So, thus far we have had a massive real asset bubble fueled by easy credit, low interest rates and low inflation. We have had that bubble burst, inflicting severe damage in the commercial, investment, mortgage, and shadow bankin system as well as the real asset markets. Despite this, there is still a large overhang of inventory in real assets (dead weight), low demand, and cap rates are still near historic lows.


The Threats from Infation are Quite Real

Well, I believe a spike in inflation, hence interest rates, will force cap rates upward and do what he investment public has failed to do thus far - and that is create a realistic pricing environment for both real assets and the credit derivatives that financed them. This will absolutely wreck margninal banks and the not so marginal banks who aren't doing that well - even in the zero interest rate environment promoted by the fed. So if the banks are sick now (see The Anatomy of a Sick Bank!) imagine how they will fare with the disease of inflation creeping up their backs. Since they power the real asset market, and the real asset market is still in the throes of bubble pricing, what happens next??? Think the S&L crisis! See the following excerpts from Reggie Middleton on the Assset Securitization Crisis for my take on how we will make the S&L Crisis look like an episode on Sesame Street. For those that remember or research, it was the rise in interest rates that pushed the S&L's over the bring - althought they probably had it coming anyway.

  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. 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 thrifts are in deep doo-doo!
  10. A little more on HELOCs, 2nd lien loans and rose colored glasses
  11. Capital, Leverage and Loss in the Banking System
Published in BoomBustBlog
Monday, 16 June 2008 01:00

GE: The Uber Bank???

I'm taking a closer look at GE, the industrial cum uber bank
bellweather of the Fortune 500. See the following draft overview, to be
followed up by a full forensic analysis. I apologiz, for I've had this
on my desk for a while and forgot to post it and was reminded about it
when a sell side analyst downgraded GE this morning.

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General
Electric (GE)

General
Electric share price has declined 22% in the last six months

image001.jpg

The General Electric share price has taken
significant beating in the last six months and has fallen 22% on account of its
exposure to the financial services business and currently trades at US$29.05
per share. GE’s share price declined almost 13% on 11 April 2008 as it reported
a significantly lower than anticipated 1Q 08 results. The share price has
fallen by almost 21% since the announcement of its 1Q 08 results.

Published in BoomBustBlog

This is a DRAFT of part 3 of Reggie Middleton on the Asset Securitization Crisis – Why using other people’s money has wrecked the banking system: a comparison to the S&L crisis of 80s and 90s. As was stated in the earlier parts, I periodically have third parties fact check my investment thesis to make sure I am on the right track. This prevents the "hubris" scenario that is prone to cause me to lose my hard earned money. I have decided to release these "fact checks" as periodic reports. This installment should be very illuminating to those who are not familiar with the CDS markets. I urge discourse, conversation and debate. To me, it is necessary to make sure the world is as I percieve it. The recent bear market rally took back a decent amount of the directional, unhedged profit (that's right, I'm a cowboy), but it appears that is over and we will soon resume our descent back into reality. Just in case, let's review some history. I will also release some of my personal bank short research to illustrate how I am implementing these expected stresses to the banking system to my advantage.

The Current US Credit Crisis: What went wrong?

  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. You are here =>The counterparty risk analyses – the counterparty failure will open up another Pandora’s box
  4. To be Published: The consumer finance sector risk is woefully unrecognized
  5. To be Published: An oveview of my personal Regional Bank short prospects
  6. To be Published: Credit rating agencies – an overhaul of the rating mechanism
  7. To be Published: US Federal reserve to the rescue

And now, on to the report...

Emergence and the extraordinary growth of the CDS market

Innovation in the financial services industry created the Credit Default Swap (CDS) market to allow banks to hedge their risk as well as speculate on the health of any company. The evolution of CDS from the time it was first introduced by JP Morgan’s Blythe Masters (Head of Derivatives Department) in 1995 has been exceptional. The CDS over the counter derivative market has grown from US$900 billion in 2000 to US$45 trillion in 2007, almost twice the size of the US equities markets. The US$45 trillion market value of CDS contracts has grown more than 10 times of US$5.7 trillion corporate bonds which it insures. The major players in the CDS market are the commercial banks as its business evolves around the credit risks on the loans its disburses to corporations. The CDS market allows banks (theoretically) to transfer risk without removing assets from its books and without involving the borrowers. Credit default swaps also help banks to diversify their portfolio and gain exposure to various industries and geographies.

