Commentary by Caroline BaumFeb. 12 (Bloomberg)
-- The chief executive officers of WallStreet’s too-big-to-fail banks traipsed up to Capitol Hillyesterday to submit to questioning from Barney Frank and theHouse Financial Services Committee he heads.
It was the latest installment in a series of show trialsfeaturing the likes of Major League baseball, the Detroit autoindustry, Big Oil and Bad Tobacco.
Not that Congress is outside its jurisdiction in inquiringafter the taxpayer money it has doled out. (If only lawmakerswere as vigilant about the rest of their spending.)
When our elected representatives are out for blood, a legitimate form of inquiry quickly degenerates into finger-pointing and grand-standing for the folks back home.Yesterday’s hearing was relatively tame, as far as lynchings go.
The eight Wall Street CEOs, including Citigroup Inc.’s VikramPandit, JPMorgan Chase & Co.’s Jamie Dimon, and Bank of AmericaCorp.’s Ken Lewis were questioned about their lending, or lack ofit, since they received an injection of government capital underthe Troubled Asset Relief Program. They were scolded for spendingthe money unwisely. They were asked about salary, bonuses and“planes and perks” (a show of hands, please).The bankers were appropriately contrite in admittingmistakes and sincere in their commitment to make amends.
Panditvolunteered to take a salary of $1 and no bonus until Citigroupis profitable again.
The execs had to dance around some of the questions, such as one on raising credit-card rates, with prosecutor Maxine Waters,Democrat of California, cutting off the witness before he could explain how banks make a profit.
Reversal of Fortune
Just imagine if the tables were reversed.
Frank and Watersare seated at the witness table instead of perched on the hearingroom dais.
The questioning would go something like this:
Chairman Frank, on July 14, 2008, you made the followingpronouncements about Fannie Mae and Freddie Mac, the two hugegovernment-sponsored enterprises that are the key players inmortgage finance:
“Fannie and Freddie are fundamentally sound.”
“They are not in danger of going under.”
“Looking at the financials, they’re solid.”
You followed that analysis with a forecast.
Referring tolegislation before your committee to allow the Treasury to lend to and buy unlimited shares in the GSEs, you said:
“We’re doingthree separate things that make it much less likely -- very, veryunlikely -- that we’ll have this kind of a housing crisis sixmonths or a year from now.”
Less than two months later, Fannie and Freddie were wards ofthe state.
Just answer the questions, Mr. Chairman.
GSE Enabler
As the ranking member of the House Financial ServicesCommittee -- before you became chairman in 2007 -- you consistently opposed stricter regulation of Fannie Mae andFreddie Mac.
I would just note that you received $42,350 fromFannie’s and Freddie’s political action committees and employees from 1989 to 2008.
In 2004, you received a report from the GSE regulator showing that Fannie and Freddie had manipulated their earnings, enriching their senior executives in the process.
Yet you and your fellowcommittee members, primarily Democrats, looked the other way.
Even worse, you shot the messenger, Armando Falcon, directorof the Office of Federal Housing Enterprise Oversight, who foundaccounting irregularities at both companies.
‘Innovation’ Lending
This is what you said to Falcon at a committee hearing:
“I don’t see anything in your report that raises safenessand soundness problems.”
Your distinguished colleague, Maxine Waters, was right thereto back you up.
“We do not have a crisis at Freddie Mac, and particularlyat Fannie Mae, under the outstanding leadership of FranklinRaines,” she said.
She went on.“What we need to do today is to focus on the regulator, andthis must be done in a manner so as not to impede their affordable housing mission.”
That mission, as you noted, has seen “innovation flourish from desk-top underwriting to 100 percent loans.”
We all know how that worked out.
Fannie had to restate earnings back to 2001, erasing $6.3 billion in previouslyreported profits.
Doing Penance
Former CEO Franklin Raines kept the lion’s share of the $91million bounty he received for his six years of service at thecompany. (Raines had to cough up $24.7 million last year to settle a claim that he inflated earnings.)
Questioned by former congressman Chris Shays, Republican of Connecticut, about Fannie’s teensy 3 percent capital cushion,Raines said of the multi- and single-family loans the companyholds:
“These assets are so riskless that capital for holdingthem should be under 2 percent.”
Finally, Mr. Chairman, you used your influence as chairman of the House Financial Services Committee to secure $12 millionfor a troubled home-state bank under the TARP program.
Treasuryhad stipulated that the banks be healthy.
It’s disingenuous to be critical of legislation you passed and a program you implemented when you’re the one bending the rules. Mr. Chairman, we thank you for your candor in appearing before us today.
(Caroline Baum, author of “Just What I Said,” is aBloomberg News columnist. The opinions expressed are her own.)
Editors: Steven Gittelson, David Henry
To contact the writer of this column: Caroline Baum in New York at +1-212-617-3369 orcabaum@bloomberg.net.
To contact the editor responsible for this column: James Greiff at +1-212-617-5801 or jgreiff@bloomberg.net
Friday, February 13, 2009
The U.S. foreclosure rate improved in January!!!?? Rubbish
The U.S. foreclosure rate improved in January
“Only” 274,399 foreclosure filings hit the books in January, down 10% from the month before.
Wait… what’s this?
According to RealtyTrac, most of decline was due to a moratorium on foreclosures at Fannie Mae and Freddie Mac.
Ah, we see the logic. If you don’t allow foreclosures to take place, the problem will just go away.
Impeccable.
Bummer. Foreclosures were still up 18% annually. The trend remains.
“Only” 274,399 foreclosure filings hit the books in January, down 10% from the month before.
