Archive for July, 2008
July 30, 2008 8:24AM
By Elizabeth MacDonald
The Securities and Exchange Commission late yesterday announced it’s extending its emergency ban on naked short selling in 19 financial companies through August 12, noting this will be the last extension of the rules.
That means the SEC will continue its regulatory apartheid by refusing to bend to requests by bankers associations to widen the rules to cover more financial concerns, with no further information from the agency on whether it believes those companies left off the list are potentially subject to market manipulation.
So that means companies whose stocks have been pounded into the sand remain off of the SEC’s list, including Washington Mutual (WM), Wachovia (WB), MBIA (MBI), Ambac (ABK), National City (NCC), KeyCorp (KEY), Sovereign Bancorp (SOV), Corus Bank (CORS) and Bank United (BKUNA).
The SEC instituted the temporary ban after shares in Fannie Mae (FNM), Freddie Mac (FRE) and Lehman Bros. (LEH) were driven lower, allegedly by rumors started by short sellers, despite the fact that legitimate questions arose over the health of their balance sheets and their accounting practices (see blogs “The SEC Comes Up Short,” “Why You Should be Worried About the Rescue of Fannie Mae and Freddie Mac,” “Fannie and Freddie on the Brink,” “Breaking Down Lehman’s Earnings,” “Questions About Lehman Brothers Continue to Mount” and “The Fire-Engine Red Flags at Lehman Brothers”).
The SEC also enacted the temporary ban despite the fact that Fannie and Freddie really started to plunge rapidly after a New York Times report indicating the White House was drawing up contingency plans to rescue these mortgage giants due to their potential insolvency, a possible insolvency raised by former St. Louis Federal Reserve president William Poole.
Also, the SEC itself says naked short selling, which it’s outlawed for these 19 companies, did not affect them to begin with.
The SEC has issued subpoenas to a raft of hedge funds to determine if rumor mongering helped cause Bear Stearns to collapse and Lehman’s shares to plunge-again despite the fact that their financial houses were clearly not in order due to their massive overleveraging.
Short sellers profit off of a stock’s fall in value. They borrow shares and then sell them, and when the price drops, they buy shares back at the lower price, returning the borrowed shares and pocketing the difference.
In a “naked” short sale, sellers don’t borrow the shares before selling them. “For this reason, naked shorting can allow manipulators to force prices down far lower than would be possible in legitimate short-selling conditions,” SEC chairman Christopher Cox said in an opinion piece in the Wall Street Journal.
The SEC’s new order forces short sellers to show specific agreements to borrow shares in these 19 companies before selling them.
Reason: The SEC wants to stop what Cox calls “distort and short” manipulations, the thinking being that illegitimate rumors are driving naked short sales and causing these stocks to experience record volatility.
“False rumors can lead to a loss of confidence in our markets. Such loss of confidence can lead to panic selling, which may be further exacerbated by ‘naked’ short selling,” Cox said when the initial ban was announced.
The SEC is examining the order’s impact, before writing final rules to potentially stop naked short selling abuses, while keeping short sales, which the SEC says does provide liquidity to the markets-and which analysts say stops certain shares from being inflated–intact.
The thinking on Wall Street is that the SEC’s ban ignited short covering in these 19 companies, helping to create a level of support for their share prices. Here are the 19 financial companies on the SEC’s list:
BNP Paribas Securities Corp
Bank of America Corp
Barclays
Citigroup
Credit Suisse Group
Daiwa Securities Group
Deutsche Bank Group
Allianz SE
Goldman Sachs Group Inc
Royal Bank ADS
HSBC Holdings Plc ADS
JPMorgan Chase & Co
Lehman Brothers Holdings Inc
Merrill Lynch & Co Inc
Mizuho Financial Group Inc
Morgan Stanley
UBS AG
Freddie Mac
Fannie Mae
To get on the list, the SEC chose “precisely those financial firms” that the Federal Reserve “has designated as eligible for access to its liquidity facilities, and for which the taxpayer could be on the hook,” Cox explained.
Ironies and questions abound, beyond the fact that many institutions on the list are helping hedge funds execute naked short sales, and that there are a large number of foreign institutions on this list (being primary dealers, they have access to the Fed window).
All US banks are eligible to access the Federal Reserve’s liquidity facilities, as even Fed Chairman Ben Bernanke noted in testimony before Congress recently that “all banks can borrow from the Fed’s discount window.” Wamu, Wachovia, KeyCorp and the other banks not on the list can go fail, too, leaving the taxpayer on the hook in a taxpayer-backed bailout. “Those institutions should be part of the group that requires better documentation on short selling as well,” says Frazier Rice, a private banker in New York City.
So why only these 19 financials?
Also SEC chairman Cox said in his WSJ op-ed piece “the SEC’s emergency order is not a response to unbridled naked short selling, which so far has not occurred,” in these 19 stocks.
So again why ban naked shorting for these 19 if it’s not occurring? In his editorial, Cox added rather flatly: “rather it is intended as a preventative step to help restore market confidence at a time when that is sorely needed.”
