Saturday, June 28, 2008

Fed can't control inflation AND stimulate growth

Classification: UNCLASSIFIED

Voltron says: NPR explains why the Federal Reserve is between a rock and a hard place.

Bob Moon: The stock market tanked again today under the growing anxiety of ever-higher oil prices. Inflation is rising around the world. And critics say the Federal Reserve is standing by and letting it happen, with its lack of attention to the sinking dollar. Barclays Capital complained today that the Fed's credibility is "below zero."

So what can Ben Benanke and Company realistically do about the situation? Marketplace's Nancy Marshall Genzer has been asking some experts.

Nancy Marshall Genzer: It's been extra hot in Washington over the past few days. But the sweating at the Fed has nothing to do with the weather. The Fed is taking heat for the weakness of the dollar. That weakness has contributed to skyrocketing oil prices. Oil is priced in dollars. When the dollar drops, oil prices rise to compensate.

But John Hancock Financial Services economist Oscar Gonzales says there are other forces at work.

Oscar Gonzales: The price of oil is determining the market. It's a matter of supply and demand.

Nonetheless, oil broke above $142 a barrel today. And that has countries around the world pointing the finger at the Fed. Low U.S. interest rates are being blamed for creating global inflation. Of course, the Fed could raise interest rates to reverse this. Barclays Capital is predicting six interest rate increases by the end of next year.

Mark Gertler: That's just completely knuckleheaded.

Mark Gertler is an economist at New York University. He says the Fed won't act until real inflation problems start showing up in the U.S.

Gertler: But if you sort of calm down and look at the facts, we're feeling the effects of food and energy prices but that hasn't fed into core inflation or wage inflation.

But Moody's dot com chief economist Mark Zandi says if that changes, the Fed won't hesitate to raise rates.

Mark Zandi: If inflation broadly becomes unhinged, starts to rise, they have absolutely no choice. They have to sacrifice the near term economy.

Zandi says there's no way to wring inflation out of the economy, without causing some pain.

In Washington, I'm Nancy Marshall Genzer for Marketplace.


Manhattan Office Rents Fall, First Time in 3 Years

Classification: UNCLASSIFIED

Voltron says: one reason  why SRS is back above $100 . . .

By David M. Levitt and Daniel Taub

June 27 (Bloomberg) -- Manhattan office rents fell 2.2 percent in the second quarter to $69.29 a square foot annually, the first decline in the most expensive U.S. office market since 2005, according to real estate broker Studley Inc.

Average rents fell to $69.29 a square foot annually, and rents for Class A office space declined 4.4 percent, to an average $90.65 a foot, according to a preliminary report by Studley. The broker blamed a ``malaise'' among Wall Street securities firms, which hadn't previously stopped the rise in rents. The full report will be released next week.

``We're really starting to see the culmination of what people have been expecting to occur since the fourth quarter of last year,'' Steven Coutts, Studley's senior vice president for national research services, said in a telephone interview. ``It's the result of the whole chain of events, from the subprime to financial jobs being lost in the city. In some cases, it's starting to affect secondary industries. We're starting to see a slowdown in advertising and publishing.''

New York City's Independent Budget Office said in a report last month that it expects the city to lose 33,300 finance jobs, a decline of 7.1 percent from the peak in 2007. That would follow an industry loss of 52,500 jobs in New York during the 2000-to-2003 market drop.

More than 9,000 jobs are being eliminated at New York-based Bear Stearns Cos., acquired this month by JPMorgan Chase & Co. New York has lost 10,000 financial services jobs since last August, a 3.5 percent fall, according to the Bureau of Labor Statistics in Washington.

`Critical Catalyst'

An increase in space offered for sublease, which had been ``contained'' before mid-March, ``was the critical catalyst that moved the market in the second quarter,'' Studley said. Manhattan's office availability rate rose to 8.2 percent in the second quarter, up from 7.3 percent a year earlier and the highest since the third quarter of 2005.

Sublet space available for rent was at a low of 6.2 million square feet (576,000 square meters) in mid-January, surged to 7.8 million square feet in late March, and reached 8.3 million square feet by the middle of this month. While the amount of space for sublet jumped by almost a third since mid-January, the new space available still is less than a third of what Manhattan tenants typically lease each quarter, Studley said.


A rising amount of space available for sublet can cut rental rates because landlords have to compete against tenants who would rather lease at a low price than lose money on empty space.

``A subletter will drop their price much more quickly than a landlord,'' said Ruth Colp-Haber, a partner at Wharton Property Advisors, a New York-based tenant representation firm. ``A landlord needs to keep their rents high to justify their financing, to justify their whole existence.''

The supply of ``big block'' space, or contiguous areas of 50,000 square feet or more, has almost doubled since its low a year ago, Studley said. The big-block supply rose to 7.6 million square feet from 4.5 million square feet in midtown Manhattan, and to 6.5 million square feet from 2.9 million square feet downtown.

Those numbers ``understate the range of space that is actually available for lease,'' because almost 3.5 million square feet of additional space that hasn't been being publicly marketed ``is rumored to be in play,'' Coutts wrote.

Large landlords such as SL Green Realty Corp. and Vornado Realty Trust are likely protected against rent declines because their occupancy rates tend to be higher than the market average, and their tenants are on long-term leases, Coutts said.

Drop in Values

Declining rents will reduce the value of their properties, he said. New York office buildings have already lost 20 to 30 percent of what they were worth last year, Green Street Advisors said in a May 25 report.

``Even though they're not feeling the pain as far as rent roll right now, ultimately the value of the properties are affected because of the fact that the expectations of increased rent upon lease rollover are absolutely coming down,'' Coutts said in the interview.

