This is downright scary!

There is no other word for it ... I am seriously worried about the state of our economy.

Fourteen percent of mortgage holders expressed worry that they might miss payments in the next six months.

Banking News

Busy day today as several banks reported first quarter earnings:

Washington Mutual reported a $1.14 billion first-quarter net loss ($1.40 a share) as the lender suffered from the mortgage meltdown and broader credit crunch. It also said it closed a previously announced deal to raise $7 billion from a group of investors led by private-equity firm Texas Pacific Group. It also reported "steady" results from its retail banking, credit card and commercial businesses.

State Street reported that first-quarter net income rose 69% but the stock lost ground as investors worried over the firm's outlook as well as unrealized losses in its investment portfolio and asset-backed commercial paper program.

Several of the nation's major regional banks saw their shares rally on better-than-expected earnings and for several a boost from selling shares in credit-card company Visa. Shares of Regions Financial (RF), M&T Bancorp (MTB), U.S. Bancorp (USB), Commerce Bancshares (CBSH) and Marshall & Ilsley (MI) were all up. Analysts responded warmly to earnings, saying that despite significant loan-loss reserves still to come, many regional banks did better than expected.

Delta-Northwest Merger

Delta Air Lines and Northwest Airlines announced plans to merge, creating the world's largest airline. The proposed merger would create a global giant with 810 jets, 6400 daily flights and nearly $32 billion in annual revenue. The carriers estimate the value of the new company at $18 billion dollars, far above their current market value.

The proposal could also be a catalyst for further consolidation among the big airlines at a time when the industry is threatened by steep losses from high fuel prices and a weakening economy (Continental and United ready to merge too).

If the merger closes, the new airline will be named Delta and headquartered in Atlanta where Delta is based; Delta CEO Richard Anderson will be its CEO (translation: it's an acquisition, not a merger). Northwest shareholders would receive 1.25 Delta shares for each Northwest share.

Wachovia News

Wachovia posted an unexpected loss for the first quarter ($393 million or 20 cents a share) on Monday, reduced its dividend (to 37.5 cents a share from 64 cents, which will save $2 billion a year) and said it would raise about $7 billion through the sale of common and convertible preferred stock because of mounting housing losses and an ill-timed acquisition of Golden West Financial. Revenue fell 4.5% to $7.89 billion from $8.27 billion. The company also said it plans to cut 500 jobs in its investment and banking unit. Company shares fell $2.26, or 8.1%, to $25.55.

Unemployment

Frontier Airlines Latest Casualty

Frontier (FRNT 0.42, -1.15, -73.5%) joined a growing list of airlines filing for bankruptcy amid rising fuel prices and a slowing economy. But Frontier said it expects to continue operating its full schedule of flights, adding it will honor tickets and reservations as well as providing refunds and exchanges as usual.

Third airline in a week

Skybus Airlines announced last night that it was halting operations today. Aloha Airlines halted operations Monday, and ATA Airlines halted operations Thursday.

April Fool's Joke?

UBS's chairman abruptly resigned today as the Swiss bank reported a first-quarter loss of $12.1 billion and said it would seek $15.1 billion in new capital. UBS revealed more serious damage from exposure to the U.S. subprime crisis and said it expects write-downs of approximately $19 billion (that's in addition to the $18 billion it wrote down last quarter). The punchline is that the stock led a rally in financial stock, posting a 15% gain.

Lehman Brothers hares jumped 18%. It said it plans to offer 3 million convertible preferred shares "in response to investor interest." Translation: we need capital.

Wall Street gains are privatized; losses are socialized

More articles on the $29B at risk for the Fed in the JP Morgan - Bear Stearns deal. I have nothing to add, so I will just provide a couple of links.

http://www.marketwatch.com/news/story/capitol-report-fed-puts-lipstick/

http://www.bloomberg.com/apps/news?pid=20601068&sid=aNXDBlrk1H1s&refer=home

$1.2 TRILLION in credit losses

Goldman Sachs forecasts global credit losses stemming from the current market turmoil will reach $1.2 trillion, with Wall Street accounting for nearly 40% of the losses. US leveraged institutions, which include banks, brokers-dealers, hedge funds and government-sponsored enterprises, will suffer roughly $460 billion in credit losses after loan loss provisions, Goldman Sachs economists wrote in a research note. Losses from this group of players are crucial because they have led to a dramatic pullback in credit availability as they have pared lending to shore up their capital and preserve their capital requirements.

Goldman estimated only $120 billion in write-offs have been reported by these leveraged institutions since the credit crunch began last summer. "US leveraged institutions have written off less than half [actually less than one third but let's not quibble] of the losses associated with the bursting of the credit bubble," they said. "There is light at the end of the tunnel, but it is still rather dim."

Ford divesting Jaguar and Land Rover

Ford Motor agreed to sell its Jaguar Land Rover operations to India's Tata Motors for $2.3 billion (really $1.7 billion as Ford will contribute as much as $600 million to the unit's pension plan). I can't believe that Ford was unable to make money with the high-end Jaguar and Land Rover product lines.

Blackstone Down 47%

Blackstone closed today at 16.35, down a precipitous 47% from its $31 IPO price in June 2007. By comparison, the S&P500 is down only 10% in the same period. Amazing!

Home prices down 2.4% in one month

Home prices in 20 US metropolitan areas fell in January by the most on record (10.7%!), a sign the housing recession is deepening, according to the S&P/Case-Shiller home-price index. The gauge has fallen for 13 consecutive months. January home prices fell 2.4% from a month earlier, following a 2.1% decline the prior month.

JP Morgan Chase ups bid to $10

JP Morgan Chase raised its offer for Bear Stearns, the beleaguered investment bank, to $10 a share Monday morning in an effort to pacify angry Bear shareholders. The sweetened offer of about $1 billion is intended to win over stockholders who vowed to fight the original fire-sale deal, struck only a week ago at the behest of the Federal Reserve and Treasury Department. Bear’s shares, which closed at $5.96 on Friday, rose to $11.44 (not sure why it's trading above $10, a new suitor is unlikely to come out of the woodwork). Under the new terms, each share of Bear Stearns common stock would be exchanged for 0.21753 shares of JP Morgan Chase stock, up from 0.05473 shares. In addition, JP Morgan Chase will buy 95 million newly issued shares of Bear Stearns common stock, or 39.5% of the outstanding Bear Stearns common stock after the issuance, at $10 a share (and essentially guaranteeing that existing shareholders are too diluted to prevent the sale).

In addition, Bear’s directors have indicated that they intend to vote their shares — worth almost 5% of Bear’s shares after the dilution of issuing shares for JP Morgan Chase. The deal is expected to be completed by April 8. While the initial agreement appeared to have defused the financial crisis of confidence that undid Bear, the initial terms of the deal — and the government’s controversial role in reaching them — drew criticism from those who say the takeover amounts to a government bailout of Bear, a firm at the center of the mortgage meltdown.

As part of the original deal, the Fed guaranteed to take on $30 billion of Bear’s most toxic assets. Under the revised deal, JP Morgan Chase will bear the first $1 billion of any losses associated with the Bear Stearns assets being financed and the Fed will finance the remaining $29 billion on a non-recourse basis to JP Morgan Chase.

Source: NYT

GOOG

LTCM II in trouble

JWM Partners LLC, the investment firm run by ex-LTCM chief John Meriwether, lost 24% in its $1 billion fixed-income hedge fund this year through March 14, according to two people with knowledge of the matter. Meriwether's Relative Value Opportunity fund was hurt as bond managers such as Peloton Partners and Carlyle Capital were forced to sell securities to meet margin calls, said the investors, who asked not to be identified because JWM doesn't publicly disclose returns.

Citigroup analysts say avoid ... Citigroup

Citigroup strategists say that as markets and economies de-leverage, investors should steer clear of companies that have relied on borrowed money, especially in the financial services sector.

Poor Presentation Skills

I am constantly amazed at the poor presentation skills of many of our most luminary fianciers. I attended a luncheon today where a superstar investment strategist made a presentation on pension fund management. She was a good public speaker in terms of her comfort in front of an audience etc, but she was absolutely NOT a good speaker when things like logical coherence are considered. While she was clearly very knowledgeable and a lot of her points provided good insight, I would estimate that 90% of what came out of her mouth bore zero relation to the topic at hand.

