Walking Away….

Reuters Staff
Feb 29, 2008 04:40 UTC

The WSJ and the NYT each have articles running tomorrow highlighting the ease with which borrowers are walking away from their mortgages. Both are highlighting the services of YouWalkAway.com, which for a $1000 fee will help borrowers do exactly that.

As house prices fall, more homeowners find themselves upside down, owing more on their mortgage than their house is worth. This is especially true in a world where 100% financing wasn’t uncommon even 18 months ago. With little or nothing down, even a small drop in home prices can lead to millions of upside down homeowners. And since those homeowners put little or nothing down, they face little risk from simply walking away.

First the stats. Buyers put nothing down:

Last year the median down payment on home purchases was 9 percent, down from 20 percent in 1989, according to a survey by the National Association of Realtors. Twenty-nine percent of buyers put no money down. For first-time home buyers, the median was 2 percent. And many borrowed more than the price of the home in order to cover closing costs.

So now trillions of mortgage debt is being carried for properties that are upside down:

Goldman Sachs economists estimate that as much as $3 trillion in mortgages could be underwater by the end of the year, leaving 30% of the country’s outstanding mortgages in negative equity. Since there is roughly $1 trillion in subprime mortgages outstanding, that means a large amount of better-quality mortgages, such as prime and Alt-A — a category between prime and subprime — will be attached to negative equity.

“The focus has been on the [interest rate] resets,” said Goldman Sachs economist Andrew Tilton. “But if you’re in a deep enough negative-equity position, defaulting has its own kind of logic.

And both articles are chock full of great lines that really capture the dynamic. For example:

“There’s a whole lot of people who would’ve been stuck as renters without these exotic loan products,” Professor Sinai said. “Now it’s like they can do their renting from the bank, and if house values go up, they become the owner. If they go down, you have the choice to give the house back to the bank. You aren’t any worse off than renting, and you got a chance to do extremely well. If it’s heads I win, tails the bank loses, it’s worth the gamble.”

And this:

“When people don’t have skin in the game, they behave like they don’t have skin in the game,” said Karl E. Case, a professor of economics at Wellesley College, who conducts regular surveys of borrowers as a founding partner of Fiserv Case Shiller Weiss, a real estate research firm.

Though many states give banks recourse to sue borrowers for their losses, Mr. Case said, in practice it’s not often done “It’s tough to do recourse,” he said. “It’s costly, and the amount of people’s nonhousing wealth tends to be pretty slim.”

Christian Menegatti, lead analyst at RGE Monitor, said the firm predicted more homeowners would walk away from their homes if prices continued to drop, regardless of their financial circumstances. If home prices drop an additional 10 percent, Mr. Menegatti said, 20 million households will owe more than the value of their homes.

“Will everyone walk out?” he said. “No. But there’s been a cultural shift. Buying a house used to be like entering a marriage, a commitment for life. Now, if you see something better, you go back into the dating market.”

When homeowners see houses identical to their own selling for much less than they owe, Mr. Menegatti said, “I wouldn’t be surprised to see five or six million homeowners walk away.”

The NYT features a borrower that was “terrified” about his high mortgage payments….

Last week he moved into a three-bedroom rental home for $1,200 a month, less than half the cost of his mortgage. The old house is now the lender’s problem. “They took the negativity out of my life,” Mr. Zulueta said of You Walk Away. “I was stressing over nothing.”

Keep this in mind when banks talk of bailouts to keep people in their homes. In a zero down world, homeowners suffer little from foreclosure. It’s the lenders that suffer. It’s the banks left holding huge portfolios of foreclosed real estate that are in need of the bailout.

Smart homeowners have already rescued themselves simply by walking away.

Forcing buyers to pay off mortgages on properties that have fallen in value benefits no one but the banks/investors who own the mortgage.

This is a classic story of the little guy sticking it to the man. I say let ‘em. It will bring prices back to normal.

——

Unfortunately, even if Congress resists a bailout plan, there are a few ways the rest of us could suffer anyway.

  • One way is the potential for Fannie and Freddie to go under; with implicit taxpayer backing, the failure of the mortgage behemoths could leave the rest of us with a tab in the hundreds of billions.
  • Another way is rising interest rates; as more buyers default, no amount of Fed rate cuts will keep mortgage rates from trending up.
  • A third way could be a hit to the dollar. Trillions of dollars are parked in mortgage-backed securities. If these prove unsafe, indeed if the U.S. economy is coming apart at the seams as pessimists are predicting, you could see a run on dollar-denominated assets. The Fed isn’t helping matters with rate cuts that reduce the incentive for savers to park their assets in dollars……

……………….
Read other popular posts on OptionARMageddon:

The Latest Borrower Vehicle: your 401(k)
Sanity at last? Paulson rejects bailouts
Bailout Watch, keep Congress on speed-dial
CDS, a hedge-funder’s view
Is anyone immune?
Credit Default Swaps, yet another shoe…..

COMMENT

It’s a pity you don’t have a donate button! I’d certainly donate to this fantastic blog! I guess for now i’ll settle for bookmarking and adding your RSS feed to my Google account. I look forward to brand new updates and will talk about this blog with my Facebook group. Talk soon!

The Latest Borrowing Vehicle: your 401(k)

Reuters Staff
Feb 28, 2008 21:05 UTC

Can Americans be trusted to save for their own retirement? A data point released today suggests not. But first a quick primer on the two basic types of retirement plans: defined BENEFIT plans and defined CONTRIBUTION plans.

The basic difference between the two is who bears investment risk. Is the employer or employee responsible for investing contributions today in a way that will provide sufficient retirement resources tomorrow? Employers bear this risk with D.B. plans. Employees take on the risk with D.C. plans.

Personally I prefer D.C. plans because I get to control my own retirement savings. And I get to take them with me if I change jobs. But it remains my responsibility to make contributions and to invest the contributions prudently.