Wait… what’s this?
According to RealtyTrac, most of decline was due to a moratorium on foreclosures at Fannie Mae and Freddie Mac.
Ah, we see the logic. If you don’t allow foreclosures to take place, the problem will just go away.
Impeccable.
Bummer. Foreclosures were still up 18% annually. The trend remains.
China: the first to recover?
China with all their trillions of dollars sitting around losing their value, and set to lose their value even more in the future, looks to have possibly turned around their recession in a heartbeat... You may recall that China put into place a 4 Trillion renminbi Stimulus Package a few months ago... And when you deal from a position of strength, you can do these things quickly and with force. So, according to an economist at Merrill Lynch, "China looks set to be the first major economy to recover from the current global meltdown. China is the only economy in the world to see significant growth in credit to corporate and household sectors since September 2008, when the financial crisis worsened to a near collapse."
Oil and Gas Transport Plays
S&P believes these six high-yielding issues should be able to maintain their distribution levels this year
By Beth Piskora From Standard & Poor's Equity Research
Quick: name an industry group where the average dividend yield is hovering around 11%. If you guessed utilities, real estate investment trusts (REITS), or banks, you're wrong. But if you guessed oil and gas transportation companies, that would be correct.
Most oil and gas pipeline companies are set up as Master Limited Partnerships (MLPs), which means they must, by law, distribute their earnings, just like REITs do. That makes them good choices for income-focused investors, in our view.
"The distribution—or dividend—level is a very important driver of investor interest in this group," explains Tanjila Shafi, a Standard & Poor's equity analyst. "The companies know this, so they are working very hard not to cut the payouts. They are doing other things like cutting capital expenditures to preserve capital, just to maintain the distribution levels."
Shafi recommends only six MLPs, and believes all six should be able to maintain their distribution levels this year. She also believes that they, as a group, are the strongest companies in the industry, have good balance sheets, and are more likely to be able to tap the capital markets. She notes investors may find other MLPs with higher dividend yields, but recommends for purchase only these six, each of which carries an S&P investment ranking of 4 STARS (buy) or 5 STARS (strong buy).
Company Ticker S&P STARS Rank (2/12/09)
Energy Transfer Partners ETP 4
Kinder Morgan Energy Partners KMP 5
Magellan Midstream Holdings MGG 4
NuStar Energy NS 4
Oneok Partners OKS 4
Plains All American Pipeline PAA 4
Piskora is managing editor of U.S. Editorial Operations for Standard & Poor's .
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure
Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
By Beth Piskora From Standard & Poor's Equity Research
Quick: name an industry group where the average dividend yield is hovering around 11%. If you guessed utilities, real estate investment trusts (REITS), or banks, you're wrong. But if you guessed oil and gas transportation companies, that would be correct.
Most oil and gas pipeline companies are set up as Master Limited Partnerships (MLPs), which means they must, by law, distribute their earnings, just like REITs do. That makes them good choices for income-focused investors, in our view.
"The distribution—or dividend—level is a very important driver of investor interest in this group," explains Tanjila Shafi, a Standard & Poor's equity analyst. "The companies know this, so they are working very hard not to cut the payouts. They are doing other things like cutting capital expenditures to preserve capital, just to maintain the distribution levels."
Shafi recommends only six MLPs, and believes all six should be able to maintain their distribution levels this year. She also believes that they, as a group, are the strongest companies in the industry, have good balance sheets, and are more likely to be able to tap the capital markets. She notes investors may find other MLPs with higher dividend yields, but recommends for purchase only these six, each of which carries an S&P investment ranking of 4 STARS (buy) or 5 STARS (strong buy).
Company Ticker S&P STARS Rank (2/12/09)
Energy Transfer Partners ETP 4
Kinder Morgan Energy Partners KMP 5
Magellan Midstream Holdings MGG 4
NuStar Energy NS 4
Oneok Partners OKS 4
Plains All American Pipeline PAA 4
Piskora is managing editor of U.S. Editorial Operations for Standard & Poor's .
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure
Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
Market Reflections 2/12/2009
Doubts that the Treasury's stability plan, under which the government would swap out the bad debt of financial firms, sent stocks lower, at least in early trading. But a report by day's end that the Obama administration is working on a plan to subsidize homeowner mortgage payments sent stocks back toward their opening levels.
Retail sales showed a strong bounce in January but are still contracting badly on a year-on-year rate. Jobless claims were decidedly weak indicating steady and severe rates of contraction in the labor market.
Money moved into safety with the dollar gaining about 1/2 cent to $1.2856 against the euro. Treasury yields slipped slightly with the exception of the 30-year bond where the yield rose 7 basis points to 3.52 percent. Demand was soft for a giant $14 billion auction of new bonds.
The March WTI contract fell another $2 to just under $34, but the April contract is much stronger ending at nearly $42. This giant gap, not seen in the Brent contract, reflects the lack of available storage space at the key delivery point of Cushing, Oklahoma. Gold ended slightly higher just over $950 and on its way, many say, to $1,000.
Retail sales showed a strong bounce in January but are still contracting badly on a year-on-year rate. Jobless claims were decidedly weak indicating steady and severe rates of contraction in the labor market.
Money moved into safety with the dollar gaining about 1/2 cent to $1.2856 against the euro. Treasury yields slipped slightly with the exception of the 30-year bond where the yield rose 7 basis points to 3.52 percent. Demand was soft for a giant $14 billion auction of new bonds.