Shares of landlords with significant office holdings in Manhattan have declined this year. Boston Properties Inc. fell 1 percent through yesterday, Brookfield Properties Corp. is down 6 percent, SL Green declined 10 percent and Vornado dropped 0.3 percent.

Manhattan's office market may still feel further pain from additional job losses resulting from declines in the financial- services industry, he said.

``This downturn started in the financial sector, the heart of Manhattan's economy,'' Coutts wrote in the report. ``Professional and business firms have just begun to feel the chill of the loss in revenues in the financial sector and will likely start to contract in the coming quarters.''


Thursday, June 26, 2008

Shorting Stocks Could Be Way to Play This Market

Classification: UNCLASSIFIED

Voltron says: remember my theory about Joe-six-pack pumping money into short ETFs and trashing the market . . .



With the Federal Reserve likely to keep interest rates on hold the rest of this year, many investment pros expect the dollar to remain weak, oil prices to keep rising—and stocks to head even lower.

"It's not going to be a fun summer," says David Rovelli, head of US equity trading for Boston-based Canaccord Adams. "There's low volume, the Fed's not going to do anything because of the election, there's no catalyst and we're just drifting in nowhere land."

The central bank announced Wednesday it was holding its key short-term rate at 2% and gave no hint that it might boost rates soon to ward off growing inflation.

As a result, the dollar is likely to remain lower against foreign currencies, which whets investor appetite for dollar-denominated commodities, specifically oil. Stocks, in turn, aren't expected to rally—even from their current low levels—until the Fed signals a change in interest-rate policy.

So with a moribund market ahead, some investors are changing their strategy: instead of trying to find individual stocks or sectors that might rise in a down market, they're taking advantage of the broader market's trend downwards.

That means shorting the market, or betting on stocks continuing to decline.

"The reality is things go up and things go down, and if we're going to be efficient in making money in the market consistently, we have to take advantage of both," says Ron Ianieri, head of Options University. "There is a time to be short and being short something that is dropping is just as profitable as being long something that is up."

For traditional stock trading, a short sale involves borrowing shares, selling them to a third party, then buying them back at a later date with the hope that they'll be cheaper. Though the rewards can be great, the risk is high.

EFT Plays Less Risky

But short playing has become much easier and less risky with the onslaught of ETFs, or exchange-traded funds, that have flooded the market over the past 10 years. ETFs work much the same way as mutual funds but offer greater trading flexibility and lower costs.

Kathy Boyle, president of Chapin Hill Advisors, has been using ETFs heavily to short the market recently and has realized 20 percent gains over the past few weeks. ProShares is a leader in not only long-play sector-based ETFs but also ones that short the market and offer double the return on downward index movements.

They include the ProShares Ultrashort QQQ (AMEX:QID - News), which rewards a fall in the Nasdaq; Proshares Ultrashort S&P 500 (AMEX:SDS - News), which rewards a fall in the S&P benchmark, and the Proshares Ultrashort Dow 30 (AMEX:DXD - News), which tracks the bluechip industrials.

Rydex recently rolled out eight new ETFs, half of which offer double-inverse plays on the energy, financial, health care and technology sectors. The Rydex Inverse 2x Select Sector Financial (AMEX:RFN - News) was up more than 8 percent in light Thursday trading.

Voltron says: If ETFs are going to cause a crash, you want to be ahead if it.  I.E. short.

Wednesday, June 25, 2008

Dow Chemical Raises Prices for Second Time in a Month

Classification: UNCLASSIFIED



Meanwhile, from the NY Times: Dow Chemical Raises Prices for Second Time in a Month


The Dow Chemical Company said Tuesday that it was raising prices for the second time in a month to offset a “relentless rise” in energy costs, a sign that companies may increasingly have to pass on price increases to their customers.

The increase of as much as 25 percent — the largest in the company’s history — comes after a 20 percent rise last month that the company said did not go far enough given the continuing surge in energy prices.


Andrew Liveris, chairman and CEO of Dow Chemical, June 24, 2008:


"Frankly, there's very few levers left ... [T]his energy crisis is affecting consumers ... People aren't spending. People aren't driving. Really, you need to look at ways to control what's happened in the inflationary world and really take the risk that by raising rates, you may actually cause some demand to go weaker. I think it's back to where Paul Volcker was in the early '80s. There's a real risk here and we've got stagflation. You can only break out of it one way and you better take on inflation head-on."


Thursday, June 19, 2008

RBS issues global stock and credit crash alert

By Ambrose Evans-Pritchard, International Business Editor, U.K. Telegraph

The Royal Bank of Scotland has advised clients to brace for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks.

"A very nasty period is soon to be upon us - be prepared," said Bob Janjuah, the bank's credit strategist.

A report by the bank's research team warns that the S&P 500 index of Wall Street equities is likely to fall by more than 300 points to around 1050 by September as "all the chickens come home to roost" from the excesses of the global boom, with contagion spreading across Europe and emerging markets.

Such a slide on world bourses would amount to one of the worst bear markets over the last century.

·  RBS alert: Quotes from the report

·  Fund managers react to RBS alert

·  Support for the euro is in doubt

RBS said the iTraxx index of high-grade corporate bonds could soar to 130/150 while the "Crossover" index of lower grade corporate bonds could reach 650/700 in a renewed bout of panic on the debt markets.

"I do not think I can be much blunter. If you have to be in credit, focus on quality, short durations, non-cyclical defensive names.

"Cash is the key safe haven. This is about not losing your money, and not losing your job," said Mr Janjuah, who became a City star after his grim warnings last year about the credit crisis proved all too accurate.