401(k) plans are a common type of defined contribution retirement plan. Your employer matches contributions you make and you’re responsible for investing the proceeds, often in a menu of mutual funds. If you change jobs, you bring the proceeds from your 401(k) with you, by rolling them over into an IRA, for instance.

The above is just meant to explain how, as employers are shifting towards D.C. plans, individuals are called on to take more responsibility for their own retirement savings. But as in so many other aspects of their financial lives, Americans are proving increasingly irresponsible with their 401(k)s.

Here’s a gem from the latest report of the TransAmerica Center for Retirement Studies:

The economy isnt just preventing employees from saving more for retirement the study shows that it is also starting to affect what theyve already put away. This years survey revealed a noticeable jump in employees taking out a loan from their retirement plans: nearly one in five (18 percent) in 2007, up from only 11 percent in 2006. Nearly half (49 percent) of those who took out a loan cited the need to pay off debt a significant increase from 27 percent in 2006.

While a loan from your 401(k) plan seems like an obvious choice when youre in need of money, many are unaware that this short-term solution can often create more problems, said Collinson. Once you terminate employment, most retirement plans require that you repay the loan in full or it will be considered a taxable distribution in which regular income tax applies and, if you are under age 59 ½, an additional 10 percent penalty applies.

What a rude awakening it will be when Social Security goes bankrupt and that won’t be there for retirees either.

……………….
Read other popular posts on OptionARMageddon:

Walking Away……
Sanity at last? Paulson rejects bailouts
Bailout Watch, keep Congress on speed-dial
CDS, a hedge-funder’s view
Is anyone immune?
Credit Default Swaps, yet another shoe…..

COMMENT

Nice comment.Thanks for sharing.

Sanity at last? Paulson rejects bailouts

Reuters Staff
Feb 28, 2008 14:12 UTC

Yesterday Barney Frank, chairman of the House Financial Services Committee and therefore a very powerful Democratic voice on the economy, was quoted as saying the government

“is not helping enough people. We’re not going to get out of this [credit] crunch until we stop this cascade of foreclosures.”

Where to start? First of all, the idea that foreclosures are the plague to be eradicated here has it exactly backwards. Foreclosure is a symptom of the disease. The disease itself is irrationally high house prices. And the housing market won’t recover until prices return to normal.

Proposals to stop foreclosure vary from bailouts, like Frank’s own plan to use taxpayer money to refinance as many as one million ‘distressed’ homeowners out of high-cost loans, to price-fixing, like Hillary Clinton’s plan to “freeze” interest rates.

Other bailout proposals include the following:

And just yesterday, Fannie and Freddie won regulatory approval to increase the size of their mortgage portfolios after winning approval to back mortgages on homes worth more than $417,000. With taxpayers implicitly backing Fan and Fred, we’re already on the hook for billions of losses when these two go under. Increasing the size of their mortgage portfolios–the same week that both companies recorded additional billions of writedowns!–simply puts us on the hook for more.

————–

The problem with housing, indeed the problem with ALL credit markets that have seized up is that cheap credit was so widely available that assets bought on credit were, and remain, vastly overpriced. Houses, leveraged loans, junk debt, corporate bonds, and now treasuries–which I will argue are due for a fall in my post on inflation later this week.

Houses just happen to be the most politically sensitive of these assets because their (perceived) value affects tens of millions of Americans.

The Democrats are betraying their socialist tendencies by arguing that the needed fix is simply to stop prices from falling when in fact the only thing that can return sanity to the housing market is for prices to fall to levels that are sane.

Of course this will impact millions who bought too high. And it will affect hundreds of banks who foolishly lent money to those buying too high. But this is the virtuous circle of capitalism folks: markets–eventually–achieve equilibrium. And the people that should lose, imprudent borrowers and lenders, are the ones that are losing.

What do Democrats hope to achieve through price-fixing and/or bailouts? You can’t legislate buyers back into the market. You have to let prices fall. Any serious attempt to actually fix prices would simply bring the market to a grinding halt. Half-hearted attempts, like interest rate freezes for some borrowers, would cause banks to lose more money on those borrowers. To offset this, banks would simply charge the rest of us higher interest rates.

Any legislative effort that would shift costs from the imprudent to the prudent is the very definition of a bailout.

Taxpayers fearful that Congress will put them on the hook for housing losses and future buyers waiting for prices to return to normal should both be thanking their lucky stars for the Bush administration’s (relatively) steady hand here. Secretary Paulson:

I don’t think I’ve seen any scenario where the American taxpayer needs to be stepping in with more taxpayer dollars.

Amen.

……………….
Read other popular posts on OptionARMageddon:

Bailout Watch, keep Congress on speed-dial

CDS, a hedge-funder’s view
Is anyone immune?
Credit Default Swaps, yet another shoe…..
Time to call Congress
Is Microsoft Overpaying for Yahoo?

COMMENT

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Posted by monimtw | Report as abusive

Fannie takes a dump

Reuters Staff
Feb 27, 2008 13:53 UTC

Fannie Mae reported earnings this morning. They’re not pretty:

The mortgage-lending giant reported net loss of $3.56 billion, or $3.80 a share, compared to year-earlier net income of $604 million, or 49 cents a share.

The company recorded negative revenue, including derivative and investment losses, of $2.25 billion. Year-earlier revenue was $1.75 billion.

The mean per-share loss estimate of analysts polled by Thomson Financial was $1.24 on revenue of $1.33 billion.

Credit costs continued to rise as the company posted a $2.79 billion provision for loan losses, compared with $221 million a year earlier.

The company also recorded $1.13 billion in investment losses compared with a year-earlier gain of $75 million. Derivative losses ballooned from $668 million.

Fannie said its “serious delinquency rate” as of Dec. 31 climbed to 0.98% from 0.65% a year earlier.

