Chase mortgage memo pushes 'Cheats & Tricks'

The bank says it never backed the strategies, which detail how to get an iffy loan approved

by JEFF MANNING

A newly surfaced memo from banking giant JPMorgan Chase provides a rare glimpse into the mentality that fueled the mortgage crisis.

The memo's title says it all: "Zippy Cheats & Tricks."

It is a primer on how to get risky mortgage loans approved by Zippy, Chase's in-house automated loan underwriting system. The secret to approval? Inflate the borrowers' income or otherwise falsify their loan application.

The document, a copy of which was obtained by The Oregonian, bears a Chase corporate logo. But it's unclear how widely it was circulated or used within Chase.

Bank spokesman Tom Kelly confirmed that the "Cheats & Tricks" memo was e-mailed from Chase but added that it does not reflect Chase corporate policy.

"This is not how we do things," he said. "We continue to investigate" the memo, Kelly said. "That kind of document would neither be condoned or tolerated."

The March e-mail was sent by Tammy Lish, a former Chase account representative in Portland. Chase fired her days after discovering she had sent it.

"I did not write it," Lish said. "It was sent to me by another (Chase) rep in another office along with some other documents that were more step-by-step customer training documents."

Even if the memo was penned by a single employee, it illustrates an attitude prevalent in certain corners of the mortgage industry during the boom years. In the face of sustained and significant home price increases, much of the industry veered away from traditional notions of safe and sound lending. Loan volume became as important as loan quality, particularly for the rank and file typically paid on commission.

During the boom, it was common for lenders and brokers to get paid more for risky subprime loans than for 30-year fixed-rate loans because the higher-interest loans fetched a higher price on Wall Street.

Chase, the nation's second-largest bank, originates mortgage loans itself but also operates a wholesale arm that underwrites and funds loans brought to them by a network of mortgage brokers. The "Cheats & Tricks" memo was instructing those brokers how to get difficult loans approved by Zippy.

"Never fear," the memo states. "Zippy can be adjusted (just ever so slightly.)"

The Chase memo deals specifically with so-called stated-income asset loans, one of the most dangerous of the mortgage industry's innovations of recent years. Known as "liar loans" in some circles because lenders made little effort to verify information in the borrowers' loan application, they have defaulted in large number since the housing bust began in 2007.

Chase no longer makes any stated-income loans, part of the bank's efforts to tighten its loan underwriting, Kelly said. It wrote down $1.3 billion in nonperforming mortgages at the end of 2007.

Lish said she sent out the document inadvertently. "The document was irrelevant by the time I sent it out because the company had ceased offering stated-income loans."

The document recommends three "handy steps" to loan approval:

Do not break out a borrower's compensation by income, commissions, bonus and tips, as is typically done in a loan application. Instead, lump all compensation as the applicant's base income.

If your borrower is getting some or all of a down payment from someone else, don't disclose anything about it. "Remove any mention of gift funds," the document states, even though most mortgage applications specifically require borrowers to disclose such gifts.

If all else fails, the document states, simply inflate the applicant's income. "Inch it up $500 to see if you can get the findings you want," the document says. "Do the same for assets."

Chase's Kelly said the bank has never encouraged any of the suggestions in the memo.

"If somebody is putting inaccurate information in their loan application, they're lying and committing fraud," he said.

Still, some local mortgage brokers view the memo as vindication. Brokers have argued they've been unfairly blamed for the lax lending standards that led to a wave of defaults. The large national lenders drove the weakening standards, they argue.

The Chase memo is "a perfect example of one of the big five banks out and out telling mortgage brokers to commit fraud," said Todd Williams, a broker with Evergreen Ohana Group in Portland. "And this has been going on for years."

Williams and other mortgage brokers gave a copy of the memo to Oregon financial regulators.

"It boggles my mind that any federally chartered organization would invite this kind of activity in such a flagrant way," said David Tatman, head of Oregon's Division of Finance and Corporate Securities.

But Tatman confirmed that as a state regulator, he doesn't have jurisdiction over the federally chartered Chase.

The U.S. Office of the Comptroller of the Currency has authority over Chase. OCC spokesman Dean DeBuck declined to comment on the document.

Treasury’s Plan Would Give Fed Wide New Power

Voltron says: sure, more power for the institutions that failed us.

By EDMUND L. ANDREWS

WASHINGTON — The Treasury Department will propose on Monday that Congress give the Federal Reserve broad new authority to oversee financial market stability, in effect allowing it to send SWAT teams into any corner of the industry or any institution that might pose a risk to the overall system.

The proposal is part of a sweeping blueprint to overhaul the nation’s hodgepodge of financial regulatory agencies, which many experts say failed to recognize rampant excesses in mortgage lending until after they set off what is now the worst financial calamity in decades.

Democratic lawmakers are all but certain to say the proposal does not go far enough in restricting the kinds of practices that caused the financial crisis. Many of the proposals, like those that would consolidate regulatory agencies, have nothing to do with the turmoil in financial markets. And some of the proposals could actually reduce regulation.

According to a summary provided by the administration, the plan would consolidate an alphabet soup of banking and securities regulators into a powerful trio of overseers responsible for everything from banks and brokerage firms to hedge funds and private equity firms.

While the plan could expose Wall Street investment banks and hedge funds to greater scrutiny, it carefully avoids a call for tighter regulation.

The plan would not rein in practices that have been linked to the housing and mortgage crisis, like packaging risky subprime mortgages into securities carrying the highest ratings.

The plan would give the Fed some authority over Wall Street firms, but only when an investment bank’s practices threatened the entire financial system.

And the plan does not recommend tighter rules over the vast and largely unregulated markets for risk sharing and hedging, like credit default swaps, which are supposed to insure lenders against loss but became a speculative instrument themselves and gave many institutions a false sense of security.

Parts of the plan could reduce the power of the Securities and Exchange Commission, which is charged with maintaining orderly stock and bond markets and protecting investors. The plan would merge the S.E.C. with the Commodity Futures Trading Commission, which regulates exchange-traded futures for oil, grains, currencies and the like.

The blueprint also suggests several areas where the S.E.C. should take a lighter approach to its oversight. Among them are allowing stock exchanges greater leeway to regulate themselves and streamlining the approval of new products, even allowing automatic approval of securities products that are being traded in foreign markets.

The proposal began last year as an effort by Henry M. Paulson Jr., secretary of the Treasury, to make American financial markets more competitive against overseas markets by modernizing a creaky regulatory system.

His goal was to streamline the different and sometimes clashing rules for commercial banks, savings and loans and nonbank mortgage lenders.

“I am not suggesting that more regulation is the answer, or even that more effective regulation can prevent the periods of financial market stress that seem to occur every 5 to 10 years,” Mr. Paulson will say in a speech on Monday, according to a draft. “I am suggesting that we should and can have a structure that is designed for the world we live in, one that is more flexible.”

Congress would have to approve almost every element of the proposal, and Democratic leaders are already drafting their own bills to impose tougher supervision over Wall Street investment banks, hedge funds and the fast-growing market in derivatives like credit default swaps.

But Mr. Paulson’s proposal for the Fed echoes ideas championed by Representative Barney Frank, the Massachusetts Democrat who is chairman of the House Financial Services Committee.

Both see the Fed overseeing risk across the entire financial spectrum, but Mr. Frank is likely to favor a stronger Fed role and to subject investment banks to the same rules that commercial banks now must follow, especially for capital reserves.

The Treasury plan would let Fed officials examine the practices and even the internal bookkeeping of brokerage firms, hedge funds, commodity-trading exchanges and any other institution that might pose a risk to the overall financial system.

That would be a significant expansion of the central bank’s regulatory mission.