Fannie Mae and Freddie Mac capital requirements reduced

US regulators may reduce capital requirements imposed on Fannie Mae and Freddie Mac to help them expand their combined $1.5 trillion in investments and revive the market for home loan securities. Fannie Mae and Freddie Mac also agreed to raise more capital as part of the deal with the Office of Federal Housing Enterprise Oversight. Fannie Mae and Freddie Mac are required by Ofheo to hold an extra 30% capital cushion to protect against losses on the mortgages they own and guarantee. An easing could amount to an extra $200 billion to $300 billion of purchases from the companies. Fannie Mae climbed 27% and Freddie Mac jumped 26% yesterday. Fannie Mae posted a $3.55 billion loss and Freddie Mac posted a $2.45 billion loss in the fourth quarter, both records as rising foreclosures sent credit costs soaring net loss for the period. The capital surcharge is one of the last remaining restrictions imposed on the companies after $11.3 billion of accounting misstatements.

This will not end well. Expand their capacity to make more of the same investments that lost them $6 billion in a single quarter? And presumably they already bought all the best mortgages, so they'd be dipping into lower quality stuff at the margin. Bad, bad idea.

Fed cuts fed fund rate 3/4 percentage point

Fed fund rate is down to 2.25%. But immediately following the news the DJIA dropped 100 points (from +300 to +200) because market was expecting a full point cut. According to MarketWatch, based on futures trading in Chicago, investor's bets implied a 100% chance of a cut of one percentage point.

Dallas Fed president Richard Fisher and Philadelphia Fed president Charles Plosser dissented in favor of less aggressive action.

In a related action, the Board of Governors unanimously approved a 75 basis point decrease in the discount rate to 2.5%.

Philip Morris International

Started trading today under ticker symbol PM, separate from parent Altria.

Bear Stearns Dead!

It turns out my guess of 28 days was wildly optimistic. JP Morgan Chase is buying Bear Stearns for $2 a share, exchanging 0.05473 share of its stock for one share of Bear Stearns. Both boards approved the transaction over the weekend. Bear Stearns opened down 88% from Friday's close at $3.70 (just one business day after it closed Thursday at $57). The collapse was bigger than Enron and faster than LTCM. I can just see the class action securities lawyers foaming at the mouth.

Bear Stearns on life support

Bear shares slumped $27 (47.4%) to $30 on news of a critical liquidity crisis at the investment house. The Federal Reserve invoked a rarely used Depression-era procedure today to bolster the firm. The arrangement allows JP Morgan Chase to borrow from the Fed's discount window and put up collateral from Bear Stearns to back up the loans. This process will be in place for 28 days. My guess is Bear Stearns will cease to exist as an independent entity before those 28 days are up.

Of course market participants are waiting for the other shoe to drop, which showed up in the stocks of all the other major players. Lehman Brothers down 14.6%, UBS down 8.3%, Citigroup down 6.1%, Goldman Sachs down 5.2%, Morgan Stanley down 4.9%, J.P. Morgan Chase 4.1%.

News of the day

If time allows I will add links, but for now I at least wanted to post quick blurbs.

1) Fed is temporarily willing to swap up to $200B of AAA structured financial products whose values are difficult to ascertain in the market (no such animal - if nobody wants them in the open market then their value is $0) for Treasuries. This will NOT end well, yet the market rallied on the news. Although subsequent analysis has shown that the added liquidity has not improved the credit crunch. Banks can take all the liquidity the Fed offers, but if they are not willing to lend then that doesn't really matter, does it?

2) A second SocGen trader has been brought in by the French police for questioning. It appears the rot goes a lot deeper than the lone trader that brought down Barings.

3) Chrysler is shutting down for two weeks to cut costs. If every car they make leaves them with a loss, perhaps the proper solution is to shut down for 50 additional weeks.

4) SecTreas Paulson says the current financial crisis shows that deregulation has failed us. We have regulations coming out of our ears; it is the regulators who failed us. Where were the SEC, the Fed, and all the other myriad regulators while mortgage banks were making all these worthless loans and Wall Street was pushing all these worthless structured products?

Carlyle Capital Collapses

Carlyle Capital, the bond fund affiliated with private-equity firm Carlyle Group, is on the verge of collapse after failing to agree a new financing deal with lenders. Late today, the fund said that it expects lenders will soon take possession of "substantially all" its remaining assets after it was unable to meet surging margin calls on its portfolio of residential-mortgage-backed securities. Shares of Carlyle Capital were all but wiped out, tumbling 98% to 29 cents from $12. So far, Carlyle Capital said it's defaulted on $16.6 billion of its debt, and its remaining borrowing is expected to go into default soon. Negotiations with lenders effectively ended when the pricing service used by certain lenders reported another drop in the value of MBSs. That was expected to trigger another $97.5 million of margin calls, on top of the roughly $400 million of demands that Carlyle Capital received last week. Margin calls have soared since the end of February as credit markets have worsened.

At the end of December, the fund had total equity of about $670 million and had used short-term loans, or repurchase agreements, to fund an investment portfolio of close to $22 billion. (That's leverage of 33x. There's the cause of the collapse right there.)

Debt > Equity

It's been widely reported (and misreported*) that home debt exceeded home equity for the first time on record (data goes back to 1945). Home equity percentage as of December 2007 is 49.6%, and I'm sure that number will go down a lot further before things recover. Other than the pain that this is going to cause me indirectly through a weak economy, I continue to fail to understand how other people's irresponsible financial decisions are my problem.

* NPR incorrectly reported that home debt exceeded home VALUES rather than equity (I've also heard at least one investment banking "expert" who should know better make this claim), and USA Today incorrectly defined the equity percentage as home debt divided by home value.

Oil Bubble

Crude oil may reach a record $130 a barrel this year because pension funds are investing more in commodities, said Pierre Andurand, the chief investment officer of BlueGold Capital Management LLP, a hedge fund. (Gee - I wonder if his fund is heavily invested in oil, which would make his opinion entirely self-serving. They shouldn't allow hedge fund managers to opine on the market.) The outlook for oil over the next five years is also bullish as producers find it hard to replenish reserves and demand outpaces supply. Oil companies are finding it tougher to replace their findings and are drilling for harder-to-reach deposits while energy demand and crude prices surge to records.

With commodities prices surging to all-time highs, Calpers, the largest US pension fund, said it plans to boost investments. "There's a lot of index funds flowing into oil, and the world is under-invested in commodities, especially pension funds,'' said Andurand. "Oil is now a medium-to- long-term outlook story, and it's bullish in terms of fundamentals of production constraints. Next year, oil may rise even further to $150 a barrel,'' said Andurand, whose $300 million fund has so far invested 70% in energy (BIG SURPRISE!) and 30% in agriculture and metals since February.

Translation: There are a bunch of upset people who have missed out on the spectacular run up in oil prices. Oil is a limited resource, so how can the value come down when everyone wants more? When they start buying oil, the price will go higher forever and ever.

Replace "oil" with "real estate" and you've got 2006, or "internet" or "telecom" and you've got 1999, or "tulip" and you've got the 17th century. The more things change, they more they stay the same.

Hedge Funds Frozen Shut

There's a chill spreading across the hedge fund industry. With more portfolios falling victim to the credit crunch, managers by the dozen are freezing investor redemptions, preventing a mad rush to the exits that would force funds to sell beaten-down assets to raise cash. But is this unprece­dented move just postponing the day of reckoning for funds and the market? Since November at least 24 hedge funds have barred or limited investors from taking their money out, tying up tens of billions of dollars for an indefinite period.

Bernanke off his gourd, as far as I'm concerned

"Principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure.''

Cool, so if I'm underwater I get my equity restored. Then when home prices rebound, I can pocket the additional appreciation in addition to Ben's giveaway. Damn, maybe real estate does ALWAYS pay off.

"Lenders tell us that they are reluctant to write down principal. They say that if they were to write down the principal and house prices were to fall further, they could feel pressured to write down principal again.''

Well, DUH! Does this strike him as unreasonable? What does he think will happen if prices drop further (which they probably will)?

