Wednesday, 04 June 2008 01:00

Lehman, the lying lemon lemming anecdotal timeline?

Let's see here. The company is the largest MBS underwriter and the smallest bulge bracket bank on the street (the bank that had the #1 spot was just taken under). The company has hit the capital markets twice and the Fed window once to access capital to (Ahem!) "prove to the market that it has liquidity" and for "testing purposes only". They then take this money that they got from the suckers, oops, investors and buy their own stock with it. Is that what those suck.. I mean investors had in mind for that money?

The company alleges short sellers conspired to drive their stock down, so they went on the PR warpath to fight these (us) bad guys. Instead of opening up their books to prove them they (I) am wrong, they try to sick the government on the short sellers. Merrill Lynch issues a buy on Lehman today, after downgrading them a couple of days agoFoot in mouth Lehman stock shoots up after being beat up for a few days, probably incited by David Einhorns choreographed, publicized short selling campaign.

Now, we have these s.. (oh, there I go again) investors buying up Lehman stock, totally disregarding the fact that Lehman took and economic loss last quarter if you strip away non-cash accounting shenanigans, smoke and mirrors. We then find out that the NYS Attorney General (Cuomo) has reached a prospective settlement with the credit wizards (see below, click to enlarge).


and then...


Coincidentally, not a full 48 hours after the end of the Attorney General's stern talk, ratings agencies get religion and decide to declare what the entire world figured out some time ago - MBIA and Ambac probably don't deserve AAA ratings. Really!!!!????

As I type this, Lehman Brothers, Morgan Stanley are rallying. WHAAAT!!!!??? Don't these guys read my blog? Morgan and Lehman only have two ways to hedge multi-billion dollar assets, and neither are very reliable these days. Short a broad index and risk a lot of slippage and uncertain correlations, or pay a counterparty to accept a risk. You know, a counterparty like MBIA and Ambac. Let's revisit my "Who's holding the $119 billion bag" post from 4 months ago. If you don't want to read through the rest of my rather dated ramblings, it can be summarized in realizing how lucky Lehman is that they just closed the last quarter, for 14% of their gross equity (as calculated in February), is about to get downgraded, give or take.

This is post is primarily to document my assertions of self insurance by the banks in their alleged efforts to prop up the monoline (or should I say multilines?). Below you will find a chart with links that provide, in extreme detail, the insured holdings of a handful of banks and one homebuilder with a large mortgage operation (I do mean extreme detail, including asset name, CUSIP #, ratings by all major agencies, vintage, etc.). Let me add that I don't know how much of this is actually bank inventory versus what was sold off, but my guess is that the banks got stuck with the vast majority of everything from the last year or so. In addition, most of the underwriting banks can get stuck with the stuff that was found to violate the agreed upon underwriting guidelines (which is potentially a lot) for a certain period, even if it was sold off. This is something that can sink the smaller equity base banks such as First Franklin.

This is $120 billion dollars right here, and it is nowhere near comprehensive. These are RMBS, CMBS, and a smattering of consumer finance ABS insured by MBIA and Ambac. I know everybody thinks that we may be coming to the end of the writedowns from real estate related devaluations, but if that is what everybody thinks then everybody is wrong. This bubble took at least 6 years to build, it is not going to dissipate in 1 year. We are about 50% through the subprime crisis, but since this problem was never a subprime issue to begin with, we have lot more to go. There are all of the other classes of mortgages, the commercial real estate market, which I went over in detail , there is the consumer finance markets (recession, anyone?), then the big grand daddy of them all, the leveraged loan, junk bond CDO and CDS market - crashing at a financial institution near you. I am 50% through a forensic analysis that will expose the junk bond CDOs held by monolines that will probably knock your socks off. Alas, I digress...

This credit problem and real asset bubble is a result of combining very cheap money with the lax, "other people's money", moral hazard to be had whenyou don't need to be responsible for your own underwriting - otherwise known as the natural consequence of asset securitization. Why fret over due diligence when we're just going to sell the stuff off. The following are a sampling of whose holding the bag...