When Fed officials agreed this month to rescue Bear Stearns, once the nation’s fifth-largest investment bank, they pointedly noted that the Fed never had the authority to monitor its financial condition or order it to bolster its protections against a collapse.

In two unprecedented moves, the Fed engineered a marriage between JPMorgan Chase and Bear Stearns, lending $29 billion to JPMorgan to prevent a Bear bankruptcy and a chain of defaults that might have felled much of the financial system.

For the first time since the 1930s, the Fed also agreed to let investment banks borrow hundreds of billions of dollars from its discount window, an emergency lending program reserved for commercial banks and other depository institutions.

But Mr. Paulson’s proposal would fall well short of the kind of regulation that Democrats have been proposing. Mr. Frank and other senior Democrats have argued that investment banks and other lightly regulated institutions now compete with commercial banks and should be subject to similar regulation, including examiners who regularly pore over their books and quietly demand changes in their practices.

In a recent interview, Mr. Frank said he realized the need for tighter regulation of Wall Street firms after a meeting with Charles O. Prince III, then chairman of Citigroup.

When Mr. Frank asked why Citigroup had kept billions of dollars in “structured investment vehicles” off the firm’s balance sheet, he recalled, Mr. Prince responded that Citigroup, as a bank holding company, would have been at a disadvantage because investment firms can operate with higher debt and lower capital reserves.

Senator Charles E. Schumer, Democrat of New York, has taken a similar stance.

“Commercial banks continue to be supervised closely, and are subject to a host of rules meant to limit systemic risk,” Mr. Schumer wrote in an op-ed article on Friday in The Wall Street Journal. “But many other financial institutions, including investment banks and hedge funds, are regulated lightly, if at all, even though they act in many ways like banks.”

Mr. Paulson’s proposal is likely to provoke bruising turf battles in Congress among agencies and rival industry groups that benefit from the current regulations.

Administration officials acknowledged on Friday that they did not expect the proposal to become law this year, but said they hoped it would help frame a policy debate that would extend well after the elections in November.

In a nod to the debacle in mortgage lending, the administration proposed a Mortgage Origination Commission to evaluate the effectiveness of state governments in regulating mortgage brokers and protecting consumers.

The bulk of the proposal, however, was developed before soaring mortgage defaults set off a much broader credit crisis, and most of the proposals are geared to streamlining regulation.

This plan would consolidate a large number of regulators into roughly three big new agencies.

Bank supervision, now divided among five federal agencies, would be led by a Prudential Financial Regulator, which could send examiners into any bank or depository institution that is protected by either federal deposit insurance or other federal backstops. It would eliminate the distinction between “banks” and “thrift institutions,” which are already indistinguishable to most consumers, and shut down the Office of Thrift Supervision.

Any effort to merge the Commodity Futures Trading Commission with the S.E.C. is likely to provoke battles.

Yet another proposal would, for the first time, create a national regulator for insurance companies, an industry that state governments now oversee.

Administration officials argue that a national system would eliminate the inefficiencies of having 50 different state regulators, who have jealously guarded their powers and are likely to fight any federal encroachment.

Arthur Levitt, a former S.E.C. chairman who has long pushed for stronger investor protection, said his first impression of the plan was positive. Even though the S.E.C.’s powers might be reduced, Mr. Levitt said, the plan would create a broader agency to regulate business conduct in all financial services.

“It’s a thoughtful document,” he said. “I’m intrigued by the fact that it puts an emphasis on investor protection, and that it establishes an agency specifically for that purpose, which would operate across all markets. I think that’s a very constructive first step.”

Bail me out Bennie

Peter Schiff, Europacific Capital

Now that the Fed and the Treasury Department have clumsily come to the rescue of the financial titans of Wall Street, it is now politically dangerous to resist similar pleas from just about everybody else. Populism is emerging as a dominant theme is this election year, and with so much largesse showered on Bear Stearns and JP Morgan Chase, politicians are demanding even more generous terms for consumers. In Washington, it seems that two wrongs apparently make a right. Another downside to corporate bailouts is that they provide the critics of free market capitalism with plenty of excuses to weigh down American economic vitality with even more unnecessary regulation.

In the first place, the current mess did not result from a failure of the free market, but from too much government interference. The real estate bubble, and the shaky securitized products it spawned, resulted from the Fed artificially setting interest rates too low. Had interest rates been allowed to find their market levels, rather than be set by government decree, the real estate bubble never would have been inflated in the first place.

In a nation short on savings and heavy with debt, the free market would naturally set interest rates quite high. With lots of demand for credit, but a limited supply of savings, the risk of lending and therefore the price of credit (interest rates) would be high. Although onerous to borrowers, high rates would have both encouraged saving and discouraged borrowing. In the end, these market forces would reduce interest rates and produce a more stable balance between savings and consumption. However, the Fed did not want American consumers to be subjected to free market discipline that might otherwise reign in their non-stop spending. After all, reckless consumption was falsely believed to be the engine of our prosperity.

So the Fed fixed the price of credit (interest rates) well below the rate that would have been set by the free market. This sent false economic signals to the market that more savings were available than actually existed, leading to an over-investment in housing. Also, by keeping the rate of interest below the rate of inflation, rampant speculation was encouraged, and the foundation was laid for the very type of mortgage financing that has now come back to bite us.

In the second place, no one on Wall Street should be bailed out. The effects of the bursting of the housing bubble should be dealt with by the market, despite the fact that the underlying bubble itself was a byproduct of government intervention.

Apart from the problems created by interfering with the market’s attempts to restore balance and reallocate resources, bailouts create all sorts of moral hazards. After all, why should bailouts be limited to investment banks or overstretched homeowners? What about renters who also borrowed too much money? What about those behind on their credit cards, auto or student loans? Why shouldn’t they get bailed out? How about small entrepreneurs whose start-up businesses failed -- should they get bailed out as well?

In market economies all sorts of people lose money, sometimes as a result of circumstances entirely beyond their control. While this is clearly not the case for most homeowners and mortgage lenders, some would obviously fall within that category. However, it is not up to government to rescue them. Even if some borrowers and lenders were lead astray by the false economic signals sent by the Fed, they are never-the-less responsible for any losses they might have incurred as a result of following them. The real danger is that while government interference is actually at fault, it’s the free-market that ends up taking the blame.

What Wall Street's CEOs Don't Know Can Kill You

Commentary by Michael Lewis

March 26 (Bloomberg) -- On March 14, a Friday, the market believed that Bear Stearns Cos. was worth $30 a share.

Say what you will about Bear Stearns on that day, you can't say that it was flying below the radar. It was as intently scrutinized as a public corporation can be, by some of the shrewdest people on our planet, and perhaps some smarter people from distant planets, too.

For nine months it had been in obvious distress; in just the previous three days its shares had fallen $30. A billionaire from outside the place -- the sort of investor who has the power to know as much as it is possible for an investor to know about a Wall Street firm -- was long the stock at $107 a share.

Three days earlier, on theStreet.com, Jim Cramer listed Bear Stearns common stock as a ``buy'' at $62. On his CNBC program that day, he showed his viewers a chart of Bear Stearns stock price and hollered, ``Bear Stearns is fine! Do not take your money out of Bear.''

Over that weekend -- days when the markets were closed and there was no material news about the company -- Bear Stearns was believed to be worth $2 a share, so long as the Federal Reserve assumed the downside risk of almost $30 billion of its mortgage securities.

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon obviously thought it was worth more than that, or he wouldn't have bought it. How much more is hard to say but the number now being floated, $10 a share, appears to sound about right even to the sellers.

Cramer's `Buy'

TheStreet.com quickly removed Cramer's March 11 ``buy'' recommendation from its page devoted to Bear Stearns. (The Cramer-obsessed Don Harrold's YouTube account of all this is priceless.)

