John Hussman of the Hussman Funds writes :

The provision of a "non-recourse" loan is outside of the Fed's mandate under the Federal Reserve Act. Specifically, the Fed agreed to provide a $30 billion “non-recourse loan” to J.P. Morgan, secured only by the worst tranche of Bear Stearns' mortgage debt. This is not in fact a loan - if it were, J.P. Morgan would be required to pay it back, unless J.P. Morgan itself was to fail. Instead of a loan, this is a "put option," which protects J.P. Morgan from losses on the collateral, regardless of J.P. Morgan's own financial status. You've heard an iteration of this from me several times.

2) The effect of the Fed's guarantee is not to protect the public, but to protect Bear Stearns' bondholders. By purchasing Bear Stearns, J.P. Morgan will take on the responsibility for paying off about $75 billion in claims to the short- and long-term bondholders of Bear Stearns. Yet J.P. Morgan requires only $30 billion from the Fed do this. This suggests that Bear Stearns' "book" of positions (excluding liabilities to Bear's own bondholders) would be worth at least $45 billion if transferred, netted, or otherwise settled. There is no reason that the public should take a loss at all. Rather, the book should indeed be sold to JPM or a competing acquirer, and the proceeds (probably far in excess of $45 billion) should be used to pay the senior claims of bondholders. Any excess over $75 billion would be a residual for stockholders. Simply put, the bondholders of Bear Stearns, not the public, should absorb any loss.

The deal is being defended on the notion that the global financial system would have "failed" had Bear Stearns not been rescued. But the orderly transfer, netting and settlement of financial derivatives and other "qualified financial contracts" (QFCs) is precisely what Title IX of the Bankruptcy Act of 2005 was written to facilitate. In effect, the Federal Reserve and the Treasury decided to ignore existing law and provide a bailout to the benefit of Bear Stearns' bondholders at public expense.

The clear historical role of the Federal Reserve has been to manage the composition of Federal liabilities (by varying the mix of Treasury securities and monetary base - currency and bank reserves - held by the public). The recent transaction is a dangerous break from that role, in which unelected bureaucrats are committing public funds to facilitate private business transactions and selectively defend the holders of corporate securities. Only Congress has the Constitutional right, by the representative will of the people, to commit public funds. The Bear Stearns deal is a dangerous precedent and a dilution of Congressional prerogative.

Investors should not be in constant fear that the global financial system will “melt down” in the event of the bankruptcy of one large financial company or another. Though Bear Stearns apparently had the highest gross leverage (total assets to shareholder equity) among the large financials, and thereby provided a thin wall of defense for its stockholders, there was never a significant risk that the company would default on its obligations to customers and counterparties. Large U.S. financial companies are sufficiently well-capitalized that even in the event of outright bankruptcy, the only parties subject to loss are the stockholders and the bondholders of that particular company. The only instance in which this would not be the case is if the book value of the company was negative even after zeroing out all stockholder equity, long-term debt, and unsecured short-term debt.

In short, investors should have confidence in the ability of the capital markets to function without the need for government bailouts at public expense.

Click the link to see the rest of his commentary.

Published in BoomBustBlog
Friday, 04 April 2008 01:00

Lehman TV

I am impressed by the energy of this Mr. Mortgage guy! He's right about Lehman's lending practices as well. Unlike Bear, they were vertically integrated and actually underwrote loans to feed thier MBS pipeline. They were quite generous in giving out mortgages as well. Remember, I used to be a residential real estate investor in the NYC metro area. I know much of this from first hand experience. Methinks Lehman is next for a full scale forensic analysis. I will post a full blown forensic of Morgan Stanley, pt. 2 in a few housrs, including a decent amount of their so-called hedged level three assets, as granular as the CUSIP numbers for the securities.

writeFlash({src:'http://www.youtube.com/v/tebO2v3qBVY&hl=en',wmode:'transparent',bgcolor:'#ffffff',width:'425',height:'350'});

Published in BoomBustBlog
Thursday, 03 April 2008 01:00

Super SIV, part deux

All of these schemes and machinations... Why don't they just take their medicine and sell them at market value - to the market! From FT Alphaville:

Wall St banks to ring-fence bad assets

Wall Street banks are drafting plans to separate troubled assets from the rest of their businesses in efforts to ring-fence problems and restore confidence in the financial sector. A number of US firms are looking to follow the example set by UBS, which this week put securities linked to US mortgages into a separate subsidiary with a view to reducing its exposure to the troubled assets, which have been responsible for more than $30bn of losses so far. The banks – among them Lehman Brothers - aim to move at least some troubled assets off their balance sheets by selling large stakes in the funds to outside investors.

