Financial, Real Estate, Stock Markets Trends and Current Affairs

From the OECD by way of WSJ's Real Time Economics :

Raising new capital from “risk-taking private institutions or” sovereign wealth funds “are a big help. But the arithmetic of getting quickly back to ‘business-as-usual’ which requires much more capital than simply offsetting the losses alone, argues for more action if possible. One such action mentioned in this context was the socialization of losses through government action like the” Resolution Trust Corp.

“Under certain assumptions concerning the Fed Funds rate and dividend pay-out rates, it could take US commercial banks 6 months to earn back the capital write-offs that will be required. But further recapitalization is necessary if banks are actually to re-start lending and expand their balance sheets. A six-month-plus period to rebuild would risk credit crunch scenarios such as happened in the 1990s.”

"“The private sector and monetary policy have combined to lead to an
outcome with unintended consequences: the potential for a serious
recession and spill-over to countries and markets where excesses were
less marked.”

Commercial and investment banks have $1.3 trillion in exposure to
hedge funds through prime brokers. Hedge fund losses triggered by
deleveraging could fall directly on bank capital. ““This is one reason
why central bank policies to flood the market with liquidity etc are
very important at this stage… If a major market break occurs and
counterparties fail, the guarantee is going to fall on prime broker
capital.”

European retail investors are heavily exposed to mortgages.
“Constant Proportion Portfolio Insurance (CPPI) products are a popular
form of this that use complex options replication programs … Europe is
in the forefront of issuing these products. By the start of this year
no less than $1trillion of these products had been issued since 2003,
and all to retail investors.”"

So, how safe is your Doo-Doo? This installment of Reggie Middleton on the Asset Securitization Crisis (part 17) is more consumer orientated, and attempts to reveal who the riskiest banks are in the Doo-Doo 32 list that I have compiled. This should be telling, for the list itself is comprised of banks that are basically knee deep in Doo-Doo, hence the moniker (for those that didn't get it). Below is where we stand in the Asset Securitization Crisis as of this article (this may even be the makings of a best seller in the fact is stranger than fiction department of Amazon, publishing companies - you know what to do ).

The Asset Securitization Crisis Analysis road-map to date:

1. Intro: The great housing bull run - creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble - A comparison with the same during the S&L crisis
2. Securitization - dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble - declining home prices and rising foreclosure
3. Counterparty risk analyses - counter-party failure will open up another Pandora's box (must read for anyone who is not a CDS specialist)
4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
5. Municipal bond market and the securitization crisis - part I
6. Municipal bond market and the securitization crisis - part 2 (should be read by whoever is not a muni expert - this newsbyte may be worth reading as well)
7. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
8. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
9. More on the banking backdrop, we've never had so many loans!
10. As I see it, these 32 banks and thrifts are in deep doo-doo!
11. A little more on HELOCs, 2nd lien loans and rose colored glasses
12. Will Countywide cause the next shoe to drop?
13. Capital, Leverage and Loss in the Banking System
14. Doo-Doo bank drill down, part 1 - Wells Fargo
15. Doo-Doo Bank 32 drill down: Part 2 - Popular
16. Doo-Doo Bank 32 drill down: Part 3 - SunTrust Bank

This installment in the series is a little different. Here's why.

This series was started as a check and balances macro study to either support or debunk my wide ranging shorting of the US, Asian and European banking system (that's right, I believe global banking is F@#$%@, and I am willing to put my money behind my convictions, not to mention publish them across the web) and real asset related companies. The series became quite popular, and a few people have asked me if I thought their particular bank was safe, should they withdraw their funds, etc. I, as a rule, absolutely do not give out advice to the public. Even if I did I don't think anyone should be taking that type of advice from a blog, but I don't give it anyway. I even shy away from giving my opinions on certain matters because I don't want to be responsible for yelling "Fire!" in a crowded theater. Then I came across this article in the WSJ: Memorandum Agreement With Regulators Effectively Puts Banking Unit on
Probation, excerpted below -

National City Corp.'s
banking unit, which has been buffeted by rising bad loans, has recently entered
into a "memorandum of understanding" with federal regulators, effectively
putting the bank on probation.

The confidential agreement with the Office of the Comptroller of
the Currency was entered into over the past month or so. It illustrates the
growing regulatory pressure some financial institutions are under as they
struggle to deal with fallout from the credit-market turmoil.

Under such agreements, which are entered into privately and
aren't publicly disclosed, banks are given an opportunity to work with federal
regulators to address serious financial problems without triggering alarm among
depositors.

The terms of the agreement with National City aren't known.
However, regulators usually urge banks to maintain adequate capital and improve
lending standards...

... National City probably isn't alone in operating under such a
memorandum of understanding. Regulators, hoping to fend off a wave of bank
failures, have been pushing lenders to raise more capital, curtail their growth,
and improve their risk-management and underwriting practices. Banking experts
estimate that a handful of midsize banks recently have entered MOUs.

Such MOUs are agreements between regulators and bank management.
They are considered serious and are fairly rare, though it is even less common
for a bank to face a public enforcement action. If a bank receives a nonpublic
enforcement action and then resolves all of the issues in a timely manner,
regulators would likely never disclose the sanction publicly.

If a bank fails to comply with an informal enforcement action,
regulators can bring more-severe penalties -- often publicly -- to clamp down on
a company's management or operations...