And Cramer went back on CNBC to explain that he never intended for anyone to go and actually BUY shares in Bear Stearns -- only that, if they happen to bank with Bear Stearns, they shouldn't worry about losing their money (a public service to all those ``Mad Money'' viewers who use Bear Stearns as a bank.)

All of this raises an obvious question: If the market got the value of Bear Stearns so wrong, how can it possibly believe it knows even the approximate value of any Wall Street firm? And if it doesn't, how can any responsible investor buy shares in a big Wall Street firm?

At what point does the purchase of such shares cease to be intelligent investing, and become the crudest sort of gambling?

CEO Ignorance

There is, of course, a reason that the market doesn't understand Wall Street firms: The people who run Wall Street firms, and who convey news of their inner workings to the outside world, don't understand them either.

Jimmy Cayne plays bridge, and Stan O'Neal golfs while their firms collapse, not because they don't care their firms are collapsing, but because they don't know that their firms are collapsing.

Across Wall Street, CEOs have made this little leap of faith about the manner in which their traders are making money, because they don't fully understand what their traders are doing.

Late last November, in a superb account of the demise of Citigroup CEO Charles Prince, Carol Loomis of Fortune magazine revealed that Prince resigned after he was informed of the consequences of liquidity puts -- options that allowed buyers of complex and presumably safe mortgage securities to hand them back to Citigroup at par if they became hard to finance.

Crappy Mortgages

Liquidity puts were about to make Citigroup the new owner of $25 billion of crappy mortgage securities at par, cost Prince his job, and put the company into the hands of Robert Rubin. Rubin is an extremely smart man with keen instincts of self- preservation, and he sat closer to Prince than anyone else at Citigroup.

Rubin said he had never heard of liquidity puts.

To both their investors and their bosses, Wall Street firms have become shockingly opaque. But the problem isn't new. It dates back at least to the early 1980s when one firm, Salomon Brothers, suddenly began to make more money than all the other firms combined. (Go look at the numbers: They're incredible.)

The profits came from financial innovation -- mainly in mortgage securities and interest-rate arbitrage. But its CEO, John Gutfreund, had only a vague idea what the bright young things dreaming up clever new securities were doing. Some of it was very smart, some of it was not so smart, but all of it was beyond his capacity to understand.

Ever since then, when extremely smart people have found extremely complicated ways to make huge sums of money, the typical Wall Street boss has seldom bothered to fully understand the matter, to challenge and question and argue.

New New Thing

This isn't because Wall Street CEOs are lazy, or stupid. It's because they are trapped. The Wall Street CEO can't interfere with the new new thing on Wall Street because the new new thing is the profit center, and the people who create it are mobile.

Anything he does to slow them down increases the risk that his most lucrative employees will quit and join another big firm, or start their own hedge fund. He isn't a boss in the conventional sense. He's a hostage of his cleverest employees.

At this point you have to at least wonder if Wall Street firms should be public companies. Their complexity renders them inherently opaque. Investors are right now waking up to this fact: They will demand to be paid for opacity, and also for volatility.

The firms have been revealed to be so treacherous in bad times that the only way they survive as public companies is to make outrageously huge sums in good times. That is, as public companies, to be economically viable they are likely to be socially problematic.

If they aren't about to go under, they are making so much money that everyone else hates them.

Something is about to give.

The Monopoly money is gone

California freefall: Home prices fell 26% in February

LA Times blog
Signs of distress are piling up in the California housing market, where prices are falling at three times the national rate of decline.

--Statewide, median sales prices fell by a stunning 26% in February, with home prices dropping at a rate of nearly $3,000 a week, the California Association of Realtors reports. Further, the CAR says the Fed's interest rate-cutting campaign "will have little near-term direct effect on the housing market."

--In the San Fernando Valley, losing a home to foreclosure is now almost as common for families as buying a home. The L.A. Daily News: "During January and February, there were 1,084 foreclosures and 1,335 sales of houses and condos in Valley communities from Glendale to Calabasas, according to the San Fernando Valley Economic Research Center at California State University, Northridge.""It's bad. It's really bad," market analyst Nima Nattagh told the Daily News.

The California Association of Realtors reports median prices fell 27.2% from year-ago levels in the hard-hit Inland Empire east of Los Angeles, 30.9% in Sacramento, and 39.1% in Santa Barbara County.

On a percentage basis, the California price meltdown is more than three times as severe as the national decline of 8.2% in median prices reported this week by the National Association of Realtors. On an absolute basis, the California meltdown is even more severe: Nationally, prices fell over the past year at a rate of $338 per week; in California, prices fell at a rate of $2,788 per week.According to the CAR, "The median sales price of an existing, single-family detached home in California during February 2008 was $409,240, a 26.2 percent decrease from the revised $554,280 median for February 2007." The February 2008 median price fell 4.8 percent compared with January’s revised $429,790 median price."The Federal Reserve Bank’s recent action to reduce the federal funds rate will have little near-term direct effect on the housing market," said CAR Vice President and Chief Economist Leslie Appleton-Young. "However, Fed rate cuts should result in more favorable real estate finance rates as we move through the year."

Excerpts from Treasury Secretary Paulson's Comments

Voltron says: the treasury is not interested in propping up house prices. Emphasis mine.

We must work to limit the impact of the housing downturn on the real economy without impeding the completion of the necessary housing correction.

Much attention has been given to the fact that an estimated 8.8 million households may currently have negative home equity. We can expect that number to rise as the housing correction plays out, and to begin to reverse once the correction has run its course. The best outcome for these homeowners is to work through this correction as quickly as possible.

Homeowners with negative equity are more common in this housing downturn because lending practices changed dramatically in recent years. In 2007, 29 percent of mortgages were originated with no down payment. Some of those mortgages went to speculators; others to responsible borrowers who were able to buy a home because of expanded access to credit.

But let me emphasize that we do not need a system-wide solution for the vast majority of loans where a homeowner temporarily has negative equity. Negative equity does not affect borrowers' ability to pay their loans. Homeowners who can afford their mortgage payment should honor their obligations --- and most do. They know that there are housing cycles, and they bought more than houses. They bought homes to become part of a community, and they bought them as places to live, not as investments. And if they live in them for the long term, they are likely to become good investments.

Let me also emphasize that any homeowner who can afford his mortgage payment but chooses to walk away from an underwater property is simply a speculator. Washington can not create any new mortgage program to induce these speculators to continue to own these homes, unless someone else foots the bill.

The people we seek to help are those who want to keep their homes but can't afford the monthly payment because of an ARM reset. If they also have negative equity in their homes, refinancing becomes almost impossible and so workouts become even more important. Secretary Jackson is examining the potential for FHA to be a solution for these borrowers.

Schoolhouse Rock: I'm just a dollar bill.

Voltron says: Get some popcorn, put on your tinfoil hat and watch this explanation of our monetary system and you will understand why we are completely screwed. The proposed solutions are a bit wacky, though.

The video takes about 10 seconds to start after you hit play

Great Moments in Accounting

Voltron says: This is a Wall Street Journal blog entry I posted back in September. It explains how Wall Steet exploits an accounting rule to create fictitious profits.

Posted by Tim Annett

Jed Horowitz explains how an accounting rule helped Wall Steet earnings reports shine a little brighter this week:

Wall Street firms are teaching investors another lesson in alchemy by turning distrust of their creditworthiness into a little gold.

Thanks to a relatively new accounting rule, firms like Morgan Stanley, Lehman Brothers and Goldman Sachs last quarter booked hundreds of millions of dollars in gains based on worsening perceptions of their own creditworthiness.