The March WTI contract fell another $2 to just under $34, but the April contract is much stronger ending at nearly $42. This giant gap, not seen in the Brent contract, reflects the lack of available storage space at the key delivery point of Cushing, Oklahoma. Gold ended slightly higher just over $950 and on its way, many say, to $1,000.
Thursday, February 12, 2009
China must buy more U.S. debt… "it is the only option"
Even though it knows the dollar will fall, China – the world’s largest holder of U.S. Treasuries – will continue buying because it’s their “only option.”
Luo Ping, a director-general at the China Banking Regulatory Commission, asked at a meeting in New York on Wednesday, “Except for US Treasuries, what can you hold? Gold? You don’t hold Japanese government bonds or UK bonds. US Treasuries are the safe haven. For everyone, including China, it is the only option.”
Read full article... (requires subscription)
Luo Ping, a director-general at the China Banking Regulatory Commission, asked at a meeting in New York on Wednesday, “Except for US Treasuries, what can you hold? Gold? You don’t hold Japanese government bonds or UK bonds. US Treasuries are the safe haven. For everyone, including China, it is the only option.”
Read full article... (requires subscription)
Market Reflections 2/11/2009
Lawmakers reached a deal on a $789 million stimulus bill and set the stage for quick passage. Sentiment is mixed. Government spending is important to stimulate growth but many say pork spending will dull the bill's economic effectiveness. A reminder of what's ahead was offered by the Treasury's monthly budget statement where deficits are already dwarfing any thing ever seen before.
Stocks regained little following yesterday's disappointment over lack of details in the Treasury's stability plan. The Dow industrials edged 0.6% higher while the dollar was little changed at $1.2897 against the euro. Money keeps moving back into Treasuries and gold with the 10-year yield down 5 basis points at 2.76 percent and gold ending more than $25 higher at $941.10. Another bulge in supplies sent oil down more than $2 to $36, yet gasoline went higher, briefly over $1.30 in reaction to draws in gasoline stocks.
Stocks regained little following yesterday's disappointment over lack of details in the Treasury's stability plan. The Dow industrials edged 0.6% higher while the dollar was little changed at $1.2897 against the euro. Money keeps moving back into Treasuries and gold with the 10-year yield down 5 basis points at 2.76 percent and gold ending more than $25 higher at $941.10. Another bulge in supplies sent oil down more than $2 to $36, yet gasoline went higher, briefly over $1.30 in reaction to draws in gasoline stocks.
Wednesday, February 11, 2009
Waiting for Geithner/Godot Part Deux (2)
This courtesy of Nouriel Roubini's RGE Monitor. It is a must read for all citizen/taxpayers in the USA.
On February 10 Treasury Secretary Timothy Geithner presented the administration’s Financial Stability Plan to deal with the financial system’s toxic asset overhang and ease, if not reverse, the ongoing decline in bank lending to households and corporations. Out of the three broad options available -including nationalization, ‘good / bad bank’, backstop guarantee on ring-fenced toxic assets- the administration plan offers elements of all three.
The first program involves a mandatory ‘stress test’ for all banks with $100bn-plus assets which should also shed some clarity on the individual banks exposures and valuations of toxic assets. The Treasury’s Capital Assistance Program stands ready with preferred shares / warrants injections where needed, only this time with clear lending requirements and strict limits on dividends, stock repurchases and acquisitions next to a $500,000 compensation cap. Any capital investments made by Treasury under the CAP will be placed in the Financial Stability Trust. However, it is still unclear what the options are for institutions that are severely undercapitalized or that fail to attract public capital on a recurring basis (see e.g. Bank of America, Citigroup after the 2nd bailout.) The program aims at ensuring full transparency disclosing all relevant information on capital recipients at www.FinancialStability.gov.
The second program, the Public-Private Investment Fund (PPP), aims at setting up a new lending/guarantee facility by leveraging an initial private capital commitment with government funds to an initial scale of up to $500bn (can be expanded to max. $1 trillion.) The aim is to involve private capital on a large scale that sits currently on the sidelines while also allowing private market forces to determine the price for currently troubled and illiquid assets.
A similar experiment was tried before with the private sector sponsored M-LEC vehicle that ultimately proved unviable due to asymmetric toxic asset exposures of participating banks and due to still unresolved asset valuation issues. Commentators agree that for a similar plan to work this time, the government will have to assume a potentially substantial downside in order to induce otherwise unwilling investors to participate in view of the size of potential losses.
As we noted before, the size of the entire shadow banking system lacking liquidity is $10 trillion of which $6 trillion are assets held in the U.S. Not all of these assets will turn bad but at RGE we expect total losses on these shadow banking assets plus traditional loan losses to reach $3.6 trillion (of which $1.8 trillion borne by U.S. banks.)
One practical example is the Federal Reserve’s Maiden Lane portfolio of toxic Bear Stearns assets. If that performance is any guide, the upside left in these toxic assets might in reality be more limited than previously assumed. Cumberland Advisors reports that this particular portfolio has lost over 10% of its value, and losses are mounting. Indeed, the authors see ‘no prospect for a profit’ on this portfolio.
Renowned distressed debt experts such as Edward Altman and Martin Fridson note that the best time to invest in distressed debt is when default rates peak. Mind that high-yield default rates are set to rise to 15-20% sometime in 2010 from currently 4-5% due to very bad credit quality at the outset of the cycle.
The third program put forth by Secretary Geithner is an expanded version of the previously $200bn Federal Reserve Term Asset Backed Securities Loan Facility (TALF) program aimed at unclogging the markets for auto, student and other consumer loans. That initiative may expand to as much as $1 trillion, using $100 billion from the Treasury's rescue funds, and include aid for commercial real estate markets.