Let's hear your opinions. Will it work this time around?

Published in BoomBustBlog

Sporting a haircut of about 55%, Centex sells land for less than half of book value to get the tax refund, ala Lennar. This should go to show you how much the actual book of these companies are worth. This is two companies now, and counting. I think it's safe to mark all homebuilder book down 55%.

______________________________

Item 1.01 Entry into a Material Definitive Agreement.
(a) Credit Agreement. The information set forth under Item 2.03 of this Current Report on Form 8-K is hereby incorporated in this Item 1.01 by reference.
(b) Sale of HomeTeam Services. Centex Corporation, a Nevada corporation (“Centex”), does not view the asset purchase agreement (referred to in Item 8.01) to be a material definitive agreement within the meaning of Item 1.01 of Form 8-K. If it is determined, however, that such agreement is a material definitive agreement within the meaning of Item 1.01, the text of Item 8.01 describing such agreement is incorporated in this Item 1.01 by reference.
(c) Sale of Land Portfolio. On March 31, 2008, Centex Corporation, a Nevada corporation (“Centex”), announced that Centex Homes, the principal subsidiary through which Centex is engaged in homebuilding activities (“Centex Homes”), sold a portfolio of developed, partially-developed and undeveloped properties to a joint venture, Corona Land Company, LLC (“Corona Land Company”), that is led by RSF Partners, Inc., and includes funds under management by Farallon Capital Management, L.L.C., Greenfield Partners, LLC and certain of their affiliates (“Corona Investor”). The transaction was effected in a multi-step transaction.
On March 29, 2008, Centex Homes entered into a Contribution Agreement with a subsidiary of Corona Land Company (“Corona Real Estate”) pursuant to which it transferred to Corona Real Estate the outstanding equity interests in 27 special purpose entities that hold a diversified portfolio of residential land and related assets that will yield approximately 8,500 partially developed or finished lots in 27 communities located throughout the United States (the “Corona Properties”). On March 31, 2008, Centex Homes entered into a Member Interests Purchase Agreement with Corona Land Company pursuant to which Corona Land Company purchased all outstanding equity interests in Corona Real Estate from Centex Homes for a sales price of approximately $161 million, exclusive of transaction costs, subject to certain adjustments. Under the terms of these agreements, Corona Real Estate generally assumed all liabilities and obligations relating to the Corona Properties, including future development obligations and all liabilities in respect of bonds and letters of credit securing obligations to perform work related to the Corona Properties but excluding specific liabilities that the parties have agreed will be retained by Centex Homes. These agreements contain customary representations and warranties, including representations and warranties by Centex Homes relating to the Corona Properties. Centex Homes has agreed to indemnify Corona Real Estate against losses arising from breaches of such representations and warranties, subject to certain limitations.

Published in BoomBustBlog
Friday, 28 March 2008 01:00

Subprime 101, in stick figure simplicity

This is actually pretty funny, most likely because I am short and not long this stuff. If you have Powerpoint or a free Powerpoint player, download pps what_happened_in_stick_figure_simplicity 2.44 Mb.

Published in BoomBustBlog
Wednesday, 19 March 2008 01:00

KB Home and Phantom JVs

This was submitted by BoomBustBlog member, Christopher Alleva. See supporting documentation for download here: pdf Crown Village Deed of Trust KB-Centex-LaSalle (3.41 MB) and pdf KB Home Crown Farm Sale Deed (4.64 MB).


Nagging questions persist about the depth
and breadth of the homebuilders' exposure to special purpose affiliate
joint venture land development liabilities. Be forewarned, discussions
of financial accounting are rather dry. Oliver Wendell Holmes, it's
not. Reviewing KB Home’s disclosures for Q3 and the 11-2007 annual
reports, it appears that they reduced debt in JVs by $180 million to
$1.54 billion and reduced their guarantee exposure by $130 million.
Tellingly, the JV asset value disclosure shown in the Q3 report was
left out of the annual report. Presumably, this omission was
made because total JV liabilities now exceed the assets (see SEC
Reports Excerpts Below).

