Financial, Real Estate, Stock Markets Trends and Current Affairs

From the WSJ:

Stocks were unable to
hold onto Tuesday’s 400-plus point rally in the Dow industrials and
attendant rallies in other indexes, and steadily marched lower through
the afternoon, until news of a lawsuit filed by Merrill Lynch against a
unit of bond insurer Security Capital Assurance, alleging the company
is trying to avoid obligations of up to $3.1 billion under seven credit default swaps.
Merrill’s own CDS widened on the news, moving to 250 basis points from
210 basis points, according to Phoenix Partners Group, and the stock
market dove, with the Dow giving back a good lot of the previous day’s
massive rally.

I stated several
times in the comments that the CDS market may very well lead us into
the next serious leg down. Many of the guys who wrote these either
don't have the cash to pay up or are wrapped up in hedges using CDS
which will easily get @#$@ed up once one leg of the hedge falls.

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.

From CNBC.com :

Lehman Brothers Holdings is unlikely to face the kind of liquidity crisis that brought down Bear Stearns
over the weekend because of the Federal Reserve's decision to let Wall
Street brokerage firms borrow directly from the central bank, CFO Erin
Callan told CNBC. It appears that in the short
term, she is right. But it also shows a big hole in both the business
model of the I banks and a dire macro situation that had to be averted
by the Fed. This is not a positive sign.

"It
certainly takes the question of liquidity off the table," Callan said
in a live interview. "I think [the Fed's decision is] the great news
that happened over the weekend." Again, I agree.

Callan said Tuesday that Lehman , which reported better-than-expected earnings on Tuesday but
has faced persistent rumors of a Bear Stearns-type liquidity crisis,
plans to borrow from the Fed through the discount window. This
is problem indicator number one. After harping on how strong your
liquidity position was and how you didn't need money, why in the world
would you go to the Fed for money, and particularly why so soon??? I
know they probably need some to help fund the accounts that left you
for fear of insolvency.

Lehman
followed up on Callan's announcement by borrowing from the window
within minutes of her appearance. At 5 p.m. New York time, Lehman
borrowed $2 billion, sources said -- a small amount relative to the
bank's $375 billion balance sheet. Hmmm, this smells very fishy. They just got finished invoking the "Short me, Please" phrase , as well.

Goldman Sachs also used the discount window late Tuesday, sources said, but it wasn't clear how much money the investment bank asked for. Again,
highly suspicious. This is a tool that wasn't invoked since the Great
Depression! Doesn't this raise speculative alarms with ANYONE besides
me?

"It’s going to be actively used" by many brokerages, Callan said. “We’ll be a participant. It’s a great opportunity." This
shows that many brokerages were either insolvent or on the brink of
insolvency. Since I am probably not the only one that sees this, I
expect credit risk monitory will increase sharply, thus making banks
much stingier. Or is it that every primary dealer is a good credit risk
since they are all backstopped by the Fed now. This is an interesting
conundrum.

The Fed announced the new lending facility for Wall Street firms on Sunday night, shortly after it helped facilitate the sale of Bear Stearns to JP Morgan Chase . And
if that deal doesn't go through, and is edged into bankruptcy, who will
honor BSC's CDS obligations? After all, I really don't see Joe Lewis
are the burned and spurned employees approving the deal, and they
collectively control 40% of the vote!

Under
the plan, primary dealers -- big Wall Street firms that deal directly
with the Fed in financial markets -- would be allowed to borrow
directly from the Fed for at least the next six months.

The Fed,
which normally lends through its discount window only to banks that
take deposits, can lend to nondepository institutions under special
circumstances. It last did so in the 1930s. The Great Depression!

In
the CNBC interview, Callan acknowledged that Lehman has had a difficult
time recently amid all the rumors that it's in financial trouble. I
heard you were losing a lot of accounts and a lot of counterparties
were quite skeptical, yet it appears as if you did a professional job
in handling the situation.

