Archive for the 'Uncategorized' Category Page 2 of 25
August 26, 2008 1:14PM
By Elizabeth MacDonald
The taxpayer bailout of the US mortgage finance giants Fannie Mae (FNM) and Freddie Mac (FRE) may not happen next year.
It may happen by the end of this quarter.
Fannie and Freddie either own or guarantee nearly half of all U.S. mortgages. The two have had a history of accounting misdeeds and of making political donations to elected officials in order to help ease regulatory demands. They have reported record losses over the past year as hundreds of thousands of borrowers around the country go belly-up on mortgages.
The two issue debt to refinance maturing securities that grease their $5 tn book of business and also to buy mortgages.
Fannie and Freddie have to repay $223 bn in bonds due by the end of the quarter, $120 bn at Fannie and Freddie, $103 bn, according to company reports. The problem is, the two are pricing their debt at gut-wrenching spreads above Treasuries, with the five year at Freddie yielding 1.13 percentage points above similar term notes.
Compare that to the 106 basis point spread when the markets were suicidal in March after the Federal Reserve’s orchestrated, shot gun wedding between JPMorgan Chase (JPM) and Bear Stearns. Why the higher yield now? Because central bankers around the globe, notably in China, have backed off buying their debt, treating it like kryptonite.
Now this $223 bn is an outsized amount of debt that will cause more than acid reflux in the already stretched to the limit bond market. And it must make you rethink Treasury Secretary Henry Paulson’s “bazooka-nomics” approach to providing an unlimited, open-ended taxpayer backstop to these two publicly traded companies, whereby Paulson halfheartedly placed a bet that an open-ended commitment would calm the markets down and cause the two mortgage companies’ shares to go up so long as Wall Street believed the government would rescue them at all costs.
The way these two companies recklessly built and operated their Ponzi-type business model boggles the mind. Teetering atop their combined $54 bn net worth is a breathtaking pyramid of debt and assets, $5 tn. That capital amounts to less than 1% of the mortgages they either own or back. This metaphor is being generous–because their thin sliver of a wedge of a capital cushion is microscopic–but would you keep just one dollar in the bank to fund a $100 loan?
Instead of shutting the spigot off, the two bought subprime and Alt-A securitizations through 2007 when the housing bubble burst, picking up the slack for banks when Wall Street shut down its printing press factory cranking out a drunken daisy chain of asset-backed paper. This is beyond impenetrably stupid. It’s obscene.
The second reason why I think the taxpayer bailout is coming faster than expected is because of the problem with Fannie and Freddie’s preferred shares. Preferred shares are a form of investment that are different from common stock, as the shares offer a dividend that is paid before any dividends are forked over to common stock investors, though the shares do not carry voting rights as common stock does.
Of paramount importance is keeping the preferred shareholders intact, as $36 bn of these investments are held by regional banks around the country, who have counted these shares as part of their regulatory capital cushions.
Reports indicate that the Federal Reserve has been pressuring the Treasury Department behind the scenes not to adopt a rescue plan for Fannie Mae and Freddie Mac that would zero out the value of their preferred shares, as doing so would ignite a cascading effect of losses at regional banks and the need to raise even more capital to fill the potholes blown open by the dramatic drops in value in the preferred shares. Moody’s slashed ratings on preferred stock of Fannie and Freddie last Friday, to Baa3 from A1 on Aug. 22. Ironically, the regional banks affected may have to raise capital in the form of issuing more preferred shares.
If the US government has to rescue Fannie and Freddie, their existing preferred shares would either be subordinated to any taxpayer-owned equity stake in the two, or the preferred shareholders would be either partly or wholly wiped out.
JPMorgan Chase already reports it expects to take a $600 mn loss on its preferred shares in its third quarter.
According to SNL Research, among insurers, American International Group (AIG) and Hartford Financial Services Group (HIG) are the largest preferred stockholders of Fannie and Freddie, as of year-end 2007, with AIG holding $313.99 mn in Freddie Mac preferred shares and $266.73 mn in Fannie Mae preferred stock estimated at fair value. SNL says Hartford holds $136.52 mn in Freddie Mac and $171.61 mn in Fannie Mae preferred shares.
Of the large-cap banks, M&T Bank (MTB), Fifth Third Bancorp (FITB) and National City (NCC) have the greatest exposure to Fannie and Freddie preferred stock, notes a report from Keefe Bruyette & Woods. KBW indicates that M&T has $120.0 mn, or 4% of its tangible capital, in the preferred stock of Fannie and Freddie, Fifth Third has $55.0 mn, or 1% of its tangible capital, in their preferred stock (Fifth Third took $13 mn in other-than-temporary impairments on their stocks in the second quarter, SNL says).
KBW says the regional banks have even greater exposures to these shares in Fannie and Freddie. Gateway Financial Holdings (GBTS) has a $38.5 mn exposure to Fannie and Freddie preferred stock, or 34% of its tangible capital. Midwest Banc Holdings (MBHI) has $62.0 mn in preferred shares, or 32% of its tangible capital, and Westamerica Bancorp (WABC) has $44.5 mn, or 16% of its tangible capital, in their preferred stock.
