Analytical Wealth

Speaking of weakness in the U.K. real estate market, here is an article from the Financial Times discussing a run on funds that focus on commercial real estate and the concerns that the funds won’t have enough cash to honor all of the fund redemptions. This situation could be a harbinger of a similar situation in the U.S., if the fate of the residential real estate market befalls the commercial one.

This article also makes me think of the rising LIBOR rate as banks borrow more and more cash to cover end of year obligations, might some of those obligations be money market funds (we already know the banks are bailing those out) and perhaps even hedge funds (and other investment funds) the banks would rather quietly inject liquidity into rather than face a lot of bad publicity?

Posted to: Global Economy on November 30, 2007 at 07:10 PM | Permalink | Comments (0) | TrackBacks (0)

The consumer spending number for October was abysmal, showing an increase of just 0.2%; personal incomes increased by the same amount. Now we know inflation was quite a bit higher than 0.2% on a YoY basis, which means that people actually spent and earned LESS on an inflation adjusted basis. The only reason the numbers showed a non inflation adjusted increase was due to the small increase in personal incomes; which also indicate that people aren’t increasing their savings amounts. Looking at October’s consumer spending data coupled with the results of Black Friday, I think it’s safe to say that we’re on the verge of a consumer spending recession.

In fact, if you consider the impact of TRUE inflation at the consumer level, we are already in a consumer spending recession. The reason the full effects aren’t being felt at the macroeconomic level, is due to people using debt to supplement their spending and smart cost cutting by retailers. Still the retailers cannot continue to cut prices and make-up for it by controlling expenses, and the consumer credit bubble is going to burst sooner than later.

Sources

The Associated Press: “Consumer Spending Slows in October” – Martin Crutsinger, November 30, 2007

Posted to: U.S. Economy on November 30, 2007 at 05:48 PM | Permalink | Comments (0) | TrackBacks (0)

Overall construction expenditures fell by 0.8% during the month of October and private housing construction fell by 2%, the 20^th straight month showing a decline. The fact that Housing inventories have risen despite a nearly 2-yr decline in residential construction, indicates that the rate of foreclosures and completed housing projects coming online need to decline considerably before housing inventories and prices stabilize.

Generally speaking the decline in construction expenditures, (especially since they were higher than expected) will be viewed as a negative indicator. However, I’m calling it a positive one because it shows that the housing market correction is continuing to run its course. While corrections are painful in the short-term, a housing market correction is necessary in order for the country to have stable housing markets over the long-term. Various aspects of our economy are over-inflated and/or out of whack; short-term painful corrections are a necessary part of getting to a place of stability and sustainability.

Over the long-term, a sustainable market is always better then a hot one, even if the hot one is more profitable in the short-term.

Sources:

BBC News – “Fall in home building in the U.S.” – November 30, 2007

Posted to: Real Estate | U.S. Economy on November 30, 2007 at 12:01 PM | Permalink | Comments (0) | TrackBacks (0)

Here is an update on the earlier story on oil prices and the pipeline explosion in Canada, oil prices have calmed down a bit from last night but are still higher for the day. The pipeline fed refineries in the U.S. that produced heating oil and gasoline, so there is likely to be an increase in the cost for those items even if oil prices fall back to down the levels seen prior to the explosion.

Posted to: Energy on November 29, 2007 at 09:26 AM | Permalink | Comments (0) | TrackBacks (0)

Thinking back to Q3, the banks reporting poor results typically indicated that the credit crunch was at fault and that Q4 would see a return to normalcy as  credit conditions improved. Well, let’s just go ahead and toss the idea of recovering credit markets out the window. Borrowing costs for British Pounds, Dollars and Euros have been steadily increasing to levels not seen since mid September, despite the best efforts of the central banks. In a somewhat related story Money Market and CD yields in the U.S. haven’t exactly matched the rate of rate cuts by the Fed, narrowing the interest rate spread for the institutions offering high yields on deposits.

Additionally, several leading buyout firms and hedge funds anticipate the credit crunch lasting another year. Suffice it to say, the credit crunch will probably be just as big of a factor in Q4 earnings results as they were in Q3. Furthermore, more and more aspects of the global economy will begin to suffer from the credit crunch. If the credit crunch is expected to last another year, then the impact is likely to stretch well into 2009.

Posted to: Financials on November 29, 2007 at 09:04 AM | Permalink | Comments (0) | TrackBacks (0)

Evidence that the Britons will be facing their own housing downturn continued to mount, as prices dropped by 0.8% compared to October and loan volume dropped by approximately 12%. 0.8% sounds small, but know that a month over month decline of 0.8% equates to an annualized decline of about 9.2%.

Worries about a decline in the British housing market have been around for some time, with the reasons behind it identical to the ones in the U.S: loose lending standards, rampant speculation, prices disconnected from market fundamentals, etc. In fact, some analysts believe that a U.K. is danger of facing mortgage crisis that will be worse than the one in the U.S.

I think it’s important for homeowners to keep an eye on Britain’s housing market due to the similarities to our own housing downturn: cheap money, over-speculation and loose lending standards artificially inflated housing prices. The artificial inflation aspect is of critical importance for people to understand, homes in the U.S. aren’t losing value they’re just returning to their TRUE value. When it comes to housing the factors that can lead to a bubble are fairly well established and should be recognized as such, instead of just being ignored or explained away when everyone is happily making short-term profits.

Asset bubbles in residential real estate are especially economically destructive and it would behoove us as a nation to avoid them in the future. Hopefully, seeing housing downturns on both sides of the Atlantic for nearly identical reasons will educate investors, home owners and members of the financial sector so they’ll all behave appropriately in the future.

Posted to: Global Economy | Real Estate on November 29, 2007 at 08:52 AM | Permalink | Comments (0) | TrackBacks (0)

Posted to: Energy on November 29, 2007 at 01:07 AM | Permalink | Comments (0) | TrackBacks (0)

Interesting read in the NY Times on how the credit crunch is beginning to affect the commercial loan market and with it economic growth in the U.S. Normally, when we talk about the credit crunch we think about banks, commercial paper, bond sales to finance LBOs, etc, however the credit crunch is now starting to affect small businesses at the local and regional levels. Local and regional companies looking to borrow relatively small amounts (hundreds of thousands, as opposed to the billions PE firms borrow) are finding it quite difficult to get the financing they need to survive. The problem stems from the banks having fewer funds to lend out, due to the 1-2 punch of the commercial paper market drying up and it being more difficult to resell loans.

The credit crunch at the small business level, is just another example of how interconnected the credit markets are and how one bad apple (in this case bad mortgages) can bring the whole thing down. In light of this fact, the bulls who were running around claiming that housing wouldn’t impact consumer spending, the larger economy, etc, were either idiots or hoped their obvious rubbish speak would keep things going.

Posted to: Financials | U.S. Economy on November 29, 2007 at 12:46 AM | Permalink | Comments (0) | TrackBacks (0)

Existing home sales fell 1.2% in October to a record low 4.97 million pace, although the term “record low pace” is somewhat misleading since the national association of realtors (NAR) only began tracking that metric in 1999. The median price for a home fell 5.1% to $207,800.00. NAR economist Lawrence Yun trotted out his usual nonsense blaming the situation on the credit crunch, as opposed to acknowledging that the market is correcting itself after being inflated by over speculation and poor lending standards.

Here are a couple of nice charts from the NY Times depicting the decline in the number of houses sold, as well as median sales price from ’06 through ’07. It’s worth noting that the housing decline began in 2006, and what we’re seeing right now is merely the acceleration of a decline that started almost two years ago.  

Sources: graphic courtesy of the NY Times.

Posted to: Real Estate | U.S. Economy on November 29, 2007 at 12:34 AM | Permalink | Comments (0) | TrackBacks (0)

Found this link courtesy of Paul Kedrosky: It looks like I got caught up in the “11% interest rate hysteria” along with the Financial Times and the Wall Street Journal. Another blogger has broken down the Abu Dhabi’s investment in Citibank and it doesn’t look as bad as the visceral impact of “11%” would lead you to believe. 

Posted to: Financials on November 28, 2007 at 01:32 AM | Permalink | Comments (0) | TrackBacks (0)

Hmm, I wonder if all of the “Pro-Euro” sentiment in the media in the form of comic strips, rappers, supermodels, etc, signals that the Euro’s strength has hit its peak, sort of like magazine cover jinxes. I suppose the Fed’s next rate cut decision will answer that question.

Posted to: Randomization on November 28, 2007 at 01:28 AM | Permalink | Comments (0) | TrackBacks (0)

Black Friday news & notes – primarily courtesy of the NY Times:

The NY Times had excellent coverage of Black Friday, along with this graphic indicating that Black Friday’s super discounts brought a lot more shoppers to the stores, but that over the weekend traffic declined on a YoY basis.

The article indicated that Black Friday traffic rose 4.8% YoY, total sales were up 8.3% YoY but shoppers spent an average of 3.5% less. One conclusion we can draw from this, is that the aggregate sales increase was driven more by an increased number of people shopping on this particular day, as opposed to consumers actually being willing to spend more than last year. Another is that people were spending money on cheaper (and lower margin) items. Once you factor in the deeper discounts, more people shopping at discounters, cheaper items, etc, it appears that YoY earnings will suffer even if total sales grows (albeit weakly).

Looking at this report (and assuming I interpreted the typo correctly) it appears that a significantly higher % of people are finished with their holiday shopping this year, when compared to last.

The NY Times ran an interesting report on “Cyber Monday” which describes the trend of the Monday after Black Friday being one of the busiest online shopping days of the year.

This article seems to be a remix of Times coverage of Black Friday from other articles, but it has enough new stuff to be interesting.

The NY Times has aggregated a lot of its coverage related to Black Friday here.

It appears that I’m not alone in my dour view of the retail sector over the holiday shopping season, investors and retailers themselves are cautious at best right now.

Here is some interesting coverage of Black Friday that seems to run somewhat contrary to what other media outlets (and the retailers themselves) are reporting.

Sources: Graphic courtesy of the NY Times.

Disclosure: at the time of publishing the Author didn’t own positions in any of the companies mentioned in this post.

Posted to: Retail | U.S. Economy on November 27, 2007 at 04:09 PM | Permalink | Comments (0) | TrackBacks (0)

History seems to be repeating itself for Citibank, once again the company is in trouble due to bad loans and once again a savior from the Middle East has stepped in to attempt to save the day. Last time the bank needed help after its balance sheet was mangled by bad loans related to commercial real estate and Latin America, this time its mortgage CDOs and the credit crunch. In both cases Citi paid 11% for the cash infusion in the form of preferred shares. I can’t see how this deal can be viewed as a positive for Citi, because they’re either overpaying for capital to shore up confidence in the bank OR they’re overpaying for capital because they’re desperate for cash.

11% is an awful lot to pay for a capital infusion, what exactly is Citi going to do to generate a larger than 11% return on that capital to justify the cost? No matter how you slice it, this points to things being worse for Citibank than previously imagined.

Disclosure: at the time of publishing the Author didn’t own a position in Citibank.

Posted to: Financials on November 27, 2007 at 03:34 PM | Permalink | Comments (0) | TrackBacks (0)

As if the financial sector needed more bad news, there are signs that Auto Loan delinquencies are rising rapidly. The pattern is similar to what’s happening with mortgages as far as increased delinquencies, followed by significant deterioration in the quality of related debt securities, etc. This isn’t at all surprising when you consider that Capital One’s auto lending unit is currently losing money. The three legs of the consumer debt stool are auto loans, credit cards and mortgages and all are shaky at best right now. The consumer debt bubble I spoke of back in September is on the verges of collapsing any minute now.

Disclosure: at the time of publishing the Author didn’t own a position in Capital One.

Posted to: Auto Industry | Financials on November 27, 2007 at 01:45 PM | Permalink | Comments (0) | TrackBacks (0)

The week begins with more bad news surrounding banks and the credit crisis: HSBC moved to rescue two of its SIVs today by agreeing to take $45 billion worth of the SIVs on to their own balance sheet. As a result of the action, HSBC won’t be participating in the super-conduit scheme proposed by Citi, Bank of America and J.P. Morgan. If you think about it, HSBC’s action flies in the face of the superconduit since the goal of the scheme is to keep SIV assets OFF the books, Citibank has even gone on record in saying that they won’t be taking SIV assets onto their books. In addition to the SIV rescue, Goldman estimates that HSBC will have to take another $12 billion worth of charges to handle the bad loans on their books.

Today’s news follows an earlier announcement from HSBC that it was going to take up to three years for the company to unwind itself from the mortgage crisis in the U.S; mind you, this doesn’t take into account HSBC’s subprime exposure in the U.K.

If HSBC is taking SIV assets onto their own balance sheet instead of waiting to leverage something like the superconduit, it makes me wonder if some of the SIVs are in too much trouble to wait for the superconduit or if it may never get off the ground in the first place.

Disclosure: at the time of publishing the Author didn’t own a position in any of the companies mentioned in this article.

