March 28, 2008 4:28PM

The Reality Check That Bounced

By Elizabeth MacDonald

Oliver Stone is doing a movie about George W. Bush.

That bit of news was a fitting end to last week’s kaleidescopic developments, straight off the fiction shelves.

Before I get to the week that was, I want to thank all of you who weighed in about my blog about listening to presidential candidate and Congressman Ron Paul. I am so deeply appreciative and grateful for all of your comments, I read them all and I am impressed with and admire your knowledge and passion.

I came here to Fox Business, the sister network to Fox News, just last October, and Fox Business gave me the honor of starting this blog this year. One thing rings through all of your responses–you deeply love this country and you are deeply worried. I hear you. Again, I thank you.

Please be aware that I am a flawed individual who is aware of my many limitations (on an hourly basis), please tell me when I am off the rails. I will do my level best. Know that I listen to everybody. I try to think things through, as I get an allergic skin reaction to knee-jerk, autopilot thinking.

I would like to see Dr. Paul debate all of the presidential candidates, not just John McCain (should Dr. Paul run as a third party candidate?). Though I may not agree with everything he says, I also don’t agree with what the other candidates say as well. Dr. Paul deserves a fair hearing, this country ought to hear what he has to say, especially about monetary and fiscal policy.

Here’s a recap of the week’s headspinning highlights: the Treasury Department plans to propose Monday that the Federal Reserve should get more oversight authority of all of the players in the financial markets, letting the central bank examine the books of any financial institution, not just banks; planned Congressional hearings into the Federal Reserve’s historic rescue of Bear Stearns and its handouts to investment banks, which it doesn’t regulate; the overleveraged, underwater Fannie Mae and Freddie Mac now needing to raise a total of $20b more via dilutive stock offerings, a whopping two-thirds of their market caps; scary talk about more bank write-downs; the weakening dollar; and oil veering toward $120.

But just as thinking that Oliver Stone’s movies are historically accurate is like thinking that the movie “Gone With the Wind” is a documentary, it is just as precarious to believe the fiction that the Bear Stearns-JP Morgan deal midwifed by the Fed signals the bottom of the market, as some media pundits wildly suggest.

It’s also just as cavalier to believe the analysts’ estimates of the writedowns in the financial sector stemming from the housing and credit crisis are etched in stone. They are all over the map, with stocks in Citigroup (C), Merrill Lynch (MER), Lehman Bros (LEH), Goldman Sachs (GS), JP Morgan Chase (JPM) and UBS (UBS) getting whipsawed (to get a handle on it, see my prior blog, “The Answer to Who’s Next on Wall Street”).

The writedowns will be sizable, to be sure, but the question is this: Might some of the writedowns be overstated, given cash flows are still coming in from loans backing these securities, securities the firms are being forced to write down because widespread panic has frozen the market for them?

And the broader policy issue: Will the Treasury secretary’s plan really put more guardrails on a free market that’s turned into a free-for-all? When will Congress stop its neat after-the-fact refereeing exhibited now in dealing with Wall Street’s very expensive, very messy, and personally enriching experiment at satisfying the government’s 100% homeownership dream? Will the Fed’s costly moves to revivify the financial’s balance sheets deadened by Frankenstein securities they created really work?

*THE REGULATORY FREIGHT TRAIN: Congress is hopping on it now, with the Treasury planning more oversight powers at the Federal Reserve of all financial institutions, not just banks. The Fed may become the sole regulator for both commercial and investment banks, following the collapse of Bear Stearns.  For now the proposals are taking the shape of letting the central bank scrutinize the books at all institutions–no sign yet of tough proposals, like whether credit derivatives would have to be listed on, say, the Commodities Futures Exchange, engendering more oversight.

Also hearings on Capitol Hill that may take a closer look at the Federal Reserve’s actions on Wall Street, including the forced nuptials between Bear Stearns (BSC) and JP Morgan Chase (JPM). No surprise that Jamie Dimon, who runs JP Morgan, is on the board of the New York Federal Reserve, which provided a $29b non-recourse backstop to the most illiquid parts of Bear’s balance sheets, now only protected by a $1bn cushion of first loss collateral from JPMorgan. Non-recourse, meaning, the Fed can’t hit up JP Morgan for this money, it has to auction those securities off and take a gain or a loss on them, not JP Morgan.

Tighter capital requirements for investment banks may also be in store–argument being if they can have access to the discount window, then they ought to face the same capital reserve requirements regular banks must meet. If the Fed is going to run with the wolves on Wall Street, then Wall Street needs to be tamed.

Also, as it stands now, the capital reserve levels the investment banks face from the Securities & Exchange Commission are roughly a third of what the Fed requires. Remember, banks in Japan dropped into a black hole in the ’90s because they didn’t have to set aside a sufficient amount in capital reserves to back their lending. The collapse of the banking sector in Japan led to that country’s lost decade of the ’90s, which it only surfaced from several years ago.

And despite what you hear that the Fed is only charged with printing money and that this backstop doesn’t hurt taxpayers, it does. The Fed gets to print money, with the US taxpayer paying the interest on the treasury bonds that the governement gives the Fed in exchange for printing a similar amount of dollar bills. The Fed also turns over to government coffers what it earns on the investments it holds in its portfolio. Taking a hit from Frankenstein securities means less money coming in those coffers from the Fed.

And printing more money to make up the difference–which taxpayers pay for in the form of inflation. Watch this quote: In 2002, then Fed board member Ben Bernanke, now the Fed chairman, said in a speech, “the U.S. government has a technology called a printing press…that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”

*BEHIND THE BANK WRITE-DOWNS: The market is volatile because the accounting rules the financials use to book these write-downs for their securities backed by mortgages and other credit act more like a weathervane, auditors and accounting pros say (for the heated debate about what’s driving the record write-downs, see my prior blogs on the controversial accounting rules to book them, the fair market rules, “The Answer to Who’s Next on Wall Street,” “What’s Really Rocking the Stock Market,” and “In the Weeds”).

You’d have to have the training of a tornado forecaster at the National Weather Center to say with any certainty what the write-downs are going to look like, and some of these estimates already have been dreadfully wrong.

That was certainly true for the recent, way off-the-mark write-downs expected at Goldman Sachs and Lehman Bros., which came in lower than estimated. There will be losses, we just don’t know the size. No one does–hence the record volatility. Transparency works–so long as it’s accompanied by common sense.

Fights are breaking out between the companies and auditors, because the accounting rules say the companies have to get a price-tag for these securities that are backed by loans based on what the market says they are worth. That’s called ‘marking to market.’

Sounding like an Abbott and Costello routine, you can’t mark something to market when there is no market to market these securities in. “Everyone seems to be clueless when it comes to projecting how much still needs to be written off and how much longer this [market distress] will continue,” says economist Ed Yardeni. One thing you can bet on: More write-downs–again no one knows the dollar amounts–and thus more shotgun weddings between damaged financials.

*INFLATION: New numbers purport to show that inflation is not a problem. Not. Talk to any middle class family struggling with health care costs and tuition expenses, and they’ll tell you it is. Why is inflation a problem? Too many dollars, rising demand for commodities, plus, again, zero oversight, no where, none, for things like health care and tuition costs.

