Summary of sub-prime write-downs in Q4

Citigroup $18.1 bln
UBS $13.7 bln
Merrill Lynch $11.5 bln
Morgan Stanley $10.3 bln
Bank of America $5.3 bln
HSBC $3.4 bln
Deutsche Bank $3.1 bln
Barclays $2.7 bln
Royal Bank of Scotland $2.6 bln
Credit Agricole $2.3 bln
Credit Suisse $2.3 bln
Bear Stearns $1.9 bln
JP Morgan Chase $1.6 bln
Goldman Sachs $1.5 bln
Wachovia Bank $1.1 bln
Lehman Brothers $0.8 bln
SunTrust Bank $0.6 bln
Total: $82,800,000,000 and counting!

Keep in mind ... this is just in one quarter...

CMBS write-down coming at Wachovia?

Analysts say Wachovia may have losses lurking in an area that has garnered less investor attention. Wachovia has in recent years aggressively tried to add market share by underwriting commercial mortgage-backed securities. Demand for such securities has slid amid credit concerns, leaving dealers struggling to unload loans whose quality might be perceived as less sound than investors now demand. Analysts have estimated Wachovia's net CMBS exposure at about $9 billion. They say Wachovia could face a related fourth-quarter write-down as large as $1.5 billion. "CMBS-related write-downs may wipe out earnings" in the quarter, wrote Howard Mason, an analyst at Sanford C. Bernstein & Co.

More Bad News about Citi

Goldman Sachs

Citigroup could write off as much as $18.7 billion in the fourth quarter, wrote Goldman Sachs analysts William Tanona, Betsy Miller and Neil Sanyal in a note to investors late Wednesday. If it does, they say, the bank may be forced to lower its dividend by 40%. Citi has about $55 billion in exposure to subprime mortgages.

Wall Street Journal

Citigroup is considering sales, the WSJ reported today, citing analysts and unnamed executives. Citi could sell 80%-held Student Loan Corp, its North American auto-lending unit, its 24% stake in Brazil credit card operation Redecard, and its Japanese consumer finance business. New Citigroup CEO Vikram Pandit is also considering laying off as many as 20,000 employees and shedding business lines.

Time to Short AAPL

Apple closed at a 52-week high of $202.96 yesterday; has it peaked? I think so!

Home Prices Down 6.7%

Yeah, I know some of you may have seen 6.1% instead, but that is not really correct. All the news articles seem to be focusing on the S&P Case-Shiller Composite 20 Index which consists of 20 large metropolitan areas. That index dropped 6.1% between October 2006 and October 2007. However in that same report S&P publishes the Case-Shiller Composite Index which includes all real estate in the country. That index dropped 6.7% between October 2006 and October 2007. And what nobody is talking about is that November was much much worse than October, so 6.7% is probably an understatement.

Some of the largest drops:
Miami -12.4%
Tampa -11.8%
Detroit -11.2%
San Diego -11.1%
Las Vegas -10.7%
Phoenix -10.6%
Los Angeles -8.8%
Washington -7.0%
San Francisco -6.2%

My own Atlanta area dropped only 0.7%. Charlotte, Portland and Seattle actually posted gains.

A picture's worth a thousand words, so here's a graph for ya...

History Repeats Itself

Excessive and inappropriate reliance on mathematical models has led to...

1) October 1987 - crash caused by portfolio "insurance"

2) September 1998 - LTCM Collapse

3) October-December 2007 - Subprime CDO collapse

For guys that are supposed to be so smart, the quants sure do make the same stupid mistakes time and time again, don't they?

Merry Christmas

Merrill Lynch will sell up to $5 billion in shares to Singapore's Temasek Holdings, $4.4 billion immediately, with an option to buy another $600 million later. If Temasek exercises its option, it will be right at the 9.9% foreign ownership limit. Merrill Lynch is selling another $1.2 billion in shares to asset manager Davis Selected Advisers. Both investors bought their stakes at $48 a share, or more than 13% below where the stock closed on Friday. News of the discount, not to mention the 13% dilution to existing shareholders due to this investment, pushed Merrill shares 3% lower. The announcement of these deals is likely a prelude to another large write-down for Merrill Lynch in the fourth quarter, with some analysts estimating the hit will be bigger than the $8.4 billion write-down Merrill recorded in the third quarter. (Sources: Yahoo, The Australian)

In related news, Merrill Lynch Capital, the middle-market commercial finance business of Merrill Lynch, is being sold to GE Capital. Terms of the deal with the GE unit weren't disclosed, but Merrill Lynch said the deal will enable it to redeploy about $1.3 billion into other parts of its business.

http://www.cnn.com/2007/BUSINESS/10/24/merrill.mortgages/index.html

Chrysler "operationally bankrupt"

Chrysler, the troubled automaker bought by private equity just four months ago, is scrambling to sell assets amid indications of huge losses, as access to cash becomes increasingly scarce. "Someone asked me, 'Are we bankrupt?'" the WSJ quoted Chrysler boss Robert Nardelli telling employees at a meeting earlier this month. "Technically, no. Operationally, yes. The only thing that keeps us from going into bankruptcy is the $10 billion investors entrusted us with." To raise money, Chrysler is looking to sell over $1 billion in land, old factories, and other holdings, even if it has to let those properties go for under book value, the Journal said.

More Write-downs

French bank Credit Agricole said it's increasing its write-downs on super-senior CDOs and because of the situation at ACA Financial Guaranty, resulting in a 1.6 billion euro ($2.3 billion) hit to 2007 results.

Bear Stearns posted its first-ever quarterly loss as the company's mortgage-related write-down grew to $1.9 billion after credit markets worsened last month. They reported a fourth-quarter loss of $854 million, or $6.90 a share. Consensus was they would come in at a loss of $1.80 a share. D'OH!

Morgan Stanley write-down

Morgan Stanley said Wednesday it's writing down an additional $5.7 billion of mortgage-related assets, taking the total fourth-quarter loss to nearly $10 billion in the latest sign that the credit crunch is worsening.

Morgan Stanley lost $5.8 billion or $3.61 a share. Analysts polled by Thomson Financial had forecast a loss of 39 cents a share.

D'OH!

To Roth or Not To Roth, that is the question

MarketWatch has a debate going on this all-important question.

Roth IRA is the surest route to retirement-savings success

Investors will watch their dollars grow faster in a deductible account

Slipping into the swamp of moral hazard

My very own government is treating me as a sucker ... As some of my friends and neighbors seemed to prosper without end in reward for their doubling-down of high personal leverage and asset concentration, I began to wonder how to explain to my children why their dad was such a, well, loser. I kept telling myself that the once-a-generation correction (the same one that stung my grandparents in the 1930s, and my parents in the 1970s) would eventually validate my own choices as a reasonable personal strategy. Now I wonder. The net effect of these bailout activities is to reward the people who took wild risk and ignored generations of wisdom about debt and gambling. It leaves me trying to explain why I chose a higher-rate fixed mortgage and a modest house and modest consumer debt, with a higher proportion of my investment in low yield supposedly "safe" mutual funds.

Citi appoints new CEO and new chairman

Former hedge-fund manager Vikram Pandit was named CEO of Citigroup. Pandit replaces Bischoff, who has filled the top post on an interim basis since former CEO Charles Prince was forced out.

Citigroup also named Win Bischoff chairman, replacing Robert Rubin, who will return to his previous duties as a director and chairman of the executive committee of the board.

Potkettleblack much?

J.P. Morgan Chase and Bank of America were downgraded to hold from buy, and Wachovia was cut to sell from hold at Merrill Lynch. J.P. Morgan is one of the largest U.S. consumer lenders and will be hard-pressed to avoid a consumer recession, Bank of America will be hurt by higher-than-expected credit losses and Wachovia will see a significant rise in net credit losses.

Stocks fall over 2%

Stocks fell off a cliff today afer the Fed cut shaved both its Fed funds target and discount rates by 25 basis points. What the heck were markets expecting?

DJIA Index down 2.14%, S&P 500 Index down 2.53%, Nasdaq Composite Index down 2.45%

Financial stocks were particularly hard hit: American Express down 5.24%, JP Morgan Chase down 3.12%, and Citigroup down 4.43%, Washington Mutual down 12.37%, H&R Block down 3.26%.

WaMu Troubles

WaMu is trading at 18.44, down 1.44 or 7.2%.

WaMu said it will stop lending through its subprime channel, close roughly 190 of its 336 home-loan centers and sales offices, shut down nine home-loan processing and call centers, and cut about 2,600 home loan positions and 550 corporate and support employees.

It will also cut its quarterly dividend to 15 cents a share from 56 cents.

"We believe the fundamental news at Washington Mutual is significantly worse than the company and we had previously expected," Bear Stearns said.

"The company is probably now a candidate for takeover but the number of potential buyers is very limited with J.P. Morgan Chase being the only realistic name at the moment," Punk Ziegel analyst Dick Bove said.

UBS Writing Down $10B

UBS will write down the value of its subprime mortgage holdings by a further $10 billion, leading to a loss in the fourth quarter and potentially wiping out all its profits for the year.

CompUSA shutting down operations

CompUSA will close its store operations (all 103 stores) after the holidays following sale of the company to Gordon Brothers Group LLC, a restructuring firm. CompUSA stores plan to run store-closing sales during the holidays. Privately held CompUSA, controlled by Mexican financier Carlos Slim Helu, said discussions were under way to sell certain stores in key markets. Stores that can't be sold will be closed. Gordon Brothers will also try to sell the company's technical services business, CompUSA TechPro, and online business. It would be up to the buyers whether to continue the CompUSA name.