Five other regional banks have preferred stock positions in Fannie and Freddie that are equal to 10% or more of their tangible capital, the largest of which is Sovereign Bancorp (SOV), with its holdings of Fannie and Freddie preferred stock equating to 13% of its tangible capital, SNL notes.
August 14, 2008 8:19AM
By Elizabeth MacDonald
After being stonewalled for nearly a month, Rep. Darrell Issa (R-CA) and Rep. Mark Souder (R-IN) have sent an official request for an Ethics Committee investigation into “disturbing allegations,” first reported in Conde Nast Portfolio, that Countrywide Financial gave illegal mortgages prohibited by House rules to members of Congress, congressional staff and other officials (see blog “Where are the Ethics Hearings into Countrywide’s VIP Loans?”)
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.
Specifically, Countrywide’s sweetheart mortgages were called VIP loans, in which lawmakers and government
employees allegedly 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.
The mortgages were allegedly given to Congressional members and staffers championing this record bailout, a bailout that fast approaches 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.
Who Got the Sweetheart Deals?
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.
Dodd, who has helped shepherd the housing bill, has received about $107,800 in campaign contributions-nearly 50% higher than initially thought-from Bank of America’s employees and political action committee, including the bank’s predecessor companies, since 1989, according to Douglas Weber, an analyst with the Center for Responsive Politics.
Both senators have denied wrongdoing and both reportedly welcome a Senate ethics inquiry (to date, no Senate ethics hearings on the matter have been announced).
Senate Budget Committee Chairman Conrad said he is donating $10,500 to charity and refinancing his loan on an apartment building after reviewing documents showing he received special treatment from Countrywide Financial Corp.
Conrad said it appears that Countrywide waived 1 point on his mortgage for a Bethany Beach, Del., vacation home. He said he would donate the equivalent amount of money to Habitat for Humanity.
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.
Rules on Illegal Gifts to Congressmen
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 serious and broad allegation” that elected officials and other government employees “were given preferential treatment - in the form of a gift from a corporation when mortgage lender Countrywide gave them loans on preferential terms - needs to be investigated,” the two congressmen wrote Representatives Stephanie Tubbs Jones (D-OH) and Doc Hastings (R-WA) of the House Ethics committee.
High-level Footdragging on Hearings
The congressmen’s complaint comes after two requests for an Oversight and Government Reform Committee investigation to chairman Henry Waxman came up short.
Rep. Waxman punted on the hearing, passing the buck to the ethics committee. In his reply, Rep. Waxman drew comparisons with the hearings into former lobbyist and now convicted felon Jack Abramoff and the Clinton campaign finance investigations.
Waxman noted that, because the issues the two raise “would require the Committee to investigate the conduct of members, the precedents of the Committee indicate that the Committee on Standards of Official Conduct would be the appropriate venue for the issues you have raised.”
Was Waxman’s Decision Arbitrary?
As it’s unclear how ‘precedents’ is defined here, it’s worth noting that 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.
Also, Waxman made room on his committee’s schedule for hearings on alleged steroid use in major league baseball (where are oversight hearings on the deceptive accounting sleights of hand the government uses to mask the impact of Medicare and Social Security costs on the US budgets?),
Waxman stated, “because the issues you raise would require the Committee to investigate the conduct of members, the precedents of the Committee indicate that the Committee on Standards of Official Conduct would be the appropriate venue for the issues you have raised.”
Reps. Issa and Souder shot a letter back to Rep. Waxman, noting that they would forward his response to the Ethics Committee and that “the precedent set by the Jack Abramoff investigation actually supports the committee conducting a probe of Countrywide VIP programs pertaining to the conduct of Franklin Raines, James Johnson, and others at Fannie Mae, Freddie Mac, and Administration officials.”
Issa and Souder Not Having It
“The allegations of illegal gift giving swirling around the Country VIP program are broad and serious,” Rep.
Issa noted. “In a Congress that was supposed to emphasize ethics, it’s disappointing that no committee chairman seems to want to claim jurisdiction and investigate the nexus between the mortgage crisis and public officials who got too cozy with lenders.”
Souder noted that: “Since the allegations surrounding the Friends of Angelo list first surfaced, I’ve been urging an investigation,” adding that he has “also introduced the Financial Disclosure and Integrity Act to urge transparency and ethics reform in this area”
What’s At Stake
Besides allegations of corruption, taxpayer money is at stake.
As I’ve already reported to you, 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 $5.3 debt, as well as $1.6 tn in borrowings to run their business. Fannie and Freddie buy and guarantee mortgages, with another $3.3 tn in hedges sitting off balance sheet, according to Lehman Bros. (LEH).
Who Else Got Sweetheart Loans?
Specifically, the two congressmen have cited the August 2008 article in 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.
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?’”
Another Congressman Demands Hearings
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.
August 14, 2008 7:33AM
By Elizabeth MacDonald
Did the SEC’s plan to stop naked short selling abuses in 19 stocks work?
The jury is still deliberating, the results so far are mixed.
Stocks in many of the companies on the list actually rose during the ban, but the stock market took shares down in others due to problematic balance sheets and poor risk management controls.
