Category: Economy

Barclays Sues Bear Stearns

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So, now the lawsuits start:

Barclays sues over sub-prime losses

British bank says hedge fund losses were hidden

Andrew Clark

Barclays’ exposure to America’s sub-prime mortgage fiasco took a dramatic turn last night as the bank sued the Wall Street firm Bear Stearns for fraud and deception over the loss of hundreds of millions of dollars in an ill-fated hedge fund.

In a lawsuit filed in New York, Barclays accused Bear Stearns of systematically hiding losses in a fund which swallowed $400m (£200m) of the British bank’s money. The fund had to be bailed out in June after reaching the brink of collapse following a disastrous series of investments in mortgage-backed securities.

Barclays described the fund’s demise as “one of the most high profile and shocking hedge fund failures in the last decade”. The suit alleges that up to the last days before the bail-out, Bear Stearns executives engaged in a cover-up to hide the slump in its value.

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This is going to get worse. We are going to see more lawsuits, and some very big jury verdicts.

With proper regulations, you stop this sort of stuff before it gets out of hand. Without it, you just have lawsuits after the fact.

Fed Shrugged as Subprime Crisis Spread

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The hed above is straight from The New York Times article about how the Federal Reserve under Alan “Bubbles” Greenspan ignored the warning signs of the real estate bubble.

It’s a clever turn of phrase. Greenspan was an acolyte of Rand’s and what was likely his first publication in the Times was his defense of Atlas Shrugged against a brutal review of the work. He argued that it was actually a “celebration of life and happiness”.

While the authors of the article rarely write the headline, it is clearly an attempt to cast the failures of the Fed to deal with the problems in the credit markets generally, and the housing market specifically as a result of Greenspan’s Randroid ideas.

It clearly shows that Greenspan was never the genius that he was viewed as in, say, 2000.

To my mind, the high opinion that many people had of him was an artifact of low oil prices and the cooking of the books with regard to inflation figures.

Read the article. It’s a hoot.

Prosecutors Investigating Bear Stearns

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Fortune has an article, somewhat amusingly titled titled Prosecutors loaded for Bear, looking into allegations of insider trading.

Specifically, it is alleged that senior fund manager Ralph Cioffi pulled his money out of Bear’s mortgage backed funds about 2 weeks before they imploded.

Drip, drip, drip…I stand by my prediction on Bear Stearns: They will cease to exist as an independent entity before August 2, 2008.

Federal Reserve to Tighten Lending Regulations

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This good, but I need to say three words: barn door cow.

The high points:

  • Prohibit giving people unaffordable loans.
  • Restrict use of “liar” loans.
  • Prohibit or limit prepayment penalties.
  • Curb or better disclose broker incentives.
  • Require or encourage escrowing of taxes and insurance.
  • Prohibit coercion of appraisers.
  • Prohibit loan servicers from engaging in unfair practices.
  • Require better disclosure overall.

Of course, half of these should be done already by anyone who wants to operate for more than a few years and then leave town ahead of the police.

Japanese Bank on Big Sh%$pile Bailout Fund: F$%# You White Man

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It appears that the major Japanese banks are getting government pressure to help bailout subprime financial instruments, and they are profoundly disinterested in doing so.

Japan big banks reluctant to pay for subprime fund
Mon Dec 17, 2007 5:44am EST

By Nathan Layne and Taro Fuse

TOKYO (Reuters) – Japan’s top three banks are expected to resist a request to put up a total of $15 billion for a U.S.-led subprime rescue fund, a move that could further cloud prospects for the bailout plan.

Sources told Reuters last week that Mitsubishi UFJ Financial Group (8306.T: Quote, Profile, Research), Mizuho Financial Group (8411.T: Quote, Profile, Research) and Sumitomo Mitsui Financial Group Inc (8316.T: Quote, Profile, Research) had each been asked to pony up $5 billion, and to give an answer this week.

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But the issue could yet become political, the megabank executive said. Japanese banks are eager to expand their presence overseas and will not want to be seen as turning a blind eye to the health of the global financial system.

“What did America do when we had our non-performing loan problem? They just pushed us into the corner. European banks also ran away. Why should Japan now shoulder this burden?” said the megabank executive. “But this is a decision made at a high political level and could end up defying logic.

Part of this is the fact that the rest of the world pretended not to know them during the Japanese crisis, but another, larger part is the fact that the Japanese banks have largely cleaned up their act. The lack of transparency, cozy relationships, and self dealing in the subprime debacle mirror their experience 15 years ago.