Based on futures prices, traders expect the Federal Open Market Committee to lower the benchmark rate by 0.75 percentage point by or at the panel's next meeting on March 18. I hope the traders are off their rocker, because another 75 basis point cut will put us well on the Japan path of zero interest rates. And we all know how well that worked out for them. Come to think of it, their mess started with bloated real estate prices - if I recall correctly at one point the real estate in Japan had a paper value larger than all the real estate in the US.

ETA: I found it; it was even more ridiculous that I remembered:
Japan suffered one of the biggest property market collapses in modern history. At the market's peak in 1991, all the land in Japan, a country the size of California, was worth about $18 trillion, or almost four times the value of all property in the United States at the time.

Now I'm certain commodities are the new bubble

The first commodities index built to allow investors to profit from rising food inflation is due to be launched today. The UBS Bloomberg Constant Maturity Commodity Food Index will cover 13 commodities directly linked to food consumption. It will include raw materials not usually included in general commodity indices, such as high-quality winter red wheat, soyameal, soy oil, orange juice and lean hogs.

Muni auctions continue to fail

Auction-rate bond failures show no sign of abating after investors abandoned the market for variable-rate municipal securities. Almost 70% of the periodic auctions in the $330 billion market failed this week as investment banks stopped buying the securities investors didn't want. Yields on the debt averaged 6.52%, up from 3.63% before demand evaporated in January.

Sharper Image Bankrupt

Sharper Image filed Chapter 11 bankruptcy.

One observation made by MarketWatch is that $25 million in gift cards and certificates became worthless overnight since federal law allows a company to stop honoring store gift cards when it files Chapter 11.

Updated (5/31):
Sharper Image was purchased by Hilco Capital, Gordon Brothers and Bluestar Alliance for $49 million. It will operate solely as a licensing company, closing all remaining stores immediately.

Dumbest Thing I've Heard in a while

I just heard a CNBC analyst on TV asking, "The question is when are we going to see some of the money going into commodities start moving back into equities. When is that appetite for risk going to return?" That is idiotic. The risk isn't in equities (they obviously aren't going to skyrocket, but they aren't going to plummet a la 2000-2 either). The risk is in commodoties, which are being built up to be the next bubble. It's ridiculous...

• Gold +43% in six months
• Oil +46% in six months
• Wheat +100% in just under a year
• Corn, Cattle, hell even soybeans, are going through the roof

Now a good deal of these increases are that the prices are quoted in dollars on world markets, and the dollar is down quite a bit (which has no effect on non-US demand) so a lot of this is explained by the decline of the dollar as opposed to real price increases, but it doesn't come near (anywhere near) explaining all of these increases. So what's going on here?

We've got media headlines like "World recession blamed for basic commodity price hikes." Wait a minute - aren't prices supposed to DROP in a recession?

Looks a bit silly (and crooked) now, doesn't it?

2005:


2006:


For those of you who are not aware of this, David Lereah was the chief economist of the National Association of Realtors at the time these books were published. It's amazing to me the self-serving crap (almost criminally so in this case) that gets published under the guise of scholarly research just because the author has a credential. How can a publisher sell this in good conscience without even putting the author's affiliation on the cover? What happened to Dr Lereah's sense of intellectual honesty?

First Stocks, Then Real Estate, Now Oil?

Perhaps we are living in a perpetual bubble economy. Speculators now hold up to 45% of all oil contracts. The underlying world supply and demand data are pretty much the same as when oil was $75 a barrel. I wonder how soon before this particular bubble also comes crashing down around us?

Sprint Loses $29.5 Billion

Sprint Nextel Corp. posted a $29.5 billion loss and scrapped its dividend after writing down most of the Nextel Communications acquisition from two years ago. Sprint sank as much as 13% in New York trading and its credit-default swaps reached a record. The company reported a fourth quarter net loss of $10.36 a share. Sales fell 5.7% to $9.85 billion, missing analysts' estimates, and the carrier borrowed $2.5 billion under a credit line. The writedown put Nextel's value at 80% less than when it was acquired and the loss is the fifth-largest among S&P500 companies since 1990. Sprint expects 1.2 million subscribers to leave this quarter, as many as it lost in all of 2007. CEO Dan Hesse, who took over in December, said business is deteriorating.

$29.5 billion!! Another useless acquisition by another idiot executive. Perhaps Sprint should concentrate on improving its crappy customer service (yes, I will probably be one of the 1.2 million who leaves this quarter when my contract expires).

Home Price Declines

Home prices fell 8.9% in 2007, the largest decline in the Case-Shiller home price index in 20 years. The index fell 5.4% in the fourth quarter alone. Prices in 17 of 20 major cities fell, with eight cities falling by double-digits. After adjusting for inflation, real home prices were lower in all 20 cities. For the fourth straight month, nominal prices in all 20 Case-Shiller cities were lower than in the previous month. The 20-city index fell 2.1% in December and 9.1% for the year. The original 10-city index fell 2.3% in December and 9.8% for the year.

The biggest annual declines were seen in the former bubble areas in Florida and the Southwest. Home prices in Miami were down 17.5% in the past year, while prices fell 15.3% in Phoenix and Las Vegas. Phoenix had the largest decline in December, falling 3.5%, followed by San Diego at 3.4% (down 15% for the year) and San Francisco at 3.2% (down 10.8% for the year). But even in non-bubble cities, such as Atlanta, Cleveland, Chicago, Dallas, Detroit and Minneapolis, prices are dropping. Detroit, down 13.6%; Minneapolis, down 8%; Cleveland, down 6.3%; Chicago, down 4.5%; Atlanta, down 3.4%; Dallas, down 2.4%. Other major cities: Los Angeles, down 13.7%; Washington, down 9.4%; New York, down 5.6%; Boston, down 3.4%.

Visa going public

Visa is moving ahead with its plans to sell $17.1 billion to $18.8 billion worth of stock late next month. It would be the biggest IPO offering in US history. Since going public in May 2006, Visa's smaller rival MasterCard has risen 408% and has a market value of $26 billion.

Stay out of my wallet, Congress!

A proposal circulated by a bank to members of Congress warns that as much as $739 billion in mortgages is at "moderate to high risk" of default over the next five years and that millions of families could lose their homes.

Well, excuse me if I sound callous, but aren't many of these "families" actually flippers who bought, refinanced, sold and re-bought their way into outsized profits while I took the safe route? Now that the pyramid scheme has collapsed on them, the gummit wants to pick my pocket to bail them (and their bankers) out? To be fair, maybe they are talking about the folks who lied about their income (sometimes by 50%+) to qualify for Alt-A mortgages they couldn't afford? No? Perhaps they are talking about the folks who got interest only loans (or even negative amortization loans) because when they rates kicked up "they would definitely be making more money" and/or "real estate always goes up"?

Not sure how any of this is MY problem. As one of my professors used to say many years ago, "Lack of planning on YOUR part does not constitute an emergency on MY part."

More Bad News From Citi

Citigroup warns it may be forced to take further write-downs due to continued crumbling of the U.S. housing market. It says in its most recent 10-K that it has been forced to move a $10 billion hedge fund onto its balance sheet after major losses and revealed it has an exposure of $4 billion to the troubled bond insurance sector. It also disclosed that its traders suffered daily losses exceeding $100 million on 15 occasions in 2007. The disclosure may signal that Citigroup's problems go beyond mortgage-related losses.

Failed muni auctions

In recent days, over 100 bond auctions by US municipal borrowers and providers of student loans have failed to attract enough buyers amid concerns about the viability of bond insurers. Banks and dealers underwriting these sales have declined to buy the unsold debt given their already constrained balance sheets. This leaves local government entities facing sharply higher borrowing costs and some analysts say the market faces further failed auctions and possible extinction as a viable source of funding.

GM $38.7 Billion Loss

GM lost $38.7 billion in 2007, almost exclusively due to a non-cash charge of $38.3 billion to write down deferred tax assets. Excluding special items GM essentially broke even (a $23 million loss). The company also said it was offering a new round of buyouts to all of its 74,000 US hourly workers who are represented by the United Auto Workers. Perhaps, they will all take the company up on it, and GM can shutter its unprofitable US operations and concentrate on better opportunities abroad.