These disclosures prompt several important
questions: KB states that guarantees extended to JVs allow them to gain
more favorable terms. While it is unclear from the SEC disclosures, it
appears that there is approximately $1.2 billion in non-recourse JV
debt as of 11-30-2007. Is there an implicit guarantee from KB on these
loans? Did KB hold themselves out as a backstop to induce the lender to
make these loans? It is beyond my comprehension how a reader of these
financial statements can make meaningful qualitative judgments
regarding the financial condition of KB Home.

While KB's SEC disclosures are wholly
inadequate, I uncovered details of a JV transaction in suburban
Washington D.C. that offers a window into the phantom JVs. Through land
records, news accounts and other sources I have pieced together the
details of a large JV they undertook with Centex. In the halcyon days
of 2005, KB purchased 180 acres in Gaithersburg Montgomery County with
Centex. Amidst the hoopla, now ousted CEO Bruce Karatz wowed the media
with the company's recreation of the TV Simpson family's neighborhood
in Las Vegas and a celebrity endorsement deal with home decor diva
Martha Stewart. All this hype and above all the sensational land
transaction intended with one purpose in mind- zoom the stock price.

Eventually the property will be entitled
for 2200 units. When the KB JV took title, it was not much more than
well-located raw land. It will take at least three years to finish
subdividing and another year after that before any unit deliveries. The
transaction was recorded at $137 million but they actually bought it
for $200 million because they took it on an assignment. There are at
least another $25 million in exactions associated with the approval of
the subdivision. At 10% interest, they will have another 80 million of
interest and $8 million in taxes during the 4 years before any
deliveries. Throw in another $12 million in professional fees for
engineering, legal and planners, and you can adduce that they will have
$325 million in the ground before dollar one of revenue.

Selling at 220 units a year it will take
10 years. Imputed interest over this period at 10% works out to $165
million bringing their basis to $223,000 a lot. Add civil work at
$52,000 a unit and your all in lot cost is $275,000 a unit. A barely
acceptable lot cost ratio is 33%, which means the actual homes have to
sell for at least $775,000. That's almost 10X the median Montgomery
County income.

All that said, rumor has it that KB and
Centex are dumping out of this mess of their making. LaSalle has a $200
million note. My guess is that it's worth between $75 and $100
million. Of course, this is one of those off b/s JVs, a $50 million
liability apparently not disclosed anywhere. This is just one market at
50/50 KB and Centex they have at least $50 million of exposure each.
In addition, this is cash exposure. Are the rest of the JVs similarly
situated? Enquiring minds want to know. Is this specific JV indicative
of the others land deals? Will KB be compelled to recognize and
liquidate large off balance sheet liabilities to survive. For
investors, the alarming prospect is not knowing how much and when these
obligations will return to the nest.

Footnotes

1.) KB Homes 10K Annual Report

The Company conducts a portion of its land
acquisition, development and other residential activities through
unconsolidated joint ventures. These unconsolidated joint ventures had outstanding secured construction debt of approximately $1.54 billion
at November 30, 2007 and $1.45 billion at November 30, 2006. In certain
instances, the Company provides varying levels of guarantees on the
debt of unconsolidated joint ventures. When the Company provides a
guarantee, the unconsolidated joint venture generally receives more
favorable terms from lenders than would otherwise be available to it.
At November 30, 2007, the Company had payment guarantees related to the
third-party debt of two of its unconsolidated joint ventures. One of
these unconsolidated joint ventures had aggregate third-party debt of
$320.4 million at November 30, 2007, of which each of the joint venture
partners guaranteed it’s pro rata share. The Company’s share of the
payment guarantee, which is triggered only in the event of bankruptcy
of the joint venture, was 49% or $155.2 million. The other
unconsolidated joint venture had total third-party debt of $6.2 million
at November 30, 2007, of which each of the joint venture partners
guaranteed it’s pro rata share. The Company’s share of this payment
guarantee was 50% or $3.1 million. The Company’s pro rata share of
limited maintenance guarantees of unconsolidated entity debt totaled
$103.8 million at November 30, 2007. The limited maintenance guarantees
only apply if the value of the collateral (generally land and
improvements) is less than a specific percentage of the loan balance.
If the Company is required to make a payment under a limited
maintenance guarantee to bring the value of the collateral above the
specified percentage of the loan balance, the payment would constitute
a capital contribution and/or loan to the affected unconsolidated joint
venture.