The Securities and Exchange Commission’s emergency move to outlaw naked short sales in shares of 19 financial stocks went into effect July 15 and expired Aug. 12. Short sellers were forced to actually have borrowed stock in hand before executing a short sale.
SEC Chairman Christopher Cox said that the agency wanted to stop certain stock price manipulations, as volatility in the financials is at historic levels.
SEC Moves to Make Ban Permanent
The SEC is moving to permanently outlaw naked short-selling for all stocks and has already begun work on the new rules so as to “extend this kind of procedural protection to the entire market”, Cox told Congress. “Very soon we will be in a position to issue a proposal on that.”
Short-sellers aim to profit from share declines, usually by borrowing a stock, selling it and buying the shares back after their price has decreased. In “naked” short-selling, the shares are sold without being borrowed first. The emergency rule requires investors to borrow the security first and deliver at settlement (see blogs “Get Shorty,” “The SEC Comes Up Short”).
Besides the ban, the SEC has also issued subpoenas to a raft of hedge funds to determine if rumor mongering helped cause Bear Stearns to collapse and shares in Lehman Bros. Holdings (LEH) to plunge–again despite the fact that their financial houses were clearly not in order due to their massive overleveraging.
Why the Temporary Ban Was Enacted
Aggressive short selling was blamed for aggravating the steep plunge in shares of Lehman, mortgage finance giants Fannie Mae (FNM) and Freddie Mac (FRE), who together hold or guarantee more than $5 tn in home mortgages, or about half the U.S. total.
The temporary ban was enacted despite the fact that these companies were under fire for poor risk management and questions over their accounting (see blogs “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 initially announced the emergency order on July 15 after a dangerous drop in shares of Fannie and Freddie. Aggravating the drop was a Wall Street Journal report http://online.wsj.com/article/SB121564782376340951.html?mod=hps_us_whats_news that said the White House had begun contingency planning in the event the mortgage finance giants failed due to their potential insolvency, an insolvency raised by former St. Louis Federal Reserve president William Poole.
The 19 Gain in Strength-Despite the Ban
But, as Bloomberg reported, the 19 companies on the SEC’s list actually saw their market value climb 26% since July 15, with the companies adding $270 bn to their market capitalization.
Bloomberg adds that the companies’ gains in market cap put them back around where they stood on March 17, the St. Patrick’s Day shotgun wedding of the nearly bankrupt Bear Stearns and JPMorgan Chase, orchestrated by the Federal Reserve.
Shorting is Back With a Vengeance
However, Richard X. Bove, a top banking and brokerage analyst at Ladenburg Thalmann who is widely followed on Wall Street, says in a new report that “the anecdotal data I am receiving suggests that shorting these companies was resumed with a vengeance.”
Bove notes that bank stocks have plunged in the past two days, with the KBW Bank Index falling 11.8% from its high Monday to its close Wednesday, the S&P Bank index down by 10.8% and the American Exchange Broker index down by 9.4%.
Bove notes that two stocks on the SEC’s list, Goldman Sachs (GS) and JPMorgan Chase (JPM), fell in response to earnings estimate cuts, and that Lehman Brothers (LEH) “continued to give off negative vibrations relative to its balance sheet.”
However, Bove says “there may be another explanation, since a number of banking and brokerage stocks are not impacted by the negative developments affecting the targeted companies.”
Who Was on the 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
Regulatory Apartheid
Raising criticism of regulatory apartheid, the SEC did not include on the list companies whose stocks have been hammered, 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).
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.
But 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.
Moreover, SEC chairman Cox recently said in a July 24th op-ed piece in The Wall Street Journal http://www.sec.gov/news/speech/2008/spch072408cc.htm that “the SEC’s emergency order is not a response to unbridled naked short selling, which so far has not occurred.”
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.”
How Did the Companies’ Shares Perform During the Ban?
Fannie Mae’s stock stood at $7 the day the ban was enacted, rose to $14 in the interim, and shares closed at $8 the day the ban was lifted.
Similarly, Freddie Mac stood at $5 the day the ban was enacted, rose to nearly $11 in the interim, and closed at $5 when it was lifted.
S3 Matching Technologies, a stock market research firm, says that while short sales for the 19 stocks dropped by a sizable 63% during the ban, the firm says short sales didn’t determine the shares’ value, the markets did.
It also says that short sales actually increased in shares of Bank of America Corp. (BAC) while the ban was in effect, despite the fact that BofA’s stock price rose from about $19 to $31 during the blackout period.
Arturo Bris, a professor affiliated with the Yale International Center for Finance, analyzed short selling data from the Big Board in the 19 stocks on SEC’s list for the trading period from Jan. 1 to July 15, 2008 and argues that the SEC didn’t need to enact the ban in the first place. Bris says that short-selling amounted to just 12% of the trades in the 19 stocks, versus 13% for comparable U.S. financial outfits.
A Curious Trade Off of the Ban
Bove also notes a curious trade off of the ban. “The theory is that the paired transaction, which was in place, had investors buying utilities and shorting financial,” he says. “When the SEC controls were put in place, the positions were reversed allowing the financials to recover in price and forcing the utilities to fall back. In the past two days, the positions may have been reversed, again, with devastating impacts on the financials and positive impacts on the utilities.”