How does that work? If the market decides a company is a bigger credit risk and starts demanding fatter risk premiums to buy its debt, the value of its existing debt falls. Under a rule being phased in throughout corporate America known as Financial Accounting Statement No. 159, that same logic applies to a company’s own debt. Companies that mark their liabilities to a market price, as Wall Street usually does, thus record as revenue a drop in the value of their own debt obligations.

In essence, they make money because they owe less.

Accounting experts said the exercise is perfectly legitimate, particularly if firms that mark liabilities to market do the same with their assets. At the same time, it highlights one of the ironies of so-called fair value accounting. “If you have a liability that declines in value because your credit worsens, you have a gain,” said Stephen Ryan, associate professor of accounting at New York University’s Stern School of Business.

But Moody’s Investors Service said buyers should beware of gains booked when brokers mark down their own debt liabilities. “Moody’s does not consider such gains to be high-quality, core earnings,” it said in a report issued Friday.

FAS 159, which brokers are adopting earlier than most companies, couldn’t have come at a better time for Wall Street. The firms are taking writedowns of billions of dollars to reflect the lower value of leveraged buyout loans and securities backed by mortgages and other assets that are stuck on their books. Concerns about those exposures weighed on perceptions of the big investment banks’ creditworthiness all quarter. The cost of protecting their bonds against default shot up, and the risk premiums on their debt widened as well.

Morgan Stanley said it booked about $390 million, or about 26% of its third-quarter profit, “from the widening of credit spreads on certain long-term debt” that it has issued. It isn’t alone. Goldman Sachs said Thursday it booked a gain of “a little bit under $300 million” because of adjustments in accounting for its structured notes. That’s a sliver of the $2.9 billion of net income it reported in the third quarter, but still helped offset some of its fixed-income and equities losses.

Bear Stearns Cos. added $225 million of equity revenue, “principally reflecting gains in our structured notes portfolio.” Without it, the 83-year-old firm – which boasts on its website that it has never had an unprofitable year — would have registered a third-quarter loss. Lehman Brothers said it used the benefit from its notes’ decline to reduce losses on some of its leveraged loans, though it wouldn’t specify the amount.

Nucking Futz

Voltron says: some of the proposals being floated by normally sane and learned individuals are nucking futz. This is because the unprecedented steps the Fed has already taken aren't working.

• Steve Forbes has suggested that banks be allowed to value all mortgage securities at face value. In other words, bury our heads in the sand.
• An editorial in the Wall Steet Journal recommends that the government buy up the bad mortgages and bulldoze the houses.
• Concern about moral hazard has flown completely out the window.
• Nationalization of our banks is a real possibility. Of course there is no talk of nationalizing the privately owned Federal Reserve Bank itself!
• Hillary Clinton is proposing a committee chaired by Alan Greenspan, the very person who caused the housing bubble. She's has also proposed a "forclosure timeout." Is this the soccer mom solution?

Everything is fine

Fed's rescue halted a derivatives Chernobyl

When the Federal Reserve stepped in to save Bear Stearns, most people had no idea what was at stake, writes Ambrose Evans-Pritchard

We may never know for sure whether the Federal Reserve's rescue of Bear Stearns averted a seizure of the $516 trillion derivatives system, the ultimate Chernobyl for global finance.

The rollercoaster week: Click to enlarge "If the Fed had not stepped in, we would have had pandemonium," said James Melcher, president of the New York hedge fund Balestra Capital. "There was the risk of a total meltdown at the beginning of last week. I don't think most people have any idea how bad this chain could have been, and I am still not sure the Fed can maintain the solvency of the US banking system." All through early March the frontline players had watched in horror as Bear Stearns came under assault and then shrivelled into nothing as its $17bn reserve cushion vanished. Melcher was already prepared - true to form for a man who made a fabulous return last year betting on the collapse of US mortgage securities. He is now turning his sights on Eastern Europe, the next shoe to drop. advertisement "We've been worried for a long time there would be nobody to pay on the other side of our contracts, so we took profits early and got out of everything. The Greenspan policies that led to this have been the most irresponsible episode the world has ever seen," he said. Fed chairman Ben Bernanke has moved with breathtaking speed to contain the crisis. Last Sunday night, he resorted to the "nuclear option", invoking a Depression-era clause - Article 13 (3) of the Federal Reserve Act - to be used in "unusual and exigent circumstances". The emergency vote by five governors allows the Fed to shoulder $30bn of direct credit risk from the Bear Stearns carcass. By taking this course, the Fed has crossed the Rubicon of central banking. To understand why it has torn up the rule book, take a look at the latest Security and Exchange Commission filing by Bear Stearns. It contains a short table listing the broker's holding of derivatives contracts as of November 30 2007. Bear Stearns had total positions of $13.4 trillion. This is greater than the US national income, or equal to a quarter of world GDP - at least in "notional" terms. The contracts were described as "swaps", "swaptions", "caps", "collars" and "floors". This heady edifice of new-fangled instruments was built on an asset base of $80bn at best. On the other side of these contracts are banks, brokers, and hedge funds, linked in destiny by a nexus of interlocking claims. This is counterparty spaghetti. To make matters worse, Lehman Brothers, UBS, and Citigroup were all wobbling on the back foot as the hurricane hit. "Twenty years ago the Fed would have let Bear Stearns go bust," said Willem Sels, a credit specialist at Dresdner Kleinwort. "Now it is too interlinked to fail." The International Swaps and Derivatives Association says the vast headline figures in the contracts are meaningless. Positions are off-setting. The actual risk is magnitudes lower. The Bank for International Settlements uses a concept of "gross market value" to weight the real exposure. This is roughly 2 per cent of the notional level. For Bear Stearns this would be $270bn, or so. "There is no real way to gauge the market risk," said an official "We don't know how much is backed by collateral. We don't know what would happen in a crisis, and if we don't know, nobody does," he said. Under the rescue deal, JP Morgan Chase will take over Bear Stearns' $13.4 trillion contracts - lock, stock, and barrel. Ben Bernanke, the Fed chairman, took decisive action when Bear Stearns began to collapse But JP Morgan is already up to its neck in this soup, with $77 trillion of contracts. It will now have $90 trillion on its books, a sixth of the global market. Risk is being concentrated further. There are echoes of the old reinsurance chains at Lloyd's, but on a vaster scale. The most neuralgic niche is the $45 trillion market for credit default swaps (CDS). These CDS swaps are a way of betting on the credit quality of companies without having to buy the underlying bonds, which are less liquid. They have long been the bête noire of New York Fed chief Timothy Geithner, alarmed that 10 banks make up 89 per cent of the contracts. "The same names show up in multiple types of positions. These create the potential for squeezes in cash markets, magnifying the risk of adverse dynamics," he said. "They could increase systemic risk, by amplifying rather than dampening the movement in asset prices," he said. This is what happened as the banking crisis gathered pace. The CDS spreads measuring default risk on Bear Stearns debt rocketed from 246 to 792 in a single day on March 13 amid - untrue - rumours that the broker was preparing to invoke bankruptcy protection. Was it the spike in spreads that set off the panic run on Bear Stearns by New York insiders? Or are the CDS spreads merely serving as a barometer? In the old days it was hard for speculators to take "short" bets on bonds. Credit derivatives open up a whole new game. "It is now much easier to short credit, " said James Batterman, a derivatives expert at Fitch Ratings in New York. "CDS swaps can be used for speculation, and that can cause skittish markets to overshoot," he said. For now the meltdown panic has subsided. Yet the hottest document flying around the City last week was a paper by Barclays Capital probing what might happen in a counterparty default. It is not for bedtime reading. Direct losses from a CDS breakdown alone could be $80bn, but the potential risks are much greater. In theory, the contracts are matching. One sides loses, the other gains, operating through a neutral counterparty (ie Bear Stearns). But if the system seizes up, the mechanism is not neutral at all. It becomes viciously one-sided. "Upon the default of the counterparty, [traded] derivatives would be immediately repriced, with spreads widening dramatically," said the Barclays report. This is "gap risk", the stuff of trading nightmares. Fortunes can vanish in a moment. One side would suddenly be trapped with staggering losses on their books. Yet the winners would be unable to collect their prize from the insolvent bank in the middle. It would take years to unravel all the claims in court. By then the financial landscape would be a scene of carnage. Warren Buffett famously described derivatives as "weapons of mass financial destruction". The analogy is suspect, of course. Allied troops never found the alleged weapons in Iraq. This time, Washington's pre-emptive shock and awe may have been well-advised.