This approach is of a piece with this administration’s doctrine of pre-emptive strikes, unilaterally stamping out problems before they crop up, as Treasury secretary Henry Paulson did when he announced his “bazookanomics” approach to an effectively open-ended taxpayer bailout of Fannie Mae and Freddie Mac.
The approach here was that if the US could show the world at large it will pull out the stops to save these two publicly traded companies, just knowing the full faith and credit of US government (taxpayers) will scare the bejeezus out of the shorts and cause their shares to stop plunging, so no taxpayer bailout of Fannie and Freddie would be needed.
“If you’ve got a squirt gun in your pocket, you may have to take it out. If you’ve got a bazooka, and people know you’ve got it…you’re not likely to [have to] take it out,” Paulson testified recently about the government’s rescue plan for Fannie and Freddie.
Naked short selling is not illegal. The SEC’s rules on short selling, enacted in January 2005, said broker dealers and traders were not required to have a physical agreement to borrow the shares if they had “reasonable grounds” to believe that the shares can be borrowed.
The SEC itself has said in public statements that “naked short selling is not necessarily a violation of the federal securities laws or the Commission’s rules,” and that in certain instances, it can replenish market liquidity. The New York Stock Exchange has also said it has found no evidence of widespread naked short selling.
Naked shorting can arise when a stock is so illiquid and there are such a small number of shares outstanding, that trying to find shares to borrow can be difficult to arrange. Also, underwriters of initial public offerings or secondary stock offerings often have an over allotment of shares they place and trade that don’t technically yet exist in the offering, so they make the trades through naked short positions, Fox Business’s news director Ray Hennessey explains.
Traders have a right to do naked short selling, if they have reasonable grounds the shares in a short sale can be borrowed later on. If they see a financial cataclysm arising due to poor accounting, they have a right to do a naked short sale.
Savvy investors know to watch short positions to do necessary trouble-shooting in their own portfolios–before they get zeroed out due to financial mismanagement. Short selling keeps potential hyperinflation in shares in check-witness the dangerous bubble that has inflated in China’s stock markets, as China has outlawed short selling.
Corruption will always be with the markets, as corruption has been around since Adam. Rare is the critic of the Wall Street trader or analyst who crooks the buy trumpets and in turn is talking long his book, lining his wallet even further.
Again, it must be reiterated that the real problem is the SEC’s decision to remove the uptick rule in July 2007. The rule was an old stock market backstop, put in place in 1938. The SEC lifted this ban right when the subprime and credit crisis exploded.
The uptick rule said that traders can only short a stock if the last trade of a stock is at least a fraction, or an uptick, higher than the prior trade. The SEC says it has no intention of reinstating the uptick rule.
July 29, 2008 8:36AM
By Elizabeth MacDonald
The forecasters who thought investors should now pile into the financials, that the sector would start seeing an upward trend, now know the pain of betting on a false bottom.
Merrill Lynch’s shocking announcement after the market’s close yesterday that it will book a huge pre-tax $5.7 bn writedown in its upcoming third quarter from its toxic securities and hedges with bond insurers, plus raise another $8.5 bn in new stock, should make investors who piled into the shares just last week at $31 thinking the worst was over after Merrill reported its disastrous second quarter results feel totally blindsided.
It defies reason that Merrill did not know about this massive problem in its book of business, that it didn’t see this freight train of a writedown coming when just last week it disclosed $4.9 bn in second quarter losses due to $9.4 bn in writedowns for the period. Wall Street had expected lesser sums here, $1.8 bn in losses due to $6 bn in writedowns.
At minimum, do you really think it takes only about a week to convince foreigners to invest even more money at a time when the stakes they’ve already bought in Merrill earlier this year are now drastically under water?
The second quarter losses marked Merrill’s fourth straight quarterly loss. The tally of losses is ranging around $21 bn, and writedowns amounting to more than $46 bn.
Now more losses are on the way for the third quarter, the fifth straight quarter, at Merrill.
Wall Street is now wondering whether Merrill’s chief executive, John Thain, has a credibility problem. On the July 17 conference call about its bad second quarter results with analysts, analysts who were skeptical as they were expecting smaller losses and writedowns, Thain said: “Right now we believe we are in a very comfortable spot in terms of our capital.”
Really? And 10 days later you announce both a massive writedown and another eye-watering, dilutive capital raise?
Since he took over in December, Thain has repeatedly dismissed the notion that Merrill needs any more capital after the firm reported poor results, with the refrain being new capital would not be necessary. For a round up of Thain’s comments that the firm does not need new capital, click on this link: http://in.reuters.com/article/governmentFilingsNews/idINN2824127720080729
When did Merrill know it planned to unload this distressed debt and when did it know it had to do another $8.5 bn equity raise? Did it really come as a eureka moment just overnight?