I pointed out to my regular blog readers that this bank and most likely quite a few others touched by the OCC (federal oversight agency for banks) are on my Doo-Doo list . I received a few more inquiries, and thought to my self, "If it were my money in the banks, I would want to know if it was in trouble." So, after blogful ruminations, I decided to approach this from more of a consumer perspective than an investment one.

National City, a membero my Doo-Doo 32 list , just entered into a memorandum of understanding with the Office of the Comptroller of Currency. Thus far, roughly one bank per week off of that list has hit the confessional hard.

From the WSJ:

National City Corp.'s banking unit, which has been buffeted by rising bad loans, has recently entered into a "memorandum of understanding" with federal regulators, effectively putting the bank on probation...

Under such agreements, which are entered into privately and aren't publicly disclosed, banks are given an opportunity to work with federal regulators to address serious financial problems ...

I have what some may consider a mind blowing update to the Doo-Doo 32 list and the asset securitization crisis - the Fed just can't help the sick banks. I'll try to post it sometime today.

Yep, I said it. The monoline business model that MBIA and Ambac used relied on the ignorance of the clients and market participants to survive. These companies attempted to undercut the market pricing of risk - charging clients consistantly less than what Mr. Market would, and pocketing the difference, all the while doing so with 100x plus leverage against products with sparse or unkowon loss histories. It was bound to hit the wall. In a few hours, I'm probably going to release some research that shows how regional banks have backed themselves up against the failure wall using 7x to 20x leverage, so just imagine 100x plus leverage...

We are now about to close a chapter in this book, but fear not fellow blogophytes, there is a new chapter whose 1st page is about to be turned...

From Bloomberg : MBIA, Ambac Signal They May Give Up Aaa Battle After Moody's Threatens Cut

MBIA Inc. and Ambac Financial Group
Inc. may give up attempts to retain Aaa credit ratings of their
bond insurance units after Moody's Investors Service put them
under review for a second time this year.

The world's largest bond insurers said they won't raise
capital after New York-based Moody's said yesterday that the
most likely result of its examination would be a downgrade of
the companies' insurance financial strength rankings.

1 day after Cuomo says, "The Truth or Else", guess what happens... Expect downgrades on more structured products as well

June 4 (Bloomberg) -- New York Attorney General Andrew Cuomo is nearing an agreement with Moody's Investors Service, Standard & Poor's and Fitch Ratings that would let the credit-rating firms avoid sanctions over their role in the subprime-mortgage crisis, people with knowledge of the accord said. The companies won't admit wrongdoing and will have six months to implement policies such as a new fee structure and increased disclosure about the deals they rate, said the people, who declined to be identified before a public announcement that might come as early as this week. Cuomo would end his nine-month probe of the ratings companies, started as part of a broader investigation into the mortgage industry. Cuomo said in February he was focused on ``the role played by the ratings agencies in the mortgage meltdown'' that caused more than $386 billion in credit losses and asset writedowns at banks. Investors had anticipated Cuomo would force bigger changes, and Moody's Corp. and McGraw-Hill Cos., parent of S&P, rose in New York trading.

I'm not going to say I told you so... I instituted a short campaign in September of last year, and started releasing research and opinion about that date as well. In November, I put out some strongly opinionated stuff and got a lot of feedback. This is part one of a two part response to comments and questions on the recent events concerning the Ambac and MBIA. The second part will be a forensic marking to market of Ambac's portfolio based upon the recent E*Trade sale. Required reading for this article includes: A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton. Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion Market Cap Follow up to the Ambac Analysis Monolines swoon, CDOs go boom & I really wonder why the ratings agencies are given any credibility Bill Ackman of Pershing Square - How to save the Monolines For those interested in the history, see Insurers and Insurance in m blog. There are literally 100's of pages of opinion and analysis over the last 9 months.

The dominoes should start to fall... If any body believes I have an inkling of knowing my way around these investment markets, I strongly suggest you re-read my Asset Securitization Crisis series, in particular, "Counterparty risk analyses - counter-party failure will open up another Pandora's box" (must read for anyone who is not a CDS specialist). We wil be entering into the next phase of the crisis, for I believe that the CDS market will start showing fissures that will illuminate rampant counterparty credit risks through the global capital markets. These insurers used CDS almost exclusively for their structured product wraps and insurance.

Moody's originally put Ambac and MBIA under review in
January, only to affirm the ratings of MBIA a month later and
Ambac in March. The credit rating company cited ``meaningful
uncertainty'' about Ambac's ability to regain market share since
the first reviews, and ``diminished new business prospects'' for
MBIA in yesterday's announcement. This uncertainty is well grounded.

``You can't go to somebody to raise capital if you don't
know what the rules for capital raising would be,'' Armonk, New
York-based MBIA Chief Executive Officer Jay Brown told reporters
yesterday. ``Goal posts move, targets change.'' On the surface, he has a valid point here, but the truth of the matter is he know full well that the company didn't deserve a AAA rating. They played along with the phony, funny money rules of the credit wizard, and when it was time for them to be "funny monied", they cry foul????

Moody's decision is ``liberating'' for New York-based Ambac,
and may enable it to consider options other than selling stock
or debt, Doug Renfield-Miller, an executive vice president at
the company, said at an investor conference. I've always alleged that it was a waste of resources and a destruction of shareholder value to chase an ephemeral AAA rating that you both never deserved and couldn't retain. IMHO, these companies are pretty much finished as the guarantors they once were.