*GDP: GDP growth came in at a low six-tenths of a percent. Don’t know if that’ll get revised downward–if it does it’ll mean the tip of a recession. I saw a great study that says GDP should be considered on a per capita basis, to show how truly productive a country’s workers really are and to get a better window on how much an economy is growing.

In Japan, GDP per head increased at annual rate of 2.1% in the  past five years to ‘07, a bit better than the US’s 1.9% and a lot better than Germany’s 1.4%, the study says. And despite all the talk about Brazil and Russia being on fire, check this out. On this basis, Brazil increased 2.3% per capita per year since ‘03, a touch faster than Japan. Russia comes in at 7.4% per capita, but that’s because its petrodollars are pouring in while its population has been on the decline.

*THE DEMOCRATS AND TAX CUTS: In his speech on the economy last week, to punish what he thinks is “the investor class” on Wall Street, Democratic presidential hopeful and Senator Barack Obama says he wants to raise taxes on dividends and capital gains; so does Democratic presidential hopeful Senator Hillary Clinton. The presumptive Republican nominee, John McCain, still backs the Bush tax cuts.

Set aside for now the fact that the Bush tax cuts on capital gains and the death tax alone raised more revenue than President Bill Clinton’s tax hike on the upper bracket, analysts note.

For some time now, the Democrats have had no more sense than a flock of geese. That’s because hiking these taxes hurts Main Street, the most important investor class of all. Many senior citizens live entirely on dividend income alone; the middle class desperately needs its 401K and IRA money like never before because Social Security is in a ditch (thanks to the Democrats changing the law in the ‘60s so it could, for the first time, get its mitts on Social Security funds to spend on pork and to buy votes).

The Democratic candidates, in their blinkered concretism, stubbornly refuse to acknowledge human behavior. Investors sit on assets, including stocks, rather than sell and pay the capital gains tax, because capital gains taxes are voluntary. You don’t have to pay until you sell. Higher capital gains taxes keep frozen all sorts of economic activity. Hike taxes, you also get tax avoidance schemes going viral too–and massive loopholes written into the colossally inefficient tax code, a big tangled pile of barbed wire as it is. But we’d rather be a nation of tax lawyers and accountants. Both Obama and Clinton want to make it even more confusing with gimmicky credits that won’t buy you a bag of groceries for a month.

Obama and Clinton want to hurt Main Street with more taxes. “Why is Barack Obama so hell-bent on pursuing policies that would wreck America’s retirement savings?” asks Ryan Ellis, tax policy director at Americans for Tax Reform. ”Because, by and large, he doesn’t have any skin in the game.”       

How so? Obama is not part of the investor class because he’s reported no dividend income on his tax returns from 2001 to 2004, and just $2,754 in dividend income on his 2005 tax return and $1,188 on his 2006 return (Clinton has yet to release her returns).

Where are the John F. Kennedy tax-cutting Democrats? Lower taxes help the economy. Even the former Soviet satellite states like Estonia and Lithuania have enacted flat taxes. Lowering rates in our anti-growth, anti-entrepreneur tax code is the best non-inflationary liquidity in the galaxy. But as the Heritage Foundation notes, though we won the Cold war, Russia has a flat tax while we’re still stuck with America’s museum of mass confusion, the IRS.

*SILVER LINING: Weekly initial unemployment claims. In previous deep recessions, they tended to rise rapidly, over 400,000 toward 500,000, notes Yardeni. In the 1990-1991 recession, jobless claims hit 496,000 on a four-week moving average basis; in 2001-2001, it hit 489,000. The latest four-week average was only 358,000. Sigh of relief. For now.

March 26, 2008 10:37AM

Time to Listen to Ron Paul?

By Elizabeth MacDonald

Time to listen to Texas Congressman Ron Paul, the lone voice of reason in Congress today who’s got to feel like he’s shouting into a field of cotton with his repeated warnings about the dangers of a collapsing dollar, while the administration goes AWOL on the problem.

The dollar just hit a record intraday low against the euro on reports that consumer confidence levels have dropped to levels not seen since the post-Watergate era. It is down 7% year to date against the Chinese renminbi, it’s weaker than the Japanese yen and the Canadian loonie.

The joke is the greenback is now only stronger than the Mexican pesos and the Zimbabwe dollar, an overstatement for dramatic effect, to be sure.But since hitting a peak in 2002, the dollar has lost about a quarter of its value against a trade weighted basket of currencies.

A weak dollar acts as an anvil around the neck of the US economy and consumers. Rising inflation is essentially a tax on consumers, so are rising energy prices, and that double whammy threatens to undermine the purchasing power of the rebate checks due out in May–backed by printing even more dollars.

A bellwether event of significant import to our nation’s finances happened this past January 1 with little notice. That’s the day the first baby boomer was allowed to retire. A new federal report wearily warns once again for the umpteenth time that the nation faces some $60t in Social Security and Medicare unfunded liabilities alone.

We’ve heard time and again conservatives say deficits don’t matter. To say that deficits don’t matter is like saying ketchup is a vegetable or trees cause pollution.

The $406b the US pays annually in interest on the $9t in federal debt alone would rank as the world’s 30^th largest economy.

That annual interest cost surpasses the gross domestic product of Belgium, and is bigger than the GDP of Denmark and Hungary combined. The $406b would cover the annual cost of investigating Medicare fraud.

Stack all those one dollar bills making up our $9t deficit (and that doesn’t include the $60t in unfunded liabilities for Medicare and Social Security) and you would reach the moon and back. “Printing money cannot create wealth, if it could counterfeiting would be legal,” economist Brian Wesbury has said.

Even Milton Friedman, the Nobel Prize-winning economist and a forceful advocate for laissez-faire economics, got so sick of the way central bankers were willy nilly printing money in the ‘70s, he advocated that the government should replace the Federal Reserve with a computer. “Money is too important to be left to central bankers,” he quipped.

Broad zoom: The US economy has spent all of a year and four months in a downturn over the last two and a half decades. During that time we’ve seen a market crash of 22% in 1987, the S&L crisis, four wars, three financial crises (Mexico, Asian flu and Russian debt crises), the blow up of the hedge fund Long Term Capital, two asset bubbles (dot com and telecom). Since the Bush tax cuts of 2003, the US economy added the equivalent of China’s GDP–and government spending has boomed.

Now Federal Reserve chairman Ben Bernanke has both cut rates at a breakneck speed and pumped a massive amount of monetary stimulus into the markets to cure the credit crisis. I still think he is doing his level best to fix a crisis not entirely of his own making. The question now is, will Bernanke yank the liquidity punch bowl when the economy returns to trend growth in 2010 or 2011 as the central bank projects?

Let’s hope so, because the case for a weak dollar is, to me, well, weak. Namely, that a lame greenback softens the housing and credit crises as it fuels profits at US exporters whose goods are now dirt cheap in the eyes of foreign customers. Strong foreign sales at places like Boeing and Caterpillar reportedly added 1.4% to US growth in the second quarter of 2007. But exports make up just 13% of GDP. Consumers make up a larger 70%.