The Partial Cost of Monoline ABS Failure
Par Equity Exposure Ratio
Bear Stearns $15,673,088,703 $11,793,000,000 132.90% icon BSC ABS inventory
Morgan Stanley $22,956,101,796 $31,269,000,000 73.41% icon MS ABS Inventory
Lehman Brothers $3,151,328,632 $22,490,000,000 14.01% icon LEH ABS Inventory
Citigroup $8,100,028,623 $127,113,000,000 6.37% icon C ABS Inventory
Countrywide $12,639,385,566 $15,252,230,000 82.87% icon CFC ABS Inventory
Wells Fargo $4,700,835,231 $47,738,000,000 9.85% icon Wells Fargo ABS Inventory
Goldman Sachs $18,673,869,328 $42,800,000,000 43.63% icon GS ABS Inventory
WaMu $7,658,982,498 $23,941,000,000 31.99% icon WaMu ABS Inventory
Merrill Lynch $10,224,387,634 $38,626,000,000 26.47% icon ML ABS Inventory
Centex $511,740,636 $3,197,130,000 16.01% icon CTX ABS Inventory
Wachovia $5,328,228,928 $76,872,000,000 6.93% icon Wachovia ABS Inventory
Totals $118,950,151,688 $477,918,010,000 24.89%

First Frankin appears to have significantly more exposure than equity (a lot more, so much so that it actually through my Excel charts out of whack): icon First Franklin Monoline ABS Inventory

This chart is using gross equity as reported, not tangible equity or foresnically scrubbed equity which is bound to be a lower number. For examples of how we use forensic analysis to reconstruct reported numbers and financial statements, see the Lennar and General Growth Properties (with conference call update ) analyses.

I am short Morgan Stanley and Bear Stearns, for the very same reasons that they are numbers one and two on this list (excluding Countrywide, whose short position was covered a while back, although I still have a bear position on WaMu). To see my take on these two banks, read my overview on the industry: Banks, Brokers, & Bullsh1+ part and Banks, Brokers, & Bullsh1+ part 2 then read or download the full analyses: "The Riskiest Bank on the Street" and "Is this the Breaking of the Bear?".

Last modified on Wednesday, 04 June 2008 01:00


  • Comment Link Reggie Middleton Wednesday, 11 June 2008 10:23 posted by Reggie Middleton

    I don't know if the deal closed yet, but if it didn't it probably never will. Keep in mind that it was foolish to by into this company now even if the share price was above $28. There is absolutely NOTHING to form a long investment thesis to back investing in this company how. It main investment assets are the most unwanted and noxious in the world, it just passed the top of its profit cycle, MAcro conditions are horrible and getting worse, etc. etc.

    The stock is about to break $25 as I type this. Now, it is plausible to assume a run on Lehman. They will assuredly be hitting the Fed's piggy banks to buffer customer defections en masse.

    How many of these can the Fed fund? Notice the Riskiest Bank on the Street's price action, right behind Lehman's, and this bank has a lot more net counterparty exposure.

  • Comment Link Chris Marshall Wednesday, 11 June 2008 08:39 posted by Chris Marshall


    I am confused about the LEH recapitalisation package. I understand they are raising $6 Billion, $2 Billion in preference shares and the other $4 Billion at a share price of $28.00.

    The share price yesterday fell to $27.50, so who would purchase at $28.00???

    Surely there has to be a risk attached to shares in LEH (probably a big one) which means that you would expect a big discount to current share price ($27.50)?

    Therefore either the offer take up will be negligible, or the offer price will have to be reduced, thereby increasing the share dilution of the current equity holders ( If they still require $6 Billion).

    This is correct or I am being incredibly sense.