Wider Losses

MBIA and Ambac raised a combined $4.1 billion in the past
six months to convince Moody's, Standard & Poor's and Fitch
Ratings they had enough capital to justify their top rankings.
Fitch cut Ambac to AA in January and MBIA to AA in April. Notice how Fitch is not part of this "settlement". They worked hard to save face and regain their credibility. I actually covered my shorts on these two insurers after booking fat profits, but reinstated them (See "Short Seller Dreamin') after hearing that the returning MBIA CEO who spearheaded the drive into structured products requested that Fitch no longer review the company. That was a bone headed move for a company whose stability is in question and whose ratings agencies credibility is already called into serious question. Such management blunders screamed out, "SHORT ME SOME MORE, PLEASE!!!"

MBIA Insurance Corp.'s financial strength rating likely
will fall to the Aa range, though a drop to the A category is
possible, Moody's said yesterday in a statement. Ambac Assurance
Corp.'s ranking will probably be cut to Aa, Moody's also said.

``I don't think they're going to respond in any way to keep
the rating,'' said Jim Ryan, an analyst with Morningstar Inc. in
Chicago. ``I don't think there's anything they can do.''

MBIA may start a new insurance business with $900 million
it raised in February, Brown said. Actually, I think the Insurance Commisioner of NY will want you to keep that money to pay policy claims and back your liabilities... Ambac shareholders suggested
the company stop writing new business and enter a state of ``run
off,'' where it winds down as policies mature, Renfield-Miller
said. Best idea yet.

While raising capital isn't likely, ``we're not giving up
with Moody's or the other rating agencies. We're going to
continue our dialogue, and try to convince them they've erred,''
Renfield-Miller said. Keep hope alive. Their own asses are on the line now (see side bar). Know more credit wizard cartoonery. See the cartoons, credit wizard one and two .

Market Disconnect

Ambac reported a $1.66 billion net loss in the first
quarter after $3.1 billion in charges related to subprime-
mortgage securities it insured. MBIA lost $2.4 billion as the
value of derivatives it sells to guarantee debt tumbled $3.58
billion.

MBIA, which had plunged 90 percent in the past year,
dropped $1.06, or 15.8 percent, to $5.63 in New York Stock
Exchange composite trading yesterday, the lowest since June 1988.
Ambac, down 97 percent in the past year, fell 51 cents, or 17
percent, to $2.49, a new low.

``The disconnect between the market's perception and the
rating agencies' assigned ratings has finally become an elephant
in the room too big to ignore,'' Kathleen Shanley, an analyst at
Chicago-based bond research firm Gimme Credit, wrote in a report
yesterday. Actually, the NYS regulators and DA got tired of the lying bullsh1t!

The prospect of downgrades earlier this year roiled markets
because of concern that guarantees for more than $1 trillion of
debt may be worthless. The problem is no less signfiicant now then it was then. Let's see if the media proffers a muted reaction.

AAA Focus

Until yesterday, MBIA and Ambac executives said they were
focused on keeping Aaa ratings.

``Our goal is to rebuild confidence and to insulate our
ratings from future volatility,'' Ambac CEO Michael Callen said
at the company's annual meeting on June 3.

Brown told shareholders at MBIA's annual meeting in May
that ``we are very comfortable that we have raised adequate
capital.''

Credit-default swaps tied to MBIA's insurance unit rose to
a record. Sellers of five-year contracts demanded 23.5 percent
upfront and 5 percent a year yesterday, according to London-
based data provider CMA Datavision. That's up from 18.5 percent
initially and 5 percent a year two days ago. Wow, I generally don't buy CDS, but it does seem to have been a very profitable trade. You know, the devil is in the details though. In order to monetize those paper profits, you have to unwind the traded - you know... Brokers, Bankers, and Bullsh1t. It will be interesting to see who gets stiffed for those profits they thought they had, and what happens to those funds NAV calculations. Side pockets, here we come!!!

The upfront cost to protect Ambac debt jumped to 25.5
percent from 21.5 percent, CMA prices show. The contracts pay
the buyer face value in exchange for the underlying securities
should the company fail to adhere to its debt agreements or if
it can't make good on its guarantees.

``It's next to impossible'' for the companies to raise
capital, Andrew Wessel, an analyst with JPMorgan Securities in
New York, told Bloomberg Television.