The Journal made the point yesterday that Fannie may not be saved by the fact that most of its loans are of the prime variety. Sure, subprime delinquencies remain far higher (and Fannie has enough of these to potentially wipe out its capital base). But as home prices continue to decline, millions of “prime” borrowers may find themselves upside down: owing more on their mortgage than their house is worth.

And home prices are certainly falling: yesterday Case-Shiller reported housing prices fell 8.9% in the fourth quarter. That’s 8.9% nationally. [So much for realtors' rosy predictions......]

Upside down borrowers, prime or not, have an incentive to simply walk away from their homes. The borrower has to move and absorb a hit to his credit rating sure. But seems to me that’s better than paying off a $400,000 mortgage on a home now worth $300,000. Is avoiding the word “foreclosure” on your credit report worth $100,000?

Not to most people I’d imagine.

And it’s not as if upside down borrowers have any equity left at stake. That they’ve already lost.

So as house prices continue to fall, subprime, AltA and prime borrowers that bought at the top will have an incentive to walk away.

Fannie will be absorbing losses for years as the housing collapse gains steam. My bet is that, absent a large taxpayer bailout, Fannie (& Freddie) will go under.

But the government can’t let that happen; the carnage in financial markets could be too severe. So bet on a taxpayer bailout.

……………….
Read other popular posts on OptionARMageddon:

Bailout Watch, keep Congress on speed-dial

CDS, a hedge-funder’s view
Is anyone immune?
Credit Default Swaps, yet another shoe…..
Time to call Congress
Is Microsoft Overpaying for Yahoo?

Bailout Watch, keep Congress on speed-dial

Reuters Staff
Feb 25, 2008 04:51 UTC

Over the weekend, the New York Times reported that Bank of America is floating ideas for a much larger housing bailout than has been imagined heretofore.

So far, the Bush administration should be congratulated for exercising restraint, for refusing to funnel more taxpayer dollars towards housing in a quixotic effort to keep prices from falling.

Yet as so-called “experts” realize that the bottom may still be far off, many with skin in the game are suggesting government rescue efforts must be more aggressive lest the financial markets come tumbling down.

The schemes pitched by B of A, Credit Suisse and JP Morgan come disguised as “rescue” attempts for homeowners at risk of foreclosure. But peel back the onion just a bit and it’s clear the real beneficiaries of any large scale government bailout would be the banks themselves.

And the losers are taxpayers.

The basic idea being pitched is to create a federal agency that “would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.”

“Foreclosure” is a scary thing, but in the age of the zero-down mortgage, it’s not the homeowners who have the most to lose. Mortgages are non-recourse loans, which is a great protection for borrowers against banks. It means that, unlike other forms of debt (like alimony for instance) a lender can’t go after a debtor’s other assets if the debtor refuses to pay.

The bank can’t compel you to pay your mortgage. Historically, they incentive for people to do so was the significant equity stake in the home that they would lose in foreclosure. If a buyer puts down 20% of a home’s value, he has his own skin in the game. A borrower with zero down has none. If the house’s price declines below the value of the mortgage, why bother paying it? Better to mail your keys to the bank and go rent.

In this scenario, it’s the bank that loses. It ends up owning another foreclosed home that it must turn around and sell.

Banks, remember, are in the lending business, not the real estate business. They make money when borrowers take out loans (and repay them). If borrowers walk away, banks not only lose interest income, but–in the case of falling home values–they often have to write down the value of the loan.

So banks need borrowers to keep paying their mortgages. To do that they have to prevent borrowers from going “upside down” on their mortgage. [That is, the condition when the principal value of the mortgage suddenly becomes HIGHER than the value of the home.] And to do this, they need prices to stop falling. With the huge and growing supply of homes in excess of demand for them, prices have to keep falling. It’s the law of supply and demand folks. When supply exceeds demand, prices fall.

Banks are hoping government intervention will at least slow the bleeding. Have taxpayers, er, the government buy up troubled loans so that banks don’t have to deal with them. Have them refinance the loans at lower (taxpayer-subsidized) interest rates so that at-risk homeowners keep making payments.

You see my point: these rescue plans aren’t meant to help troubled homeowners. They’re meant to rescue banks that made poor lending decisions.

I find it highly ironic that anti-corporate Dems, like Hillary Clinton, are some of the loudest advocates for homeowner rescue plans. Do they not realize that their housing bailout plans amount to one of the largest corporate giveaways in the history of the U.S.?

How can Hillary and the Dems criticize Wall Street fat cats yet still propose that your tax dollars be used to bail them out? If the system is just left alone to sort out its own problems, you’ll see that the biggest banks will continue to suffer mightily.

Any large-scale government invention is nothing more than an attempt, at taxpayers expense, to control prices. Ask the folks in Zimbabwe and Venezuela how well price controls have worked for their economies.

The fact is, the only way for the housing market to repair itself is to let prices fall. And to let banks fail…..

……………….
Read other popular posts on OptionARMageddon:

CDS, a hedge-funder’s view
Is anyone immune?
Credit Default Swaps, yet another shoe…..
Time to call Congress
Is Microsoft Overpaying for Yahoo?

Baltimore Sun Op-Ed: Why Fan and Fred could cost taxpayers billions

Credit Default Swaps, a hedge funder’s view

Reuters Staff
Feb 21, 2008 17:59 UTC

Received a fascinating e-mail from a former hedge-fund colleague that I want to share with all of you (with his permission of course!). Before I get to it, some introductory words:

Morgenson’s article in the NYT earlier this week kicked up a bit of controversy in the blogosphere. She puts the size of the CDS market at $45 trillion, but Felix Salmon responded at Portfolio.com that her numbers are a bit misleading.

That may be so, but there’s still tons of risk built into this market. Salmon doesn’t address fears that someone must be sitting on billions of unrealized losses. That’s a big problem in the markets for RMBS, CMBS, leveraged loans, junk debt, CDOs, CDPOs, CDS, etc. No one knows who’s sitting on the losses. Is it the big Wall Street banks? Which ones? Is it hedge funds? Probably all of the above and more. Hell, even NON-financial companies like pharma giant Bristol Myers have taken losses…..