It’s no surprise consumer confidence is as weak as it was in the ’70s. LBJ had promised this country it could have both guns and butter in the ‘60s, so the Federal Reserve gunned the printing presses to pay for spending on entitlement programs and for the Vietnam war. For the first time, too, politicians got their mitts on taxpayers’ Social Security funds, after Democrats passed a so-called “unified budget” in the late ‘60s.

All that spending caused the dollar to nosedive in the 1970s amidst an oil embargo that sent oil costs, priced in dollars, soaring. Paul Volcker, then Fed chairman, enacted rapid rate hikes hitting 21% by 1979, and the Treasury went so far as to sell $6.4b in “Carter bonds,” largely denominated in Deutschemarks, to prop up the dollar. Gold got ripped off its mooring of an average $35 an ounce in the ‘70s, and in 1980 it hit a record $835 an ounce, around $2,250 in today’s prices.

Gold acts as a dew line for inflation. We essentially have a good handle on how much gold there is in the world and potentially below ground. When gold rises in price, it signals we are printing too many dollars, which indicates a concurrent drop in the greenback’s value. Over the last seven years, gold and oil prices have risen in lockstep, up 239% and 267% respectively. If the dollar had also risen in value at the same rate, oil would be selling at about $30 a barrel.

But now central bankers say that because of the weak dollar, they’ve seen capital losses carved out of an estimated $3.34t worth of US dollars they hold in foreign currency reserves; Japan holds the most dollars, China is second. The fear is they may unload these plunging greenbacks en masse to cut their losses and run–which would really tip the US into a protracted recession. Already reports out of China show government officials there willing to rotate future planned investments out of US treasurys into other investments.

Countries pegged to the dollar are rightly saying, too, that we are exporting inflation to their shores. Saudi Arabia is a land that has had nearly zero inflation since 1998, but recently inflation soared to 7% annually, despite the fact the country is flush with petrodollars.

Congressman Paul rightfully warns us when he says the US government has “systematically undermined” the US dollar by expanding “the money supply at will for financing war or manipulating the economy with little resistance from Congress–while benefiting the special interests that influence government.”

It’s not just the US gunning the mints. Goldman Sachs figures that three-fifths of the world’s broad money supply growth came from emerging economies over the past year or so. Three-fifths. That’s gigantic.

Goldman Sachs says the growth in Russia’s M3 measure of broad money grew 51% over the last year or so, India by 24%, and by 20% in China, Saudi Arabia, South Africa and Brazil. That’s three times as fast as the US and the rest of the developed world, and it’s faster than their GDP growth rates. It’s the fastest pace in decades.

All that loose money is pouring into commodities, stock exchanges around the planet as well as bond markets–it’s largely why our long-term bond yields have been historically low, spurring a dramatic increase in mortgage borrowing, as mortgage rates typically track the 10-year Treasury note.

Watch out here–emerging economies are just as susceptible to minting lots of money due to political pressures, including things like paying for wars, or calming local populations clamoring for higher pay and more jobs.

What can be done stateside?

The administration needs to state more emphatically that it supports a strong dollar. A stronger dollar would draw liquidity back into the credit markets, lower inflation risks, cut oil prices and restart economic growth, notes Bear Stearns economist David Malpass.

Presidential candidates vilify NAFTA and free trade, when the weak dollar is partly to blame for problems like jobs lost to overseas operations, Malpass adds.

“Empires fail because they run out of money, or more accurately, run out of the ability to spend or inflate,” Congressman Paul warns. “We need to control spending, immediately, before it is too late.”

March 25, 2008 12:41PM

How Congress Can Fix the Crisis

By Elizabeth MacDonald

It’s the question of the hour: How can Congress fix the housing and credit crisis? And where are we in this crisis? We’ve been talking about this issue on our morning show Money for Breakfast.

I don’t make it a habit of trying to call the end of the world and I don’t think we’re headed for the abyss. I also fully support a moonshot to Mars so we can pack all those recession fanatics on it so they can annoy each other into oblivion. It’s true, if you call a recession long enough, you can call yourself a seer, as someone once said–a stopped clock is right twice a day. Global growth is here to stay. 

Same for the market’s “bottom callers,” in full regalia now, telling us to expect an upswing, though beats me why if they’re that good, they’re even sticking around and not hitting the beaches on the Riviera.

The market hasn’t hit the bottom yet because housing hasn’t found its bottom yet. Do the math and we’re still in at best inning three. Congress is going to hold hearings next month on the crisis. There is a way for elected officials to get us out of this crisis and avoid future disasters.

First the parade of horribles. Foreclosed properties held by lenders accounted for 493,000 of all homes on the market in January. Again, that’s held by lenders, and that’s out of an estimated 3.3 million home-mortgage defaults in 2007 and 2008, with about two-thirds of those homeowners losing their homes, says Moody’s.com.

Western banks have taken about $180b in writedowns to date out of the projected $300b-$400b. And that’s only for subprime, it doesn’t include other credit problems like leveraged loans and other consumer installment credit. Credit problems are the reason why GDP growth rates will slow and return to trend at the earliest in 2010. Analysts estimate the economic cost to clean up the current crisis is $1.1T, or 9% of GDP–the bailout of Argentina cost 55% of GDP to fix, the S&L crisis here in the US cost 3% of GDP.

What to do now? Set aside the government bailouts–yes it’s unfortunate that traders, investors and borrowers like to be Milton Friedman, free-market types on the way up, but John Keynesian, “run to Uncle Sam” ninnies on the way down. Yes we privatize the gains and socialize the pain, hearing that now is like chewing tin foil. Yes we want as much homeownership as possible–but this is one heck of a grossly expensive, upside down way to get there.

Here’s a rundown of how Congress can fix the mess–and how it could save us grief in the future:

DON’T GET LOST IN THE WEEDS. Take heart in this broad-zoom perspective. The world is still in the early innings of globalization. Already, China, India, Indonesia, South America, places a generation ago considered dirt-poor, are now seeing explosive growth in the middle class. Some 1.8b new entrants are expected to join the middle class over the next 12 years. By 2010 the world’s middle class will make up 52% of the total world population, up from 30% now. As the middle class grows, that means burgeoning demand for things like healthier diets, better, more fuel efficient cars and gadgets. Global growth, in fits and starts, is here to stay.

BOOST IMMIGRATION. Ballooning housing inventory is now at a record levels, with foreclosure signs popping up like crabgrass in Nevada, Arizona, California, Florida–which is why the volume about government bailouts has turned up in these key swing states in this presidential election year. Strengthen the borders, absolutely, but boost LEGAL immigration. It’s good that teachers, firemen, policemen can now afford first-time homes. Hardworking immigrants can help pick up the slack, too (and let’s face it, can they help Social Security? Watch that debate in coming months as well). 

SUPPORT BUZZSAW BEN. Time to turn down the volume in Congress on the criticism of Federal Reserve Chairman Ben Bernanke–much of it is self-serving, arm-chair quarterbacking. Dramatic cuts in interest rates help homeowners facing some $350b in ARMs resetting, as the cuts lower the hikes in their monthly payments to an increase of about 10% from 25%. And Bernanke’s creative moves such as broadening the discount window and auction facilities to reliquefy bank balance sheets could cement his place in the history books as helping to soften a cataclysm set in motion by his predecessor Alan Greenspan, who kept rates too low for too long and disregarded growing subprime excesses while telling borrowers to take out riskier ARMs vs traditional fixed rate loans. “American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage,” Greenspan once said.

