Tuesday, 16 September 2008 01:00

I won't say I told you so, again

My warnings on Goldman Sachs, Morgan Stanley, and CDS have born fruit, by the bushels, for those who have heeded it. The Doo Doo 32 and commercial real estate shorts will be revisited soon, for they are in for a round of hell after this malaise. My industrial shorts will follow, as well as my lesser known real estate and finance services positions and research.

Goldman is down over $50 per share (from about $185 to $134) since I issued my warnings and forensic analysis. Many thought they were too connected to fall with the crowd. That is not a scientific approach to these markets. It's simple math, they are at extreme risk and trade at a significant premium. For those who are hesitant to subscribe to my proprietary research, this trade (off of a relatively small commitment) would have paid the professional subscription for several years, with plenty left over. We have been hitting on all cylinders with the investment banks. I expect the Goldman trade to be more profitable than the Bear Stearns trade where the research came out at about $105 or so and eventually warned that a long would make sense at $3 and it was bought at $10 (see More on the accuracy of this blog's research and Performance of This Site for historical details of much of the research performance). The market is starting to see Morgan Stanley as the bastion of risk that I see it as, and it is paying off. I'll assume that there is no need to comment on how we did with the Lehman research and forewarning.

Reference the Moody's and S&P downgrades of AIG to see how my multiple warnings of the risks the CDS markets will pose come to pass. Bloomberg - AIG's Ratings Lowered by S&P, Moody's, Threatening Efforts to Raise Funds:

Published in BoomBustBlog

Okay, I'll admit it. I watch CNBC when I should be trying to make money. What can I say? It's entertaining. On CNBC today, there are the usual cadre of long only guys talking their book. Don't get me wrong. There is nothing wrong with talking your book, after all that's all that I do. But there comes a point where you would want a little common sense to be thrown in there as well. Being long only, regardless of the trend of the market cycles and macro environment is akin to driving a car that can only make right turns. Seriously, it is a simple as that. Despite this undeniable fact, we still have the long only crew who help develop mentalities that produce what would be some fairly humorous happenstances if your money wasn't actually at stake.

For instance:

  1. Lehman went bankrupt yesterday. It's ratings get dropped severely - shortly thereafter???

  2. Goldman and Morgan get pummeled today and yesterday in the markets. I am sure I am the only one who had outright sell on Goldman (not to mention sell short). More than 100% in return later, who still has this company as a hold or buy. Please pundits, limit the bullsh1t on the "I'm in there for the long term" speeches. I'm in it for the long term as well. That doesn't mean that I'm willing to voluntary let me money scatter in the wind.
  3. Have you guys hear the "AIG is not insolvent, it simply has a liquidity problem." line yet? The inability to meet your obligations due to a lack of cash is called...... are you ready???........ INSOLVENCY!!!
    1. From Wikipedia: Insolvency means the inability to pay debts when they fall due.

      This is different to having negative net assets. A business can have
      negative net assets showing on their balance sheet but still be (cash flow - I had to add this for accuracy) solvent
      if ongoing revenue is able to meet debt obligations. Reggie comment: The article does not distinguish between cash flow insolvency and balance sheet insolvency...

      Insolvency is not a synonym for bankruptcy, which is a determination of insolvency made by a court of law with resulting legal orders intended to resolve the insolvency... Under the Uniform Commercial Code,
      a person is considered "insolvent" when the party has ceased to pay its
      debts in the ordinary course of business, or cannot pay its debts as
      they become due, or is insolvent within the meaning of the Bankruptcy Code.
      This is important because certain rights under the code may be invoked
      against an insolvent party which are otherwise unavailable.

So, not only is AIG insolvent, but so are many of its financial services brethren. This insolvency will not be assisted, at least significantly, by another rate cut. To add, the Fed's mandate is not to guaranty the bonuses of traders. The rate cut will placate the market for an hour or two, and then it will fall - just like it did with the last 3 rate cuts. It will also increase the risk of inflation. As partial evidence of the inability of rate cuts to significantly assist the insolvents in our financial system, I bring you excerpts from "
The Anatomy of a Sick Bank!".