The SEC has said that short sales do provide liquidity to the markets–and which analysts say stops certain shares from being inflated due to things like unlawful accounting moves.
Naked Shorting is Not Illegal
I’ve noted before, 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 a public statement 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 often 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.
Reinstate the Uptick Rule
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.
August 12, 2008 8:31AM
By Elizabeth MacDonald
Despite the initial burst of positive headlines, John Thain of Merrill Lynch, Vikram Pandit of Citigroup, Robert Willumstad of American International Group and Robert Steel of Wachovia are winning mixed praise, according to Wall Street analysts.
These were the go-to guys, the rescue squad hired to ride steerage on the ocean liner of damaged, levered securities drowning Wall Street firms, the heroes parachuting in to groom to a champion-show finish bombed-out financial results never before seen in the history of Wall Street.
But their clarion call to glory has been muted of late, their honeymoon period is pretty much over at Merrill Lynch (MER), Citigroup (C), AIG, (AIG) and Wachovia (WB). And some of these executives are getting their credibility sewaraged in the process.
The problems are not of their creation, to be sure, having taken the reins from executives who stayed too late at the party “dancing” in subprime, to quote Citi’s former chief executive Charles O. Prince.
As the writedowns and losses reached epic proportions, it soon became clear that the companies’ former top executives, Citi’s Prince, Merrill’s Stanley O’Neal, AIG’s Martin Sullivan and Wachovia’s G. Kennedy Thompson were smoking in bed while the house was on fire, to paraphrase one Wall Street analyst.
Pain Circles the Globe
Worldwide, banks and investment houses have taken more than $500 bn in subprime and credit-related writedowns since January 2007, largely from the drunken daisy chain of paper Wall Street spat out in the form of asset-backed securities, now circling the globe from here to the Arctic and beyond. To date, more than $353 bn has been raised to plug balance sheet holes.
While the $500 bn plus figure is still less than the $600 bn in inflation-adjusted losses from the S&L crisis, a growing number of analysts believe that $500 bn figure could more than double when all is said and done. And some market pros believe the housing downturn is only half way over.
A Light at the End of the Tunnel?
Goldman Sachs looked at 24 house price busts declines of more than 15% since the ’70s across 15 countries, and found that on average, the fall is around 30%, bottoming out after six years.
Closely watched housing indices such as the Standard & Poors/Case Shiller Index indicate the housing downturn is about at the half way point. JPMorgan Chase says it sees a “continued decline in US housing prices,” with its chief executive, Jamie Dimon, characterizing the outlook as “terrible” as the bank’s losses on prime loans triple in coming months. Freddie Mac (FRE) recently said the overall price decline still has as much as 20 percentage points to go.
The executives are overseeing the worst losses since the credit crisis began in the summer of 2007.Merrill is off 62% since early August of 2007, Citigroup’s shares are down 58% , AIG is down 62% and Wachovia is down 61%.
The CEOs Desperately Holding On
Meanwhile, chief executives at other damaged banks and investment houses are holding onto their jobs by their fingernails.
Despite losing his role as chairman last June, Washington Mutual’s (WM) Kerry Killinger is still on the stick, as shares in his bank hover around the cost of a gallon of milk or gasoline.
Morgan Stanley’s (MS) John Mack is still running this blue-chip firm, though its risk management practices have been under fire (Morgan ousted last fall co-president Zoe Cruz, a 25-year veteran and head of its trading operations after a $3.7 bn subprime trading loss).
And let’s not forget the richly paid chief executives of Fannie Mae (FNM) and Freddie Mac (FRE), Daniel Mudd and Richard Syron, who have hardly seen their compensation curtailed despite helping to run into the ground the country’s largest mortgage finance giants, now backstopped by the new, taxpayer-funded $300 bn housing bill, which bails out Wall Street, reckless lenders and numerous irresponsible borrowers.
Covering Up With a Multitude of Spins
For their part, Wall Street’s new A-team has been making habitually self-deceiving, misguided statements about the rosy state of their companies, triggering acid reflux on the part of investors who buy their shares only to get drilled later when the companies’ earnings blow flat tires after more writedowns. History repeats here, as others have made unfortunate forecasts too.
Who Said This in June 2007?
“Troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system.”
Answer: Federal Reserve chairman Ben Bernanke, less than a year and half into his new job.
Two months later all holy hell broke loose.
JOHN THAIN, CHIEF EXECUTIVE, MERRILL LYNCH. Perhaps no other executive has been pilloried more for making overly optimistic statements about their companies’ capital position than Thain.
Initially it was thought, give Thain a break, he’s new to the job, he took over from O’Neal, an executive who mindlessly turned the Thundering Herd into the Blundering Herd, with misguided decisions like buying subprime loan purveyor First Franklin Financial from National City for $1.3 bn at the height of the bubble in September 2006 and for taking any junk loan Countrywide Financial (CFC) threw at the firm (no writedowns yet on O’Neal’s $160 mn in total compensation he walked out the door with).
