Thursday, 17 July 2008 01:00

It's Reggie Middleton vs. the "Man"!

Government manipulation in the free markets will lead to more volatility, not less

The market has predictably rallied as a result of a massive, US government induced short squeeze. We all saw this coming. We all know this is government manipulation, and not a fundamental occurrence. Yes, that's right! Pure, unadulterated government manipulation. The government gave special relief to a very small segment of the market, the very same segment from which many of those same officials hail from (Wall Street), in an attempt to prevent the price of their shares from reaching equilibrium with their value. This is nothing but interference in the free market system. Let's not even broach the discussion of the ethics or legality of naked short selling. The government failed to ban the practice for the homebuilders whom I shorted into single digits, they failed to do it for the monolines whom I shorted into the single digits, they failed to do it for the regional banks whom I am on way to riding to the single digits, they failed to do it for the retain industry, the automotive industry. So what makes them do it for Wall Street? Let me help you ponder that query... The table below is derived from  , and is a compilation of Washington lobbyist money by sector. If you had to guess who donated the most money to Washington over the past 10 years, who do you think it would be? Okay, I know that's a hard question, so I'll give you a hint. What sector just got preferential treatment in an attempt to prevent entities such as mine from shorting certain companies' share to the point where their share price matches their companies' intrinsic value (ex. Goldman Sachs is worth a tad bit less than $130 per share, yet it is trading over $180, an ideal opportunity for me)? Still can't guess. Okay, here is another hint. What industry (or even company whose shares are currently overvalued) spawned the last few treasury secretaries? Need more hints???

Sector Total
Finance, Insurance & Real Estate $3,102,713,952
Health $2,902,546,732
Misc Business $2,764,829,300
Communications/Electronics $2,561,657,697
Energy & Natural Resources $2,052,875,397
Transportation $1,626,912,330
Other $1,570,867,542
Ideological/Single-Issue $1,055,993,246
Agribusiness $960,997,755
Defense $875,340,534
Construction $339,588,492
Labor $323,749,249
Lawyers & Lobbyists $248,316,048

So the SEC participates in this cronyism cum capitalism for sale game (and I really mean that) and the shares of the financial stocks (whose macro situations, micro situations, and balance sheets are very bad and getting worse) sky rocket upwards. The CEOs of these companies such as Dimon (who just bought a $20 billion company for less than 5% of that and still had bad numbers), says outright, things are bad and they are getting worse - yet his shares jump, and jump hard (more on this later). Well, if you think that there was a lot of volatility when they fell the first time, what do you think will happen to the volatility number after they knee jerk upward with valuations still falling down. Eventually, price = valuation, then free fall. Granted, somebody may have had an opportunity to dump some stock while the prices were artificially elevated above their intrinsic value, but so be it.

So, now you all know what I think will happen when the market eventually comes to the same valuation conclusions that I do? The government (actually, the SEC) has exercised its rendition of the Bernanke put, and I have been assigned. No problem, I have plenty of cushion from reading the overvaluations in the market correctly up till this point. Thus, I will accept my assignment and move on with my synthetic short position ala the SEC, for I am confident equilibrium will be reached. So, what happens if I am right?

At the end of the day, the fundamentals will always rule. After all, we all eventually have to pay our bills

I've been offline for a day or two, come back and see many have lost faith in the fundamentals due to a government induced bear market rally! My, hence this blog's focus and forte, is extreme fundamental and forensic analysis. My strength is cutting through the bullsh1t. You know how some guys are good at basketball, some are natural poker players, well my nose is acutely attuned to bullsh1t. Do not, and I repeat, do not take the PR and marketing pitch's in press releases, financial media news blips, and people who generally either have no idea what they are talking about or have an extreme incentive to bend the facts as a proxy for actual

This should put the current banking
crisis in perspective. No amount of government manipulation will make
the subject matter of these postings dissipate, sans proper regulation
of off balance sheet activities and mortgage lending - Oh Yeah, it's
too late for that, isn't it!
Remember, if the link leads to this message, "Cannot
find the entry.The user has either change the permanent link or the
content has not been published." it means that the article has already
been archived, and you will need to access it through this link in the
main menu - "Archives"

The orginal Doo Doo 32 post: As I see it, 32 commercial banks and thrifts may see the feces hit the fan blades

A sampling of the Asset Securitization series:

  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 32 Bank Drill Down 1.5: The Forensic Analysis of Wells Fargo

performance. Look at the actual performance numbers, not the press releases, and not the "analyst's "so-called" expectations which fluctuate like the wind and are easily manipulated by management. An example of what I am referring to is when analysts expect a company to report $1 profit. The company comes out with guidance, 60 cents lower, and the sell side community drops there expectations accordingly to 40 cents (I look at its as this company is #$@#$ up). Well, when the company reports a 50% drop in profit, the "Street" applauds and the stock skyrockets because the company beat expectations by 25%. Whaaaaat!!!!??? Think about it. The company earnings stream, based on this period's earnings, is half as valuable as it was last period, yet the stock pops as if there was some good news to be had. This is a shell game, plain and simple. I understand why the Street plays it, but the readers of this blog know better. Just imagine if you received a 50% pay cut, then your boss wants to celebrate your "promotion" with a party. I already see many with that bewildered look on their face as I type this. Well, welcome to the earnings expectations vs. reality game.

Now, I will briefly go over the results that accompanied the Cox version of the Bernanke put:

JP Morgan: CEO has dire outlook for the present and even worse for the future, credit reserves increase across the board, gets a $20 billion plus company (along with a $3 billion Park Avenue office building), a fat government subsidy and plethora of guarantees, for almost less risk adjusted economic outlay than the Yankees paid for A Rod, and still reports 51% drop in net (I didn't even check to see if BSC's profit and revenue were added in to JPM's numbers). Where is the good news in this???

PNC: As I forecasted in my analysis, charge-offs skyrocket, capitalization remains thin.

MTB: More of the same

Wells Fargo: Smoke and mirrors at its best. They move the goal posts closer then say they kicked a field goal. Note the HELOC charge off modification. Note no explanation on how they profited from MBS sales when the rest of the WHOLE WORLD failed to do so. They raise their dividend during a time of global bank capital constraints. Why do such an imprudent thing, you ask? Smoke and mirrors, my friend. Smoke and mirrors.

I will go a little more in depth into PNC and WFC if I get the time later on today.

As a backdrop, for those who haven't read my background research on the banking system, please do. After reading it, I don't see how anybody can be very positive on the US banking system - at all.

Published in BoomBustBlog
Sunday, 13 July 2008 01:00

Weekend Ruminations

As some may have gathered, I may getting increasinly busy, thus may not be able to get to all emails and comments. No need to fret though, we have some of the brightest, and capable financial minds in the blogoshere wafting through these vitual annals. I've noticed the various experts in their respective fields, analysts, traders, money managers and ultra high net worth inverstors have more than taken up the slack. Thank you.

For those who may be wondering about my shorts, stay calm. I've grown to become pretty good at this stuff. Don't look at Amex as what you think they do, look at them for what they actually do. As one astute commenter pointed out, their debt to equity ratio has skyrocketed in an attempt to gain rapid fire growth, their credit risk is significant, and their core business market is being wrecked by the current economic hard landing. Did I mention the credtit risk that they were exposed to?

When AXP ended up on my short list, I smiled wide. A virgin short, that most would not see until it was too late. Oops, I better keep quite until I have fullybuilt up a position.

The run has started on Lehman again according to the rumor mill.

    FreddieMac is set to sell $3bn on short-term debt on Monday. Secreatry Paulson is working on plans to inject up to $15 billion into F&F at highly dilutive terms for current shareholders. Paulson and Bernanke are apparently on a mission to prove that they are not the barons of moral hazard by purposely punishing the risky taking investors in failed companies. I agree with this stance, for the Bear Stearns equity investors got more than they probably would have recieved from the market in a conventional dissolution - all thanks to Fed subsidies. The leaves a black eye on the credibility face of the Fed.

  • In a recent Lehman Brothers report: If FAS 140
    change goes through requiring to put off-balance sheets items back on
    books, Fannie Mae would need to add $46 billion of capital and Freddie
    Mac would need about $29 billion, although companies will probably get
    an exemption from the rule--> stocks plunge around 20%, agency
    spreads over Treasuries highest since March 13 (=benchmark for prime
    mortgages); CDS on both F&F above 200bp. Let me be clear on this, F&F ARE the mortgage market now. Most other banks have stopped writing much of the non-conforming stuff, and the conforming stuff is written due to the F&F liquidity put. If F&F slow down to any signficant degree, housing values will plummet significantly.
  • William Poole of the St.Louis Fed recently stated the obvious (and what I have been alleging about banking concerns since last year): INSOLVENCY -"Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules" i.e. if assets and liabilities were marked-to-market--> Lockhart (OFHEO), May: By Q1 2008, FannieMae 'fair value' Tier 1 capital ratio at 0.4%, and -0.2% for FreddieMac - These numbers are ridiculous and obvious take into consideration implicit government backing
  • James
    Lockhart (OFHEO): "F&F are adequately capitalized wrt regulatory
    requirements" which are not mark-to-market but historical cost. Hey, I historically had a couple million extra dollars lying around. Do you think I could spend them now???