Investors who bought in last week when it was said the worst was over at Merrill, when it was trading at around $31, are getting hammered now. The stock is trending down toward $20. “Shareholders are seeing their positions diluted massively,” says Dennis Gartman of the Gartman Letter.
Gartman adds the blame should also be put squarely on Merrill’s former chief executive Stanley O’Neal, ousted last fall due to his mismanagement, who walked away with $161.5 mn in compensation, compensation “that is not being written down even as the shareholders are having their positions massively corrupted,” Gartman says.
“If there is a crime on Wall Street it is this.” That compensation effectively was paid out based on artificial profits made during the housing bubble. Merrill to date has laid off 5,200 people.
Yes, I have raised the question of what some analysts were saying, whether we were seeing a bottom in the financials.
I also warned you that thinking that way would be like trying to hold onto a piece of Styrofoam in a typhoon.
Merrill’s stock got pounded in after hours trading, closing down 12% to $24.33. Shares are down 54% this year, and are trading at their lowest levels in ten years.
Meredith Whitney, a top analyst at Oppenheimer, says Merrill’s pro forma book value per common share is more like $21 and that shares are still trading at levels that are “at a premium” and “expensive.” Whitney does think Merrill is getting closer to being fairly valued and that “the hardest work” is behind the company. Whitney now expects Merrill to post a loss of $10.50 per share for the entire year, versus the $8.37 expected earlier.
Don’t be fooled by false bottoms in the financials. As economist Ed Yardeni points out, the financial sector of the S&P 500 jumped 31% “in a six-day short-covering rally that was interrupted by a 6.7% drop last Thursday, the biggest decline since a 7.7% decline on April 14, 2000.”
The jump came after Congress said it was close to signing the $300 bn housing bailout bill, which included the taxpayer backed rescue of publicly traded Fannie Mae (FNM) and Freddie Mac (FRE), and also turned these two as well as the Federal Housing Administration into a halfway house for severely delinquent, bombed out loans.
“The financials tend to rally following massive government programs to avert a financial meltdown,” Yardeni says.
What you should be watching for are writedown announcements such as Merrill’s, because it means the rest of Wall Street will start marking down their assets to potentially 22 cents on the dollar. Watch out, Lehman Bros. (LEH). Watch out Citigroup, which has $22.5 bn in subprime securities exposures here, and UBS, $15.6 bn, both ranked the highest in this category, Oppenheimer’s Whitney says.
A new report from Goldman Sachs on Merrill’s 22 cents on the dollar pricing indicates it thinks there will be “a negative read-through to Citigroup given its exposure and the levels where these assets appear to be marked ($0.50).”
Investors in Merrill should be notably concerned with what is happening at the country’s largest brokerage. Merrill was a repackaging factory for some truly toxic subprime debt, including those pumped out by Countrywide Financial. Countrywide pointed its conveyor belt of nasty loan products at Wall Street, and Merrill was first in line to gin them up into asset-backed securities.
Merrill’s latest writedowns resulted from the sale of a huge $11.1 bn slug of its asset-backed securities, helping to create the latest $5.7 bn pre-tax writedown. It also pulled the plug on hedges with troubled bond insurers, the two white hot zones on many financials’ balance sheets.
Watch how this deal to unload a whopping slug of Merrill’s distressed debt breaks down. Merrill said it sold $30.6 bn worth of distressed debt in the form of super senior asset-backed debt, once rated Triple A, for just $6.7 bn. Merrill had just said at the end of its second quarter these assets were worth $11.1 bn, or just 36 cents on the dollar.
So, being that it has sold this distressed debt, called collateralized debt obligations, for just $6.7 bn to a unit of Lone Star Funds, a Dallas private equity firm, when you do the math, that’s about 22 cents on the dollar. That’s a writedown of 78%. Gasp. That created $4.4 bn of the writedown.
Moreover, Lone Star only has to pony up $1.7 bn to seal the deal, borrowing the rest, or 75%, from Merrill. So Lone Star is effectively putting up just 25% of the deal, about six cents on the dollar, for the gross value of the deal. “That does not sound very good for the about-to-be diluted shareholders, now does it?,” says Jill Schlesinger, executive vice president and chief investment officer for StrategicPoint Investment Advisors.
One of the sharpest minds on Wall Street, Whitney Tilson, points out that Merrill’s announcement said Lone Street ” will not own any assets other than those pursuant to this transaction.” Tilson says that means Lone Street is setting up a special unit to house Merrill’s toxic CDOS, sheltered away from the pension, family trusts, endowment assets and insurance company portfolios Lone Star manages. That means if Lone Star defaults on its loan from Merrill, the only assets Merrill has recourse to are these CDO assets, Tilson notes.
So Tilson asks whether Merrill got to book this deal as a $6.7 bn sale, or as a $1.7 bn deal, with an account receivable on its balance sheet of $5.0 bn.
Does anyone at Merrill or on Wall Street know what these assets are really worth?
The sale cuts Merrill Lynch’s total CDO long exposures from $19.9 bn at June 27, 2008, supposedly to $8.8 bn. Most of what’s left is made up of older vintage securities, dating back to 2005.