RBS expects Wall Street to rally a little further into early July before short-lived momentum from America's fiscal boost begins to fizzle out, and the delayed effects of the oil spike inflict their damage.

"Globalisation was always going to risk putting G7 bankers into a dangerous corner at some point. We have got to that point," he said.

US Federal Reserve and the European Central Bank both face a Hobson's choice as workers start to lose their jobs in earnest and lenders cut off credit.

The authorities cannot respond with easy money because oil and food costs continue to push headline inflation to levels that are unsettling the markets. "The ugly spoiler is that we may need to see much lower global growth in order to get lower inflation," he said.

·  Morgan Stanley warns of catastrophe

·  More comment and analysis from the Telegraph

"The Fed is in panic mode. The massive credibility chasms down which the Fed and maybe even the ECB will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets," he said.

Kit Jukes, RBS's head of debt markets, said Europe would not be immune. "Economic weakness is spreading and the latest data on consumer demand and confidence are dire. The ECB is hell-bent on raising rates.

"The political fall-out could be substantial as finance ministers from the weaker economies rail at the ECB. Wider spreads between the German Bunds and peripheral markets seem assured," he said.

Ultimately, the bank expects the oil price spike to subside as the more powerful force of debt deflation takes hold next year.


Saturday, June 14, 2008

Lehman Execs Summoned for Weekend Meetings


By Charles Gasparino

Voltron says: The author is well known for spreading false rumors of bailouts and buyouts of mortgage insurer MBIA, which never panned out.  The takeaway, though, is that Lehman execs are scrambling this weekend much like Countrywide, New Century, and Accredited Home Lenders executives did before their companies imploded.

Senior executives at Lehman Brothers, the embattled Wall Street securities firm, have been summoned this weekend for a series of meetings as the firm prepares to release second-quarter earnings on Monday and speculation swirls that the firm may be sold to a larger bank, CNBC has learned.

Shares of Lehman have been hammered in recent weeks amid growing investor concern over the firm's balance sheet.

On Monday, Lehman preannounced a $2.8 billion loss and that it would raise $6 billion in new capital to bolster its balance sheet, which is bleeding losses because of soured loans on its books.

On Thursday, CNBC was first to report that Erin Callen, the firm's chief financial officer, and Joe Gregory, Lehman's president, were stepping down from their posts, only adding to investor concerns about Lehman's future.

Lehman Chief Executive Dick Fuld has been working overtime to restore investor confidence in the firm a after some investors believed they were misled about the size of the firm's losses and need for new capital. Because of the eroding investors support, and damage stemming from the firm's financial troubles, speculation is growing that the firm might have to be sold. CNBC reported that private equity firm Blackstone is interested in taking a stake in Lehman. Other firms have expressed interest in buying Lehman as well. Only after the reports of a possible sale, did shares of Lehman reverse a week-long slide.

The weekend meetings are unusual, say people close to the firm. The executives summoned to headquarters include everyone from Stephen Lessing, the head of Lehman private client group to Scott Freidheim, the firm's co-chief administrative officer. It is unclear if the meetings are related to a possible deal, or just preparation for the Monday's official earnings announcement, possibly the most important earnings release for Lehman in recent years.

A spokeswoman for Lehman had no comment. Contacted at his office on Saturday morning, Freidheim had no comment as well.

Wall Street executives say Lehman's current problems have taken a tremendous toll on CEO Fuld, known as the "gorilla" on Wall Street because of his tough management style that has saved Lehman from crisis in the past.

Fuld has resisted selling Lehman to bigger players in the past, and in doing, has built one of the most successful securities firm, which before the recent crisis was a darling of Wall Street.

However, many Wall Street executive believe the current fiscal crisis hitting Lehman is different that past troubles because of the size of the bad loans on the firm's balance sheet, and because Wall Street firms will likely face eroding profit margins for at least the next year.

Like most firms on Wall Street, Lehman has been cutting back on how much risk it will taking in trading and other businesses, in an attempt to prevent the firm from imploding as Bear Stearns did three months ago. While taking less risk may soothe investors concerns that the firm may lose even more money, it also means that Lehman will produce lower profits in the future.

The lower profit margins combined with the possibility of further writedowns of losses could force Fuld to sell the firm. At the very least, people close to Lehman expect Fuld to make some announcement about Lehman's future on Monday when it releases earnings.


Friday, June 13, 2008

Something big is happening

Voltron says: The graph below is the total amount of money that the Federal Reserve has had to lend banks in it's role as lender of last resort since 1920.

Voltron says: It's clear that something big is happening. What you are seeing in the nationalization of our financial system.

Thursday, June 12, 2008

LEH fires CFO and COO

Voltron says: Lehman fired their 3rd and 4th in command (basically the OpsO and AMO)


Lehman Brothers Holdings Inc. is replacing Chief Operating Officer Joseph Gregory and Chief Financial Officer Erin Callan as the brokerage deals with a tumbling stock price and questions about the firm's future.

Wednesday, June 11, 2008

Why SRS is down

Voltron says:  good explanation for why SRS is down.  See my comments in the middle and at the end.


IYR and SRS: When Opposites Attack

Adam Warner  Jun 11, 2008 1:45 pm


Inverse fund performance sometimes needs some explaining.




The more of these you look at these Inverses, the uglier it gets. Here's iShares Dow Jones US Real Estate (IYR), down about 5% over the past six months.

Click to enlarge

So how about the UltraShort Real Estate ProShares (SRS), the Double Inverse of this? It's up 10%, right? Well, not exactly. It's down 12%. I'm sure there were some dividends over this stretch, but that can't quite make up this shortfall.