Published in BoomBustBlog
Tuesday, 16 September 2008 01:00

Why isn't this called a bailout?

The government is not paying back any of my loans or margin?


Lehman Brothers Holdings Inc., the securities firm that filed the biggest bankruptcy in history yesterday, was advanced $138 billion this week by JPMorgan Chase & Co. to settle Lehman trades and keep financial markets stable, according to a court filing.

One advance of $87 billion was made on Sept. 15 after the pre-dawn filing, and another of $51 billion was made the following day, according to a bankruptcy court documents posted today. Both were made to settle securities transactions with customers of Lehman and its clearance parties, the filings said.

The advances were necessary ``to avoid a disruption of the financial markets,'' Lehman said in the filing.

The first advance was repaid by the Federal Reserve Bank of New York, Lehman said. The bank didn't say if the second amount was repaid. Both advances were ``guaranteed by Lehman'' through collateral of the firm's holding company, the filing said. The advances were made at the request of Lehman and the Federal Reserve, according to the filing.

Or how about this: AIG Loan Package Under Consideration by Federal Reserve, Reversing Course

The Federal Reserve is considering
extending a ``loan package'' to American International Group
, the insurer facing a cash shortage, according to a person
familiar with the negotiations.

The stance by federal regulators is a reversal from a
position they held as late as last night, and people with
knowledge of the talks are ``cautiously optimistic,'' said the
person, who declined to be identified because negotiations are

Senate Banking Committee Chairman Christopher Dodd warned
the Fed and Treasury against a rescue of AIG without checking
with him first, expressing anger about past incidents where he
was only informed afterwards. He also said he was skeptical that
AIG merited aid while Lehman didn't.

``Tell me why this situation is different from Lehman,'' he
said today. ``I'm willing to listen.''

Now, the markets will rally because excessively risky, insolvent companies are being bailed out by an increasingly socialist government. Let's count the bailouts - Countrywide???, Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, AIG??? Oh government, oh government, where is thou credibilty when thou decry no government assistance???

Published in BoomBustBlog

With Lehman in bankruptcy, AIG about to fail and WaMu and many regional banks about to implode, you can bet your Aunt Petunia's toe nails that CDS default events will be triggered left and right. Remember, the regionals have not crumbled yet, but it will come.

Lack of regulatory authorities in the credit insurance market

The valuation of CDS contracts by banks and other institutions are typically done based on highly complex statistical models as they are generally bought and sold in the over the counter (OTC) derivative market. The nonexistence of any exchange or centralized clearing agent where these insurance contracts trade results in their prices not being reported to the general public. Furthermore, as the CDS contracts are sold and resold again and again among financial institutions, an original buyer may not know that a new, potentially weaker entity has taken over the obligation to pay a claim raising doubts about the counterparty failure and the impact on its books.

The lack of regulations and proper settlement mechanisms in the CDS market saw the Aon Corporation (AON) book huge loss on its protection sold to Bear Stearns. Aon, having sold credit protection to Bear Stearns, had hedged itself by purchasing protection from Societe Generale but had to ultimately bear the loss as it was unable recover losses from Societe Generale.

Bear Stearns provided a loan of US$10 million to a Philippine entity and demanded the borrower obtain a surety bond from a Philippine government agency, the Government Service Insurance System (GSIS). Bear Stearns, to further hedge default risk on the US$10 million loan purchased protection contract from AON for US$0.425 million. AON, to hedge this risk purchased protection from Societle Generale for US$0.3 million believing it made a cool profit of US$0.1 million.

Published in BoomBustBlog

I really think that I will scream if I hear another pundit or regulator comment on how the injection of liquidity will help this or that bank or lending institition. Haven't we all learned by now that the problem is insolvency, not liquidity? The Fed has created an alphabet soup of lending programs, discount windows and mechanisms to provide literally unlimited liquidity to the banks, even the option to offer stock as collateral! That's right, the US government has become the world's largest broker dealer, offering margin lending for stock accounts, mortgage financing and M&A deal finacing and advisory.