Insurance companies and financial guarantors emerged as dominant players in the CDS markets as net sellers of credit insurance protection. Insurance companies and the financial guarantor industry are the big sellers of protection in the CDS market, with a net sold position of US$395 billion and US$355 billion, respectively at the end of 2006. In addition, global hedge funds have emerged as active players in the CDS market. According to Greenwich Associates, the hedge funds are responsible for driving nearly 60% of all the CDS trading volume and 33% of the Collateralized Debt Obligations (CDOs) trading volume.

CDS has emerged over the last few years as an important tool to manage credit risk and has allowed banks to offset risk from their lending and bond portfolios. CDS has similar risk profile to a corporate bond. However, unlike a corporate bond the CDS does not necessarily require an initial funding which helps to build leveraged positions. Credit default swaps also assist in entering into a transaction wherein the cash bond of the reference entity of particular maturity is not available. In addition, by buying credit insurance (protection) of any reference entity, it provides the investors an opportunity to create a short position in the reference entity. Consequently, CDS having all these unique feature evolved as an important tool to diversify or hedge one credit portfolio and even take a long or short call on any company.

The two important factors driving the growth in the CDS market has been the strong US economy growth post 2001 and the low interest rate environment which has allowed for refinancing opportunities for marginal borrowers and deals that may have gotten into serious trouble without such a low cost capital environment – both resulting in very few corporate defaults thus encouraging banks to underwrite more credit insurance. The banks found it to be an attractive and low risk method to make profits since the number of failures were relatively few as the economy was in strong shape. In addition, the advent of speculators in the credit insurance market was a key growth driver for the CDS market as these contracts provided an alternative to bet on the company’s health. These instruments provided speculators a means to take short or long positions depending on their analysis of the company’s future performance.

Functioning of the credit insurance market

In a CDS transaction, the buyer and the seller of credit insurance protection enter into a contract wherein the buyer pays a fixed premium for protection against a certain credit event such as a bankruptcy of the reference entity, or default on the debt issued by the reference entity. Generally, there is no exchange of money between the two parties when they enter into the contract, but they make payments during the term of the contract. The key terms in the contracts entered between the parties are:

Published in BoomBustBlog

The spillover from the financial world to the real economic world happened as a result of tightened credit. The banks are not very generous with credit, despite a lower fed funds rate and access to the discount window. Credit availability is what drives business (and consumer) investment, as it has done in excess during the recent boom, and the lack of which will will cause a dearth of business and consumer activity that will prolong the recession.

In addition, the very real threat of higher rates, real or nominal, could very well damage banks even more. It was interest rate volatility that pushed lenders over the edge in the S&L crisis, and the extreme inflation that we are witnessing now could very well force the Feds hand in regards to rates. Volcker's predecessor was forced to push rates to 20% during a slow economy after dropping them too much in an attempt to stave off recession, but instead causing a worse one due to highly inflated prices which Volcker inherited. We shall see what Bernanke does. He surely knows that an increase in rates will quicken many insolvent bank's demise. In the following excerpts, all red font comments and graphics are mine.

From the lastest Federal Reserve Board Senior Loan Officer Opinion Survey on Bank Lending Practices: [We] queried banks about changes in terms on commercial real estate loans during 2007, expected changes in asset quality in 2008, and loss-mitigation strategies on residential mortgage loans. In addition, the survey included a new set of recurring questions regarding revolving home equity lines of credit. This article is based on responses from fifty-six domestic banks and twenty-three foreign banking institutions. In the January survey, domestic and foreign institutions reported having tightened their lending standards and terms for a broad range of loan types over the past three months. Demand for bank loans reportedly had weakened, on net, for both businesses and households over the same period. This tightening covers price and non-price characteristics for commercial and consumer loans over real estate, secured and unsecured lending and credit lines. A very broad spectrum tightening at a time when demand is weakening.

From Wolfgang Münchau at FT.com: "So this crisis is about to end, right? There are two failsafe ways to justify a solid dose of optimism: define the crisis in a sufficiently narrow way; and, even better, look at the wrong crisis. In that spirit I am happy to state my optimism about the prospective end of the subprime crisis. But this would be disingenuous. It is no accident that our multiple crises – property, credit, banking, food and commodities – have been happening at the same time. The simple reason is that they are all part of same overriding narrative. The mother of all these crises is global macroeconomic adjustment – a rare case, incidentally, where the word “crisis” can be used in its Greek meaning of “turning point”.

It is a huge global macroeconomic shock. How long the financial part of the crisis will go on will depend to a large extent on how bad the economic part of the crisis gets. The economic part of the story started more than a decade ago with a liquidity-driven global boom. Property, credit and equity bubbles were all part of this.