2.) KB Homes Q3 2007 10Q Report

The Company conducts a portion of its land
acquisition, development and other residential activities through
participation in unconsolidated joint ventures in which it holds less
than a controlling interest. These unconsolidated joint ventures
had total assets of $2.75 billion and outstanding secured construction
debt of approximately $1.72 billion at August 31, 2007.
In certain
instances, the Company or its subsidiaries provide varying levels of
guarantees on the debt of unconsolidated joint ventures. When the
Company or its subsidiaries provide a guarantee, an unconsolidated
joint venture generally receives
more
favorable terms from lenders than would otherwise be available to it.
At August 31, 2007, the Company had payment guarantees related to the
third-party debt of three of its unconsolidated joint ventures. One of
the unconsolidated joint ventures had aggregate third-party debt of
$450.6 million at August 31, 2007, of which each of the joint venture
partners guaranteed its pro rata share. The Company’s share of the
payment guarantee, which is triggered only in the event of bankruptcy
of the joint venture, was 49% or approximately $218.5 million. The
remaining two unconsolidated joint ventures had total third-party debt
of $14.6 million at August 31, 2007, of which each of the joint venture
partners guaranteed its pro rata share. The Company’s share of these
payment guarantees was 50% or $7.3 million. The Company’s pro rata
share of limited maintenance guarantees of unconsolidated entity debt
totaled $126.3 million at August 31, 2007. The limited maintenance
guarantees apply only if the value of the collateral (generally land
and improvements) is less than a specific percentage of the loan
balance. When the Company is required to make a payment under a limited
maintenance guarantee to bring the value of the collateral above the
specified percentage of the loan balance, the payment constitutes a
capital contribution and/or loan to the affected unconsolidated joint
venture and entitles the Company to receive a greater aggregate amount
of the funds any such unconsolidated joint venture may distribute.

Published in BoomBustBlog
Wednesday, 19 March 2008 01:00

Something stinks!

As far as I can discern, Lehman effectively had a run on the bank Monday. They admitted portions of it in the WSJ article I linked to earlier, and word is that many clients left to the tune of several billion dollars. They same appears to be happening in the UK, this is after:

  • one of their largest mortgage banks faced a run and had to be nationalized,;
  • The biggest US investment banks, numbers 1, 2 and 5 just ran to the government for emergency funds and investment bank 5's shareholders just got wiped out.
  • Investment banks 1 and 4 reported 50% drops in earnings and revenue, but rallied because analysts dropped expectations enough to say that they were beat;
  • They then started to recommend "buys" on each other;
  • The mechanism used by the Fed to prop up the I banks was used only once before, and that was during the worst economic period in the history of this country - the "Great Depression".

It doesn't take a detective to figure out all is not well in Smallville! There is probably a big negative waiting in the near future for the financial sector. The problem is that I have not fully deduced what it is, yet. I am growing extremely suspect of the Fed's move. I definitely understand why they felt they had to do it, the issue is the true facts surrounding the move and what the repercussions are. I think the US tax payers can kiss that $30 billion dollar back stop goodbye.

Published in BoomBustBlog

My blog has been quite popular as of late,
most likely because it may appear to some that I have a crystal ball.
My last 5 or so warnings have resulted in 50 point or so price drops in
the shares of the companies in questions. Let me be both modest and
honest. I am not that smart and do not have a crystal ball. There is a
simple premise behind all of this that allows me to understand what is
going on, but this premise does not get any press play and is not
harped on by the analyst community. Many major players in our financial system are simply insolvent.
Plain and simple. The liquidity issues that you see are simply a result
of that insolvency, not a cause. When you lever up on assets at the top
of a bubble and that bubble pops, you become insolvent, delevered or
not. If forced to delever, the balance sheet insolvency now becomes an
income statement insolvency as the cash outflow outstrips the cash
inflows, but it all stems from the original balance sheet insolvency -
not the other way around.

Borrowing more money, no matter what the
terms, will not aide you in your dilemma. That is, of course, unless
you can borrow large amounts of that money quickly on non-recourse
terms. But that is not really borrowing money, it is someone giving you
money with the option to pay it back.
It is the equivalent of a straight bailout, isn't it? That is what just
happened last weekend, which leads me to the next paragraph...