YANK THE LIQUIDITY PUNCH BOWL. To avoid inflation and repair the weak-dollar damage, Congress must fingerwag Bernanke by telling him to avoid tipping the economy into the bottomless liquidity punch bowl. He has to be ready to hike rates when the economy returns to trend in 2010 and 2011, as the Fed expects. The dollar is at its weakest since the era of floating exchange rates began in 1973, and inflation is coming a cropper. Central bankers would do well to heed the advice of Richard Fisher at the Federal Reserve Bank of Dallas: “Easy money is like truly tasty tequila, it’s tasty–but dangerous.”

BRING BACK SOME VERSION OF GLASS-STEAGALL. Originally enacted in 1933 after the crisis of the Great Depression, it took another crisis–the 1987 crash–to get bankers to start lobbying for its repeal, which took 12 years to do. The act separated the barbarians of Wall Street from the mahogany-lined board rooms of white shoe bankers. Since its repeal in 1999, which let banks compete for the first time in the securities industry, the free market banking system has turned into a disastrous free-for-all.

Banks lobbied hard to repeal this act soon after the 1987 crash as foreign competition from Japan bore down on them–Japan, whose banks did not face the same strict rules on maintaining capital reserves and whose calamitous lending helped foster the lost decade of zero growth in that country in the ‘90s.

Congress should ignore mindless, self-serving entreaties from the bankers now. Listen to what Dennis Weatherstone, president of J.P. Morgan, said in the late ‘80s: “I don’t think the repeal of Glass-Steagall should be seen as a way of providing relief for the banks,” adding, “rather, I think it should be seen as a way of making capital markets more efficient.” Abolishing Glass-Steagall let Citigroup make disastrous bets underwriting and trading mortgage-backed securities and collateralized debt obligations. Citi now faces potentially another $15b in write-downs on top of the $22b it’s already taken due to the housing and credit crisis. 

Footnote: Talking to top executives on Wall Street about the crisis, a number of them now brazenly finger the act’s repeal as the reason behind their woes, proving with age comes no maturity.

PUT UP THE GUARDRAILS. I’ve noted in prior blogs how deregulation shoved 3/4ths of Wall Street borrowing into the shadow lands, away from the prying eyes of regulators. If the investment houses want access to taxpayer-backed financing from the Federal Reserve, a historic move the central bankers have made, then these investment houses must meet commensurate capital reserve requirements that are forced on the big banks, which means new regulation forcing them to hold more capital on their balance sheets. Watch the securities industry lobbyists fight this one hard. They want all of the upside of taxpayer-backed funding with none of the downside.  

KEEP TABS ON LOANS. It’s been suggested that lenders should be forced under new regulation to keep the riskiest parts of securitized loans on their balance sheets, and I agree. Banks broke the last vestige of oversight of derelict borrowers when they sold these loans off the balance sheets and into the ether.

MORE HEDGE FUND DISCLOSURES. Congress should enact laws that would get the Securities & Exchange Commission to force hedge funds at minimum to publish their balance sheets so the brokerage houses can truly see how leveraged they are before risking their house money in loans to these funds. It’s what got Bear Stearns in trouble. Investment banks and hedge funds tend to blow out their leverage in boom periods, then dry out in bumpy times, spreading their hangover to the rest of us. With debt that amounts to half of all leverage outstanding, expect more collapses and shotgun weddings at these shops.

BRING CREDIT DERIVATIVES INTO THE LIGHT. Bring credit derivatives onto one of the major exchanges. Yes it’ll be costly, but transparency is better at catching future problems then wasting tax dollars fighting a financial nuclear winter.

REPORT CARD FOR THE RATINGS AGENCIES. Congress should force Moody’s Investors Service, Standard & Poor’s, Fitch Ratings, Egan Jones, all the ratings agencies to publish a report card on their prior ratings calls from now on. They’ve got a virtual monopoly on this business, time their feet is held to the fire.

STOP THE AFTER-THE-FACT REFEREEING. Congress, regulators, the government has found it a lot simpler to more or less let things happen. With bureaucratic apathy comes wasted tax dollars. Enough is enough.

March 24, 2008 11:30AM

Best Safe Haven Stocks Now

By Elizabeth MacDonald

You’re crazed about your stock portfolio now, because it seems like the economy is headed for a national nervous breakdown, right? A systemic credit crunch is underway, record bank writedowns are rocking the stock market, inflation is eating away at returns, and the euro, the Canadian loonie, the Japanese yen, all are flexing their muscles at record levels against the dollar.

What stocks could be safe havens now?

How about some stocks that throw off dividends?

It’s good to get both a stock that throws off decent returns and a dividend, when the dollar is toboggan sledding down like never before. I tend to like dividends for a variety of reasons. Number one, you get an income tax deduction on your dividend payouts. Plus dividends in most cases can be great proof that a company is doing pretty decently–else how could they have the cash flow to pay out the dividend?

But you want dividend stocks that are backed by solid quality of earnings. I asked Sageworks, a financial research firm in Research Triangle Park, NC, to pull together a list of the companies that it thinks have pretty solid quality of earnings that also throw off nice dividends. The companies below have decent liquidity, real cash, plus they are not overleveraged with debt, says Brian Hamilton, head of Sageworks. Here they are:

Of course, don’t expect dividends to last at the banks pounded by the credit crisis.

But watch what happens at the mere suggestion that dividends should be cut at these institutions–which is why they have been holding onto their dividends in a tight crab grip.

The largest U.S. banks saw their stock prices recently drop after remarks by Treasury Secretary Henry Paulson suggesting that banks may need to suspend dividend payments in order to shore up capital. “We are encouraging financial institutions to continue to strengthen balance sheets by raising capital and revisiting dividend policies,” Paulson said. After those remarks, JP Morgan Chase (JPM) soon dropped 4.43%, Bank of America (BAC) was down 3.56%, Citigroup (C) fell more than 5%, Washington Mutual fell almost 5% and Wells Fargo dropped 4%.

Paulson is essentially saying that banks should cut their dividends and instead use that money to plug the holes in their balance sheets blown out by record write downs from the credit crisis, totaling about $180bn so far. That’s a lot of dividend money that could be cut out of investors’ wallets–one report has it that the banks shelled out more than $110bn in cash dividends last year, up nearly 18% from 2006.

Banks are already slashing dividends. Washington Mutual (WM) has cut its dividend. Citigroup (C) cut its dividend by 40% last January, but it’s still paying out $1.28 a share this year, or $6bn it may need to plug some balance sheet holes. Mortgage financing giants Fannie Mae (FRM) and Freddie Mac (FRE) have slashed their dividends as well, to stabilize their balance sheets. Freddie Mac (FRE) cut its dividend on its common stock by 50% in November, but it still pays $1 annually or $650mn.

