Commentaries

from Rolfe Winkler:

Lunchtime Links 1-19

MUST READ -- Souring mortgages, weak market put FHA on tightrope (Timiraos, WSJ) Good article, though Timiraos doesn't address the absurd circularity perpetuated by FHA Chief David Stevens when Stevens says, on the one hand, that more gov't lending protects the housing market from further declines, while simultaneously arguing that such lending isn't sustainable. That said, Timiraos has worked lots of interesting stuff into this piece, especially towards the end. For instance, in late '07 investors were refinancing at-risk borrowers into FHA loans in order to shift risk to taxpayers. Barney Frank defends permanently raising FHA maximum loans for certain geographies to $729k. Also lots of data about how badly FHA loans are performing.

Citi's Q4 earnings: Not terrible but not great (Wilchins, Reuters) Trading revenues in the investment bank were much weaker compared to last quarter. Citi also benefited from a tax break, without which they wouldn't have met consensus estimates for the quarter. Here's a helpful chart.

(Click here to enlarge in new window)

How the French outplayed AIG and the Fed (Berman, WSJ...subscription req'd) Great column. Goldman gets all the bad press, but it was far from the only bank that got 100¢ on the dollar for derivative contracts with AIG...

Too big to fail is here to stay (Salmon, Reuters) Felix does a great takedown of Andrew Ross Sorkin's latest column.

Record cash means S&P 500 at half 2007 valuation (Xydias/Nazareth, Bloomberg) A very interesting idea, though lots of bones to pick with the way this piece was written. In nearly 1,300 words the writers never manage to provide a solid definition of how they're computing valuation. What is price to cash flow? Do they mean price to free cash flow? Do they mean price to EBITDA? There's a line about cash flow being earnings plus depreciation and asset writedowns. That may be a very relevant metric. But it's not one that investors know or understand and the authors fail to explain it.

from Rolfe Winkler:

Architect of Citi says bring back Glass-Steagall

Objective observers mostly agree that it doesn't make sense for banks to be in the securities business, not if they're explicitly insured by the government. Wall Streeters invent rationalizations to support the current structure because a large chunk of their profits come from trading.

It's very refreshing that John Reed, an architect of Citigroup -- the biggest, most disastrous financial supermarket of them all -- now says the merger was a mistake and banks should be broken up.

From Bob Ivry, Bloomberg:

Congress’ overhaul of U.S. financial regulations should include ordering banks to hold more capital, ensuring executives’ compensation is aligned with long-term profitability and banning firms that take deposits from also engaging in equities and fixed-income trading, Reed said.

“I would compartmentalize the industry for the same reason you compartmentalize ships,” Reed said in the interview in his office on Park Avenue in New York. “If you have a leak, the leak doesn’t spread and sink the whole vessel. So generally speaking you’d have consumer banking separate from trading bonds and equity.”

Lawmakers were wrong to repeal the Depression-era Glass- Steagall Act in 1999, Reed said. At the time, he supported overturn of the law, which required the separation of institutions that engaged in traditional customer banking services from those involved in capital markets.

“We learn from our mistakes,” said Reed, who wrote an Oct. 21 letter to the editor of the New York Times endorsing a division of banking activities. “When you’re running a company, you do what you think is right for the stockholders. Right now I’m looking at this as a citizen.”

Again, this is just half the battle. Getting dangerous activities outside of insured banks doesn't mean the activities themselves, which in many cases still pose systemic risks, won't continue to benefit from an implicit government guarantee.

As long as investment banks remain highly complex, systemically dangerous institutions, they'll always have a government lifeline. ("No more Lehmans!")

Calling Geithner

Good work by the AP in getting a copy of Treasury Secretary’s Tim Geithner’s phone log, which shows that he was quite busy during the first-half of the year speaking to Wall Street bankers. These stories are fun reads and I recently did one based on FDIC Chairwoman Sheila Bair’s datebook.

To me, the most interesting thing to come out of the Geithner call list is the revelation that he spoke several times with both Citigroup Chairman Dick Parsons and Citi CEO Vikram Pandit. Now, given the dicey situation Citi is in, that’s not surprising. But compare this to Bair’s dealings with Citi–in which she all but kept Pandit at arms length this summer.

