based P&L and seen all those red cells.
“[Aid] could be considerably higher, I won’t deny that,” Rattner said, when asked whether U.S. aid sought could rise to $30 billion or $40 billion. Rattner spoke in an interview on Bloomberg Television’s “Political Capital with Al Hunt,” scheduled to air today.

“What they’ve asked for depends on them achieving plans that are somewhat ambitious,” Rattner said. “Like all management teams they tend to take a reasonably, slightly perhaps, optimistic view of their business. So it could be more, I can’t rule that out.”
"Reasonably, slightly perhaps optimistic view?" Sweet baby Jesus, was Rattner on the verge of confirming that everyone from Geithner down to hot dog vendors all pray in the Church of Latter Day Hockeystick Saints? And the reason why the March 31 deadline will come and pass with nothing at all having been achieved?
“Part of why there’s a lack of appearance of movement is nobody wants to go first,” Rattner said. “You say here’s the deadline, everybody has to get there by this date or we’re going to do something else.”
Hey Steve, isn't it your job to explain just what the downside is if there is no agreement by March 31? Sigh, if only Hunter Thompson were still alive to write about the lunacy that is our everyday lives.

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Some More Fuel For GGP Fire

ISDA just announced it will publish a protocol for the Rouse Company's (read General Growth Partners) CDS auction protocol. Yet another consequence of the Monday default on over $2 billion in debt. At this point I don't see how a successful forbearance makes little sense as the CDS has been officially triggered.
New York, Friday, March 20, 2009 – The International Swaps and Derivatives Association, Inc. (ISDA) today announced that it will launch a CDS auction protocol to facilitate the settlement of credit derivatives trades referencing The Rouse Company LP.

Rouse is a subsidiary of General Growth Properties, Inc., the Chicago-based real estate company. Rouse was reported to have failed to pay more than $2 billion in debt on March 16.

ISDA will facilitate the process by publishing the Protocol and auction terms on its website, in due course. The Protocol will be open to ISDA members and non-members alike. The auction will be administered by Markit and Creditex.
Sphere: Related Content

SPG Likes Leverage So Much It Upsizes Bond Offering

Simon Property Group's new "A3/A-" bond issue, which is pricing at a 10.875% yield just got upsized from $500 million to $650 million. Just like the marginal buyers of the MGM 13s of 13 are now very sorry, we smell something quite comparable happening here oh so soon. Sphere: Related Content

Preliminary Goldman Call Observations

In a nutshell - Goldman had bought billions in AIG CDS in the 2004 to 2006 timeframe. Whether this was predicated by their expectation that subprime would blow up, or their very early understanding just how bad things at AIG were, one will never know, especially not the SEC. However, one look at the CDS chart below shows what prevailing levels for AIG's CDS was in that time frame. As one can see, AIG 5 yr CDS traded in a range of 4 bps to 52.50 bps between October 1, 2004 (only goes back so far) and December 31, 2006. Indicatively 5 yr CDS closed yesterday at a comparable running spread equivalent of 1,942 bps.

Purchasing $10 billion in CDS (roughly in line with what Viniar claims happened) at a hypothetical average price of 25 bps (and realistically much less than that) and rolling that would imply that at today's AIG 5 yr CDS price of 1,942 bps, the company made roughly $4.7 billion in profit from shorting AIG alone! This would more than make up for the $2.5 billion collateral shortfall (out of $4.4 billion total) GS claims AIG had with Goldman Sachs... If AIG had filed for bankruptcy, and assuming Lehman is any indication, the P&L would have likely hit $6+ billion.

Implicitly, one could say GS was incentivized to see AIG fail. Does that maybe answer some of the questions of why GS allegedly pulled AIG's collateral and started the avalanche that lead to its bailout? However, a fine point - if AIG had really tanked none of the CDS would be collectible as the entire CDS market would have likely imploded... Thus demonstrating the need for a zombie bank system: not totally dead (systemic collapse) but barely alive to pocket a nice little CDS annuity from daily cash collateral posts as it leaks wider (and taxpayers foot the bill).

Full preliminary conference call transcript here.

Disclosure: Zero Hedge has no position in any Goldman Sachs securities. Sphere: Related Content

Liveblogging The Goldman Call

Some of the Q&A. FT, Bloomberg and WSJ are ripping David Viniar apart:

Q. How did you treat mark to market dispute and did you do anything in response to noticing improprieties with AIG's marking methodology?