DJIA Changes

Bank of America and Chevron will replace Altria Group and Honeywell International in the benchmark Dow Jones Industrial Average effective February 19. The change is the first in four years and reflects the index's continued shift away from industrial firms and into other sectors such as energy and financial services. Excluding thinly traded Berkshire Hathaway, Bank of America and Chevron are the two biggest US companies by market capitalization that currently are not in the DJIA.

Option ARMs

The US housing crisis has focused attention on ARMs and the danger posed by their spiking interest rates, but mortgage bankers, industry experts and nonprofit officials say that the impact of Option ARMs has yet to be felt. And, they say, it will hit prime borrowers and subprime borrowers alike. People like Bruce Rose, who never should have got a loan. Rose bought his home in Boston in 1986. After stress and depression forced him to retire as a state employee in April 2006 he maxed out his credit cards on his annual income of around $16,000. On medication, he refinanced his debts through Countrywide (who else?). The new loan totaled $439,000. Rose said he did not know his mortgage broker and Countrywide used a stated income loan -- also called a "liar loan" because no proof of income is required -- and that they claimed his monthly income was $12,166. "If I had known what I was signing I would never have agreed to the loan," he said. "Now I may lose my home." With an Option ARM, borrowers can make a minimum monthly payment like a credit card, but if they do the principal increases. Rose's minimum payment rose from $1,200 a month to $2,800 and his loan now totals more than $500,000. He is fighting foreclosure. "No reasonable lender would have given him a loan like that."

If the story is trying to evoke sympathy for Mr Rose, it fails miserably. He didn't know what he was signing? He didn't know he couldn't afford a $439K mortgage on an annual income of $16K? I'm sure he took cash out (probably several years worth of income) when he refinanced; he didn't understand he'd have to pay it back? Did he think the mortgage fairy was giving away money? Gimme an effin' break!

China's latest export is inflation

After falling for years, prices of Chinese goods sold in the United States have risen for the last eight consecutive months. American consumers could see prices increase by as much as 10 percent this year on specific products — including toys, clothing, footwear, and other consumer goods — just as the United States faces a possible recession. Whether Chinese factories will succeed in making wholesalers pay more for their goods and whether retailers will be able to pass much of their higher costs on to American consumers is unclear, analysts say. Starting last June, for instance, China removed or reduced tax rebates on hundreds of items for export, including toys, garments, leather, wood and other goods. The moves are also part of Beijing's desire to move China higher up the global manufacturing chain — away from the least finished products, like plastic children's toys, toward more advanced exports that require skilled labor, like small electronics and even automobiles. Whatever the government's motivation, many Chinese exporters say the timing of the rebate cut was disastrous. Their factories had been struggling to cope with an array of other problems, including power shortages, higher raw material costs, rising wages (up to 80% in some places) and inflation in other areas. Many Chinese factory owners say a tough, new labor law, which went into effect on Jan. 1, complicates the hiring process and threatens to raise labor costs even more, at a time when parts of the country are already plagued with labor shortages.

It looks like the days of outsourcing manufacturing to obtain cheap imports from China are at an end. There's that labor arbitrage at work again.

Microsoft bids $45B for Yahoo

Microsoft to pay a $44.6B (a 62% premium) for Yahoo, in order to take on Google. This is probably not good news for Google, whose shares were already under pressure. It must be pretty nerve-wracking when Microsoft turns its guns on you. Just ask Lotus, WordPerfect, Novell, Borland and Corel about that.

News of the Day

Merrill Lynch's new CEO, John Thain, announced the firm will leave the subprime, CDO and structured credit businesses. In related news, Merrill Lynch agreed to pay $13.9 million to settle a dispute with the city of Springfield MA over CDOs that sank in value. Merrill said it agreed to reimburse Springfield after finding the city did not expressly consent to the CDO purchase. I'm sure there's more news like that in Merrill's future.

John Mack, CEO of Morgan Stanley, said the firm will stick with proprietary trading, despite trading losses that resulted in a $9.4 billion fourth-quarter writedown. It's a risky strategy for Morgan Stanley, which may face as much as $2 billion in additional writedowns for the current quarter.

Pershing Square manager William Ackman warned that the bond insurance industry might suffer crippling losses and has bet against the insurers' shares. He said MBIA and the Ambac Financial Group might lose $24 billion on the securitized mortgage investments they have guaranteed, a loss that could set off a chain reaction.

Motorola may be divesting the cellular phone business that represents half its revenue. This division has been beset with problems for the better part of a decade. The market actually greeted this news by driving Motorola stock higher; apparently the smaller company is expected to be more profitable.

Q: What happens when the Fed runs out of ammo?

A: Japan

The Fed cut the federal funds rate another 50 basis points (on top of their 75 bp cut last week) with indications of further cuts. The DJIA quickly jumped 200 points ... and just as quickly gave every point of it back before the close.

Recession - here we come

The economy grew at an anemic 0.6% rate in the fourth quarter.

Somebody's going to jail!

The FBI said it is investigating whether accounting fraud or other crimes were committed by mortgage lenders, loan brokers and Wall Street banks involved in extending loans to borrowers with poor credit. The agency has refused to identify the companies under investigation since the probe began last spring. However, it is known that at least 14 companies are involved. The FBI is cooperating with the SEC, which is investigating how subprime loans were made and packaged, and how the securities they backed were valued.

FBI Director Robert Mueller said investigators believe a "substantial" amount of mortgage fraud was committed in connection to home loans made to risky borrowers. The bureau is looking into the practices of subprime lenders. Agents also are probing potential accounting fraud by financial firms that hold subprime loans themselves or securitize them and sell them to other investors.

Subprime woes spread to Japan

Mizuho Financial Group may soon report subprime losses of as much as $2.8 billion, Japanese newspapers report. The losses could force Japan's second-largest bank to cut its full-year profit forecast for the second time.

Japan's other three top banks -- Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group and Sumitomo Trust & Banking -- will take subprime hits totaling approximately $2 billion.

First ever loss at UBS

After writedowns of about $14 billion on subprime-related losses, UBS posted a fourth-quarter loss of $11.4 billion. The loss was nearly twice as much as what analysts had estimated. The result is the first annual loss for UBS since it was created a decade ago through a merger.

Near Zero CMBS Volume in January

Barring some big (and highly unlikely) surprise tomorrow, January will end with the smallest issuance of commercial mortgage-backed securities priced in the market's two-decade history. Dealers sold a record $234 billion of US CMBS in 2007, up 14% from 2006 even as volume began to dry up at midyear.

Edited to add:

Three CDOs -- two in Asia and one in the U.S. -- worth a combined $1.3 billion were sold in January 2008. As a comparison, in January 2007, 37 CDOs worth a total of $22 billion were issued.

News of the day

Six months after acquiring the Chicago Board of Trade for $12 billion, the CME Group has confirmed that it has entered a 30-day exclusive negotiating period to consider buying the New York Mercantile Exchange for about $11 billion. The deal would solidify CME's position as the most important futures market in the world.

Purchases of new homes in the U.S. unexpectedly fell to a 12-year low in December, ending the worst sales year since records began in 1963. The S&P/Case-Shiller 20-city home price index fell 7.7% for the year through November. The 10-city index fell even further, declining a record 8.4%. The 20 city index showed yearly price declines in 17 of the 20 cities surveyed and all 20 cities showed monthly price drops. Not only did the 10-city composite index post another record low in its annual change rate, but 13 of the 20 metro areas did the same. The weakest market in November was Miami, where prices fell 15.1% in the past twelve months.

Analysts at Bank of America are warning of trouble for credit default swaps if even a small bond insurer defaults. ACA Capital Holdings may face delinquency proceedings next month from the Maryland Insurance Administration if it can't delay action on $60 billion of CDS contracts. The company guarantees more than $75 billion of debt.

Countrywide Financial Corporation reported a fourth-quarter loss of $422 million, but the results were not expected to hinder its proposed $4.1 billion takeover by the Bank of America. Countrywide’s earnings fell far short of Wall Street estimates. Still, shares rose 36 cents (6%) to $6.31. CEO Angelo Mozilo will voluntarily give up $37.5 million in severance and consulting pay in connection with the proposed takeover by the Bank of America Corporation. His stock and employee equity awards would be treated the same as that of other shareholders and employees if the sale goes through. However, Mozilo sold almost $450 million in stock from April 2004 to August 2007.