"The Mother of all Bad Ideas" by Patrick Schiffer

Without question, the Bush administration’s mortgage rescue plan will exacerbate, not alleviate, the problems in the housing market. As the plan will sharply reduce the ability of new buyers to make purchases, it really amounts to a stay of execution and not a pardon.

Although there are mountains of uncertainty as to how the plan will be structured and implemented, there is no question that as lenders factor in the added risk of having their contracts re-written or of being held liable for defaulting borrowers, lending standards for new loans will become increasingly severe (higher down payments, mortgage rates, and required Fico scores, lower loan to income ratios, and perhaps the death of adjustable rate loans altogether). The result will be additional downward pressure on home prices, despite the fact that in the short term fewer homes will be sold in foreclosure than what might have been without the rescue plan.

Most homes temporarily saved from foreclosure will continue to depreciate as new buyers fail to qualify for loans. As a result, lenders will be on the hook for more losses than had the foreclosures taken place sooner. Of course, as these chickens will likely come home to roost after the next election, that’s a trade-off incumbent politicians will happily make.

Compounding the problem is that subprime borrowers with frozen payments on loans that exceed the values of their homes will likely choose not to pay property taxes, condo or homeowners fees, or maintain the condition of their properties. Were these properties to be sold in foreclosure now, at least their new owners would have financial incentives to maintain the value of their investments. Upside-down subprime borrowers will have no incentive to throw money down a rat hole: why make additional payments on properties in which they have no equity and which they will likely lose to foreclosure anyway? When these homes do go into foreclosure, back taxes and other fees on dilapidated properties will inflict even greater losses on lenders.

Also, subprime borrowers with frozen resets will be unable to either borrow additional money against their homes or sell them. As rising credit card payments, higher food and energy bills, and stagnating wage growth or unemployment make even paying the frozen rates increasingly more difficult, this lack of flexibility will prove fatal. Also, the moral hazard inherent in offering help to only those who can demonstrate an inability to afford the reset rates, or restricting the bailout to borrowers with low credit scores, guarantees that borrowers will alter their circumstances to qualify for the aid. Therefore more loans will be frozen than are currently forecast, and the financial circumstances of the borrowers will be that much more impaired as they endeavor to pile on added debt or reduce their incomes to conform to the requirements of the bailout.

Lost in current discussion is the fact that few subprime borrowers have any skin in the game in the first place. Having put nothing down or having extracted equity in previous refinances, most subprime borrowers will lose nothing if their homes go into foreclosure. In some cases the teaser rates were so low that borrowers actually paid less than what they might otherwise have paid in rent. In fact, those who have already extracted equity have received huge windfalls from their homes and will leave their lenders holding the bag.

Also missing from the dialogue is the fact that those individuals and companies that sold these homes to subprime borrowers in the first place pocketed large sums of money they never would have received if these exotic loans were not available. Is anyone going to ask them to give some of that money back in order to compensate the lenders for their losses?

Finally, it’s the camel’s nose under the tent that is the most troubling. Delinquencies on auto loans are now at record highs, and with no home equity left to extract and a weakening economy, this problem can only get worse. What is next, a moratorium on car payments? Of course if the government can “require” private parties to rewrite contracts, what about the government’s obligations to re-pay its debts? After all, the Federal government is the biggest subprime borrower of all and it has committed the American taxpayer to the mother of all adjustable rate mortgages. With the majority of our near 10 trillion dollar national debt financed with short-term paper, what happens when interest rates rise? Will the government extend the maturities of one-year treasury bills, tuning them into 10-year treasury bonds, forcing holders of government debt to accept below market returns for extended time periods? These are real risks that will not go unnoticed by a world already saturated with depreciating U.S. dollar denominated debt.

Ostensibly, this plan is being offered in an attempt to stem the tide of foreclosures that might otherwise cause further weakness in home prices. The reality of course is that current home prices are still too high, having been a function of the lax lending standards and rampant real estate speculation that got us into this mess in the first place. A return to prudence in lending also means a return to prudence in pricing. Everyone seems to agree that a return to traditional lending standards is a good idea, but no one seems willing to accept a return to rational prices as a consequence. The government’s attempt to orchestrate such an outcome is doomed to failure, as it is impossible to maintain bubble prices after the bubble has burst!

The final absurdity is the Government’s attempt to portray their plan as voluntary. Of course the authorities point out that if their “suggestions” are not adopted by lenders, much more draconian legislation will surely follow. Let freedom ring.

RAGE!!!!

The Bush administration and major financial institutions are close to agreeing on a plan that would temporarily freeze interest rates on certain troubled subprime home loans, according to people familiar with the negotiations. An accord could reassure investors and strapped homeowners, both of whom are anxious as interest rates on more than two million adjustable mortgages are scheduled to jump over the next two years.

Exactly which borrowers will qualify for the freeze and how long the freeze would last are yet to be determined. Under one scenario, the freeze could run as long as seven years.

Borrowers whose loans are resetting are likely to have a tougher time sidestepping the rising payments by refinancing or selling their homes. Lending standards have tightened and many borrowers can't qualify for refinancing. And falling home prices mean that many borrowers have little or no equity in their homes. Some owe more than their homes are worth.

Well, boo f'ing hoo! Things like this make me so outraged I can hardly see straight. These people (and I mean both the borrowers and the lenders) took huge risks because they thought they were going to make outrageous profits; their idiotic bets didn't pay off. And now those of us who did NOT take those risks (and did not earn any profit) are forced to subsidize the risky decisions and prevent losses to those who took the risks? What the bloody hell?! There are not enough bad words in the English language to describe my outrage! ¡Me cago en todos ellos!

Bad Day on Wall Street

The weekend retail numbers were good, so the market started off OK (an exception was Circuit City, down 8.0%). But then came multiple banking whammies, and the Dow Jones Industrial Average slid 237 points to 12743, as 28 of its 30 components retreated.

Citigroup fell 3.15% amid news of massive layoffs. The official number is not known, but analysts said it could be as many as 45,000. I don't understand that. Citi may have lost money in sub-prime, but doesn't the work of those 45,000 people still need to get done? If not, then why weren't they laid off BEFORE the sub-prime losses? The absurdity of big business! In after hours trading, Citi dropped an additional $1.

JP Morgan Chase fell 3.55% on no particular news.

UBS downgraded both Fannie Mae (down 10.19%) and Freddie Mac (down 7.44%).

And the current news from Asia is likewise bad...

Japan is down 2.1% (both Topix and Nikkei indices). Hong Kong's H-share index is down 3.4%. Seoul's Kospi index was down 2.7%.

Tomorrow is going to be a bad day on Wall Street.

Barclays Write-down

Barclays Plc, Britain's third-biggest bank, unveiled a 1.3 billion pound ($2.7 billion) writedown for losses on securities linked to the U.S. subprime housing crisis.

In related news...

Capital One Financial said it expects to take a writedown of about $5 billion. Washington Mutual said it will take $2.7 billion to $2.9 billion in writedowns because of falling home values (and at least one analyst at Lehman Brothers expects that amount actually to be closer to $3.8 billion).

Bank of America Write-Down

Bank of America said it expects to write down $3 billion of debt in the fourth quarter as fallout from the nation's housing slump deepens.

Money Market Issues

Bank of America, stung by the fallout in subprime mortgages, acted to safeguard its money market mutual funds. The bank planned to set aside $600 million to cover potential losses in its money market funds and an institutional cash management fund. The action is the largest recent step by a financial institution to ensure that its money funds aren't forced to reduce the value of their shares below $1.

The crisis in subprime mortgages has jolted the market for the short-term securities in which money funds invest. Bank of America's move is a sign of how the crisis has gone beyond complex institutional portfolios to potentially affect everyday savers. The bank said $300 million will be used by a group of its money funds that are offered to individuals. The other $300 million will support an institutional cash fund, which isn't technically a money fund. The money would help keep the funds' share price at $1 if some of their holdings defaulted.

Several other financial institutions have also bolstered their money funds:
• SEI, an institutional money manager, has set aside $129 million to support two of its money funds.
• Legg Mason has set up a $238 million line of credit for two money funds. It also invested $100 million to buoy an offshore money fund.
• SunTrust Bank has received SEC permission to set up credit lines for two money funds.

What's tripped up many funds are investments in Structured Investment Vehicles. SIVs use short-term loans to buy longer-term assets, such as mortgage-backed securities, that pay higher rates. The SIVs with the worst problems were often invested in subprime mortgages. As a result, some SIVs have stuck money funds with losses.

Money funds fear that if any fund "broke the buck," falling below $1 a share, investors would flee. That's why they're moving fast to try to avoid defaults.

The USA Today article does not mention (online, the print version does) that the only time in history when a money fund has broken the buck was Community Bankers U.S. Government Fund, a small institutional fund run by Community Bankers Mutual Fund in Denver, which liquidated in 1994 because of losses on interest-rate derivatives. The fund, which had more than 27% of its assets in the derivatives, paid investors 96 cents on the dollar.

The reason the fund lost money despite US Government in its name explains the problems that it (and a lot of other funds in that period) got into trouble in the first place. While US Treasuries are of course guaranteed by the US government with regards to both principal and interest, derivatives based on them such as Interest-Only bonds (IOs) or Principal-Only bonds (POs) can rise or drop in price because of movements in interest rates. That caused losses at many money funds although only Community Bankers actually broke the buck. Money funds had no business investing in IOs and POs in the first place.

