Financial, Real Estate, Stock Markets Trends and Current Affairs

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.

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.

Morgan Stanly puts are significantly under priced. I didn't need any more but picked some up anyway.

Now matter if you like him, love him or hate him, you have to admit that Bernanke is firing on all 8 cylinders. The man is executing, give him some credit. If this would have been the EU, we would be facing a total market melt down right now. I think we are in some rough times anyway, but Bernanke is doing his job without necessarily just opening the money spigots.

I am still wary of LEH, but will sit back patiently and observe, hoping my lowball bids get picked up.

"Bear Stearns' second largest shareholder, Joe Lewis, said Monday JPMorgan's $2 a share offer for the investment bank is "derisory."

"I think it's a derisory offer, and I don't think they will get shareholder approval," Lewis said, in an interview with CNBC.

Lewis also discounted rumors that his position in Bear Stearns was leveraged.

The British-born billionaire, who amassed his fortune as a currency trader, is the biggest individual loser in Bear Stearns' debacle. It is estimated that he has lost nearly $1 billion from his decision to pile into Bear Stearns stock in recent months."

The problem with the deal is that it is too low, and too favorable for Morgan. It is literally guaranteed to drive angst from the other side. Whenever you do a deal, you always make sure the other side gets to walk away with something. If you don't you always risk the deal falling though unnecessarily. $2 is a slap in the face to employees who have lost a life savings and have the power to block the deal. At the very least, by the building at market price and get the company for free!

It's time to revisit the home builders. Toll is carrying an
undeserved premium and the JVs that I uncovered in Lennar will bite
Toll, KB Home and Centex (who has a very large mortgage operation that
has to be falling apart by now). Banks have been skeptical to take land
back, for if you think MBS were hard to move, try raw land in a real
estate depression with no available financing. I think the banks now
realize that they either take it back today or lose it tomorrow. We
will see over the next quarter or two. See the WSJ article on this and give me your comments.

"Two
massive housing developments in Las Vegas, involving several of the
nation's largest home builders, have received default notices on about
$765 million in debt, according to one of the partners in the projects.

John
Ritter, chief executive of Las Vegas-based Focus Property Group, says
that two joint ventures -- involving Focus as well as builders Toll Brothers Inc., KB Home and Lennar Corp. among others -- have each missed an interest payment in recent weeks and are in negotiations with lenders."

Stories from RGE Monitor and around the net related to Banks, Brokers, & Bullsh1+ part 2:

• Carlyle Capital Corp (CCC) defaults on about $16.6 billion of AAA agency debt as widening spreads led to huge losses and margin calls on position leveraged 32 times. Lenders seizing all of its assets--> Carlyle Group's only material financial exposure to CCC is through a $150 million unsecured subordinated revolving credit agreement with CCC.
• Sudden Debt, FT: Almost all structured finance transactions are based on unfunded margin debt--> Margin debt cannot be "restructured" with falling asset prices.
• Brunnermeier/Pedersen (Princeton/NYU), BIS: Under certain conditions, margins are destabilizing and market liquidity and funding liquidity are mutually reinforcing, leading to liquidity spirals.
• Whalen (IRA), Joseph Mason: With prime brokers and hedge funds there is no such thing as a "true sale" or complete risk transfer because the hedge fund has little capital and the prime broker, as a result, ultimately bears all the risk. Same as securitized assets landing back on balance sheet without capital to account for them.
• InvestorsInsight: Hedge Funds are net sellers of credit protection in CDS market, like insurers. Seides: hedge funds sell 32% of all CDS ($14.5 trillion) with only about $2.5 trillion in net assets under management--> watch counterparty risk.
• S&P via FT Alphaville 75% of loans to junk-rated U.S. companies provided by HF/non-banks (about $400bn)--> worst asset class performance in Q4.
• Peloton hedge fund run by former Goldman Sachs partners is liquidating $1.8bn ABS fund that produced 87% gain in 2007. Potential $9bn asset fire sale.
  Strategy: go short subprime paper, go long prime rated paper--> as of Jan 2008 however spreads on both low and prime rated assets widened due to deleveraging (=reverse leveraged bets on good assets). Margin calls triggered decision to unwind.
• FT Alphaville: January 08 worst month for hedge funds since August 1998 LTCM episode--> average fund tracked by the HFRX index lost more than 2% in January, with event-driven funds, which include activists, the worst hit with a 3.39% loss. Equity long-short funds with net long exposure down too.

While I can't know for sure which IB it may be, my studies tell me it is either the Bear with the Broken Back or the Riskiest Bank on the Street, and that's where I'm concentrating my bets...

From the London Business Times:

Global stock markets may have cheered the US Federal Reserve yesterday, but on Wall Street the Fed's unprecedented move to pump $280 billion (£140 billion) into global markets was seen as a sure sign that at least one financial institution was struggling to survive.

The name on most people's lips was Bear Stearns. Hey, it pays to read the boombustblog.com. Although the Fed billed the co-ordinated rescue as a way of improving liquidity across financial markets, economists and analysts said that the decision appeared to be driven by an urgent need to stave off the collapse of an American bank.

“The only reason the Fed would do this is if they knew one or more of their primary dealers actually wasn't flush with cash and needed funds in a hurry,” Simon Maughan, an analyst with MF Global in London, said. Bear Stearn's new CEO states unequivocally that his balance sheet hasn't changed since November and that they have $17 billion of cushion. He did not outright say that they were in good shape though. My concern was looking forward. They are a significant counterparty risk (along with Morgan Stanley) and they have signficant illiquid level 2 and 3 assets as a percentage of tangible equity. In addition, 17 billion is not much considering the leverage and amount of illiquid assets held by this bank.

The amount of equity devaluation has literally doubled BSC's leverage and potentially halved the market's confidence in this company. At this point, I would feel comfortable issuing a going concern warning.

All banks use excessive leverage to monetize the perception that they can make money for their clients. BSC has lost that perception, thus is at risk of painful deleveraging, by force. They will also have a hard time incentivizing strong talent with such a weak share price and no cash to spare. They aready have the highest bar to cross in regards to compensation as percent of tangible equity and revenues.