Another leftist idea

Senate Banking Committee Chairman Christopher Dodd proposed creating a federal program to buy “very distressed” mortgages at steep discounts as part of economic stimulus legislation being developed in Congress. The Federal Homeownership Preservation Corporation would buy loans and finance them as 30-year fixed-rate mortgages to help keep borrowers from losing their homes, Dodd said today at a Washington news conference to outline the committee’s agenda.

The latest way the gummit is going to tax me to reward those who took risks that I chose to avoid. ARGH!

GOOG down

Google closed yesterday at $566.40, down 24.2% from its all-time high of $747.24.

Financial WMDs

Societe Generale said today that a single trader who fooled his bosses carried out a massive 4.9 billion euro ($7.15 billion) fraud -- one of the biggest in financial history. Trading in the bank's shares was temporarily suspended but fell 5% after they resumed because of the fraud and a 2.05 billion euro loss in the US subprime mortgage market. The bank said it needed a 5.5 billion euros capital increase to restore its balance sheet. Chairman Daniel Bouton said the unnamed rogue trader had used "extremely sophisticated and varied techniques" to carry out "fraud of a considerable scope." The trader, based in Paris, is believed to have built up the huge losses gambling on share futures. The bank said the trader took out "massive fraudulent directional positions in 2007 and 2008 beyond his limited authority." The case dwarfs that of Nick Leeson, the original British "rogue trader" who lost $1.5 billion at Barings, causing the failure of the venerable British bank in 1995. (Source: AFP)

GM by a nose

Toyota sold 9.366 million vehicles last year globally (up 6% from 2006). Toyota had said as late as yesterday that its total was 9.37 million vehicles, but today Toyota spokesman Paul Nolasco in Tokyo confirmed the extra digit in Toyota's sales, showing that GM's total (9,369,524 up 3% from 2006) was narrowly higher. So GM retains its crown as the world's #1 automaker for the 77th year in a row.

Last year, Toyota deposed Ford as the #2 auto seller in the US. Toyota sold 2.6 million vehicles for a 16% share of the market, more than double from what it sold in 1990.

GM remains the auto sales leader in the US, but its market share has dropped dramatically from about 35% in 1990 to about 24% in 2007. GM sold 3.8 million vehicles in the United States last year, down 6% from 2006, due largely to a reduction in fleet sales. Sales in the rest of the world are up 10%. It's like I wrote about Ford about 2.5 years ago. If they could just close down their US operations, they would be insanely profitable companies.

Wachovia Earnings

Wachovia's fourth-quarter net income plummeted 98%, as the company's deteriorating lending portfolio forced it to dramatically increase its loan-loss provision. The company also saw its bad loans and delinquencies surge. The bank reported net income of $51 million, or three cents a share, versus $2.3 billion, or $1.20 a share, a year earlier. The latest results included five cents in net merger-related costs. The company increased its loan-loss provision by $1.3 billion.

Roller Coaster Day

The DJIA recovered from a 325 point loss to end the day up 300 points.

AAPL Slaughtered

Apple reported a first-quarter profit that rose 58% from a year ago, but the company gave an earnings outlook that fell short of Wall Street analysts' forecasts. I don't know how reasonable those forecasts were, but the stock got slaughtered. They dropped 11% in after hours trading yesterday, and as of 11:45 this morning are down 16% at $130.60. They are now down an amazing 35.7% from their high of $202.96 just a few weeks ago. I really wish I had shorted them as I suggested at that time. I guess I am just too much of a chickenshit to play the market.

Follow up on earlier post

Yesterday, Ambac shares went up 34%, and shares of MBIA went up 40%.

So let's see if I understand the sequence of events here...
1) Wall Street analysts rate Ambac and MBIA buys
2) Ambac and MBIA lose over half their value
3) Wall Street analysts downgrade Ambac and MBIA to holds
4) Ambac and MBIA shares skyrocket

Brilliant!

Fed Blinks

The Federal Reserve unexpectedly slashed the federal funds rate by a bold three-fourths of a percentage point from 4.25% to 3.5%, responding to a global plunge in stock markets that heightened concerns about a recession. The Fed signaled that further rate cuts were likely. The reduction marked the biggest reduction since 1990. It also marked the first time that the Fed has changed the rate between meetings since September 2001, in response to the terrorist attacks. Despite the Fed's bold move, Wall Street plunged at the bell with the DJIA down 465 points immediately after trading started. Stocks rebounded somewhat and the DJIA finished the day off 128 points at 11,971.

ETA - turns out a good part of that global plunge was caused by SocGen unwinding its derivative positions.

Bank of America Earnings

Bank of America posted earnings of $0.05 EPS, while First Call had estimates at $0.18 on last look. Net income was down 95% at $268 million for the quarter. Trading account losses were $5.44 Billion, driven almost exclusively by $5.28 Billion in CDO writedowns (considerably larger than the $3.3 billion estimated as recently as Dec 22). Provision expenses increased $1.74 Billion, mostly due to a $1.33 Billion addition to the reserve for credit losses. Amazingly despite the bad day overall on Wall Street, Bank of America shares actually closed up 4% after slipping in early trading.

Stock Bloodbath

Markets in the US are closed today, but around the world stocks took quite a beating...

India, down 9.5%, trading was halted
Hong Kong, down 8%, down 21% so far this year
Australia, down 7%
Brazil, down 6.9%
Germany, down 6.7%
South Korea, down 6%
France, down 5.9%
Japan, down 5.7%
Canada, down 4.8%
UK, down 4.7%

On barns and horses

Yesterday Ambac shares lost more than half their value when Moody's Investors Service warned that it may cut the AAA ratings of Ambac and rival MBIA. Fitch Ratings actually took the plunge and downgraded Ambac Financial to AA from AAA. Today Banc of America Securities analyst Tamara Kravec cut her rating on the bond-insurance sector to neutral from overweight and downgraded Ambac, MBIA and Security Capital Assurance to neutral from buy.

ETA: And it's not like this would have taken any brilliant insight or unavailable information to discover. The at-risk nature of the rating has been discussed on websites like www.marketwatch.com since the company announced a $737M loss for the fourth quarter and the resulting need to float a $1B bond offering.

S&P down 10% for year

Wow, it's only January 18th and the S&P500 is already down almost 10% for the year, closing today at 1325. If you remember my prediction just 9 days ago was that 1322 by year end was a pessimistic prediction. Of course, there's a good chance of some sort of bounceback in the next 11 months, but any way you slice it 2008 is going to be a rough year for the market. I hate looking at my 401(k) balances; at least I'm buying some cheap shares - thank God for dollar averaging in down markets.

Countrywide still plummeting

Despite the deal to be bought out by Bank of America, Countrywide stock continues to plummet. It dropped 9.5% today to $4.96, far below the price BoA is planning to pay. Presumably, the market thinks this deal might not happen.

Self-serving opinion

David Ellis is executive vice president of the Greater Atlanta Home Builders Association. He wrote an editorial in today's AJC entitled "Law of supply and demand says: Buy a home now." What an incredibly self-serving opinion. I wonder if he actually believes it.

NYSE to buy AMEX

The New York Stock Exchange agreed to buy the American Stock Exchange, ending a once intense rivalry that began in colonial times when brokers traded in outdoor markets. The AMEX, unable to compete like it once did, began to focus on trading options and other financial products. It now trades generally smaller companies that are often too illiquid to meet the standards of bigger rivals. NYSE said it would pay AMEX's seatholders $260 million in NYSE Euronext stock. In addition, they would receive more stock after the sale of the AMEX's building at 86 Trinity Place, a landmarked art deco building it moved into in 1921 that sits only blocks away from the World Trade Center site. The deal will give NYSE a second US license for an option exchange and make the NYSE the #3 US options marketplace after CME and CBOT.

Sprint

Sprint Nextel shares are down 25% to close at $8.70 today.

Fitch Ratings downgraded several of its debt ratings to BBB- from BBB on Friday over a lack of visibility of the company's performance going forward and concerns over financial and operating results.