CA and FL lead in foreclosures

More homeowners across the United States are having trouble making mortgage payments on time, but borrowers in metro areas of California, Florida and other once-booming housing markets are accounting for the biggest spikes in foreclosure filings.

Bear Stearns Woes

Bear Stearns will take a $1.2 billion write-down in the fourth quarter related to weakness in its credit portfolios, CFO Samuel Molinaro said today, adding that the worst of its mortgage write-downs are behind it. Molinaro said the $1.2 billion write-down will lead the company to post a loss during its fiscal fourth quarter, which ends Nov. 30.

Blackstone Quarterly Loss

Blackstone Group reported a $113.2 million third-quarter loss on charges related to its initial public offering and lower real estate fees, sending shares down more than 8%. It was Blackstone's first full quarter operating as a public company. Blackstone's stock is down about 39% since the firm went public. Shares closed yesterday at $22.26, down $2.02.

Citigroup Woes

Citigroup announced significant declines since September 30, 2007, in the fair value of the approximately $55 billion in US sub-prime related direct exposures in its Securities and Banking business. Citi estimates that, at the present time, the reduction in revenues attributable to these declines ranges from approximately $8 billion to $11 billion (representing a decline of approximately $5 billion to $7 billion in net income on an after-tax basis).

(ETA: Note that this writedown is in addition to the $6.5 billion writedown already taken for the third quarter.)

And another CEO goes down...

Citigroup says its chairman and CEO, Charles Prince, has retired and is being replaced as chairman by former Treasury Secretary Robert Rubin. Citigroup also said Sir Win Bischoff, chairman of Citi Europe and a Member of the Citi management and operating committees, would serve as interim CEO.

And one last (mostly symbolic) piece of news...

Bank of America is now the largest bank in the country by market capitalization, and it may stay that way for a while. After weeks of flip-flopping with Citigroup for market-cap supremacy - with the financial rivals no more than $3 billion apart at various points - Bank of America surged ahead on the heels of Citigroup's implosion. Bank of America's total market value was $197B while Citigroup was at $179B.

Bring on the lawyers!

Three different shareholder lawsuits...

Law Offices of Brian Felgoise Announces Class Action Lawsuit Against Merrill Lynch

Abraham Fruchter & Twersky LLP Files Class Action Lawsuit Against Merrill Lynch

Coughlin Stoia Geller Rudman & Robbins LLP Files Class Action Suit against Merrill Lynch

And just for good measure an ERISA lawsuit against the 401(k) plan...

Keller Rohrback L.L.P. Announces ERISA Investigation of the Merrill Lynch 401(k) Savings and Investment Plan

Citigroup CEO on way out

Citigroup's board plans an emergency meeting tomorrow, and CEO Charles Prince is expected to offer to resign, according to the Wall Street Journal, which cited people familiar with the situation.

People familiar with the matter said the Securities and Exchange Commission is looking into the bank's accounting for its off-balance sheet investment funds that have recently attracted scrutiny. Citigroup may report further losses on Monday, reflecting continued declines in the value of some mortgage-linked securities since the third quarter ended Sept. 30, people familiar with the matter said.

O'Neal out

Stan O'Neal, chairman and CEO of Merrill Lynch, has decided to retire from the company effective immediately.

The board of directors has elected Alberto Cribiore as interim non-executive chairman. Ahmass Fakahany and Gregory Fleming will continue as Merrill Lynch co-presidents and chief operating officers.

Countrywide

Countrywide Financial Corp., the nation's largest mortgage lender, said Tuesday it will begin calling borrowers to offer refinancing or modifications on $16 billion in loans whose interest rate is set to adjust by the end of 2008.

There's two aspects of the story on which I'd like to comment...

Countrywide said it would refinance about $10 billion in loans and modify another $4 billion. It also plans to contact borrowers of some $2.2 billion who are late on their loans and having trouble paying because of a recent rate reset. In total Countrywide's plan would reach out to about 82,000 borrowers for some kind of relief. [...] The company estimates some 10,000 borrowers with subprime loans who are now behind on their payments due to their mortgage interest rate resetting will be offered rate reductions by the end of the year.

So if you did the right thing and did NOT overextend by taking on more mortgage than you could afford, Countrywide only has one thing to say to you: SUCKER!

So far this year, Countrywide has completed about 20,000 loan modifications -- a figure that represents less than 5% of the more than 500,000 loans the lender reports were behind in payments as of last month and about 24% of the roughly 82,000 loans the company said were in foreclosure as of September.

There's over 80,000 loans in foreclosure and another420,000 behind? That doesn't mean anything good for Countrywide.

Bank of America moves to cut jobs

Bank of America is acting swiftly in the wake of its disappointing earnings, announcing cuts in its work force that run deeper than investors had foreseen. The bank said late Wednesday that it planned to cut 3,000 jobs, mostly in investment banking, after incurring about $4 billion of trading losses, defaults and write-downs in the third quarter. Brian Moynihan, head of wealth management, will replace Gene Taylor as head of the 20,000-person securities unit, the bank added.

The chief executive, Kenneth Lewis, said he would scale back in investment banking after profit at the division plunged 93% to $100 million. Lewis, who blamed the drop mainly on the company's mistakes, promised to weed out units that posted four or five annual profits "and then give it all back in one year."

"While some of these changes are a direct result of our underperformance, others have been contemplated for a number of months as we looked at how we could operate more effectively," Lewis said. Lewis, 60, was reversing a strategy outlined by Taylor at an investor conference in February, when he said Bank of America would lift corporate and investment banking profit by 70% and revenue by 50% over the next five years. The goal was to gain a top-three share of investment banking in the United States within five years. In the third quarter, Bank of America marked down the value of financing for leveraged buyouts and other lending by $247 million, and trading mistakes led to $717 million in losses. Lewis signaled the job reductions were coming last week during his earnings conference call with analysts when he said the results were "not acceptable."

"I've had all the fun I can stand in investment banking," Lewis said October 18. The next day, Chris Hentemann left as head of global structured products, which had reported a net revenue loss of $527 million.

Merrill (and its CEO) in trouble

Merrill Lynch chairman and chief executive, E. Stanley O’Neal, broached the possibility of a merger with Wachovia without first getting the approval of Merrill’s board, a major breach of corporate protocol.

Bank of America Exits Wholesale Mortgage Business

Today Bank of America announced that it will exit the wholesale mortgage business in order to devote increased energy to its expanding retail channels.

Merrill Lynch Loss Wider Than Expected

From Yahoo...

Merrill Lynch said it was taking a sharper-than-expected writeoff of 7.9 billion dollars for losses in its mortgage activities in the third quarter. Merrill Lynch said the charge was "significantly greater" than the 4.5 billion dollars forecast earlier this month. The investment bank reported a third-quarter net loss from continuing operations of 2.24 billion dollars compared with a net profit of 2.14 billion dollars a year ago. The loss amounts to 2.85 dollars a share, far wide that that the Wall Street consensus forecast for a loss per share of 45 cents.

From TheStreet...

Merrill Lynch stunned Wall Street for the second time this month with the disclosure that it was forced into a $7.9 billion writedown of bad debt tied to risky mortgages and structured paper. The announcement comes three weeks after Merrill surprised investors by estimating that its third quarter would swing to a loss under the weight of $4.5 billion in writedowns on certain securities. Merrill said the writedown increased after the firm took a second look at its valuation of collateralized debt obligations and subprime mortgage backed securities.

Merrill's third-quarter report has to rank among the worst in modern Wall Street history. The firm swung to a loss of $2.24 billion, or $2.85 a share, from continuing operations from a year-ago profit of $3.05 billion, or $3.14 a share. The firm took a $5.9 billion loss on its in-house trading operation. said $6.9 billion of the third-quarter writedown was related to its CDO positions and $1 billion to its subprime holdings. The firm said its net exposure to those securities dropped from second-quarter levels, but it continues to have $15 billion worth of CDO exposure and nearly $6 billion worth of subprime exposure.

What I (and I'm sure others) want to know is how could the loss be SIX TIMES as large as expected just three weeks ago. What kind of risk management do the guys at Merrill Lynch have in place?

[Obsolete] Bear - Citic Swap

Bear Stearns and Citic Securities [a Chinese firm, not to be confused with Citi] will each invest about $1 billion in each other. In return for its investment in Bear Stearns, Citic will receive securities that can be converted into about 6% of Bear Stearns's outstanding shares. As part of the deal, Citic has the right to buy an additional 3.9% of the brokerage's outstanding shares [for that magic 9.9% share]. In return for its investment in Citic, Bear Stearns will receive a 2% stake in the firm. It has the option to buy an additional 5%.

Edited (3/17/2008): Citic Securities has canceled this investment deal with Bear Stearns. "The situation has changed," said Citic Chairman Dan Kong, after Bear's buy-out yesterday by JPMorgan Chase.

Bank of America Earnings Drop 32%

Bank of America reported that third-quarter earnings plummeted 32% because of problems in mortgage and credit markets.

More Recalls

US retail giant Target has become the latest company to recall Chinese-made toys because of safety fears.

Another Chinese product in the United States is under scrutiny. Federal officials ordered a recall of 450,000 Chinese-made tires.