Click to enlarge

David Merkel is not optimistic about the Triple Funds coming down the pike. I'm afraid to mention my "Duodecaphonic Inverse ETF," currently in the pipeline.

So what's going on? It could be bad management, but Woodshedder has a simpler explanation.

Let's say they're both $100. And then on Day 1 IYR rallies 1%. SRS will go down 2%, or $2 to $98. Then on Day 2, IYR dips back 1% to 99.99. SRS should then go up 2%, to $99.96. No one will really notice, but obviously this adds up.

On the flip side, an extended move in one direction will cause the combo to lift. Let's say IYR goes up 1% a day for five straight days. IYR is now 105.10, SRS is 90.39. You can even throw in some reversal days and get similar results.

Voltron says: SRS has 2x leverage, but IYR does not, so if you bought 2 shares of IYR (a bet that the index goes up) and 1 share of SRS (a bet that the index goes down)  In the previous scenario (up 1% for 5 days)  The two trades would not cancel out, you would actually make $0.59.  This is due to “negative convexity” or “non-linearity” of the SRS payout.

The bottom line though, is any round trip to "unch." will cause a loss in the combo over that particular time frame.

Why is this important? I mean, after all, it's essentially a directional bet, no?

Well, if nothing else, it implies an Inverse Fund is not likely your best alternative over the course of time, when compared with something like simply shorting the regular ETF, or using puts and/or calls.


Voltron says:  So if there is an extended move down in the real estate index, you’ll profit, but if the index whipsaws around (price volatility) you may take some lumps.  But compare the alternatives:  If you short, you have unlimited downside risk.  If you buy puts, you actually benefit from price volatility but you also have to get the timing right, which is difficult.  Given that and the convenience, in the long run I still think ETFs are like SRS a good tool.  SRS’s negative convexity isn’t a good thing, but it’s worth it to not have to worry about timing or unlimited risk.


Monday, June 9, 2008

Lehman Talks a Rosy Talk

The Wall Street Journal


Walking the Walk
May Prove Thornier
Than Bank Predicts

After raising $6 billion in fresh capital, Lehman Brothers Holdings Inc. quickly declared dead any questions about its ability to survive.

"The discussions at this point aren't about our viability or the fact that we will be here or the fact that we have sufficient liquidity," Chief Financial Officer Erin Callan said on a conference call with investors Monday. "I think we put that to bed on a number of different levels through our own actions."

Not so fast. Any firm that is forced to sell equity at a 20% discount to book value while diluting existing holders by 30% is far from out of the woods. And the recent track record of both Lehman and Ms. Callan means it will be some time before investors regain confidence in the firm.


Consider that earlier this year Lehman, amid falling mortgage markets, increased by about $2 billion its holdings of so-called Alt-A loans, or mortgages made to borrowers who aren't exactly prime. "We saw a great opportunity," Ms. Callan said March 18.

Now, less than three months later, that move doesn't look so smart. Lehman said Monday that it had gross write-downs of about $2 billion on residential-mortgage holdings, which are mostly Alt-A loans, during the fiscal second quarter that ended in May. That helped fuel what Lehman expects to be a $2.8 billion net loss for the quarter.

While Lehman may eventually see some of those holdings rebound, the episode underlines the big worry surrounding the firm: that it has been slower than peers in adequately marking down holdings and shedding deadweight assets.

Lehman may still face further losses on its still-big books of residential- and commercial-mortgage holdings. Those could cause the firm's reliance on borrowed money to again increase, even as they eat into its now-replenished capital base. Also, while Lehman in the past quarter trimmed its balance sheet by $130 billion, the firm had expanded the balance sheet by $95 billion in the previous quarter.

Lehman's defiant tone in the face of woeful performance also has jarred investors. Indeed, rather than sounding contrite about the firm's losses, Ms. Callan was quick to say it is ready to again play offense in markets.

True, the capital raising, along with the sale by Lehman during the quarter of about $130 billion in assets, is a step in the right direction. But the balance sheet is still wobbly.

And Lehman's most-vocal critic, David Einhorn, manager of hedge fund Greenlight Capital, who has been short the stock, betting it will decline, remains dissatisfied. "They just raised $6 billion of capital that they said they didn't need, to replace losses they said they didn't have."

Banks' Tries at Hedging Likely Will Show Losses

One criticism of Wall Street firms is that they are like hedge funds since their results are at the mercy of their trading strategies.

That viewpoint is likely to gain ground only as the brokerages report second-quarter earnings. The results at several investment banks are likely to contain big losses on trades made to protect their balance sheets against write-downs on risky assets.

Lehman Brothers, which gave investors an advance snapshot of its fiscal second-quarter earnings Monday, said these losses totaled $400 million on financial instruments that were bought to protect the bank against declines in the value of its commercial-mortgage assets.

The "hedging" losses increased the overall quarterly write-down on Lehman's commercial mortgages to $1.1 billion from $700 million. Analysts also expect hedging losses at Goldman Sachs Group Inc. and Morgan Stanley.

Since investment banks are supposed to have razor-sharp risk managers, how is it that they have been tripped up by their own hedges? In short, it appears they were all betting the same way.

Whenever a trade becomes popular, it becomes vulnerable to an adverse move because so many people try to exit it at the first sign of losses.

One of the most common trades on Wall Street has been to place a bearish bet on the CMBX index, which tracks the performance of credit-default swaps on bonds backed by commercial mortgages. In the second quarter, the CMBX moved against bearish trades. Making matters worse: Often the assets being hedged didn't post gains when the hedge lost value.