Over the past 12 months, Merill has reported more than $19 bn in losses, wiping out all of the earnings it earned during the housing bubble in the prior three years. It’s booked an estimated $51.8 bn in writedowns and losses since the crisis began, and has raised an estimated $29.9 bn.
The Spin Doctor
But analysts grew increasingly irked by what they view as an attempt to cover up with a multitude of spins Merrill’s dangerously low capital position, moves which run counter to the scissored, communion wafer crisp profile Thain has cut on Wall Street, and the reputation he won running the Big Board as a cerebral, by-the-book executive who looks more like a laser physicist.
As Thain’s rosy statements kept piling up, Reuters ran a wire story spotlighting what he was saying.
The problem was, each time Thain made a positive statement after yet another writedown, specifically, that Merrill’s capital sufficed, the stock market ran Merrill’s shares up, investors piled in hoping for the best, only to get hammered when Merrill announced yet more writedowns and that it had to enter the equity markets once again to do more capital raises.
The worst example just occurred. Thain told analysts on July 18, after the bank wrote down $9.4 bn and sold a 20% stake in financial information services company Bloomberg LP for $4.5 bn, that: “We believe that we are in a very comfortable spot in terms of our capital.” Investors bought in when the stock rose to $31.
About ten days later, Merrill announced it was writing down another $5.7 bn and needed to raise $8.5 bn in equity capital, igniting massive dilution, leaving Merrill with a whopping 1.6 bn in shares outstanding. Thain is slowly learning the art of saying something without really saying it–an art form which supports the jobs of numerous analysts tasked with slicing through the rhetoric.
Merrill’s Garage Sale
Merrill’s Thain has moved quickly to rid the brokerage’s balance sheet of the shoddiest assets. It recently unloaded $30 bn in collateralized debt obligations for just $6.7 bn to Lone Star Capital, a Dallas vulture fund.
Although former Merrill chief Daniel Tully applauded Thain for unloading this “dynamite” off its books, on closer look, the implied, garage-sale price was really just 6 cents on the dollar to Lone Star, who got Merrill to finance 75% of the $6.7 bn deal, using as collateral the very CDOs Merrill was unloading.
Moreover, the Bloomberg sale doesn’t look so hot on closer look. According to Douglas Kass, founder and president of Seabreeze Partners Management who reviewed Merrill’s recently issued quarterly report, the $4.5 bn deal to sell its 20% stake in Bloomberg LP back to Bloomberg News calls for Merrill to receive only $110 million of the purchase price in cash and the rest in notes with maturities of 10 to 15 years.
A Top Analyst Weighs In
Thain “has yet to gain control of the business, because everywhere he looks he is finding additional problems to deal with,” says Richard Bove, Wall Street’s top bank analyst at Ladenburg Thalmann. “He chooses not to take a long view in solving the company’s problems, but is slashing and burning to get to a position where he can focus on rebuilding the business model. In the process his credibility has been shot.”
The Worst Isn’t Over
Thain has said about $25 bn in problematic securities and assets still sit on Merrill’s books. Meanwhile, as the firm cuts costs, as its lays off thousands of employees, as even Bloomberg terminals get yanked from trading desks, in a stupefying move Thain gave former Goldman Sachs top executive Thomas Montag $40 mn to run the brokerage’s global sales and trading unit.
That’s five times what Thain got paid to run NYSE Euronext in 2006, and nearly equals the total $51.20 mn Stan O’Neal earned in his first four years as Merrill Lynch’s chief executive, according to Forbes Magazine.
VIKRAM PANDIT, CHIEF EXECUTIVE, CITIGROUP. While Pandit is racing to trim down Citi’s eye-watering $2.2 tn balance sheet, in the process he is trying to revivify Citi’s blue-chip brand, having resurrected the old tagline “the Citi that never sleeps.”
But that tagline has quickly morphed into “the writedowns that never sleep,” as the subprime and credit mess have cost the bank an estimated $55.1 bn in writedowns and losses since the crisis blew in last year, the most of all banks and investment houses worldwide.
Junk mortgage paper, souring loans for leveraged buyouts, problematic consumer loans and credit cards continue to plague the bank. Citi has raised an estimated $49.1 bn to fill the potholes on its financials.
Investors and Analysts Skeptical
Citi plans to lay off over the next two years about 30,000 workers out of some 370,000 employees spread across more than 100 countries. Pandit is now overseeing likely the worst period in the bank’s history, as things have gotten so bad that last spring, he had to endure an angry investor meeting where shareholders’ bags were searched at the door, and some were relieved of their fruit for fear they would whip projectiles at bank executives.
Analysts now question whether Pandit will force Citigroup to ditch once and for all its financial supermarket model built by predecessor Sanford Weill, as disparate computer systems and technology held together by baling wire and duct tape have bedeviled the bank amidst chaotic losses. So far Pandit says Citi will not be broken up.
A Herculean Task
Instead Pandit is now desperately trying offload about a half a billion dollars in assets off of Citi’s $2.2 tn balance sheet, amid record writedowns that caused Citi to lose its number one ranking as the world’s biggest bank to Bank of America (BAC).