Posted to: Financials on November 26, 2007 at 01:05 PM | Permalink | Comments (0) | TrackBacks (0)

The NY Times ran an article on Friday discussing the Black Friday holiday sales, depicting them as a case of “desperation” on the part of retailers due to the extra deep price discounts. The article also documents the trend of consumers going down market to save money. Despite the large crowds I’m sticking with my original prediction that holiday sales will disappoint from an earnings perspective, due to customers going down market and thinner retailer margins. However, I wouldn’t be surprised if some early positive sales numbers lift retail stocks only to see to them fall when the earnings numbers come in. As I’ve said numerous times in the past, you have to really consider the underlying quality of the YoY sales numbers and not assume they’ll translate into earnings growth when you’re in an environment of deep discounting.

Posted to: Retail on November 24, 2007 at 03:05 AM | Permalink | Comments (0) | TrackBacks (0)

A view on the U.S. Mortgage Market from someone who actually wants to buy mortgage backed securities in today’s market. While I don’t agree with some of his views on when to buy CDOs (he says Q4, I say Q2 ’08) or on the overall health of the mortgage market, it’s an interesting perspective from a money manager who made a killing off of the U.S. S & L crisis. Either way, someone is going to make a King’s Ransom making contrary bets off of the credit crunch. The question is: since nearly everyone has LOST money, who is going to be left to make money?

Posted to: Real Estate on November 24, 2007 at 02:31 AM | Permalink | Comments (0) | TrackBacks (0)

With the holiday shopping season having officially kicked off this Friday, here is a particular interesting story: Vizio a U.S. based company is currently out selling its Korean and Japanese rivals in the area of LCD TVs. This story stands in stark contrast to the late 80s, when the business media began lamenting the lack of U.S. based TV manufacturers as signs of the Japanese taking over American business in addition to losing our edge in technology.

However, those death rumors were greatly exaggerated.

It’s worth noting that Vizio is largely assembling their TVs with parts sourced from other manufacturers, their “hook” (at present) is a combination of lower prices, excellent designs and the ability (so they claim) to respond to market trends faster. In the consumer electronics world most manufacturers are building their products from nearly the same parts bin, with the performance differences coming from a combination of design, parts selection and implementation. As a result, Vizio’s focus on design, marketing and price enables them to use the Panasonic/Sony/Samsung parts bin, build a nearly identical product and out-sell them all the same.

As for Vizio, their model isn’t particularly innovative as it’s been used by various audiophile manufacturers for a couple of decades now. Rotel is one example: British designs, Asian manufacturing and parts sourced from other manufacturers have helped the company thrive for several decades. As the story of Vizio’s success in a large mainstream market segment spreads, it will be interesting to see if other companies/start-ups attempt to replicate their success.

Finally, a lot of start-ups come out of the gate claiming to be difference then their more established competitors but wind up becoming more and more like them as time moves on, will the same thing happen to Vizio?

Disclosure: at the time of publishing the Author didn’t own a position in Sony, Samsung or Matsushita (Panasonic).  

Posted to: Electronics & Gadgets on November 24, 2007 at 01:32 AM | Permalink | Comments (0) | TrackBacks (0)

Only with the usual sarcastic, business orientated humor of this blog of course ;)

Disclosure: No Window Washers were hurt during the making of this post; Analytical Wealth doesn’t advocate the smiting, underpaying, maiming or in any way hurting of Window Washers or any other blue collar workers.

Posted to: Randomization on November 22, 2007 at 10:48 AM | Permalink | Comments (0) | TrackBacks (0)

In advance of Black Friday, here is a Seeking Alpha article I wrote earlier in the week on the pending holiday sales season. Think of an extended companion piece to my earlier article on Holiday Sales.

These aren’t worth much right now (because predictions based on surveys are often wrong), but here is an article detailing the predictions for this year holiday sales.

(From Washington AFP) “US consumers, battered by a horrific housing slump and soaring energy costs, are expected to show caution in holiday spending this year, putting more pressure on retailers and the overall economy, analysts say.

Surveys project tepid growth in gift spending for the holiday shopping season set to begin Friday, the day after the Thanksgiving Day holiday.

The grim outlook has retailers starting early promotions and discounts to get consumers out and ensure that stores are not stuck with too much merchandise.

The National Retail Federation is projecting a 4.0 percent rise in holiday spending. A separate survey by Ernst & Young suggests growth of 4.5 percent.

Ratings firm Standard & Poor's predicts general merchandise sales to rise only 3.0 to 3.5 percent, well below increases of 4.9 and 5.8 percent in 2006 and 2005, respectively.

That would keep nearly flat the 250-billion dollar holiday shopping season in November and December that typically accounts for about 23 percent of annual retail sales and even more in profits, according to S&P.”

I recently heard a brief tidbit on the radio from the fellow at Ernst & Young responsible for driving their retail sales analyses, he says E & Y uses a different model based on Government data and sees only a slight downtick this year compared to last. I had to laugh at his reference to “Government Data” since the economic data from the Government is completely disconnected from reality and the inaccuracies become exaggerated during an economic downturn. Since the Government data is flaming rubbish, what does that make a forecast based on the same data?

My view is that the housing boom, abuse of credit and home equity withdrawals helped mask the impact of energy, food and healthcare inflation on the American consumer; in addition to inflating retail sales and/or enabling people to live well above their means. The sales of the last couple of holiday seasons were financed with credit cards and home equity loans. I’m sure there are many instances where an individual consumer hasn’t paid off their purchases from holiday season ’03, and/or are facing foreclosure on a house that’s full of items purchased with a HELOC.

With the housing market in a full-on recession and home equity withdrawals declining rapidly, it’s quite obvious that retail spending is poised to take a big hit during the coming holiday season. The retail spending decline will be greater than the final numbers indicate, since price inflation will inflate sales numbers in excess of their impact on earnings AND with respect to the amount of goods purchased. Think of it as retailers reaping fewer profits per dollar spent and the consumer purchasing fewer goods. YoY spending would have to significantly exceed last year’s numbers just for retailers and consumers to see the same level of benefit/profit. I suspect that the actual number for YoY sales growth will be closer to the S & P's conservative number of 3-3.5%, with the net impact being far lower due to inflation.

Finally, a significant YoY increase in consumer spending during the holidays is a BAD thing because it means that consumers are continuing to live above their means. This country simply cannot build a stable economic future on the backs of people spending more than they earn and living off of debt, it’s a house of cards that will crumble eventually. Signs that the consumer is starting to pull back and save are NOT bad signs, they’re positive signs for the long-term economic stability of our nation.

A full-on popping of the consumer credit bubble could be more financially disastrous than the mortgage crisis, cheering for the consumer to continue to overspend for the sake of short-term gains is completely fatuous. If holidays sales in 2007 and 2008 show significant gains it’s NOT a sign of strength, it’s a sign of people living above their means and creating a severe economic problem for the future.

Posted to: Financials on November 21, 2007 at 11:12 PM | Permalink | Comments (0) | TrackBacks (0)

According to a Deutsche Bank report, it appears that the central banks of various Asian nations are behaving in manner that could lead to the region creating a currency union. DB basis their assumption on the increased level of policy emulation and cooperation by the central banks of Asia; in addition to ten Southeast Asian nations agreeing to create a barrier free trade zone by 2015. DB discusses some investment strategies one could use to take advantage, based on patterns observed in Euro prior to the Euro being created. While it’s rather early to speculate too much on something that could be more mere cooperation then a move towards a singular currency, it’s still worth keeping an eye on and preparing for from an investment perspective.  

If the Asian nations are beginning to function as a de facto economic bloc, then the actions of individual central banks have weighed both singularly and as if the entire region is going to follow suit. The implications for the dollar are rather significant, it’s one thing if Korea reduces its dollar reserves on its own, it’s far another if eleven other nations do the same based on Korea’s lead.

Posted to: on November 21, 2007 at 10:54 PM | Permalink | Comments (0) | TrackBacks (0)

A very interesting read from the NY Times on Western Union and how it has re-invented itself from a sender of telegrams, to a financial link between immigrants and their family back home. At the present the company’s ability to forecast the movement of migrants, tally immigrant populations, etc, exceeds that of the U.S. census. For the entrepreneurs among us, this flow of money presents an interesting opportunity: a business that could capture just 1% of the $300 billion being sent by migrants back to their families would rack in $3 billion/yr.

Posted to: Global Economy on November 21, 2007 at 10:22 PM | Permalink | Comments (1) | TrackBacks (0)

Good Seeking Alpha read on “The Five Stages of Grief over the U.S. Dollar”, touching on the global trade issues and only lightly touching on the issues related to taxation and our social welfare programs. The latter issue needs to be discussed and resolved before it’s too late because the combination of the weak dollar + the impact of the housing downturn will only increase the demands on those programs.

Posted to: FOREX on November 20, 2007 at 01:52 PM | Permalink | Comments (0) | TrackBacks (0)

The chart below tracks the YoY decline in housing starts from 2006 through 2007; looking at the chart it’s pretty easy to see the rather significant decline in housing starts over a YoY basis from 2006.

I would guess that 2007 – 2008 will see a similar drop off and the 2006 – 2009 drop off will be very steep indeed.

Sources:

Chart courtesy of the NY Times.

Posted to: Real Estate on November 20, 2007 at 11:58 AM | Permalink | Comments (0) | TrackBacks (0)

Here is analysis from Barron’s on Fannie Mae, while it’s interesting the thing that struck me the most is repeated mention of Fannie’s “difficult to understand accounting practices”, in today’s times I would be wary of any company whose finances I couldn’t understand. How can an investor determine when it’s safe to go into the water if the company utilizes byzantine accounting practices that no one understands?  While they are recommending that investors avoid the stock until the company is done with charge-offs, I would add increased accounting transparency.

Disclosure: at the time of publishing the Author didn’t own a position in Fannie Mae. As always the content on this site shouldn’t be viewed as a recommendation to buy or sell a stock; do your own research and consult a financial advisor before making any significant financial decisions.

Posted to: Financials on November 20, 2007 at 11:27 AM | Permalink | Comments (0) | TrackBacks (0)

Today’s big financial markets story is the loss of $2 Billion reported by Freddie Mac, due to credit market and mortgage crisis related losses. However, this shouldn’t have been too much of a surprise for the markets as they were indications that the downturn in the housing market would place the mortgage GSEs at risk during the summer. Simply put, holding securities backed by subprime, alt-a and other risky loans was just as likely to generate major losses for the GSEs as they were for the private banking sector.

Up until recently there was very little ink spilled on the financial risks facing the GSEs, despite them having the same toxic CDOs on their books. Today’s news shows that the GSEs are not invulnerable to the credit turmoil roiling the traditional financial companies.

Freddie Mac reporting a loss and indicating that they may not have the cash to meet capital requirements, reduce the size of their mortgage portfolio, may have to cut their dividend, etc, has far wider reaching implications than if they were a company like Countrywide or E-Trade. The entire mortgage industry depends on the mortgage GSEs to buy their loans/inject liquidity, the shaky finances of Freddie Mac (and in all likelihood Fannie Mae) coupled with the credit crunch is just going to make it harder for mortgage lenders to operate. Granted, a GSE is effectively backed by the Federal Government, but bailouts, liquidity injections from the treasury, etc, aren’t free and have wide reaching implications of their own.  

Better yet, what in the world were the GSEs thinking purchasing the same toxic CDOs that the big banks were buying? Aren’t the GSEs supposed to have standards?

(From Reuters) “Freddie Mac, the second-largest U.S. mortgage finance company, on Tuesday posted a wider third-quarter loss and said it may slash its dividend and raise new capital as it works through what it called an "extremely difficult year" for housing and credit markets.

Freddie shares plummeted 23 percent to an 11-year low after reporting a net loss of $2 billion as falling home prices and tighter credit conditions increased the number of borrowers defaulting on their mortgages.

Freddie said it has hired Goldman Sachs and Lehman Brothers to help it study raising capital in the "very near term" as its soaring losses force it to raise cash to ensure it has enough capital to meet regulatory requirements. It may also cut its fourth quarter dividend by 50 percent

If its capital fell below required levels, the company may be forced to reduce the size of its mortgage portfolio…

… More of Freddie Mac's home loans are heading into foreclosure, which has forced the company to increase its provisions for failing loans. Freddie said Tuesday it had put aside $1.2 billion for credit losses and had begun to increase fees for guaranteeing the payment on home loans…

… The company said in a statement that it might sell preferred stock to increase its capital. Fitch Ratings, however, said it may cut Freddie's AA- preferred stock rating following news it was looking at raising additional capital.

Partly to increase its capital reserves, Freddie sharply shrank its holdings of mortgage securities in October and pushed them further below a growth limit set by the regulator, the Office of Federal Housing Enterprise Oversight.”

When a mortgage GSE has engaged Goldman Sachs to discuss options to raise cash, I think it’s safe to say that (at the very least) we have a mid-level mortgage banking crisis on our hands if not a banking crisis in general, albeit in mild form (for now).

I’m still amazed that many in the media persist in blaming subprime loans for mortgage related losses, when it’s quite obvious that borrowers of all types are defaulting on their mortgages. The real problem comes from bad lending standards, and banks allowing people to take on loans that weren’t financially sustainable over the long-term. Good credit doesn’t help someone make good on a mortgage they simply can’t afford. Additionally, the credit crunch needs to stop being blamed for rising mortgage defaults. Healthy credit markets won’t really help average everyday homeowners who simply have a mortgage they can’t afford; furthermore blaming the credit crunch for mortgage defaults is fatuous since the mortgage crisis helped cause the credit crunch in the first place.