You don’t see brokerage firms listed on this table, because they tend to pay tiny dividends if at all. Brokerages tend to pay out a lot of their earnings towards year-end bonuses, so a 1% to a 2% yield is quite high for these guys.

There are other dividend plays to look at, too. Consolidated Edison (ED) has a nice 5.7% yield and is an evergreen in the business of power supply. US energy trusts are good, too, because they tend to pay out almost all their income to avoid paying taxes, plus oil prices are likely to remain high. Check out the Permian Basin Trust (PBT), a mix between oil and gas companies with a 12% yield.

Some companies, I think, would do well to raise their dividends. I agree with analysts who point to cash rich and dividend cheap tech companies, even those doing stock buybacks, as dividend announcements can be good for stock prices. Watch what happened to AT&T (T) when it raised its dividend recently and upped its share buy-back. The company’s stock rose almost 9% on the news, the most in five years.

Apple (AAPL) has piled up about $18.4bn of cash and equivalents as well as short-term investments on the balance sheet. Since it hardly ever buys other companies, some say it could probably afford a $6 or $7 special dividend, an announcement which might help its stock, beaten up of late.

Cisco (CSCO) can afford a 3% yield, analysts say, with its shares declining in value. Other profit machines can afford to boost their dividends. Exxon Mobil (XOM), the most profitable company in history, cheaps out with a yield of 1.5%. Don’t you think it can afford to more than double that amount to 4%?

March 20, 2008 1:42PM

Obama’s Little Speech Problem

By Elizabeth MacDonald

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March 18, 2008 1:34PM

The Answer to Who’s Next on Wall Street

By Elizabeth MacDonald

Beating analysts expectations–expectations that companies routinely jawbone down–has shares in Lehman Bros. (LEH) and Goldman Sachs (GS) trading higher today, despite the fact their first-quarter profits fell more than 50% versus a year ago.

Brush aside the pixie dust. Don’t join the hallelujah chorus just yet, much as I’d personally like to, given that I am a long-term bull–I like to quote a buddy of mine who jokes that his epitaph on his tombstone is going to read “I’m in it for the long term.”

There is a little-known, little-understood but crucially important time-bomb of a profit figure that is swamping the net worth of Wall Street firms with red ink and putting their book values per share, one of the most important valuation measures for banks and brokerages, in intensive care.

It’s a relatively new number investment houses now must disclose beginning this past Jan. 1, according to new accounting rules. It’s a number Wall Street has been desperately submarining out of sight in their profit reports, hoping you’ll zip right by it.

It’s an issue we’ve been talking about on our morning show, Money for Breakfast, for months now, as the result helps answer the question on everyone’s lips: Who is next?

This earnings result has helped blow out the economic circuits at places like Citigroup and Merrill Lynch, it’s helped create a record $195b in writedowns at western banks. Its being held partly to blame for the meltdown at Bear Stearns, and it’s a big reason why the Federal Reserve threw Bear a $30b lifeline.

It is also partly why CEOs have been frog marched out the door, it has helped torch tens of billions of dollars out of investor portfolios and it has caused many market watchers to start applying Novocaine to their nerve endings. It’s the reason why Wall Street has sheepishly gone hat in hand to sovereign wealth funds in the Middle East and Asia.

It’s such a touchy number that Goldman didn’t disclose an updated figure for it in its recent profit release or on its earnings call today, waiting to do so weeks from now when it has to file its latest quarterly with the Securities & Exchange Commission. Lehman also didn’t print the figure in its earnings release, but disclosed the number on its earnings conference call this morning.

But with the help of Fox’s crack statistician and researcher, Jonathan Fallon, we got the figures for you. It’s important to hold onto these numbers, known as level 3 assets, in coming days, even if you don’t own shares in these companies, because the financials are causing chaos in the markets.

Note: Latest figures available. Source: Company filings; Lehman’s numbers were reported in the company’s conference call

The figures represent the value of the risky, illiquid mortgage- and credit-backed securities that companies can’t get price tags on because the markets for them are frozen solid, as traders have bolted in panic from all corners of the credit market. They are the zombie securities that are typically backed by the sub prime and other credit deals now defaulting left and right, dead loan walking.

Companies must deduct the changes in the value of these Frankenstein securities from their profits, causing steam pipes to burst. These securities, which are going belly up right and left, are already submerging shareholder capital (a company’s assets minus it’s liabilities, similar to your own net worth).

Now this isn’t to say that all of these assets will drop into a ditch. No one knows, it depends on the credit markets. All could be worthless–all could have value. Some analysts now say to figure out what future hits to earnings could be at each firm, multiply the level 3 assets by 15% to 20% to get a rough idea, those percentages equivalent to what the best guesses are about how much mortgage- and other credit-backed assets have further to drop (if you’re really bearish, raise those percentages). The resulting writedowns get carved out of both company profits and book value.

Level 3 assets provide one of the truest gauges of the speculative bender Wall Street was on during the housing bubble. And it proves we are still in the third inning of this crisis.

The level 3 bucket can hold other items, to be sure. For instance, Morgan Stanley and other firms generally classify private-equity investments as level 3, because private equity deals, being private, aren’t traded on any market.

But for the most part, level 3 assets are a no-man’s land, as they tend to be securities no one wants, which is why the firms tend to bury information about these holdings in footnotes using typeface that are the font size of pharmaceutical disclosures.

Because no one wants them, there is no market for them. And because there is no market for them, these holdings are priced based on top management’s best guess of what they think they are worth, using their own idiosyncratic, internal models, a “mark to market” valuation approach that has been jokingly redubbed “mark to  myth” or “mark to make-believe,” (see prior blogs “What’s Really Rocking the Stock Market,” and “The Bear Trap“). Level 3 assets are also the subject of a growing controversy in Washington, DC as the Securities & Exchange Commission mulls a plan to relax the accounting rules used to book them.

Lehman Bros. says its level 3 assets have lately dropped by $3b to $38.7b, after having more than doubled to $42b in the last six months of last year. Lehman in its most recent quarterly report took just a $1.8b “mark to market” haircut against earnings due to the market downturn in these holdings.

But $38.7b is still a big number, oustripping Lehman’s $24.8b in shareholder equity, or what’s generally understood as net worth. The number was of such concern that it was partly why Lehman has hastened in recent days to point out that it has not just a $2b credit line–a sign of the good faith and confidence its lenders have in its operations–but also that it has a “robust liquidity pool” of $34b plus other “unencumbered” assets of $64b to plug this black hole.

The numbers are pretty frightening–they show the financials still have a long way to go. For instance, Wall Streeters are now talking about just how vulnerable Merrill Lynch really is. The numbers show that Merrill has $41.4b in level 3 assets, far above its $31.9b in shareholder equity.

Check out the havoc level 3 assets have wreaked in the third quarter. These assets caused Morgan Stanley (MS) and Lehman Bros. to report earnings declines, and they helped create an $8.4b writedown at Merrill Lynch ($24.5b to date), triggering the largest losses in Merrill’s history.

Goldman Sachs has been better than its compatriots at disclosing its level 3 assets, being first out of the box to do so last summer, a full two quarters before new accounting rules forcing such disclosures began January 1. “We are in the asset valuation business, and we don’t think it’s possible to manage risk effectively if you don’t know the value of your assets and liabilities,” says a Goldman spokesman.