What’s more, they understand that this bailout will interfere with reform, because it will largely serve to allow the worst miscreants to dump their investments on someone further down the economic knowledge chain (you know, teachers’ retirement funds, etc).

Quick Economic Update

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Citigroup just took a $49 Billion charge after deciding to take a bunch of exotic, and well below par, investments and put them on its books.

My guess it that they think that they will have to account for this piece of the big sh#@pile sooner or later, and that sooner is the better option.

And there are inflation worries, that are making Treasurys tumble. If this is a part of a trend, then we can see interest rates going way up.

Fannie Mae CEO expects home prices to fall 4 to 5 percent more in 2008.

I think that he is an optimist. My house is (according to Zillow) down 5% so far this year already.

Krugman On Difference Between Illiquidity and Insolvency

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Once again, Paul Krugman demonstrates why the New York Times pays him to write.

He clearly and concisely describes why the current problem is insolvency, and not illiquidity.

He then goes on to explain just why the Fed really cannot fix this. If you have a run on a sound bank, an quick loan to infuse of cash works, because it gives everyone time to get their heads screwed on straight again, but if a bank is busted, a loan, no matter how large cannot help.

Basically, it means that the Fed, which after all only loans money, and sets up rules for short term loans, cannot help.

Go read his article.

The last line, which is a note from the editor, that “David Brooks is off today,” is also a bit of an unintentional hoot.

David Brooks is a bit off every day.

Your Daily Economic Update

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First, you have calculated risk reporting that the discount rate spread has jumped to near record levels:

This is the spread between high and low quality short term (30 days) commercial paper. Even the bad stuff is supposed to be pretty much a sure thing, and the spread between the two is big, indicating a very high fear level.

It’s worse than when the big sh$@pile started to collapse in August.

It’s worse than when the Twin Towers DID collapse on 911.

People are scared, and getting people UNscared will be a very difficult thing.

Then there is the fact that the Producer Price Index took the biggest one-month jump in 34 years, 3.2% in a month, or 45% a year.

The economists will tell you to look at the core rate, but I live in a non core world, as do you.

Florida says $9B can’t be pulled from fund — OrlandoSentinel.com

Remember when I wrote about a Florida money market fund for local governments that froze its accounts because of a run on the account due to its investments in the big sh#$pile?

They are finally releasing some funds to the local governments, but only ¼ of what was deposited.

Citigroup to lay off as many as 32,000 employees.

Alan “Bubbles” Greenspan, the “I Didn’t Do It” Kid

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Yep, he has an article in the Wall Street Journal claiming that it’s not his fault.

Felix Salmon of Portfolio.com pretty much eviscerates him on his lies.

That said, however, the main reason why the housing bust seems to be much worse in the US than elsewhere is surely those ARMs – which, as Greenspan concedes, were a function of low short-term interest rates. They allowed many people to buy houses they couldn’t afford, which in turn created a massive solvency crisis.

Greenspan’s reputation is trashed, as well it should be.

On the Fed Shoveling Currency Out The Door

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Yesterday, the Fed cut rates, and the market screamed in anguish, because it was not enough.

Well today, the Federal Reserve, and other nations’ central banks, came up with a scheme to deal with the credit freeze that is a result of what amounts to widespread insolvency in the financial markets (here, here, here, here), and here).

Basically, they are flooding the market with currency by lending out large sums of money on the basis of illiquid worthless securities.

Quotes from some of the articles cited above:

You will note that it allows the lending of up to 85 percent of the face value of AAA-rated collateralized mortgage obligations, if there is no observable market value.

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So much for discouraging future risk taking.

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The most prominent sign of that is that the Libor, a benchmark for many dollar-loans between banks especially in Europe, has shot up as much as 0.8 percentage points above the federal funds rate. The gap is normally less than 0.2 points. A high Libor rate raises banks’ costs of funds and thus the rates they charge borrowers. In addition, many U.S. homeowners have adjustable rate mortgages with linked to Libor.

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“Clearly, the Fed is feeling its way in the dark here,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics.

(Emphasis mine)

Nouriel Roubini says that this is, “Too Little Too Late To Address the Fundamental Problems of the Financial System.”

I tend to agree with Dr. Roubini, but he’s a bear, as I have been, for the past few years.

Honestly, I think that what is going on here is the beginning of a major devaluation of US currency, so people will be paying back loans in devalued dollars.

Basically, it’s using inflation to get out of the problem. It was done during the Great Depression, and the amount ov exotic and dishonest leverage in 1929 is far less than now.