Imagine that. Offshoring production to China (or elsewhere) only results in savings if those other countries cut corners on the safety regulations that are required here in the US. Who could have imagined such a thing? It's not like Economics 101 would suggest that such a thing was likely.

Investment Bank Results

Goldman Sachs earned $2.85 billion, or $6.13 a share, in the three months ended Aug. 31, compared to $1.59 billion, or $3.26 a share, in the third quarter a year ago. Net revenue rose 63% to $12.33 billion from $7.58 billion a year ago.

Bear Stearns reported net income of $171.3 million, or $1.16 a share, for the quarter ended Aug. 31, down from $437.6 million, or $3.02 a share, earned in the same period a year earlier. Net revenue declined 37% to $1.33 billion. Lehman Brothers and Morgan Stanley also reported a profit decline.

In trading (as of 2:40pm today), Lehman Brothers (LEH) is down around 3% and Morgan Stanley (MS) is down around 5%. Goldman Sachs and Bear Stearns are essentially flat. Bear Stearns' troubles had already been priced into its stock since its disastrous bailout of two hedge funds, but I am very surprised that GS has not spiked on the earnings surprise.

Top Ten International Accounting Firms

Ranked by 2007 fiscal year revenue...

PricewaterhouseCoopers International, $25.2B
Deloitte Touche Tohmatsu, $23.1B
Ernst & Young Global, $21.1B
KPMG International, $19.8B
BDO International, $4.7B
Grant Thornton International, $3.5B
RSM International, $3.1B
Praxity, $2.8B
Baker Tilly International, $2.5B
Horwath International, $2.5B

[Updated with 2007 numbers]

Top Ten US Accounting Firms

Ranked by fiscal year 2007 revenue...
1 Deloitte & Touche $9,856,000,000
2 PricewaterhouseCoopers $6,922,000,000
3 Ernst & Young $6,890,000,000
4 KPMG $4,438,000,000
5 RSM McGladrey $1,389,260,000
6 Grant Thornton $939,551,000
7 BDO Seidman $589,000,000
8 CBIZ & Mayer $466,810,000
9 Crowe Group $430,276,000
10 BKD $318,078,000

http://www.wolterskluwer.com/WK/Press/Product+Press+Releases/2007/Sep/pr_19Sep07b.htm

CIT Shuttering Home Lending

CIT Group said it will take a $35 million pre-tax charge in its third quarter associated with its previously announced plans to shutter its home lending business. Its loan collection and customer service activities are unaffected by the announcement.

Men Earn Less Than Fathers at Same Age

In 2004 the median income for a man in his 30s was $35,000. Adjusted for inflation, that's 12% less than what men the same age were making in 1974.

It's time for central banks to stop bailing out markets

The global credit bubble is bursting. This bubble is primarily leverage financing for owning risky assets. The people who were responsible for what happened played with other people's money, marketed arcane financial products with false promises of fat profits, but stuffed their own pockets with big bonuses. Neither these masters of the universe nor their greedy but naïve investors deserve to be bailed out. They deserve what is coming to them. The central banks bear equal responsibility in the current debacle. After 9/11, central banks cut interest rates dramatically and provided the cheap money for this leverage bubble. They must not flood the world with liquidity again to sustain this bubble or create another.

Ameriquest Closing Its Doors

The last assets of its parent ACC were sold to Citi today. This is largely a formality, since the company had ceased origination at the end of last year.

Lousy business model (lending to subprime borrowers) but great Super Bowl commercials.

Earthlink Lays Off Half Its Workforce

EarthLink, one of the few survivors of Atlanta's tech wave of the 1990s, said it will slash its work force nearly in half in an effort to stabilize its business after a string of losses. The company will focus on providing Internet access while cutting 900 jobs -- 562 of them in Atlanta. EarthLink last quarter reported a $16.3 million loss, following losses of $30 million, $24.8 million and $3.2 million in the previous quarters. Perhaps more ominous, revenues stagnated. EarthLink reported revenues of $312 million in the most recent quarter -- a third consecutive quarter of decreasing sales.

The company will close its Orlando FL, Knoxville TN, Harrisburg PA and San Francisco CA offices and substantially reduce its presence in Pasadena CA and Atlanta GA.

Krispy Kreme posts loss

KKD posted a net loss of $27M for the quarter ending 7/29/2007. That comes on the heels of loss of $7.4M and $24.4 in the prior two quarters.

Countrywide

Some interesting discussion on the MarketBeat blog (emphasis mine).

Investors jumped for joy on news of Countrywide Financial’s $2 billion gift, er, investment from Bank of America, which got a nice deal by investing in convertible preferred shares, and gets the platitudes for putting down money to help assuage those worried about the going health of one of the nation’s biggest mortgage lenders. Bank of America gets a $2 billion stake that pays them 7.25% annually in interest, and converts to shares at $18 each.

Rob Cox of Breakingviews.com notes: “If Countrywide’s recent woes are primarily liquidity driven — that is, they are simply a consequence of the bank’s inability to fund itself – then BofA boss Ken Lewis’ investment will prove masterful.” But Doug Kass of Seabreeze Partners Management, who is shorting Countrywide, notes that “the discounted strike price of its non-voting preferred security speaks volumes about Bank of America’s financial and operating concerns facing Countrywide Financial.” After all, the housing shakeout isn’t over, and Countrywide holds nearly $30 billion of option ARM mortgages, where defaults are rising, according to Breakingviews.

John Succo, in Minyanville, agrees, saying the terms of the deal were “struck at egregious terms for CFC,” and it will dilute earnings. It’s hard to know whether to take comfort from CEO Angelo Mozilo’s interview on CNBC, either — within the span of a few minutes he’s blamed the current problems on the Federal Reserve, frightened investors, and worried sell-side analysts (Merrill Lynch in particular). “The problem at Countrywide Financial is that it originated crappy loans — thats how it got into the problem in the first place,” Mr. Kass writes in an email.

Note that Countrywide common shares have fallen 38% in one month, from $34 to $21.

Capital One to close mortgage unit

Capital One Financial said Monday it will cut 1,900 jobs and shutter its wholesale mortgage banking business, a move that comes as lenders continue to struggle in the nation's housing and mortgage markets. Capital One said it will shut down GreenPoint Mortgage and eliminate most of the jobs by the end of year. The company will close 31 GreenPoint locations in 19 states and "cease residential mortgage origination" effective immediately.

HomeBanc Files for Chapter 11 Bankruptcy

HomeBanc today announced that, after careful consideration, its Board of Directors has authorized the Company's management team to seek protection for the Company through the bankruptcy process in order to best preserve the value of the Company's remaining assets. Accordingly, HomeBanc Corp., together with certain of its subsidiaries, has today filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware. HomeBanc believes that, under the protection of Chapter 11, it will have the time and opportunity that it needs to achieve the best possible value for the creditors and other constituencies of its assets and operations, and to effect an orderly wind down of the Company.

Blackstone Down To $24.90

It is now down an amazing 29% from its IPO price.

Wells Fargo Jumbo Rate Jumps to 8%

Wells Fargo, one of the nation's biggest mortgage lenders, raised the interest rates on it 30-year, fixed-rate, non-conforming (AKA jumbo) loan to 8 percent last week, up from 6.875 percent. Other lenders are likely to join Wells Fargo.

The reason is apparently the collapse of the secondary mortgage market.

HomeBanc exiting the mortgage business

HomeBanc today announced that it intends to exit the mortgage loan origination business. The Company at present is unable to borrow on its credit facilities and was unable to fund its mortgage loan funding obligations. Accordingly, the Company does not anticipate funding any future mortgage loans and is no longer accepting any mortgage loan applications or funding any mortgage loans previously originated and not yet funded. The Company is seeking the most appropriate course of action to preserve the value of its remaining assets. Kevin Race, HomeBanc's President and CEO, stated, "In light of the extraordinary difficulties that HomeBanc continues to face in the mortgage loan origination market, we feel that it is in the best interests of the Company to exit this business so that we can focus on preserving the value of our investment portfolio assets and loan servicing operations."

HomeBanc also announced that it has reached agreement with Countrywide Financial Corporation whereby Countrywide will acquire certain assets related to HomeBanc's retail loan origination operations, including up to five branches located in Georgia, Florida and North Carolina, and will assume the leases related to those branches. In addition, Countrywide expects to make offers of employment to substantially all of HomeBanc's retail loan originators. Countrywide will pay no cash premium in this transaction and will not acquire any other assets or assume any other liabilities related to HomeBanc. This transaction, which is subject to certain conditions, is expected to close by Friday.

There's that phrase again.

Also, I found this really good website which tracks the mortgage lenders that have imploded recently (112 in the last 15 months). I see tough times ahead for the real estate market.

Bear Stearns President/co-COO Resigns

Bear Stearns President and co-COO Warren Spector resigned, becoming a casualty of a credit risk crisis at the investment bank.

American Home Mortgage Closing

American Home Mortgage Investment Corporation will shutter most of its operations and lay off more than 6250 workers. "Unfortunately, the market conditions in both the secondary mortgage market as well as the national real estate market have deteriorated to the point that we have no realistic alternative," chief executive Michael Strauss said in a statement. The company will maintain 750 employees in its thrift and servicing businesses "as it seeks the most appropriate course of resolution to preserve the value of its remaining assets."

Chrysler Taken Private

Private equity firm Cerberus Capital Management took control of Chrysler Group on Friday in a $7.4 billion deal designed to set the beleaguered 82-year-old automaker on a path to recovery as a private company. Daimler AG will retain a 19.9% interest in the company.