"We
know we're always the next name on the list," she said. “There isn’t a
great appreciation for the fact that we’ve evolved our franchise
dramatically over the last decade. In fact, we’ve structured our
liquidity exactly for this kind of situation. So, we feel like we’re in
a good spot."

However, Callan said
Lehman's difficulties aren't over. “Expect to see more [writedowns] in
the second quarter," she said. "Later in the year things will start to
stabilize more in asset prices.” And how do
you know this? The cause of the asset price destabilization, housing,
will probably not stabilize later in the year, so who do you think the
derivative written on top of housing will? What about the things that
are just starting to get worse: leveraged loans, high yield securities,
consumer finance securities written at the apex of an easy money bubble
that is popping in a recession, high yield securities with naught the
covenant protection of the past...

“It
feels like, at this point, the greater part of the calendar year will
be rough sledding and I wouldn’t expect it to feel pretty stable until
2009.”

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:

• 
  Are the Mortgage Insurers in Serious Trouble? 9/3/2007
  

• A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton -11/13/2007

• 
  Tie-in to the Halloween Story11/21/2007
  
• 
  Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion in Equity 11/29/2007
• Follow up to the Ambac Analysis 12/4/2007

More on Insurers and Insurance

• 
  The Commercial Real Estate Crash Cometh, and I know who is leading the way!

More on Commercial Real Estate

• 
  Lennar Insolvent: Enron redux???

More on Residential Real Estate

• 
  Banks, Brokers, & 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)
• Is Lehman a Lemming in Disguise (from a conributing individual investor)
• Liquidity vs Insolvency
• Bear Stearns Bear Market, Revisited

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.

According to the WSJ.com, Lehman did a phenomenal job at damage control, most likely learning their lesson from Bear Stearns.

Goldman
and Lehman beat estimates, but that is not as positive as the press is
making it seem. Estimates were lowered. If you lower the fence, it
doesn't mean you jumped higher to get over it. They lost a lot of
money on illiquid securities. The Fed's work has backstopped companies
against liquidity runs, but after Bear Stearn's, the banks trust each
other even less than they did last week.

We are sure to get a
dead cat bounce here. I am still quite bearish on the investment
banking industry, though. The revenue and earnings prospects have
diminished significantly, and the cause of this mess (devalued housing)
is still on a sharpening downward slide. The key is to look at the
results of the mortgage insurers, mortgage bankers, and homebuilders to
see where the bankers will be the following quarter.

I also
believe the leveraged loan, consumer finance and high yield markets
will start showing evidence of the cracks that have been forming over
the last year or so.

And those BSC calls that were going for a few pennies yesterday were a
good deal when nobody wanted them. Contrarian investing at its best!!!

From CNN:

British billionaire Joe Lewis is working to
block JP Morgan Chase's 236 mln usd takeover of peer Bear Stearns
(NYSE:BSC) in order to negate a 1 bln usd loss he now faces as a major
shareholder of the ailing investment bank, the Daily Telegraph reported.

Lewis, whose Tavistock Group is Bear's second largest investor with a
9.4 pct stake, is understood to be deeply unhappy with JP Morgan's 2
usd-a-share offer, the newspaper added without naming sources.

Lewis is involved in a number of alternative strategies, including
talking to potential rival bidders who might act as a white knight, it
said.

Other options he is considering include voting against JP Morgan's
offer at the scheduled shareholders' meeting, something that would only
work if he were to garner the support of other investors.

JP Morgan bought Bear Stearns for $230 something million, about 7%
of its closing price Friday, and about 2% of what it was trading for 2
weeks ago. On top of it, this was an all stock deal with the government
funding more tha 100% of it (the Fed will be financing $30 billion of
non-liquid BSC securities, the back stop that I said would happen).