The Partial Cost of Monoline ABS Failure Par Equity Exposure Ratio Bear Stearns* $15,673,088,703 $11,793,000,000 132.90% BSC ABS inventory Morgan Stanley** $22,956,101,796 $31,269,000,000 73.41% MS ABS Inventory Lehman Brothers*** $3,151,328,632 $22,490,000,000 14.01% LEH ABS Inventory Citigroup $8,100,028,623 $127,113,000,000 6.37% C ABS Inventory Countrywide**** $12,639,385,566 $15,252,230,000 82.87% CFC ABS Inventory Wells Fargo**** $4,700,835,231 $47,738,000,000 9.85% Wells Fargo ABS Inventory Goldman Sachs $18,673,869,328 $42,800,000,000 43.63% GS ABS Inventory WaMu**** $7,658,982,498 $23,941,000,000 31.99% WaMu ABS Inventory Merrill Lynch $10,224,387,634 $38,626,000,000 26.47% ML ABS Inventory Centex***** $511,740,636 $3,197,130,000 16.01% CTX ABS Inventory Wachovia**** $5,328,228,928 $76,872,000,000 6.93% Wachovia ABS Inventory Totals $118,950,151,688 $477,918,010,000 24.89% * collapsed two months after I warned on the blog: Is this the Breaking of the Bear? ** the most exposed bank to counterparty credit risk on the street: The Riskiest Bank on the Street and Reggie Middleton on the Street's Riskiest Bank - Update *** at risk due to the largest proportionate MBS inventory on the street, effectively un hedgeable at this amount and in these markets **** card carrying members of the Doo-Doo bank 32 list. See:As I see it, these 32 banks and thrifts are in deep doo-doo! and Doo-Doo bank drill down, part 1 - Wells Fargo. ***** Centex and Lennar have (had) some of the largest subprime mortgage operations in the country. They don't publicize it much, but I am sure they are getting stuck wth a lot of paper, as well as real estate on their books. I have an update to Lennar which I will hopefully get to post in a few days. Till then, see the older analyses: Lennar Insolvent: Enron redux??? and Voodoo, Zombies, Lennar�s Off Balance Sheet Accounting and Other Things of Mystery & Myth. For those who haven't read them, see :Banks, Brokers, & Bullsh1+ part 1 and Banks, Brokers, & Bullsh1+ part 2 Fall out from the municipal sector, most of whom have already been granted monoline immunity from regulators (they knew this was coming and actually expect ratings to fall to junk status ): Municipal bond market and the securitization crisis - part I and Municipal bond market and the securitization crisis - part 2 (should be read by whoever is not a muni expert - this newsbyte may be worth reading as well)

Fallout before the US trading day starts:

Asia-Pacific Bond Risk Rises to Six-Week High on MBIA, Ambac: The cost of protecting Asia-Pacific
bonds from default increased to a six-week high, led by banks
and consumer lenders, after Moody's Investors Service threatened
to cut the ratings of MBIA Inc. and Ambac Financial Corp.

The potential loss of the two bond insurers' top Aaa credit
rankings renewed concern that guarantees for more than $1 trillion
of debt may be worthless, leading to more losses in global credit
markets. The first downgrade reviews in January boosted Asian
credit-default-swap benchmark indexes to what was then a record.

``It just shows, you can never price in enough bad news,''
said Tim Condon, head of Asia research at ING Groep NV in
Singapore. ``There's a bout of credit angst.''

The Markit iTraxx Japan index rose 1 basis point to 91 as of
2:23 p.m. in Tokyo, according to Morgan Stanley. Australia's
benchmark default-swap index advanced 2.5 to 110.5, Credit Suisse
Group AG prices show. Rising prices suggest deteriorating investor
perceptions of credit quality.

Contracts on Macquarie Group Ltd., Australia's biggest
investment bank, posted the largest increase among the world's
financial companies, according to data compiled by Bloomberg.
Credit-default swaps on Macquarie's senior and subordinated bonds
both gained 5 basis points to 145 and 230 respectively, according
to Citigroup Inc. prices.

Japanese Notes Advance as Stock Losses Boost Demand for Debt June ...: June 5 (Bloomberg) -- Japanese five-year notes rose on
speculation a decline in the Nikkei 225 Stock Average boosted
demand for the relative safety of government debt.

Yields approached a two-week low on concern credit-market
losses may spread as U.S. and European financial firms release
earnings. Moody's Investors Service said yesterday it may
downgrade the world's biggest bond insurers and Lehman Brothers
Holdings Inc. lowered its rating on the Japanese banking sector.

``While inflation is still the biggest focus of the market,
some attention is paid to credit market concerns before earnings
results of financial institutions, leading to debt buying,''
said Atsushi Ito, a strategist at Morgan Stanley Japan
Securities Co. in Tokyo. ``Declines in stocks added support.''

From WSJ:

Federal Reserve Chairman Ben Bernanke on Tuesday put the U.S. dollar squarely on the Fed's radar screen, saying its slide against
other currencies has led to an "unwelcome" rise in U.S. inflation and may be a factor in inflation expectations. Bernanke also suggested that the Fed is unlikely to lower official interest rates further, though his remarks suggested that - barring a further rise in inflation expectations - the Fed probably won't contemplate higher rates until there is more stabilization in home prices.

Any rise in rates in the near term will crush marginal banks.

It is good to see that inflation is finally getting officially recognized. It cos me $200 to bring my family to the zoo the other day. That's ridiculous!

Home prices will not stabilize any time soon. If they do, it will be bad for the general public. Prices are still much to high relative to real incomes and rental yields. It goes to show how the interests of the Wall Street and instiutions pandering to the Fed are in direct contravention to the interests of Main Street.

I always thought Paulson would eat those "worst is behind us" words. I wonder if he likes his verbs bland or spicey??? In today's news (and I mean early today, it is only1:44 am and already my puts are bursting at the seems with premium reading to match the week Bear Stearns went bust):

From Bloomberg:

Bradford & Bingley Plc, the U.K. lender struggling to raise cash in a rights offering, must honor a 2006 deal to buy about 2.1 billion pounds ($4.1 billion) of mortgages by the end of next year from GMAC LLC.

Customer payments are more than three months late on 5 percent of loans already purchased from Detroit-based GMAC, the car and home lender trying to avert bankruptcy for its residential mortgage unit. That's more than double the average rate for mortgagesheld by the Bingley, England-based bank, it said yesterday in a statement.