Credit Default Swaps

Voltron says: Credit default swaps (a facy term for side bets on the solvency of companies) were a growing new product when I left wall street. I had no idea that the market had grown so large. Who ever sold these swaps is in serious trouble if a major investment bank goes down.

Are we in a recession?

Diversify out of the U.S.

The FED is crushing the dollar.

I'm moving out of inflation linked treasuries and into dividend paying foreign stocks such as DBN (basic materials), DKA (energy), and DBU (utilities).

I'm also moving into commodities such as GLD (gold) and DBC (oil, gold, aluminum, wheat and corn).

The Audacity of Hopelessness

Voltron says: took it in the shorts today as expected, but used the opportunity to double down. Here's some humor to dull the pain.

Jim Rogers predicts crash of the dollar and demise of the Fed

Peter Schiff predicts market crash

Blood is in the water

Lehman is chum.

Bank-To-Bank Lending Freezes; Bankers Ask 'Who's Next?'

By Mike Dolan and Kirsten Donovan

LONDON (Reuters) - Financial trading and interbank lending
almost ground to a halt on Monday as banks grew fearful of
dealing with each other following Friday's near collapse of
U.S. investment firm Bear Stearns (BSC.N: Quote, Profile, Research), prompting talk of
another round of coordinated central bank aid.

As banking stock prices and the U.S. dollar plummeted,
banks' access to unsecured borrowing from other banks fell to a
relative trickle and dealers said the over-the-counter market
had become highly discriminatory, depending on the bank name.

The seizure in money markets was reflected in a dramatic 80
basis point surge in overnight dollar London interbank offered
rates (Libor), the biggest daily increase since the attacks of
September 11, 2001.

"Banks and institutions are just scrambling for cash, any
cash they can get their hands on," said a money market trader
at a European bank.

"And it's seen as a U.S. market problem for the moment, or
a dollar problem anyway," he said, noting the relatively modest
increase in overnight euro and sterling Libor.

Published dealing rates were unreliable and analysts said
any bank that had not already secured funding further than a
week or so would struggle to raise cash at all.

"Bear's near-collapse and takeover accelerates the
liquidity crunch and the money market crisis," Dresdner
Kleinwort analyst Willem Sels told clients in a note.

"Banks' risk aversion and sensitivity to counterparty risk
should rise even further, leading to more pressure on hedge
funds. Money markets are having a brutal wake-up call."

COMING TO TERMS

Bankers said they were struggling to assess developments
since the New York Federal Reserve said on Friday it was
propping up the stricken firm via Wall St bank JP Morgan
(JPM.N: Quote, Profile, Research), and intense concerns about the stability and solvency
of financial counterparties had dealing volumes in lending
markets seize up.

In an effort to minimise the fallout and in conjunction
with the fire sale of Bear Stearns to JP Morgan, the Fed on
Sunday cut its discount lending rate by a quarter percentage
point to 3.25 percent and announced another series of liquidity
measures.

But with concerns about whether other firms may meet a
similar fate to Bear Stearns, nerves on every trade were
jangled.

"It's quite illiquid this morning. If you want unsecured
cash you're really going to have to pay up for it. It's really
quite an intense situation," said Calyon analyst David Keeble.

Banks led the losers as stock markets lost more than 3
percent. UBS (UBSN.VX: Quote, Profile, Research), Royal Bank of Scotland (RBS.L: Quote, Profile, Research) and
Barclays (BARC.L: Quote, Profile, Research) all fell more than 8 percent. HBOS (HBOS.L: Quote, Profile, Research)
and Alliance & Leicester (ALLL.L: Quote, Profile, Research) slid more than 11 percent.

Shares in Lehman Brothers (LEH.N: Quote, Profile, Research) dropped 34 percent before
the opening bell on Wall St.

"There's turmoil in all markets after Bear Stearns," said
BNP Paribas strategist Edmund Shing. "Everyone's asking: Who's
next? Is there a Bear Stearns in Europe? Could investment banks
start to fail?"

The problem was said to be particularly acute in sterling
markets, with the gap between indicative three-month interbank
borrowing rates and the Bank of England loans more than 70
basis points -- the highest for the year.

Some analysts said major players on the interbank market
had been doing as little as 700 million pounds a day of
business over the past week, a fraction of the several billions
that would have been executed a year ago, and far less on
Monday.

"Counterparty risk is back in play, every trade is being
scrutinised ahead of time," one interest rate trader said. "

The stress in the market forced the UK central bank to make
an emergency offer of five billion pounds of three-day funds.

"This action is being taken in response to conditions in
the short-term money markets this morning," the Bank said in a
statement. "Along with other central banks, the Bank of England
is closely monitoring market conditions."

PROBLEMS EVERYWHERE

Three-month euro interbank rates were also some 65 basis
points above ECB rates, compared with around 40 basis points at
the start of the month. The spread reached a peak of around 90
at the end of last year.

Dollar spreads were also wider than on Friday but heavy
discounting of further Fed rate cuts have meant the spread has
actually narrowed this month to around 65 versus 80 basis
points at the start of March.

The European Central Bank declined to comment, even though
speculation of coordinated central bank statements, liquidity
injections and even synchronised rate cuts circulated around
markets.

A German finance ministry spokesman said no extraordinary
meetings of the Group of Seven economic powers was planned.
"We're watching developments very closely in the United
States."

But International Monetary Fund chief Dominique
Strauss-Kahn said the global financial markets crisis was
worsening and risk of contagion was increasing.

With the dollar sliding to record lows, traders said
currency options markets were seizing up too, another
reflection of the state of panic and fear that appears to be
dominating all financial markets.

Implied volatilities on FX options, a measure of expected
volatility in the underlying asset price and investors' demand
to protect themselves against these moves, soared on Monday.

As the dollar sank to 13-year lows against the yen further
below 100 yen, one-week dollar/yen implied "vols" <JPYSWO=>
jumped to 25 percent, a level not seen since 1999.

"This is a market where you should be on your guard.
Shorting options is quite a difficult position to manage," said
the senior FX trader in Tokyo.

Two Dollars! Two Dollars!

Is Bear Stearns "Better off Dead?"

The Yankees paid more for A-Rod than JP Morgan Chase paid for Bear Stearns!

The FED bailout means the executives at Bear Stearns get to keep their multi-million dollar bonuses. If they went bankrupt, the execs would most likely have to give it all back.

Why the market is not down more.

Voltron says: The market is waiting to see what the Fed does tomorrow.

Lehman Too Big to Fail?

From Silicon Alley Insider, March 17, 2008:

Bear Stearns (BSC) is gone, so the markets are wondering who's next. The leading contender? Lehman Brothers (LEH).