From CNBC:

Investors will wake up to see their portfolios shrunk compared to close of trading on Friday and there will be some panic selling in the U.S. market Monday morning, but the Lehman collapse is unlikely to bring any more investment bank bankruptcies, Dennis Gartman, founder of the Gartman Letter, told CNBC.

Isn't this what was said when Bear Stearns blew up?!

Published in BoomBustBlog


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So, Merrill, who up until recently was the world's largest brokerage firm and investment bank, gets bought by Bank of America on the cheap (or maybe not so cheap considering the quality of its assets). Lehman prepares for a bankruptcy filing by midnight tonight, as its counterparties scramble to cross net trades. For those who don't realize it, those $70 billion or so of assets that allegedly did not have a credible bid, will now be dumped onto the market in a bankruptcy sale. Pundits are crowing that the Fed's credit life-line to Lehman will allow for an orderly liquidiation. Not happening... Lehman couldn't dump these assets as a going concern, so what they hell makes anyone think that a bankrupt Lehman hanging by a government credit line thread (which may not even be available since it may no longer be a going concern) as creditors bark down its throat for payment will have even a comparable time getting anything above a penny a pound for these assets? Boys and girls, the sh1t apparently has hit the fan. I've been working on this for a couple of days, but I'm going to release it early and unfinished since current events have made it even more pertinent and timely. Please excuse gaps in thought and logic since it is an unfinished work.

There has been a lot writing lately about the coming
collapse of the shadow banking system in the US, hence the global shadow
banking system. In lieu of repeating the arguments which have been made so many
times on the web (and in my blog),I will simply link to two of them. First,
there's the ever so cheerful
Nouriel Roubini
, and then this guy who I have never heard of but who appears
to mirror my thoughts
, and to a lesser extent this FT blog. The issue with the FT blog is not its accuracy, for it is on point, it is just the extent (actually, the lack thereof) of its bearishness. The good professor harps on exposure to real assest, mortgages, etc. combined with asset liability mismatch being the catalyst of the weaker banking players fall. I argure that all of the shadow banking system's universal I bank players are at extreme risk of failing (this was written right before Merrill Lynch agreed to be bought and Lehman prepared their bankruptcy filings - so you see I was right, 3 or the nations 5 top banks went bust or bye-bye in less than 6 months - the other two are on standby). All of the US I banks have asset liability funding mismatches, they all of leveraged exposure to popped bubble assets (real property, mortgage derivatives, leveraged loans, leveraged private equity), and most importantly, they do not report the economic risk assumed in the generation of accounting earnings. This is my argument for the short of Goldman Sachs (see the sidebar for related reading). An accurate reporting of economic risk assumed in profit generation on risk adjusted assets would removed the incentive to play the off balance sheet SIV games that hide the bulk of the surprises for the banking industry. Nobody really knows how much risk was taken to generate the accounting rewards reported quarterly, and no one really knows the quality of the assets "allegedly" being reported on. I know one thing for sure. That quality level is not very high.
Then again, we have the CDS dilemma, which I will get into in detail a little.

Is Lehman too big to fail?

Obviously not. It is failing, isn't it? The question of the day is, "Can it be allowed to fail? Lehman is very closely intertwined with US, UK and Eurozone banks through the CDS network. Either it, or one of the other 4 or 5 "quasi" bank failures coming down the pike will set this powder keg a kindle. Let's take a look-see at exactly what is making these banks go pop.

A comparison of the major US investment banks reveals they are cooking dinner with the same seasonings!