In the fourth quarter, Sprint lost 109,000 subscribers overall and 683,000 postpaid customers.
Sprint ended 2007 with 53.8 million wireless customers, barely higher than the 53.1 million it served at the end of 2006. AT&T gained a net 4.7 million mobile customers through the first three quarters of 2007 to 65.7 million. In the same time frame, Verizon added 4.6 million mobile subscribers to 63.7 million. What's worse, the number of postpaid subscribers served by Sprint fell by 1 million in 2007 to 40.8 million.

Sprint said it would cut 4,000 jobs from its workforce of 60,000 just one year after it eliminated 5,000 positions. Sprint also said it would close 125 of its 1,400 stores. Those cuts would save as much as $800 million on an annualized basis, the company said. Sprint aims to complete the reductions in the first half of 2008.

Poor customer service is cited as the reason for the mass subscriber defections. Anecdotally I can vouch for that. I am in a dispute with them now because they overcharged me for data usage both of the prior months and refuse to budge. If I weren't locked into a contract I'd be one of that million.

WaMu

Washington Mutual reported a nearly $2 billion fourth-quarter net loss as the lender continued to struggle in the face of a meltdown in the mortgage industry and questions about its viability. The company lost $2.19 a share in the period after taking a $1.6 billion charge to write down the value of its home loan business and set aside more provisions to cover the cost of housing-market weakness.

However ...

The stock was up 8.75% on speculation that it is a tempting takeover target

Merrill Lynch 4Q Numbers Out

Merrill Lynch wrote off $11.5 billion of bad debt and derivatives and reported a fourth-quarter net loss of $9.83 billion, or $12.01 a share. Revenue was negative $8.19 billion. [Analysts were expecting $702 million on the plus-side, with a range between +$7.86 billion and -$3.34 billion. D'OH!] Merrill also made $2.6 billion in credit-valuation adjustments related to hedges on CDOs. The loss from continuing operations was $12.57 a share. [The analyst range was between $1.51 and $11 a share.] The stock closed down $5.56 (10.1%) at $49.45.

Busy day on Wall Street

Market down over 2%, led by several key stocks.

Story 1: Bad news (REALLY bad news) from Citi

Citigroup reported its first quarterly loss since 1998 and the largest loss in the bank's 196-year history. It slashed its dividend by 41% and raised more than $12 billion to bolster its capital position. The company swung to a fourth-quarter loss of $9.83 billion, or $1.99 a share. Continued woes in the subprime-mortgage market caused the bank to book pre-tax write-downs and credit costs of about $18.1 billion. Revenue dropped 70% to $7.22 billion from $23.83 billion. This was the worst quarter in Citi's 196 year history. Its stock fell $2.12 (7.3%) to $26.94. It took JP Morgan Chase and Merrill Lynch, both down 5.29%, with it.

Story 2: Bank of America exiting investment banking

Bank of America today outlined a streamlined corporate and investment banking unit that guards the functions most closely aligned with serving large businesses but eliminates or scales back more exotic trading functions. Bank of America is selling its prime brokerage, which lends to hedge funds. The company is also gutting parts ofits trading unit and shutting down such structured products areas as CDOs. Bank of America will lay off 650 people in its global corporate and investment bank in the coming weeks, in addition to 500l ayoffs announced in October after the unit posted disastrous third-quarter results. (Source: WSJ) The stock dropped 3.4%. Also, its upcoming acquisition Countrywide was down 4.6%.

Other bank stocks were clobbered too. Wells Fargo was down 6.1%; State Street was down 5.94%; Washington Mutual was down 5.1%; Wachovia Bank was down 4.38%.

Story 3: Apple down

Despite revealing its new (super-cool) machine at MacWorld, Apple shares went down $9.74 (5.45%) to $169.04. I'll note that the stock is now down 16.7% from its 52-week high of $202.96 just two weeks ago.

As an aside, not a big market mover, but Krispy Kreme was down 9% to $2.32, a 52-week low.

China putting brakes on US investment

Beijing put the brakes on a plan by its investment arm, China Development Bank, to invest $2 billion in Citigroup. No surprise. Earlier this year, China Investment Corporation made a $5 billion investment in Morgan Stanley (which as I've discussed in this blog has done very poorly), and as part of its 2007 IPO, Blackstone solicited and obtained a $3 billion investment from China (which is worth less than $2 billion today).

Source: Marketwatch

Structured Finance Market Dead For Now

Here's a graph of new securitization deals (in billions of dollars) by month during 2007...

Clearly the securitization market is dead.

Continuing Saga at Merrill Lynch and Citi

Merrill Lynch is expected to report write-downs of $15 billion stemming from soured mortgage investments, coming in at nearly double the original estimate. The losses are expected to be disclosed when Merrill reports earnings next week. Wall Street expects Merrill to report losses of $10 billion to $12 billion. In related news, Charlie Gasparino reported on CNBC that sources inside the firm have told him the Citigroup write-downs could be $24 billion when earnings are announced next Tuesday.

These write-downs are prompting both firms to raise additional capital from outside investors. Citigroup could get as much as $10 billion from foreign governments, and Merrill is expected to receive $3-4 billion, with much of the cash coming from a Middle Eastern government investment fund. Citi is also expected to consider slashing its dividend in half in a move that would save it around $2.5 billion a year. Both firms are rushing to finalize the deals before they report earnings.

http://www.marketwatch.com/merrill-lynch-reportedly-facing-massive/

http://www.marketwatch.com/citigroup-merrill-reportedly-seek-fresh/

Bank of America to acquire Countrywide Financial!

Bank of America is purchasing Countrywide Financial for $4 billion, effectively doubling down on its previous investment in the troubled firm and catapulting the buyer into the top spot among mortgage lenders and loan servicers in the US. The stock-swap deal will put an end to the independence of the troubled California lender. Terms call for Countrywide stockholders to receive 0.1822 of a share of Bank of America stock in exchange for each share they own. At yesterday's close, that values Countrywide at $7.16 a share - lower than the $7.75 closing price after news leaked of a possible deal. Countrywide's shares fell 13%, dropping $1.04 early today, to $6.71.

While Countrywide's market value is a fraction of its peak level of $45 billion last year, Bank of America's bigger expense would be writedowns from declining value of the lender's $209 billion loan portfolio, said Sean Egan, managing director of Egan-Jones Rating Co. in Philadelphia. A 5% writedown on the portfolio would be more than $10 billion, roughly half of the bank's 2006 profit of $21 billion. And keep in mind that it is more likely to be much much MUCH worse than $10B than to be any better than that. In my mind $10B is an optimistic best case scenario.

Sources: WSJ, MarketWatch

ETA:

The Good
* Merger would create by far the largest mortgage lender and servicer in the US - with approximately 12.8 million customers and 23% market share
* BofA would gain the opportunity to cross-sell bank products to an estimated 9 million Countrywide mortgage customers
* BofA would gain Countrywide's retail bank (thrift deposit) customers
* BofA would acquire leading - while proprietary - loan origination and loan servicing platforms

The Bad
* Managing through a potential culture clash between Countrywide's aggressive mortgage operations and Bank of America's professional retail banking environment may be a significant challenge
* With the prospect of this merger, BofA will test regulators anxiety levels associated with the 10% deposit rule by exploiting a little known, never used loophole
* BofA's balance sheet status and capitalization requirement will come under further scrutiny, which started when it acquired LaSalle bank
* Identification and elimination of redundant lending and banking systems is complex, and will be a multi-year process

The Ugly
With a recession looming, capital markets becoming more nervous, an overspent consumer, rising energy rates and a collapsing real estate market, this acquisition is a very bold move by the BofA board. In fact, the timing of this acquisition seems on the surface little more than a bailout strategy to protect its earlier $2 billion investment in Countrywide.

CC

Circuit City down 80% for the year. Who would have thought that their brilliant strategy of firing all their employees who, like, actually knew stuff and replacing them with cheaper noobs would not pay off? I mean who could possibly have foreseen that?

I am continually amazed at the arrogance and stupidity of executives who view their sorry asses as irreplaceable while looking down at the folks who actually get the work done as interchangeable cogs to be obtained at the lowest possible price.

Delta Seeking Merger Partner

In a story in today's WSJ, "people close to the matter" were cited as saying Delta would seek permission from its board of directors for CEO Richard Anderson to begin merger talks with Northwest. Analysts also expect Delta to consider a tie up with either UAL or Continental. Wow, what a collection of financially weak airlines. Perhaps merging will give you a stronger company. Then again, maybe it will just give you a larger weak airline.