Daimler paid $33 billion for Chrysler in 1998. Now the company is apparently worth $9.2 billion. That's almost $24 billion gone with the wind. In other terms it's a compounded 13% loss every year for nine years, without even counting the losses that Chrysler accumulated over those 9 years. What a bonehead move.

Tyco Spins Off Two Units

On Friday Tyco International spun-off to its shareholders two of its five units -- Tyco Healthcare (which has been renamed Covidien) and Tyco Electronics.

About 500 million Tyco Electronics shares and 500 million Covidien shares will be distributed to Tyco International shareholders. Immediately following the distributions, Tyco International's shareholders will own 100% of the common shares of Covidien and Tyco Electronics.

Tyco International also said that its board approved a one-for-four reverse split which will become effectively immediately following the completion of the dividend distribution. As a result, Tyco International will have about 500 million shares outstanding after the reverse stock split.

Tyco Electronics and Covidien have applied for listing their shares on the New York Stock Exchange and the Bermuda Stock Exchange under the trading symbols "TEL" and "COV" respectively.

Blackstone Down Another 9.8%

Blackstone closed at $29.27 today, down another 9.8% from its $32.44 closing price a week ago. It's dropping even faster than I thought.

Beazer Homes cans chief accounting officer for ethics violations

Beazer Homes, already under a Securities and Exchange Commission informal investigation, has fired Chief Accounting Officer Michael Rand "due to violations of the company's ethics policy stemming from attempts to destroy documents." The move comes four months after the company fired General Counsel Kenneth Gary "for a pattern of personal conduct which includes violations of company policies." In a filing with the SEC, the Atlanta-based homebuilder said Rand's termination followed a briefing by independent legal counsel retained by the company's audit committee, which is conducting an internal investigation of the company's mortgage origination business and related matters. Beazer said it recently became aware of Rand's actions during that investigation.

You have to think that the news in the housing sector is even worse than we think if accounting officers are destroying documents to hide the facts.

Blackstone Down 7.5%

Shares of Blackstone Group fell in their second day of trading as doubts set in about the valuation of the private equity firm. Blackstone shares were down 7.5% to $32.44 on the NYSE.

It could be that Friday was the high point of the market for the foreseeable future. A lot of smart people are wondering about that when the smart money (i.e., Blackstone) starts selling.

Bear Stearns Bails Out Hedge Fund

Bear Stearns said it would provide up to $3.2 billion in financing for a struggling hedge fund it manages, raising concern about other funds that invested in bonds linked to subprime mortgages. The biggest bailout since Wall Street's 1998 rescue of Long-Term Capital Management signaled that the funds' main investments -- a type of bond known as a collateralized debt obligation (CDO) -- may be riskier than previously reckoned. Bear Stearns, the fifth-largest U.S. investment bank, said it would provide secured financing to its High-Grade Structured Credit Strategies Fund so the fund can sell assets in an orderly fashion. Bear also said a second fund (High-Grade Structured Credit Strategies Enhanced Leverage Fund) that took greater risk is still working out a restructuring plan with creditors. The two funds melted down after rising U.S. subprime mortgage defaults earlier this year depressed prices of CDOs, which were essentially repackaged portfolios of subprime home loans and were among the funds' main investments. Bear Stearns' High-Grade Structured Credit Strategies Fund was down about 5% so far this year through the end of April. The High-Grade Structured Credit Strategies Enhanced Leverage Fund, meanwhile, which borrowed more to magnify potential returns and potential risk, was down 23% over the same period.

Another story that provides more of the numbers and paints a much clearer -- and much bleaker -- picture than above...

Merrill Lynch seized $850 million of bonds held as collateral for loans it had made to the funds. Lehman Brothers, JPMorgan Chase and Cantor Fitzgerald also pulled out, leaving Bear Stearns to sort through the wreckage of bad bets on subprime mortgage bonds and collateralized debt obligations. Without assistance from his Wall Street peers, Bear Stearns was forced to salvage the healthier of the two funds, putting $3.2 billion of the firm's capital at risk in the biggest bailout since LTCM. Bear Stearns may dissolve the second fund after more than $600 million of investors' money dwindled to less than $200 million.

First Lucent, Then Agere, And Now Finally Avaya

Avaya announced that it has entered into a definitive merger agreement with Silver Lake, the leading investment firm focused on large-scale investments in technology-driven growth industries, and TPG Capital, a leading private investment partnership, for approximately $8.2 billion or $17.50 (cash!) per common share.

2006 Fortune 500

Top Fifteen by Revenue

1 Wal-Mart Stores $351.1B
2 Exxon Mobil $347.3B
3 General Motors $207.3B
4 Chevron $200.6B
5 ConocoPhillips $172.5B
6 General Electric $168.3B
7 Ford Motor $160.1B
8 Citigroup $146.8B
9 Bank of America $117.0B
10 AIG $113.2B
11 JP Morgan Chase $100.0B
12 Berkshire Hathaway $98.5B
13 Verizon Communications $93.2B
14 Hewlett-Packard $91.7B
15 IBM $91.4B

Top Fifteen by Profit

1 Exxon Mobil $39.5B
2 UAL $22.9B (due to bankruptcy accounting)
3 Citigroup $21.5B
4 Bank of America $21.1B
5 General Electric $20.8B
6 Pfizer $19.3B
7 Chevron $17.1B
8 ConocoPhillips $15.6B
9 JP Morgan Chase $14.4B
10 AIG $14.0B
11 Microsoft $12.6B
12 Altria Group $12.0B
13 Wal-Mart Stores $11.3B
14 Johnson & Johnson $11.1B
15 Berkshire Hathaway $11.0B

Top Fifteen by Market Cap

1 Exxon Mobil $426B
2 General Electric $368B
3 Microsoft $274B
4 Citigroup $256B
5 AT&T $243B
6 Bank of America $231B
7 Procter & Gamble $201B
8 Wal-Mart Stores $198B
9 Pfizer $182B
10 Altria Group $179B
11 AIG $177B
12 Johnson & Johnson $175B
13 JP Morgan Chase $169B
14 Berkshire Hathaway $167B
15 Chevron $159B

You can slice and dice the data anyway you want at
http://money.cnn.com/magazines/fortune/fortune500/2007/

Housing Index

http://www.speculativebubble.com/videos/real-estate-roller-coaster.php

Structured Products

Just got my hands on Structured Products by Satyajit Das. It consists of two volumes, 2600 pages total. Volume 1 covers applications of derivatives, synthetic assets, exotic options, and interest rate and currency structured products. Volume 2 covers equity linked structures, commodity linked structures, credit derivatives and new markets (e.g., inflation, insurance, weather, etc).

You'd think that such massive tomes, covering such an encyclopedic list of topics, contain a wealth of knowledge. You'd be wrong. The explanations are at such a basic level that they are essentially useless to anybody with even an elementary understanding of structured products. And to top it off, the material is incredibly dated (even though the third "revised" edition was published in 2006). For example, the author dedicates pages to employee stock option plans and how they are not reflected in the financial statements, with references to articles written in the 1990s. He appears completely unaware that IASB and FASB both now require employee stock options to be accounted for in company's financial statements.

A total waste of money.

WHD Problem 5.9

Calculate the theta, gamma, vega and rho for European call and put options.

Note: I have assumed a non-dividend stock.

Θ = ∂Π/∂t

Θ_c = - ½S₀N'(d₁)σ/√T - rKe^-rTN(d₂)

Θ_p = - ½S₀N'(d₁)σ/√T + rKe^-rTN(-d₂)

Γ = ∂₂Π/∂S₂

Γ_c = Γ_p = N'(d₁)/S₀σ√T

v = ∂Π/∂σ

v_c = v_p = S₀N'(d₁)√T

ρ = ∂Π/∂r

ρ_c = KTN(d₂)e^-rT

ρ_p = -KTN(-d₂)e^-rT

Transforming the Black-Scholes equation into the Heat equation

(∂V/∂t) + ½ σ² S² (∂²V/∂S²) + r S (∂V/∂S) - rV = 0

First substitution: u = V e^-rt

V = u e^rt

(∂u/∂t) = (∂V/∂t) e^-rt - V r e^-rt

(∂u/∂t) + V r e^-rt = (∂V/∂t) e^-rt

(∂V/∂t) = e^rt (∂u/∂t) + V r = e^rt (∂u/∂t) + r u e^rt

(∂u/∂S) = e^-rt (∂V/∂S)

(∂V/∂S) = e^rt (∂u/∂S)

(∂²V/∂S²) = e^rt (∂²u/∂S²)

And the equation changes to...

e^rt (∂u/∂t) + r u e^rt + ½ σ² S² e^rt (∂²u/∂S²) + r S e^rt (∂u/∂S) - r e^rt u = 0

(∂u/∂t) + ½ σ² S² (∂²u/∂S²) + r S (∂u/∂S) = 0

Second substitution: S = e^x

x = ln S

(∂S/∂x) = e^x
(∂x/∂S) = 1 / S

(∂u/∂x) = (∂u/∂S) (∂S/∂x) = (∂u/∂S) e^x = S (∂u/∂S)

S² (∂²u/∂S²) = S² ∂/∂S (∂u/∂S)

= S² (∂x/∂S) ∂/∂x (∂u/∂S)

= S² (1/S) ∂/∂x (1/S ∂u/∂x)

= S [ 1/S ∂²u/∂x² + ∂u/∂x ∂/∂x (1/S) ]

= ∂²u/∂x² + S (∂u/∂x) (-1/S² ∂S/∂x)

= ∂²u/∂x² - (1/S) e^x (∂u/∂x)

= ∂²u/∂x² - ∂u/∂x

And the equation changes to...