Take a closer look through Merrill’s books and you’ll still see problems. As of June 27, it said it had exposures of $33.7 bn to U.S. prime mortgages, $1.01 bn to U.S. subprime mortgages, $1.54 bn to “Alt-A” mortgages and $7.45 bn to non- U.S. residential mortgages.
It’s also got a big $18 bn in exposures to subprime- and commercial-backed securities. Of that sum, its net exposure to subprime alone is $4.5 bn.
Merrill has been in acute pain due to what it has had on its balance sheets, with 30 CDOs worth in the aggregate $32 bn for deals Merrill underwrote in just 2007 alone. Some 27 of these have seen their top triple-A ratings downgraded to “junk,” Janet Tavakoli, a structured-finance consultant in Chicago, reportedly said. Their performance has been “dreadful,” she says.
Merrill has about $41 bn in net worth, or shareholder equity against about $34.4 bn in illiquid level three securities, those securities it has price tagged itself because no one wants them.
The $8.5 bn capital raise will dilute existing investors by nearly 40%. Merrill has to compensate Temasek and the Kuwaiti Investment authority who both bought shares in Merrill earlier this year at a higher price.
Last week, Merrill announced it would unload its stake in Bloomberg for $4.43 bn to raise capital. It had to unload this asset due to the fine print of an earlier $12 bn equity offering sold to Singapore’s investment fund Temasek and the Kuwaiti investment authority, which forces Merrill to remunerate them in the event of any further dilutive equity raises.
The new equity offering now forces Merrill to reset its earlier deals with Temasek and Kuwait, an issue I warned you would happen (see earlier blog, “Why Merrill May Cut Into its Muscle”).
Temasek had bought $5 bn at $48. As Merrill is now trending toward $20, Merrill has to pony up $2.5 bn to Temasek, and Temasek is expected to turn around and invest that remuneration into its new $3.4 bn investment in Merrill’s latest equity raise.
So in effect Merrill lent $5 bn to Lone Star to buy, gross value, $30 bn in securities, and at the same time it paid Singapore’s Temasek $2.5 bn to buy its shares.
Merrill also is in talks with the Kuwait Investment Authority to renegotiate the terms of its original investment. And Merrill’s management will buy 750,000 shares in the new offering.
July 28, 2008 8:49AM
By Elizabeth MacDonald
Wall Street executives now expect the Securities and Exchange Commission to extend its temporary limits on a certain type of short selling beyond the 19 financial companies on its initial list, the Wall Street Journal says.
However, the crackdown was problematic from the start, because, in a curious bit of regulatory apartheid, the list of 19 excluded a range of other financials, and because the SEC itself says the brand of shorting it’s outlawed for these 19 stocks did not affect them to begin with.
The limits are set to expire tomorrow, but executives, lobbyists and representatives of the Managed Funds Association have reportedly been talking to the SEC over the weekend about possible approaches to extending the rules another two months and expanding the rules to cover more companies, including insurance, housing-industry and a broader range of financial concerns, the WSJ says.
The talk now is whether the SEC’s temporary crackdown stopped the death spiral in stocks of financial outfits such as Lehman Brothers (LEH), Fannie Mae (FNM) and Freddie Mac (FRE), as it’s believed that traders conducting a certain type of short sale covered their positions, causing the shares to form a level of support.
But when you consider the SEC’s moves here, you may rightfully ask yourself in all irony:
Doesn’t it seem that the government’s farflung and costly attempts to stop the financial crisis are of a piece with the administration’s doctrine of pre-emptive strikes, unilaterally stamping out problems before they crop up?
For example, Treasury secretary Henry Paulson says he supports an effective, open-ended taxpayer bailout of Fannie Mae and Freddie Mac to show the stock market and the world at large the US means business and will pull out the stops to save these two publicly traded companies, the thinking being that the enormous backing of the US government (taxpayers), even if it’s not used, will cause their shares to stop plunging.
“If you’ve got a squirt gun in your pocket, you may have to take it out. If you’ve got a bazooka, and people know you’ve got it…you’re not likely to [have to] take it out,” Paulson testified recently about the government’s rescue plan for Fannie and Freddie.
The SEC’s crackdown on naked shorting in 19 financial companies are of a piece with Paulson’s bazookanomics–because the SEC says, get this, these 19 are not under attack from naked shorts at all. And to begin with, naked short selling is not illegal.
In a short sale, a trader sells borrowed stock in a bet the share’s price will decline and the stock can be resold for a profit at a lower price; the trader then simply returns the stock to the entity it borrowed the shares from and pockets the difference.
But “in an abusive naked short transaction, the seller doesn’t actually borrow the stock, and fails to deliver it to the buyer,” SEC chairman Christopher Cox explained in an op-ed piece in the WSJ that defended the SEC’s crackdown to protect the 19. “For this reason, naked shorting can allow manipulators to force prices down far lower than would be possible in legitimate short-selling conditions,” he added.