So far it’s unclear in total which assets Pandit thinks are “non-core” and should be sold to the highest bidders, but he’s likely keeping his cards close to his chest to avoid arbitrage. At this point, it’s unclear whether Pandit can pull off this massive sale as the credit markets largely remain in blackout mode. The concern is, too, those assets would have thrown off profits in the future. Underperformers are in the crosshairs.
Capital Raises and a Focus on Top Guns
Along with the meta-asset sale and new capital raises, Pandit and his squad slashed Citi’s dividend and unveiled a plan to cut the fat marbled through the bank’s operations. He’s also unveiled tighter risk controls, as well as systems to centralize capital allocation and spending.
Pandit is also focusing the bank on its top rainmakers, including top gun Sallie Krawcheck, head of Citi’s lucrative global wealth management business.
Pandit’s Thain Moment
However, like Thain, Pandit also initially was given to overly optimistic comments about capital positions. On his first earnings call as the new CEO on January 15, 2008, Pandit said: “The first priority of risk has been to make sure that our legacy portfolio of assets in the sub-prime and mortgage areas are separated and managed to be optimized, and we have done that. We have also made sure they are well-capitalized.”
About three months later, Citi wrote down $12.1 bn, $6 bn of which came from subprime. And in the following quarter it took about a $7 bn hit.
Pandit has also been dinged for eye-glazingly wonky talk in his “Rules of the Road” guidebook he gave to top executives, a seven-part guide to managing Citi in the future. Eye-rolling cliches like “client connectivity” and “product excellence” ran rampant.
Pandit Wins Praise
Still, he’s winning praise. Pandit “seems to be taking all of the correct steps,” Ladenburg Thalmann bank analyst Bove says. “He is building a management team he is comfortable with,” adding “he is decentralizing the operating structure to get more accountability at local levels” and “is writing off problems as he sees them develop.”
Bove notes Pandit “is attempting to solve the company’s problems business by business. This is what made [JPMorgan Chase's] Jamie Dimon a success.”
ROBERT WILLUMSTAD, CHIEF EXECUTIVE, AIG. Willumstad, a 40-year bank veteran who was chairman of AIG, got the CEO job June 15th after AIG ousted former top exec Martin Sullivan amid record losses, historic writedowns, regulatory probes and stock lows not seen in decades at the world’s biggest insurer, which operates in 130 countries.
Despite promises of a major overhaul in the works, Wall Street was initially skeptical of Willumstad’s appointment, sending AIG’s shares down a half a point the day Willumstad got the top job. Prior to his new CEO role, in January, 2006, Willumstad left his job as chief operating officer of Citigroup to take over the chairman role at AIG from former Nasdaq head Frank Zarb.
AIG’s Hard Top Spin
AIG’s former top exec, Sullivan, was also prone to rosy comments, telling investors in early December that the insurer’s credit default swaps written on complicated mortgage-backed debt securities, or collateralized debt obligations, were fine, “because this business is carefully underwritten…we believe the probability that it will sustain an economic loss is close to zero.”
Within months, AIG disclosed $13 bn in losses driven by problematic CDSs, among other things. To date it has reported $25 bn in total write-downs and nearly $19 bn in three consecutive quarterly losses that have nearly wiped out its profit for the past two years.
Shares plunged 19% in intraday trading after the disclosure of its most recent $5.4 bn in losses, the largest one day percentage in 39 years. Shares eventually closed down 18%, the fifth-largest percentage drop in its history.
Spooking the Street was AIG’s disclosure that its core businesses, property-casualty policies, also posted deep operating losses.
Capital Raises, and a Plan
Willumstad says he will unveil a plan to dramatically overhaul AIG’s financial products division at an investor meeting on Sept. 25. It’s expected Willumstad will try to unload toxic mortgage-backed assets and divisions where bad loans have sucked dry profits, such as mortgage insurer United Guaranty Corp., which posted a $440 mn operating loss in the second quarter, analysts said.
Analysts are watching closely to see how quickly Willumstad moves to dump nettlesome securities, or whether he hews to the position Sullivan took, that these are paper losses and not cash losses generated by faulty accounting rules that force companies to mark to market securities, when the markets are in blackout mode and no one wants them, even though these securities may be backed by decent assets.
Willumstad Crooks the Trumpets, Too
AIG raised $20.3 bn in May via a debt and equity offering to restore capital and against future writedowns. The capital raise led Willumstad to tell investors that he was “comfortable” with how much capital AIG has, despite the fact it ended the second quarter with less capital than the first. Citigroup analyst Joshua Shanker noted in May that AIG may have to raise $10 bn more.
Now Standard & Poor’s threatens to downgrade AIG if earnings “do not stabilize by the third quarter,” a downgrade that would force AIG to pony up $10 bn more to back the swaps (AIG says it has $16.5 bn in collateral against the swaps).
The End Not Here Yet for AIG
For now, the company does not see the light at the end of the tunnel just yet. At the first quarter’s end, it said final losses could come in between $1.2 bn and $2.4 bn.
The company recently more than tripled its “worst-case” estimate for credit swap losses to as much as $8.5 bn. That is still below a $9 bn to $11 bn estimate made recently by an outside firm hired by AIG. Morgan Stanley estimates the losses at $13 bn. Asset sales may be in the offing.