Why did Bear Stearns collapse just a few months ago? Contrary to popular belief, it wasn't liquidiy. Lehman has access to unlimited liquidity trhough tht government lending window. Bear Stearns, like Lehman, like Merrill Lynch, like Washington Mutual, like IndyMac Bank, like Fannie and Freddie Mac, like Goldman and Morgan Stanley, are insolvent - that is what's causing the malaise! A quick (historical - this was drafted in January) Bear Stearns drill down reveals the root cause. Notice the highlights in red representing the similarities among the various banks mentioned below. Keep in mind that the investment banks are basically giant hedge funds (in the guise of proprietary trading desks that include clients subscribers) who gamble their own capital along side that of their clients, with secondary fee-based revenue streams from activities such as M&A, securitization (used to be), and brokerage...

Level 2 and Level 3 Assets – Model Risk run amok!

risk, or the risk of the bank living in a spreadsheet in lieu of the
market, has already reared its head in the summer of ’07 with the blow
up of two of BSC’s hedge funds
, which have left them in litigation with
their own customers. Basically, many of the assets of the fund were
levered highly, and valued based upon modeled cash flows from assets,
and not from the actual tradable value of the assets. This is fine,
until you need to liquidate by selling assets. As luck would have it,
they found no market they felt was acceptable and were forced to mark
value down significantly
, approaching zero. It has also manifested
itself in the announcement that they will be
moving at least 7 billion dollars to the level three (the most
BullSh1+) category
. Bear Stearns has recently announced another hedge
fund blow up,
which doled
significant losses to investors and is attempting liquidation. For my
laymen’s plain English take on level 1, 2, and 3 asset accounting, see
the Banks, Brokers and Bullsh|+series (
Banks, Brokers, & Bullsh1+ part 1 for model risk,).

Level 3 Assets at 231% of Total Equity; Amongst the Highest on Wall Street

the top investment banks, Bear Stearns has one of the highest exposures
to the riskier class of assets. The company’s exposure to Level 3
assets further increased by $7 billion to $27 billlion as of 30
November 2007, representing almost 229% of its equity, as compared to
70% for Merrill Lynch for the same period. Bear Stearns also has a
$43.6 billion of MBS & ABS inventories of which $15 billion is in
the CMBS portfolio. In addition, Bear Stearns is exposed to riskier
assets through its arrangements with Special Purpose Investment
Vehicles (SIVs) having assets totaling $41 billion, of which $37
billion comprises Mortgage Securitizations.


the assets which makeup the Level 2 and Level 3 assets such as
distressed debt, non performing mortgage related assets, MBS, Chapter
13 and credit card receivable which are likely to decline in value, our
default probability ranges from 2% to 20% in the base and worst case
scenarios. Moreover, considering the addition of $7 billion from level
2 to level 3 assets in 4Q 07, we have conservatively assumed a base
case default probability of 2% on the Level 2 assets.

Published in BoomBustBlog

This is unprecedented. Bear Stearns, Countrywide, Merrill Lynch, and Lehman go poof. These are not you local banks on the corner, they are Primary Dealers. Consider yourselves warned - Morgan Stanley and Goldman Sachs are highly suspect!

That CDS domino effect that I warned you about will be here any minute. I doubt the revolution will be televised, though.

Let's look into just TONIGHT'S news:

Lehman goes bankrupt!

Lehman faces the possibility of liquidation and Merrill Lynch sold itself to Bank of America on a day in which the U.S. financial system was shaken to its core. The federal government's refusal to provide support to potential Lehman buyers prompted Barclays and Bank of America to walk away from talks. AIG sought to raise cash and craft a survival plan amid investor pressure.

Fed Plans Expanded Lending Facilities

The Federal Reserve is expected to expand its lending facilities, taking a wider array of securities, including equities, as collateral for its loans. (Fed statement)

document.write(uescEnt('• '))• Banks Roll Out $70 Billion Loan Program

NY Times Dealbook :

The American International Group is seeking a $40 billion bridge loan from the Federal Reserve, as it faces a potential downgrade from credit ratings agencies that could spell its doom, a person briefed on the matter said Sunday night.

Ratings agencies threatened to downgrade the insurance giant’s credit rating by Monday morning, allowing counterparties to withdraw capital from their contracts with the company. One person close to the firm said that if such an event occurred, A.I.G. may survive for only 48 hours to 72 hours.