However, Cox says “the SEC’s emergency order is not a response to unbridled naked short selling, which so far has not occurred,” in these 19 stocks, adding, “rather it is intended as a preventative step to help restore market confidence at a time when that is sorely needed.”
Also, a score of banks and financial under siege by the shorts were not on the SEC’s list to begin with, igniting a growing chorus of criticism that says the SEC was unfair to keep them off the list.
Not on the list are stocks that have been savagely beaten up, including Washington Mutual (WM), Wachovia (WB), MBIA (MBI), Ambac (ABK), National City (NCC), KeyCorp (KEY), Sovereign Bancorp (SOV), Corus Bank (CORS) and Bank United (BKUNA). Wamu, Ambac and MBIA have plunged to around the price of a gallon of milk or gasoline, off 80% or more over the past year.
To stop the naked shorts, the SEC’s new rules forced traders to show specific agreements to borrow shares in these 19 companies before they actually started a short sale. The list includes:
BNP Paribas Securities Corp
Bank of America Corp
Barclays
Citigroup
Credit Suisse Group
Daiwa Securities Group
Deutsche Bank Group
Allianz SE
Goldman Sachs Group Inc
Royal Bank ADS
HSBC Holdings Plc ADS
JPMorgan Chase & Co
Lehman Brothers Holdings Inc
Merrill Lynch & Co Inc
Mizuho Financial Group Inc
Morgan Stanley
UBS AG
Freddie Mac
Fannie Mae
To get on the list, the SEC chose “precisely those financial firms” that the Federal Reserve “has designated as eligible for access to its liquidity facilities, and for which the taxpayer could be on the hook,” Cox explained.
The SEC’s moves raise ironies and legitimate questions here, beyond the fact that hedge funds pounding these stocks borrowed tens of billions of dollars from the same Wall Street investment banks and commercial banks on the list to do their short sales, and that there are a large number of foreign institutions on its list.
The SEC chose these 19 because they now can borrow funds at the Federal Reserve’s expanded discount window, borrowings for “which the American taxpayer is now on the line,” Cox explained.
However, Wamu, Wachovia, KeyCorp and the other banks not on the list can go under, too, leaving the taxpayer on the hook for them in a taxpayer-backed bailout.
And as Mark McHugh writes on the financial analysis website Seeking Alpha, on July 11, 2008, Bespoke Investment Group reported that “the short interest of the S&P 500 was 6.0% (percentage of float),” yet, absent Freddie Mac and Fannie Mae, the other 17 stocks “have a cumulative short interest of just 1.18% (percentage of outstanding).”
He adds: “Is that really cause for concern? In my universe, 1.18% short interest is no great shakes.” McHugh asks too why Goldman is on the list, “why are the “smartest guys on the street hiding under mom’s apron? They should just buy puts on themselves, make billions and squeeze these cretins until their eyeballs pop; they’ve pulled similar stunts, right?” (http://seekingalpha.com/article/85999-the-sec-s-sacred-cow-list-where-are-wamu-and-wachovia)
The SEC’s attempt to outlaw naked shorting was problematic from the start. In 2004, well-intentioned bureaucrats at the SEC tried to “attack the problem of naked shorting,” Cox has said.
The new rules, enacted in January 2005, forced broker-dealers and traders “before they accept short sale orders or effectuate short sales in their own accounts, to first borrow the security to be shorted, or enter into a contract to borrow it,” Cox said.
The problem was, the SEC wrote a loophole into that 2004 rule, saying broker dealers and traders were not required to have a physical agreement to borrow the shares if they had “reasonable grounds” to believe that the shares can be borrowed. “Opportunities for evasion of the rule’s purpose” were born via the “reasonable grounds” loophole, Cox has noted, and the thinking is the naked shorts piled through.
So the belief is traders shorted stock in the 19 companies, including Citigroup (C), Lehman, Fannie Mae, and Bank of America (BAC) without borrowing the shares to deliver to buyers, even though the SEC’s Cox says from the start that “has not occurred.”
Short sales add liquidity to the market, and provide a needed correction to stop overheated trading. Shorts are often attacked for talking their books, despite the bullish bias on Wall Street and despite the fact that Wall Street tends to bruit about its long positions.
Shorts often do their homework poring through financial statements finding economic potholes that protect investors, and can provide a necessary reality check, a reality check that clearly bounced in this crisis. China has outlawed short selling, which has helped inflate the bubble in those markets.
Yes abuses occur. But the SEC itself has said in public statements that “naked short selling is not necessarily a violation of the federal securities laws or the Commission’s rules,” and that in certain instances, it can replenish market liquidity.
The New York Stock Exchange has already said that the Big Board has found no evidence of widespread naked short selling.
Also, naked shorting can arise if a stock is so illiquid or has a tiny number of shares outstanding, making the attempt to find shares to borrow difficult to arrange. And underwriters of IPOs or secondary stock offerings often have an overallotment of shares they place and trade that don’t technically yet exist in the offering, so they make the trades through naked short positiosn, Fox Business’s news director Ray Hennessey explains.