Geithner points out that securitization created about 40% of the demand for new loans extended to consumers, students, and auto buyers. The decline of securitized lending to the tune of $1.2 trillion between 2006 and 2008 leaves a hole that needs to be filled if a severe lending contraction should be prevented.
Nouriel Roubini in his latest writing It Is Time to Nationalize Insolvent Banking Systems argues that, ultimately, nationalization may be a more market friendly solution of a banking crisis: it creates the biggest hit for common and preferred shareholders of clearly insolvent institutions and – possibly – even the unsecured creditors in case the bank insolvency is too large; it provides a fair upside to the tax-payer. Moreover, it bypasses the asset valuation issue as any overpayment goes back into taxpayers pockets. “With the government starting stress tests to figure out which institutions are so massively undercapitalized that they need to be taken over by the FDIC the administration is putting in place the steps for the eventual and necessary takeover of the insolvent banks.” This might well explain some of the negative market reaction.
The Treasury has stressed that while the ongoing price correction will stimulate home demand, there is a need to reduce foreclosures, which otherwise adding to the excess overhang of homes pose the risk of price over-correction, pushing more homeowners into negative equity. The Treasury plans to announce a Housing Program in the next few weeks to help refinance mortgages and contain foreclosures by reducing monthly payments for homeowners. The program will be financed by using $50 billion from the remaining TARP funds. To increase lender participation, the plan makes it compulsory for banks using government funds under the Financial Stability Plan to participate in foreclosure mitigation. In order to stimulate home demand and help the current homeowners refinance, the Treasury and Fed will continue with their November 2008 plans use $600 billion to buy MBSs and debt of the GSEs using and reduce mortgage rates to the 4-4.5% range. More importantly, the plan will increase flexibility to modify loans under the Hope Now and FHA Programs started in 2007-08 to help increase participation and foreclosure prevention.
Efforts to stimulate demand reducing mortgage rates and offering tax incentives will be largely ineffective as they are a small factor in determining home demand relative to factors such as tighter lending standards, changing dynamics for households - job and income loss, wealth erosion, rising savings rate, and low expectations of income or asset appreciation. These factors will constrain home demand in the short run while potential buyers await further price correction and banks don’t see the viability in offering mortgage for a house whose value is expected to fall.
As a result, the government needs to focus on the supply side of the market by refinancing at-risk mortgages and preventing foreclosures that will only add to the existing overhang of houses. Moreover, government’s loan modification program should reduce mortgage principal rather than just reducing the mortgage rate or extending the loan maturity, which has been the case in past government programs. Unless the problem of insolvency among a large number of households is addressed, default on modified mortgages will also continue. Also, given the large number of homeowners with negative home equity, the program will need much larger funds - over $600 billion to $1 trillion though the actual cost might be much less, since the government will receive a share from future home appreciation. Monetary incentives for servicers are also low and ineffective. Even the number of homeowners the program plans to target, 1.5-2 million is a very small fraction of the over 12 million homeowners with negative equity. In fact, several Democrats are pushing a legislation to allow bankruptcy judges to change mortgage terms that would allow lenders to reduce the mortgage principal for primary homes and bring down monthly payments. To increase participation, they support offering monetary incentives for servicers while lenders will be entitled to a share if the homeowner sells the house and also have the government share any losses on the modified mortgage.
As we have argued before at RGE Monitor, looking at the shortcomings of past government programs such as the Hope Now, Housing Retention and FDIC programs, the new program should be mandatory for lenders in order to increase participation. The government will also need to share the cost of modifying the loan, by matching the principal or the interest rate cut in a proportionate or less than proportionate amount. By guaranteeing the loans, the government will be the senior debt holder. The new interest rate should be based on the risk assessment of the borrower and all three parties – homeowner, lenders and servicers, and the government should share the cost of modification. However, determining the extent of principal reduction based on the true value of the house, and dealing with second lien mortgages and the diverging interests of mortgage servicers will be challenging.
Under the new guidelines for compensation issued by the Treasury, firms receiving federal aid will be subject to shareholder say on pay and will be required to cap executive compensation at $500,000 with any additional compensation given out in restricted stocks which can be cashed only after the government has been repaid or the bank has satisfied repayment obligations, and met lending and stability standards. Moreover, bonuses and compensation for other top executives will also be reduced. The Treasury requires disclosure of the compensation structure and strategy, and expenditure on luxury items.
While government intervention is warranted, the compensation reform does little to align risks with rewards. Large share of the compensation can and will still be given out in restricted stocks including compensation for several traders and funds managers who are not under the lenses of the current plan. Government measures also give a green signal to those who have already received large compensation and severance packages at the troubled banks. More importantly, the measures might act a disincentive in attracting credible executive talent to these troubled institutions in the future who can help deal with the bank losses and overhaul. Wall Street compensation is determined in a competitive market with CEOs joining a firm offering the most attractive pay packages and perks. Many banks are already reluctant to seek capital injection from the Treasury or are contemplating to payback past borrowings in order to avoid government scrutiny over their compensation packages.
To reduce excessive risk-taking in the short-run, compensation, bonuses and even severance packages should be based on the long-term performance of the employee relative to the risk undertaken with large part of the payments given out in restricted stocks that can be redeemed over a longer period of time.
On February 10 Treasury Secretary Timothy Geithner presented the administration’s Financial Stability Plan to deal with the financial system’s toxic asset overhang and ease, if not reverse, the ongoing decline in bank lending to households and corporations. Out of the three broad options available -including nationalization, ‘good / bad bank’, backstop guarantee on ring-fenced toxic assets- the administration plan offers elements of all three.