    FreddieMac is set to sell $3bn on short-term debt on Monday. Secreatry Paulson is working on plans to inject up to $15 billion into F&F at highly dilutive terms for current shareholders.

  • In a recent Lehman Brothers report: If FAS 140
    change goes through requiring to put off-balance sheets items back on
    books, Fannie Mae would need to add $46 billion of capital and Freddie
    Mac would need about $29 billion, although companies will probably get
    an exemption from the rule--> stocks plunge around 20%, agency
    spreads over Treasuries highest since March 13 (=benchmark for prime
    mortgages); CDS on both F&F above 200bp. In case this point is lost on somebody, let's make it clearer. THe MBS market supported by F&F, alleged AAA and AA rated agency debt, will absolutely crush those undercapitalzed (and that would be many) CDS writers who have used this stuff as underlying. Left holding the (BIG) bag would be those who actually thought they would be getting paid on the stuff... the chain reaction dominoe effect begins... look into AGO for an example of the hubris of Super Senior AAA false confidence. I have thorough analysis on this site of AGO and the CDS market - definitely worth looking into.
  • William Poole (St.Louis Fed): "Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules" fair value accounting rules are just that - FAIR, for example, if assets and liabilities were marked-to-market
  • S&P estimated that the cost of a Fannie/Freddie bailout would run somewhere between $420 billion and $1.1 trillion compared to $140bn taxpayer bill for S&L ($250bn in today's dollars).In Reggie Middleton on the Asset Securitization Crisis, I made a direct comparison of this crisis to the S&L debace, see The Asset Securitization Crisis vs. the S&L Crisis - pt 2
  • Resolution Trust Corp, part deux: Rosner (via Bloomberg): Government could move the companies' combined $1.5 trillion investment portfolios into a separate limited liability corporation that would gradually liquidate the assets. Meanwhile, securitization business could continue.

Published in BoomBustBlog
Thursday, 10 July 2008 01:00

An inspiring email from a reader

Quite a few readers have emailed me with similar stories. I thought I would post this one, with permission, of course.

I know that I've said thanks. I'll say it more before its over, no doubt.

Since Jan 16, 2008....we have doubled my initial investment while keeping over 50% in cash. Thats short term - pay taxes on it and I'm sittin on half that much paper gain.

I don't know much but I can read. That was achived usin what I've come to call 'sell and wait'.

About 3 months in I noticed I was 'early' often. I took a nore relaxed approach and things got easier.

I 'missed' bear btw so this wasn't a 1 shot deal.

I've learned and hopefully will be more adept as time goes on.

My major drawback is I take too many naps. :-)

Published in BoomBustBlog
Thursday, 19 June 2008 01:00

Blogger will work for food





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As I have mentioned before, I am looking
for avenues to syndicate the content of my blog. I know I am biased, but I
think this blog delivers top notch, timely and unique content. It being my
blog, I am probably not the most objective judge… Many of you came to this blog
from Seeking Alpha,
where I was a contributor. It appears as if I have done something to piss them
off, for they have not ran any articles lately and have not returned my emails.
I’m pretty sure the reason is my complaining about the changing of the content
of my articles, something that I cannot tolerate. The editors that I dealt with
were always very professional and polite though, and I would like to make that
clear. Nevertheless, being forced to gather my own eyeballs may have been the
best thing that has happened to this blog. Let me tell you why…

The possible offense (I am not quite
sure why I am not getting return emails or articles ran) probably came from my
linking to a very interesting discussion on Seeking Alpha’s business model,
editorial practices (of which I complained in the actual linking), and
blogonomics in general. You can read my comment here
(you may have to scroll up a bit to see it). The actual discourse that I linked
to is here,
and stems from a little beef that Barry Ritholz, the popular blogger, analysts
and CNBC contributor had with SA over some of the exact same issued that I had.
I recommend those interested in blogonomics give it a glance. Keep in mind that

(being the stuck up, conceited bastard that I am) truly believe that a steady
stream of buy side quality, forensic research is a rarity on the web, hence I
often lapse into a state of actually believing this blog’s content has some
value. The argument made by SA’s founder about the blogger’s incremental effort
in content redistribution is a little murky, but I will get into that at a late
time. My content easily costs me into the six digits to produce, thus it is not
cheap. Although there are some very good blogs out there, especially in the economics
research and opinion space, ex. Ritholz’s is one, as well as Calculated Risk
and Mish (see my blog
), I think I am the only one that performs thorough buy-side forensic analysis
from a macro investor’s perspective - at least the only one that does it for