Goldman’s level 3 assets actually helped juice its earnings in its third quarter. It booked a 79% increase in third-quarter profit, the biggest on Wall Street at the time, even after it took a $1.48b loss from problematic high-yielding loan assets.

Goldman reaped a third quarter net gain of $2.94b from level 3 derivatives, $2.62b of which came from what are called “unrealized” or paper gains made from these derivatives trades that can’t yet be cashed out yet–likely because no one wants to give cash for this, shall we say, mysterious paper, according to excellent analysis by Fortune Magazine. 

Again, Goldman is not telling investors yet what its level 3 assets are right now. Investors have to wait a month or so for those numbers, to see how much of its profit figures came from such paper gains.

What we do know is that Goldman held a bigger slug of hard-to-value assets at the end of the third quarter than Citigroup (C), which, besides Bear Stearns, was among the hardest by the subprime meltdown.

Goldman’s level 3 assets accounted for 6.9% of the New York-based firm’s $1.05t total at the end of the third quarter 2007. Citigroup recorded 5.7% of its assets as level 3 on Sept. 30th.

However, Goldman’s exposure becomes more serious on closer look. For the full fiscal 2007 year ending November, Goldman had $69.2b in gross level 3 assets, with over half coming from the iced-over private equity and real estate investment market, which has left firms including Goldman stuck with loans.

Although the $69.2b is down from the $72b Goldman reported in the quarter ending in August, it is still 45% higher than the $47.6 b the company reported in February, and was 26% more than Goldman’s shareholder capital of $42.9b.

And the level 3 number can show how the credit crisis has clearly gone viral, which we’ve known for some months now. For instance, buried in  Morgan Stanley’s year-end financial results, you’ll see that the level 3 pot grew by about $7b due to problems with commercial loans–now of growing concern, too, as it’s largely been the residential housing sector that has caused lots of hair-tearing around the country.

March 16, 2008 7:35PM

The Bear Trap

By Elizabeth MacDonald

The news that Bear Stearns (BSC), near collapse on Friday, was bought by JPMorgan Chase for a breathtakingly low $236.2 million in an all-stock deal won’t calm rattled nerves in the market on Monday.

The deal price is nothing short of shocking and is causing whiplash-inducing double-takes on Wall Street. The bailout of Bear comes after the near-destruction of the 85-year old U.S. institution, the fifth largest investment bank in the country and the nation’s second largest mortgage bond shop. The deal’s price comes in at about $2 a share–Bear opened at $57 on Friday, but then suffered its biggest one-day drop in its history. So far this year, Bear has lost $6.8b in market capitalization.

The company announced late Sunday that it was cancelling its planned announcement of its first-quarter earnings today, after moving the date up from this Thursday.

All this, despite the fact that top Bear executives were out in force last year saying the company’s capital position was strong. Similar to Countrywide’s chief executive Angelo Mozilo’s bullish statements last summer and fall about the health of the nation’s largest mortgage lender, at a time when he wasn’t buying shares in the bank, he was selling millions of dollars worth of shares.

The government-orchestrated takeover of Bear Stearns is historic in a number of ways. The Federal Reserve and the Treasury Department oversaw the acquisition talks, with the Fed agreeing to guarantee up to $30b of Bear’s “less liquid” mortgage and other assets in a non-recourse deal, according to the companies’ release.

Aside from the fact that the Fed is helping JP do a virtually risk-free deal, the loan is the most dramatic expansion of the central bank’s lending authority since the 1930s. If the collateral backing the $30b loan drops in value, the central bank, meaning taxpayers, will bear the cost by taking on that bad paper. Also, the Fed’s five governors voted unanimously to waive for the first time ever the usual restriction on Fed loans to nonbanks, The Wall Street Journal reports. The Fed also just announced a quarter point cut in its key lending rate to financial institutions, its discount rate, down to 3.25% from 3.5%. I’ll be reporting this story and updating this blog throughout Monday. Read More

March 13, 2008 10:56AM

What’s Really Rocking the Stock Market

By Elizabeth MacDonald

It’s the most serious problem facing investors today.

It’s the reason why we are witnessing spectacular bank writedowns never seen before in the history of the stock market.

It’s an issue that, once you understand it, you’ll see why the red ink swamping the stock market and your stock portolio is now increasingly being talked about by accounting experts, economists and corporate executives as both flawed and absurd. At minimum, it’s one of the factors behind the record volatility in trading.

Say you bought a house for $200,000. History tells you that things like population growth and inflation will cause your house to increase in value. For the sake of this explanation, say the housing downturn hasn’t happened yet, (most economists agree housing will come back, however far off in the future).

Say derelict teenagers lit a fire that roasted the woods near your house, and a pestilence has descended in the form of a neighbor who enjoys murdering silence by playing round the clock Whitney Houston’s brain-scraping “I Will Always Love You.”

Say the Steineckes up the street now keep every Christmas decoration they could find at Home Depot on the roof until August, and say garden moles are riddling your front lawn with potholes.

Your house has dropped in value. Sell today and you’d get $150,000. But you know that time will bear you out, that these neighborhood blights will be gone one day. Wait five, ten years, you know you’ll get that $50,000 back, and then some.

But say a new government rule dictates that you must immediately deduct that $50,000 loss from your bank account as if you were selling your house today. You say to yourself, hey, why should I have that lower price jammed down my throat, even though that is not the price of what my home is really worth? Sounds absurd, right? Read More

March 11, 2008 10:14AM

The Spitzer Distraction

By Elizabeth MacDonald

That New York Governor Eliot Spitzer was caught planning to meet a prostitute in Washington, D.C., as first reported by the New York Times, presents a tale almost too rich with ironies.

It’s an amusing sideshow to those who came under Spitzer’s battle axe, a sideshow blast of entertainment for Wall Street struggling with one of the worst crises in its history.

The fear is it may create a distraction from what needs to be done. We’ve been dissecting the implications of this alleged sex scandal on Money for Breakfast and the rest of the Fox Business shows.

The ironies are rich.

That the governor was allegedly caught cheating with a prostitute when he once reveled in catching cheats in Wall Street research units prostituting themselves to their fellow investment bankers; that the announcement of the allegations came while the governor was giving a speech on family planning; that a prosecutor given to believing he could use the press to indict companies without benefit of the court process, who seemed to believe that an indictment is tantamount to a conviction, who now is all but convicted by the press he manipulated; that the governor now needs to beg mercy when he seemed to have none, shows that it’s a glaring understatement to say that truth sometimes is better than fiction.

A clean-up on Wall Street was desperately needed after the dot.com and tech bubble burst. Spitzer cracked down on Wall Street research operations tailoring reports to win sizable investment banking deals. He eventually hammered out a $1.4bn settlement with 10 Wall Street banks and brokerages, including Citigroup (C), Merrill Lynch (MER), Credit Suisse First Boston (CSGKF), Goldman Sachs (GS), Deutschebank (DB), Bear Stearns (BSC)

But Spitzer was criticized for being an intemperate, self-anointed crusader when he routinely convicted these companies, including American International Group (AIG), in the press via numerous leaks.