You can’t develop a solution for a problem until you accurately identify the cause. When banks blame the credit crunch for their mortgage losses and not bad lending standards, investing in garbage CDOs, etc, it doesn’t give me a lot of confidence that they can fix their problems or prevent this sort of thing from happening in the future. There seems to be an attitude that healthier credit markets would somehow fix the housing situation, resolve the mortgage crisis, etc, and it’s nothing more than a fantasy.

Sources

Reuters: “Freddie Mac May Cut Dividend After Loss, Shares Dive” – Patrick Rucker, November 20, 2007

Disclosure: at the time of publishing the Author didn’t own a position in Goldman Sachs, Freddie Mac or Fannie Mae.

Posted to: Financials on November 20, 2007 at 11:18 AM | Permalink | Comments (0) | TrackBacks (0)

Despite some of the rosier predictions for holiday sales and consumer spending strength (which is a misnomer when it’s financed with credit), from various retail analysts and the Federal Government, the retailers themselves see a far worse picture. Between Wal-Mart’s heavy discounts well in advance of holiday sales, weak retail sales numbers and retailers estimating weak sales into 2008, it appears the consumer is not only pulling back, but the retail sector is well aware and taking steps to compensate.

The question offered is, when will the Government and various retail analysts catch-up with reality? I almost wonder if some of the analysts are off since they tend to be high income people, live in high income neighborhoods and are influenced by the economic reality around them. I live in a fairly affluent area where the stores were packed last weekend, however I’m well aware that the typical American isn’t living my reality. When will other analysts wake-up to that fact? It’s my belief that a disconnect from the economic reality of the typical homebuyer using an ARM, negative amortization loan, buying above their means, etc, helped contribute to the mortgage crisis.

When will reality hit the street?

Posted to: Real Estate on November 20, 2007 at 02:15 AM | Permalink | Comments (0) | TrackBacks (0)

3 Goldman Sachs analysts are predicting an additional $48 billion in write downs by the end of 2008, simply adding to the mounting evidence that the write down carnage is far from over. Between the unraveling mortgage crisis, credit agency downgrades and CDO payment cut-offs, the value of the mortgage securities portfolios held by the banks will continue to decline. Of course, I already noted this last week. ;)

My question is, how many 10s of billions of write downs need to happen before we admit that that we have at least a near moderate scale banking crisis? Do we need 200 billion in losses, banks writing down their CDO holdings to zero and a couple of major banks to go bankrupt before we realize we have the beginnings of a VERY large problem on our hands?

Disclosure: at the time of publishing the Author didn’t own a position in Goldman Sachs.

Posted to: Financials on November 19, 2007 at 10:06 PM | Permalink | Comments (0) | TrackBacks (0)

Um, the management consulting profession isn’t like this at all ;)

Posted to: Randomization on November 18, 2007 at 09:59 PM | Permalink | Comments (0) | TrackBacks (0)

Lately, Pay Pal has become a source of constant frustration for me. The frustrations started (ironically) when I went ahead and completed the account set-up process, as opposed to just paying for eBay auctions with my credit card via eBay checkout without really having an account. The problem is as follows: the default payment method for all auction payments is always your checking account and Pay Pal doesn’t give you the option to change the default payment source to your credit card. Instead, you have to change your payment source to credit card during the transaction itself. While you’re changing your payment source to credit card, you get messages attempting to talk you out of it, the links/buttons to leave your checking account as the payment source are highlighted, brighter colors, etc. In short, Pay Pal does everything it can to keep you from using your credit card as the payment source.

I find the emphasis on the buttons/links to leave the payment source as your checking account to be rather insidious, because a lot of users could be tricked into paying with their checking account and racking up overdraft fees, throwing their budgets off, etc. It’s very easy to accidentally click the wrong button. Just last night I clicked the wrong button, but caught myself in time. Now everyone is responsible for their own actions, but Pay Pal shouldn’t create a situation that makes it quite easy for someone to make a financial impactful mistake either.

A quick Google search revealed that many customers have their Pay Pal accounts attached to a checking account that is only used for Pay Pal, and have just enough funds in it to keep it active. If Pay Pal is going to stick with this strategy, they should at least have a better understanding of how their customers use the service and the risks to customer satisfaction. If they had that understanding, they’d know that there are a LOT of customers infuriated by not being able to specify that their credit card be the default payment source for all transactions.

Now the reasons for this strategy by Pay Pal are not to protect the customer from finance charges or credit card bills (despite the wording of their marketing messages), instead it’s to protect THEM from having to pay the processing fee to Vista/MasterCard/Amex/Discover. In fact, the customer is LESS protected via the check payment scenario since the typical credit card offers far greater purchase protection then Pay Pal (or eBay), not to mention the fact that people like to use their cards to rack up rewards points, earn cash back, track their expenses better, etc.

This situation is a very clear example of how a business and its customers often have differing objectives, thus making it difficult for a product/service to be delivered in a way that makes both parties happy. Faced with choosing between their own convenience and that of their customers, most business elect to serve their own interests as opposed to innovating their way out of the situation or implementing a “compromise solution”. I’ve witnessed these decisions before; the typical scenario is that the company implements what’s best for them and has marketing figure out how to “sell the pain” to the customer.

Free Markets “should” resolve these issues as another smart company should come along and simply deliver the service in the way the customer likes the most. However, what sounds good in theory isn’t always feasible in real life. Competitors operating within the same market will probably be pushed to make the same decisions, the “pain seller” may have dominant market share, or the conventional wisdom in a particular industry may be that the decision the customer hates is simply good for business.

Still, simple innovation could easily solve this problem in a way that would make everyone happy. If Pay Pal wants its customers to only use checking accounts to fund their payments, they should give the customer the option of setting their own default payment source and create a rewards program for people who use their checking accounts. If structured properly, increased profits should easily cover the cost of the rewards program due to more people funding their purchases with their checking accounts. In fact, it could be taken to another level by giving buyers more rewards/cash back if they use them to buy things from other merchants who accept Pay Pal, marketing partners, etc.

If simple innovation could solve these “conflicts” between companies vs. customer convenience, why aren’t more of these types of solutions implemented? The simple answer is that companies tend to drink their own Kool-Aid and more importantly fool themselves into believing their own marketing spin. I’m sure that there are multiple pay pal executives would argue against this article, saying that they’re indeed helping customers by pushing them towards using their checking accounts. Still, any company that is purposely irritating its customers is simply giving the competition the blue print to defeat them in the market place.

Disclosure: at the time of publishing the Author didn’t own a position in eBay; he may send them a bill (through Pay Pal of course) if they implement his suggestion.

Posted to: Organizational Management on November 18, 2007 at 01:12 PM | Permalink | Comments (0) | TrackBacks (0)

The usual irregular posting of news and notes in advance of the coming shortened business week.

A NY Times article discussing the recent trend of Private Equity companies backing out of deals, despite there not being a significant change in the business being acquired. I guess a credit crunch can bring people to their senses and cause them to realize when they’re overpaying for a company/are entering into a bad deal in general.

The larger issue is the impact on financial sector earnings, which (up until recently) were generating hefty fees from advising on Private Equity deals. We look at companies based on YoY growth and it’s unlikely many of them will be able to generate growth over the LBO boom levels (at least with respect to advisory fees) any time soon. The lack of growth also applies to profits from consumer lending, as that’s another market that’s going into a temporary recession.

If you’re looking for financial companies to invest in, I would look towards ones that generate a significant amount of their earnings from overseas and avoid the U.S. based retail banks with little or no presence outside of the U.S. for another quarter or two.

The $300 billion sent by migrants back to their home countries is more than triple the amount of foreign aid and in some cases comprises as much as 10% of the GDP.

Borrowing costs for financial institutions like Merrill Lynch and Citibank are now higher than those of industrial companies, the first such occurrence in 10 years. The reasons for this are undoubtedly a combination of worried investors in addition to the 10s of billions worth of CDOs both firms have written down over the past month or so.  

Treasuries are at their highest level in two years due to worries of risks in the credit markets, and I’m sure the weak dollar is a factor as well. Since mortgage rates are linked to treasuries, it’s quite likely that mortgage rates may inch up if this trend continues. Doug Kass discussed this very scenario a few weeks ago, namely that rate cuts cause the dollar to fall, which causes treasuries to go up and mortgage rates to increase as well.

The CEO of Northern Rock has stepped down according to a BBC report issued on 11/17. To be honest I was somewhat surprised by this announcement, because for some reason I thought he had already gotten the sack a long time ago. I find it mind boggling that he unceremoniously dismissed back in September, after leading his bank to being effectively nationalized and putting the British taxpayer on the hook for $60 billion and counting.

If you ever hear the British slang-term “Bollixed it all up” – know that it basically means what the alleged leadership of Northern Rock are responsible for.

A discussion on the possibility of a recession in the U.S., only from the perspective of what the global impact will be (particularly in Europe) with predicted growth rates for Britain, the Eurozone and Japan. The article is from a U.K. publication so it also discusses the possibility of a housing slow down in Britain and the impact of the U.S. subprime crisis on U.K. banks, which supplied a lot of the money for U.S. mortgages in addition to originating their own shaky mortgages. Upshot: the economies of the world are all rather interconnected and they all depend disproportionately on the U.S. due to the size of our consumer market. The discussion really needs to center around the possibility of a G8 Recession, rather than just talking about a U.S. one.

Disclosure: at the time of publishing the Author didn’t own a position in any of the firms mentioned in this or the referenced articles.

Posted to: Financials | Global Economy on November 17, 2007 at 11:21 PM | Permalink | Comments (0) | TrackBacks (0)

I was looking through the FDIC’s web site today and found this list of failed banks since 2000. As you can see, the # of failed banks spiked in 2002 no doubt a function of the post 9/11 recession, in addition to a remnant of the tech crash and subsequent corporate downturn. So far, there have been three failed banks in 2007 and the mortgage crisis undoubtedly played a part in all three. Chances are, there will be a spike in the number of failed banks in 2008 – 2009, as a result of the credit crunch and mortgage crisis.

The FDIC quarterly banking profile for Q2 showed a sharp increase in the number of unprofitable banks, and a 17 year high for loans that were 90 days or more past due. Q3’s banking profile is due in the next week or so (they’re usually issued 50 days after the end of the quarter), the data on unprofitable banks and loan defaults will be fairly revealing with respect to the overall health of the financial sector.

Posted to: Financials on November 17, 2007 at 11:12 PM | Permalink | Comments (0) | TrackBacks (0)

Ohio State Defeats Michigan 14 – 3 and all is well with the world! On to the Rose Bowl! Today’s game marked the sixth time in the last seven years (and fourth straight) that Ohio State defeated their arch-rivals from Michigan. Whilst it’s not the longest rivalry in College Football, (that honor belongs to the Lehigh vs. Lafayette rivalry in Division I-AA) it has to be the most intense due to the typical implications with respect to the Big 10 title, the Rose Bowl and in many cases the national title hunt.

Continuing with the college football theme, 2007 continues to be the “Year of the upset” with Texas Tech defeating OU 34 – 27.

Posted to: Sports on November 17, 2007 at 10:49 PM | Permalink | Comments (0) | TrackBacks (0)

I have to admit I was genuinely surprised by Wal-Mart’s recent earnings report, as I had expected flat earnings due to a combination of negative margin pressures and the weak comp sales reports the company issued in Q3. In particular, if comp store sales were weak despite heavy discounting, how could the company have generated a solid YoY earnings increase? Did the deep discounts actually work as many in the media claimed? Further review revealed some rather interesting things about Wal-Mart’s Q3, which represent some solid indicators as to the state of the low income/lower middle class consumer.

First, the numbers:

• 8.8% net increase in revenue, 6.4% Wal-Mart, 6.1% Sam’s Club and 16.9% internationally.
• Without fuel comparable store sales were up 1.5% for Wal-Mart and 1.8% for Sam’s Club, 1.5% for the U.S. segment overall, indicating that the overall increase in revenue was driven by expansion.
• Super Center Food sales grew by more than 13%
• Super Center Food Comps were 5.3% and pharmacy comps were 8% during Q3.
• The pharmacy’s prescription business grew by 40% in October on a YoY basis.
• Grocery now represents over 40% of Wal-Mart’s business; grocery, pharmacy and entertainment represent over 2/3rds of Wal-Mart’s total business.
• Wal-Mart US saw an increase in average ticket size, but a decline in total traffic
• Operating income for Wal-Mart stores increased 11.1%, 6.2% for Sam’s Club and 8.6% for the international segment.
• Earnings per share increased roughly 11% once you factored out a one-time gain from real estate sales.
• Wage, advertising, accident and costs overall were down for the Quarter. Sales per labor hour increased 4% for the quarter and inventories declined 1.6%.
• A 4.6% YoY decrease in capital expenditures, a savings of $500 million. In fact, if capital expenditures had remained flat from last year Wal-Mart would’ve seen an 11% YoY earnings decrease. 

Something we didn’t see mentioned that has been a problem for Wal-Mart in the past was the performance of its clothing and household good divisions. Clothing was an area that was only loosely alluded to, namely the performance of a new initiative around 10 items for $10.00. The focus on the grocery and pharmaceutical segments, whilst ignoring clothing and household goods seems to reflect the continued poor performance of the latter two areas.