Lehman's stock dropped 15% on Friday, and it's down another 33% in pre-market trading. Some specific concerns:

• Like Bear Stearns, Lehman is relatively small and undiversified.
• Like Bear Stearns, Lehman just reiterated that its "liquidity position is strong."
• Like Bear Stearns, at least one of Lehman's trading partners is cutting it off: The WSJ reports that Southeast Asia's biggest bank, DBS Holdings, has asked traders not to enter new transactions with Lehman Brothers. "DBS has sent an internal e-mail saying it would not deal with Lehman Brothers from now on."
• Like Bear Stearns, Lehman is levered about 30-to-1.
• Like Bear Stearns, Lehman chose not to raise additional capital last fall.
• Like Bear Stearns, no one has any idea what's really on Lehman's balance sheet (including, probably, Lehman)
  
• Unlike Bear Stearns, says an analyst at ING, Lehman is NOT too big to fail, which means that the Fed might not be in such a panic to bail it out.

If Lehman is hellbent on following the Bear Stearns playbook, it will now trot Dick Fuld out onto CNBC to say that the bank is in great shape. And then, a day or two later, it will go bankrupt.

Generalized Run on the Shadow Financial System

from RGE Monitor : Nouriel Roubini's Global EconoMonitor by Nouriel Roubini's Global EconoMonitor

Since the onset of the liquidity and credit crunch last summer this column has been arguing that monetary policy would be impotent to address such a crunch because, in part, of the existence of a non-bank “shadow financial system”. This system is composed of conduits, SIVs, investment banks/broker dealers, money market funds, hedge funds and other non bank financial institutions.

All these institutions look similar to banks because they are highly leveraged and borrow short and in liquid ways and invest or lend long and in illiquid ways. This shadow financial system is, like banks, subject not only to credit and market risk but also to rollover or liquidity risk, i.e. the risk deriving from having a large stock of short term liabilities (relative to liquid assets) that may not roll over if creditors decide to withdraw their credits to these institutions.

Unlike banks this shadow financial system does not have access to the lender of last resort support of the central bank as these are not depository institutions regulated by the central banks. What we are now observing – with the case of Bear Stearns and the recent disaster among SIVs, conduits, run on a number of hedge funds and money market funds is a generalized liquidity run on this shadow financial system.

The response of the Fed to this run has been radical and in the form of the extension of the lender of last resort support to non bank financial institutions. Specifically, the new $200 bn term facility allows primary dealers – many of which are non banks – to swap their toxic mortgage backed securities for US Treasuries; second, the Fed provided emergency support to Bear Stearns and following the purchase of Bear Stearns by JPMorgan, is now providing a $30 bn plus support to JPMorgan to help the rescue of Bear Stearns; finally, now the Fed is allowing primary dealers to access the Fed discount window at the same terms as banks.

This is the most radical change and expansions of Fed powers and functions since the Great Depression: essentially the Fed now can lend unlimited amounts to non bank highly leveraged institutions that it does not regulate. The Fed is treating this run on the shadow financial system as a liquidity run but the Fed has no idea of whether such institutions are insolvent. As JPMorgan paid only about $200 million for Bear Stearns – and only after the Fed promised a $30 billlion loan – this was a clear case where this non bank financial institution was insolvent.

The Fed has no idea of which other primary dealers may be insolvent as it does not supervise and regulate those primary dealers that are not banks. But it is treating this crisis – the most severe financial crisis in the US since the Great Depression – as if it was purely a liquidity crisis. By lending massive amounts to potentially insolvent institutions that it does not supervise or regulate and that may be insolvent the Fed is taking serious financial risks and seriously exacerbate moral hazard distortions. Here you have highly leveraged non bank financial institutions that made reckless investments and lending, had extremely poor risk management and altogether disregarded liquidity risks; some may be insolvent but now the Fed is providing them with a blank check for unlimited amounts. This is a most radical action and a signal of how severe the crisis of the banking system and non-bank shadow financial system is. This is the worst US financial crisis since the Great Depression and the Fed is treating it as if it was only a liquidity crisis. But this is not just a liquidity crisis; it is rather a credit and insolvency crisis. And it is not the job of the Fed to bail out insolvent non bank financial institutions. If a bail out should occur this is a fiscal policy action that should be decided by Congress after the relevant equity holders have been wiped out and senior management fired without golden parachutes and huge severance packages.

Time for action

Buy commodities and short everything else!

Peter Schiff

Watch this clip of Peter Schiff getting ridiculed back in Aug 2007 when the dow was over 13,000. Charles Payne recommended Bear Stearns which was just sold to JP Morgan Chase for 1/10th what it was worth a week ago!!!

click here to view clip

watch the other videos on his website. It may soon be time to move into foreign stocks in Canada, New Zealand and Australia.

Lehman is next

From RGE Monitor:

Bear [Stearns] is only the first broker dealer to go belly up. Rumors had been circulating in the market for days that the exposure of Lehman to toxic ABS/MBS securities is as bad as that of Bear: according to Fitch at the beginning of the turmoil Bear Stearns had the highest toxic waste ("residual balance") exposure as percent of adjusted equity on balance sheet; the exposure of Bear was 54.5% while that of Lehman was only marginally smaller at 53.3%; that of Goldman Sachs was only 21%. And guess what? Today Lehman received a $2 billion unsecured credit line from 40 lenders. Here is another massively leveraged broker dealer that mismanaged its liquidity risk, had massive amount of toxic waste on its books and is now in trouble. Again here we have not only a situation of illiquidity but serious credit problems and losses given the reckless exposure of this second broker dealer to toxic investments.

It's starting

'Facing foreclosure, some homeowners set fire to their own homes. CNN's Chris Lawrence reports.'