Your Update on the Economy

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Let’s see, the Fed cut rates by 25 basis points, but the market wanted 50, so the Dow dropped 294.26 points.

The WSJ is saying that the U.S. mortgage crisis rivals the S&L meltdown.

While it’s nice that they take it seriously, the US Credit/Insolvency crisis is already worse than the S&L meltdown. Still, it’s a good read.


Own to rent cost ratio, the real estate equivalent of P/E:


The discount for the mortgage packages:

And while we are at it, how about MBIA, the world’s largest bond insurer, getting $1B infusion from private equity firm?

This is not about someone finding a deal. It’s about a private equity firm keeping MBIA alive while they offload their piece of the big sh&%pile on some other idiot.

Also, Washington Mutual is closing offices and laying off more than 3000 employees, including a friend of mine, because of mortgage and credit problems.

Also, Freddie Mac is looking at $5.5-$12 billion in additional losses. That’s in addition to the $4.5 billion that it’s already lost this year.

At the rate this is going, it will be raining Katz and Hutton on Wall Street.

Watch out for jumping finance professionals.

Krugman on the Bush/Paulson Mortgage Rate Freeze

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Once again, he nails it. The Bush/Paulson program isnot about fixing the problem, it’s about making sure that no one else does, or as Dr. Krugman puts it:

In particular, the Paulson plan is probably an attempt to take the wind out of Barney Frank’s sails. Mr. Frank, the Democratic chairman of the House Financial Services Committee, has sponsored legislation that would give judges in bankruptcy cases the ability to rewrite mortgage loan terms. But “Bankers Hope Bush Subprime Plan Will Scuttle House Bill,” as a headline in CongressDaily put it.

As it currently stands, a bankruptcy judge cannot rewrite the terms of a mortgage, but Frank’s legislation would allow that.

He makes a compelling case that this is about protectinb banks and bond holders, so go read his OP/ED

Real Estate Update

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existing household real estate assets declined $67 Billion in the 3rd quarter. That’s about $200 for every man, woman, and child in the US.

You can see this in declining home equity percentages over time (there are more graphs at the link):

While we’re at it, Morgan Stanley analysts are saying that home prices could be falling for at least the next three years.

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The property derivatives market seems to be suggesting that we are in a very different environment, on the heels of market events that could force a housing recession like none ever imagined or experienced,” Morgan Stanley analysts said.

“The fundamental argument for going long housing is that history has never seen such extended periods of house price declines,” Morgan Stanley said. “We think that such arguments have limited credibility because of limited periods of data and over-reliance on analysis using national level data.”

While home price declines for three years or longer have not occurred in recent years on a national level, regional data demonstrates that unusual price increases often lead to sustained corrections, the report said.

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And then we have Standard and Poors sayint that the mortgage relief program might cause downgrades on some of the related bonds.

Honestly though, I don’t see how the action will make things much worse:

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The share of all home loans with payments more than 30 days late, including prime and fixed-rate loans, rose to a seasonally adjusted 5.59 percent, the highest since 1986, according to a report today from the Washington-based bankers trade group. New foreclosures hit an all-time high for the second consecutive quarter in a survey that goes back to 1972.

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Steven Pearlstein Explains the Credit Crunch

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He does not get into the why this crunch has happened, short form is that you had regulators who allowed investment banks to use fairy dust and call it innovation, but its a very good picture regarding what forces are in motion now, and where they are likely to lead.

His OP/Ed is aptly titled It’s Not 1929, but It’s the Biggest Mess Since:

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The financial giants that originated, packaged, rated and insured all those subprime mortgages were the same ones, run by the same executives, with the same fee incentives, using the same financial technologies and risk-management systems, who originated, packaged, rated and insured home-equity loans, commercial real estate loans, credit card loans and loans to finance corporate buyouts.

It is highly unlikely that these organizations did a significantly better job with those other lines of business than they did with mortgages. But the extent of those misjudgments will be revealed only once the economy has slowed, as it surely will.

At the center of this still-unfolding disaster is the Collateralized Debt Obligation, or CDO. CDOs are not new — they were at the center of a boom and bust in manufacturing housing loans in the early 2000s. But in the past several years, the CDO market has exploded, fueling not only a mortgage boom but expansion of all manner of credit. By one estimate, the face value of outstanding CDOs is nearly $2 trillion.

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Those are scary numbers, but he goes on to explain why we are in trouble:

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In the simple version, each investor owned a small percentage of the entire package and got the same yield as all the other investors. Then someone figured out that you could do a bigger business by selling them off in tranches corresponding to different levels of credit risk. Under this arrangement, if any of the mortgages in the pool defaulted, the riskiest tranche would absorb all the losses until its entire investment was wiped out, followed by the next riskiest and the next.