The overall picture is that Wal-Mart’s Q3 performance was driven by a combination of grocery-pharmaceutical, international sales and expense control, as opposed to deep discounting for household items, toys and clothing. Moving forward, Wal-Mart’s domestic story may in fact resemble that more of a Grocery-Pharmacy retailer rather than a discount department store. Overall, the key to Wal-Mart’s future growth is its international businesses. Despite failures in South Korea and Germany, if Wal-Mart is able to catch-on in emerging markets like India and China, $100 billion quarters will be child’s play for this company.  

Moving forward, Wal-Mart’s domestic focus should be on its grocery, pharmacy and financial services businesses in addition to growing the international business as a whole. Looking at Wal-Mart’s weak areas, it will still need to build a stronger brand in order to effectively compete with Target in the areas household goods and clothing and should consider building a separate brand apart from Wal-Mart.

Finally, it’s quite obvious that food and healthcare inflation (whilst ignored by the Fed) is really hurting the budgets of consumers at the middle class level and below. It’s quite likely that Wal-Mart’s foot traffic declined due to the tighter budgets of its low income customers, and was only somewhat offset by an influx of new middle income customers going down market.

Wal-Mart’s Q3 numbers are a strong indicator of the need to look for the story behind the story as opposed to cheering numbers blindly, because Wal-Mart’s Q3 strength was an indicator of high inflation at the household level and a weaker American consumer. 

Sources: 

Seeking Alpha: “Wal-Mart F3Q08 (Qtr end 10/31/2007) Earnings Call Transcript –November 13, 2007”

Disclosure: at the time of publishing, the Author didn’t own a position in Wal-Mart.

Posted to: Retail on November 17, 2007 at 09:01 AM | Permalink | Comments (0) | TrackBacks (0)

The foreclosure situation in the U.S. may be on the verge of getting very, very messy. Apparently, due to the way many loans were securitized, the loans are often in multiple securitization pools AND it’s very hard to prove who actually owns the loan. If a particular party cannot prove they own the loan, then they can’t foreclose on them. The NY Times recently reported that a Federal Judge dismissed 14 foreclosure cases brought by Deutsche Bank National Trust Company (DB) (An entity formed by Deutsche Bank to administer mortgage securities in the U.S.), because Deutsche Bank couldn’t prove they actually owned the loans.

I’ve heard of bad risk management practices, but this situation is ridiculous. How in the world can a bank invest in a series of mortgage loans, without making sure that things are structured in a way that would allow them to foreclosure on the loans if necessary? Not only does this leave the homeowners in limbo, but it could magnify the potential losses on the part of the CDO holders.

Disclosure: at the time of publishing, the Author didn’t own a position in Deutsche Bank.

Posted to: Real Estate on November 16, 2007 at 09:49 PM | Permalink | Comments (0) | TrackBacks (0)

Interesting post from the WSJ’s economics blog on the topic of money market funds losing value: instead of bailing out a money market fund whose NAV has fallen under $1.00, GE has decided to let the NAV of one of its funds fall under $1.00 to roughly $0.96. Aside from the fact that a money market fund falling $1.00 is rare, I’m surprised that GE is risking the bad PR of letting it happen. I guess it helps the majority of the funds come from GE’s own pension funds and benefits plans, still, the outside investors who are losing money will be none too pleased.

The issues around a run on money market funds, a contraction in the short-term funding market, et al, are covered well enough by the referenced blog post so I won’t discuss them. Instead, let’s consider the impact of the credit crunch on investor/consumer confidence at the institutional, wealthy, generally affluent and average Joe levels. A lot of people felt their homes were the smartest investment they could make, now they’re seeing a loss of home equity and rampant foreclosures that are arguably unprecedented, at least in the minds of most Americans. Many feel money market funds are as safe as banks and losses may get to the point where the banks stop bailing out their funds and let the NAV fall under $1.00. Not too long ago we Americans joked about the Canadian Peso, now we’re Canada’s Mexico.

In the end, the above gives us some big questions whose answers will be readily apparent over the next 1-3 years:

1. What’s the next “allegedly stable financial domino” to fall?
2. What will American financial confidence look like and how long will it take for it to recover?
3. Will the financial habits of children growing up during this era learn from their parents?

The rest of this decade is going to be very interesting indeed.

Disclosure: The Author doesn’t own a position in GE.

Posted to: Financials on November 16, 2007 at 09:17 PM | Permalink | Comments (0) | TrackBacks (0)

This isn’t business or finance related, but it’s still interesting to those interested in electronics or high-end audiophile gear. On this date in 1904 the Vacuum Tube was born and with it the age of modern electronics.  

(From Wired Magazine) “1904: British engineer John Ambrose Fleming invents and patents the thermionic valve, the first vacuum tube. With this advance, the age of modern wireless electronics is born…

The article notes that Tubes (or Valves as they’re known in the U.K.) were replaced by transistors in the mid 20^th century, which isn’t quite accurate because for many applications (audio electronics in particular) they were still heavily in use until the late 1970s. Even today, many audiophiles and musicians prefer tube based equipment although their number is waning. However, the numbers of tube aficionados are still large enough for Stereophile Magazine to have rather extensive listings, rankings and reviews of all tube gear. In fact, tube gear is still rather easy to find at a high-end audio store or music stores catering to musicians.

Personally, I think that for “some” applications tubes sound better, but that is probably more due to the “pleasant” distortions tubes add to the sound, as opposed to reproducing sound as accurately as possible. Still 103 years after their birth tubes have set a “standard” with respect to audio reproduction, which today’s engineers still aim to either match or best with solid state electronics. Typically the goal is to combine the “sparkle” of tubes for mid range sounds (like vocals) with the overall tonal accuracy and power of transistors.

Other modern day uses of tubes include the electronics of Soviet (now Russian) Fighter jets, which (to the best of my knowledge) still use tubes for some of their electronics. In fact the ending of the cold water undoubtedly prolonged the usage of tubes in audiophile gear, as the defense factories of the Soviet Union began producing tubes for the audio world.

The fact that tubes never really died out is a good example of the fact that new technologies don’t always supplant older ones, because the old technologies are sometimes capable of doing things the new tech isn’t. In fact the adoption of newer technologies isn’t always due to it being better, but is often a function of lower cost, greater convenience, etc. On the flip-side, sometimes older technologies can persist due to personal preference, nostalgia or it even due to simply being more refined (due to being around longer) then a newer technology that has greater long-term potential.

In the end, it’s always interesting to see how an older technology and a newer one are merged in order to give consumers the benefits of each. A great example of this is Fatman’s tubed power amplifier and iPod Dock a rather esoteric high-end product, which combines tube amplification with the more modern technology of the iPod. Both my pragmatic and audiophile sides agree that this product is a bit ridiculous, why spend $1,800 on a high-end power amp when the source is as lo-fi as an MP3 player?! BUT, it’s a classic example of the old being reborn in a way that compliments the new.

Sources:

Wired: “Nov. 16, 1904: Vacuum Tube Heralds Birth of Modern Electronics” – Tony Long, November 16, 2007

Disclosure: the Author is an avid audiophile who currently uses both tubes and solid-state gear in his beloved audiophile rig, which no one is allowed to touch…ever.  

Posted to: Randomization on November 16, 2007 at 07:03 PM | Permalink | Comments (0) | TrackBacks (0)

The Chief Economist of Goldman Sachs estimates that while losses from the Credit Crunch will total roughly $400 billion, the fact that those bearing the losses are levered up rather significantly will magnify the impact to $2 trillion.

(From Reuters) “But unlike stock market losses, which are typically absorbed by "long-only" investors, this mortgage-related hit is mostly borne by leveraged investors such as banks, broker-dealers, hedge funds and government-sponsored enterprises.

And leveraged investors react to losses by actively cutting back lending to keep capital ratios from falling -- A bank targeting a constant capital ratio of 10 percent, for example, would need to shrink its balance by $10 for every $1 in losses…

… "The macroeconomic consequences could be quite dramatic," Hatzius said in the note to clients. "If leveraged investors see $200 billion of the $400 billion aggregate credit loss, they might need to scale back their lending by $2 trillion."

"This is a large shock," he said, adding the number equates to 7 percent of total debt owed by U.S. non-financial sectors.

Hatzius said such a shock could produce a "substantial recession" if it occurred over one year, or a long period of sluggish growth if it occurred over two-to-four years.”

No matter how you slice it, we’re going to be feeling the pain of the easy money era for years to come. The things that worry me the most are:

a) We don’t really know how big the problems are, with respect to the mortgage crisis, credit crisis, et al

b) As time goes on we find that more and more organizations, institutions, aspects of the banking business, etc, were involved

c) The very same people who made the bad decisions that got us into this mess are by and large the people who are supposed to be making the decisions to get us out of it; does anyone else see something wrong here?  

d) After the tech crash we learned that some of the biggest cases of corporate fraud aren’t necessarily committed during boom times, but during the bad times when people do whatever they can to prolong the good times a bit longer/mitigate the impact.  

Point “d” coupled with the potential impact of $2 trillion is the real risk facing the credit markets, the financial sector and the economy overall.

Sources:

Reuters: “U.S. could face $2 trillion lending shock-Goldman” – November 16, 2007

Disclosure: at the time of publishing the Author didn’t own a position in Goldman Sachs.

Posted to: Financials on November 16, 2007 at 06:20 PM | Permalink | Comments (0) | TrackBacks (0)

In “What did the “easy money era/credit crunch/mortgage crisis/credit bubble infect this time?” news, it appears that money market funds are beginning to lose value do their investments in CDOs, SIVs, shaky commercial paper, etc. As a result, the banks are bailing out their money market funds via injecting cash into them in order to preserve asset value. The situation is thus: the banks can’t afford to have their money market funds to lose value (even though they’re not guaranteed not to), as it would hurt their reputations and cost them money, so they’re bailing them out.

Aside from the fact that the money market fund situation represents another drain on financial sector profits, it does beg the question: what corner of the financial world won’t the mortgage crisis infect?

Posted to: Financials on November 15, 2007 at 07:48 PM | Permalink | Comments (0) | TrackBacks (0)

Barclays joined the subprime write down party, by announcing $2.7 billion worth of write downs related to the company’s investments in subprime CDOs, with over $1.6 billion of that total come during the month of October alone. For my money the key isn’t what Barclay’s writes down today, it’s what Barclay’s writes down tomorrow. Nearly every bank that has announced a big write down has followed it with another one just a few weeks later. It’s going to be a long-time before the banks get their write downs out of their systems.

A key aspect to keep in mind with respect to mortgage write downs is each wave of foreclosures not only devalues CDO holdings, but it also causes CDO payments to get cut off. It’s quite likely that the banks will have to continually adjust and mark down the value of their CDO holdings until the housing market stabilizes. Unless an institution has marked down the value of their mortgage related securities to zero, I would take any claims that the “write downs are over” with a very large grain of salt.

Disclosure: at the time of publishing, the Author didn’t own a position in Barclays.

Posted to: Financials on November 15, 2007 at 07:40 PM | Permalink | Comments (0) | TrackBacks (0)

Whilst I think there is a degree of exaggerated irrational fear over the falling dollar, this is still quite humorous:

Posted to: Randomization on November 15, 2007 at 10:46 AM | Permalink | Comments (0) | TrackBacks (0)

If you recall I noted about six weeks ago that HSBC’s decision to close Decision One Mortgage was just the tip of a subprime iceberg comprised of Mortgages, Credit Card, Unsecured Loans and Auto Loans. Today there came the news that HSBC is taking a $3.4 billion charge to cover loan losses within its U.S. based lending operations.

(From the NY Times) “HSBC Holdings warned today that losses in the United States housing market were spreading to credit card and other consumer loans, forcing the bank to set aside $3.4 billion to cover bad loans, more than it had forecast about four months ago.

However, revenue growth at its consumer lending business in the Middle East, Hong Kong and China more than offset the losses at the American unit, resulting in an increase of third-quarter profit, the company said, without giving any figures.

HSBC said it set aside $1.4 billion more than anticipated earlier because of a “broader deterioration” in the United States housing market and will also take a $55 million charge to close 260 more consumer finance branches in the country..

.. HSBC, which had started to close mortgage units and exchanged managers to limit the effects on its business, said it could take up to three years to resolve the bank’s issues related to the subprime crisis, especially as the difficulties are widening.

“Early stage delinquency rates in both cards and branch unsecured lending are also showing signs of deterioration,” HSBC said in a statement”

Reading the article I appreciated the candor from HSBC, while U.S Banks are acting as if the end of the mortgage crisis (which is turning into a consumer credit crisis) is right around the corner, HSBC is being honest: “three years to resolve all issues”. As an investor, I’d rather hear a company provide a dire prediction of the future, rather than to tell me that everything is going to be fine next quarter only to announce $11 billion in write downs three weeks later. Thinking about the larger issue of recovering from the mortgage crisis, even if it takes HSBC’s peers 1.5 years to recover it would still mean we’re going to be facing the after effects of the mortgage crisis well into 2009.