Everyone knows there are huge losses sitting on SOMEONE’S books. But while lenders wait to find out who, they’re exercising an overabundance of caution: refusing to lend to ANYONE. Another reason they may be hoarding capital is that lenders themselves may be sitting on losses and will need capital to cover them when the day of reckoning arrives. [The dynamic above, market panic created by uncertainty, is a big reason you may read that regulators are encouraging banks to disclose as much as possible about the losses hidden on their balance sheets. Markets fail to function during periods of great uncertainty. If we just knew where the losses were hidden, credit markets might start to function again.]

So that’s my way of introducing his e-mail:

We spent some time a couple weeks ago learning more about these CDS instruments. I was wrongly under the impression that you closed out a position by simply taking the other side of it, thus creating a zero-sum market but also exposing you to downside risk until the contract expires. The way the market really works, though, is you’re able to settle your position for cash simply by calling a broker and agreeing on a price, which is based on current spreads and the forecast for future spreads coupled with the remaining duration of your contract. The broker then either takes your position and pays you cash from its own BS or finds someone who will and pays you the cash proceeds from that transaction.

I’m not sure if you’ve seen the numbers, but most of the Tiger Cubs [a group of hedge funds with seed capital from Tiger Mgmt guru Julian Robertson] were up 40%+ last year and nearly all of their performance came from CDS positions. They were buying in at 10 to 20 bps spreads on companies like Countrywide and homebuilders like Lennar whose spreads have since widened to 300 to 600+ bps. That’s a pretty solid return. Smart guys for making that trade.

My question, though, was whether they could actually realize these returns like you could with a stock – i.e., by simply selling them for cash. As I mentioned above, it turns out you can.

That catch, of course, is that someone needs to PAY you that cash price at settlement for your gain to be realized.

GREAT point. There’s a huge difference between PAPER gains and REAL gains. If I buy a stock that doubles in price, I have a PAPER gain of 100%. I don’t have a REAL gain until I close the position, until I sell the stock for actual cash. That can complicate matters. If my position is very large, for instance, then the act of selling the whole position may drive the price down. It’s important not to forget this necessary step–the actual conversion of paper gains to cash.

While the particulars differ, the point is the same with Credit Default Swaps. To turn a gain into cash, you have to sell your position. John Paulson reportedly generated billions in gains in 2007 using CDS to bet against subprime mortgage-backed securities. But to close out his CDS positions, he had to settle them for cash. Someone had to pay him billions of dollars for the derivative contracts he sold. Where did those billions of dollars come from? For every dollar made, somewhere a dollar is lost.

…….I wonder how well the banks, insurance companies, and others that are on the other side of these transactions can actually afford to cash out the CDS holders. To date, most of those contracts have reflected unrealized losses, but if there’s a run on the banks to cash out the realized losses could mount very quickly.

We have yet to see a major CDS blowup from someone who is was writing these contracts for banks to hedge their credit portfolios and/or hedge funds to speculate on credit spreads widening. That seems inevitable at some point. We talked to a fairly large buy-side institution a few weeks ago that’s been dealing in CDS for some time (mostly going long spread widening). Even they are unsure who is on the other side of their transactions, and these are sophisticated guys. They tend to settle their positions with their brokers and don’t know if that cash at settlement is coming from the broker or someone buying in to take over their position. Either way, there have been some nice fortunes made from the spread widening (Paulson, Hayman, Blue Ridge, Lone Pine, etc.) but I have yet to see where the fortunes are being lost on the other side of those trades. I guess you don’t have to blow up until you have to cash in those positions for massive losses. I think, though, that if we follow the cash on these transactions we’ll see that something ugly will happen at some point as more book losses convert to realized losses.

Time will tell but, as I said above, I think another blow up or two might be inevitable. Within six months it’s possible the term “counter-party risk” will have become almost as colloquial as “subprime” has.

Indeed.

……………….
Read other popular posts on OptionARMageddon:

Is anyone immune?
Credit Default Swaps, yet another shoe…..
Time to call Congress
Credit Woes may Widen
Is Microsoft Overpaying for Yahoo?

Baltimore Sun Op-Ed: Why Fan and Fred could cost taxpayers billions

Funny video

Reuters Staff
Feb 20, 2008 02:07 UTC

I don’t think it takes an econ major to appreciate the humor here. (Hat tip to CR for this one. )

……………….
Read other popular posts on OptionARMageddon:

Is anyone immune?
Credit Default Swaps, yet another shoe…..
Time to call Congress
Credit Woes may Widen
Is Microsoft Overpaying for Yahoo?

Baltimore Sun Op-Ed: Why Fan and Fred could cost taxpayers billions

COMMENT

So the banks get very creative with their financing schemes, putting themselves at risk of ending up in the home selling business. Then, when they do end up in that business, they say that home selling is not what they do and they shouldn’t be put in that position???Now the guys at the top of the banks when they were doing the creative financing are “fired” and leave with great wealth, no admission that they did anything wrong, no condemnation by their successors, and soon they pop up somewhere else raking in more dough.Meanwhile, those who worked at the bank carrying out the orders of the ones directing the shenanigans, or working in other departments of the bank, see the bank as a company, their employer, at risk for decisions they had no control over.So we have people creating risk then escaping the consequences while others take the hit. The system invites this because of the nature of limited liability. There has to be protection of personal wealth from the results of business activity in order for there to even BE business activity. But here we see how it can play out, shielding those who run the show while leaving everyone else subject to the consequences.Enter Uncle Sam to pick up the pieces, especially if there are lots of people who can be hurt financially. It IS infuriating that we all seem to end up getting the bill for the results of what a relatively small percentage of the population does but isn’t that the nature of the system we’ve created?If you fail and you are at the top there are essentially no meaningful consequences. You were fabulously wealthy before and you remain so. You lose a job, but from your impressive personal network you are soon back in action. This invites dodgey initiatives. It’s what we expect, what we promote because we want creativity to create wealth. We see the down side of it now. Some people are paid to take risk but are put beyond it by the system we have.Joe Average is definitely not put beyond risk, yet he takes it on in keeping with the times. Been through the Depression? Keep money in a mattress, spend the absolute minimum and never take a loan for anything. Common sense, everyone is doing it. Spent your whole life in a credit culture? Don’t think twice about taking on debt and pay little heed to the fine print above the line where you sign your name. Common sense, everyone is doing it.So Joe Average, as a mortgage owner or a rank-and-file bank employee wants limited liability too, just like the big guys, and there’s Uncle Sam to offer it. Democracy and a free market are not compatible. For them to coexist the tensions between the two must be resolved. America has been a study of how this can be done, but there is no guarantee it will work out in a stable or long-term solution