But it isn't all bad news. One investor thinks the bearish bets on the CMBX will work out. Carlos Mendez, managing director at asset manager ICP Capital, says the deterioration in the performance of bonds underlying the CMBX will move the index in a bearish direction -- and benefit the investment banks. But that assumes the banks haven't locked in the losses by then.

Lehman Bombshell: Erasing Eight Years of Gains

by Henry Blodget

Lehman Brothers (LEH) is smart to raise another $6 billion, and the move will probably save it from succumbing to the same fate as Bear Stearns. Given the terms on which Lehman is raising the money, however--$28 a share for the common stock component--this is clearly a fire sale (despite Lehman's protestations as recently as late last week that it "didn't need" capital).

The firm's massive write-downs in Q2, moreover, show that it badly underestimated the state of its balance sheet and the size of the capital infusion it would need to get through the crunch.

Lehman's management, starting with CEO Dick Fuld, will likely continue to frame the firm's problems as an act of God--an unforeseeable "perfect storm" or "100-year flood" that management should be congratulated for surviving.


Companies can--and should--be built to survive storms, and Lehman apparently wasn't. The firm made its biggest mistakes when everything appeared to be going well--by taking on too much leverage and crappy debt. That the firm has reacted to the crisis with more urgency than Bear Stearns is fortunate, but this doesn't let management off the hook for getting into this mess in the first place.

Lehman's crisis has wiped out the past 8 years of stock gains, and the rescue will dilute current shareholders by up to a third. Lehman's management needs to take responsibility for that--by stepping down. Once they're gone. new management can begin to rebuild the firm's credibility.


Fitch downgrades Lehman to A+ from AA-

By Alistair Barr

SAN FRANCISCO (MarketWatch) -- Fitch Ratings said on Monday that it downgraded Lehman Brothers (LEH) to A+ from AA- mainly because the brokerage firm's results have become more volatile and are expected to remain that way for some time. "Lehman's Rating Outlook remains Negative because profitability is expected to be challenged with continued fixed income volatility," the agency wrote in a note. "Despite asset sales, Lehman's exposure to higher risk asset categories as a percent of Fitch core capital is higher than peers."


Lehman Lower As Numbers Surprise

The devil, it would seem, is in the details. Wall Street has been forecasting that Lehman Brothers (LEH) would record its first quarterly loss as a public company. Check. Reports said the bank would need to raise new capital to augment the $8 billion its raised since February. True enough, the firm said Monday. The market expected that both numbers would be big, and ugly - sure enough - and that, like most of the other investment banks, the sheer act of demonstrating that it could absorb stiff losses and still find an appetite for its securities would be reason enough to convince those investors to buy the shares. But, no, not this time. Lehman Brothers put up a preliminary version of its second-quarter results that showed losses proved stunningly steeper than Wall Street had been expecting - a net loss totalling $2.8 billion, or about $5.14 a share, versus forecasts of a loss of just 13 cents - and raising questions about the bank’s ability to post a full-year profit. Perhaps even more frightening, Lehman said it would tap the capital markets for another $6 billion in capital - twice the total that had been talked about when rumors of Lehman’s requirements for fresh capital first started to gain traction last month, and higher still than the $5 billion that Wall Street had been talking about as recently as last week. Both the scope of the losses and the surprisingly expansive capital needs sparked fresh worries about the integrity of Lehman’s balance sheet. While investors probably don’t have to fret about Lehman’s ultimate solvency - a stark contrast to the consequences that the old Bear Stearns found itself in back in February, before the Federal Reserve effectivley promised to keep even capsizing banks afloat - there are new risks to Lehman’s ability to attract and maintain parties who will get on the other side of its trades. Moody’s cut its outlook on the debt for the second time this year, and now has a negative rating, despite the fact that Lehman has boasted that its common- and preferred-share offering has been wildly over-subscribed. Shares have fallen 7% in premarket action, and the stock, which traded at a low of $20 a share back in March, threatened to fall back below $30 a share for the first time in nearly three months. The conference call slated for an hour hence promised to hold some drama.


Lehman Close To Raising $5 Billion, Face $2 Billion in Losses

Lehman Brothers is close to raising $5 billion in fresh capital and could book a loss of more than $2 billion in the second-quarter, The Wall Street Journal reported citing unnamed sources.

Most analysts have been predicting a loss of about $300 million, the report said. It also named the New Jersey Division of Investment as one of the possible investors.

People close to the firm told CNBC last week that Lehman executives were weighing whether to pre-announce results in an effort to dispel market rumors that the firm is facing a liquidity crisis.

The troubled investment bank is expected to announce details of its capital raising plan on Monday or Tuesday, the paper said.

Sunday, June 8, 2008

Option ARMs: Moving from NegAm to Fully Amortizing

Voltron says: well, the story is in businessweek, so it's officially too late to short.

From BusinessWeek: The Next Real Estate Crisis

[T]he next wave of foreclosures will begin accelerating in April, 2009. ... hundreds of thousands of borrowers who took out so-called option adjustable-rate mortgages (ARMs) will begin to see their monthly payments skyrocket as they reset.
According to Credit Suisse, monthly option recasts are expected to accelerate starting in April, 2009, from $5 billion to a peak of about $10 billion in January, 2010.
The loans automatically recast after five years, but many will recast sooner as loan balances hit specific principal caps—typically between 110% and 125% of the initial loan amount.
Employment Measures and Recessions Click on image for Business Week graph in new window.

This graph from Credit Suisse (via Business Week) makes a key point. Many of the Option ARMs will recast sooner than originally scheduled, because the loan amount will have hit the principal ceiling (usually 110% of the original loan amount).