  • Comment Link Reggie Middleton Sunday, 08 June 2008 07:34 posted by Reggie Middleton

    Thanks kcdallas23, you seem to quite the independent thinker. I am absolutely amazed at how seemingly very bright people refused to think for themselves. The other day, I actually got into a lengthy discussion regarding inflation. There are those who are trying to toe the core inflation line and limited unemployment. I have not heard of or seen a company do significant hiring in over a year, all prices are going up not down where I shop, and many companies are firing and going out of business without an offsetting amount of companies and jobs being created. IT appears that many will believe what they see on TV or are told by Paulson and CEOs over what they see with their own eyes and experience in their own daily routine. Amazing!

  • Comment Link Anil Goyal Thursday, 05 June 2008 15:14 posted by Anil Goyal

    There is an article at

  • Comment Link c k Thursday, 05 June 2008 04:36 posted by c k

    Thanks to Reggie and to all for the insight and discussion.

    do you have to pay the dividend yield on the shorts ?

    some of these carry a hefty % dividend.

    any comments / advice on how to minimize this ?

    thanks !

  • Comment Link a b Thursday, 05 June 2008 03:12 posted by a b

    Thanks so much. I'm starting just with puts until I have more experience but straight shorting seems more efficient. I do agree with Reggie's thesis and I'm assuming that information leading to "efficient" pricing is still travelling, and being acted on, faster than it used to.

  • Comment Link Reggie Middleton Thursday, 05 June 2008 02:57 posted by Reggie Middleton

    Well put. Shorting is not for the weak of heart or the faint of insight!

  • Comment Link K V Thursday, 05 June 2008 01:17 posted by K V

    squashnut, check out the site It will give you an idea of the short interest for a given company. "Days to cover" and "Short Percent of Float" are the first two indicators I look at.

    I'd also recommend taking a small enough position that you can ride out a major squeeze and potentially add to your position should such a squeeze occur. For example, if you're short Lehman, are you going to cover if it hits 35? If so, when will you short again? If after covering, LEH immediately drops to 32 are you going to short it again then? If not, when will you short again? What if it then drops to 28?

    The action on the shares I've shorted has been so abrupt that its made me realize I'm the world's worst timer. If I'd just held on the my shorts instead of covering the squeezes and then reshorting (usually at what ends up being a lower price than my cover) I'd be significantly ahead.

    But the warning on holding on is you need to have a small enough position to be able to withstand a major squeeze. If you short LEH and LEH goes to 45, can you take the pain? Self-doubt and emotion really kick in if your position is large enough to damage you. Before they went to single digits Countrywide went from 33 to 41 and 20 to 27. Downey went from 22 to 37, MBIA from 28 to 42, ABK from 20 to 33. If you shorted too large at the bottom of these troughs and were forced to cover, you would have ended up missing on some of the great short plays of the year.

  • Comment Link a b Wednesday, 04 June 2008 21:42 posted by a b

    Can anyone recommend a tool or formula for analyzing risk of a short squeeze. I'm a shorting novice.

  • Comment Link Kip Coon Wednesday, 04 June 2008 18:29 posted by Kip Coon


    A thought....

    Lehman and the other investment banks have the ability to borrow from the Primary Dealer Credit Window. One guideline rule is the debt backed by mortgage paper, or other collateral used, MUST BE AAA rated. Ambac and MBIA receiving a downgrade will reduce the amount of AAA debt paper the iBanks can use to borrow from the window. This obviously increases the severity of the pending downgrades, since the AAA mortgage debt available for use at the discount window will be reduced. A reduced amount at the discount window could be trouble for any iBank in a liquidity crisis.

    Based on the information you have in the PDFs, does your research info contain an easy way to pull out:
    1) How much AAA rated paper the iBanks have to use as collateral?
    2) How much of the AAA paper available for use as collateral is backed by Ambac and MBIA?

    This would give a general idea of how much an iBank (Lehman for example) could use at the window if they faced a liquidity crisis.

    Again, just a thought. I know you're a busy guy.


  • Comment Link Kip Coon Wednesday, 04 June 2008 17:41 posted by Kip Coon

    As someone who's a visual person, the "cartoons" you posted make it very easy to see how the new [s]scam[/s] sorry... policy will work. The downgrade news comes out today and the market sells off. Wow! It's as if people had no idea Ambac and MBIA were potentially NOT triple A rated. I guess they're not reading this blog either.