Posted by Clif | Report as abusive

Is anyone immune?

Reuters Staff
Feb 19, 2008 12:15 UTC

To date, three banks I can think of have remained largely unscathed by credit-related writedowns. Goldman Sachs, JP Morgan and Credit Suisse, while Lehman’s writedowns have been small relative to others. My hunch, and it’s nothing more than a hunch, is that none of these companies will escape without writing down anything.

Today, Credit Suisse is joining the bangwagon, though it’s writedown is rather small:

Swiss bank Credit Suisse, until now relatively unscathed by the credit crisis, Tuesday said first-quarter earnings will be reduced by $1 billion from mismarkings and pricing errors by traders which led to the reduction in the value of some asset-backed securities by $2.85 billion.

The news came only a week after the company reported robust fourth-quarter profits largely free of any impact from subprime-credit exposure. The Zurich-based bank said it is reviewing whether the change in value of the securities will impact last year’s earnings as well.

I find it interesting that the bank is blaming its traders for misvaluing securities like CDOs. Methinks that’s a cop-out by higher ups trying to avoid taking responsibility.

Goldman and JP Morgan will have large writedowns on their leveraged loan portfolio I’m guessing.

But the market is anticipating some of this. Goldman’s stock is well off of its high near $250…..always dangerous to short those guys, but I certainly wouldn’t be a buyer here. It’s too early.

———-

Post script: missed an article this morning noting that Lehman is about to take one on the shoulder……..

In recent weeks, credit markets have worsened, and Lehman believes it is now facing a write-down in the $1.3 billion range, according to people familiar with the matter. That has risen from a recent estimate of $800 million to $1 billion, and from a $830 million write-down in the fourth quarter.

This may be a prelude to a shot square in the face. The article notes that Lehman has $93 billion worth of securities on its balance sheet that may be vulnerable to writedowns:

  • $39 billion of commercial real estate loans
  • $37 billion of residential mortgage exposure, including $18 billion worth of Alt-A mortgages
  • $13 billion in loan commitments to junk-rated borrowers
  • $4 billion of leveraged buyout commitments

With only $19 billion or so of tangible equity “even a relatively small percentage decrease in that $93 billion could gouge out a substantial chunk from the firm’s tangible capital.”

Lookout below.

……………….
Read other popular posts on OptionARMageddon:

Credit Default Swaps, yet another shoe…..
Time to call Congress
Project Lifeline: A Lifeline for banks, not borrowers
Credit Woes may Widen
Is Microsoft Overpaying for Yahoo?

Baltimore Sun Op-Ed: Why Fan and Fred could cost taxpayers billions

Credit Woes ARE widening

Reuters Staff
Feb 19, 2008 04:55 UTC

Following up on last week’s post about trouble in the leveraged loan market, the WSJ is reporting tomorrow that the big banks may be forced to take $15 billion worth of writedowns on their leveraged loan portfolios.

In case you need a refresher on leveraged loans, see that link above.

Briefly, leveraged loans were used to finance the private equity buyout boom over the last few years. Competition to work on those buyouts, and to generate the investment banking fees that go with them, was intense among the big Wall Street banks. To win the business, they often “used their balance sheets.” That is, they offered to provide or guarantee the financing so that the private equity firms could get deals done.

The idea was that there would be high demand among investors for high-yielding leveraged loan paper. For years there WAS high demand for this stuff, which is one reason yield spreads for junk debt versus treasuries reached record lows. But like real estate speculators who plowed profits back into the market only to see them evaporate when their last deal went sour, Wall Street banks now find themselves with billions of leveraged loans on their balance sheets that they couldn’t sell to investors.

The value of these loans, according to indexes which measure such things, has fallen significantly. Again, see last week’s post. It’s not likely that their value will recover before banks close their next fiscal quarter, which means they’ll have to write down their value.

If the trend holds, analysts and investors are bracing for as much as $15 billion in leveraged-loan-related write-downs at commercial and investment banks in the first quarter, further depleting capital levels already sapped by the mortgage mess. Estimates of the markdowns range from 2% to 10%.

To be sure, the writedowns on leveraged loans aren’t going to approach the size of writedowns related to subprime mortgage-backed securities and CDOs, which have already surpassed $100 billion. But these aren’t going to be the last writedowns either.

Who has the most exposure? Citi leads the pack with $43 billion of leveraged loans on their balance sheet. Goldman is second with $36 billion. JP Morgan Chase has $26 billion. Royal Bank of Scotland has $24 billion. And UBS and Credit Suisse have substantial exposure, which last week forced them to write down a combined $400 million. More writedowns may mean more trips to the well to raise capital.

But how often can these guys keep going back to sovereign wealth funds for capital infusions?

……………….
Read other popular posts on OptionARMageddon:

Credit Default Swaps, yet another shoe…..
Time to call Congress
Project Lifeline: A Lifeline for banks, not borrowers
Credit Woes may Widen
Is Microsoft Overpaying for Yahoo?