If excess liquidity was the ultimate cause of this crisis, the real estate sector was its most important driver. Experience shows that housing cycles are long and symmetrical: downturns last as long as upturns. We also know from the past that house prices undershoot the long-term trend on the way down, just as they overshoot it on the way up. You can see this quite easily when you look at long-run time series of inflation-adjusted house prices for several countries.

The last property downturn in the US and the UK lasted some six years. This is not a prediction of what will happen this time, more like a best-case scenario – because this bubble has not only been more intense than previous ones; it has also bubbled on for longer.

But even if we take six years as an estimate of the peak-to-trough period, that means the housing downturn will last until 2012 in the US and a couple of years longer in the UK. It is difficult to see how either of these countries could grow close to trend as long as the housing market is in recession.

When you look at the global macro side, you are looking at similar timescales of adjustment. An important part of the adjustment will be a rise in the US and UK household savings rates. That, too, might take several years to accomplish, during which period economic growth could be below trend.

The really important question about the US economy is not whether the official recession starts in the first or second quarter, but how long this period of economic weakness will last overall. In Japan and Germany macroeconomic adjustment of similar scale took more than 10 years, starting in the 1990s. Even if you believe that the US is structurally stronger, the country will probably not replenish its savings in a couple years.

If global inflation rises, as I expect, this process will become even more difficult. The central banks will have less room for manoeuvre. Fiscal policy is constrained, which leaves the exchange rate as the main tool of adjustment. This would necessitate a weak real exchange rate during the entire period of adjustment.

Obviously inflation would make everything worse, and our future scenarios will depend critically on the inflation outlook. A rise in inflation might alleviate the pressure on some mortgage holders, but is not a good environment for a country to build up savings. If higher inflation were tolerated by the central bank, it would clearly prolong the macroeconomic adjustment process. If it were not tolerated, interest rates would go up and we might experience a re-run of the 1980s. It would get a lot worse before it got better.

Either way, adjustment would take time. Would you really want to predict that under any of those scenarios, the worst was already over for a fragile financial sector? There may be no global financial meltdown. But our multiple crises could easily return with a vengeance, like one of those bloodstained image001.gifvillains in a horror movie who rises to fight his last battle.

It will end at some point, but several pockets of the financial market remain vulnerable in the meantime: US government bonds (under an inflation scenario); US municipal bonds (if the downturn is severe and long); several categories of credit default swap; credit card debt securities among others.

Our macroeconomic adjustment is not going to be as terrible as the Great Depression. But it might last longer. There will be time for optimism, but not just yet.

I had an email discussion with an analyst and blog regular who brought up the topic of inflation and real estate. Academically, inflation is supposed to be good for real estate prices and can actually drive up the price of real estate without driving up the cost of debt, thus allowing the Fed to "infate" certain insolvents out of insolvency. The problem is, too often reality hits. When inflation is rapid and extreme, it actually hurts holders of real estate. For those who hold income producing properties, it drives up the cost of owning and/or maintaining the property faster than rents can be increased, thus puts significant stress on the property holder (think of leases with provisions for 2 and 3 percent annual rent increases while inflation is runnin at that much per month - ala oil and gas prices). This can also work against homeowners who can't keep pace with the inflated costs of homeowner ship, ex. property taxes, heating fuel and other energy (electricity), etc.

From a J P Morgan Research Note: US banks face threat of capital Punishment - The current problem for US banks starts, naturally enough, with a deterioration in loan performance. Noncurrent loans—those delinquent for 90 days or longer—rose to 1.39% of all loans in the fourth quarter of 2007, an increase of 31 basis points from the previous quarter. (All figures cited in this note refer to the universe of all federally guaranteed depository institutions: including banks, thrifts, and credit unions). In historical perspective, the amount of noncurrent loans does not look particularly onerous. However, this conclusion is likely too sanguine for two reasons:

 • The increase in delinquencies on real estate loans is probably just getting started. Noncurrent real estate loans were 1.71% of real estate loans last quarter, more than double the figure one year earlier. Given that the decline in real estate prices accelerated into year end, delinquency rates are set to move higher.

• The banking system entered the current episode with a relatively slim cushion of loan loss allowances. In 4Q06, loan loss allowances—a balance sheet item set aside for bad loans—reached a low of 1.07% of loans outstanding, down from over 2% in the mid-1990s. The interaction of these two factors means that banks have been, at best, running to stand still. Even though credit loss provisions—the addition to loan loss allowances—were set aside at the highest pace (relative to assets) since the 1980s, that provisioning did not keep pace with the deterioration in loan quality. The aggregate coverage ratio—the stock of loan loss allowances relative to noncurrent loans—slipped below 100% last quarter for the first time since early in the1990s, meaning that banks have less than $1 in loan loss allowances for every dollar of noncurrent loans.