Tanta explained this in Negative Amortization for UberNerds:
[Once the loan hits the principal ceiling], the loan must become a fully amortizing loan—no more minimum payment allowed, all payments must be sufficient to pay all interest due and sufficient principal to amortize the loan over the remaining term.

The percent of original balance limitation, in other words, marks the day that neg am is no longer an option for the borrower, and the loan has to start paying down principal from here on out—the borrower is “caught up,” and never again allowed to “get behind.”
Note that the loan remains an ARM, even though it is now no longer a neg am ARM. That means that the borrower’s payment can still increase or decrease at future rate change dates. It will simply be, from here on out, an increase or decrease from one fully-amortizing payment to a new fully-amortizing payment.
emphasis added
What matters for the housing market is the gray bars - and we are just starting to see the impact on delinquencies of homeowners moving from NegAm payments to fully amortizing payments on their Option ARMs.

And, finally, the blue bars tell us when these homeowners obtained their loans - usually 5 years before the scheduled recast. Since the peak is in 2011, we know that most of these homeowners bought or refinanced from 2005 through early 2007. Therefore, with falling house prices, most of these homeowners are underwater (owe more than their homes are worth), and selling or refinancing will not be a viable alternatives.

The Fed's Strong Dollar Policy

By Peter Schiff (Europacific Capital)


Ever since Robert Rubin began the tradition in the mid-1990s, it has been a significant element of the Treasury Secretary’s job description to continuously state that a strong dollar is in the national interest. It is widely regarded that such utterances, if repeated often enough, can constitute the sum total of what is still laughingly known as the nation’s “strong dollar policy.”

Over the past two generations, the American government has launched many failed campaigns. To name just a few, there has been the war on drugs, the war on poverty, and the continued attempts to improve education. But the strong dollar policy must be seen as the poster child for all failed Federal policies. However, many in the market took cheer that the policy is now being greatly expanded. In an unprecedented move, the Fed Chairman is now adding his voice to the chorus and using the same rhetoric previously used by Treasury alone. That’s two people saying the words…not just one. A double barrel strong dollar policy!

As the administration is so fond of saying, a nation’s currency reflects the underlying strength of its economy, and in that sense can be seen as a nation’s economic report card. In truth, a strong currency is in the interest of every nation, just as good grades are in the interest of every student. Using this basic analogy, a flunking student cannot improve his grades by simply telling his parents, teachers, and fellow students that he has adopted a “straight A policy.” If his words are not accompanied by a change in actual behavior, whereby he stops cutting class, and starts studying more, his new policy is unlikely to achieve results. So long as his bad habits persist, the policy will not be any more effective simply because one of his friends chimes in.

In his speech this past Tuesday, Ben Bernanke finally admitted that the weakness in the dollar was contributing to both higher inflation and elevated inflation expectations. This stands in stark contrast to his recent testimony in front of the House Banking Committee, where in response to a question asked by Congressman Ron Paul, he confidently declared that the weakness of the dollar only effected Americans who travel abroad. It is amazing how little attention this complete reversal received.

The media of course wasted no time in declaring that Bernanke’s speech heralded the opening of a new front in the campaign against the falling dollar. For example, CNBC’s Larry Kudlow proclaimed that Bernanke had endorsed “King Dollar” (someone needs to remind Kudlow that the king has long since abdicated his throne) and the network ran an entire segment on how to profit from the new dollar rally. All of this because Bernanke merely mentioned the dollar, acknowledged its effects on inflation, and expressed concern for its plight. As far as the media and Wall Street are concerned, words without action are enough. Too bad that’s not the way things work here on the planet Earth.

The real take away from Bernanke’s comment is not that the dollar is about to rally, but that it is now more likely to sink even lower. I believe the main reason Bernanke has refrained from mentioning the dollar in the past is that he did not want to be put in a position of actually having to do something about its decline. He is now so fearful of an imminent dollar collapse that he must have felt compelled to throw down the gauntlet despite his fear that someone might actually pick it up.

My guess is that currency traders will ultimately see this as an act of desperation. When the dollar keeps falling a chorus will swell to demand that the Fed put teeth in its new policy. If Bernanke does nothing the world will finally see a naked emperor and the dollar’s decline will turn into a rout. If, on the other hand, the Fed raises rates to defend the dollar, and only a short term bounce results, then all remaining confidence in the Fed’s ability to support the dollar will evaporate as well. This is probably Bernanke’s greatest fear and is likely the main reason he waited so long before mentioning the dollar. The fact that he felt compelled to do so now likely means he knows the game is coming to an end. Got gold?

Lehman Brothers may raise more capital

Voltron says: If Lehman reports a profit, short every share you can get your hands on.

Bank in focus after reports it may announce results early, raise cash

By John Spence, MarketWatch


BOSTON (MarketWatch) -- Investors will be paying close attention to Lehman Brothers at the start of the week after reports the company may announce its second-quarter results ahead of schedule and unveil a plan to raise additional capital.

Lehman (LEH) is widely expected to post a quarterly loss -- its first as a public company -- as a result of exposure to troubled mortgages and other faltering assets. The company has faced lingering concerns over its capital position and leverage as investors remain vigilant for the type of problems that forced the near-collapse of Bear Stearns.


Estimates on the amount of capital Lehman may be compelled to raise have ranged as high as $6 billion, according to news reports late last week. Also, some Wall Street analysts said certain Lehman counterparties have grown increasingly wary of trading with the firm. See related story.


On Friday, a Lehman representative declined to confirm the release date of the bank's second-quarter earnings report, but the results had been originally expected to be issued the week of June 16. A Lehman spokesman couldn't immediately be reached on Sunday.