(∂u/∂t) + ½ σ² (∂²u/∂x² - ∂u/∂x) + r (∂u/∂x) = 0

(∂u/∂t) + ½ σ² ∂²u/∂x² + (r - ½σ²) ∂u/∂x = 0

Third substitution: z = x - (r - ½σ²)t to cancel the first derivative term, and t' = - t to conform to the usual sign convention.

(∂u/∂t) = (∂u/∂z)(∂z/∂t) + (∂u/∂t')(∂t'/∂t) = (∂u/∂z)[-(r - ½σ²)] + (∂u/∂t')(-1)

∂u/∂x = ∂u/∂z

∂²u/∂x² = ∂²u/∂z²
And the equation changes to (dropping the ' on the t variable) ...

- (∂u/∂t) - (r - ½σ²) (∂u/∂z) + ½σ² (∂²u/∂z²) + (r - ½σ²) (∂u/∂z) = 0

- (∂u/∂t) + ½σ² (∂²u/∂z²) = 0

And finally, voila, we have the heat equation...

∂u/∂t = ½σ² (∂²u/∂z²)

WHD Problem 3.6b

Find the most general solution of the Black-Scholes equation that has the special form V=A(t)B(S).

(∂V/∂t) + ½ σ² S² (∂²V/∂S²) + r S (∂V/∂S) - rV = 0

V = A(t) B(s)

(∂V/∂t) = B (dA/dt)

(∂V/∂S) = A (dB/dS)

(∂²V/∂S²) = A (d²B/dS²)

B (dA/dt) + ½ σ² S² A (d²B/dS²) + r S A (dB/dS) - r A B = 0

(1/A) (dA/dt) + ½ σ² S² (1/B) (d²B/dS²) + r S (1/B) (dB/dS) - r = 0

½ σ² S² (1/B) (d²B/dS²) + r S (1/B) (dB/dS) - r = - (1/A) (dA/dt)

Since the left-hand side depends only on S and the right-hand side depends only on t, the only way the equality can hold is if both sides are equal to a constant K.

- (1/A) (dA/dt) = K

A(t) = c e^-Kt

½ σ² S² (1/B) (d²B/dS²) + r S (1/B) (dB/dS) - r = K

½ σ² S² (d²B/dS²) + r S (dB/dS) - (r + K) B = 0

S² (d²B/dS²) + (2r/σ²) S (dB/dS) - (2/σ²) (r+K) B = 0

This equation proceeds as in the previous exercise.

λ² + (2r/σ² -1)λ + (-2/σ²)(r+K) = 0

λ = { (1 - 2r/σ²) ± [ (2r/σ² - 1)² + (8/σ²)(r+K) ]^½ } / 2

λ = { (1 - 2r/σ²) ± [ (2r/σ² - 1)² + (8/σ²)(r+K) ]^½ } / 2

λ = { (1 - 2r/σ²) ± [ (2r/σ² + 1)² + (8K/σ²) ]^½ } / 2

There are three cases depending on the roots: two real roots, one real root, two complex roots. And to be explicit, we should note that the case of two real roots can come about either with a real value of K (which leaves the form of A(t) above unchanged) or with a complex value of K (which would require rewriting A as we'll see in a minute).

Case 1: λ₁ and λ₂ are distinct real roots.

B(S) = c₁ S^λ₁ + c₂ S^λ₂

V(S,t) = (c₁ S^λ₁ + c₂ S^λ₂) e^-Kt

Case 1A: K = 0
(Special scenario under case 1)

This reduces to the special case where there is no time dependence V = B(S)

V = c₁ S + c₂ S ^(-2r/σ2)

Case 2: λ₁ = λ₂ = λ is the only real root.

B(S) = S^λ (c₁ + c₂ ln S)

V(S,t) = S^λ (c₁ + c₂ ln S) e^-Kt

Case 3: λ₁ = a+ib and λ₂ = a-ib are complex roots (with K real).

B(S) = S^a [ c₁ cos (b ln S) + c₂ sin (b ln S) ]

V(S,t) = S^a [ c₁ cos (b ln S) + c₂ sin (b ln S) ] e^-Kt

Case 3A: λ₁ = a+ib and λ₂ = a-ib are complex roots (with complex K = c + id).
(This is not strictly separate from case 3; it's simply a matter of expanding e^-Kt for complex K.)

B(S) = S^a [ c₁ cos (b ln S) + c₂ sin (b ln S) ]

V(S,t) = S^a [ c₁ cos (b ln S) + c₂ sin (b ln S) ] e^-ct (cos dt - i sin dt)

Note that all of these solutions (except Case 1A) have too many degrees of freedom, due to the freedom of choice in choosing K. Normally boundary conditions would restrict the universe of valid values for K, but the problem as stated did not provide any such conditions.

WHD Problem 3.6a

Find the most general solution of the Black-Scholes equation that has the special form V=V(S).

(∂V/∂t) + ½ σ² S² (∂²V/∂S²) + r S (∂V/∂S) - rV = 0

Substituting V=V(S) reduces the partial differential equation to an ordinary differential equation.

S² (d²V/dS²) + (2r/σ²) S (dV/dS) - (2r/σ²) V = 0

This is an Euler differential equation x²y'' + axy' - by = 0, the solutions of which can be found with the aid of the characteristic equation.

λ² + (a-1)λ + b = 0

λ² + (2r/σ² -1)λ + (-2r/σ²) = 0

Applying the quadratic equation, one obtains (after a bit of algebra) two roots

λ = 1 and λ = (-2r/σ²)

Using these roots, we determine that the most general solution of the Euler equation is
V(S) = c₁ S + c₂ S ^(-2r/σ2)

WHD Problem 2.5

There are n assets S_i,...,S_n satisfying the following stochastic differential equations dS_i = σ_i S_i dX_i + μ_i S_i dt, for i = 1, ..., n

The Wiener processes dX _i satisfy E[dX_i] = 0 and E[dX_i²] = dt, as usual, but the asset price changes are correlated with E[dX_idX_j] = ρ_ijdt where -1 ≤ ρ_ij ≤ 1.

Derive Ito's Lemma for a function f(S_i,...,S_n) of the n assets.

Actually, I already know most or all of the content of The Mathematics of Financial Derivatives; I am reading it as a review in preparation for more advanced materials I am hoping to get to in the near future.

This exercise is pretty trivial, mostly a matter of keeping track of all the variables.

The Taylor series expansion is
df = (∂f/∂t)dt + Σ(∂f/∂S_i)dS_i + ½Σ(∂²f/∂S_i∂S_j)dS_idS_j

dS_idS_j = (σ_i S_i dX_i + μ_i S_i dt)(σ_j Sj dXj + μj Sj dt) = σ_i σ_j S_i Sj dX_i dXj = ρ_ij σ_i σ_j S_i Sj dt
dropping all higher order terms and then substituting in the correlation assumption.

So finally we obtain
df = [ (∂f/∂t) + Σ μ_i S_i (∂f/∂S_i) + ½ Σ ρ_ij σ_i σ_j S_i Sj (∂²f/∂S_i∂S_j) ] dt + Σ σ_i S_i (∂f/∂S_i) dX_i

Here we go...

Senator Charles Schumer and other members of the Senate Banking Committee said the federal government should spend "hundreds of millions of dollars'' to bail out subprime mortgage borrowers facing foreclosure. Non-profit groups would distribute the money to help homeowners refinance loans they can't repay, Democratic Senators Schumer of New York, Robert Menendez of New Jersey and Sherrod Brown of Ohio.

So, let me get this straight those of us who did the RESPONSIBLE thing and did not buy more house than we could afford (while watching prices skyrocket out of our reach due to these irresponsible buyers) are now being asked to bend over and take it once more as our tax money goes to subsidize those who did buy more house than they could afford? Why?

And I'm tired of hearing that folks didn't understand what they were getting as a mortgage. Everyone understands adjustable interest. And everyone understands whether or not a payment is more than they can afford. And last of all everyone should understand the consequences of lying about his/her income on a mortgage application. I don't have any sympathy.

These folks took a risk. If it had worked out for them, the profit was all for them. They weren't planning to share it with me. It didn't work out, so I have to share the loss? WTF?

Job Cuts at Citigroup

Citigroup will eliminate about 17,000 jobs as part of a companywide restructuring to reduce costs and improve profit. Overall, the cuts amount to about 5% of the bank's 327,000-strong work force. Citigroup said its plans include "shrinking the size of corporate centers," several of which are in New York. It also expects to move some 9,500 jobs to lower-cost locations. Still, the elimination of the jobs won't reduce the bank's work force, but merely slow its growth, Citi executives said.

Ravings Brands Selling Moe's Southwestern Grill

Moe's Southwest Grill, the crown jewel of Atlanta-based parent Raving Brands, is being sold to Focus Brands, the Atlanta-based owner of Carvel Ice Cream, Schlotzsky's, Cinnabon and international stores of Seattle's Best Coffee. The announcement Wednesday comes on the heels of a lawsuit by franchisees, who among other things said the chain's management was secretly considering a sale. Raving Brands founder Martin Sprock denied that claim as recently as last week.