Spitzer got caught up in the type of regulatory dragnet he so loved, a joint FBI, Justice Department, Treasury Department and IRS crackdown on shell corporations, traditionally used for tax evasion, but now used for more nefarious things like money laundering and potentially terrorist activities, a problem I’ve written about before.

Oversight of shell corporations, now blooming like mushrooms here in the US and often set up by foreign operators, are largely left up to the states who do little to stop bad guys from opening shop here. The international prostitution ring that allegedly tripped up Spitzer was fronted by shell companies that took his money.

That Spitzer seemingly has blown both feet off not only will make it more difficult to conduct the state’s business, it also poses a distraction when serious repair work needs to be done in the markets.

The problem with the stock and credit markets is a solvency crisis gone viral. Anemic capital positions have left investment houses on life support.

This morning’s $200bn emergency move by central bankers to inject even more liquidity to chop up the ice in the markets has the Dow Jones Industrials up so far more than 260 points, but will it be enough?

Moody’s estimates 3.5mn people will lose their homes to foreclosure during this crisis. After dropping 9% last year, prices in 10 leading US cities are forecast to fall at least 18% by November this year, according to the Chicago Mercantile Exchange futures based on the S&P/Case-Shiller home price index.

The back story is this. Wall Street took a collection of sub prime mortgages that were owed by highly leveraged borrowers with bad credit records and, presto-change-o, magically altered them into marketable securities, buying a triple-A stamp of approval for these securities from the bond insurers, a rating IBM (IBM), Procter & Gamble (PG) and Coca-Cola (KO) do not enjoy.

All this created an unsustainable credit-driven boom, because, as one analyst put it, financial engineering can’t transform sows’ ears into silk purses.

As mortgage backed bonds and other securities plunge in value, lenders are demanding more in cash and assets, what are known as margin calls, to back up trades. That’s causing a graveyard spiral.

The Great Unwind has begun.

It’s not just the bond insurers, where Spitzer was active in hashing out a recapitalization plan. Buyout firms like the Blackstone Group and Kohlberg Kravis Roberts, lauded only a year ago for their deal-making magic, are seeing their profits collapse under the weight of debt as the credit crisis spreads.

Capital problems are behind more than 30,000 layoffs estimated coming at Citigroup (C), losses that won’t come all at once, but over two years. Layoffs, too, of about 5% of the workforce at Lehman Brothers Holdings (LEH), and Goldman Sachs (GS) are blamed on capital problems. Capital problems at Merrill Lynch are also seeing top executives being shown the door through early retirement packages.

Some 11,400 workers have already been laid off at Countrywide (CFC), which faces a severe capital drain. Countrywide is now being investigated by the Securities and Exchange Commission for civil violations, and by the FBI and the Justice Department over alleged criminal violations involving potential securities fraud.

Just a $37mn margin call, on the face of it seemingly small bore stuff at Carlyle Capital, the levered up fund owned by the Carlyle Group, and a $28mn margin call recently at jumbo loan seller Thornburg Capital are causing meltdowns in their shares.

Carlyle borrowed 28 to 32 times its assets to buy triple-A rated bonds backed by Fannie Mae and Freddie Mac, the big mortgage finance companies. It essentially borrowed anywhere from $28 to $32 of every $1 it had in its own money, leaving it with a tiny capital reserve cushion to meet a very thin $37mn margin call from seven of its 13 bank lenders. It’s already faced $482mn in margin calls from lenders in the second half of last year

Same story holds true for the levered up Thornburg Capital, the jumbo lender which saw shares lose half their value last week after it defaulted on a tiny $28mn margin call for more collateral from JPMorgan (JPM).

But the scariest issue facing the stock market now are the weak capital cushions at the bond insurers as well as at Fannie Mae and Freddie Mac.

It’s an issue I’ve flagged to you already in a prior blog (“There Will Be Bonds”) and I’ve reported on Money for Breakfast.

Turn to the bond insurers. The stock market is waiting on news whether or not one of the bond insurers will go bankrupt, or whether all will survive and keep their triple-A rating, a rating they’ve built their entire existence on.

Bond insurers are a key linchpin that prevents the financial markets from caving in. They save banks, investors and taxpayers money by keeping company and state borrowing costs low. If a bond does default, the bond insurers take over paying out the principal and interest, payments that dribble out over the remaining lifespan of the bond.

Bond insurers MBIA and Ambac guarantee yield on $1.2tn in municipal and corporate debt. But they got into trouble and may lose their triple-A ratings after increasingly insuring Frankenstein subprime securities tossed off by the housing crisis.

If the bond insurers lose their triple-A rating, corporate and muni bonds will have to offer more in the way of yields to lure investors, costing investors and taxpayers hundreds of billions of dollars in extra shareholder capital and higher taxes. “We sell promises for a living,” admitted Joseph Brown, chairman and chief executive of MBIA told the Financial Times.

Promises that are life-threatening. MBIA faces potential losses of $13.7bn. William Ackman, who runs Pershing Square Capital Management and is short the bond insurers, estimates MBIA and Ambac each face $11.6bn in exposures to toxic subprime securities and collateralized debt obligations. He estimates that the total universe of asset-backed securities CDOs is about 534 deals from 2005 to 2007, and that these deals alone will rack up losses of about $231bn, a total of some $27.5bn at the bond insurers.

In their defense, both MBIA and Ambac say they have $17bn and $14bn respectively in capital reserves. That’s a total of $31bn to support a $1.5tn book of business.

And I’ve already reported to you that, on closer inspection these capital reserve numbers are terrifyingly weak. About half of these capital reserves are really just more debt in the form of credit lines, as well as insurance premiums these bond insurers haven’t earned yet as the bonds are still outstanding, and premiums that the two estimate they’ll get from bonds they’ll insure in the future, money that’s not even in the door yet (see my earlier blog, “There Will be Bonds”).

Ambac is now struggling to bolster its triple-A credit ratings, by going into the market with another highly dilutive equity offering to raise $1.5bn, nearly twice its market cap.

As Dennis Gartman of the Gartman Letter asks dryly: “We ask all who believe that Ambac really is once again a [triple] AAA corporation to please send in your applications for Cleveland Browns season tickets immediately, for your naïve faith is genuine and should be rewarded.”

And for its part MBIA has raised more capital. But now its CEO, Joseph Brown, has decided to pick a fight with Fitch, which has put MBIA’s triple-A rating under review, while S&P and Moody’s has reaffirmed its rating. He recently wrote Fitch telling the credit rating agency to stop issuing ratings on six of its business units, because his company has “very little idea” why Fitch’s model produces ever-changing charges “when there is no obvious change in our circumstance or in the credit market at large,” blaming Fitch for causing “serious volatility” in how the Armonk, N.Y.-based company is viewed in the equity markets.

Brown did admit that: “Make no mistake about it, we wrote some business that in hindsight we wish we hadn’t, and those decisions have certainly had an impact on the market’s confidence in MBIA.”