``This is what has spooked everybody,'' said Alan Beaney, who manages $2.1 billion of stocks as head of investments at Principal Investment Management in Sevenoaks, England. ``They are committed to keep buying these things.''

Rising loan defaults were ``by far the biggest factor'' in Bradford & Bingley's decision to sell a 23 percent stake to U.S. leveraged buyout firm TPG Inc., Chairman Rod Kent told analysts on a conference call. The bank fell 24 percent in London trading yesterday, the most since an initial public offering in 2000, after it slashed the price of the rights offering by a third and said the U.K. housing market is deteriorating.

The bank first agreed in 2002 to buy loans from GMAC. Steven Crawshaw, who stepped down June 1 as Bradford & Bingley's chief executive officer, renewed the deal in December 2006 and committed to buy as much as 4 billion pounds of loans a year through 2009.

Wachovia, Alt-A speculators , Countrywide, WaMu and Merrill weren't the only one's who binged on bad debt during the top of a bubble!

From WSJ:

Lehman Brothers Holdings Inc., set to report its first quarterly loss since going public, is considering raising billions of dollars in fresh capital to help shore up its balance sheet, according to people familiar with the matter.

The exact amount of the capital hike isn't known, but analysts and Wall Street executives estimate it is likely to be $3 billion to $4 billion. They said Lehman would probably announce the capital raising in conjunction with its quarterly results, due the week of June 16. The amount of new capital under consideration suggests Lehman's quarterly loss could be larger than the $300 million or so that some analysts have been expecting. Now I made it very clear that Lehman was guaranteed to take a loss this quarter because, they took an economic loss last quarter but covered it up with accounting shenanigans and smoke and mirrors. Lehman was one of the few companies that I shorted heavily despite not performing a full forensic analysis because they had too much smoke and too many inconsistencies. Starting in September of last year, I started uncovering a lot of Lehman lemmings. See my chronological smoke trail below.

On Monday, shares in the 158-year-old firm fell $2.98, or 8%, to $33.83 on the New York Stock Exchange after negative comments from two Wall Street analysts. The shares are down almost 50% this year compared with year-to-date drops of about 20% for rivals Goldman Sachs Group Inc. and Morgan Stanley. The Street's Riskiest Bank will have some surprises for us. Amazingly, S&P picked up on my view of riskiness with MS, I was shocked, and concerned to be in such company - considering their accuracy in these matters over the last year or two. The new capital would likely be raised by issuing common shares, diluting current shareholders, people familiar with the matter said.

Lehman is Wall Street's smallest independent firm now that the sale of Bear Stearns Cos. to J.P. Morgan Chase& Co. is complete (see Is this the Breaking of the Bear?). Lehman says it is well-positioned to weather the current credit-market turmoil, and its management has been aggressive at facing down its critics. Isn't that what Bear Stearns, Thornburg Mortgage, Indymac Bank and Countrywide said??!!! I am not one for litigation, but these guys seem to be pushing their luck!

In the past year, Lehman has raised $6 billion in capital, including $4 billion last quarter. The firm's financial position was further strengthened in March when Lehman, like all U.S. investment banks, was allowed to borrow directly from the Federal Reserve against a variety of collateral, which gives it ready access to considerable funding. The availability of Fed funding significantly reduces any worries that Lehman and other firms might suffer a cash crunch.

Nonetheless, some investors remain concerned that relative to its size, Lehman is holding more securities tied to both residential and commercial real estate than any other big Wall Street broker, according to Bernstein Research.

Mortgage Exposure

"Lehman still has a lot of exposure to the mortgage market, and they are going to need capital to get through it," said UBS analyst Glenn Schorr.

On Monday, Standard & Poor's cut long-term debt ratings on Lehman, Merrill Lynch& Co. and Morgan Stanley. The credit-rating agency focused in particular on Lehman, saying it expects a "relatively meaningful deterioration" in the firm's earnings for its second quarter, which ended May 31.

Also Monday, Merrill Lynch analyst Guy Moszkowski lowered his rating on Lehman stock to underperform from neutral. Oppenheimer & Co. analyst Meredith Whitney swung her earnings forecast to a loss from a profit. What took so long Meredith? You are usually lock step with me...

The immediate impact of the S&P downgrade will likely be minor, but the downgraded firms may face slightly higher borrowing costs. The cost of buying protection against a default at Lehman Brothers increased by $15,000 Monday, bringing the cost to $245,000 for five years of protection on $10 million of debt.

In contrast to Bear Stearns, Lehman has successfully raised capital, sold off risky securities and responded forcefully to rumors about its situation. After its most recent capital raising on March 31, its gross leverage ratio -- a measure of borrowing relative to assets -- fell to a more conservative 27.3 from 31.7 at the end of its first quarter in February. The figure is expected to be down to 25 as of the end of the second quarter. Semantics! There's more conservative, and then there is conservtive. None of the banks that use proprietay trading as a revenue source have conservative leverage ratios. In addition, I believe this reduction to be smoke in mirrors, in part because they have reduced the balanc sheet but retained the risk of the assets that that they shed, simply in another form. It can be seen as actually concentrating the risk in and attempt to placate naive investors (as in less knowing, not meaning to be offensive) shareholders. See the CLO funny business towards the end of the long list below.