The Probes Continue
Also, the Justice Department and the SEC are reportedly investigating whether the world’s biggest insurer overstated the value of credit default swaps, derivative contracts linked to subprime mortgages. Prosecutors from the Department of Justice and the U.S. attorney’s office in Brooklyn, New York have reportedly asked for information the SEC is gathering, which reportedly could signal a criminal investigation.
An AIG spokesman has said the company would co-operate in regulatory and governmental reviews on all matters.
ROBERT STEEL, CHIEF EXECUTIVE, WACHOVIA. A Wall Street and Washington veteran, Steel, 56, took over from G. Kennedy Thompson, the former head of the Charlotte, N.C.-based Wachovia Corp., after Thompson was ousted by Wachovia’s board of directors in early June.
At the time a deluge of problems threatened to swamp the country’s number four bank, based on assets. Since the crisis began, Wachovia has been hit with an estimated $22.5 bn in writedowns and losses, and has raised $11 bn.
Regulatory probes, criticism over poor internal controls, directionless strategy and this whopper. Much like Merrill’s move to buy First Franklin, Wachovia has since been heavily criticized for its decision to buy Golden West, a bank that made its living giving out subprime loans, for $24.2 bn at the top of the market in October 2006.
Wachovia may have to write off much of the $14 bn in goodwill from the purchase of the California mortgage lender.
By the time Thompson left, Wachovia’s shares plunged 50% in price. As mortgage defaults mount, Wachovia also said it now plans to lay off 6,950 people, up from 6,350 last month.
A Man of Steel
Steel joined Wachovia from the Treasury Department, where as under secretary for domestic finance he worked on legislation to bolster the agency regulating mortgage finance giants Fannie Mae and Freddie Mac.
Steel was also involved in JPMorgan Chase’s spring bailout of Bear Stearns, a shotgun wedding ushered along by the Federal Reserve chairman Ben Bernanke and Treasury Secretary Henry Paulson (JP’s Dimon sits on the board of the New York Federal Reserve Bank). Prior to that, the North Carolina native worked for 28 years at Goldman Sachs Group, retiring as vice chairman in February 2004 (Treasury Secretary Paulson was chief executive back then).
A Fight for Survival
Now Steel is fighting for the survival of the bank, which has $809 bn in assets, in the face of record losses and writedowns.
Wachovia is now struggling to resurface from under the weight of an eroding $122 bn portfolio of option adjustable-rate mortgages, and another $206 bn in commercial loans, up 25% from a year ago. Wachovia recently said it will stop offering option ARMs, which let borrowers skip some payments, a blue plate special sold by Golden West.
Steel at the Wheel
Steel has reportedly bought one million shares in Wachovia worth $16 mn, and in a bout of optimism has said that Wachovia has no plans to either raise more capital or issue more common shares.
Steel is also said to be considering a “good bank-bad bank” structure for Wachovia, a move used during the S&L crisis of the late ‘80s and early ‘90s to fix damaged thrifts, whereby separate units are set up to absorb bad loans and ring fence troubled assets away from the good assets that are working.
Bank analyst Richard Bove is skeptical. Steel “has never run a large institution,” Bove says. “He does not know commercial banking and he has no background in risk management. Thus, it is intellect and learning on the job that we are looking at here.”
Regulatory Probes Mount
Wachovia has an unusually large number of regulatory probes.
It recently agreed to pay $144 mn to settle charges of turning a blind eye when telemarketers used the bank’s accounts to steal from customers, many of them senior citizens. Wachovia did not admit or deny wrongdoing.
Telemarketers reportedly had obtained account information from consumers through a variety of ruses, and then used the information to write themselves fraudulent checks, which they deposited at Wachovia.
Wachovia is also reportedly under scrutiny for money laundering by Mexican and Colombian money transfer companies moving proceeds of US drug sales to Latin America. Wachovia had reportedly cultivated ties with the money-transfer outfits, but says it cut its ties to them when the probe began last December.
And Wachovia has been caught up in the municipal securities bid-rigging investigation involving auction rate securities sold as liquid cash equivalents, when they turned out to be highly illiquid instruments after the $330 bn market for them collapsed in February 2008, stranding investors.
“Progress was made” with Wachovia towards an agreement to address the $9.5 bn of ARS held by Wachovia customers, says the Missouri secretary of state, Missouri being one of the government bodies looking into Wachovia.
Wachovia recently made a regulatory filing detailing a $500 mn pretax increase to legal reserves. It also said that will increase its second-quarter net loss, originally disclosed on July 22, to $9.11 bn from $8.86 bn.
August 8, 2008 3:01PM
By Elizabeth MacDonald
There are plenty of fights grabbing headlines these days.
The Microsoft fight over Yahoo, the internal battles at Lehman, the fights in Congress over the fiscal recklessness of Fannie Mae and Freddie Mac, as well as the debates over the Federal Reserve’s ad hoc orchestration of the JPMorgan and Bear Stearns shotgun wedding.
But another battle of a potentially larger sort has been looming that should not go unnoticed.