The first program involves a mandatory ‘stress test’ for all banks with $100bn-plus assets which should also shed some clarity on the individual banks exposures and valuations of toxic assets. The Treasury’s Capital Assistance Program stands ready with preferred shares / warrants injections where needed, only this time with clear lending requirements and strict limits on dividends, stock repurchases and acquisitions next to a $500,000 compensation cap. Any capital investments made by Treasury under the CAP will be placed in the Financial Stability Trust. However, it is still unclear what the options are for institutions that are severely undercapitalized or that fail to attract public capital on a recurring basis (see e.g. Bank of America, Citigroup after the 2nd bailout.) The program aims at ensuring full transparency disclosing all relevant information on capital recipients at www.FinancialStability.gov.
The second program, the Public-Private Investment Fund (PPP), aims at setting up a new lending/guarantee facility by leveraging an initial private capital commitment with government funds to an initial scale of up to $500bn (can be expanded to max. $1 trillion.) The aim is to involve private capital on a large scale that sits currently on the sidelines while also allowing private market forces to determine the price for currently troubled and illiquid assets.
A similar experiment was tried before with the private sector sponsored M-LEC vehicle that ultimately proved unviable due to asymmetric toxic asset exposures of participating banks and due to still unresolved asset valuation issues. Commentators agree that for a similar plan to work this time, the government will have to assume a potentially substantial downside in order to induce otherwise unwilling investors to participate in view of the size of potential losses.
As we noted before, the size of the entire shadow banking system lacking liquidity is $10 trillion of which $6 trillion are assets held in the U.S. Not all of these assets will turn bad but at RGE we expect total losses on these shadow banking assets plus traditional loan losses to reach $3.6 trillion (of which $1.8 trillion borne by U.S. banks.)
One practical example is the Federal Reserve’s Maiden Lane portfolio of toxic Bear Stearns assets. If that performance is any guide, the upside left in these toxic assets might in reality be more limited than previously assumed. Cumberland Advisors reports that this particular portfolio has lost over 10% of its value, and losses are mounting. Indeed, the authors see ‘no prospect for a profit’ on this portfolio.
Renowned distressed debt experts such as Edward Altman and Martin Fridson note that the best time to invest in distressed debt is when default rates peak. Mind that high-yield default rates are set to rise to 15-20% sometime in 2010 from currently 4-5% due to very bad credit quality at the outset of the cycle.
The third program put forth by Secretary Geithner is an expanded version of the previously $200bn Federal Reserve Term Asset Backed Securities Loan Facility (TALF) program aimed at unclogging the markets for auto, student and other consumer loans. That initiative may expand to as much as $1 trillion, using $100 billion from the Treasury's rescue funds, and include aid for commercial real estate markets.
Geithner points out that securitization created about 40% of the demand for new loans extended to consumers, students, and auto buyers. The decline of securitized lending to the tune of $1.2 trillion between 2006 and 2008 leaves a hole that needs to be filled if a severe lending contraction should be prevented.
Nouriel Roubini in his latest writing It Is Time to Nationalize Insolvent Banking Systems argues that, ultimately, nationalization may be a more market friendly solution of a banking crisis: it creates the biggest hit for common and preferred shareholders of clearly insolvent institutions and – possibly – even the unsecured creditors in case the bank insolvency is too large; it provides a fair upside to the tax-payer. Moreover, it bypasses the asset valuation issue as any overpayment goes back into taxpayers pockets. “With the government starting stress tests to figure out which institutions are so massively undercapitalized that they need to be taken over by the FDIC the administration is putting in place the steps for the eventual and necessary takeover of the insolvent banks.” This might well explain some of the negative market reaction.
The Treasury has stressed that while the ongoing price correction will stimulate home demand, there is a need to reduce foreclosures, which otherwise adding to the excess overhang of homes pose the risk of price over-correction, pushing more homeowners into negative equity. The Treasury plans to announce a Housing Program in the next few weeks to help refinance mortgages and contain foreclosures by reducing monthly payments for homeowners. The program will be financed by using $50 billion from the remaining TARP funds. To increase lender participation, the plan makes it compulsory for banks using government funds under the Financial Stability Plan to participate in foreclosure mitigation. In order to stimulate home demand and help the current homeowners refinance, the Treasury and Fed will continue with their November 2008 plans use $600 billion to buy MBSs and debt of the GSEs using and reduce mortgage rates to the 4-4.5% range. More importantly, the plan will increase flexibility to modify loans under the Hope Now and FHA Programs started in 2007-08 to help increase participation and foreclosure prevention.
Efforts to stimulate demand reducing mortgage rates and offering tax incentives will be largely ineffective as they are a small factor in determining home demand relative to factors such as tighter lending standards, changing dynamics for households - job and income loss, wealth erosion, rising savings rate, and low expectations of income or asset appreciation. These factors will constrain home demand in the short run while potential buyers await further price correction and banks don’t see the viability in offering mortgage for a house whose value is expected to fall.
As a result, the government needs to focus on the supply side of the market by refinancing at-risk mortgages and preventing foreclosures that will only add to the existing overhang of houses. Moreover, government’s loan modification program should reduce mortgage principal rather than just reducing the mortgage rate or extending the loan maturity, which has been the case in past government programs. Unless the problem of insolvency among a large number of households is addressed, default on modified mortgages will also continue. Also, given the large number of homeowners with negative home equity, the program will need much larger funds - over $600 billion to $1 trillion though the actual cost might be much less, since the government will receive a share from future home appreciation. Monetary incentives for servicers are also low and ineffective. Even the number of homeowners the program plans to target, 1.5-2 million is a very small fraction of the over 12 million homeowners with negative equity. In fact, several Democrats are pushing a legislation to allow bankruptcy judges to change mortgage terms that would allow lenders to reduce the mortgage principal for primary homes and bring down monthly payments. To increase participation, they support offering monetary incentives for servicers while lenders will be entitled to a share if the homeowner sells the house and also have the government share any losses on the modified mortgage.