Bank of America to acquire Countrywide Financial?

The Wall Street Journal just reported that Bank of America is in advanced talks to acquire Countrywide. It isn't clear how quickly a deal might be struck. Bank of America last August propped up Countrywide by buying $2 billion of preferred shares convertible into a stake of about 16% in the lender. The total market value of Countrywide has plunged to about $3 billion.

Too bad. It looks like they will avoid bankruptcy after all. Although I am unclear why BoA would want them in the first place. Perhaps after some due diligence this deal will fall apart, but presumably BoA already did a lot of due diligence when they bought their stake in August (although maybe not given how poorly that stake has performed since then).

Weak December Sales

For December 2007, 27 retailers missed December forecasts for sales at stores open at least a year (14 beat forecasts and 2 met forecasts). The worst results were...

AnnTaylor posted a 9.4% decline, worse than the 1.9% decline anticipated

Limited posted a 8% drop, worse than the 4% decline anticipated

Macy's posted a 7.9% drop in same-store sales, worse than the 6.5% decline anticipated

Gap posted a 6% decline, worse than the 2.2% decline anticipated

Abercrombie & Fitch posted a 2% decline, worse than the 0.8% decline anticipated

Those sales numbers are REALLY bad. It would indeed appear that a recession is in the works.

Annual Forecasting Dinner

The CFA Society of Atlanta had its annual forecasting dinner tonight. I have two thoughts related to this...

1) As an aside, I was reminded of my recent post referencing an article about the intellectual benefits of living in a big city. Our speakers were OK, but the New York chapter? For their most recent soiree they got ... the Secretary of the Treasury!

2) More to the point, I have the answer to some questions you might have. Have you been wondering how the investment experts at UBS could have been left holding the bag on over $13 billion of worthless CDOs? Have you been wondering how the investment experts at Bear Stearns could have lost almost $7 a share in a single quarter? Well, wonder no more. Tonight I learned the truth ... They are smoking some good s--t! Both those firms are predicting 12/31/2008 S&P 500 at 1700. That's a +17.6% return ... for an economy where the best-case scenario is that it narrowly avoids recession in 2008.

For the record, the predictions for 12/31/2008 that I put in for the contest were

S&P 500 = 1322 (a 10% drop from its 12/31/2007 value, which I now think is overly pessimistic, but I do think the market is going to be slightly to moderately down for the year)
Well, so much for overly pessimistic. The S&P500 ended down 38.6% at 903. 1700 my butt.

Ten year Treasury note yield = 3.70% (down from its 3.79% value today)
Yield as of 12/31/2008 = 2.21%

Fed Funds Rate = 3.50% (down 75 basis points from its value today)
Fed Funds Rate = 0.25% (!)

Countrywide Going Down?

Shares of Countrywide plunged today on reports that the company was nearing bankruptcy. The stock recovered somewhat since the company put out a statement saying that "There is no substance to the rumor that Countrywide is planning to file for bankruptcy, and we are not aware of any basis for the rumor that any of the major rating agencies are contemplating negative action relative to the company." But that's not the only bad press the company has gotten today. Federal bankruptcy judge Thomas P. Agresti had this to say about documents "recreated" by Countrywide that are part of a bankruptcy proceeding in Pennsylvania: "These are a sign that something is not right in Denmark". This is big trouble for Countrywide.

Judge Agresti said that discovery should proceed so that those involved in the case could determine how Countrywide’s systems might generate such documents. A spokesman for the lender, Rick Simon, said: “It is not Countrywide’s policy to create or ‘fabricate’ any documents as evidence that they were sent if they had not been. We believe it will be shown in further discovery that the Countrywide bankruptcy technician who generated the documents at issue did so as an efficient way to convey the dates the escrow analyses were done and the calculations of the payments as a result of the analyses.” The documents were generated in a case involving Sharon Diane Hill, a homeowner in Monroeville, Pa. Ms. Hill filed for Chapter 13 bankruptcy protection in March 2001 to try to save her home from foreclosure. After meeting her mortgage obligations under the 60-month bankruptcy plan, Ms. Hill’s case was discharged and officially closed on March 9, 2007. Countrywide, the servicer on her loan, did not object to the discharge; court records from that date show she was current on her mortgage. But one month later, Ms. Hill received a notice of intention to foreclose from Countrywide, stating that she was in default and owed the company $4,166. Court records show that the amount claimed by Countrywide was from the period during which Ms. Hill was making regular payments under the auspices of the bankruptcy court. They included “monthly charges” totaling $3,840 from November 2006 to April 2007, late charges of $128 and other charges of almost $200. In May, Countrywide sent Ms. Hill another notice stating that her loan was delinquent and demanding that she pay $4,715.58.

Countrywide is going down. And in my opinion it couldn't happen to a more deserving company. Too bad that CEO Mozilo is going to avoid the worst of it. Scum!

Banks could lose a quarter TRILLION dollars

Banks could lose as much as $242 billion from the mortgage crisis, leaving the industry in need of more capital, analysts warned on Monday. Since subprime mortgage problems erupted in August, banks, thrifts and brokerage firms around the world have written down the value of mortgage-related assets by more than $94 billion. Banks could suffer another $59 billion to $148 billion of such losses over the next few years, partly depending on how fast house prices in the U.S. fall, the analysts forecast. That would leave total losses at between $153 billion and $242 billion, forcing the banking industry to raise more capital.

Edited (2/1) to add:
Standard & Poor's estimates that banks, credit unions and foreign financial institutions may be hit with more than $265 billion in losses from securities tied to subprime mortgages.

Bear Stearns CEO Ousted

Bear Stearns's James Cayne is relinquishing the post of CEO but retaining the chairman post. They got it half right.

Krispy Kreme CEO Ousted

Daryl Brewster has left the building for “personal reasons.” And it's about time, with the results KK has been having. The only reason KK's loss narrowed by 20% recently was a halving of general and administrative costs while sales, free cash flow and cash continued to crumble.
Chairman James Morgan now slides into the President and CEO spots, and according to the company: “This is not an interim appointment, and it is anticipated that he will serve as President and Chief Executive Officer for the foreseeable future.” Until the company goes into bankruptcy, anyway.

5% Unemployment

A follow-up on my comment almost three years ago about economic reporting (by the way, you will note that there was no stagnation or inflation in 05, 06 or 07) ...

Bush is getting blasted for the weak economy as unemployment climbs to 5%. Does anybody remember when Clinton was praised for the strong economy as unemployment dropped to 5%?!

Credit Suisse Write-Down

Credit Suisse is expected to announce further losses from its exposure to U.S. subprime loans and declare new writeoffs worth $2.3 billion.

Response to Comment

I take a look at this - which I find hard not to believe is not a result of the bursting of the real-estate/housing bubble - and what I perceive to be the idiocy which is causing successive loss after successive loss on Wall Street in recent days, and immediately think in terms of 1929's foolishness all over again. I remember Alan Greenspan's comment when the market was on the rise - "irrational exhuberance", he called it - and I see much of the same irrational action today, just in the opposite direction.

Unfortunately the issue is that the foolishness is the run-up in prices, not the subsequent drop. Once the idiocy is apparent, there is nothing rational markets can do but price down the assets involved. Without reaching out to the 1929 crash, we have the much more recent 2000-2002 stock market collapse. Collateralized Debt Obligations (CDO) simply became overpriced due in large part to an overreliance on mathematical models that seriously understated the possibility of default. If you lend money to borrowers who cannot manage 3% down payments and need interest-only loans to "afford" payments and who are relying on unrealistic appreciation of their houses, what do you think is going to happen? Duh! Massive default, resulting in a massive drop in value of the CDOs. And that's what we're seeing now. And what should happen to a company that foolishly invested tens of billions of dollars in these CDOs that are now close to worthless? Exactly what we're seeing - their balance sheets are ravaged, their income statements disintegrate, their CEOs are terminated, and some of their other assets are liquidated in a fire sale. I do not view it as reverse irrational exhuberance, but rather a rational pricing of companies that were irrationally priced before.