BearingPoint

The Company's continuing failure to timely file certain required periodic reports with the SEC imposes significant risks to the Company's business, including the possible loss of business, delisting from the New York Stock Exchange and defaults under the Company's credit facility. The Company has identified material weaknesses in its internal control over financial reporting, which could materially and adversely affect its business and financial condition. The Company's current cash resources might not be sufficient to meet its expected near-term cash needs, especially to fund intra-quarter operating cash requirements and non-recurring cash requirements (e.g., to settle lawsuits).

Apparently, BearingPoint didn't file its annual reports for fiscal 2004 and 2005 on time, nor will it file its 2006 report on time. It also has failed to file quarterly reports on time for the past six quarters in a row.

MBA Salaries

Came across the following in the WSJ...

The following business schools reported the highest average annual base salaries for full-time graduates, according to "The Wall Street Journal Guide to the Top Business Schools 2006".

Stanford University: $100,400

Harvard University: $99,848

Massachusetts Institute of Technology: $94,131

University of Pennsylvania: $92,986

Dartmouth College: $91,900

Northwestern University: $91,390

New Century Cuts Over Half Its Workforce

New Century Financial will immediately cut 3200 jobs (54% percent of its workforce) as part of its Chapter 11 bankruptcy reorganization. The company also said it agreed to sell its servicing assets and platform to Carrington Capital Management for $139 million, subject to bankruptcy approval. Separately, New Century said CIT Group and Greenwich Capital Financial Products have agreed to provide up to $150 million of debtor-in-possession financing to keep the company in business as it reorganizes.

LSI Swallowed Agere Today

Agere (a spin-off from Lucent) was acquired by LSI, effective today. The purchase price was 2.16 shares of LCI ($22.55) for each Agere share.

The Mebert Hoax

I've always been fascinated by this ultimate example of Dilbert-ism in the real world, but the story due to age (it happened back in 1997) has been getting more difficult to find on the internet. So I've taken a minute to document the story here for posterity.

Here's the story as originall written in the San Jose Mercury News...

My goal is to see if a group of executives will allow somebody who has very few credentials, except for good hair, to come into their meeting and get them to write a mission statement which is so impossibly complicated that it has no real content.--Scott Adams, Oct. 8, 1997, 9:30 a.m.

Two hours later, management consultant Ray Mébert strides through the doors of Logitech International's headquarters in Fremont. Few employees give a second glance at the short, mustached man in a gray suit as he weaves through a maze of cubicles to a conference room in which almost a dozen senior executives have been assembled.

In a memo distributed to a selected group of Logitech's vice presidents and senior managers, Pierluigi Zappacosta, the company's co-founder and vice chairman, described Mébert as a man with ''special talents as a facilitator'' and ''a very original thinker'' who has collaborated with big-name consultants.

It's not as if Logitech, the world's largest manufacturer of computer mice and related devices, is in a slump. In Silicon Valley, the 3,000-employee company is considered a strong innovator. But in this fast-paced industry, survival depends in large part on aggressively finding new business opportunities, which is why the gifted Mébert has been summoned. His charge, in the words of Zappacosta's memo, is to help ''crisply define the goals'' of the New Ventures Group. Translation: It's time for that most dreaded of corporate exercises, rewriting the mission statement.

Mébert (the French pronunciation, please!) carries nothing but a thin manila folder with documents summarizing Logitech's business goals--which he has studiously avoided reading. ''I try not to become too familiar with the companies I'm consulting for,'' Mébert explains. ''I find that, otherwise, generic solutions might not fit as well.''

If the size of his entourage is a yardstick, Mébert clearly is a success. Does Michael Porter, the celebrated authority on competitive business strategy, arrive with a photographer, a videotaping crew and a personal assistant named Sheena Diamond? Noting all the electronic gear, one exec is heard to mutter, ''Wow, he's got to be expensive.''

Mébert quickly confirms his stature in the management consulting universe. ''I did the Harvard MBA thing, and then I went to Procter & Gamble where I worked on the Taste Bright Project,'' Mébert says. Taste Bright, he explains, was a top-secret effort his team worked on for years, to boost soap sales by cashing in on not only the olfactory but also the gustatory sense.

"There actually are some people who admitted in focus groups that they would sometimes taste soap. We found that to get repeat business it was necessary to actually improve the smell as well as the taste of the soap,'' Mébert says. Zappacosta nods empathetically at such a difficult assignment. There follow serious nods--and a few chuckles--around the table.

Mébert continues with his credentials: He did a stint at Fortune Computer (one of the valley's legendary business failures), then founded Ray Mébert Associates. Apple immediately recruited him to strategize on its much ballyhooed--now beleaguered--handheld computer, the Newton.

These less-than-proud consulting experiences do not raise an eyebrow. Then again, as any loyal reader of ''Dilbert'' can tell you, consultants play by their own rules. To quote that management guru Dogbert, ''Consultants don't need much experience in an industry in order to be experts. They learn quickly. If your 26-year-old consultant drives past the Egghead software outlet on the way to an assignment, that would qualify as experience in the software industry.'' Mébert, it seems, adheres strictly to the Dogbert doctrine.

If the Logitech execs were to look closely, they would notice a few signs that Mébert is not exactly who he says. Strands of sandy blond hair peek from under his thick brown locks. His mustache is a little too symmetrical. Not bad, though, given the hasty transformation Mébert underwent two hours earlier at his home in Danville. It's also home to Mébert's alter ego, ''Dilbert'' creator Scott Adams.

And here's a couple of interviews Scott Adams gave about the incident shortly afterwards.

I got a call from Tia O'Brien [an independent reporter on assignment] for the San Jose Mercury News. She wanted to do a story that was going to be interesting and different. We brainstormed and came up with the idea that I'd put on a disguise, go to a corporation as a consultant, and see if I could fool people into thinking that I was a high-paid consultant when, in fact, I was just full of crap. Zappacosta thought it would be a fun idea. So we set up the scam. Tia acted as my assistant, and Pierluigi was the only one who was in on it in a room full of business executives at Logitech. For over one hour I took them through an exercise on how to rebuild their mission statement. I actually convinced them that the one they had was woefully inadequate. That's part of the humor of it - all mission statements are quite useless. So to tell them the one they had wasn't doing the job should have raised a red flag to begin with. But people in corporations are so used to two things: First, absurdity - so nothing seems too unusual. And second, there is not enough payoff to rock the boat. It was much easier for everyone to listen to what I had to say than to jump on me at the first sight of absurdity. Certainly everyone in the room had at least a moment where they said, "Man, I'm wasting my time!" But I made sure I always skated just below the level at which somebody would call my bluff and would think it was worth taking the chance of calling me a fraud. I had them thinking, "What if it just turns out that he's just eccentric but the best consultant in the world?"

See that picture to the left there, by the light switch? Where I'm peering from behind Dilbert? I have a big mustache and fake brown hair on? I was outfitted by a makeup artist and I went into Logitech as a famous consultant. I was brought in by the founder of the company, who was in on it, and he was in on the joke, and a reporter for the San Jose Mercury News, a freelancer who was working there, set it up with me. They had their senior management there and I gave a whole presentation and reworked their mission statement with them. They thought I was there to give them a better mission statement. But, my stated goal was to give them the worst mission statement ever written, convince them it was good, and get them to agree to put it to music. I succeeded in all that. They agreed to put it to music and I didn't actually have them put it to music. But I got volunteers, and people volunteered. It was the worst mission statement ever written. Every person in that meeting was way above average in intelligence and not one bit more gullible than anybody else on Earth. Completely normal gullibility.

Private Equity Firm To Go Public

Blackstone Group is preparing to become the first major private equity firm to go public. The $4 billion IPO values Blackstone at $40 billion. But investors can only buy into Blackstone's management company, not the companies it owns, and they'll have limited voting rights. Blackstone's partners will remain in control, said Martin Mayer at the Brookings Institution.

[Thanks to CP for bringing this to my attention.]

45% of first-time buyers put $0 down

According to the National Association of Realtors 45% of first-time buyers nationwide put no money down.

That's up from 42% the last time I posted the statistic back in March 2005.

Federal Reserve advisory group warns foreclosures to get worse

Members of a Federal Reserve advisory panel on Thursday warned of a rising tide of US mortgage foreclosures in the coming year, as subprime borrowers in particular are expected to feel the sting. Members of the Fed's Consumer Advisory Council said the number of foreclosures in 2007 is expected to exceed the roughly 1.2 million from 2006. "Foreclosures are at a historic high, and they're going to get higher," said Alan White, a supervisory attorney with Community Legal Services, adding that subprime loans represented about 50% of last year's foreclosures. "It's getting to a point where it's no longer an anecdotal problem, but it relates to the nature of the product," White said, referring to the proliferation of subprime mortgage products.

Collapse of Arthur Andersen LLP

To those who think that the destruction of Arthur Andersen was an over-reaction, keep in mind that we are not just talking about Enron. Arthur Andersen over its last few years also signed off on the extremely dirty books of Sunbeam, Waste Management, Global Crossing, Qwest, and (most appaling of all) WorldCom. This was clearly not just a few bad apples but a systemic cancer within a company that not that long ago was held up as the paragon of auditing ethics.

Staff:

Of course, the jewel of the crown was Arthur Andersen's tax practice, with its approximately 500 US partners, which was won by Deloitte Touche Tohmatsu in April 2002.