As for HSBC, their wellness plan should be as follows:

1. Close down all of their U.S. based subprime lending units; shuttering Decision One was just a start, the next step should be to close down Household Finance. A lot of HSBC’s U.S. lending businesses focus on subprime, the company needs to get out of subprime and focus on building its prime lending business.
2. Tighten up lending standards, and begin taking steps to prevent future pain within their credit card, personal and auto lending businesses. If they already see weaknesses in those businesses, I want to know what they’re doing to avoid future pains.  
3. Make a significant investment into expanding their retail banking operations in the U.S., because outside of the NYC metro area they don’t have very many branches state side. Additionally, I think HSBC’s premier service for wealthy clients represents a value proposition that no U.S. bank can match as far as providing services for clients who travel/work between multiple countries.  
4. Begin to wind down U.K. based subprime operations now; if Northern Rock is any indication and if the predictions of a sharp rise in U.K. foreclosures are true, HSBC needs to start hedging itself against a U.K. subprime debacle ASAP.  
5. Continue to invest in the businesses that are doing well, but do a deep review of them to identify any potential risks, particularly around lending standards.
6. Overall the company needs to streamline as there appears to be a lack of cohesiveness in the larger business. The goal should be build a synergistic group of business around the company’s present success areas and kill off tertiary operations (like U.S. subprime) that aren’t contributing to the success of the whole.

Right now, HSBC is the tale of two companies: the successful international bank and the beleaguered U.S. subprime lender. The key to future success is to try and replicate what had has made the bank successfully internationally in the U.S. and to kill off its stateside subprime operations.  

Sources:

NY Times: “HSBC Takes $3.4 Billion Charge” - By JULIA WERDIGIER and LANDON THOMAS Jr. – November 15, 2007

Disclosure: at the time of publishing the Author didn’t own a position in HSBC.

Posted to: Financials on November 15, 2007 at 07:44 AM | Permalink | Comments (0) | TrackBacks (0)

An absolute MUST READ from the BBC on the mortgage crisis (focusing on subprime), which aggregates a lot of data and analysis I’ve only seen bits and pieces of scattered over several other places. In particular, read the parts that discuss undisclosed banking losses hidden in SIVs and how the collapse of the mortgage securities market is spreading into the bond market in general and how that will impact the financial sector and the economy at large. It’s a well written with a lot of great charts and data points on the mortgage market, I’ll write a more detailed analysis of the information later.

Posted to: Financials on November 15, 2007 at 12:36 AM | Permalink | Comments (0) | TrackBacks (0)

According to an article on the BBC’s web site, it’s projected that Northern Rock will have borrowed over $60 Billion in emergency funding from the Bank of England by the end of the year; the amount comes out to nearly $1,500 per tax payer. Additionally, the treasury has identified roughly $40 Billion in retail deposits that the British Government has agreed to guarantee. All told, total exposure to the Northern Rock debacle is roughly equivalent to about 3% of Britain’s GDP.

Bank bailouts aren’t cheap and before all is said and done, the American tax payer may be facing a similar bill for an institution the U.S. deems so vital to the economy that it’s effectively nationalized instead of letting it fail. IF we as a nation decide that certain businesses are so vital to the U.S. economy that they can’t be allowed to fail, then safeguards must be put in place to prevent situations where the cost of the bailout is exorbitantly high.

Obviously bailouts and cost motivated safeguards run somewhat contrary to the concept of a “free market economics”, but free markets don’t prevent companies from acting so moronically that they take down the economy with them. So the only choice is to take the necessary actions to protect the economy. As it is, corporate leaders only should “free markets, no regulations, no government intervention” when it’s convenient, I seriously doubt they really entertain any free market illusions.

Disclosure: at the time of publishing the Author didn’t own a position in Northern Rock.

Posted to: Financials on November 15, 2007 at 12:20 AM | Permalink | Comments (0) | TrackBacks (0)

Lately it seems that if a financial sector company reports bad news, but tempers it with the phrase “the worst is over”, the stock will increase in value as investors see a buying opportunity. Case in point: Countrywide’s stock popped after reporting a loss and rapidly accelerating delinquency rates for Q3, based on the company’s expectation that Q4 will see a return to business as usual, calling a veritable mortgage bottom, etc. As if Countrywide’s customers are going to suddenly start paying their mortgages on time next quarter. Bear Stearns’ stock popped an initial 5% after reporting a 60% YoY earnings decline because its write down of $1.2 billion was less than expected, and on Wednesday of this week Bank of America’s stock popped 3% after announcing a $3 billion write down.

Don’t fall into this value trap. Don’t forget that the worse was supposed to be over after the Q3 earnings were announced, but those same banks went on to announce billions more in additional write downs. Bank of America, Bear Stearns, Citibank, Chase, HSBC, Morgan Stanley and Wachovia have announced over $30 billion in write downs and Q4’s write downs are easily on track to exceed Q3’s number. Let’s not forget that many of these same companies were saying the mortgage situation was contained, over, not that bad, etc, back in Q1 & Q2 and look at where we are now.

At present, the markets simply aren’t receiving honest guidance from many financial companies and/or these guys simply don’t know their own businesses well enough to give proper guidance in the first place. As a result, investors should be wary of throwing their money into the financial sector until the consumer credit, mortgage crisis, credit crunch, et al, unwinds a bit more.

The key to value investing is to have enough information to place a proper valuation on the company, and then buying if the stock’s intrinsic value is sufficiently higher than the current trading price. At present investors simply don’t have enough information to place a proper valuation on financial sector stocks, so it’s probably smart to avoid the lot of them for now. Don’t blindly run after an alleged blue chip just because the stock is down and you figure “it’s a solid business it just has to go back up”, a true value investment is one that the market is ignoring but you know is truly undervalued. Considering the lemming behavior investors are showing towards financial sector stocks provided the company claims “the worse is over” after reporting bad news, most financial sector stocks don’t qualify as value investments at this point.

This is not to say that these stocks won’t go back up at some point, these companies won’t recover, etc. However, it’s too early to tell how everything is going to shake out, so why risk your money? Isn’t the first rule of investing to “not lose the money”?

Finally, has everyone just forgotten the billions worth of ARMs that are scheduled to reset over the coming months? The problem with the ARM situation is that rate cuts won’t help nor will refinancing, because in many cases the ARMs teaser rate payment is about as much as the borrower can afford. Once the teaser rate period is over the borrower has a loan they can’t afford even if they refinance to an uber-prime fixed rate mortgage, and rate cuts won’t prevent the loan from resetting to a rate that’s higher than the teaser rate. Over the next 2-4 months there is going to be a spike in ARM resets, followed by an accompanying spike in foreclosures 3-6 months later.

Things are going to get worse for the banks before they get better, consumer credit losses will probably accelerate well into 2008 and we have no reason to believe that the CDO write downs factor in potential losses from 2008-2009. After all, these CDOs were overvalued by optimistic mark to model valuation methods in the first place, why should we believe that the Bank’s have suddenly gotten cynical? 

Sources:

• Graphic Courtesy of Credit Suisse
• Associated Press: “Countrywide Loses $1.2B, Sees Turnaround” – Alex Vega, October 26, 2007
• Bloomberg: “Bear Stearns Cuts Subprime Assets, Limits Writedown” - Yalman Onaran, November 14, 2007
• Forbes: Street Discounts Bank of America Write-Down – Ruthie Ackerman, November 13, 2007
• NY Times: “HSBC to take $3.4 Billion Charge” - Julia Werdigier, November 14, 2007 

Disclosure: at the time of publishing the Author didn’t own a position in any of the companies mentioned in this article.

Posted to: Financials on November 14, 2007 at 05:32 PM | Permalink | Comments (0) | TrackBacks (0)

In the past I’ve posted about bailouts be they the superconduit or ineffectual rate cuts, a recent issue of Barron’s had an article about very real bailouts via sweetheart lending deals from the Federal Home Loan bank to troubled lenders. Now, I can’t disagree with the argument that the U.S. economy would be eviscerated if large banks were to fail. However, let’s not forget that these actions all come with a price, and there will be a reckoning down the road due to the various bailouts, rate cuts, lifting of banking regulations, etc. The cost could be a negative impact on the economy (we’re currently paying for the Greenspan Put) or it could be shareholders holding the “rump company” in a situation like with Northern Rock.

Disclosure: at the time of publishing, the Author didn’t own a position in Northern Rock or any of the firms mentioned in the linked to article.

Posted to: Financials on November 13, 2007 at 12:05 PM | Permalink | Comments (0) | TrackBacks (0)

didn’t post this yesterday because taking a little time to support the troops on Memorial Day and Veterans day is common place, what we need is MORE support for the troops the other 363 days of the year. Too often discussions of the military turn into a political fracas, because people on both sides of the aisle are just exploiting the military for their own narrow political agendas, as if only those on their side are patriotic and able to support the troops. In the end the political fighting is flaming rubbish, all that matters is that a citizen of this nation has volunteered to risk his life in defense of our nation.

During combat, the politics of the war mean nothing to the soldier who is down range from the enemy and is hoping to live to see his/her family again. While watching the evening news a few years back, a large, archetypal, hard as nails soldier was being interviewed by the local news: “they starting shooting and I wanted my Mama, now I’m home, my Mom is here (his rather large arm was around his mother) and I’m going home. The guy ended the interview right there.

It’s just that simple.

Let’s recognize our soldiers every day of the year, not just on Veterans Day and not just during war time as well. The USO is a great organization not just for the shows we all think of, but for the every day, small things they do with regards to supporting soldiers as they travel, are separated from their families, etc.  

Posted to: Randomization on November 13, 2007 at 11:51 AM | Permalink | Comments (0) | TrackBacks (0)

An update on the Northern Rock situation in the U.K: the Financial Times published the details of a leaked memo laying out a possible future for the embattled U.K. mortgage lender. The likely scenario is that the company’s business and assets would be sold to a willing buyer/patsy and the shareholders would be left owning a “rump company” that would owe the British Government billions. The shareholders would gradually begin to be compensated as Northern Rock’s debt is wound down. The reason for the likely scenario is that it’s going to be very hard to find someone willing to buy Northern Rock outright, i.e. buy the business, the assets and take on the debt, especially when it’s possible to leave the shareholders holding the debt bag.

The implications for the U.S. Banking sector are pretty clear: even in an instance where the Government steps in to prop-up a failing bank, the shareholders are probably going to get the shaft. Not because the U.S. and the U.K. banking systems are identical, but because no one is going to want to buy an American Northern Rock outright either.

The London Telegraph has a page dedicated to the Northern Rock situation here.

Disclosure: at the time of publishing, the Author didn’t own a position in Northern Rock.

Posted to: Financials on November 13, 2007 at 11:15 AM | Permalink | Comments (0) | TrackBacks (0)

There was an article on TheStreet.com’s web site this morning that took a populist bent towards advocating for homeowners facing foreclosure, by claiming that since the lenders are “getting away with it”, why can’t homeowner’s “write-off their homes and continue to live in them?”. The idea is that since the larger lenders are deemed “to big to fail”, why can’t the home owner get the same treatment? I understand the author’s viewpoint in that it seems as if it the homeowner faces all the pain, while the lenders just “write-down” their losses, but things aren’t that simple. In fact, I think these types of articles are somewhat dangerous as they distort the true reality of the situation.  

1. If a homeowner “wrote-off” the home they’re losing they wouldn’t get to keep it, the concept of a write down, charge, etc, implies that the assets value is gone/declined significantly. Write-offs and write-downs simply aren’t ways to have your cake and eat it too; you’re adjusting your balance sheet because your cake is gone. I.e. write-downs aren’t an innocuous activity that allows a company to escape the impact of losing money. A write-down is in no way shape or form a bailout or escape from bad investment decisions.
2. When a mortgage goes bad the banks lose money and the homeowner loses their home, both parties are losing their piece of the transaction. The difference is that the homeowner was smaller and more vulnerable, not that the Government, Corporations or any other group is colluding to oppress the homeowner.
3. The article absolves the homeowner of any personal responsibility. IF the homeowner had taken on a loan they could actually afford there wouldn’t be a problem. In cases of bad lending standards, someone bought a home that simply wasn’t fiscally capable of being a home owner. The banks did in fact enable bad decisions on the part of the borrower, but that doesn’t reduce the borrower’s culpability.
4. When it comes to foreclosure the core problem is a home owner with a mortgage they can’t afford, nothing short of large scale debt forgiveness or someone else footing the bill is going to change that.
5. The motivation behind the rate cuts was to help borrowers AND lenders, however, due to the nature of the situation the impact of the rate cuts was muted at best. 

The problem with this article was that it didn’t frame the home owner’s problems properly and simply misinterpreted the nature of a write-down. There needs to be a dialogue on solutions for the lenders and the borrowers, but it needs to frame things properly, avoid over-simplicity and hyperbole. Write-downs aren’t bailouts or a way to avoid responsibility, and write downs in the face of foreclosures aren’t an assault on free enterprise. The rate cuts were meant to help a broad swath of borrowers and lenders, had very little impact and weren’t a lender bailout either.  

The true assault on free enterprise comes from “solutions” that absolve either lenders or borrowers of the responsibility of their decisions, outside of situations where things get so bad that letting a group or company fail would crush the economy. An open dialogue on this situation cannot portray the banks as vampires and the borrowers as victims, and has to recognize wrong-doing on both sides.

Don’t get me wrong, I’m not indifferent to the plight of home owners in trouble. However, we have to accept that many of these people simply can’t afford the houses they’re in or cannot afford to be homeowners in general. Only then can we begin to devise solutions that will get these families into sustainable housing situations. Again, I can see the author’s viewpoint and respect the fact that she’s trying to speak up for the homeowner, but (again), we have to frame the dialogue properly to get results.