"We believe the value of some positions was lower than they believed. Our response to their weakness was to scale down our trade." [Here comes the MTM can of whoopas at AIG and elsewhere.]

Q. Was it GS's collateral calls that pushed AIG over the edge and does GS feel guilty?

"Had commercial terms, had to protect ourselves, that's why we have collateral terms. there isn't any guilt whatsoever."

Q. GS was biggest counterparty of AIG. Does GS acknowledge that its collateral calls pushed AIG over the edge?

"No. We do not know what the other counterparties were. We just know we called the collateral under our contracts."

Q. Why did GS not alert treasury when it noticed warning signs? How many meetings did Lloyd have with Hank Paulson?

"There were no meetings. Regulators are supposed to regulate. Regulators were posted regularly on what exposure GS had to AIG." [No meetings? Really? This is very easy to be double checked... regardless, another nail in SEC's coffin]

Q. Has there been any discussion of management changes at GS?


Q. Of $4 billion in collateral on synthetics, how much would have been disastrous if had not been paid?

"$2.6 billion at risk from a daily collateral post perspective. $2.6 paid after the bailout" [Despite GS's earlier protests that it was "perfectly hedged" to AIG directly, although not so indirectly].

Q. What is collateral now against full exposure to AIG?

"$4.4 billion in collateral against $6 billion in exposure."

Q. What is P&L on AIG hedges (read CDS GS bought in AIG)

"Net/net gain over time."

Q. Was GS compensation affected by whether collateral was able to be collected.

"Not at all... Goldman was perfectly hedged"

Q. Follow up - Did you tell regulators about their view on how securities should be trading, how collateral should be disputed, i.e. that stuff at AIG was crashing.

"Regulators were posted on collateral, they knew."

Q. What is GS net exposure?

"Roughly 0. If markets move one way we'll put on CDS hedges, if they move the other way, we'll take them off."

Q. Did GS continue to put on AIG CDS after 2006?

"Yes, but very small....really small"

Q. Was GS ever asked to take a discount on its collateral?

"Had ongoing negotiations with AIG. AIG wanted to settle for less than they owed GS. Both before and after September. Not that unusual when negotiating contract transactions." [in fact, happens all the time when dealing with insolvent entities]

Q. Were the bulk of AIG CDS transactions done by end of 2006?

"Almost all was finished by end of 2006. Very little in 2007."

Q. So you had some good visibility on the subprime crisis then didn't you seeing how you stopped buying AIG protection as everyone else was only realizing how bad subprime is?

"We made the right decision at the time." [no comment] Sphere: Related Content

S&P Freaks Out After Learning 3 GGP Loans Transferred To Special Servicers

And if you are long any tranche of CMBS deals GCCFC 2004-GG1 and LB-UBS Commercial Mortgage Trust 2004-C4, you may want to freak out too. S&P just announced that it is monitoring these two loans "after learning that the loans for three General Growth Properties Inc. (GGP)-related malls that serve as collateral for the transactions were transferred to their respective special servicers on March 18, 2009, due to maturity defaults. The three GGP loans collateralized by three malls were transferred to the special servicer after representative borrowing entities notified the master servicer that they would not be able to repay the loans due to difficult capital market conditions. The borrowing entities have indicated that they are continuing to pursue various financing options."

This is likely just the tip of the iceberg as more and more properties, making up assorted loans, which in turn make up various CMBS pools, move to special servicing. And that is only for GGP... Which, one wonders, will have such an uphill battle to restore all the actions already taken place from the technical defaults on its loans and bonds. 5 pm today will be interesting.

A description of the properties in spec servicing below:

-- The Town East Mall loan is the third-largest loan in the LB-UBS 2004-C4 transaction and is with the special servicer, LNR Partners Inc. The loan has an unpaid principal balance of $105.4 million (9.4% of the pool) and is secured by 415,755 sq. ft. of a 1.3 million-sq.-ft. regional mall in Mesquite, Texas. The property was constructed in 1971 and most recently
renovated in 2004. The five-year loan has a coupon of 3.46% and is scheduled to mature on April 11, 2009. The master servicer reported debt service coverage (DSC) of 2.45x and 99% occupancy for the nine months ended Sept. 30, 2008.