original article

Bear Stearns to Get Backing From J.P. Morgan, N.Y. Fed

Firm's Shares Sink Amid Liquidity Fears
By KEVIN KINGSBURY, ANDREW DOWELL and SERENA NGMarch 14, 2008 5:01 p.m.
NEW YORK -- In an unprecedented move Friday, J.P. Morgan Chase & Co. and the Federal Reserve Bank of New York stepped in with emergency funds to keep beleaguered investment bank Bear Stearns Cos. afloat.
The move, after a week of persistent concerns about whether Bear could continue to meet its obligations, took the credit crisis to a new, more serious stage and was a reminder of how quickly an erosion of confidence can undermine even leading financial institutions.
The involvement of the Fed -- coordinating with the Treasury Department and the Securities and Exchange Commission -- made clear authorities were concerned about the risks to the broader financial system. Bear is the smallest of Wall Street's big five investment banks, but it is a significant player in markets for debt, particularly for securities backed by mortgages.
A sharp selloff in the bank's stock and demand for protection against a default on its debts showed the market isn't convinced the plan will stabilize the bank, which now faces the prospect of fighting to convince customers to stick around or finding a merger partner.
Bear Stearns' problems built this week, as counterparties in the market grew extra cautious about entering deals with the bank. Executives tried all week to reassure markets that the bank's financial position was solid. But in a week that also saw the collapse of the $22 billion, mortgage-focused hedge fund Carlyle Capital, those reassurances went unheard, and Bear ultimately was forced to seek help.
"We have tried to confront and dispel these rumors and parse fact from fiction," CEO Alan Schwartz said in a release. "Nevertheless, amidst this market chatter, our liquidity position in the last 24 hours had significantly deteriorated. We took this important step to restore confidence in us in the marketplace, strengthen our liquidity and allow us to continue normal operations."
Friday afternoon, Standard & Poor's cut its long-term credit rating on Bear Stearns by three notches to BBB and said further downgrades are likely, noting the company's liquidity squeeze.
S&P said, "Bear has been experiencing significant stress in the past week because of concerns regarding its liquidity position. Although the firm's liquidity, at the beginning of the week, held steady with excess cash of $18 billion, ongoing pressure and anxiety in the markets resulted in significant cash outflows toward the week's end, leaving Bear with a significantly deteriorated liquidity position at end of business on Thursday."
S&P said it current ratings "are based on our expectation that Bear will find an orderly solution to its funding problems. However, although we view the liquidity support to Bear as positive, we consider it a short-term solution to a longer term issue that does not entirely affect Bear's confidence crisis. We also remain concerned about Bear's ability to generate sustainable revenues in an ongoing volatile market environment."
Moody's Investors Service cut its rating on Bear Stearns to Baa1, three levels above junk.
Fed Steps In
J.P. Morgan will borrow funds from the Fed's discount window and re-lend them to Bear Stearns for 28 days, with the Fed bearing the risk of any losses. The size isn't predetermined, but is limited by the available collateral.
The arrangement employs a little-used Depression-era provision of the Federal Reserve Act. New York-based J.P. Morgan, unlike investment banks like Bear, has the advantage of being able to borrow directly from the discount window and, with just over $3 billion in write-downs thus far, has weathered the credit crisis far better than commercial banking peers like Citigroup Inc.
The timing of the move made its urgency clear. If Bear could have held out until March 27, it could have borrowed directly from the Fed itself under a new program announced just Tuesday.
The developments could mean the end of independence for Bear, founded in 1923. J.P. Morgan is "working closely with Bear Stearns on securing permanent financing or other alternatives for the company" -- Wall Street lingo for a sale or other strategic-level change -- and CNBC reported that the bank is "actively being shopped" to potential buyers. Mr. Schwartz said on a conference call that the bank is considering the full range of options.
The cost of protecting investments in Bear Stearns debt against default jumped sharply, indicating growing concerns about Bear's creditworthiness. Similar protection for other financial companies also rose in value, a sign of rising worry in the markets.
Bear's shares plunged, dropping by more than half at the day's low. Shares recently were trading nearly 42% lower at $33.07, knocking around $3 billion in market value off the stock. The options market signaled a dim outlook, with contracts giving the right to sell Bear Stearns stock for $25 soaring in value. The shares have fallen by two-thirds in the past three months.
The news also unnerved the broader markets, which just yesterday were cheering a report from Standard & Poor's that suggested the end might be in sight for write-downs related to subprime mortgages. The Dow Jones Industrial Average was down about 300 points at its low but closed down 195 points.
U.S. Treasurys surged, as investors sought a safe place for their money, and the dollar fell.
"It's just pure fear across the board right now," said Geoffrey Yu of UBS. "All the promising news this past week has been undone over this Bear Stearns news. ... I don't think the market has seen anything of this magnitude before, such a big bank."
Bear Stearns started this week with sufficient access to cash, but persistent rumors rattled lenders, clients and counterparties, prompting a run on the bank, Mr. Schwartz said on the call.
"A lot of people wanted to get cash out," he said. "We recognized that, at the pace things were going, there could be continued liquidity demands that would outstrip our liquidity resources."
Lehman Parallels
Analysts and investors say Bear's predicament has parallels to what Lehman Brothers went through during the late 1990s.
During the credit crunch of 1998, which was sparked off by the Russian debt crisis and the implosion of hedge fund Long-Term Capital Management, Lehman was the subject of rampant market speculation that it might face financial difficulties, because it held emerging market bonds and other assets that were falling in value.
As Lehman's shares and bonds dived on the rumors, the Wall Street firm, which at the time depended heavily on short-term funding, ran into problems obtaining such financing. It fought its way out of the trap without having to turn to the Fed, however.
"The nature of financial companies is that they are pretty much a black box," says Jeff Houston, a bond fund manager at American Century Investments in San Francisco. "If people start to worry about what's in the box, there's not much the firms can do to demonstrate that they are not as weak as they appear to be."
Lehman's shares dropped 11% Friday -- outpacing declines of roughly 3% for its investment banking cohorts. The bank is bigger and more diversified than Bear geographically and across business lines, but is smaller than Goldman Sachs Group or Morgan Stanley.
Lehman said late in the day it closed a $2 billion unsecured credit line. Global Treasurer Paolo Tonucci called it "a strong signal from the market and our key bank relationships."
At the end of November, Bear had short-term borrowings of $24 billion, of which $11.6 billion was unsecured and $12.4 billion was secured. It also had $68.5 billion in long-term borrowings and $21.4 billion in cash or equivalents, according to regulatory filings.

Muni bond insurance demand likely to abate-MBIA CEO

NEW YORK, March 13 (Reuters) - More state and city issuers
are likely to forgo bond insurance for a while, but demand will
in time pick up again, said Jay Brown, chief executive at bond
insurer MBIA Inc (MBI.N: Quote, Profile, Research)

When asked how long it might take for demand to pick up,
Brown told Reuters, "If I had that crystal ball, I'd probably
be doing something else for a living."
(Reporting by Dan Wilchins)

Reason the market is up.

Voltron says: S&P (affectionately known as "Poor Standards", who missed the whole subprime thing in the first place) issued a report that we are already half way through the subprime crisis. The market jumped at the light at the end of the tunnel like a moth. What S&P probably knows and did not mention, is that the light at the end of the tunnel is actually a train. Yes, the subprime crisis is half over, but the larger Alt-A/Option-ARM crisis will be larger, so we are less than 1/4 of the way through this mess and the Fed is running out of bullets.

Despite the Federal Reserve's efforts Wall Street fears a big US bank is in trouble

From The U.K. Times

Siobhan Kennedy and Suzy Jagger

Global stock markets may have cheered the US Federal Reserve yesterday, but on Wall Street the Fed's unprecedented move to pump $280 billion (£140 billion) into global markets was seen as a sure sign that at least one financial institution was struggling to survive.
The name on most people's lips was Bear Stearns. Although the Fed billed the co-ordinated rescue as a way of improving liquidity across financial markets, economists and analysts said that the decision appeared to be driven by an urgent need to stave off the collapse of an American bank.
“The only reason the Fed would do this is if they knew one or more of their primary dealers actually wasn't flush with cash and needed funds in a hurry,” Simon Maughan, an analyst with MF Global in London, said.
Mr Maughan said that the most likely victim was Bear Stearns, the first bank to run into trouble in the sub-prime crisis and the one that, among all wholesale and investment banks, is most reliant upon the use of mortgage securities for raising funds in the money markets.
“The average financial institution was up 7.5 per cent yesterday after the Fed's actions, but Bear Stearns rose just 1 per cent on massive trading volume,” Mr Maughan said. “The market is telling you it's Bear Stearns.”
The Fed's intervention sparked fears of deeper underlying trouble because it came only days after it had made $200 billion (£99 billion) available in emergency funds. The nature of the financing was also unusual, bankers say, because it was the first time that the Fed had offered to lend Treasury securities in exchange for ordinary AAA-rated mortgage-backed securities as collateral.
Chris Whalen, of the financial consultancy Institutional Risk Analytics in New York, said: “The Fed move is confirmation that at least one of the banks is in trouble. A huge part of the banks' inventories are illiquid. If a broker-dealer is illiquid, it dies.”
Speculation has swirled for months about the collapse of an American bank as the credit crisis has escalated and spread from sub-prime to other mortgage-backed securities, treasuries and bonds. As well as Bear Stearns, attention has focused on UBS, the Swiss bank, which has been forced to make more than $18 billion in sub-prime writedowns, and Citigroup, the world's largest financial institution, which has turned to sovereign wealth funds to help to shore up its credit-stricken balance sheet.
Bankers say that mortgage lenders, such as Paragon, Alliance & Leicester and Bradford & Bingley, could also be teetering on the brink soon if they cannot raise enough money in the markets to continue to lend to customers. All the banks have denied that they are facing a cash crunch and each has said that its liquidity position is strong. Nonetheless, the speculation continues to mount. Alan Schwartz, the Bear Stearns chief executive, reiterated that stance yesterday after Punk Ziegel analysts gave warning that the bank could be forced to seek a merger partner.
“We don't see any pressure on our liquidity, let alone a liquidity crisis,” Mr Schwartz told CNBC yesterday. He said that Bear had finished fiscal 2007 with $17 billion of cash sitting as a“liquidity cushion”. He added: “That cushion has been virtually unchanged. We're in constant dialogue with all the major dealers, and I have not been made aware of anybody not taking our credit.”
Yet banking sources said yesterday that a collapse seemed inevitable. One senior banker in London said: “Someone will go under in this crisis, that's for sure. The question is whether they stay under or get rescued. Let's see whether this latest round of stabilisation helps, but if it doesn't, it's difficult to see what Plan B is. The Fed can't just keep on printing money.”
One problem with the credit crunch is that banks' solvency positions can change overnight. As banks force firesales of assets to recover their loans from hedge funds, the prices of those assets fall. But as the prices fall, the amount of capital that the banks need rises. Lena Komileva, a Tullett Prebon economist, said: “This is what is fuelling the vicious cycle. Things can deteriorate very rapidly and banks can reach insolvency almost overnight.”
Ms Komileva said it was clear that the Fed was reacting to address a “specific counterparty risk”, although she declined to comment on which bank might be in trouble. She said: “The speed and severity of their action appeared disproportionate to what had actually happened, so, consequently, it seems the Fed really reacted to prevent a Northern Rock-style problem in the US.”
She said that the Fed's moves amounted to window-dressing. “All the signs of stress that were there before are still here,” she said.