Lehman has already raised about $8 billion in capital this year and has been trying to reel in its leverage. The company last week denied reports that it had borrowed money from the U.S. Federal Reserve through the discount window.

The stock has lost about half its value so far this year. Shares of the broker finished down 4.6% at $32.29 Friday.

Lehman's plan to pre-release its quarterly financial statement was driven by pressure from investors who are short Lehman shares, including hedge fund manager David Einhorn at Greenlight Capital Re Ltd. (GLRE) , according to a report last week by the New York Post.


The report also said the capital injection would come through a rights offering.

The earnings announcement and capital-raising plans could come as early as Monday or Tuesday, the Financial Times reported, citing people briefed on the matter.

Lehman's purported difficulties come as U.K. banking giant Barclays (UK:BARC: news, chart, profile) (BCS) , which has also faced pressure over its capital position, is seeking to raise cash from overseas sovereign wealth funds, according to a Sunday Telegraph report. See related story.


Black Gold or Yellow Gold?


Voltron says: I edited out some of the political ranting.  You can read the entire article here if you wish.

By Michael Fitzsimmons (

Take your pick. Either one is going to make you money. Oil was up over $10 on Thursday and Friday, setting records for both its high price and its US dollar move. In response, the US stock market tanked on Friday and the S&P500 is now down 6.5% for the year.

Reports say US citizens' net worth fell in the first quarter for the second quarter in a row. Talk from Israel about bombing Iran didn't help. If this happens and Iran responds by bottling up the Straits of Hormuz, well then $200/barrel oil will look like a nice bargain and a very severe recession, if not depression, will begin. Of course Israel is on track with Project Better Place to switch over to electric cars. Perhaps the Israelis will wait until their transition to electric cars is complete so they won't be affected by the high price of oil. If that is the case, I suppose we have a year or two before the bombs start dropping.

Regardless of any Israeli action, oil will go to $200/barrel and higher. The inconvenient truth is that worldwide oil supply is simply not keeping pace with worldwide oil demand. The speculators are getting a lot of the blame, but I can't blame them. Are there any rational policies coming from the largest consumer and importer of oil (the US)? Is there any reason to believe that China, India, Russia, and the Middle East will slow down their growth in consumption? Exxon (XOM), Chevron (CVX), and ConocoPhillips (COP) all reported less oil production in 2007 than in 2006 - this in a time when oil prices doubled. That can't be a good sign.

Countries around the world are nationalizing their oil reserves, cutting off needed investment and reducing production capability. The US dollar remains weak, and appears to be headed for another leg down despite all the rhetoric. Because that is all it is, rhetoric. Who can blame the speculators for pushing up the price of crude? I can't. In fact, oil over $200/barrel is exactly what the US needs as it is probably the only thing that will prod the government into action (but don't hold your breath).

Speaking of government policy, just what has been the response of the US government to high oil prices? A lot of talk, no action. There is talk of windfall profits taxes. Well, we all know that doesn't work, as the oil company's lawful responsibility to shareholders means they will simply cut back on exploration and production budgets to keep their profit margins. This will result in LESS crude oil and exacerbate the problem. They also talk about suing OPEC members, which is so laughable I won't spend any print on it. Gas tax holiday? Sure, let's encourage gasoline usage at a time when oil prices are high - that makes a lot of sense [not]. It is exactly the opposite to what we should be doing (raising taxes on gasoline to fund non-oil energy projects like wind, solar, nuclear, and LNG). Any talk of drilling in Alaska or off the continental shelf in the lower-48? Of course not.

Even more worrisome is the US dollar policy. Bernanke talked a good game, but everyone knows he can't do anything but print more dollars: the banking sector is in shambles, the US consumer is loaded with debt (credit cards, home, auto), the US savings rate is a disgrace, and the fiscal and trade deficits out of control. The US imports 60% of its oil and is sending $650 billion dollars out of the country every year, and that number is rising with the price of oil.

What does the President have to say? Well, on Friday, a day when oil was up nearly $8 to a record high and the US dollar was weak (again), President Bush made yet another urgent plea to make his tax cuts permanent (!). In his mind, it is more important to give tax cuts to those making hundreds of millions of dollars every year than it is to acknowledge the role that deficit spending has had on the weak US dollar and therefore the price of oil! Amazing. If that is the government's policy, then why stop at $600 rebate checks? Why not just print $6000 rebate checks? Or even $60,000 checks? I mean, once the currency is not defended, what exactly is the end game here? Do the uber-wealthy making hundreds of millions of dollars every year simply find another country to make their homes once the US currency goes to zero? This is insanity at its highest level.

People wonder why I mix politics and economics. Well, here is the answer: the US dollar. Don't think for a minute that politics are not related to the US dollar! Look at the S&P500 return for the last 10 years - less than 3.5% and less than inflation. Meanwhile, the value of the US dollar has dropped by 50% in that time period.

Speaking of inflation, just wait til Dow Chemical's (DOW) 20-30% price increases ripple through to Wal Mart (WMT).


Saturday, June 7, 2008

House prices: Look out below!

Voltron says: they said that housing prices never decline without unemployment increasing first.  Well look out below . . .


Job Losses and Surge in Oil Spread Gloom on Economy

By PETER S. GOODMAN for the New York Times

The unemployment rate surged to 5.5 percent in May from 5 percent — the sharpest monthly spike in 22 years — as the economy lost 49,000 jobs, registering a fifth consecutive month of decline, the Labor Department reported Friday.

The weak jobs report, coupled with a staggering rise in the price of oil — up a record $10.75 a barrel to more than $138 — unleashed a feverish sell-off on Wall Street, sending the Dow Jones industrial average down nearly 400 points. The dollar plunged against several major currencies.