A.I.G.’s sickly financial health emerged late into one of the most tumultuous days in Wall Street history. Lehman Brothers, the 158-year-old investment bank, is expected to file for bankruptcy protection Sunday night, while Bank of America has agreed to buy Merrill Lynch for $50.03 billion.

It has already raised $20 billion this year. But even that enormous capital raise may not be enough.

This just a glance at the front page of the Wall Street Journal. I have warned about these occurrences consistently for a year. And no, the worst is still not behind us. The commercial and regional bank failures have yet to really kick in. I see the house of Morgan being reunited.

Think about this, the Fed is now accepting stocks (that's right, common stock) as collateral for their high quality credit lines. That is ridiculously desperate. Just think about how volatile US stocks have been lately! The Fed is putting the US tax payer at EXTREME risk, and I don't think they wil do it without due cause. This means only one thing. Those two standalone I banks that are left to take advantage of the discount window are in some BIG trouble!

Published in BoomBustBlog
Sunday, 14 September 2008 01:00

To think the government said no more bailouts

Broke banks lend $70 billion

Where do these cash strapped banks get 70 billion from. They borrow it from the US tax payer through the Fed's credit line. So they drawdown $10 billion dollars each from the Fed (even though they have to scrape and beg to raise less than that in capital) using volatile, and in some cases worthless (can we say Washington Mututal) stocks as collateral, then turn around put that money into a fund to help banks that need to borrow from the Fed.

Okay, I want to know which one of you are stupid enough to fall for this one, this time?

Bank of America Agrees to Buy Merrill for $50 Billion After Shares Plunge

Lehman Says It Will Seek Bankruptcy Protection as Suitors, Government Balk

Fed Eases Loan Terms, Banks Set Up $70 Billion Fund in `Firebreak' Effort

Asian Stocks, U.S. Futures, Dollar Tumble on Lehman Bankruptcy; Banks Fall

Europe Shuns U.S.-Style `Active Role' in Boosting Economy, Bank Bailouts (Don't you believe it!!!)

Centro Shares Plunge to Record as Asset Sale Fails; Babcock, Allco Slide

(If you think CRE and the GGP types had a problem before, you ain't seen nothin' yet. Wild horses couldn't drag CRE loans out of these banks now)

Published in BoomBustBlog

From Bloomberg:

Treasury Secretary Henry Paulson and New York Federal Reserve Bank President Timothy Geithner met this evening with Wall Street executives to discuss this week's slump in the financial markets.

Securities and Exchange Commission Chairman Christopher Cox also took part in the discussions, New York Fed spokesman Andrew Williams
said in a statement. The talks with ``senior representatives of major
financial institutions'' were held at the Fed's New York district bank,
he added, declining to identify the executives.

The Wall Street Journal reported earlier that Morgan Stanley Chief Executive John Mack (HMMMM!!!!) and Merrill Lynch Chief Executive John Thain participated in the discussions with Paulson, Geithner and Cox.

New York Fed meeting came as Lehman Brothers Holdings Inc. continues to
seek a buyer or buyers for the investment bank that lost 77 percent of
its value this week.

We all know what is happening to Lehman, and if you followed this blog you knew it about 7 months ago. We also know why Thain from Merrill was at that meeting. But why was John Mack there??? Well, registered users and subscribers know from the readings in the sidebar.

Banks, Brokers, & Bullsh1+ part 1

Wednesday, 19 December 2007 | Reggie Middleton

A thorough forensic analysis of Goldman Sachs, Bear Stearns, Citigroup,
Morgan Stanley, and Lehman Brothers has uncovered... Last week, Morgan
Stanley called Citibank the “short play of...