Finally there are indeed attempts to bailout the lenders, the super-conduit is one noted example as is the whining from CEOs for either the Fed or the Government to bail them out. Now these activities are indeed an assault on free-enterprise, but let’s talk about those specifically, not write downs, rate cuts and severance packages.

Posted to: Real Estate on November 12, 2007 at 09:50 AM | Permalink | Comments (0) | TrackBacks (0)

As the mortgage crisis has unfolded, we’ve discussed the impact on consumer spending, on housing prices and even on the psychology of home owners and the public at large. One thing that hasn’t been discussed is the impact on the retirement situation in the U.S., namely how many people aren’t prepared for retirement AND how many (up until recently) planned to depend on their homes to fund their retirement. It would be one thing if housing price appreciation merely leveled off and many home owners simply found themselves with less equity than they had hoped, instead we’ll have a population of home owners (many of whom are probably baby boomers) who are:

1. Dealing with being upside down in their homes
2. Are facing a bankruptcy or foreclosure within ten years of retirement
3. Forward progress towards a well funded retirement was thrown off track by some combination of upside down mortgages, speculation gone wrong, excessive HELOC withdrawals to fund discretionary spending, etc, etc.
4. Depended too heavily on real estate to fund their retirements, to the detriment of equity investing.

While preparing for retirement can take decades, it only takes a few years and a couple of bad decisions (or strokes of bad luck) to throw one off track. Even if a home owner suffers some form of financial malaise from the mortgage crisis in their early 30s giving them years to recover, the impact on their ability to accumulate wealth for their retirement years will likely be felt for years to come. Looking at the next 10-20 years it’s a pretty much a given that the mortgage crisis will put more of a strain on Social Security, Medicare and other Social Service programs; additionally, it’s also quite likely that the impact of the mortgage crisis will be felt (in some way) decades down the road as 30-somethings like myself retire.

The flip side of this argument is that the mortgage crisis causes Americans to be more financially conservative and increase their savings rates. This action would probably be too late to save the baby boomers but it would undoubtedly set a new course for the younger generation, sparing them many of the same pains their parents are feeling right now.

It’s going to be interesting to see which scenario plays out.

I’m a cynic and I’m betting on the first one: significant negative impact on programs like Social Security and Medicare for the next 3-5 decades.

I hope I'm proven wrong.

Posted to: U.S. Economy on November 12, 2007 at 03:06 AM | Permalink | Comments (0) | TrackBacks (0)

During the housing boom, a lot of “housing boom deniers” would scoff at the idea that a  housing downturn would impact consumer spending, either by claiming the two weren’t related or by saying that the consumer was resilient enough to shrug off any downturn in housing. In last week's NY Times there was an excellent article discussing the impact of the housing downturn on consumer spending, which was especially good for its quantification of the numbers involved. However, the real strength of the article is in articulating the sort of consumer behavior that led people to abuse the housing ATM in the first place, as it’s a stronger indicator of future behavior around personal consumption.

Here are some quick data points from the article:

1. From 2004 – 2006 Americans pulled $840 billion/yr out of residential real estate; to give that number some perspective that an amount large enough to be the world’s 14^th largest economy on a GDP basis.  
2. The housing ATM financed $310 billion/yr worth of personal consumption from ’04 à ’06.
3. A year ago, money taken out of homes was equivalent to about 9% of total personal income, now the number is down to around 5%.
4. A 2% drop in consumer spending is enough to send the nation into a recession.
5. In 2006 20% of the personal consumption spending in California and Nevada was financed by HELOCs, it’s now down to 9%. 

(From the NY Times) “As his wedding day approached last spring, Marshall Whittey found that his money could not keep pace with the grandiosity of his plans. But rather than scale back, he chose instead, like millions of homeowners across the country, to borrow against the soaring value of his home…

… He and his bride, Holly Whittey, exchanged vows on the grounds of a sumptuous private estate in the Napa Valley. They spent their honeymoon at a resort in Tahiti.

But now, in an ominous portent for the national economy, Mr. Whittey has grown tight with his money. His home is worth far less than it was a year ago, and his equity has evaporated. And like many other involuntary adopters of a newly economical lifestyle, he can borrow no more.

“It used to be that if I wanted it, I’d just go and buy it and finance it,” Mr. Whittey, 33, said. “I’m feeling the crunch, and my spending is down significantly.”

… From 2004 through 2006, Americans pulled about $840 billion a year out of residential real estate, via sales, home equity lines of credit and refinanced mortgages, according to data presented in an updated working paper by James Kennedy, an economist, and Alan Greenspan, the former Federal Reserve chairman. These so-called home equity withdrawals financed as much as $310 billion a year in personal consumption from 2004 to 2006, according to the data.

…in the first half of this year, equity withdrawals were down 15 percent nationally compared with the average for the last three years, and consumption supported by such funds plunged nearly one-fourth, according to the Kennedy and Greenspan data…

… Only a year ago, money taken out of houses was still more than 9 percent of the nation’s disposable income, Mr. Zandi calculated, using a sampling of Equifax credit reports to supplement Fed data. By this fall, it had dropped to about 5 percent, a difference of about $350 billion a year.

…Much of the attention in the recent collapse of the housing boom has focused on those in danger of losing their home or facing higher monthly payments in their adjustable mortgages. But the broader effect on the economy is likely to come from the much larger group of homeowners who can no longer count on rising home values to bolster their wealth…

… Reno encapsulates, in concentrated form, the forces at work on American consumers. In Nevada, and in neighboring California, home equity finance was about 20 percent of all disposable income at the end of last year, according to Economy.com. This September, it was down to about 9 percent…

… Local businesses are already suffering the effects of consumers who are less inclined to buy. A Volkswagen dealership downtown said sales were down two-thirds from a year ago…

At the Meadowood Mall, near the airport, shoppers were scarce. “We’re dead,” said Cendy Rodriguez, manager at Lane Bryant, the plus-size women’s clothing store, who said business was down 25 percent over the last two months. “I don’t think it’s going to be nowhere near the Christmas we had last year.”

At Sierra Nevada Spas and Billiards, Ezra O’Connor, the sales manager, complained that not even drastically lower prices were attracting shoppers. “We’re way down, 35 percent down from last year,” Mr. O’Connor said. “People just aren’t wanting to spend.”

Mr. Whittey once seemed an unlikely member of that cohort. A sales manager at a flooring and tile company, he exudes the unflappable air of someone raised amid the easy money of the casino world. Until recently, he and his wife regularly embarked on shopping sprees of $1,000 and up.

He bought a 21-foot boat and two flat-screen televisions for their home. He sold his old truck and bought a new one, he said, “just ’cause I didn’t like the color.” Mr. Whittey could live in such fashion because his company was making good money and his house was appreciating.

Some additional thoughts regarding the article:

1. If the people discussed in the article are any indication, a lot of people really went overboard with using HELOCs to finance a “higher lifestyle”, and became entirely too comfortable with debt. It will be interesting to see if there is a backlash and people go completely in the opposite direction, if this happens, the retail sector will go into a protracted downturn as will earnings from the consumer credit divisions of the retail banks.
2. If you look at the numbers, the closing of the housing ATM is the equivalent (so far) of removing 4% of the money available to fund personal consumption or $340 billion dollars. In other words, a pool of money nearly the size of the GDP of Switzerland has been removed from the consumer spending part of the economy. Considering the numbers, doesn’t a protracted downturn in consumer spending seem inevitable and with it a decline in GDP growth if not a recession?
3. If you review the Fed’s monthly report on revolving credit balances, you’ll notice a sharp YoY uptick beginning in 2006, which falls right in line with the decline of the housing market. Obviously consumers are using their credit cards to fill in the financial gap that used to be filled by HELOCs, and are effectively exchanging one form of credit abuse for another. This practice of “credit abuse arbitrage” is beginning to fall apart, as nearly all of the major banks reported increased defaults within their credit card businesses.
4. This Christmas Shopping Season ’07 (and I suspect ’08) will not be a good one for retailers, with the biggest declines being seen in the high ticket items that many home owners used the “faux wealth effect” to finance.
5. Over the next 12-18 months signs of consumer spending “resilience” should not be regarded a positive, it should be viewed as a sign that consumers are continuing to live above their means, especially if credit card balances continue to increase. While it may cause some short term pain, the best thing for the economy right now is for consumers to pull back, get their financial houses in order and break their addiction to debt. It’s a simple question: do we want retailers to beat their ’08 numbers or long-term financial stability for consumers and the economy?

Sources:

NY Times: “Homeowners Feeling the Pinch of Lost Equity” – Peter S. Goodman, November 8, 2007

Disclosure: as of the time of publishing, the Author didn’t own a position in any of the companies mentioned in this article.

Posted to: U.S. Economy on November 12, 2007 at 03:02 AM | Permalink | Comments (0) | TrackBacks (0)

The Federal Reserve’s data release on consumer credit came out this past Wednesday and it continues to show a trend of increased revolving credit use. Although September’s increase was the smallest so far this year, it’s still larger than the typical increase from ’02 – ’06. If you look at the data you can see a sharp uptick beginning right around the time housing began to slow down. This situation relates directly to a recent article of mine regarding the impact of HELOCs on consumer spending, both during the housing boom and in the present day as home equity withdrawals have slowed substantially. Either way, the increase in revolving credit usage is a form of “credit abuse arbitrage” as consumers have gone from abusing HELOCs to abusing credit cards.

The retail sector is due to take a huge hit from this situation, think about it: retail sales have been stagnant for a couple of months now, how bad will they be when we have a full fledged revolving debt crisis on our hands?

Finally, ignore anyone in the media (or laugh at them if you’d like) who says that increased revolving debt usage is a positive trend because it means only one thing: consumers are continuing to live above their means. The best thing for the economy (over the long-term) is for consumers to pull back on retail spending and credit card usage, yes it will cause short-term pain, but it will also give us long-term economic strength. It’s a simple question: do we want the retailers to beat their ’08 earnings estimates or do we want long-term economic stability?

Posted to: U.S. Economy on November 9, 2007 at 04:40 PM | Permalink | Comments (0) | TrackBacks (0)

Sometimes Dilbert reflects real life a bit too closely, I’ve run into this situation on more than one occasion where business processes are blindly followed without thinking about what the organization actually needs to get done. What’s happening here is that executing the process has become more important then delivering the process’ outcome, I.e. providing resources with the equipment they need to do their jobs. Executing the purchasing process has become more important than providing Dilbert with the bar scanner in a time frame that allows him to meet his commitments.

The solution for this situation is fairly simple; managers need to be provided with the right incentives so that they realize that getting Dilbert his bar scanner is more important than executing the purchase process. While it's easy to blame bad managers for these situations, in many instances they're only behaving in accordance with how they're rewarded. The pointy haired boss is undoubtedly rewarded for following the process properly, more than he is for ensuring his resources have the equipment they need.

Another issue is that managers need to sufficently engaged with their businesses, so they understand WHEN to apply a particular  process  and when not to.

Posted to: Organizational Management on November 9, 2007 at 03:16 AM | Permalink | Comments (0) | TrackBacks (0)

If you recall I noted the other day that I anticipated total mortgage related write-downs to top $60B before long, well, it appears that multiple analysts agree with me, sort of. Analysts from Citibank and J.P. Morgan are expecting total write-downs in the area of $60-$70 billion, whilst I anticipate we’ll hit $60B (either reported, warned or estimated) by December. Overall, I anticipate the total number will be much higher as the problems around foreclosures, bad mortgages, et al, escalate. Let’s not forget the 100s of billions worth of ARMs that are scheduled to reset over the next 12 months.

I’m actually not surprised the analysts are under-estimating the total number, remember, these individuals work for the same companies that purchased bad mortgage backed CDOs, didn’t think housing would collapse, underestimated their CDO exposure time and time again, etc, etc. In fact, if companies like Citibank are pegging the number at $60 billion, you might as well add 50% to it or the modifier “well, $60 billion until we’re forced to write down the 10s of billions more of toxic CDOs on our books that we’d rather not talk about right now". But seriously, considering how badly banks like Citibank screwed up  with respect to subprime and mortgage CDOs, why is anyone even listening to them about this issue?

Disclosure: as of publishing, the Author didn’t own a position in Citibank or J.P. Morgan Chase.  

Posted to: Financials on November 8, 2007 at 08:57 PM | Permalink | Comments (0) | TrackBacks (0)

In a performance that is sure to garner him the win for “Best Depiction of Extreme Chutzpah by a CEO” Countrywide CEO Angelo Mozillo slams the U.S. Government for “zero effort” to tackle the subprime crisis. I had to read the article twice just to make sure it was real, I even checked the URL to make sure it wasn’t a joke site. Angelo Mozillo has the gall to blame the Government for not bailing him out of a problem of his own making, a problem he could’ve helped avert by not originating so many unsustainable ARM mortgages and/or through the use of common sense loan underwriting standards? Angelo Mozillo the clown who will call a bottom to the mortgage crisis one week, then try to spin away news on the deteriorating condition of his company the next, is slamming someone for not doing more to fix the mortgage crisis?

Are you kidding me?