This one is the fight between the cable industry and the telecoms over who will dominate the pipelines into American homes, and whether competition suffices to help consumers’ wallets.
This is a fight over a massive amount of money.
Revenue from consumer telecoms network services will hit $2tn globally by 2012, Instat, a market watcher, predicts. In-Stat says the strongest growth will be in the broadband and pay-TV sectors, though 60% of total revenue will be derived from consumer mobile services, the research firm notes in a report.
And this fight is a hot one, because it involves a potentially hyperactive federal government regulator making unfair moves against one of these players.
It’s a fight that affects Comcast (CMCSA), Time Warner Cable (TWC), News Corp. (NWS) (parent of the Fox Business network), Cablevision Systems (CVC) and Charter Communications (CHTR). Walt Disney (DIS) and Viacom (VIA) would also be affected.
On the other side of the aisle sit the telecoms, AT&T (T), Verizon Communications (VZ), Sprint Nextel (S) and Alcatel-Lucent (ALU).
The telecoms have been steadily encroaching on the cable companies’ turf in providing cable services to their telecom customers. AT&T and the cable industry are spending fast and furiously in their lobbying and public relations war not just at the federal level, but in states across the country as they try to grab cable licensing deals.
Why the Fight Matters to You
In 2001, only 30m households worldwide had access to broadband internet connections. By the end of last year that figure had grown about ten times.
The world’s biggest telecoms and cable companies are rushing to add capacity to keep up with exploding demand fueled by consumers increasingly downloading bandwidth-chewing video content from YouTube, iTunes and other sites.
But the fight matters to you because competition lowers prices. The big news for most consumers isn’t just access to broadband, but prices. If you can bundle your home phone, cable TV and broadband for less than the cost of even one of these services from your own cable TV company, you’d do it, right? You could save nearly half your bill if you do it right.
The Battle is Waged Locally
The cable guys know this, so does the telecom crowd. And that’s why they are taking the battle to the streets. For instance, Time Warner Cable (TWC) and Verizon (VZ) are beginning a battle for TV viewers in New York City.
And despite being outspent in a lobbying war by the cable guys by about $2 mn in Tennessee, telecommunications giant AT&T finally won its legislative goal in bypassing local government cable franchise rules, even though AT&T apparently did not get everything it wanted.
So Who’s Really the Big Gun?
Thanks to its acquisitions, AT&T is now larger by market capitalization than the entire cable industry, notes Leo Hindery, a cable industry top executive. AT&T and Verizon now have market caps that are 2.4 to 4.4 times larger than any big cable player. Each serves 36% and 24%, respectively, of the country’s homes and businesses.
Is the Government Interfering?
Despite the fact that the government has approved a wave of telecom mergers, Hindery says that the Federal Communications Commission has been wrecking competitive forces that may bring cable prices down by unfairly hamstringing the cable companies with discriminatory ownership caps that stop a cable company from covering more than 30% of a potential marketplace and in turn from sufficiently competing against the Bells.
Meanwhile, AT&T and Verizon are not handicapped by any federal ownership limitations.
Hindery is someone the cable and telecom market listens to. Before he became managing partner of InterMedia Partners, a New York media industry private equity fund, he was chairman and chief executive of the YES Network, which he founded as the television home of the New York Yankees.
Prior to that post, he ran Telecommunications (TCI) before it was merged into AT&T in 1999, and he became CEO of AT&T Broadband. Hindery also served briefly as interim CEO of Global Crossing, a company that belly-up due to a corporate accounting scandal.
Hindery was also presidential candidate Sen. John Edwards senior economic policy advisor for from December 2006 until February 2008 and is now an economic advisor to Democratic presidential nominee Barack Obama, the senator from Illinois.
Hindery fears this arbitrary federal cap on competition could cause less service and higher prices.
The US is Losing Out
Hindery notes that the US has dropped from its position as a global leader in per capita broadband use, now ranking 15th out of the 30 Organization for Economic Cooperation and Development countries, with less than half of US households subscribing to broadband services.
Hindery says it’s time for the federal government to stop this craziness and level the playing field between the cable and telecoms to unlock potential economic growth.
Hindery says that independent estimates show that universal broadband adoption would generate $500 bn in economic growth and more than 1.2 mn new high-wage jobs. Broadband technology, he says, makes all sorts of industries more productive, connecting people to information and services on a revolutionary scale.
Despite Government Help, Telecoms Need to Catch Up
Comcast and Cablevision have both shown growth in new voice lines, as well as digital, video and broadband lines.
The telcos though are hurting.
Verizon in its last quarter lost 1.7 mn access lines and 171,000 DSL lines, leading Bernstein Research analyst Craig Moffett to note that this was the first time a major U.S. telco reported a quarterly decline in DSL lines, although it did add 176,000 video subs for its FiOS service and 187,000 FiOS broadband lines, though growth was slower than in the first quarter.
Also new net customer subscribers for Verizon’s FiOS broadband were a teensy 6% higher versus a year ago, even though Verizon expanded its territory by a third.
Meanwhile, AT&T lost 993,000 residential primary access lines in the quarter, while adding 170,000 U-verse video customers.
So who is really in the catbird seat?