As we have argued before at RGE Monitor, looking at the shortcomings of past government programs such as the Hope Now, Housing Retention and FDIC programs, the new program should be mandatory for lenders in order to increase participation. The government will also need to share the cost of modifying the loan, by matching the principal or the interest rate cut in a proportionate or less than proportionate amount. By guaranteeing the loans, the government will be the senior debt holder. The new interest rate should be based on the risk assessment of the borrower and all three parties – homeowner, lenders and servicers, and the government should share the cost of modification. However, determining the extent of principal reduction based on the true value of the house, and dealing with second lien mortgages and the diverging interests of mortgage servicers will be challenging.
Under the new guidelines for compensation issued by the Treasury, firms receiving federal aid will be subject to shareholder say on pay and will be required to cap executive compensation at $500,000 with any additional compensation given out in restricted stocks which can be cashed only after the government has been repaid or the bank has satisfied repayment obligations, and met lending and stability standards. Moreover, bonuses and compensation for other top executives will also be reduced. The Treasury requires disclosure of the compensation structure and strategy, and expenditure on luxury items.
While government intervention is warranted, the compensation reform does little to align risks with rewards. Large share of the compensation can and will still be given out in restricted stocks including compensation for several traders and funds managers who are not under the lenses of the current plan. Government measures also give a green signal to those who have already received large compensation and severance packages at the troubled banks. More importantly, the measures might act a disincentive in attracting credible executive talent to these troubled institutions in the future who can help deal with the bank losses and overhaul. Wall Street compensation is determined in a competitive market with CEOs joining a firm offering the most attractive pay packages and perks. Many banks are already reluctant to seek capital injection from the Treasury or are contemplating to payback past borrowings in order to avoid government scrutiny over their compensation packages.
To reduce excessive risk-taking in the short-run, compensation, bonuses and even severance packages should be based on the long-term performance of the employee relative to the risk undertaken with large part of the payments given out in restricted stocks that can be redeemed over a longer period of time.
Trojan horse in Senate bill: healthy care nationalization
And here's something in the plan that I bet you didn't know was a part of it.
This past weekend and Monday I took the time to read "The Obama Stimulus Plan".
I will leave politics to the side and will leave my interpretation from an Economic perspective aside. What I will NOT leave to the side is what is buried in "The Bill" from a health care standpoint. YOU NEED TO KNOW.....the "stimulus bill" is a Trojan Horse.....hidden in "this horse" is the legislation to NATIONALIZE HEALTH CARE."
So... Do I have your attention now? Here's a link to the story by Betsy McCaughey on Bloomberg...http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aLzfDxfbwhzs
This past weekend and Monday I took the time to read "The Obama Stimulus Plan".
I will leave politics to the side and will leave my interpretation from an Economic perspective aside. What I will NOT leave to the side is what is buried in "The Bill" from a health care standpoint. YOU NEED TO KNOW.....the "stimulus bill" is a Trojan Horse.....hidden in "this horse" is the legislation to NATIONALIZE HEALTH CARE."
So... Do I have your attention now? Here's a link to the story by Betsy McCaughey on Bloomberg...http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aLzfDxfbwhzs
Q4 Earnings
Q4 earnings: they made me a pessimist
Econoday Short Take 2/11/09
By Mark Pender, Senior Writer, Econoday
The fourth-quarter earnings season is still dragging on as companies, not surprisingly, are in no hurry to post their results. With two-thirds of the season in the books, data courtesy of Thomson Reuters show year-on-year profit growth for the S&P 500 down just over 41 percent. The quarter began with high expectations but has slid day by day since.
The graph below tracks S&P 500 profits over the past seven years. Companies posted consistent and often very strong profit growth until third-quarter 2007, one quarter ahead of the recession. Profits (blue bars) have contracted every quarter since the third quarter of 2007 and look to continue to contract based on the outlooks for the first and second quarters (outlined bars at right of graph).
There are countless factors offered to explain the movement of the stock market, including financial factors, economic factors, and sometimes even astrological factors. One factor that does track convincingly with the stock market is change in corporate profits. The graph below combines the above graph with a graph of year-on-year change in the S&P 500 index. Only twice, at the pivot of the business cycle, did the direction of stock market change not match up with directional change for profits. The degree of the changes are also matching tightly at a decline of 40 percent for stocks in the fourth quarter against the latest count of a drop of 41 percent for profits and a decline of 24 percent for stocks in the third quarter against a drop of 19 percent in profits. So far in the first quarter, the S&P 500 is at a year-on-year decline of 44 percent, a bit ahead of the 29 percent drop in the outlook for profits — a mismatch that anticipates further contraction in profits.
The outlook matters
I keep telling myself that analyst outlooks matter. But each quarter, year after year, analysts over-estimate corporate results by a mile. In their defense, analysts base their estimates on the company's estimates. Either way, optimism is the system, the system by which company outlooks are offered to the public and priced into the stock market.
Going into the earning season at the beginning of the month, analysts expected virtually no change in profits — no change vs. the current decline of 41 percent. The quarter before, analysts expected virtually no change for third-quarter profits which ended up sinking 19 percent. Their performance is not improving.