Baltimore Sun Op-Ed: Why Fan and Fred could cost taxpayers billions

COMMENT

lol very funny video

The Subprime Primer

Reuters Staff
Feb 17, 2008 07:31 UTC

For a hilarious AND informative primer on the subprime debt bomb, check out this slideshow.

Hat tip: JB

………………..

Read other popular posts on OptionARMageddon:

Time to call Congress
Project Lifeline: A Lifeline for banks, not borrowers
Credit Woes may Widen
Is Microsoft Overpaying for Yahoo?

Baltimore Sun Op-Ed: Why Fan and Fred could cost taxpayers billions
SunTimes Op-Ed: Prophecy?

Credit Default Swaps–yet another shoe

Reuters Staff
Feb 16, 2008 21:15 UTC

…..that will drop, that is. A fascinating and very readable piece by Gretchen Morgenson in today’s NYT gives the lowdown on systemic risks posed by credit default swaps.

Credit Default Swaps are highly complex derivative securities that, in the simplest of terms, function like insurance contracts created to protect bond owners from default.

If you buy a bond and want protection in case the borrower defaults, you can purchase a credit default swap that promises to pay you back.

The tricky, and very dangerous thing about this market is that is is completely unregulated. In the regular insurance business, insurers are required by law to carry sufficient reserves to cover losses. Sellers of credit default swaps face no such requirements. You, the buyer of a credit default swap, pay premiums to a counterparty who, in the end, may not have the capital to pay you back.

Moreover, CDS sellers can exit their “position” by selling it to another, who can sell it to a third person and so on. It’s entirely possible that you, the buyer of protection, may not even know who’s on the other side of your trade when the underlying issuer defaults and you seek to cash-in your insurance policy. It’s as if State Farm could resell your auto insurance policy to Nationwide, who could sell it to Allstate who could sell it to Geico……none of whom have to inform you that your insurance policy was transfered. If you get in a bad wreck and don’t know who to call, what do you do?

[Insurers can by reinsurance to protect themselves from loss, but they can't just sell your policy to another company. At least I don't think they can....again: I'm no expert on insurance.]

To give you an idea of the risk posed by the anonymity of these trades, Morgenson includes this item:

During the credit market upheaval in August, 14 percent of trades in these contracts were unconfirmed, meaning one of the parties in the resale transaction was unidentified in trade documents and remained unknown 30 days later. In December, that number stood at 13 percent. Because these trades are unregulated, there is no requirement that all parties to a contract be told when it is sold.

Here’s a handy graphic from the Times article that may help you understand the relationships involved (click on it to make it larger):

So far we’ve encountered two big risks with CDS:

  • The complexity/anonymity of the relationships between buyers and sellers
  • The lack of regulations requiring that sellers of protection maintain sufficient capital to pay back buyers of protection in case of default.

Add to this list a third risk, the sheer size of the market, which has grown from $900 billion in 2000 to $45.5 trillion today.

Of that amount, approximately a third provides insurance against a particular corporate debt issuer. Another third provides protection against a basket of bonds. And 16% protect holders of CDOs……

Ominously, this market has never really been tested under stress, what with corporate default rates hovering at record lows for most of the past few years. But CDOs have started to default, exposing the first signs of trouble in the CDS world itself.

Just last week, insurer AIG disclosed “material weaknesses” in the valuation of its CDS portfolio. It seems they hold CDSs that serve as protection against $62 billion worth of CDOs. Turns out their CDS portfolio lost $3.6 billion in November alone.

And now one academic expert predicts junk bond default rates will leap 9-fold to 4.64% in 2008 from a historic low of 0.51% last year. Combined with the continued implosion of mortgage securities, the spike in corporate defaults will put unprecedented stress on the heretofore untested CDS market.

Morgenson gives us a feel for some of the exposures at major Wall Street banks:

Commercial banks are among the biggest participants — at the end of the third quarter of 2007, the top 25 banks held credit default swaps, both as insurers and insured, worth $14 trillion, the currency office said, up $2 trillion from the previous quarter.

JPMorgan Chase, with $7.8 trillion, is the largest player; Citibank and Bank of America are behind it with $3 trillion and $1.6 trillion respectively.

Commercial bank capital levels are already under significant strain as writedowns have forced many to seek capital infusions from abroad.

But perhaps a scarier thought is that the other large players in this market tend not to have any spare capital at all. In fact, they tend to be overlevered themselves. Who’s are these other players you ask?

Hedge funds.

………………..

Read other popular posts on OptionARMageddon:

Time to call Congress
Project Lifeline: A Lifeline for banks, not borrowers
Credit Woes may Widen
Is Microsoft Overpaying for Yahoo?

Baltimore Sun Op-Ed: Why Fan and Fred could cost taxpayers billions
SunTimes Op-Ed: Prophecy?

Bad News Keeps Piling Up

Reuters Staff
Feb 15, 2008 15:17 UTC

Bad news cascading its way through the market this morning. But equities still seem positively resilient at this writing, with the Dow off a mere 44 points. A taste of today’s news releases:

The New York Federal Reserve reported early Friday that its general business conditions index tumbled to -11.72, falling below zero for the first time since May 2005, from a reading of 9.03 in January. The index was well below the median forecast of 6.5 in a Dow Jones Newswires survey.

Import prices jumped 1.7% last month as higher energy, food and commodity prices pushed the annual increase to a record high. Economists had been expecting only a 0.5% rise. Compared to a year ago, prices soared 13.7%, the highest reading since the government began gathering the data in 1982. Export prices also surged last month, by 1.2%.

UBS dropped almost 3% in early trading after Citigroup analysts speculated the bank might need to write off another 12 billion Swiss francs ($10.9 billion) to 20 billion Swiss francs in 2008. Also, The Wall Street Journal’s report that Citigroup has barred investors in one of its hedge funds from withdrawing their money could spook already wary investors.