1. Isn’t this the same guy who claimed that CFC would return to profitability in Q4, as if the credit market is suddenly back in 2006, foreclosures aren’t skyrocketing, CFCs loan defaults aren’t increasing, etc? Sure, the company “could” be profitable in Q4, but more conservative and realistic guidance would’ve been appreciated.
2. Is this the same guy who went on a hiring binge over the summer, as the mortgage crisis was really building up steam and then had to turn around and lay those people off a few months later?
3. Mr. Suspicious stock sale? Yes, we’ve heard it a thousand times he was selling as part of an automatic plan. However, considering everything that’s going on, he could’ve just shut the thing off.
4. Isn’t Mozillo the CEO of the company that runs the “faux” loan modification program? As in, we only fix loans for people who haven’t had their rate reset, make you jump through 8,000 hoops, are refinancing people who could easily refinance anyway and rarely fix anyone’s loan in the first place?  

Despite my mini-rant Mr. Mozillo has a point: the Government should be blamed for their lack of effort in controlling the subprime crisis. If the Government had done a better job of regulating the supply of cheap money, regulating mortgage lenders and ensuring that common sense underwriting standards were used, Countrywide wouldn’t have shot themselves in the foot.

Of course, all of those regulations would’ve caused Mozillo to whine about Governmental interference, because a lot of these guys think the Government’s role is to bail them out and promote risk free capitalism.

Disclosure: as of publishing, the Author didn’t own a position in Countrywide.

Posted to: Financials on November 8, 2007 at 08:35 PM | Permalink | Comments (0) | TrackBacks (0)

Retail Sales were abysmal this past October with nearly every major retailer reporting either a sales decline or a same stores estimate miss, with the only exceptions being Target and Costco. Retail sales have been weak to mixed at best for several months now and the overall trend points retail sales data points towards a poor Christmas shopping season. During the holiday shopping season, consumers will likely spend less and retailers will slash prices to attract customers, the result being thin margins, flat revenue numbers and poor earnings numbers for Q4. Consumer spending strength from ’02 – ’06 was built on the back of the housing ATM, cheap/easy access to credit, it was going to be time to pay the piper eventually.

Outside of retailers that cater to the top 10-15% of the population income wise, any significant growth in retail sales/consumer spending, has to be greeted with a degree of cynicism for the time being. On aggregate consumers have been living above their means and are on the road to being tapped out, so any persistent growth is merely an indicator of people continuing to abuse credit, pointing towards an even greater fall down the road. From a medium to long-term perspective, a pull back in consumer spending is actually a good thing as it will produce a more financially stable consumer down the road.

The markets, business leaders, the American public, etc, HAVE to get behind the idea of abandoning short-term gains (be they in the form of profits, investment gains or buying a HDTV on credit) for long-term stability. Consumers beginning to pull back, live within their means and SAVE may hurt the retail sector and the economy in the short-term, but it will produce a more stable economic environment at the macro and household level in the long-term.  

Disclosure: as of the time of publishing the Author didn’t own a position in any of the companies mentioned in the referenced article.  

Posted to: Retail on November 8, 2007 at 04:35 PM | Permalink | Comments (0) | TrackBacks (0)

As I noted yesterday, the Dollar was at risk of falling further if the European Central Bank and the Bank of England raised their interest rates. Today, both central banks elected to keep rates steady, despite concerns about inflation and increasing borrowing costs. Long-term it’s going to be interesting to observe the behavior of the BOE and the ECB, are they going to begin to imitate the Fed or will they go their own route? Maybe, this recent action is a sign that the BOE and the ECB understand that you don’t solve problems caused by cheap money with more cheap money.

Posted to: Global Economy on November 8, 2007 at 04:01 PM | Permalink | Comments (0) | TrackBacks (0)

The hits just keep on coming for Citibank: first there was the $6.8 billion in Q3 write downs and losses, then the alleged “resignation” of their CEO and Monday’s announcement of $11 billion in additional write downs. If that wasn’t enough, there came Tuesday’s news that Citi has provided its SIVs with a $10 billion credit line due to funding issues and Wednesday’s news of a possible downgrade from Moody’s.

(From Reuters) “Citigroup Inc which faces rising losses from the global credit crisis, said it provided $7.6 billion of financing to off-balance sheet investment funds that have had trouble funding themselves recently.

Citigroup said it has given the funds, known as structured investment vehicles, or SIVs, $10 billion of available financing, and the funds had drawn $7.6 billion of that financing as of Oct. 31.

The move, disclosed in a quarterly filing with regulators late on Monday, may add to investor concern about Citi's $83 billion of structured investment vehicles, which issue short- and medium-term debt to finance their acquisition of bank bonds, repackaged debt, and other securities...”

… Citi said in its filing that its credit lines to the SIVs were done on "arms-length commercial terms," and that the bank has no plans to list the SIVs' assets on its own balance sheet…

… Citi has faced a series of problems in recent weeks. Over the weekend, its chief executive resigned and Citigroup revealed it may face $11 billion more in pre-tax write-downs this quarter for repackaged debt known as collateralized debt obligations…

.. Those potential write-downs are on top of $6.8 billion of write-offs and losses already recorded in the third quarter.

The funding problems are likely to get worse if Moody’s does indeed cut the ratings on some of Citibank’s SIVs:

(From Bloomberg) “Citigroup Inc. and HSBC Holdings Plc received warning of possible downgrades to their structured investment vehicles as Moody's Investors Service reviewed its ratings on $33 billion of debt.

SIV ``debt ratings continue to be vulnerable to the unprecedented large and sustained declines in portfolio value combined with a prolonged inability to refinance maturing debt,'' Moody's said in a statement today...

... Citigroup, the largest U.S. bank by assets, said this week it provided $7.6 billion of financing to the SIVs it runs after they were unable to repay maturing debt. U.S. Treasury Secretary Henry Paulson is pushing for Wall Street to establish a fund by year-end to help SIVs avoid a fire sale of assets because of the contagion from record mortgage foreclosures.

Citigroup's Beta Finance Corp., Centauri Corp. and Dorada Corp., with combined assets of more than $50 billion, risk downgrades to their capital notes, debt that ranks below commercial paper. Moody's may also cut London-based HSBC's Cullinan Finance Ltd. capital notes. ”

So after reading the two articles, the following things immediately came to mind:

1. The combination of the $10s (if not hundreds of billions), the words “off balance sheet” and “no equity exposure”, make me nervous. Citibank can pretend it isn’t exposed to its SIVs, but I know a hobgoblin when I see one, especially when Citi isn’t exactly acting like a company that doesn’t have any exposure. 
2. Citibank’s SIVs or perhaps “fiscal sieves” are in trouble and the super-conduit may not be able to save them. Even though balance sheet alchemy allows Citi to legally keep the SIVs off book, if the SIVs aren’t able to pay back the credit lines the situation turns into a loss for Citi, period. Eventually, these SPEs will come back to hurt Citi.
3. Can anyone really question Citibank’s participation in the super-conduit as anything more than an effort to avert disaster for its own troubled SIVs? Let’s not forget that Citibank led the way in pushing for the plan in the first place; it’s quite likely that their SIV problem is significantly larger than anyone outside of Citi realizes.
4. If the debt downgrade does happen, don’t be surprised if Citibank extends additional credit lines to its SIVs as their funding issues are only going to get markedly worse. However, due to the current credit market turmoil it won’t be easy for Citibank to just toss $10s of billions more down the SIV drain, something has to give.  
5. All of Citibank’s statements regarding its exposure to CDOs, SIVs, future profitability, etc, need to be taken with a large grain of salt and heavily scrutinized. This is the same company that predicted a return to normalcy just a few weeks ago and then turned around and announced $11 billion worth of write-downs. $11 billion worth of losses didn’t magically appear over the course of a couple of weeks.
6. Does anyone remember when we were looking at around $20 billion worth of write downs heading into Q3 earnings season and it seemed like a really big deal? In fact, many financial scribes suggested that the Banks were just getting the write downs out of their “systems” and/or that there was a lot of exaggeration in that $20B number. Well, it’s only a couple of weeks later and it looks like Citibank will have nearly $18 billion in write downs on its own and Q4 isn’t even over yet. Considering the speed at which the lending loss problem is increasing (mortgage defaults, credit card defaults, et al), is it really a stretch to say that Citi could hit the $20B mark by the end of Q4?
7. Continuing on the theme of write downs: Merrill Lynch may have to write down another $10 billion in CDOs on top of the $7.9 billion they wrote down last quarter, and Morgan Stanley announced that they may have to write down $3.7 - $6 billion in subprime CDOs. How much longer before the U.S. Banking sector crosses the $60 billion mark in total write downs? How many $10s of billions of write-downs do we need to see before we at least accept that we have some sort of crisis or the very least a rather significant malaise infecting the financial sector? We may find ourselves looking at back on a mere $20 billion in write downs as a “better place”. 
8. Finally, the larger issue is that Citibank has some very significant financial problems that didn’t just suddenly appear; instead the market conditions that allowed Citibank to hide these problems are no longer present. As a result, past “strength” has to be questioned and investors need to be wary of this stock because we just don’t know how bad things truly are.  

Sources:

• Reuters: “Citigroup provided $7.6 bln to struggling SIVs” – Dan Burns, November 6, 2007
• Bloomberg: “Citigroup SIVs Risk Cut in $33 Billion Moody's Review” – Neil Unmack, November 7, 2007

Disclosure: at the time of publishing, the Author didn’t own a position in Citibank or HSBC. The proceeding article does not constitute investment advice and is for informational purposes only; investors should always do their own research and consult a financial professional before buying/selling securities or making any other financial decisions.

Posted to: Financials on November 7, 2007 at 10:22 PM | Permalink | Comments (0) | TrackBacks (0)

Paul Kedrosky has a funny post over at his blog regarding Morgan Stanley’s recent announcement of $3.7 - $6.0 billion worth of subprime write downs. Since we’re tying in the worlds of Monty Python, sackings and finance, here is an apropos and hilarious Monty Python clip from “The Meaning of Life”.

Posted to: on November 7, 2007 at 08:03 PM | Permalink | Comments (0) | TrackBacks (0)

Interesting blog over at the Financial Times web site called the Undercover Economist, the Blog is UK centric (of course) but the questions people pose to the blog and many of the topics discussed are more than applicable to a U.S. audience.

Posted to: Economics on November 7, 2007 at 07:20 PM | Permalink | Comments (0) | TrackBacks (0)

The U.S. Dollar has fallen to fresh lows vs. the British Pound, Canadian Dollar and Euro, due to a combination of things: mortgage fears, problems in the financial sector, China’s plan to diversify its currency reserves and GM’s record $39 billion loss. At one point during the trading day, the Pound hit $2.10, the Canadian Dollar $1.10 (the Loonie is at 57 year high) and $1.47 for the Euro. Adding to the dollar’s woes is speculation that the European Central Bank and the Bank of England will raise interest rates during their meetings tomorrow. The U.S. cutting interest rates whilst the Central Banks of the Eurozone and Britain raise their rates, would represent a double whammy of one nation devaluing its currency whilst others appreciate it via the raising of interest rates.  

Overall, the factors driving the dollar’s fall all point to one thing: weakness in the U.S. economy, no matter how rosy a picture some would like to paint. Moving forward the larger question is: after the U.S. economy recovers, will the damage to the reputation of the U.S. dollar as a preferred currency recover as well or are those days gone for good? Even if the U.S. dollar recovers to say ’03 – ’05 levels, it will just be a “less weak” currency and the overall issues of a weak dollar will remain. Regardless, corporate credit, consumer credit, mortgage and housing issues are likely to plague the U.S. economy for years to come, the issue isn’t if the dollar keeps falling, but “how far”.

If you wish to track this issue, the BBC’s web site has a great page for tracking intra-day levels of various currencies and tracking currency values over the past year.

Find below, several charts (courtesy of the BBC) depicting the dollar’s fall against the British Pound, Canadian Dollar and Euro since the beginning of the year.

Sources:

Charts courtesy of the BBC

Disclosure: as of the publishing of this article, the Author invests in the following currencies: the British Pound, Canadian Dollar and Euro.

Posted to: FOREX on November 7, 2007 at 10:02 AM | Permalink | Comments (0) | TrackBacks (0)

Over the last week or so, the financial markets have been heavily focused on Merrill Lynch and Citibank with respect to write-downs, losses and the departures of MER CEO Stanley O’Neal and Citi CEO Chuck Prince. Meanwhile, the Canadian Imperial Bank of Commerce (CIBC) has been facing similar issues to the point of being forced to sell its U.S. investment banking division for a song, and the quiet departure of the head of its debt division. As the saying goes, things are tough all over.

All that being said, CIBC plans to focus on its retail operations and may even purchase a U.S. bank, no doubt helped by the weak dollar; still, it does lend credence to the idea that we may be heading towards a mini banking crisis on a global scale.

Disclosure: at the time of publishing, the Author didn’t own a position in any of the companies mentioned in this article.

Posted to: Financials on November 6, 2007 at 01:36 PM | Permalink | Comments (0) | TrackBacks (0)

Since it’s “resignation” season in the financial sector, here is an interesting article discussing severance packages and how the way they’re structured encourages risk taking, especially when combined with healthy stock option packages. The relationship is as follows: if you take risks and they pay off the value of your options increases, if you take risks and fail the value of your severance package increases. In other words, the relationship between options and severance packages doesn’t give CEOs an incentive to build long-term value. If you recall, this is similar to my earlier post regarding the inverse relationship between large stock option packages and company performance.