-- The Southland Mall loan is the third-largest loan in the GCCFC 2004-GG1 transaction and is with the special servicer, CWCapital Asset Management LLC. The loan has an unpaid principal balance of $81.3 million (3.6% of the pool) and is secured by 1.0 million sq. ft. of a 1.3
million-sq.-ft. enclosed regional mall in Hayward, Calif. The property was constructed in 1964. The five-year loan has a coupon of 3.62% and was scheduled to mature on March 1, 2009. The master servicer reported a DSC of 2.69x and 98% occupancy for the nine months ended Sept. 30, 2008.

-- The Deerbrook Mall loan ($73.7 million, 3.3% of the pool) is the fourth-largest loan in the GCCFC 2004-GG1 transaction and is secured by 461,298 sq. ft. of a 1.2 million-sq.-ft. enclosed regional mall in Humble, Texas. The property was constructed in 1984. The five-year loan has a coupon of 3.46% and was scheduled to mature on March 1, 2009. The master servicer reported a DSC of 2.55x and 99% occupancy for the nine months ended Sept 30, 2008.


This just out too: Citigroup Moves To Foreclose On General Growth Mall In New Orleans; $95M Mortgage That Wasn't Paid (0.50 +0.00)

Everyone is picking up on the foreclosure run... Sphere: Related Content

MGM Gets The Tripple Hooks

Last night S&P downgraded MGM from B- to CCC. Didn't take much more than an impending default to stir the rating agency. S&P analyst Ben Bubeck discovered what even Kirk Kerkorian has known for years (and being 90+ years old, these things are expected to take some time).
"The downgrade reflects our belief that, given our projections for cash flow generation over the next few years, combined with substantial capital needs to fund the completion of CityCenter and to meet debt maturities, MGM MIRAGE's ability to service its current capital structure is in doubt,"
And some more insight on what the prospects for Vegas and the Strip in particular are:
"While the company maintains a leading presence on the Las Vegas Strip, we expect the Strip to be among the weakest performing U.S. gaming markets in 2009. The company's ability to weather the current downturn relies on a moderation of the revenue and cash flow declines recently observed across the industry, which we believe is unlikely until at least 2010, or a restructuring of its debt obligations. As of Dec. 31, 2008, operating lease-adjusted total debt to EBITDA, excluding income from unconsolidated affiliates, was 7.5x."
Sphere: Related Content

Investment Grade SPG's New $500 Million Notes Yield 10.875%

REIT Simon Property Group, which yesterday announced it was raising $500 million in bonds, will price these notes to yield 10.875%. And this is an A3/A- issue!

This is what happens when "high-rated" investment grade companies approach the debt market without access to the TLGP or the discount window. As SPG is the highest rated REIT and has the largest market cap in the space, one can only imagine what kind of interest rates all the other, lesser-rated REITs will need to pony up when they start coming to market to refi all their impending maturities... Ain't gonna be pretty. Sphere: Related Content

Ken Griffin's Brother All Over Dutch Auctions

Black River Asset Management, which according to Hedge Fund Alert "runs many funds and at one time had $10 billion under management, [and] was hit with a slew of redemptions requests last year," has employed a spin on the reverse auction process utilized by other formerly reputable funds such as Golden Tree. The Cargill affiliate, trying to appease a wave of March 31 redemptions, has told investors to submit the largest discount they are willing to accept for their shares. Subsequent to tabulating all the bids, Black River paid out these skittish elements at an undisclosed discount to its book value at the end of February. Black River has also employed the recently (un)popular illiquid asset concept, moving 60% of its asset pool into a liquid share class, with the 40% balance going into an illiquid tranche.

Black River in February 2008 threw a life vest and subsequently hired Ken Griffin's brother Loren out of Bear Stearns (curiously a mere 3 weeks prior to the first major Wall Street implosion in March of last year). Nonetheless, it has not been a pleasant tenure for Loren, who runs Black River's convertible fund, as the general fund is fighting tooth and nail to come up with redemption-mitigating strategies. Nonetheless, maybe Loren can put his Dutch Auction experience to good use, if and when he has to advise his brother Ken on how to come up with comparable strategies. Sphere: Related Content

$233 Million IG Bond BWIC Latest On The Menu

In addition to the $261 million loan BWIC reported yesterday by Debtwire, another $233 million BWIC, this time in IG bonds has hit the market. Traders have only until 11 am this morning to submit lowball bids. While loan BWICs over the past month have been increasing rapidly, bond and especially investment grade bonds have not seen wholesale blue light specials yet. It is no surprise that BWICs pick up in advance of the March 31 redemption deadline - it is certainly the case that many smaller and mid-sized funds are seeing the bait-and-switch from their prime brokers, who are now selling their collateral-call seized assets, and likely also submitting the winning bids at a big discount (hopefully not while ignoring bid flow from accounts, as that would be flagrantly illegal).