Analysts' outlook for the first quarter, which had been up 30 percent at this time last quarter, currently calls for a 29 percent contraction followed by a 25 percent contraction in the second quarter. If the usual overstatement applies, actual contraction may prove much worse.
The government's tally of corporate profits is very slow with the latest data available only for the third quarter. The graph below compares changes in the S&P 500 index (red line) with changes in corporate profits (blue line). The blue line has already peaked, at an annual rate of just over $1.5 trillion in third-quarter 2007. Profits for the third quarter 2008 were $1.3 trillion — a level that is certain to fall.
Bottom Line
If the first-quarter earnings season proves as bad as the current season, this time next quarter the red bars and lines of the S&P 500 index will likely be pointing downward once again. Keeping track of company news and tracking earnings are central to the understanding of the financial markets and the outlook for the economy.
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2009 Econoday, Inc.
Econoday Short Take 2/11/09
By Mark Pender, Senior Writer, Econoday
The fourth-quarter earnings season is still dragging on as companies, not surprisingly, are in no hurry to post their results. With two-thirds of the season in the books, data courtesy of Thomson Reuters show year-on-year profit growth for the S&P 500 down just over 41 percent. The quarter began with high expectations but has slid day by day since.
The graph below tracks S&P 500 profits over the past seven years. Companies posted consistent and often very strong profit growth until third-quarter 2007, one quarter ahead of the recession. Profits (blue bars) have contracted every quarter since the third quarter of 2007 and look to continue to contract based on the outlooks for the first and second quarters (outlined bars at right of graph).
There are countless factors offered to explain the movement of the stock market, including financial factors, economic factors, and sometimes even astrological factors. One factor that does track convincingly with the stock market is change in corporate profits. The graph below combines the above graph with a graph of year-on-year change in the S&P 500 index. Only twice, at the pivot of the business cycle, did the direction of stock market change not match up with directional change for profits. The degree of the changes are also matching tightly at a decline of 40 percent for stocks in the fourth quarter against the latest count of a drop of 41 percent for profits and a decline of 24 percent for stocks in the third quarter against a drop of 19 percent in profits. So far in the first quarter, the S&P 500 is at a year-on-year decline of 44 percent, a bit ahead of the 29 percent drop in the outlook for profits — a mismatch that anticipates further contraction in profits.
The outlook matters
I keep telling myself that analyst outlooks matter. But each quarter, year after year, analysts over-estimate corporate results by a mile. In their defense, analysts base their estimates on the company's estimates. Either way, optimism is the system, the system by which company outlooks are offered to the public and priced into the stock market.
Going into the earning season at the beginning of the month, analysts expected virtually no change in profits — no change vs. the current decline of 41 percent. The quarter before, analysts expected virtually no change for third-quarter profits which ended up sinking 19 percent. Their performance is not improving.
Analysts' outlook for the first quarter, which had been up 30 percent at this time last quarter, currently calls for a 29 percent contraction followed by a 25 percent contraction in the second quarter. If the usual overstatement applies, actual contraction may prove much worse.
The government's tally of corporate profits is very slow with the latest data available only for the third quarter. The graph below compares changes in the S&P 500 index (red line) with changes in corporate profits (blue line). The blue line has already peaked, at an annual rate of just over $1.5 trillion in third-quarter 2007. Profits for the third quarter 2008 were $1.3 trillion — a level that is certain to fall.
Bottom Line
If the first-quarter earnings season proves as bad as the current season, this time next quarter the red bars and lines of the S&P 500 index will likely be pointing downward once again. Keeping track of company news and tracking earnings are central to the understanding of the financial markets and the outlook for the economy.
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2009 Econoday, Inc.
Tuesday, February 10, 2009
IN THE SPIRIT OF TRANSPARENCY
DOW JONES NEWSWIRES
Treasury Secretary Timothy Geithner received nearly $435,000 in severancefrom his previous employer, the New York Federal Reserve, and Securities andExchange Commission Chairman
Mary Schapiro $7.2 million from the privateauthority she left to join the Obama administration, the Washington Postreported Tuesday on its Web site.
Geithner disclosed $434,668 in severance fromthe New York Fed, plus between $50,000 and $100,000 in unused vacation time andcomp days.
The SEC said Schapiro will receive $7.2 million from the FinancialIndustry Regulatory Authority, the self-regulatory group she headed. Schapiro also received between $750,000 and $1.5 million in deferred compensation fromDuke Energy Corp. (DUK) in cash and stock, and a payout of $675,033 in deferredcompensation from Kraft Foods Inc. (KFT), where she was a board member.
Attorney General Eric Holder Jr. received a severance of between $1 million to$5 million from his former law firm employer.
Full story athttp://www.washingtonpost.com/wp-dyn/content/article/2009/02/09/AR2009020903274html
Treasury Secretary Timothy Geithner received nearly $435,000 in severancefrom his previous employer, the New York Federal Reserve, and Securities andExchange Commission Chairman
Mary Schapiro $7.2 million from the privateauthority she left to join the Obama administration, the Washington Postreported Tuesday on its Web site.
Geithner disclosed $434,668 in severance fromthe New York Fed, plus between $50,000 and $100,000 in unused vacation time andcomp days.
The SEC said Schapiro will receive $7.2 million from the FinancialIndustry Regulatory Authority, the self-regulatory group she headed. Schapiro also received between $750,000 and $1.5 million in deferred compensation fromDuke Energy Corp. (DUK) in cash and stock, and a payout of $675,033 in deferredcompensation from Kraft Foods Inc. (KFT), where she was a board member.