In a statement, a Lehman spokesman said: "It is our clearly articulated strategy to reduce the size of our balance sheet this quarter." What you need to do is reduce the risk of your balance sheet, and make that your stated goal. No more smoke an mirrors.

Lehman's long-serving chief executive, Richard Fuld Jr., has experience in tough situations. In 1998, he fought off rumors about a cash crunch that were triggered by the near-collapse of hedge fund Long-Term Capital Management.

But Lehman's second-quarter results are expected to show some fresh difficulties. The firm is saddled with billions of dollars in hard-to-sell commercial real-estate assets and leveraged loans and is expected to face further write-downs on these portfolios. That has led the firm to consider raising additional capital. Wall Street firms including Merrill Lynch and Morgan Stanley have also raised billions of dollars as losses from the mortgage meltdown have mounted.

If Lehman proceeds with plans to raise capital, it is expected to do so by issuing common stock, the first such issue since it went public in 1994. In its earlier capital raising over the past year, it issued preferred shares, a stock-bond hybrid that doesn't dilute the ownership of common shareholders. D-I-L-U-T-I--V-E at a time when there are scant earning to go around to the shares that are already in existence. When will (foreign) investors learn that you are throwing your money down the tubes by funding these institutions at this point in the game. Just sit back and look at how much money was loss with the BSC, C, MS, and the whole list that is too long to run through, gamut of I-bank investments that were made over the past year. I don't want to hear that "this is a long term commitment nonsense either. Why don't you guys make your long term commitment at HALF the price by waiting until next year. Hey, I'm a long term player too. That doesn't mean I voluntarily burn my money like matchsticks.

While a common-share issue will hurt Lehman's already-suffering shareholders by diluting their ownership stake, rating agencies and regulators like to see a balance of common and preferred shares. That is why Lehman will likely go the common-share route.

Stung by Hedges

During the second quarter, Lehman was stung by hedges used to offset losses in real estate and other securities, according to people familiar with the matter. The firm bet that indexes tracking markets such as real-estate securities and leveraged loans would fall. If that happened, it would book profits that would make up some of its losses from holding these securities and loans.

However, in an unexpected twist, some of the indexes rose, even as the assets they were supposed to hedge against continued to lose value or stayed relatively flat. Lehman's losses from both write-downs on assets and ineffective hedges will likely top $2 billion, people familiar with the matter said. Lehman will also realize additional losses related to its decision to reduce its work force, according to a person familiar with the matter. I warned about bad hedges in February in the Morgan Stanley opinion: Street's Riskiest Bank .

The S&P downgrades came after the ratings agency completed a review of the entire securities industry. S&P said it believes Lehman and other securities dealers' revenues may decline more than anticipated based on the firms' still large exposures to illiquid and hard-to-value assets.

S&P analyst Scott Sprinzen said the Federal Reserve's decision to allow brokers to borrow money directly from the Fed, "gave us the comfort not to go further with some of the downgrades that we did," he says. "But we can't count on that indefinitely."

S&P cut Lehman's rating to A from A+, and also cut the ratings of Morgan Stanley to A+ from AA- and Merrill Lynch to A from A+. Despite the downgrades, the firms are still considered high-quality investment-grade credits. S&P affirmed Goldman Sachs's ratings at AA-, but revised its outlook of the firm to negative.

Now reflecting on why I haven't doubled down on Lehman more than the once or twice that I dipped in to the coffers... I am resource constrained. If I had more analytical firepower I would have really had a homerun position. I have hefty proportionate position as it is, but let's reminisce on the ruminations that was (notice the dates on each snippet while remembering that I started bloggin in September). Call this the chronological anatomy of a short selling blogger's tale of speculative anecdotal research and use the chart to peg the comments to Lehman's share price...

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I warned about the Muni market
last year. I warned that the monoline model couldn't stand the test of time (36
years is not time, that is barely 1 generation). I warned that munis will
weaken already emaciated monolines and cause significant stress on banks. In
the beginning of the 6th month of this year, we already have 300% more
defaults than all of last year - and things are getting much worse, not better.
Before we go on to the article though, a quick recap for those that don't
follow me:

·
Muni Primer: beginner - Municipal bond market and the
securitization crisis - part I

·
Muni Primer: Intermediate - Municipal bond market and the securitization crisis
- part 2

From part 2 of the muni report: "Muni failures will provide
a backdrop for the increase in stress and pressure on the monoline industry,
which I believe has a strong chance of creating a CDS domino effect throughout
the investment banks and other insurers. For more info on the risks and threats
of the CDS market see Counterparty risk analyses -
counterparty failure will open up another Pandora's box. See "I know who's holding the
$119 billion dollar bag" for a listing of the most likely candidates
to suffer, as well as Banks, Brokers, &
Bullsh1+ part and Banks,
Brokers, & Bullsh1+ part 2 for my take on the general risks in the
investment banking industry today. Reggie Middleton on the
Street's Riskiest Bank - Update drills down on one of my short positions to
reveal why I am bearish on Morgan Stanley - way before the sell side started
yelling sell may I add, very similar to the contrarian position taken in Bear
Stearns late last year.