Seeking Alpha does seem to expose
certain popular writers with a significant amount of exposure, and their coup d’etat
and primary value driver is the deal that they inked with Yahoo Finance to have
their blog’s content carried on Yahoo’s ticker news feeds, which are very heavily
used. Now, being the conceited bastard that I am, I wondered, “If they don’t
want my stuff, and I think my stuff is worth wanting, why don’t I just move to
have my stuff carried directly by the major news feeds and outlets?”. Damn,
could you imagine if Yahoo, Reuters or Bloomberg carried analysis as hard hitting,
thorough and extensive as “
and the type of investigative analysis you will not get from your brokerage
house” on their newswires?

``There's nothing you can glean from
them that's going to make you any money,'' said Jack
, who oversees $62 billion as chief investment officer at Harris
Private Bank in Chicago. ``Right now `Wall Street' and `unique research' is an
oxymoron. Unless they're able to do some kind of very unique research, I don't
see any of them coming up with an edge.''

I’m thinking that this could literally
transform financial news and reporting, as well as give the traditional rags
the much needed shot in the arm they’ve been craving every since the Web
started devouring their margins and their business models. Now, how do I get
these guys’ attention? Well, I’ve put together a little compilation of popular
(but far from complete) articles, posts and analyses from the blog, and have
date stamped them along with the company that they are referencing. I am not
going to publish performance figures, but you guys (and girls) can figure it
out for yourselves. The factor for determining the results of a short sale is
about -1.9x the change in price. If any of you know one of the major media
publications with a finance interest, use the mail or recommend functions of
the blog to forward them a copy of this article. Of course, I would appreciate any
feedback or comments that my readers have as well.

Published in BoomBustBlog

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
Thursday, 12 June 2008 01:00

Name brand investing in the WSJ

Reading through the journal, I came across the following chart and thought, "Hey, I shorted all of those companies last year. Thanks guys!":


Among the many disastrous bets made on struggling financial institutions, here are some of the worst whoppers:
Buyer/Company Deal Terms Status
Citigroup/Old Lane Partners Acquired in July 2007 for nearly $800 million Citigroup plans to shut down the hedge fund
Bank of America/Countrywide Financial Bought stake last August with an $18-a-share conversion price Mortgage lender's stock now trading at $4.77; BofA is buying the company
Joseph Lewis/Bear Stearns British billionaire spent $1.1 billion building a roughly 9.6% stake at prices near $100 a share Bear sold to J.P. Morgan Chase for $10 a share
Abu Dhabi Investment Authority/Citigroup $7.5 billion infusion in November 2007 gave ADIA convertible stock Citigroup shares plunged 35% since then
Warburg Pincus/MBIA Private-equity firm agreed in December to buy $500 million in stock for $31 a share Bond insurer's shares now at $4.91

Reference my post on reliance on name brands, we are all wrong some of the time.

Published in BoomBustBlog

According to this Bloomberg article, the articles more than doubled the performance of the best performing Wall Street analyst of the past year, and soundly out-performed ALL of the analyst and brokerages house recommendations - most of whom had deeply negative returns and failed to beat the broad markets. Hey, I'm just lowly Internet blogger. That's a damn shame. If I had the time, I would seriously consider opening up a pure research shop to put these guys out of their misery. If they let a blogger roll over them like this, imagine what a professional with a big budget could do!

From Bloomberg:

Investors who followed the advice of analysts who say when to buy and sell shares of brokerage firms and banks lost 17 percent in the past year, twice the decline of the Standard & Poor's 500 Index.

Buying shares on the advice of Merrill Lynch & Co.'s Guy Moszkowski, the top-ranked brokerage analyst in Institutional Investor's annual survey, cost investors 17 percent, according to data compiled by Bloomberg. Deutsche Bank AG analyst Michael Mayo's counsel to purchase New York-based Lehman Brothers Holdings Inc. lost 59 percent. Citigroup Inc.'s Prashant Bhatia still rates Merrill ``buy'' after its 56 percent retreat from a January 2007 record.

Of the 39 analysts tracked by Bloomberg who follow stocks in the Amex Securities Broker/Dealer Index, 32 produced losses for investors. Investors who bought brokerages on ``buy'' recommendations, sold when they switched to ``hold'' and speculated prices would decline when analysts said ``sell,'' lost 17 percent in the last year through June 3, compared with the S&P 500's 8.5 percent drop...


Meredith Whitney, who correctly predicted Citigroup Inc. would reduce its dividend to preserve capital, lost 16 percent collectively at Oppenheimer & Co., her current employer, and CIBC World Markets, where she worked until mid-January. Whitney's advice included buying Lehman shares up until March 24 as the stock lost 35 percent.