The real problem at the SEC is its mysterious decision to remove the uptick rule in July 2007, just as the crisis in the financials was about to explode.
The uptick rule said that traders can only short a stock if the last trade of a stock is at least a fraction, or an uptick, higher than the prior trade.
The rule was an old stock market backstop, put in place in 1938. When the SEC lifted this ban, the subprime and credit crisis blew up and the rule change helped whipsaw volatility in financial stocks faster than a tractor trailer on a bungee cord.
July 25, 2008 8:42AM
By Elizabeth MacDonald
Sweetheart mortgages given by Countrywide Financial, the nation’s biggest mortgage lender, to elected officials and government bureaucrats seem tailor-made for an ethics inquiry by Congress, especially as the country is seeing a rising tide of voter anger in this presidential election year due to the massive $300 bn bailout of the housing industry at taxpayers’ expense.
The mortgages at issue were allegedly given to Congressional members and staffers championing this record bailout, a bailout that now surpasses the taxpayer cost of the S&L crisis in the late ‘80s and early ‘90s.
But Rep. Darrell Issa (R-Calif.) and Rep. Mark Souder (R-Ind.) say Rep. Henry Waxman (D-Calif.), chairman of the House Committee on Oversight and Government Reform, is ignoring their demands for an investigation into cheap, VIP mortgages allegedly given by Countrywide Financial to House staff members and elected officials.
Countrywide allegedly gave cheap, sweetheart mortgages to Sen. Kent Conrad (D-ND) and Sen. Christopher Dodd (D-Conn.), chairman of the Senate Banking committee who reportedly saved $75,000 on his inside deals from Countrywide.
At issue are Countrywide’s VIP mortgages, in which borrowers received lower interest rates and point shaves on their mortgages. Countrywide’s controversial VIP mortgages were given under the “Friends of Angelo” program, nicknamed after Countrywide chief executive Angelo Mozilo, a story that first broke in Portfolio Magazine.
Both Senators have denied wrongdoing and both repotedly welcome a Senate ethics inquiry (to date, no Senate ethics hearings on the matter have been announced).
The Wall Street Journal has also reported that James Johnson, a former chief executive of Fannie Mae, resigned recently as an adviser to the presidential campaign of Sen. Barack Obama after it was disclosed that Johnson received sweetheart loans from Countrywide. Johnson’s lawyer has said those loans were made on normal terms. Franklin Raines, a former head of Fannie Mae, also received sweetheart Countrywide loans, the Wall Street Journal reports.
Rep. Waxman’s office did not return calls for comment.
Reps. Issa and Souder wrote to Rep. Waxman that, “given the fact that Congress is actively considering bailing out Fannie Mae, Freddie Mac, Countrywide, and other lenders, it is essential that Congress investigate to determine the extent that public officials and staff have been compromised by improper gifts,” adding, “for all the hearings your committee has held on subjects other than waste, fraud, and abuse in the Federal government, it is an appalling lapse that the Committee is not investigating this matter.”
House and Senate rules bar members from knowingly receiving gifts worth $100 or more annually from companies that use registered lobbyists. Countrywide’s ethics code restricts executives, employees and board directors from improperly trying to influence government employees with money, gifts, loans, rewards, favors or anything of value.
The House committee on Oversight and Government Reform has already held hearings that attempted to link the housing bubble to outsized executive pay packages given to Countrywide’s chief executive Angelo Mozilo, Merrill Lynch’s former chief executive E. Stanley O’Neal and Citigroup’s former head, Charles O. Prince.
In their letter to Rep. Waxman, Representatives Issa and Souder demanded that Waxman use his “influence as chairman to stop any legislation bailing out mortgage lenders until all tainted individuals have recused themselves and the legislation has been examined and declared free of any undue influence.”
The housing bailout bill would provide $300 bn worth of taxpayer funds to rescue borrowers who took tens of billions of dollars worth of mortgages from lenders like Countrywide, among other things. Bank of America (BAC), helped shape the legislation via two lobbying documents outlining how to construct the bailout, obtained by Fox Business, after it announced its $2.5 bn purchase of Countrywide last January (see blog “The Bank of America Housing Bailout Bill”).
The housing bill would also provide rescue funding to Fannie Mae (FNM) and Freddie Mac (FRE), two publicly traded companies who critics say have gunned their lobbying engines on Capitol Hill in order to lighten regulatory oversight, including any increases in their capital cushions, now at perilously low levels.
The two mortgage finance giants have a total $54 bn in net worth, upon which sits a pyramid of debt, including $1.6 tn in borrowings to run their business. Fannie and Freddie operate a $5.3 tn book of business in which it buys and guarantees mortgages, with another $3.3 tn in hedges sitting off balance sheet, according to Lehman Bros. (LEH).