    I fully realize the economic consequences of the downgrade and I wish the rating agencies would just step up and do what should have been done last year. The sad part, is the people who listen to the talking heads as Gospel, saying the worst is over. These people will get crushed, financially. I'll bet that most people are NOT set up for a massive market decline.

    I trade for a living and even my friends don't want to hear the truth. One or two have taken my warnings and they're laughing all the way to the bank. This is in part because Reggie's BoomBust Blog has enabled me to better explain what's happening. It's even better with cartoon pictures!! THANK YOU Reggie!! The information posted on this blog is an easy read for those who don't understand what's going on.

    I think it's great people have a place to go where they can read in depth reports on the companies contributing to the horrible economic state we're in. I encourage people to be diligent in their research BEFORE investing. Reggie (please edit if I misquoted you or quoted the wrong person) is correct.... "some blog just to blog." Just because you read something on a blog, it doesn't mean the information is correct. There could be talking heads with a blog, too. What you'll find here, is factual information to make your OWN investment decision. I don't blame Reggie one bit for not making buy or sell recommendations. Too many legal issues! If you read the information here, you'll know what to do. I'm curious if the TV talking heads just recommend a stock because the price is down and the stock's P/E Ratio is low? Hmmm..... sounds like a great way to throw away hard earned money. Remember the tech bubble burst?? According to the talking heads, those tech stocks were buys ALL THE WAY DOWN!

    It's tough being short a manipulated market when you know the truth and the "Lying Lemmings" are using a megaphone. Lengthen your timeframe as the manipulation is in FULL FORCE right now. Just listen to the the crap being tossed out. P/Es are low, time to buy! The "Bottom" was set in March! How do they really know? Aren't these the same people who bolstered the "subprime is contained" BS dished out last year? They couldn't make an accurate prediction last year and they can't do it this year either.

    We'll all know when it's finally time to buy! The decisions of which company to invest in will be easier since the choices will be less.

    Reggie, I still owe you the info I compiled last Friday going against Dick "Hey Cool-Aid" Bove's financial buy recommendations. FYI.... he's getting clobbered!


  • Comment Link Chris Marshall Wednesday, 04 June 2008 16:02 posted by Chris Marshall

    Dear Reggie,

    I can't decide as to whether an investment bank or a monoline will fold first. Do you have an opinion?

    Chris M

  • Comment Link Milton Castillo Wednesday, 04 June 2008 15:55 posted by Milton Castillo

    Reggie, do you see any price at which the stock would be a buy?

  • Comment Link Chris Marshall Wednesday, 04 June 2008 15:05 posted by Chris Marshall

    Hi Reggie, I keep hearing in banking circles that Lehman will not be allowed to fail, because of the risk of contagion. I think that this is BS, but the authorities are interfering in the options market under their "contingency funds". I think it would be better for the overall markets to let Lehman fold, take a hit on valuations, recapitalize, and move on. Any other option just delays the inevitable.

    What are your views on the authorities interfering in the markets ( financially, and bringing undue pressure to bear?)

    Chris M

  • Comment Link Matt Binder Wednesday, 04 June 2008 14:57 posted by Matt Binder

    Great analyses, loved the cartoons. I was looking to expand my shorts outside of homebuilders and your posts sold me on shorting Lehman...I'm just a few points away from matching my yearly salary on Lehman puts only...many thanks. I am amazed that anyone can listen to what is coming from Lehman and take it as a buy signal..its nuts! Using their capital reserves to buy a falling equity- even with the small gain today they are still down on the position based on where it looks like they started buying yesterday.

  • Comment Link Reggie Middleton Wednesday, 04 June 2008 14:27 posted by Reggie Middleton

    There are better shorts for me to go after, but its situation is looking worse as time progresses.

  • Comment Link Angus North Wednesday, 04 June 2008 14:25 posted by Angus North

    Hi Reggie. Are you still sour on AGO?

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