Sphere: Related Content

Latest DTCC CDS Update ( Week Of March 13)

Huge CDS buy rally last week - net notional purchasing of protection skyrocketed from a mere $12 billion last week to $250 billion, with a net contract increase of 14,330 contracts compared to only 4,615 in the prior week. As ZH presumed last week, the consumer services space did in fact see significant net purchasing ($42 billion) and spread widening. Other major derisking sectors were financials ($65 billion) and sovereigns ($34 billion).

Gross outstandings increased by $300 billion to $27.5 trillion, consisting of $14.9 trillion in single name CDS ($300 billion increase from last week), and index and index tranches of $12.7 trillion, flat with last week.

While the derisking was to be expected as the credit market yet again anticipated the end of the equity rally, the gross and net notional changes do not imply a dramatic fall off in CDS activity ahead of either the fixed coupon transition or the clearinghouse trading. This is a good indication of the health and stability of the market, which has full confidence that both transitions should be smooth and seamless.

Sphere: Related Content

Frontrunning: March 20

  • Citi CFO Crittenden becomes chairman of winding down division Citi Holdings, Ned Kelly new CFO (Reuters)
  • Bonus tax has left Wall Street scrambling for the exits (Reuters)
  • IMF says US stability plan is worthless, lacks "essential details" (FT)
  • A "sober" look at GECC's sad state of affairs (Bloomberg)
  • Thomas Frank picks up where Jon Stewart left: Financial Journalists Fail Upward (Huffington)
  • TALF will be ground zero for next round of rating agency abuse (1440 Wall St)
  • In times of crisis, Russians drink... milk (Moscow Times)
  • China aims to increase gold output by 3%, government will encourage industry consolidation (Shanghai Daily)
Sphere: Related Content

Thursday, March 19, 2009

Overallotment: March 19

  • Tearing up monetary policy rulebooks in Eastern Europe (Bloomberg)
  • The noose tightens: BofA was involved in Merrill's writedowns (FT)
  • Leon Black says the commercial real estate black hole will cost $2 trillion. (FT)
  • ...While his Apollo wants to equitize its Charter bonds and control the bankrupt cableco (WSJ)
  • First round in the Chinese trade war fired (Bloomberg)
  • AIG sues US for $306 million tax return, wants even more money from its owner (NYT)
Sphere: Related Content

Brutalizing The FASB's Attempts At Piglipsticking

Jonathan Weil of Bloomberg goes apeshit on the FASB, whom he affectionately calls the Fraudulent Accounting Standards Board, claiming that the FASB whored away its soul earlier this week when it "unveiled what may be the dumbest, most bankrupt proposal in its 36-year history."

Here’s what the board is floating. Starting this quarter, U.S. companies would be allowed to report net-income figures that ignore severe, long-term price declines in securities they own. Not just debt securities, mind you, but even common stocks and other equities, too.

All a company would need to do is say it doesn’t intend to sell them and that it probably won’t have to. In most cases, it wouldn’t matter how much the value was down, or for how long. In effect, a company would have to admit being on its deathbed before the rules would force it to take hits to earnings.

So, if these rules had been in place last year, a company that still owned shares of American International Group Inc. or Fannie Mae, for instance, could exclude those stocks’ price declines from net income entirely. It would make no difference that the companies were seized by the government last year, or that both are penny stocks. The loss would get buried away from the income statement, in a balance-sheet line called “accumulated other comprehensive income.”

Jonathan then goes off on an almost personal vendetta with the 3 members of the 5-person FASB board who voted in favor of the proposal.

These are the earnings we get when the people who write accounting standards give in to desperate bankers. And it’s no mystery why the three FASB members who voted for this -- Leslie Seidman, Lawrence Smith and Chairman Robert Herz -- did so. (The two who opposed it were Tom Linsmeier and Marc Siegel.)

Since the credit crisis began, the board’s members have been under assault by the banking industry and its wholly owned members of Congress. The most recent display came last week at a House Financial Services Committee hearing, where Democratic Representative Paul Kanjorski and other lawmakers beat Herz like a dog. Herz declined my request to be interviewed. A FASB spokeswoman, Chandy Smith, confirmed my understanding of how the rule change would work.