Bair’s datebook reveals that she dealt exclusively this summer with Parsons or other Citi board members. There’s no indication that Bair had any private talks with Pandit.  

This notably different treatment of Pandit is further proof of the icy relationship that exists between Bair and Pandit. And this is why it may be too early for Pandit to believe his job is secure–even if an outside consultant hired by Citi reportedly gave him high-marks as a manager.

Dow 10,000 is a gas

Jack Healy’s story in The New York Times about the Dow getting closer and closer to the magical 10,000 mark is OK, but it contains few surprises. But I really was blown away by the chart that shows the perfomance of Dow component stocks since March 29, 1999–when the index crossed 10,000 for the first time.

The chart, which includes a number of stocks that are no longer part of the Dow–such as AIG, Citigroup and Eastman Kodak–is interesting because more component stocks have lost ground over the past 10 years than posted gains.

The list of losers that are still part of the Dow include a broad swath of US industries. Some of the stocks that have lost ground in the decade since the Dow first hit 10,000 include American Express, Walt Disney, Cisco, JPMorgan Chase, Microsoft and Home Depot.

This long list of illustrious losers should be a sober reminder for the bulls prediciting an ecomonic rebound simply because the stock market is rising.

And maybe just as disturbing is the fact that two of the biggest gainers in the Dow over the past 10 years are oil and gas giants, ExxonMobil and Chevron. That, of course, is a byproduct of the ill-fated and ill-advised love affair US citizens have with gas guzzling SUVs.

Exxon and Chevron’s dominance should also serve as reminder that we remain too heavily dependent on a dwindling natural resource that makes us dependent on tyrannical foreign governments and is quickly destroying our environment.

One can only hope that 10 years from now, the top performers in the Dow will include a solar cell manufacturer and a wind farm manufacturer.

Citi still loves Beantown

It appears Citi may not be pulling out of cities like Boston and Houston after all.

The Wall Street Journal is reporting that Citi is giving serious consideration to shrinking its retail banking presence in the US by retreating from cities where its laggard, such as Boston, Houston and Philadelphia. Instead, the bailed out banking giant would focus on six major US cities where its retail presence is strongest.

But the WSJ story only may be half right. I’m told that Citi does intend to put more focus on the six cities its strongest in and may close or sell some branches in the cities where it’s weakest. But for now, according to a source close to the bank, there is “no plan to dramatically change” Citi’s retail footprint in the US.

Seems to me, a retrenchment from three major metropolitan areas would be a dramatic change.

Now it’s possible there are people within Citi discussing a full-scale retail banking retreat, but I think it’s unlikely. If Citi were to abandon three major US cities it would spark a firestorm of protest on Capitol Hill and rekindle populist anger over the big bailout for the struggling bank.

And it would lead one to question whether it makes sense for US taxpayers to keep bailing out a bank that’s bailing on them?

Giving props to Wall Street’s risks

Wall Street would like you to believe that when investment banks take on risk they are largely doing it for the benefit of investors — maybe even you and me.

Bankers say much of the capital that their firms put at risk each day is to complete trades for big corporations, mutual funds, pension funds, hedge funds and university endowments. And contrary to the conventional wisdom, proprietary trading — bets made for a bank’s own behalf — is really just a small part of their business.

Lately, Wall Street’s captains of capitalism have been aggressive in pushing the “we take big risks for our customers, not for ourselves” line of argument.

That’s especially so in the wake of the public furor over the outsized trading gains at the big banks like Goldman Sachs Group, JPMorgan Chase and Barclays and even Citigroup, so soon after the collapse of Lehman Brothers.

The notion that risk is being taken for customers as opposed to for the firm’s own benefit is somehow supposed to make it seem more palatable and somehow less risky.

Still, for many, the image persists that investment banks spend a lot of time and resources gambling on stocks, bonds, commodities or currencies to generate fat profits and big bonuses. And there’s good reason for that image: Wall Street firms don’t break out the dollars they take in from client trades versus those generated by prop trading.

Yet from the perspective of Wall Street bankers, it’s perfectly logical to see much of their risk taking simply as part of trades for their customers.