Capital ratios under stress - As banks realize losses on their assets, capitalization continues to come under pressure. In our GDW Research note of Nov 30, 2007 (“New data intensify spotlight on US banking sector”), we observed that banks can respond to deteriorating capital in three ways: allow capital ratios to drift lower, raise or retain more equity capital, and shed or slow the growth of assets. To varying degrees, the data show all three responses in play.
 • Bank capital ratios generally drifted lower last quarter. Of the four capital ratios that regulators use to determine capital adequacy, three declined last quarter. The fourth, total risk-based capital, increased a touch because some banks issued more subordinated debt. The lower capital ratios fall, the more banks will feel compelled to arrest the decline by raising capital or slowing asset growth. Although most banks are a long way from triggering
regulatory action, they would like to keep it that way.
• Banks have been increasing equity capital. The most visible equity infusions in recent months have been through investments by sovereign wealth funds in US banks. However, banks have also been replenishing capital through more mundane means. Dividend payments (to both individuals and bank holding companies) have fallen sharply. Share buybacks—to be reported in next week’s Flow of Funds report—likely also slowed in 4Q.
• Banks will likely slow asset growth. Data through 4Q show bank balance sheets expanding rapidly. However, much of the acceleration in lending likely reflected prior commitments, such as asset-backed commercial paper, coming back onto balance sheets. Indeed, for commercial and industrial loans (to take one well documented category of lending), around 80% of lending is done under prearranged credit lines. Moreover, an average of about
nine months elapse between the time when contract terms for these loans are set and their actual disbursement. This lag suggests that C&I lending should begin to slow as the tightening of lending standards over the past six months begins to be realized in the data. This will put a significant drag on the real economy as working capital is dried up.

In the published Remarks by John C. Dugan, Comptroller of the Currency, before the Florida Bankers Association in Miami, Florida on
January 31, 2008, I excerpt
: "I’m referring to the challenges we face – both community banks and the OCC – from the intersection of two inescapable facts: significant community bank concentrations in commercial real estate loans, and the declining quality of a number of these loans, especially those related to residential construction and development. Today, I’d like to talk briefly about both of these facts, and then turn to our supervisory perspective and expectations.

Published in BoomBustBlog
Saturday, 19 April 2008 01:00

It ain't over...

From Fitch's latest report :

As the U.S. housing crisis continued to deepen in 2007, Fitch’s global
structured finance rating actions took a decidedly negative turn, driven
overwhelmingly by the unprecedented credit deterioration in the U.S.
subprime mortgage sector. By year’s end, U.S. subprime-related
downgrades affected 3,529 tranches, or 77% of the year’s 4,570 global
structured finance downgrades. Total downgrades readily topped upgrades
of 1,790, the first year in recent history to see such a trend in structured
finance. However, the nonmortgage ABS and CMBS sectors reported
more upgrades than downgrades in 2007.

The subprime mortgage sector downturn also pushed up the global
structured finance default rate in 2007 to 1.19% from 0.37% in 2006. The
average annual global structured finance default rate over the 17-year
period ending in 2007 subsequently moved up to 0.77% from 0.68% in
2006...

In reviewing 2007 global structured finance rating
activity, it is important to note that credit quality
continued to deteriorate in the subprime mortgage
and CDO sectors in early 2008, resulting in
additional and significant negative rating migration.


Highlights
• Fitch’s global structured finance rating activity
turned net negative in 2007, with downgrades at
least 2.5 times more frequent than upgrades and
a record 14% of structured finance tranches
experiencing negative rating actions over the
course of the year, compared with 6%
experiencing positive rating actions. This
produced an upgrade-to-downgrade ratio of 0.39
to one in 2007, a stark contrast to the 4.54 to one
ratio reported in 2006.
• Despite weak performance in the U.S. subprime
mortgage securitization and CDO sectors, 80%
of global structured finance ratings remained the
same in 2007. However, this is down from an
85% stability rate in 2006.

Published in BoomBustBlog
Wednesday, 16 April 2008 01:00

Wall Street still doesn't get it.

From WSJ.com:

Some 10 months after the mortgage hurricane made landfall, Merrill Lynch & Co. is still trying to dig out.

On Thursday Merrill will report $6 billion to $8 billion in new write-downs, according to a person familiar with the matter. The latest would bring its total since October to more than $30 billion and mean that Merrill reports a third straight quarterly net loss, the longest losing streak in its 94-year history.

New chief executive John Thain has said that, having recently raised $12.8 billion in fresh capital, Merrill won't need to seek more in the foreseeable future. Mr. Thain has increased the importance of weekly risk-management meetings by requiring the heads of trading businesses to attend and by having the top risk managers report directly to him. Since taking over in December, he also has reduced executives' incentive to swing for the fences by tying more of their pay to the firm's overall results and less to how businesses do individually.