I’ve never been one to pile on CEOs regarding large pay packages; however, in some cases incentives need to be restructured in order to ensure that the CEOs are focused on creating long-term value for shareholders instead of short-term value for themselves. When the reward for success is $100s of millions and the reward for failure is a little over $100 million, CEOs aren’t being incented to strike a balance between risk and reward. No CEO wants to be deposed, but you have to admit that the reward for failure is pretty sweet.

Here is a link to a slide show of the top ten severance packages.

Posted to: Business Commentary on November 5, 2007 at 09:18 AM | Permalink | Comments (0) | TrackBacks (0)

I’ve decided to bring back this post from July as it’s actually quite relevant to the situation we’re right now with respect to the Financial Sector, i.e. rapidly escalating write downs. In other words, the danger isn’t so much in the write downs we know about, it’s in the write downs we don’t know about, the gains that may never be realized claimed by companies like Goldman, etc.

Now on to the original post:

The following is a must read on how we could face a problem similar to the Japanese Bank crisis of the 90s, due to banks and other investors holding on to subprime credit securities instead of selling them and having to recognize the losses.

There are a lot of naysayers running around who say that there isn’t much chance of a big credit crisis, who are probably right (to an extent of it being a HUGE global crisis) – but more and more evidence is coming out every day that suggests we’ll probably face “some” sort of crisis, we just don’t know what it will look like yet.

Posted to: Financials on November 4, 2007 at 06:12 PM | Permalink | Comments (0) | TrackBacks (0)

Well it’s now official: Citibank CEO Chuck Prince tendered his resignation today amidst mounting losses due to bad investments in mortgage securities. Tomorrow Citibank is expected to announce another $9 billion worth of write downs related to the U.S. mortgage crisis. Between Citibank and Merrill Lynch, we have over $20 billion worth of write downs related to mortgages and debt securities, and it's likely that more will follow. I wonder, where are those people who called us bears “alarmists and cynics” by claiming subprime fears were overblown and the situation would be contained? Are they two busy eating crow to own up to how clueless they were?

An allegedly contained situation has generated well over $30 billion in write downs, taken out CEOs at two of Wall St’s largest institutions and the banks and brokers may just be getting started with “write down madness ’07-‘08”. As I’ve stated before we don’t know how many billions worth of toxic CDOs and debt securities are sitting on the bank’s balance sheets and it stands to reason that we’re going to be dealing with write downs well into 2008.

Disclosure: as of the time of publishing, the author didn’t own a position in Citibank.

Posted to: Financials on November 4, 2007 at 05:50 PM | Permalink | Comments (0) | TrackBacks (0)

This is what often passes for leadership and management: simply name the problem and bring me a cafeteria list of solutions which I can either rip apart or choose from, because it allows me to appear to be a “take charge proactive leader”. However in order to be an effective leader, one has to be engaged with the business and the problems it faces. This is not to say that one has to get engaged at a granular level but a leader should definitely have a solid understanding of his/her business, which can’t be achieved if you immediately start talking about solutions without having a discussion about the problem.

Posted to: Organizational Management on November 4, 2007 at 05:09 PM | Permalink | Comments (0) | TrackBacks (0)

The last couple of days have been rather tumultuous for the financial sector; here are some of the big stories heading into the weekend.

A good Bloomberg article covering the WSJ report that CEO Chuck Prince is going to step down, as well as an SEC investigation into how Citibank accounted for certain SIV transactions. I won’t be surprised if Prince is either ousted outright or forced into retirement before the year is over, I will be surprised if he and Merrill Lynch CEO Stanley O’Neal are the only CEOs of major banks to lose their jobs over the next 2-3 quarters. Looking at the SEC investigation, if it’s determined that Citibank didn’t account for the SIVs properly, then it’s quite likely that the superconduit scheme will have difficulties getting off the ground. As it is, the viability of that ludicrous endeavor has yet to be determined.

Merrill Lynch is still in the news with various analysts estimating that there will be another $10 billion worth of CDO write downs before all is said and done.. This doesn’t surprise me, as I’ve been saying for weeks we don’t really know the full extent of the CDO malaise on the balance sheets of the major banks and brokers. Additionally, there is an investigation into some of MER’s transactions related to mortgage debt, which could spell even bigger trouble for the firm.

Notable financial sector Mike Mayo estimates that the major banks and brokers will need to write down at least $10 billion more worth of CDOs, mortgage securities, etc. Mike Mayo has had an interesting career; I recall an old Fortune article from early 2001 discussing how Mike was fired for saying (true) things about the banking sector, which irritated his firm’s banking clients, as well as his bosses.

More revelations of potential CDO write downs and losses.  

Posted to: Financials on November 2, 2007 at 11:47 PM | Permalink | Comments (0) | TrackBacks (0)

Great article in today's Financial Times regarding the role of central Banks with respect to asset bubbles, namely that they should be more involved in the control and outright "pricking" of asset bubbles, lest they wreak havoc on the economy.  I suppose there are those who may feel that a central bank getting involved in regulating credit and controlling asset bubbles runs contrary to the idea of a free market, however, how is that different from the Fed injecting liquidity, cutting rates, et al, when things go bad? The markets can't have it both ways - e.g. the convenient intervention paradox: crying foul when a central bank (or other Governmental agency) intervenes to protect the economy during the good times, and begging those same agencies for a bailout when times are bad.

The "convenient intervention paradox" is especially glaring when you consider that the un-desired type of intervention, could very well prevent the pain which sends the financial sector running to central banks for help in the first place.

Posted to: Global Economy on November 1, 2007 at 12:08 PM | Permalink | Comments (0) | TrackBacks (0)

In overnight trading (in Asia) oil reached a hit of $96.00/barrel before coming down a bit today, a prime example of just how volatile the energy markets are right now. A recent article from the BBC discusses the situation and provides an interesting graphic depicting the rapid upwards climb of oil prices since August.

Since the Asian markets closed, Oil is down in the $93/barrel range as the dollar rebounded a bit this morning. I would guess that the long-term trend will be a weaker dollar and oil prices continuing to rise, as this morning’s activity is probably driven primarily by profit taking more than anything else. It’s somewhat fatuous at this point to even celebrate oil being “down” to the low 90s or the dollar gaining a bit, as we’re simply talking about numbers that were new highs in the past week or so.

Sources:

Graphic courtesy of BBC News

Posted to: Energy on November 1, 2007 at 08:48 AM | Permalink | Comments (0) | TrackBacks (0)

UBS has been in the news quite a bit lately, no doubt stemming from their $730 million Q3 loss and $4.4 billion in fixed income security write downs. While the profit estimate was actually in line with what was reported earlier, total write downs were actually $1B higher. UBS’ Q3 was somewhat similar to Merrill Lynch’s, in that the weak performance of the asset management segment dragged down strong performances from other divisions like Wealth Management. As expected, UBS announced that they’re going to shore up their risk management controls, make some organization changes, etc, in order to prevent this from happening in the future.

At this point, it’s too soon to tell if the changes UBS plans to make will have the desired effect, since some of the people making the changes are responsible for many of the bad decisions that got UBS into this situation in the first place. Case in point, UBS’ new COO is actually their former Chief Risk Officer, which doesn’t give me a lot of confidence.

“Oct. 30 (Bloomberg) -- UBS AG, Europe's largest bank by assets, reported its first quarterly loss in almost five years after the U.S. subprime mortgage contagion led to $4.4 billion in writedowns on fixed-income securities.

The third-quarter net loss was 830 million Swiss francs ($715 million), or 49 centimes a share, compared with net income of 2.2 billion francs, or 1.07 francs, a year earlier, Zurich- based UBS said today. UBS shares fell 1.3 percent in Zurich trading after the loss exceeded analysts' estimates.

The slumping U.S. housing market, which cost the world's biggest financial companies more than $30 billion, makes it unlikely UBS's investment bank will return to profit in the fourth quarter, Chief Executive Officer Marcel Rohner said today. Losses at the unit led to the ouster of investment banking head Huw Jenkins and finance chief Clive Standish this month, and outweighed record profit at the wealth management division.

``The fixed-income and credit business are still exposed to the subprime and credit markets in the U.S.,'' said Stefan Raetzer, who helps manage about $28 billion at Allianz Global Investors in Frankfurt. ``If a further weakening of the markets there occurs, UBS will have to make additional writedowns.''

UBS shares fell 80 centimes to 61.35 francs. The bank is the fifth-worst performer in the 63-member Bloomberg Europe Banks and Financial Services Index in the past 12 months, down 22 percent. ”

Before we get too carried away piling on institutions like Merrill Lynch and UBS, let’s not forget that there are dozens of other banks that haven’t recognized all of the losses from the devalued CDOs on their balance sheets; at some point these banks will be forced to come clean. Additionally, there are other banks and brokers (like Goldman Sachs) recognizing paper gains on CDOs based on their own internal valuation models, when it still remains to be seen whether or not the models are correct and if they could even collect the paper gain. Finally, let’s not forget that the reasons the financial sector is struggling right now: the rising mortgage defaults, the housing market slow down, escalating loan losses, the consumer credit bubble et al, none of which are going away any time soon.

I would be very surprised if we didn’t see another round of write downs, earnings declines and even losses from various financial institutions in Q4 ’07 and Q1 ’08.

Sources:

Bloomberg: “UBS Reports SF830 Million Loss on Debt Writedowns” --- Jacob Greber, October 30, 2007

Disclosure: as of the time of publishing, the Author didn’t own a position in any of the companies mentioned in this article.

Posted to: Financials on November 1, 2007 at 08:25 AM | Permalink | Comments (0) | TrackBacks (0)

Interesting article about Jim Rogers (who co-founded the Quantum Hedge Fund with George Soros), who says he’s shorting U.S. I-Banks due to a combination of money losing investments, high operational costs and toxic balance sheets.

(From Bloomberg) “Jim Rogers, co-founder of the Quantum Hedge Fund with billionaire George Soros, boosted his bets against U.S. securities firms because of their salary ``excesses'' and money-losing investments.

Rogers said he increased his year-old short positions in the past six weeks in U.S. investment banks, using exchange-traded funds and bets against individual companies he declined to name. Stocks in the industry, which pays too much in bonuses, may fall as much as 70 percent in a bear market, he said.

``You see 29-year-olds on Wall Street making $10 million to $20 million a year, and they think it's normal,'' Rogers, 65, said in an interview in London today. ``There have been lots of excesses,'' said Rogers, chairman of Beeland Interests Inc...

…`Bad Paper'

``Who knows how bad the balance sheets are,'' Rogers said. ``They took on gigantic amounts of bad paper…

… The slump in the U.S. housing market ``still has a long way to go'' before recovering, he said. ``Market excesses don't clear themselves out in just four or five months; they take years.''…

…Rogers is best known for being a commodities bull since 1999, before the market started to rally in 2001. His Rogers International Commodity Index has more than quadrupled since its start in 1998, while the Dow Jones Industrial Index gained 56 percent.

``History shows that the bull market in commodities will last a long time,'' Rogers said last year. He predicted in 2005 that commodities will rally at least until 2014 and perhaps until 2022. ''

While I think that Jim can lean towards hyperbole at times, it’s hard to argue against his track record and he makes some excellent points about the brokers. With respect to the bad debt issue, the thing that stands out in my mind is: “Can we even take the earnings reports of the past 6-8 quarters seriously?” The brokers (and retail banks for that matter) were overvaluing mortgage and other debt securities by mark to model methods, based on the anticipated performance of the underlying loans. As the mortgage crisis continues to worsen and the market realizes how risky and toxic certain securitized loans are, it’s quite obvious that many of those securities were overvalued from the start. 

Meaning: included in the earnings statements of past quarters are paper gains from overvalued securities, which the banks won’t be able to realize and/or were gains that just didn’t truly exist in the first place. The financial sector’s Q3 write downs helped to clean up some of the “faux” paper gains on their balance sheets, but I doubt they removed all of them. Let’s not forget Goldman’s $2.62 billion paper gain in Q3. If the financial sector wants to come clean, it should quantify and reveal the remaining “suspect” paper gains on their balance sheets.  

On the topic of housing it comes down to one fundamental fact: the housing market was simply overinflated due a combination of factors related to market psychology, cheap money, bad decision making, lax lending standards, etc. In other words, housing isn’t in a downturn per se (as that usually indicates a drop from fair value); instead the housing market is correcting itself due to being overinflated. Since housing prices were overinflated over the course of roughly 5-6 years (depending on the region), it stands to reason that it’s going to take a long-time for the housing market to correct itself.

Analysts, executives, pundits, et al, need to stop talking about “housing recoveries”, as they’re effectively wishing for prices to go back to being overinflated, which will (of course) only lead to another set of housing and mortgage related problems down the road.

Sources:

Bloomberg: “Rogers Bets Against U.S. Investment Banks, Housing” -- Saijel Kishan and David Clarke, October 31, 2007

Disclosure: at the time of publishing the Author didn’t own a position in any of the firms mentioned in this or the referenced article.

Posted to: Financials on November 1, 2007 at 08:23 AM | Permalink | Comments (0) | TrackBacks (0)