In a letter to Brown, Fitch CEO Stephen Joynt responded that MBIA had asked Fitch to “return or destroy” key portfolio information “and discontinue all use of that information in proceeding with our rating analysis. He then said it appeared to be “‘disingenuous at best” for MBIA to have said, as it did last week, that it intends “to work with Fitch to perform the analysis needed to rate [MBIA’s] debt securities.”

Now for the big mortgage finance companies. Freddie Mac (FRE) and Fannie Mae (FNM) each have about $45bn in capital reserves to support a $2.4tn book of business, up from just $136bn in capital reserves in 1990. Both say their capital bases have a cushion of about $3.9bn above the minimum required by regulation, both aver that all is fine.

“Except that Freddie is holding $100bn in subprime asset-backed securities in its portfolio, while Fannie has $74bn or so,” notes Ed Yardeni, an economist. He adds too that 21% of Freddie’s $100bn in subprime assets are 60 days delinquent or more, with 40% of those on watch for a downgrade.

And Barron’s writes that $13bn of Fannie’s $45.4bn net worth consists of deferred tax assets that only have value if Fannie earns enough money in the future to offset them against profits. Fannie though has been booking record losses from the housing crisis, forestalling the use of those assets.

Which is why Fannie and Freddie are also moving rapidly to shore up their capital reserves, including doing even more dilutive equity offerings.

Meanwhile, Fannie Mae backs “the Homesaver Advance” program, where Fannie will lend each delinquent borrower as much as $15,000 over 15 years, unsecured, no collateral needed, to clear their debts.

All that’s needed to get the $15,000?

“A verbal confirmation of financial capacity.” That’s it.

Fannie is working to reduce the number of delinquent loans by shoveling more money at delinquent borrowers, Yardeni adds dryly, money they can get with more “no doc” loans that started the problem in the first place.

Spitzer footnote: It’s Lent, being raised a Catholic girl, someone who has eaten her fair share of fish sticks on Fridays and who doesn’t like the ukelele mass, and someone who has lapsed in so many myriad and interesting ways, I must confess:

Maybe I’m crazy, maybe I have a lot of Catholic guilt (ok I do), but I believe that any job that involves the public trust is a vocation. Be it a job in elected office or any job in the media. It is a call to duty, it is a call to serve. Our military who lay down their lives to protect us understands this. Our law enforcement officials who work so hard to protect us understand this.

Market regulators, too, try to protect us, not enough to be sure, and Spitzer over-the-top version of rough justice won many enemies. But the broader point is that, if the Spitzer allegations are proven true, they should rightly offend the good people out there who treat their jobs as a vocation. You the public deserve no less.

March 10, 2008 12:34PM

The Changes Coming at Citigroup

By Elizabeth MacDonald

In a bid to revive profit growth, Citigroup’s new chief executive, Vikram Pandit, is restructuring the world’s biggest bank to focus on the strongest parts of the beleaguered banks’ operations, its global wealth management operations headed by Sallie Krawcheck, its global transaction services and its international consumer businesses, sources at Citigroup tell me.

Pandit is getting high marks from my sources for his attempts to fix the bank, which includes taking a sharp battle-axe to cut the fat marbled through its operations and bringing some rationality to its businesses. My sources tell me Pandit is the right choice for this really difficult task, and his squad is lining up behind him. And despite what some media pundits misguidedly say, a breakup of the bank is not in store, my sources say, nor should it be on the table. Asset divestitures and cost-cutting, the route Pandit is taking, are the right moves for the bank for now.

To re-engineer the company, Citigroup (C) will lay off more than 30,000 workers out of its 370,000 staffers, a workforce number that includes consultants and temps, sources at the bank say.

However, the layoffs will not occur all at once, but instead will be stretched out over the next two years, and involve not just letting workers go, but attrition and branch and office closings.

“We essentially plan to take out our bottom performers and reallocate that capital to higher growth opportunities or better talent,” a source at Citi says.

Pandit has called upon Citi’s top guns to get their new strategic plans ready in advance of the company’s annual investor meeting in May.

In a memo Pandit sent to employees last week, he noted that “while we face a challenging economic environment in many segments of our operations, fundamentally we remain strong,” adding that the bank maintains “incredibly strong positions in emerging markets throughout Asia, Latin America and Eastern Europe” and that “Citi is financially sound - we are well capitalized and extremely focused on the strength of our balance sheet.” Oppenheimer analyst Meredith Whitney has said shares in Citi could drop to $16 if it doesn’t shore up its capital cushion.

Pandit, sources say, is looking at not just dialing back its calamitous foray into risky asset backed scuritizations, as well as cost-cutting in its operations, but executing more cross-selling of Citi’s own products to customers in its other high-growth divisions, notably, at Krawcheck’s global wealth business.

That effort, though, has been hung up by Citi’s problematic computer systems which have been hurting the company for years, insiders say.

Citi’s former chairman and chief executive, Sandy Weill, cobbled together disparate businesses that were never integrated. “There are so many overlapping computer systems that don’t connect or work with each other, I can’t begin to tell you,” a source says. “The computer systems are so bad in that they are not integrated, the technology is way behind.”

Another source explains: “A Smith Barney client can’t walk into a Citi branch anywhere in the world and get a commercial loan from Citigroup or a Citi credit card sold to him. Also, a Smith Barney customer can’t transfer his or her account to Citi if he or she wants to, it’s ridiculous,” adding, “take that one instance and multiply it by 100, that will give you a sense of what’s going on here.”

Citigroup has been moving more rapidly than ever before to fix this problem of lack of cross-selling as well as its computer issues.

The bank recently conducted a pilot project in Boston and Philadelphia aimed at cross-selling Citi’s products, such as credit cards, consumer and commercial loans, in its retail branches to its high net worth customers at its global wealth management unit, the Smith Barney legacy division run by Krawcheck which is seeing strong growth. The pilot project was a success, sources say.

Meanwhile, Krawcheck is also overseeing a strategic realignment of Citi’s global wealth management division, which has seen strong revenue growth of 28% in 2007 versus 2006, resulting in earnings rising 37%.

Citi is also looking to focus on its fast growing global transaction services, which sells integrated cash management, trade, and securities and fund services to multinational corporations, financial institutions and public sector organizations around the world. This division has a network spanning over 100 countries, with over 65,000 clients and $13.1 trillion in assets.

And Pandit wants to put more capital behind investment banking and trading, as well as its retail banking services in Asia, Latin America and Eastern Europe, notably Brazil, Russia, China and India, to take advantage of the growing middle classes there.

The company has already said it is reviewing consumer lending practices in the wake of record write downs in its mortgage business, commercial lending and weakness in consumer lending. Citigroup has already announced more than $20 billion in total writedowns, and analysts expect even more double digit writedowns this quarter due to the housing and credit crisis.

Citi will also reduce $45 billion worth of mortgage business on its books over the next 12 months a 20% decrease from December 2007 levels, by not replacing loans when they mature or are paid off. It also aims to sell or convert into securities 90% of the mortgage loans it makes in the future, up from 65% now. Concerns still remain over Citi’s leveraged loan portfolio.

The shift will mean less pressure on the bank’s balance sheet, letting Citi hold less capital against those kinds of loans and letting the bank instead deploy that capital toward other high growth areas.