Yet as of year end, Merrill still appeared to be taking large risks. Its "leverage ratio" -- how many times assets exceed equity -- stood at 31.9 to 1, higher than most other Wall Street firms. Heavy borrowing like this magnifies both profits and losses.

This does not solve the problem, it just incentivizes star employees to jump ship when they overperform yet have their bonuses dragged down by those that don't. What you need to do is give them what they want. If everybody wants mini-fiefdoms, then they get it - all of it. Producers, bankers and traders should be individually responsible for risk AND reward. Currently, they get paid only for the rewards they produce, and the shareholder gets stuck holding the bag of risk - with most of the reward stripped out in the form of overly generous compensation.

In my entrepenerial financial pursuits, not only do I not have a regular and reliable salary, but I am fully responsible for risk and reward. Although I still take significant risks for a living, they are in no way (and never will be) outsized in relation to the commensurate reward. As a matter of fact, I won't even take a risk if the reward doesn't outstrip the risk. The risks that I take may seem large to the untrained eye, but they are actually small when taking the whole pie into consideration. The extreme volalitility that I faced head on with large directional bets are an example of such. I was short certain sectors of the market, and as volatility spiked, trash companies rallied hard and short covering ramped up I sold shorts and/or bought puts into these rallies. This resulted in my account showing much more volatility than the broad market averages and mutual or hedge fund indices, but at the end of the day the resultant profit easily outstrips all indices and averages by several multiples - even according to all of applicable risk adjusted measures. A quick perusal of my blog should confirm this in an indirect way.

I am able to discpline myself in the gorging of volatility and market risk because I am responsible for my own losses and have no one to lay them off on. If the bankers, traders, and sales persons of Wall Street had the same responsibilities, I am sure the genius in them will be able to produce similar results. If you read the entire article linked above, it appears to be spotted with many "managers" who were not compensated with risk adjusted return, just with return. Thus they pushed for imprudent risks. This is not the way to do it. Be entrepenurial.

Hey, Merrill, this individual investor is available for consulting if you need him.

Published in BoomBustBlog

This was referred to me by a reader whose email I misplaced, so I cannot give him a hat tip, but thank you anyway. Here is an excerpt from Institutional Risk Analytics :

Here's our question: Why did the Fed of New York facilitate the rape of BSC by JPMorgan Chase (NYSE:JPM)?

The
announcement by the Fed of a new lending facility for broker-dealers to
borrow from the discount window, made just hours after BSC's board of
directors apparently was forced by the Fed to sell for $2 per share to
JPM, strikes us as clear evidence of an anti-BSC bias by the US central
bank. Why not just lend directly to BSC under the new Fed loan
facility?

One prominent New York lawyer who is very well acquainted with the Federal Reserve Act tells The IRA
that the Fed of New York did two things last week: 1) approved a loan
to JPM, which was then passed through to BSC; and 2), created a new
facility to lend directly to broker dealers under Section 13 of the FRA.

"There
is nothing new here," adds the lawyer, who notes that the Federal
Reserve Banks made loans to individuals in the 1930s under the
emergency provisions of Section 13 of the FRA and could have easily
lent directly to BSC without involving JPM at all.

Thus
again the question to Fed of New York President Tim Geithner: Why was
JPM involved in this transaction? Why not simply extend liquidity
support to BSC as you now offer to every other primary dealer? As and
when BSC shareholders litigate over this mess, Geithner et al may be
forced to answer those questions in public.

To
us, even at $10 per share, the JPM buyout stinks to high heaven because
of the conflicted role played by the Fed of New York. Does anyone
believe that the Fed would force Lehman Brothers (NYSE:LEH) or Goldman
Sachs (NYSE:GS) into such a fire sale? Indeed, it looks to us like the
Fed of New York and BSC both got rolled by JPM CEO Jamie Dimon and his
merry banksters. But the JPM crowd won't be laughing much longer.

The
same forces that pushed BSC into insolvency are working on JPM and the
other money centers as you read these lines, but JPM first and
foremost. Just look at the range of valuations included in JPM's
disclosure to Canadian officials regarding price estimates for illiquid
structured assets and you can see why JPM's Dimon has been so upbeat in
recent months.

Published in BoomBustBlog

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.

Published in BoomBustBlog

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

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

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



More on Insurers and Insurance

More on Commercial Real Estate

More on Residential Real Estate


More on Investment Banks

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

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

Published in BoomBustBlog

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.

Published in BoomBustBlog