The following
municipal bond portion of the asset securitization crisis is also a tie-in to
the prospects of the monoline insurance industry. The latest of my monoline
analyses is the Assured Guaranty Report. You can also peruse the
work I did on MBIA and Ambac starting from the inception of my short position
in these companies last year, which turned to be nearly as profitable as the
Bear Stearns short (see Is this the Breaking of the
Bear?) instituted late last year as well, and based on the same
investment thesis. A quick background of my older musings on the monoline
industry: A Super Scary Halloween
Tale of 104 Basis Points Pt I & II, by Reggie Middleton

1. Tie-in to the
   Halloween Story
2. Welcome to the World
   of Dr. FrankenFinance!
3. Ambac is Effectively
   Insolvent & Will See More than $8 Billion of Losses with Just a $2.26
   Billion
4. Follow up to the
   Ambac Analysis
5. Monolines swoon, CDOs
   go boom & I really wonder why the ratings agencies are given any credibility
   
6. More tidbits on the monolines
7. What does Brittany Spears, Snow White and
   MBIA have in Common?
8. Moody's Affirms
   Ratings of Ambac and MBIA & Loses any Credibility They May Have Had
   Left
9. My Analyst's Comments
   on MBIA/Ambac/Moody's Post
10. As was warned in this
    blog, the S&P downgrade of a monoline insurer reverberated losses
    throughout Wall Street and Main Street"

From Bloomberg: Muni's, New
Subprime Woe

The amount
of municipal bonds that have defaulted this year is already more than triple of
what it was for all of 2007.

And who
could doubt there's more bad news on the way?

So far
this year, $736 million in municipal bonds have defaulted. That doesn't
necessarily mean they didn't pay investors; they may have just drawn down
reserves. That's what happens just before they stop making payments to
bondholders.

During all
of 2007, only $226 million in municipal bonds defaulted, according to the May
edition of the Distressed Debt Securities newsletter, published in Miami Lakes,
Florida.

That $736
million is nowhere near the record for municipal bond defaults, to be sure. The
record year, if you're counting, was 1991, when almost $5 billion went bust.
That's still small potatoes compared with what happens over in the corporate
bond market, where $36.6 billion blew up in 2006 and almost $24 billion in
2007.

But wait a
minute: Municipal bonds never default, do they? Or at least this is how they
are perceived by individual investors, right?

We're
probably going to see a lot more munis default this year and in the years to
come, because of the subprime crisis and, maybe, just maybe, because of the
high price of a barrel of oil.

The
hangover from the collapse in real estate prices is going to be a boom in
so-called dirt-bond defaults.

These are
bonds sold by municipalities to build the infrastructure for housing
developments, and are backed by the taxes paid by all the new residents who are
going to move in. If no residents move in, or too few do, the bonds aren't
repaid.

Of the 30
bond issues that have defaulted so far this year, more than half are from
issuers in two of the states that have figured prominently in all tales of the
housing bust: 10 in Florida and seven in California.

Consider
the $50 million in special assessment bonds sold by the Monterra Community
Development District in Broward County, Florida, for example. On May 7, the
district disclosed that it had tapped its $1,279,200 reserve fund for
$1,211,727.11.

You can
just stop right there and know that this story is bound to be a sad one.

These
particular bonds were sold by the district in 2006 in a limited offering. The
bonds were unrated, and sold in minimum denominations of $100,000. The bonds
carried a 5.125 per cent coupon due in 2014, and were priced to yield 5.198 per
cent.

Remember
Colorado
The Monterra development is located in Cooper City, which is about 20 miles
north of Miami and has a population of almost 30,000. Of the 10 Florida bonds
that defaulted this year, all were sold by community development districts, and
all within the last four years.

The big
jump we are going to see in the number of such municipal bond defaults this
year won't be limited to Florida and California, but will include all those
places where the high tide of real estate mania has now receded.

This isn't
an uncommon phenomenon after housing busts. In the past, the damage was usually
confined to certain states where the boom was craziest, such as Colorado in the
1980s.

More
bondholders are going to be affected this time around because the housing
collapse is more national rather than regional or isolated, and because of the
relatively recent development of so many "exurbs,'' as chronicled, for
example, by New York Times columnist David Brooks in his 2004 book, ‘On
Paradise Drive'.

Three-hour
commutes
These are the suburbs beyond the suburbs, where Americans have moved to enjoy
the good life, commute (usually) be damned. Not too long ago, the newspapers
seemed to be filled with stories about people who gladly commuted two and even
three hours each way for affordable real estate. Most people knew actual
examples of such hearty souls. I wonder how much gasoline at $4-plus a gallon
will dent the growth, and tax base, of such communities.

It's not
just the price of gasoline that is going to make the nation's many far-flung
communities less attractive. On May 28, Bloomberg carried a story detailing how
the increase in the price of jet fuel was causing airlines to curtail service
throughout the country.

Maybe we'll have to reconsider this whole
flight-from-the-coasts idea that got such attention a few years ago.

I warned on Key Corp when I posted the Deep Doo-D00 32 List. 6 days before they announced their not so surprising news, and 6 days before the stock lost 12% in a day. If you missed that article, don't worry. There is a lot more to come. But you have to be a regular on my blog to catch this stuff.

From Reuters:

KeyCorp, a large U.S. Midwest regional bank, said mounting loan losses could cause net charge-offs to double from its prior forecast, causing its shares to tumble to a new year-low.

The bank's shares were down $2.65, or 12.1 percent, at $19.30 in afternoon trading on the New York Stock Exchange. The KBW Bank Index .BKX, which includes KeyCorp, was down 3.2 percent.