PE and the Citi

One would think that leaders of large financial insitutions whose very existence is dependent on the kindness of taxpayers would be more circumspect in their words and actions. It’s not a blunder on the same scale as the recent tough-guy talk from AIG’s new chief executive, Robert Benmosche, yet today’s news that Richard Parsons will join a private equity firm is a little worrisome.

The statement announcing that Parsons will become a senior adviser to Providence Equity Partners, a private equity firm known for its many media investments, stresses that Parson’s “primary business activity” will continue be as chairman of Citigroup. The new role, however, still suggests that Citi no longer requires Parsons’ full-time attention — a suggestion that Citi’s legions of skeptics will find astounding.

Parsons, to be sure, may no longer be needed as a “referee,” as the Wall Street Journal had it earlier this year, in the acrimonious relationship between the bank’s management and its regulators. And the management reshuffle and restructuring, not to mention the discussion toward paying back some of the government’s investment may be steps in the right direction.

But there are few if any signs of a turnaround. The core banking business is still weak, with several billions of dollars of additional loan losses expected. The chief executive, Vikram Pandit, has his supporters, but his survival is anything but guaranteed. And the bank is effectively a subsidiary of the U.S. government.

So is this the right time for the chairman of Citi to be focusing on media deals? Sure, having the former chief executive of Time Warner join Providence makes loads of sense. But it still looks bad. Taxpayers may well wonder why the chairman is broadening his portfolio when they have a $45 billion invesetment and a guarantee on $300 billion in assets at stake.

The New York Times reports that Parsons’ move was originally planned to be earlier in the year until it was delayed so that he could focus on Citi’s problems. He should have waited another year.

Kraft moving ahead with financing

Why let a little rejection stand in your way? Kraft is proceeding with the financing it would need to buy Cadbury, even though the U.K. confectioner spurned the initial offer. It looks like it’s financing plans are  above what had been initially expected, which could mean slightly more new cash could  be added to a revised bid.

Credit Suisse had put the new debt at $6.667 billion. Bloomberg reports it looks more like $8 billion.

Kraft Foods Inc., the world’s second-largest foodmaker, is in talks to arrange about $8 billion of financing for its bid to buy candy maker Cadbury Plc, according to two people with knowledge of the matter.

Citigroup Inc. and Deutsche Bank AG are working on setting up debt financing to cover about half of the 9.77 billion-pound ($16 billion) offer to buy Cadbury, said the people, who declined to be identified because the talks aren’t public. The financing would consist of a bridge loan to be repaid with the proceeds of an investment-grade bond offering, one of the people said. Officials from the two banks declined to comment.

They could also be using the new debt to refinance some of Cadbury’s outstanding debt of $2.4 billion.

The key remains that the financing is based on an investment-grade rating. The added financing isn’t likely to pressure the company’s ratings enough to make a junk rating more likely.

Moody’s Investors Service warned Tuesday that it could downgrade Kraft’s ratings if the deal goes through, but most likely would limit it to a one notch drop.

Songbird deal backs Canary Wharf

Nomura’s decision to move its Lehman staff from Canary Wharf to the City earlier this summer seemed a victory for London’s historic financial centre over its upstart rival.

However, the astonishing terms Nomura secured, combined with a recent rescue fund-raising for Songbird Estates, owner of much of Canary Wharf, show that the Docklands estate retains its pulling power. (more…)

Time to get tough with AIG

It’s time for someone in the Obama administration to read the riot act to Robert Benmosche, American International Group’s new $7 million chief executive.

Since getting the job, Benmosche has spent more time at his lavish Croatian villa on the Adriatic coast than at the troubled insurer’s corporate offices in New York.

And in the short term, Benmosche’s vacation strategy appears to be paying dividends.

This week, AIG’s shares surged 44 percent, to nearly $50, after Benmosche said that he intended to move slower than his predecessor in selling off AIG’s still viable divisions.

Maybe Benmosche should consider relocating AIG’s headquarters to Dubrovnik.

But the big run-up in AIG shares is merely a sideshow for momentum players, speculators and Hank Greenberg, the former AIG chieftain who controls about 11 percent of the company’s outstanding shares.

The reality is that AIG exists today only because of the $180 billion lifeline the insurer has received from the federal government. Even Benmosche acknowledges that, telling The Wall Street Journal: “If the U.S. government doesn’t continue to support AIG, we will fail.”