People familiar with the situation told The Wall Street Journal that Financial Guaranty Insurance Co., has notified the New York State Insurance Department that it will request to be split into two companies. The news comes a day after New York Gov. Eliot Spitzer and the state’s insurance commissioner Eric Dinallo testified to Congress about the problems facing the bond insurers.

Shares of Best Buy slipped 3.9% after the opening bell Friday after the consumer-electronics retailer cut its fiscal 2008 earnings forecast, citing soft domestic customer traffic in January.

Crude oil futures gained 62 cents to $96.08 a barrel.

General Business conditions are off, inflation is ticking up, banks are headed for more write-downs, a bond insurer is asking to throw in the towel on its stuctured finance obligations, consumer spending continues to soften and oil is creeping its way back to $100 per barrel.

Not to mention the continued failure of muni-bond, student loan and other fixed-income auctions. Another credit market grinding to a halt.

This last issue is particularly interesting. Municipalities aren’t all of a sudden going to go bankrupt. I’m definitely on the bearish side as anyone who reads this blog regularly can attest, yet even the most ardent bear has to acknowledge that the economic situation at present is not all that terrible. Unemployment is still at 5% for goodness sakes. Sure credit markets are seizing up everywhere, but the real economy, while deteriorating, is by no means imploding.

The fact that municipalities are having trouble getting credit doesn’t mean that they are going to default…..but it does mean they’ll likely have to sell their bonds at higher interest rates in order to attract buyers. Despite the Fed’s aggressive action to cut short-term rates, longer-term rates probably have to move up in order to bring buyers back into the market.

And this is one way that the trouble in credit markets is likely to impact the real economy: higher long-term interest rates.

………………..

Read other popular posts on OptionARMageddon:

Time to call Congress
Project Lifeline: A Lifeline for banks, not borrowers
Credit Woes may Widen
Is Microsoft Overpaying for Yahoo?

Baltimore Sun Op-Ed: Why Fan and Fred could cost taxpayers billions
SunTimes Op-Ed: Prophecy?

COMMENT

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Time to call Congress

Reuters Staff
Feb 14, 2008 04:13 UTC

Folks, it’s time to dig up the phone numbers for your congressman and your Senators. According to the Journal “worried bankers are…urgently shopping proposals to Congress and the Bush administration that could shift some of the risk for troubled loans to the federal government.” That is, to taxpayers.

One proposal, advanced by officials at Credit Suisse Group, would expand the scope of loans guaranteed by the Federal Housing Administration. The proposal would let the FHA guarantee mortgage refinancings by some delinquent borrowers.

Credit Suisse officials have met with senior officials from the Department of Housing and Urban Development, which runs the FHA, and other policy makers to discuss the proposal.

The risk: If delinquent borrowers default on their refinanced loans, the federal government (i.e. TAXPAYERS!!!) would have to absorb the loss.

I find it HIGHLY odd that Credit Suisse is leading the charge on this. If you look at the list of the big multinational banks that have been forced to write down billions due to subprime exposure, Credit Suisse ranks near the bottom. Their CEO, Brady Dougan (a product of my alma mater….The University of Chicago) has won accolades for steering his bank through the subprime minefield largely unscathed.

So why is Credit Suisse asking Congress to bail out lenders and homeowners? Like I said: odd.

The article also says JP Morgan Chase is working on its own idea “to expand the number of homeowners who could refinance into FHA-backed loans.” Jamie Dimon, JP Morgan’s CEO, is the other guy getting plaudits for leadership in the age of subprime. Hmmmm.

It’s scary that such ideas may be getting traction in Congress:

Sen. Schumer called the Credit Suisse plan “an interesting idea, which we are looking at pretty seriously.”

Schumer is my Senator here in NY so I will be placing a call to him to express my displeasure over this as well as his support for expanding conforming loan limits for Fannie and Freddie.

The crux of the problem is summed up in one line of the article:

Politicians and bankers are now abuzz with talk about broader ideas to prevent the housing market from deteriorating.

The housing market has to deteriorate. Prices are too high by any reasonable measure. The only way to “prevent” the market from deteriorating would be to keep prices artificially inflated. Short of the Federal Government buying up housing stock, which of course it can’t do, there’s no way for it to keep prices from correcting. Backing a wider swath of mortgages will just put taxpayers on the hook for steep losses as housing prices decline.

Taxpayers may already be on the hook for hundreds of billions in housing-related losses if Fannie and Freddie go under.

Get on the phone people. Call Washington and tell them you don’t want your tax dollars being used to bail out the housing market.

……………………

Read other popular posts on OptionARMageddon:

Project Lifeline: A Lifeline for banks, not borrowers
Credit Woes may Widen
Is Microsoft Overpaying for Yahoo?

Baltimore Sun Op-Ed: Why Fan and Fred could cost taxpayers billions
SunTimes Op-Ed: Prophecy?

Buffett Bids to Back Bonds

Reuters Staff
Feb 13, 2008 05:26 UTC

There’s a fantastic editorial in today’s Journal regarding Warren Buffett’s offer to reinsure $800 billion of municipal bonds currently backed by monoline insurers like Ambac and MBIA.

The man is brilliant folks. He’s been sitting on billions in cash the last few years waiting for appealing investments to materialize. Municipal bond reinsurance is very appealing.

It’s a boring, low growth business, but one that dumps off stable cash flows. Ambac, MBIA, et al had a lock on the business for years. But it bored them too so they decided to chase the growing business of insuring asset-backed securities like CDOs.

Now they’ve got $1.0 trillion of exposure to asset-backed securities and only a few billion of capital to pay claims. Everyone knows losses on asset-backed securities will wipe them out. Wall Street and New York’s insurance regulator Eric Dinallo are panicked that if the companies do go bankrupt it will throw the credit markets into further turmoil.