The Riskiest Bank on the Street
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)

Key highlights of my research on the "Riskiest Investment Bank on the
Street": The Riskiest Bank on Wall Street – Morgan Stanley has US$74
billion of Level 3 assets, over 200% of its eq
Monday, 11 February 2008

A closer look at the exposure of the other brokers
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)

...- Who has the most of their assets tied up in illiquid Level 3 as a proportion to tangible equity? You guessed it, The Riskiest Bank on the Street. Now, they do have a decent amount of liquidity the ...
Sunday, 16 March 2008

19. On the insolvencies of non-bank financial institutions
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
...Bullsh1+ part 1 Banks, Brokers, & Bullsh1+ part 2 Money Panic
Bear Fight The Breaking of the Bear The Riskiest Bank on the Street Here comes the CRE Bust (Quip on Lehman Brothers)...
Tuesday, 18 March 2008

20. Quick Morgan Stanley update from my lab
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
This is a refresher to the The Riskiest Bank on the
Street piece that I posted a few months ago on Morgan Stanley. Let me
get straight to the salient points. High exposure to lev
Thursday, 20 March 2008

21. Early morning scan of events
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
For those that haven't noticed, I've begun sharing my early morning
news and data routine with the blog. Here goes Monday moring EST. Is
the Fed running out of ammo? Reserve
Monday, 31 March 2008

22. Reggie Middleton on the Street's Riskiest Bank - Update
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
This is the update to my forensic deep dive analysis of Morgan Stanley. It is still, in my opinion, the "riskiest bank on the street". A few things to make note of as you browse through my opinion a
Sunday, 06 April 2008

23. Banks, Brokers & Bullsh1t 3.0: Shenanigans at Morgan and Lehman
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
I've been promising to give an illustration of the shenanigans being
played by the commercial and investment bank's for some time now, but
I've been quite busy working on my entrepeneurial pursuits
Wednesday, 16 April 2008

24. I warned you about the risk of those I Banks
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
...ive counterparty and credit risk to imperfect hedges to dead and depreciating assets held off balance sheet: The Riskiest Bank on the Street Is this the Breaking of the Bear? Banks, Broke...
Wednesday, 21 May 2008

For those who are not part of the inner caucus:

Morgan Stanley has US$74 billion of Level 3 assets, over 200% of its
equity, which is the highest amongst its peers. Although the Level 3
assets have declined from the previous quarters owing to huge
writedowns, the reclassification of assets from from Level 2 to level 3
category continues as the liquidity for the troubled mortgage paper
drys up.

Increasing level 3 assets likely to cause further losses:
Morgan Stanley’s hard-to-value assets, represented by level 3 assets
have grown persistently, rising from 4.3% of the total assets in 1Q2007
to 7.0% in 1Q2008 partly off the transfer of assets from level 2 to
level 3 due to unobservable market inputs. As liquidity crisis and
credit spread widening continues to hamper the global financial
markets, we expect the increasing proportion of level 3 assets in
Morgan Stanley’s balance sheet to translate into higher losses and
asset write-downs for the company. Also noteworthy is the fact that
Morgan Stanley’s level 3 assets as a proportion of its shareholders’
equity are the highest in its peer group which makes it one of the most
vulnerable companies to be hit by continuing credit market turmoil.

Morgan Stanley’s significant level 3 exposure and high leverage remain a cause for extreme concern

Large write-downs likely due to level 3 assets exposure: Morgan
Stanley’s level 3 asset exposure, which stood at 261% of its equity as
of February 29, 2008, is likely to cause a significant drag on its
valuation in the near future. These assets, for which the bank uses
proprietary models to gauge their value, will witness the largest
write-downs of all asset categories amid the current credit market
turmoil. When compared with other leading investment banks, Morgan
Stanley clearly stands out to be the most vulnerable to falling values
in these hard-to-value assets. It is worthwhile to mention that Bear
Stearns, which last month witnessed significant erosion in its market
capitalization, had level 3 assets equal to 239% of its equity, next
only to Morgan Stanley. Although the Fed has mitigated liquidity
concerns of investment banks in significant part, the balance sheet
solvency is a far more difficult problem to address – and one in which
Morgan Stanley leads the pack.