With these tranches, mortgage debt could be divided among classes of investors. The riskiest tranches — those with the lowest credit ratings — were sold to hedge funds and junk bond funds whose investors wanted the higher yields that went with the higher risk. The safest ones, offering lower yields and Treasury-like AAA ratings, were snapped up by risk-averse pension funds and money market funds. The least sought-after tranches were those in the middle, the “mezzanine” tranches, which offered middling yields for supposedly moderate risks.

Stick with me now, because this is where it gets interesting. For it is at this point that the banks got the bright idea of buying up a bunch of mezzanine tranches from various pools. Then, using fancy computer models, they convinced themselves and the rating agencies that by repeating the same “tranching” process, they could use these mezzanine-rated assets to create a new set of securities — some of them junk, some mezzanine, but the bulk of them with the AAA ratings more investors desired.

It was a marvelous piece of financial alchemy, one that made Wall Street banks and the ratings agencies billions of dollars in fees. And because so much borrowed money was used — in buying the original mortgages, buying the tranches for the CDOs and then in buying the tranches of the CDOs — the whole thing was so highly leveraged that the returns, at least on paper, were very attractive. No wonder they were snatched up by British hedge funds, German savings banks, oil-rich Norwegian villages and Florida pension funds.

What we know now, of course, is that the investment banks and ratings agencies underestimated the risk that mortgage defaults would rise so dramatically that even AAA investments could lose their value.

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As part of the unwinding process, the rating agencies are in the midst of a massive and embarrassing downgrading process that will force many banks, pension funds and money market funds to sell their CDO holdings into a market so bereft of buyers that, in one recent transaction, a desperate E-Trade was able to get only 27 cents on the dollar for its highly rated portfolio.

Meanwhile, banks that are forced to hold on to their CDO assets will be required to set aside much more of their own capital as a financial cushion. That will sharply reduce the money they have available for making new loans.

And it doesn’t stop there. CDO losses now threaten the AAA ratings of a number of insurance companies that bought CDO paper or insured against CDO losses. And because some of those insurers also have provided insurance to investors in tax-exempt bonds, states and municipalities have decided to pull back on new bond offerings because investors have become skittish.

If all this sounds like a financial house of cards, that’s because it is. And it is about to come crashing down, with serious consequences not only for banks and investors but for the economy as a whole.

That’s not just my opinion. It’s why banks are husbanding their cash and why the outstanding stock of bank loans and commercial paper is shrinking dramatically.

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This may not be 1929. But it’s a good bet that it’s way more serious than the junk bond crisis of 1987, the S&L crisis of 1990 or the bursting of the tech bubble in 2001.

What’s the Deal With the So-Called Mortgage Bailout

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To paraphrase Atrios:

To qualify:

  • have an income and live in their homes
  • are currently making their payments on time
  • would default if their interest went up
  • ARM mortgage has to have been taken between 1/05 and 7/7
  • Has a rate reset between 1/8-1/10

The following rules you out:

  • have missed payment
  • can afford mortgage rate increase
  • don’t have an income
  • own homes which are worth less than their mortgage

So, if you are poor, you are more likely to have missed a payment, and more likely not to have put anything down, and so be under water. As Duncan Black puts it:

I became increasingly skeptical that such a broad-based bailout would be workable for various reasons, but as is usually the case with anything the Bush administration gets involved in, they aren’t even really trying.

As Kevin Drum puts it:

The lower your income, the more likely you are to have missed a payment already, and the lower your income the more likely you are to have been sold a no-down loan that’s already left you underwater due to falling housing prices. Net result: no help for low-income folks.

Like Atrios, I’ve become increasingly unsure that any kind of broad-based bailout plan can work — or work well, in any case — but if you’re going to do it everyone ought to have a shot at getting help. Bush’s plan, conversely, pretty transparently doesn’t care about anyone with a modest income. Not part of his base, I guess.

My assesment is less charitable. He does not want to do anything but score political points.

National Banks Try to Bolster the Dollar

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Lower interest rates overseas make the dollar a more attractive investment, so, in an attempt to bolster the dollar, you have the Bank of England cutting rates to 5.5%, the ECB, which intended to raise rates, leaving the Euro interest rate unchanged, and the Bank of Canada cutting interest rates, which is why the Canadian dollar is below parity for the first time in about a month.

It won’t last. The Fed will cut rates at the next meeting, and might do it by 50 basis points (½%).