The business of bond insurance is effectively one of renting out a AAA credit rating. Bond issuers who wish to pay lower interest rates purchase default insurance from the monolines. With “insurance” to back them up, issuers have lower default risk. Lower default risk translates into higher ratings from the likes of Moody’s and Fitch and, consequently, lower interest rates.

But an insurance policy is only as good as the insurer writing the policy.

Since the monoline insurers don’t have the cash on hand to cover expected losses for the asset-backed credits they’ve insured, all their policies, including those for ultra-safe municipals, are effectively worthless.

[Here it may be appropriate to answer a question: why, if municipal bonds have such low historical default rates, do municipalities bother purchasing insurance? Some of them wonder the same thing. The reason they have is that the amount they save on interest rates has been more than the cost of the premiums to buy insurance. Until recently anyway.]

If the monoline insurers are downgraded by the ratings agencies, then many securities they back, whose high-ratings are based in part on the insurance they’ve purchased, may themselves be downgraded. Some investors, required to hold only highly-rated fixed income securities, may be forced to sell some of these investments. Lots of forced selling would not be good for credit markets. Hence the rescue plans being discussed by Wall Street at Dinallo’s behest.

Riding to the rescue is Buffett, who made his fortune selling insurance policies and investing the premiums wisely. He knows that insuring municipal securities is a safe business that will be up for grabs as the monolines fail. So he’s using the muscle on his balance sheet, $46 billion cash ($12 billion net of debt), to write insurance policies for the safest of the safe credits.

The monolines responded coolly to Buffett’s offer of help of course. Their municipals book is the only one that’s still stable. Why should they waste money buying reinsurance on safe securities from Buffett when they’re scrambling to raise capital to cover losses on much riskier asset-backed credits?

If Buffett were willing to reinsure asset-backed securities as well, the monolines might be interested in his offer. But he doesn’t want any part of that business. He’s not a charity. He wants to cherry pick the best bonds to reinsure; the ones with the lowest default rates: the municipals.

My favorite line from the Journal editorial derives from one of Buffett’s famous investment axioms, specifically “be brave when others are fearful, and be fearful when others are brave.”

Like any good insurance salesman, Mr. Buffett wants nothing to do with the riskiest policies [insuring asset-backed securities], which makes it more likely that the bond insurers will be stuck with them. Hence the sell-off of the insurers’ stocks. Who wants to be brave where even Mr. Buffett is fearful?

Who wants to be brave indeed. It’s too early to call a bottom when it comes to CDOs and other asset-backed credits. Why do we know this? Because Buffett, who sniffs out value like a bloodhound, won’t touch ‘em with a 30-foot pole…..

…………………..

Read other popular posts on OptionARMageddon:

Project Lifeline: A Lifeline for banks, not borrowers
Credit Woes may Widen
Is Microsoft Overpaying for Yahoo?

Baltimore Sun Op-Ed: Why Fan and Fred could cost taxpayers billions
SunTimes Op-Ed: Prophecy?

NYT: Mortgage Crisis Spreads Past Subprime

Reuters Staff
Feb 12, 2008 04:34 UTC

On the heels of yesterday’s front page article in the Journal about widening credit woes, the NYT has a front page article of its own this morning noting that mortgage troubles aren’t limited to so-called subprime borrowers:

The credit crisis is no longer just a subprime mortgage problem.

As home prices fall and banks tighten lending standards, people with good, or prime, credit histories are falling behind on their payments for home loans, auto loans and credit cards at a quickening pace, according to industry data and economists.

The rise in prime delinquencies, while less severe than the one in the subprime market, nonetheless poses a threat to the battered housing market and weakening economy, which some specialists say is in a recession or headed for one.

Until recently, people with good credit, who tend to pay their bills on time and manage their finances well, were viewed as a bulwark against the economic strains posed by rising defaults among borrowers with blemished, or subprime, credit.

“This collapse in housing value is sucking in all borrowers,” said Mark Zandi, chief economist at Moody’s Economy.com.

Like subprime mortgages, many prime loans made in recent years allowed borrowers to pay less initially and face higher adjustable payments a few years later. As long as home prices were rising, these borrowers could refinance their loans or sell their properties to pay off their mortgages. But now, with prices falling and lenders clamping down, homeowners with solid credit are starting to come under the same financial stress as those with subprime credit.

Prime borrowers received Option ARM loans too. Plenty have elected to defer payments, allowing the loan balance to grow. Now they face the prospect of rates adjusting upward on mortgages that have GROWN for properties that have fallen in value. Naturally, many find themselves upside down on their homes and have an incentive to default and walk away.

Walking Away is especially bad for banks, which is why they plan to throw borrowers a “lifeline.

And the problem isn’t limited to first mortgages of course. Default rates are rising for all sorts of consumer debt:

About 5.7 percent of home equity lines of credit were delinquent or in default at the end of last year, up from 4.5 percent a year earlier, according to Moody’s Economy.com and Equifax, the credit bureau.

About 7.1 percent of auto loans were in trouble, up from 6.1 percent. Personal bankruptcy filings, which fell significantly after a 2005 federal law made it harder to wipe out debts in bankruptcy, are starting to inch up.

On Monday, Fitch Ratings, the debt rating firm, reported that credit card companies wrote off 5.4 percent of their prime card balances in January, up from 4.3 percent a year ago. The so-called charge-off rate is still lower than before the 2005 law went into effect.

Is any of this really news? Not to anyone who’s been following the housing implosion over the last year. Falling prices affect overlevered homeowners of all kinds, regardless of credit rating.

What’s news is that the phenomenon is so wide-spread that national newspapers are making it the subject of page one articles above-the-fold.

………………….

Read other popular posts on OptionARMageddon:

Project Lifeline: A Lifeline for banks, not borrowers
Credit Woes may Widen
Is Microsoft Overpaying for Yahoo?

Baltimore Sun Op-Ed: Why Fan and Fred could cost taxpayers billions
SunTimes Op-Ed: Prophecy?

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