Whitney made investors 1.8 percent over the past three months, the eighth-best performance. A phone message left for Whitney wasn't returned, and John Parks, the director of research at Oppenheimer, didn't respond to an e-mail.

Judging analysts solely by the return their picks generate isn't fair because their goal is to beat indexes of stocks in the industry they cover, said Christopher Malloy, a professor at Harvard Business School in Boston.

``Whether they make money in down markets, I don't think analysts think that way,'' said Malloy, who studies the performance of stock pickers. ``Investors shouldn't hold them to that. There is a good deal of evidence that analysts bring some value to the market. They beat benchmarks.''...


Mounting Losses

Analysts cut their ``buy'' ratings on the brokerage industry to 41 percent from 56 percent last June as New York-based Morgan Stanley, Lehman and Merrill racked up $53 billion in losses. The number of ``sell'' ratings more than doubled to 10 percent, according to data compiled by Bloomberg. ``Holds'' climbed to 48 percent from 38 percent.

Analysts rate 39 percent of all U.S. stocks ``buy,'' down from 45 percent a year ago, 55 percent ``hold'' from 47 percent a year ago, and 5.6 percent ``sell'' from 7.5 percent at the start of June 2007. Wall Street ``sell'' ratings have fallen to half their level of five years ago...

Best Performances

The analysts who made investors the most money were Charles Peabody of New York-based Portales Partners LLC and Richard Bove of Ladenburg Thalmann & Co. in Miami, Florida, whose ``sell'' ratings on Merrill, Morgan Stanley, Lehman and Goldman Sachs Group Inc. produced profits of 47 percent and 18 percent, respectively, according to data compiled by Bloomberg. Citigroup's Colin Devine made 4.8 percent by rating Ameriprise Financial Inc., the only brokerage stock he covers, ``sell'' before moving to ``hold'' in July.

``Ten years ago, the expectation was that analysts would simply avoid the worst excesses,'' Bove said in an interview. ``The idea was just to beat the benchmark. Today, analysts have got to make you money in both up and down markets. You don't have any excuse.''...

... Bove said other analysts may have made money-losing recommendations because they based their reports on brokerage earnings rather than examining risk in credit markets...

...``There's nothing you can glean from them that's going to make you any money,'' said Jack Ablin, who oversees $62 billion as chief investment officer at Harris Private Bank in Chicago. ``Right now `Wall Street' and `unique research' is an oxymoron. Unless they're able to do some kind of very unique research, I don't see any of them coming up with an edge.''...

The bottom of this article actually has a tabulation and itemization of all of the individual analyst's performance, as well as performance aggregated by firm.

I cannot explicitly state my performance, but you smart guys (and gals) out there can download the pundit tool, go through the blog and plug in the info yourselves.

Tell me now, why shouldn't the banks just by this blog for $XXX million and instantly have the best research and absolute performance (benchmark marked or not) on Wall Street? We all know these guys could do better than what they are doing. If the mentality of the investment public were to change, and valuable research was actually sought after with a willingly high premium paid, then I am sure the whizzes on Wall Street will find their wizards. As it is now, all of the high end talent runs to the hedge fund world once it has proven itself, and then is no longer available to the common man and woman. If congress succeeds in pushing the HNW qualification even higher, then this fleeing talent will be even futher out of the reach of the retail investor. The BS runs thick in the corporate finance and investment world!

Published in BoomBustBlog
Wednesday, 21 May 2008 01:00

Just a reminder regarding patience

Patience is key in hardcore fundamental investing. I find that I
need to remind my self and my staff of this regularly. You can control
the vigor and rigor of your research and analysis, but you can't
control the markets. There are many factions that profit from momentum,
hence distor the fundamentals. In the end, history has always proven
fundamentals to reign supreme. This about all of those over the last
calendar year to have made continuing bull claims (with no real
credible evidence to support such), the worst is over (the current
credo), etc.

Below is a glimpse of my trading screen. Those blank
spaces are the results of fundamental research. Thos companies are
effectively out of business. They rallied at some point, too. Technical
analysis is useful in determing the trends that those who use technical
analyis will create, but at the end of the day Stochastics cannot pay
the light bill nor the lease payments for the companies in question.
Creditors don't believe in technical analysis.


and LEH aren't doing so well either. They are still recommended by most
investment banks despite the fact that their business models are
broken, the macro environment is nasty, they are at the nadir of their
business cycle and they both issued smoke and mirrors for earnings
reports last quarter.

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 "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

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.

• 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