To
put this into perspective (I'm a NYer, so I am quite familiar with the
landscape), the BSC headquarters is worth at LEAST $1 to $2 billion.
Between the clearing infrastructure, asset management, structured
product assets and real estate, there is at least a $1.5 billion
immediate gain here. How much that will be offset by litigation risk is
an unknown. The CEO got up on CNBC and clearly told the world that BSC
had no problems. Lawyers must be getting a boners in real time.

I
will admit to a big mistake that I made. I hedged my gains at $35
Friday to lock in the profts. Those calls are literally worthless now.
I shouldn't be complaining since my gains as of this post are averaging
over 800% on this trade, it was the largest position in my portfolio,
and that was after taking profits last week. Just thought I would be
honest and let everyone know that I am far from perfect, thus as I have
said so often, no one should be taking anything I say as investment
advice.

Now, as for Monday's trading.... I am not a trader, and
I believe in medium to long term investment horizons, but there is a
LOT of opportunity to be had here. Lehman is probably going to get a
drubbing. Morgan Stanley is being overlooked by the Street. Citibank
will get no love. I already covered on WaMu, with all of the
opportunities abound, I don't believe that I should be trying to dabble
below $10 when I have ridden shares down from last year in the $30's.

I
fear Goldman will be seeing a lot of devaluation. Don't forget the
companies that we have covered earlier in the blog. There financing is
damn near gone. GGP, the builders, etc.

The Fed is working hard
to help the country. That is undeniable. They have cut rates, extended
financing directly to non-banks, cut more rates - but, and as I
thought, the markets are ignoring these actions and driving financials
down and commodities up.

Lehmans asset make up will make it a
target in US trading. I will probably attempt to expand my position and
will be willing to pay premiums. My small position is quite profitable
already. I will attempt to expand the financials on my list in
aggregate, and MS (who is my 2nd largest position in the financials)
will be expanded as well.

One thing of note - The Fed's attempts to prop up the market should
help most banks, but the issue is that the bank's problems are that of
solvency and not liquidity. Liquidity problems have popped up, but they
are a consequence of the market being fearful of insolvency. The Fed
has created a limited backstop against general liquidity issues, but if
there is another run on the bank the Fed will not be able to afford to
stop it. Even if they could, they can't stop all of them by supplying
money. If there is a run on the bank, Lehman is next in line. I mention
this because if you really read my pieces - Banks, Brokers, & Bullsh1+ part 1
and Banks, Brokers, & Bullsh1+ part 2 you should walk away appreciating the risk between large private
investors and the I Banks. The I banks are starving for liquidity to
balm their solvency issues, so if they get money from the Fed you can
bet your booty that they will not be lending it back out (I was told that the banks were told by the Fed to allow their clients to borrow through them to the Fed window, but seeing is believing). They will
also be very jittery about collateral and credit risks, which means
more margin calls. The calls will be devastating. That means that if or
when banks start calling in collateral, the crash just may occur in the
hedge fund/private institutional investor arena before the actual I
bank arena. I that happens, the collateral will devalue futher as
deleveraging occurs, and it will put a liquidity strain on the I banks
again as they bang against the Fed's lending facility. I can't
guarantee this will happen, but it is a distinct possibility.

The BSC employess own 1/3 of the shares outstanding, and most of them
have lost at least 98% of thier company stock wealth. Would you approve
the deal if you were an employee or try and shop it around? Just a
question to ponder.

"Please
be advised that current margin requirements for Lehman Brothers
Holdings Inc (LEH) are currently under review by our Risk Management
group and will likely be increased shortly. Please take appropriate
actions and manage your risk accordingly."

Risk
management is expecting a lot of downward pressure and the word is at
least a few institutional client have left the bank. I am sure Lehman
is probably hitting the Fed fund window. I wonder what the mentality of
their counterparties are. The issue is not whether you think they are
sound or not, but whether it is worth the risk to find out. I know I
wouldn't take the chance, despite the fact the risk is not extravagant,
it is still more than my tiny operations can afford.