In a filing late Tuesday with the U.S. Securities and Exchange Commission, the Cleveland-based bank projected full-year net charge-offs in the range of 1 percent to 1.3 percent, up from its prior forecast of 0.65 percent to 0.90 percent.

KeyCorp said net charge-offs in the second quarter and possibly the third quarter could be higher than the new range, citing exposure to residential homebuilders, and in its education and home improvement loan portfolios.

"The disclosure is bad news," wrote Scott Siefers, an analyst for Sandler O'Neill & Partners LP. "Key simply happens to be among the first so far to increase its net charge-off guidance, and as time goes on, we would expect similar deterioration to impact many others."

Many U.S. banks have struggled with mounting credit losses as the economy slowed and housing market slumped, making it more difficult for many borrowers to keep current on their debts.

This is the first of several drill downs into the list of 32 banks in deep doo-doo. Before I go on, let's outline the articles in this series thus far...

The Asset Securitization Crisis Analysis roadmap to date:

1. Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis
2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
5. Municipal bond market and the securitization crisis – part I
6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
8. More on the banking backdrop, we've never had so many loans!
9. As I see it, these 32 banks and thrfts are in deep doo-doo!
10. A little more on HELOCs, 2nd lien loans and rose colored glasses
11. Will Countywdiw cause the next shoe to drop?
12. Capital, Leverage and Loss in the Banking System

Well, the first bank on the drill down list will also be 2nd of the banks that I will deliver a forensic analysis on (the first was PNC Bank). That bank is,,, (drum roll in the backgroud, crescendo.... I know some of you hate it when I do this........) Wells Fargo! I can hear a few of you naysayers cackling behind your computer screens as I type this. Wells Fargo is a big name brand bank (cackle, cackle)! Wells Fargo has Warren Buffet as its largest investor (cackle, cackle)! Wells Fargo this and that and blah, blah and (cackle, cackle).... All I can say is, beware of name brands (I actually felt compelled to address this in earlier posts). I have made more than a couple of dollars benefiting from name brand hubris and smaller investors who would rather be told what to do than read a balance sheet! Time will tell if I am right or not on Wells Fargo, just be forewarned - several of the banks on teh Doo-Doo 32 list have already taken a trip to the confessional! The score card for the credit crisis to date, Reggie Middleton - 10, big name brand investors - 0 (not to toot my own horn, I'm sort of a modest guy and I know I have a big mistake/loss coming soon, it just isn't going to be this one).

I actually have a lot of respect for Buffet, though. Hell of a fundamental investor and cash flow king, and charming public persona as well as being modest (at least he's got me beat). My appreciation differs from that of many, though. His investment track record is quite impressive for it stands the test of time as consistent. As a smaller, unknown investor, he was the most impressive, but now he is an icon and his very words and even a scent of investment from him actually moves markets. Even though he has a much larger capital base to work from (which makes it harder to generate large proportionate returns), his influence can be confused for investment acumen. All in all, he is one to be admired, but the investment results stemming from alpha have to be seperated from the ability to manipulate and move the market (unless that actual ability can be defined as alpha - topic for another day). We all make mistakes though, and Wells Fargo is a mistake waiting to happen. Let's walk through this company as I see it. Of course, since Wells Fargo failed to cooperate with me in releasing their numbers, I used statistical data to back into their probable delinquincies where they weren't directly available from their public filings.

This is eleventh installment of the Asset Securitization series: and overview of Capital, Leverage and Loss in the banking system. After this post, I will drill down into the list of 32 banks on my Doo-Doo list with some more discreet info and then wind it up with a forensic analyis, or two or three - contingent on my time.

The Asset Securitization Crisis Analysis roadmap to date:

1. Intro:
   The great housing bull run – creation of asset bubble, Declining
   lending standards, lax underwriting activities increased the bubble – A
   comparison with the same during the S&L crisis
2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
5. Municipal bond market and the securitization crisis – part I
6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
8. More on the banking backdrop, we've never had so many loans!
9. As I see it, these 32 banks and thrfts are in deep doo-doo!
10. 
    A little more on HELOCs, 2nd lien loans and rose colored glasses
11. 
    Will Countywdiw cause the next shoe to drop?

Thus far, we have reviewed the recent history of banking crises, the source of this current one in comparison to the S&L crisis, geographic losses, concentrations, delinquincies and charge offs. Now, we have to put these into perspective. For instance, a $1 billion loss can mean a lot more to a larger $60 billion company than it could to a smaller $40 billion company. It all depends on the amount of leveraged used by the company and its core/tangible capital. If the smaller company is less levered, it may have less assets, but also have more equity capital to act as a cushion. That is why those armchair investors that proclaim multi-billion, or trillion dollar asset, brand name companies are unapproachable just haven't done thier homework. Think of it in terms of buying a house. Just because someone gave you a 110 LTV subprime loan to by a McMansion doesn't mean you are wearlthy and immune to reproach. Not only are you able to be foreclosed on (just like everybody else who doesn't live on McMansion street), you arguably may be more prone to it thanks to the leverage you employed. Well, banks are the same way.

The more equity you have in your house, the more insulate you are from downturns and volatility in the markets. It really doesn't matter how big the house is or what brand name street you live on! With that being said, let's take a look at hose massive McMansions being built by culling random subset out of our Doo-Doo list.

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