Bank Level 2 Assets Level 3 Assets Shareholder Equity Total Assets Level 2 Assets-to-Equity Level 3 Assets-to-Equity Leverage (X)
Citigroup $934 $133 $114 $2,183 822% 117% 19.21
Merrill Lynch $768 $41 $32 $1,020 2405% 130% 31.94
Lehman Brothers $177 $39 $26 $786 687% 152% 30.59
Goldman Sachs $277 $72 $47 $1,120 586% 153% 23.71
Morgan Stanley $226 $74 $31 $1,045 723% 236% 33.43
Bear Stearns 227 $28 $12 $96 1926% 239% 8.15
Based on latest quarterly filings and transcripts
Let's pay close attention to the chart above. Bear Stearns flamed out in March. I warned you twice that they were going to flame out in January. Stearns is the only company that has (had) a higher L3/equity ratio than Morgan Stanley. The next runner up after Morgan is Lehman Brothers. 'Nuff said. Then after Lehman we have Merrill, the Street's latest whipping boy. Who sports the highest adjusted leverage on the Street (includint what was Bear Stearns)? I'll give you two guesses...
the growing proportion of level 3 assets in Morgan Stanley’s total
asset exposure is raising investors’ concerns over expected write downs
in the coming quarters. The bank’s level 3 assets have increased partly
due to re-classification of assets from level 2 to level 3 on account
of unobservable inputs for the fair value measurement. During 4Q2007,
Morgan Stanley re-classified $7.0 bn of funded assets and $279 mn of
net derivative contracts from level 2 to level 3. Morgan Stanley’s
level 2 assets-to-total assets ratio declined to 5.2% in 4Q2007 from
8.9% in 1Q2007 while its level 3 assets-to-total assets increased to
7.0% in 4Q2007 from 4.3% in 1Q2007 indicating growing uncertainty
associated with valuation of assets not readily marketable. The trend
can be expected to continue in the coming quarters as uncertainty
associated with realizing values from illiquid assets continues to grow.
The following is excerpted from a post that I made in April - most prescient. Remember, back in April most sell side houses had buy recommendations on Morgan AND Lehman with targets in the 60 dollar range. With friends like those, who needs enemies.

On a different, but related, note we seem to have Lehman playing hide the sausage with losses.

The most recent 10Q has a realized gain of $695 million in the Corporate Equities line for Level II assets, (see Banks, Brokers, & Bullsh1+ part 1 for bullsh1t updates - I just knew I would get to use this link againCool).
Comparing this to prior quarters shows a significant jump, averaging
considerably less that $70 million, with the largest being $135
million. This is even more fishy considering equities on a global basis
were trending downward for the reporting period at hand. I know that
level III is supposed tto represent assets with no observable inputs,
but come on now, where were these equities as the global markets sank,
Mars? Okay, maybe Pluto since Mars may be a little less hospital to
financial entitiy life forms.

We also have gains of approximately $550 million from proprietary investment activity.
I read this as benefits from playing with adding assets to level three
at values they "think" are higher than last reporting period since
there are no observable inputs to tell them otherwise (except for a
global drop in fixed income and equity prices - but why let that rain
on the parade). We now have a new meaning for the term prop desk.

These unrealized Level III equity asset gains were millions of dollars
more than what Lehman reported as pretas income for the quarter. That
should scare anybody long in the stock. If it it doesn't make you wet
your pants, just remember that they also booked about $600 million in
FAS 159 gains to arrive at about a $500 million profit for the quarter.
FAS 159 gains are for the most part phantom gains (this was addressed
in detail in the Reggie Middleton on the Street's Riskiest Bank - Update,
and I will excerpt it llater on in this missive as we illustrate MSs
games). Take these two tidbits of data in perspective, and Lehman took
a very deep loss last quarter, and rallied hard on the their results,
on top of it. I believe they were a good short before the price pop,
and they are an even better short with the stock 20% higher. I may
even consider welcoming an SEC investigation against me for shorting
the stock. We can open my trading books, research and blogs, and in
exchange we can also open Lehmans books to see if my research,
observations and assertions had any merit or empirical standing - Uh
Oh! Here comes that Jack Nicholson effect again, after all, all we want
is the truth. "The TRUTH! The TRUTH! YOU CAN'T HANDLE THE TRUTH!!!" I love that scene...