The two publicly traded companies have had a history of accounting misdeeds and have reported a total of $11.1 bn in losses over the last few quarters. Freddie and Fannie combined have on their balance sheets $260 bn in subprime and Alt-A (just a notch above subprime) securitizations, backed by potentially shoddy loans.
Freddie also has disclosed it has $156.8 bn in level three assets nobody wants and for which it can’t get pricetags on since the market for them is frozen; Fannie has $56.1 bn.
So far, any money given to Fannie and Freddie has not been conditioned on capping executive pay or receivership, which would include breaking up the companies and cleaning out their richly paid management and boards that concocted these two potential economic sinkholes.
A growing number of economists and analysts belive the two are insolvent, as home foreclosures rise to record levels and borrowers fall underwater on their mortgages. Senate majority Leader Harry Reid (D-Nev.) is now blocking a vote on an amendment proposed by South Carolina Republican Jim DeMint to bar the two from lobbying in the future.
In their letter to Rep. Waxman, Representatives Issa and Souder refer to fresh details on Countrywide’s sweetheart loan deals given to government officials via its VIP mortgage program.
Specifically, the two cite an August 2008 article in Conde Nast’s Portfolio Magazine, which reports new allegations that House of Representatives staffers, a California state appeals court judge, and other current and former federal officials received special treatment in their mortgages from Countrywide due to their positions.
Portfolio has reported that former Clinton cabinet member Donna Shalala, former Bush Cabinet member Alphonso Jackson, as well as former United Nations Ambassador Richard Holbrooke also received VIP mortgages from Countrywide.
And Portfolio says that VIP Countrywide loans were given to former Countrywide director Henry Cisneros, who served as secretary of Housing and Urban Development in the Clinton administration; former White House staffer Paul Begala, now a commentator on CNN; and Postmaster General John Potter. Countrywide also offered special discounts to Congressional staffers involved in housing issues, the magazine says (http://www.portfolio.com/news-markets/national-news/portfolio/2008/07/16/Countrywide-Deals-Exposed?print=true).
The Portfolio article reported that former Countrywide Financial loan officer Robert Feinberg stated that he personally spoke with Senator Dodd and Senator Conrad about their special mortgage deals. It also noted the existence of e-mail traffic between Mr. Feinberg and former Countrywide CEO Angelo Mozilo on the subject of VIP loans and notes that Mr. Feinberg is in possession of “stacks of documents about the VIP operation.”
On the subject of Countrywide’s federal lobbying efforts, the Portfolio article provides quotes from retired Countrywide managing director Sidney Lenz, who oversaw government relations for the lender. Lenz reportedly says the company’s lobbyists identified potential customers on Capitol Hill and in federal agencies and directed them to Countrywide’s VIP program.
The company’s lobbyists were “incredibly receptive” to loan requests from officials, Portfolio quotes Lenz as saying, adding, “Countrywide had an incredibly good relationship with Congress. It was not unusual for us to get a call saying, ‘A bill’s being introduced. It’s a little technical, and there are parts we don’t understand. Can you help educate us on this?’”
Similarly, Rep. Jeb Hensarling (R-Texas) has also called for hearings to determine whether members received “preferential treatment” with their mortgages from Countrywide, “while millions of hardworking Americans struggle to repay their mortgage debts and cope with $4 [per] gallon gasoline and soaring foods prices,” he noted in an open letter to Congressional colleagues.
I will let the letter from Representatives Issa and Souder to Rep. Waxman speak for itself:
“As members of the House Committee on Oversight and Government Reform, we are troubled by your lack of response to our previous request and would like to know why the Committee is hiding from its duty to investigate this matter. Both documents and witnesses are clearly ready and available for an investigation and we would note that the Committee has investigated other improprieties committed by lobbyists.”
The letter adds: “The Committee’s failure to act when presented with rapidly growing evidence of wrongdoing makes a mockery of Speaker Pelosi’s election promise to improve House Ethics.”
July 24, 2008 10:24AM
By Elizabeth MacDonald
“In this present crisis, government is not the solution to our problem, government is the problem… It is no coincidence that our present troubles parallel and are proportionate to the intervention and intrusion in our lives that result from unnecessary and excessive growth of government.” – Ronald Reagan, Inaugural Address, January 20, 1981
The moves by the government to calm the waters over the perilous health of Fannie Mae (FNM) and Freddie Mac (FRE), the mortgage finance giants, have had a temporary Xanax effect on the markets, similar to the Federal Reserve’s shotgun marriage between JPMorgan Chase and Bear Stearns. This, despite the fact that the moves have kicked into high gear the haymaker of inflation now coming a cropper through family budgets.
What puts me near to having a stroke is when Congress thinks it can whip a fast ball by Americans by saying the moves to bolster Fannie and Freddie will cost $25 bn, in order to sell the $300 bn housing bailout bill.
The $25 bn number is a fake number, the cost will be dramatically higher. And it’s not just because the government’s estimate of the cost to taxpayers for the S&L crisis rose from an initial $50 bn to more than $124.6 bn (not inflation adjusted). Read to the bottom to find out why.