The other big ticket item in the collapse of Arthur Andersen LLP was that Robert Half International established the firm Protiviti by hiring more than 700 professionals from the risk consulting practice including more than 50 partners.

The rest of the firm was carved up like a Thanksgiving turkey...

Ernst & Young Acquires Arthur Andersen's Chesapeake Office - 350 employees including 39 partners.

Ernst & Young Acquires Pittsburgh Offce - 87 employees including 8 partners.

Ernst & Young Acquires Louisville Office - 45 employees including 3 partners.

Ernst & Young acquired the Financial and Commodities Risk Consulting and Financial Services practices of Arthur Andersen's Chicago office - 65 employees including 12 partners

Ernst & Young hired 78 Andersen staffers in Miami, Fort Lauderdale and West Palm Beach.

Ernst & Young acquired Ann Arbor, Grand Rapids and Toledo offices - 159 employees including 14 partners

Ernst & Young hires approximately 100 Arthur Andersen professionals including 6 partners from Andersen's Los Angeles, Denver, Phoenix, and San Diego practices.

Deloitte & Touche acquired about 950 staffers from the Chicago office, far more than any other Big Four firm.

Deloitte & Touche acquired 225 employees from the Milwaukee office

Deloitte & Touche acquired 50 employees from the Las Vegas office

Deloitte & Touche acquired the Minneapolis office - 229 employees including 16 partners

From the Atlanta office, Deloitte & Touche hired 359 employees including 39 partners, and Ernst & Young hired 51 employees including 5 partners

The Boston office was divided up between the Big Four - Ernst & Young signed up 15 partners, PricewaterhouseCoopers 5 partners, Deloitte & Touche 11 partners and KPMG 4 partners

KPMG picked up more than 200 employees and partners from the Seattle office

Grant Thornton picked up 50 employees including 6 partners from the New York office

Grant Thornton got 161 employees including 19 partners in Charlotte, Greensboro and Columbia

Grant Thornton buys Tulsa office with 35 employees

Huron Consulting Group was formed by 35 Andersen professionals, mostly from the financial consulting practice, in Chicago.

Keep in mind that this entire process was started in April and was completed by July. I did not think a company with 28,000 US employees (85,000 globally) could collapse in four months. If anybody has information on offices that are not listed here, I'd like to hear from you. In particular, I am interested in learning what happened to the rest of the NYC office.

Clients:

This list is entirely too long to reproduce in this blog since Arthur Andersen had almost 2500 clients. In this case, I will rely on internet links and hope they do not die on me.

http://www.accountingweb.com/cgi-bin/item.cgi?id=74745
http://www.forbes.com/2002/03/13/0313andersen.html
http://www.forbes.com/2002/06/28/0627andersen.html

Collapse of Andersen Worldwide

Defections of Andersen's global affiliates
I would normally provide this information via a link, but I wanted the actual text documented here in case the link dies because this information is becoming increasingly difficult to find on the web.

Argentina 4/16/02 Plans to merge with Ernst & Young
Australia 3/28/02 Announces plans to merge with Ernst & Young
Baltic States 4/15/02 Announces plans to merge with Ernst & Young
Belgium 4/23/02 Announces plans to merge with Deloitte Touche Tohmatsu
Brazil 4/9/02 Announces plans to merge with Deloitte Touche Tohmatsu
Bulgaria 4/24/02 Announces plans to merge with Ernst & Young
Canada 4/12/02 Announces deal to merge with Deloitte Touche Tohmatsu
Chile 4/9/02 Announces plans to merge with Ernst & Young
China 3/22/02 Announces plans to merge with PricewaterhouseCoopers
Colombia 4/23/02 Announces plans to merge with Deloitte Touche Tohmatsu
Croatia 4/24/02 Announces plans to merge with Ernst & Young
Czech Republic 4/24/02 Announces plans to merge with Ernst & Young
France 4/16/02 Plans to merge with Ernst & Young
Germany 4/24/02 Plans to merge with Ernst & Young
Holland 4/24/02 Announces plans to merge with Deloitte Touche Tohmatsu
Hong Kong 3/22/02 Announces plans to merge with PricewaterhouseCoopers
Hungary 4/24/02 Announces plans to merge with Ernst & Young
India 5/4/02 Announces plans to merge with Ernst & Young
Indonesia 4/14/02 Announces plans to merge with Ernst & Young
Italy 4/23/02 Announces plans to merge with Deloitte Touche Tohmatsu
Japan 3/28/02 Announces plans to merge with KPMG
Mexico 4/9/02 Announces plans to merge with Deloitte Touche Tohmatsu
Middle East 4/22/02 Announces plans to merge with PricewaterhouseCoopers
Netherlands 4/22/02 Announces plans to merge with Deloitte Touche Tohmatsu
New Zealand 3/28/02 Announces plans to merge with Ernst & Young
Norway 4/9/02 Announces plans to merge with Ernst & Young
Phillipines 4/24/02 Announces plans to merge with Ernst & Young
Poland 4/9/02 Announces plans to merge with Ernst & Young
Portugal 4/9/02 Announces plans to merge with Deloitte Touche Tohmatsu
Romania 4/24/02 Announces plans to merge with Ernst & Young
Russia 3/22/02 Announces plans to merge with Ernst & Young
Singapore 4/3/02 Announces plans to merge with Ernst & Young
Slovakia 4/24/02 Announces plans to merge with Ernst & Young
Slovenia 4/24/02 Announces plans to merge with Ernst & Young
South Africa 4/11/02 Announces plans to merge with KPMG
Spain 4/3/02 Announces plans to merge with Deloitte Touche Tohmatsu
Sweden 4/22/02 Announces plans to merge with Deloitte Touche Tohmatsu
Switzerland 4/17/02 Announces plans to merge with Ernst & Young
Taiwan 4/11/02 Plans to merge with Deloitte,Touche Tohmatsu
Thailand 4/3/02 Reaffirms plans to merge with KPMG
United Kingdom 4/10/02 Announces plans to merge with Deloitte Touche Tohmatsu
Vietnam 5/10/02 In discussions to merge with KPMG

http://www.accountingweb.com/cgi-bin/item.cgi?id=76820

What it would take to bring down another big accounting firm

The key to survival [of a Big Four firm] lies in the willingness of the partners to stay committed and at their desks — something that the Andersen partners did not possess, as proved by the two-week period in 2002 during which they bailed out en masse and thus smashed the firm beyond recovery.

A study done for McCreevy calculates that the partners of a European firm would bolt in numbers large enough to be destabilizing rather than be forced to finance a litigation payment that extracted a profit reduction of 15% to 20% over three to four years. Applying those assumptions to the Big Four's latest reported US revenues of $4.7 billion to $8.7 billion, the US firms would confront partner flight and possible failure at liability levels as small as $450 million to $1.8 billion. Those amounts are modest to the point of insignificance against the size of this decade's financial debacles — examples ranging from the $20 billion hole in the balance sheet of Parmalat to Enron's $67 billion bankruptcy.

Response to Comment

Any comments on how Unions caused problems in high costs? Japanese companies who have factories in America with no Unions seem to have a very good profit margin. I think Chrysler's workers did themselves and the company in. Any thoughts on comparing this to some airlines troubles? (Eastern, PanAm)

No question that the problems of GM, Ford and Chrysler are due to overly high compensation and benefits demanded by the union. For example, in 2005, GM’s US other postretirement employee benefits expense, consisting of retiree health care and life insurance, increased to $5.3 billion (that's HALF of GM's $10.6 billion loss right there).

However, it is too easy just to blame the unions. Past management (and here I mean as far back as the 50s) is also to blame in that it was far too easy to promise benefits that would be paid years later rather than wages that would have to be paid on the spot.

I agree that Japanese companies that have factories in the US with no unions indeed have a very good profit margin. Furthermore, it's worth noting that GM and Ford operations abroad are also much more profitable than their US operations. I've previously commented that if Ford could just make their US segment disappear they'd be in top-notch financial shape. This is the reason why I don't think GM would ever buy Chrysler. Folks who know a lot more about cars than me observe that the two companies' vehicle portfolios don't mesh well. And they are right. However, from a financial point of view it just wouldn't work out. GM has more than its fair share of "Detroit troubles" and has no business trying to take on Chrysler's very similar problems.

Your comment in comparing the automakers to airlines is quite insightful. Heavily unionized industries are all collapsing due to the unsustainable wage/benefit promises extracted from management by the unions. Steel, airlines, automakers. They're all going down for the same reasons.

GM rumored to be in talks to buy Chrysler

I have of course been following the many reports of problems at the Chrysler unit of DaimlerChrysler including all the discussion about how the "merger of equals" was falling apart and Daimler was looking at "strategic opportunities" (translation: divestiture) for Chrysler. However, this story BLEW ME AWAY:

General Motors is in talks to buy the Chrysler Group in its entirety, Automotive News reported Friday, citing unnamed sources in Germany and the United States.

MMC selling Putnam

Power Financial, the owner of the biggest mutual fund company in Canada, agreed yesterday to buy Putnam Investments, based in Boston, from Marsh & McLennan for $3.9 billion in cash. Power Financial is buying Putnam, which managed $192 billion as of December 31, through its Great-West Lifeco insurance unit. Marsh, which has owned Putnam since 1970, put the company up for sale in September after assets fell 60% in five years because of below- average returns and fallout from a fund-trading scandal.