I have been alleging that many investment banks, monoline insurers, home builders and commercial banks are effectively insolvent. Nouriel Roubinin wrote an accurate piece on the topic.
Between that and the the five or six major analytical pieces that I put
together, I believe a pattern emerges (please take note of the dates
the pieces were written and the share prices at the time of the post).
I believe the pattern is indisputable. You could have made a fortune on
the short side of these analyses, and you could have lost a fortune on
the long side, just ask the employess and shareholders of Bear Stearns,
Ambac, MBIA, Lennar, etc. My condolences go out to the rank and file
employees of all of these companies whose savings have been lost in the
share price devalution. Hopefully, there is a lesson to be learned
here:



More on Insurers and Insurance

More on Commercial Real Estate

More on Residential Real Estate


More on Investment Banks

As you can see, the path was not impossible to determine as
practically all of these companies shared the same catalyst to their
downfall - excessive leverage at the top of an asset and credit cycle
bubble. Now, the Fed is attempting to lend directly to institutions
that it has no jursidiction over. If I am not mistaken, the Fed's
balance sheet is only good for $400 billion dollars or so. There are a
lot of potential "runs on the non-bank" coming down the pike, enought
to drain the coffers. This is an ingenious, albeit very risky endeavor.
Moral hazard abounds. I know the Fed believes that they have nixed the
moral hazard argument in the butt by wiping out the Bear Stearns
shareholders, but this is an imperfect argument. The shareholders have
to approve this $2 buyout deal, and $2 is low enough to risk a battle
with the Fed and their agents. This is a major flaw in the plan that I
see as coming back to bite the markets. If this happens when the next
shoe drops, I can see the Fed getting overwhelmed.

As an investor and analytical pundit, I will be looking for the next
shoe to drop, which I believe I have found. I will keep you posted.

Published in BoomBustBlog
Thursday, 06 March 2008 00:00

MBIA LETTER TO OWNERS DATED MARCH 3, 2008.

The following is the MBIA "LETTER TO OWNERS DATED MARCH 3, 2008" excerpt and my comments. My next post will be my comments on out ongoing monoline research, and in particular Assured Guaranty.

Dear Owners:

... Obviously the big news of the week was the affirmation of our Triple-A ratings by both Standard & Poor’s and Moody’s. This added to the growing confidence shown by our investors in MBIA’s firm financial footing and the steps we’ve taken to weather the worst credit crisis in a generation. The reaffirmation of our Triple-A ratings means that MBIA holds up under the worst-case scenarios the rating agencies use to stress test our claims-paying ability. The fact is, the losses from the U.S. mortgage market would have to be many times higher than any credible projections before MBIA’s ability to satisfy its obligations to policyholders would be compromised. The bottom line is that the rating agencies recognize the moves we have made to raise additional capital and that, over the next 12 to 18 months, they will observe how we fortify our position and make changes to our business model so as to support the highest ratings. The ratings agencies and the management of the major monolines have been so wrong, so often on the mortgage risks thuse far that thier current opinions have less than zero credibitiy. In addition, notice how they commented on their mortgage risk, but failed to opined on the risks and liabilities coming down the pike in consumer finance, leveraged loans, CMBS, high yield CDOs, and looming increase in municipal bond risk. These risks, taken in light of there significantly diminished revenues, are far from trivial.

Published in BoomBustBlog

In Banks, Brokers, & Bullsh1+ part 2 I forecasted Morgan Stanley having beef with their hedge fund clients and counterparties. Well, actually I claimed that they had excessive counterparty risk from these clients, which was bound to come back to bite them. In today's WSJ.com:

Some other hedge-fund managers say they've been bullied by securities firms when they've tried to cash out on profits from such positions. When one hedge-fund manager considered selling out of a credit-default swap -- in which his fund bought protection on $10 million of bonds of Countrywide Financial Corp. -- he says there was a condition attached by two securities firms. He says the firms -- Bear Stearns Cos., which sold him the swap, and Morgan Stanley -- told him they would cash him out of his profitable position, only if he would simultaneously enter into another swap-selling insurance protection on the bonds equal to his fund's $3 million profit. Eventually, he says, his fund sold the position through Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc., allowing him to book the $3 million profit. Representatives for Bear Stearns, Morgan Stanley, Goldman and Lehman declined to comment.

Published in BoomBustBlog