Lehman and it's MSRs: Multiple Statutory wRightups!

With Bear Stearns gone (Is this the Breaking of the Bear?),
Lehman is the undispute king of MBS on the street. They are, as a
result of being so involved in the industry, rich in MSRs (it really
stands for mortgage servicing rights, I was just being an asshole in
the subtitleFoot in mouth,
or was I?). Lehman wrote UP the value of these assets. Granted, with
the current financing home sales market slowing to a crawl, prepayments
have dropped considerably, giving a plausible gain to these rights
since they will not be eliminated through loans being retired, but their amortization rates fell below the reduced (by one third) long term assumptions. Thus, they are not only kitchen sinking for this quarter, but this is a) a non-cash gain
(yeah, like the level III hide the sausage game and the FAS 159 benefit
- so "Where's the cash?"), and b) supposedely a hedge (albeit an
imperfect one) against Alt-A impairments - we may see some horrow
related to this in the future.

Morgan Stanley guys teasing the Lehman guys - "My sausage is bigger than yours..."

The Reggie Middleton on the Street's Riskiest Bank - Update
piece was posted right before Morgan reported. No need to fret though,
there were no surprises and they are still the riskiest bank on the
street. I would like to not that many sell side instutions have buys on
Lehman and Morgan - some with price targets of $65! Whaaaatttt???!!
Methinks someone may be sniffing the ink off of the analyst reports
before it dries... Since I am just a neophyte individual investor and
blogger, I will try not to be intimidated by the big boys, but I must
disagree. Consider me the diminuitive captain contrarian.

In the recent 10Q, Morgan's gains from level III assets were exactly 100% more than the level III asset gains for ALL OF LAST YEAR!
This was during the roughest and most illiquid structured product,
fixed income, and most volatile equity quarter in recent history, if
not ever. Hmmmm! I wonder... Oh yeah, they get to determine the values
of level III assets, not the market (Banks, Brokers, & Bullsh1+ part 1)
- and did they need to do some constructive determining this quarter.
Instead of going into MS assets indepth, I will defer to the full
report: Reggie Middleton on the Street's Riskiest Bank - Update,
but will point out a few interesting tidbits. The report shows a
constant trend of shifting assets from Level II to Level III,
presumably as they become impossible to value due to illiquidity, in
other words - are worth less - this increase is despite impairments
incurred in extant level III assets. It appears that as these assets
are shifted from level II to III, they may also be revalued to the

Published in BoomBustBlog

This is the Fannie/Freddie recap, and their addition to the Asset Securitization Crisis. They were taken over just before they had to roll over a $223 billion of debt. Nick of time financing measures...

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
  17. The Anatomy of a Sick Bank!
  18. Doo Doo Bank 32 Drill Down 1.5: Wells Fargo Bank
  19. GE: The Uber Bank???
  20. Sun Trust Forensic Analysis
  21. Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street
  22. Goldman Sachs Forensic Analysis
  23. American Express: When the best of the best start with the shenanigans, what does that mean for the rest..
  24. Pt one of three of my opinion of HSBC and the macro factors affecting it
  25. The Big Bank Bust

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  • Fannie Mae & Freddie Mac - Who will finance their future?

Fannie Mae and Freddie Mac were formed as government agencies to expand home ownership and provide stability and liquidity to the secondary mortgage market. The continued decline in housing prices in the US has resulted in huge write downs in the residential mortgage backed securities market. The S&P Case Shiller home price index has been declining consecutively for the last 23 months; it fell 0.5% in July 2008. The imminent threat to Fannie Mae's and Freddie Mac's combined debt of US$1.59 trillion, and lack of financing options have raised doubts about the viability of mortgage companies.

Published in BoomBustBlog