Take oil, for example. It once again broke the $100/barrel benchmark, based on [...] "fear" that violence in Nigeria - which has not impacted its production of oil - might do so. Say what? I found the following on Bloomberg: "Not one drop of oil was disrupted when Benazir Bhutto was assassinated last week, but prices surged," Mueller said. "Anything that can is sending the market higher. That's what happens when you have a jittery market." Huh?!? So let me get this straight: Nothing real or tangible has actually happened which directly impacted oil supplies - but we hammer its price ever wildly upward because ... of expectations? Fears? Psychological BS??? Whiskey Tango Foxtrot!!!! That tells me we are actually not working with what a thing is worth - which, to me, is the foundation of what free-market capitalism means - but instead catering to the psychological well-being and/or unreasonable reactions of people I must assume are fundamentally insane (given the volatility of what they're acting upon) and allowing such people to determine these things for ... well, pretty much everything. Uh oh.

Something to remember is that all investors like predictability. The real (even if unlikely) possibility of disruption is going to cause a type of hoarding mechanism to kick in, driving prices higher.

Although your point about the resulting insanity of prices is well taken, I think we have a fundamental disagreement over the phrase I've underlined. In a completely capitalist free market, what exactly is a thing "worth"? Exactly what willing buyers and willing sellers agree to trade that thing at, no more and no less. So if oil prices are bid up because morons panic without need and want to buy more, then the higher price is exactly what oil is worth.

Is this really what (and who) we want controlling our economic viability and well-being? Regrettably, I do not have a solution. But it sickens me to watch the markets move for no good reason, know that especially some of the ridiculous trends we've seen recently hurt those people everywhere who depend upon them for their every-day survival, and see signs which tell me no one's paying attention to Santayana's maxim as regards what happened in the late Twenties and early Thirties. Sorry for the rant. But I must be honest and say I find almost everything about what I see in the markets, these days, as utterly laughable. Do any of the people there have so much as two undamaged neurons to rub together? I guess the same goes for the morons who runs some of the companies showing the most egregious foolish behavior.

In my mind, the issue of mismanagement is a completely different one from the issue of prices. The institutions I've been posting about (Citi, Morgan Stanley, Merrill Lynch) are supposed to be the nation's premier investment institutions. It should go without saying that a large part of prudent investment is proper risk management, but the common thread in all these write-downs -- which have passed the $70 billion mark at this point and will certainly surpass $100 billion before all is said and done -- is a complete breakdown in the risk management process. As far as I'm concerned, it borders on the criminally negligent. That not all these executives have been fired, that those who have been fired have walked away with multi-million dollar packages, and that the boards have not been held accountable, is appalling.

Any ideas? Something sure would be nice to settle the mind that there is something more reasonable than what I believe I see ...

Unfortunately the only idea I have - administering IQ tests before you allow folks to invest - is unworkable for a variety of reasons.

Problems at SSgA

State Street is parting ways with William Hunt, head of the company's investment management arm State Street Global Advisors. Although the company said Hunt resigned, he will receive a severance package worth $14.1 million.

State Street has reserved $618 million to contend with investor lawsuits related to its fixed income strategies (translation: the CDO subprime mess), which resulted in a $279 million charge to earnings.

Indian Salaries

The meteoric rise of India's currency, the rupee, might be good news for Indians who travel abroad, but it spells disaster for millions of entrepreneurs like Rajiv Prem, a clothing exporter in this dusty boomtown. Prem has had to close one of his three factories and lay off about 200 workers, more than a fifth of his work force. Most were tailors and seamstresses who made clothes mainly for U.S. retailers, including H&M, Kohl's and Anthropology.

This clearly illustrates what I've been saying for a long time. The rampant replacement of Indian labor for US labor is a temporary arbitrage. Currently, Indian labor is cheap relative to US labor. Like any arbitrage, this encourages buyers (companies) to short the expensive US labor (layoff employees) and buy the cheap Indian labor (offshore). Of course, economics 101 tells us what happens when you do this. US wages go down; Indian wages go up. And due to the overhead of setting up in a foreign country, the wages don't have to become equal (not even close) before it's no longer worth it for US firms to get their labor offshore.

One conclusion is that Cooper Anderson should have a Coke and a smile and ... . Another conclusion is that all the companies that built their business models on offshoring work to cheap Indian labor to compete on price are in for a rude awakening. They'd better find a new way to compete because the long-term consequences of the short-term decision to offshore are starting to come due. Hewitt Associates, which pioneered this model in the benefits outsourcing industry, had a loss of $175M last year. Offshoring doesn't seem to be a panacea for them.

Stock Futures Point to ... ?

"Stock Futures Point to Further Decline"--headline, Associated Press, Jan. 3, 7:02 a.m.

"Stock Futures Point to Flat Open"--headline, Associated Press, Jan. 3, 8:22 a.m.

"Stock Futures Point to Higher Open"--headline, Associated Press, Jan. 3, 9:21 a.m.

(Thanks to WSJ's Best of the Web)

Interesting Article on FT website

Since September, Middle Eastern and east Asian sovereign wealth funds have made a succession of investments in four US banks: Bear Stearns, Citigroup, Morgan Stanley and Merrill Lynch. Most commentators have been inclined to welcome this global bail-out: better to bring in foreign capital than to shrink balance sheets by reducing lending. Yet we need to recognise that these “capital injections” represent a transfer of the revenues from the US financial services industry into the hands of foreign governments. This is happening at a time when the gap between eastern and western incomes is narrowing at an unprecedented pace.

Edited to add links to explanations of the four deals in question:
Merrill Lynch, 12/25/2007
Morgan Stanley, 12/19/2007
Citi, 11/26/2007
Bear Stearns, 10/23/2007
What's most striking is the speed of the collapse - we're talking about 2 months for foreign interests to own 10% of four of the largest US investment banks.

Worst is not over at Merrill

Merrill Lynch may cut 1600 jobs soon, as they struggle with billions of dollars of mortgage-related write-downs. Merrill could also unveil write-downs of as much as $10 billion from the fourth quarter.

John Thain, Merrill Lynch's new CEO, is in talks with Chinese and Middle Eastern investors that could lead to a capital-raising sale of another big stake in the US investment bank. Thain is taking calls from a number of potential buyers, understood to include sovereign wealth funds from the Gulf and China, in a bid to raise extra capital. The observer quoted an unnamed US observer as saying that the Temasek cash would not be enough to insulate the group from the impact of the global credit crunch and another unidentified source as saying Thain was seeking extra overseas capital to boost Merrill's balance sheet and to avert potential future liquidity problems.

World Economy

The World Bank says China and India are not what they are pumped up to be. The Bank has "downsized" the economies of the two Asian giants by nearly 40% under new metrics, which it says are more reliable and accurate than previous estimates.

According to the new data, India's GDP in Purchasing Power Parity (PPP) terms was $2.34 trillion in 2005 and in nominal dollar terms was $779 billion. Prior to the revision, India's GDP in PPP terms was $3.8 trillion in 2005, which would have made it the third largest economy after China and ahead of Germany, tied with Japan. Using the new figure, it's fifth.

The revised estimates also downsized China's economy, although it remained the second largest economy behind the US. China's economy under the new metrics was $5.33 trillion in 2005 in PPP terms against the $8.8 trillion estimated earlier.

The top 10 economies in the world, totalling 64% of the global $55 trillion GDP(PPP):
1 United States $12.38T (22.5%)
2 People's Republic of China $5.33T (9.7%)
3 Japan $3.87T (7.0%)
4 Germany $2.51T (4.6%)
5 India $2.34T (4.3%)
6 United Kingdom $1.90T (3.5%)
7 France $1.86T (3.4%)
8 Russia $1.70T (3.1%)
9 Italy $1.63T (3.0%)
10 Brazil $1.59T (2.9%)

Source: World Bank

Apparently others think so too

Currency analysts say the value of the U.S. dollar in 2008 will depend on the country's economic growth. Hans Redeker of BNP Paribas says the main reason for the dollar's recent decline has been the idea that the US is no longer the world's driving economic force. He says 2008 will show that decoupling has not happened as much as previously thought, giving the dollar a boost.

Has the US dollar bottomed out?

USD against
GBP 0.50178
EUR 0.68006
JPY 113.115

I think 2008 will be a moderately good year for the greenback.

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.