Investors’ recent hopes that the United States might yet skirt a recession sank swiftly in the face of gloomy indications that the economy is gripped by a slowdown and pressured by record fuel prices.

For tens of millions of Americans struggling to pay bills, the jobs report added an official stamp of authority to a dispiriting reality they already know: A deteriorating labor market is eliminating paychecks just as they are needed to compensate for the soaring cost of food and fuel, and as the fall in house prices hacks away at household wealth and access to credit.

“It’s unambiguously ugly,” said Robert Barbera, chief economist at the research and trading firm ITG. “The average American already knows that gas prices are up a ton and it’s really hard to find a job. Sally and Sam on Main Street are already well aware of this, and that’s why sentiment surveys are lower than they were in each of the last two recessions.”


About 1 in 11 Mortgageholders Face Loan Problems

By VIKAS BAJAJ and MICHAEL M. GRYNBAUM for the New York Times

About 1 in 11 American mortgages were past due or in foreclosure at the end of March, according to a report released on Thursday, a figure that is rising fast as home prices fall and the job market weakens.

The first three months of 2008 marked the worst quarter for American homeowners in nearly three decades, according to the report, issued by the Mortgage Bankers Association. The rate of new foreclosures and past-due payments surged to their highest level since 1979, when the group first started collecting the data.

All told, about 8.8 percent of home loans were past due or in foreclosure, or about 4.8 million loans. That is up from 7.9 percent at the end of December. (About a third of American homeowners do not have mortgages.)

Delinquency and foreclosure rates started rising from historically low levels in late 2006 and have picked up speed in nearly every quarter since. Analysts say at first past due mortgages represented mostly high-risk loans made to borrowers with blemished, or subprime, credit. Now, as the economy has weakened and home prices have fallen in many parts of the country, homeowners with better loans are also falling behind.

Economists worry that a big loss of jobs in the coming months could drive default rates much higher. The Labor Department will release its report on the job market for May on Friday.

“It’s not going to help the housing market out at all if you have a loss of jobs,” said John Lonski, chief economist at Moody’s Investors Service. “When employment’s contracting, that makes it all the more difficult to sell your home at an attractive price.”

Though defaults are rising in many places, it is worst in areas where home prices soared in recent years or where the local economy is now struggling.

California and Florida, for instance, accounted for nearly a third of all mortgages that were in foreclosure or 90 days delinquent. Home prices, construction and mortgage lending were particularly ebullient in those states earlier this decade. The housing industry accounted for a bigger portion of their economies during the boom.

“The problems in California and Florida are extraordinary, and they are the main drivers of the national trend,” said Jay Brinkmann, vice president for research and economics at the Mortgage Bankers Association.

Midwestern states like Michigan and Ohio, where home prices did not soar, are suffering mostly from the loss of manufacturing jobs and high-risk loans. Default rates in those states appear to have leveled off in the last few months, which may be an early hopeful sign.

About 9.7 percent of loans in five Midwestern states were past due or in foreclosure in the first quarter, down from 10.5 in the fourth quarter.

“This decade has been brutal on the industrial economies of the United States,” said Michael D. Youngblood, a mortgage analyst at Friedman, Billings, Ramsey. But “the rate of labor market deterioration in these depressed cities is significantly slowing.”

Michigan, Indiana and Ohio are still among the five states with the highest default rates. The other two states in that list are Florida and Mississippi.

Defaults are highest for adjustable-rate mortgages — loans that promised a low, fixed-interest rate for the first few years. But people who took out such mortgages are falling behind even before those loans reset to a higher adjustable rate. Analysts say that reflects the fact that those mortgages were popular among investors, buyers who made small or no down payments, and those who did not provide proof of their incomes.

Falling home prices are also contributing greatly to foreclosures. Homeowners who owe more on their loan than their homes are worth are more likely to default if they encounter financial distress, said Robert Van Order, an adjunct finance professor at the University of Michigan.

In past housing downturns like the one in the early 1990s, he said, housing prices did not fall nationwide and even in local markets they fell much more slowly. So far, home prices have fallen about 16 percent from their peak in the summer of 2006, according to the Standard & Poor’s/Case-Shiller index. Economists at Lehman Brothers expect the decline to bottom at 25 percent.

“What that means now is people don’t have that equity cushion as they get into trouble,” said Mr. Van Order, who was once chief economist at Freddie Mac. “The incentive to beg, borrow and steal is not there.”

By many measures the job market is not falling apart; the unemployment rate was 5 percent in April. But these are challenging times even for those who have not lost jobs with gas prices at $4 a gallon, economists said.

“Wage increases are not keeping pace with inflation,” said Bernard Baumohl, managing director of the Economic Outlook Group. “That really puts a lot of pressure on households to make some very serious financial decisions.”

The surge in defaults has been challenging for mortgage servicing companies, which find it hard to keep up with the growing backlog of loans awaiting foreclosure, analysts say.

Some mortgage servicing firms appear to be holding off because lawmakers in Congress are talking about a plan to refinance up to $300 billion in loans using the Federal Housing Administration, Mr. Youngblood said. The discussions are “giving servicers hope of a better solution for many borrowers,” he said.

In states like California and Florida where they have huge inventories of repossessed homes, some companies are starting to move a little faster by auctioning off properties, Mr. Youngblood and others say. In some markets like Las Vegas about half the homes sold in recent months had been in foreclosure.

Dean Williams, chief executive of the auction firm Williams & Williams, said mortgage companies are most eager to hire his firm in markets that have a “rapidly and constantly increasing pile up” of homes.