Attorney General Eric Holder Jr. received a severance of between $1 million to$5 million from his former law firm employer.
Full story athttp://www.washingtonpost.com/wp-dyn/content/article/2009/02/09/AR2009020903274html
1ST IMPRESSION OF GEITHNER PLAN
I can sum this up in one word - underwhelmed.
Equity market reaction right now has the right read on this in my opinion.
The expanded TALF is the only good piece of information I like.
STILL waiting for details.
What a disappointment.
Equity market reaction right now has the right read on this in my opinion.
The expanded TALF is the only good piece of information I like.
STILL waiting for details.
What a disappointment.
Housing in Crisis: When Will Metro Markets Recover?
Moody's Economy.com Research reports as follows:
Despite the darkening national economic outlook and the weak conditions in the housing market, some positive signs give hope that housing is about to hit bottom. Housing in Crisis: When Will Metro Markets Recover?, a comprehensive new study, evaluates the near-term prospects for housing markets in a recessionary environment.
Key Findings:
House prices will stabilize by the end of this year.
The national Case-Shiller® house price index will decline by another 11% from the fourth quarter of last year for a total peak-to-trough decline of 36%.
By the end of this unprecedented downturn, house prices will have declined by double digits peak to trough in nearly 62% of the nation's 381 metro areas. In about 10% of metro areas, price declines will exceed 30%.
See the Table of Contents and the Executive Summary »
Despite the darkening national economic outlook and the weak conditions in the housing market, some positive signs give hope that housing is about to hit bottom. Housing in Crisis: When Will Metro Markets Recover?, a comprehensive new study, evaluates the near-term prospects for housing markets in a recessionary environment.
Key Findings:
House prices will stabilize by the end of this year.
The national Case-Shiller® house price index will decline by another 11% from the fourth quarter of last year for a total peak-to-trough decline of 36%.
By the end of this unprecedented downturn, house prices will have declined by double digits peak to trough in nearly 62% of the nation's 381 metro areas. In about 10% of metro areas, price declines will exceed 30%.
See the Table of Contents and the Executive Summary »
Nouriel Roubini: Anglo-Saxon Model Has Failed
Roubini: The Anglo-Saxon model of supervision and regulation of the financial system has failed. The supervisory system relied on self-regulation that, in effect, meant no regulation; on market discipline that doesn’t exist when there is euphoria and irrational exuberance; on internal risk management models that fail because - as a former chief executive of Citigroup put it - when the music is playing you gotta stand up and dance. All the pillars of Basel II have already failed even before being implemented
In many countries the banks may be too big to fail but also too big to save, as the fiscal/financial resources of the sovereign may not be large enough to rescue such large insolvencies in the financial system. The current U.S. and UK approach may end up looking like the zombie banks of Japan that were never properly restructured and ended up perpetuating the credit crunch and credit freeze
Click Here For Full Analysis
In many countries the banks may be too big to fail but also too big to save, as the fiscal/financial resources of the sovereign may not be large enough to rescue such large insolvencies in the financial system. The current U.S. and UK approach may end up looking like the zombie banks of Japan that were never properly restructured and ended up perpetuating the credit crunch and credit freeze
Click Here For Full Analysis
Waiting for Geithner/Godot
Details of the TARP overhaul and details of the 2009 stimulus package will shape the day, and profit-taking may greet the actual news.
Just as existential an exercise as Waiting for Godot.
Just as existential an exercise as Waiting for Godot.
Market Reflections 2/9/2009
Markets held in mostly narrow ranges awaiting the outcome of the 2009 stimulus package and details of the Treasury's plan to overhaul TARP. The day did see the resignation of the SEC's enforcement chief and a civil agreement with Bernard Madoff. The criminal case against the suspected Ponzi giant, the giant who slipped by the SEC, is still open.
The Dow industrials slipped slightly on the day while Treasury yields were little changed. The pending stimulus news didn't help the value of the dollar which fell back 1-1/2 cents against the euro to end at $1.3016. Oil, benefiting from talk of OPEC quota compliance, is holding near $40. Benefiting from talk of post-stimulus inflation, gold is holding near $900, ending just under on the day.
The Dow industrials slipped slightly on the day while Treasury yields were little changed. The pending stimulus news didn't help the value of the dollar which fell back 1-1/2 cents against the euro to end at $1.3016. Oil, benefiting from talk of OPEC quota compliance, is holding near $40. Benefiting from talk of post-stimulus inflation, gold is holding near $900, ending just under on the day.
Monday, February 9, 2009
Fannie Mae to lower refinancing standards
Guaranteeing home loans issued to people with no proof of employment, bad credit scores, and almost no equity is what bankrupted Fannie Mae and Freddie Mac in the first place.
So of course, that's the "new" strategy the government is taking by lowering standards for re-financing loans. Washington might as well take our tax money and throw it on a bonfire.
So of course, that's the "new" strategy the government is taking by lowering standards for re-financing loans. Washington might as well take our tax money and throw it on a bonfire.
Race to the Arctic: The New Source of Oil and Gas?
U.S. Geological Survey suggests that the area north of the Arctic Circle has an estimated 1,670 trillion cubic feet of natural gas – 2/3 the proved gas reserves of the entire Middle East – and 90 billion barrels of oil. Most of the gas is concentrated in Russian territory
Wood Mackenzie suggested that Arctic basins, hold 233bn of discovered oil and gas and another 166bn that has yet to be found, the vast majority of it gas
Wood Mackenzie suggested that Arctic basins, hold 233bn of discovered oil and gas and another 166bn that has yet to be found, the vast majority of it gas
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