The Congressional Budget Office spitballed this one and came up with a best guesstimate based on its averaging out of what it thought the losses might be. The $25 bn tossup represents an average of the odds of no government money spent whatsoever (weighted at better than 50-50 odds, who is the fantabulist who cooked those odds up?), what the CBO believes is the smaller odds of spending in excess of $25 bn and then in excess of $100 bn (pegged at a rosy 5% probability).
More importantly, the $25 bn arises despite the fact that the Congress just this week sent in the Eliot Nesses from the Federal Reserve and the Office of the Comptroller of the Currency to go find out what the heck is really sitting on Fannie and Freddie’s books, as it clearly doesn’t believe the management at these two levered up examples of crony capitalism.
And don’t forget the history here, CBO’s estimates on the annual cost of tax code legislative changes (federal tax revenues gained or lost) are often way off by $150 bn or more.
But here’s what should concern you.
Instead of reining in their colossal, outsized portfolios which has caused such danger to taxpayers, the legislation went in the opposite direction. It would increase the statutory limit on the national debt by $800 bn, to $10.6 tn, as the two would now get to buy and back jumbo loans worth $625,000.
However, the House bill doesn’t force Fannie and Freddie to wipe out, or even cut, their dividends to investors in the event they draw down on the government’s line of credit, a pipeline into the Treasury worth $2.25 bn each, now expanded and open for the next year and a half. Treasury gets to make that call. Also, the two can use the securities they mint on their own to use as collateral when borrowing at a cheap $2.5% at the Federal Reserve discount window.
And nowhere to be found is any talk of capping the top execs’ pay at Fannie and Freddie. Last year, Freddie’s chief exec Richard Syron got paid about $19.8 mn even though shares in his company lost half their value. Fannie’s top gun Daniel Mudd got paid $12.2 mn in compensation, (with a $2.2 mn bonus).
I don’t know where to begin with the stink bombs, potholes and steam pipes bursting in these two reckless publicly traded companies, which have a total $5.3 tn book of business and another $3.3 tn off balance sheet. Why taxpayers now must now be forced to own a piece of these publicly traded disasters, who exhibit zero fiduciary responsibility, is beyond me.
The two have much higher leverage ratios than banks or hedge funds, but lower borrowing costs due to their implicit government backing, capital cushions they whittled down after they gunned their lobbying engines on Capitol Hill, showering elected officials with money.
Here’s a list–notice none of these issues are addressed in the housing bailout bill:
*Both have a total of a microscopic–did you see it, did you catch it?–$54bn in net worth, generally assets minus liabilities (don’t listen to the $81 bn figure tossed around for their total capital, that’s a pro forma fake number that doesn’t include certain losses).
*Teetering atop that razor thin wedge is a pyramid of debt.
*One stink bomb is the total of $260 bn in securitized assets backed by subprime and Alt-A loans, loans which sit in between subprime and prime. Those sums dwarf their capital positions.
*Freddie has $156.8 bn in level three assets, those illiquid securities it can’t get a pricetag on because no one wants them now. Remember, under US accounting rules, it gets to assign its own values to these assets, they could be worth more, they could be worth less.
*Fannie has $56.1 bn in level three assets, or about a seventh of its fair valued assets.
*Fannie and Freddie have combined debts of $1.59 tn, borrowings they made merely to operate their businesses. Again, that’s against just $54 bn in total net worth. Their guaranteed liabilities were 29 times their net worth at the end of the first quarter.
*They each have $2.25 bn pipelines into the Treasury, which the government now wants to expand. Forty years ago, when they went public, Fannie had debt of about $15 bn. Do the math against Fannie’s $804 bn in liabilities today, and the pipelines should be about $120 bn each.
Still believe that $25 bn figure Congress is selling you?
The right thing to do would be to pull the sheet over the two, put them in receivership and restructure their businesses. Restrain their portfolios, the two need statutory limits on their portfolios, put the guardrails up and do it now.
We’re not talking bankruptcy here, calm down banks and central bankers who hold Fannie and Freddie debt overseas, we’re talking about a restructuring that protects everyone, let the portfolios run off, or else you, foreigners, will be importing our inflation.
Congress must insist on showing a “profit” from this misadventure, beyond the equity you and I will now hold in these two via the government’s moves (taxpayer-owned stakes which are subordinated to other investors, but that’s for another day).
End note: Isn’t it interesting that Fannie and Freddie went public after former US president Lyndon Johnson, worried about the effect of the Vietnam War on the federal budget, moved both off of the government’s books, in an off-balance sheet, adumbrated move presaging Enron?
Remember for the first time in the late ‘60s, Congress changed the rules to let it get its mitts on taxpayer’s our Social Security funds, which it since spent on pork to buy votes.
The ‘60s were when all fiscal and monetary responsibility started to fly into a ditch, and when taxpayers were loaded into the backseat of Congress’s spaceship pointed directly at the center of the sun.
Read Reagan’s quote again at the beginning of this blog–it’s back to the future time.