The banks want unfettered license to value their assets however they see fit, and to keep burgeoning losses out of their earnings and regulatory capital. The FASB had been holding its ground, for the most part. Now, though, the board has assumed the fetal position.

Zero Hedge applauds Jonathan for his passion and his desire to out those who first create, then flip flop on, core critical accounting matters. However, while the FDIC's action is at best deplorable, Jonathan's rage may be a little over the top. The reason for that is that more sophisticated investors realize all the accounting tricks in the book, much better than the FASB itself.

In its essence, the recent FASB proposal is a fudge on the often ignored FAS 115 rule, which Zero Hedge wrote about previously (in a post also dealing with FAS157 and Level 1-3 asset evaluation: I recommend it for anyone who wants to catch up on these two most critical accounting standards). That rule deals with the distinctions of marking-to-market three types of assets: trading, available for sale and held-to-maturity. In its essence the proposed rule does not change anything materially. As Weil himself points out, to every fudge the FASB proposes, there is a counterfudge. While the FASB has tried to make Tier 1 as the critical threshold for balance sheet viability, investors have realized that Tier 1 adds intangible assets, ignores certain losses and treats some liabilities as assets. As such Tangible Common Equity has become the defacto marker for healthy balance sheets, and even the administration has been forced to adopt TCE in its stress test evaluations as anything else would be immediately singled out as fluff by the sophisticated crowd and would not get no credibility. And as Tier 1 is to the balance sheet, so is Net Income to the income statement: the proposed changes will provide a vastly inflated net income line items for most commercial banks (not so much for pure broker dealers). However, once the garbage FASB standards become prevalent, their entire impact can be ignored by avoiding the Net Income line altogether and instead looking at Comprehensive Income which differs from Net Income by an adjustment line known as Accumulated Other Comprehensive Income (AOCI).

As more investors focus exclusively on Comprehensive Income, what the FASB does with FAS 115 or any other rule fudging is irrelevant. But this is old news to credit investors who haven't looked at "below the line" items for decades, and instead have focused exclusively on EBITDA and Free Cash Flow.

It is time people learn to read between the lines of the garbage the government spews forth, in its pervasive agenda to push "transparency" all the while covering every single pig in the U.S. economy with lipstick, restylane and botox. In the meantime, as Weil says "Enough with the fluff. Net is dead." Sphere: Related Content

Bank Rally: A Temporary Bear Market Bounce

The reason why so many investors have been skeptical about the recent rally in stocks has to do with the role of bank stocks, which have been at the heart of both the drop as well as subsequent 20% rebound. The question is whether this recent dramatic move up in financials is sustainable or is merely a temporary blip, as the market reevaluates the inherent risks. I present a good summary by Goldman, arguing that all signs point to the latter. I particularly draw your attention to exhibit 9 showing the number and magnitude of some bear market rallies in the context of an overall declining market.

Rally in context

Bank stocks have staged a big rally and investors are now asking is this a bear market bounce or have we seen the bottom. In our view, this is a bear market bounce as:

(1) Non-performing assets are still accelerating: The fundamental data is not getting any better on consumer credit. Master trust data on credit cards points to a significant deterioration in consumer credit quality – losses increased 90 bps month on month which is the highest increase since the cycle started. Moreover, we are likely to see a resumption of writedowns in March given the “X” indices have fallen by 8% so far this month.

(2) Reason for rally: Part of the rally has been driven by comments from several banks that they have been profitable in the first 2 months of the year. However, we expect that some of this performance is driven by one-off factors such as write up on debt, mortgage origination fees, strong capital markets activity in Jan and Feb, which may fade in coming months and limited reserve builds despite our expectation that NPAs will continue to grow.

(3) Next catalyst: The next major catalyst in the banks sector will be stress test results, which will most probably come out in the middle of April. We cannot rule out banks unexpectedly failing this test and being forced to either raise capital from investors or take government capital. We expect that some banks that pass the test will look to issue equity to pay back government TARP. Either way, we expect significant equity issuance.

(4) Valuation may not provide a floor. We are now back to 0.8X tangible book, up from 0.5X two weeks ago. Both are low relative to long term averages. That said, when we look at prior severe regional home price depressions both in the US and globally, we find "trough" valuations within the range of 0.2X - 0.7X tangible book.

Sphere: Related Content