RUMOR: Lehman failed to meet margin calls

read it on the LEH yahoo! message board. It's the only thing I've seen to explain the sudden drop.

The next shoe to drop in housing

Rising foreclosures and big losses at Fannie Mae and Freddie Mac are making it harder for people with good credit backgrounds to get a traditional mortgage.

By Tami Luhby, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) -- The credit crunch has finally hit the traditional mortgage market.
Investors are now shunning mortgage-backed securities issued by government sponsored enterprises Fannie Mae and Freddie Mac, which have been critical in keeping the real estate market from completely falling apart.
Some fear this development will make it harder for people, even those with strong credit histories, to get a home loan.
"Even if you have good credit, you don't know if they are going to give you a loan or not," said Joseph Mason, a senior fellow at the Wharton School of the University of Pennsylvania.
And for those who can still get a loan, the tremors in the mortgage-backed securities market has made loans more expensive for borrowers. As the prices of mortgage-backed securities have fallen, their yields have risen, leading to higher mortgage rates.
The national average rate on a 30-year fixed-rate mortgage was 5.96% Thursday, after jumping to 6.08% earlier this week, according to Bankrate.com. Rates on a 30-year fixed mortgage were about 5.90% a week ago. A borrower looking for a 5-year adjustable-rate mortgage would pay 5.71% today, up from around 5.03% a week ago.
"The cost of mortgage financing has increased dramatically and it couldn't come at a worse time," said Tom LaMalfa, managing director of Wholesale Access, a mortgage research firm. "We're going to see a further diminishment of available mortgage money."
Not just a subprime problem anymore
Rising defaults and delinquencies effectively shut down the subprime and jumbo mortgage markets last summer, but borrowers with good credit could still get conventional loans that met the agencies' criteria. That's because investors continued to buy securities - backed by Fannie (FNM) and Freddie (FRE, Fortune 500) - seen as safe since they carry an implicit federal government guarantee.
But the landscape changed in late February. Investors were spooked after Fannie and Freddie reported a combined $6 billion in losses for the fourth quarter as defaults rose.
A new round of fear washed over Wall Street last week when financial fund Carlyle Capital announced its lenders wanted more money to make up for the depressed value of the agency mortgage-backed securities Carlyle had put up as collateral for loans. An announcement by the Mortgage Bankers Association last Thursday that defaults had reached record levels didn't help soothe concerns.
This bad news comes as Congress, in an effort to stimulate lending in higher-cost areas, temporarily raised the size of the mortgages Fannie and Freddie can guarantee to as much as $729,750.
The situation has grown so worrisome that the Federal Reserve took several steps this week to inject liquidity into the agency mortgage-backed security market by allowing banks to trade these securities in as collateral for loans.
On top of that, to shore up their finances and regain investors' trust, Fannie and Freddie have been instituting new fees and stricter underwriting guidelines, making it costlier and harder to qualify for traditional mortgages.
In an investor conference Wednesday, Freddie officials sought to calm jitters by saying the agency has "significantly" increased prices, introducing new fees based on risk levels.
Prepare to pay more for a mortgage
Wholesale Access has estimated that all these changes mean 30% to 40% of borrowers who could have qualified for a conventional mortgage a year ago can no longer do so.
Fannie and Freddie are demanding higher credit scores and charging higher rates for those who don't have them. Until recently, a borrower with a 620 score might pay the same as one with a 680 score, said Victoria Bingham, chief executive with Pacific Rim Mortgage in Tigard, Ore.
But now that person might have to pay a half percentage point more. With today's rates, that translates into 6.75% for a 30-year fixed-rate mortgage instead of 6.25%, or $74 more a month on a $225,000 loan, typical for her client base.
Borrowers must also put more money down, especially if they don't have stellar credit. For instance, those with down payments of less than 5% need a credit score of at least 680, said Steven Plaisance, executive vice president of Arvest Mortgage Co. in Tulsa, Ok. Previously, he could make loans to people without big down payments if they had other strong points, such as stable employment.
Experts said they don't think traditional mortgages will disappear. But if they are harder to get, it will take longer for the housing market to recover as a glut of unsold houses could lead to even more declines in real estate values.
"Fewer buyers who can come into the market mean more homes on the market," LaMalfa said. "The absence of an increase in demand will put further pressure on prices."

Quick update

Voltron says: market is up because FED is injecting $200B into the system. expect commodities to rise and dollar to fall as a result. Moody's is down on downgrade by Lehman brothers.

Fitch, MBIA fight it out over request to stop ratings

Agency says it will continue to rate bond insurer despite not being paid

By Alistair Barr, Greg Morcroft & John Spence, MarketWatch

NEW YORK (MarketWatch) -- In the latest salvo in a now highly public war of words, ratings agency Fitch said it will continue to rate MBIA Inc.'s subsidiaries without charge, despite the bond insurer's request that it stop.

The increasingly confrontational dialogue was initiated on Friday when MBIA asked Fitch in a letter to stop providing some ratings on the firm. That letter, released to the public, also asked Fitch to return or destroy data MBIA had provided to Fitch.

MBIA Chief Executive Jay Brown defended the firm's decision and said the company has started to generate new business.

In response, Fitch CEO Stephen Joynt said the agency plans to keep rating the bond insurer and questioned the company's reasons for trying to end their relationship.

"It seems disingenuous at best to assert in your letter to investors published yesterday, March 9, that you 'intend to work with Fitch to perform the analysis needed to rate MBIA's debt securities,' while privately demanding return of the portfolio information and materials that you freely provided to support our ratings and that of other rating agencies for many years," Joynt wrote.

MBIA shares fell 10% to $10.77 on Monday, leaving them down 29% so far this year.

Fitch's decision to keep rating MBIA is a positive development, according to Joseph Mason, associate professor of finance and LeBow Research Fellow, at Drexel University's LeBow College of Business.

"This is the kind of market discipline we need to get back to," Mason said. "Before the 1970s, there was a very prevalent traditional of unsolicited ratings. This kept the agencies that get paid to do the ratings in line."

Most ratings agencies are paid by the companies they analyze. That's created the perception of a conflict of interest because agencies may be less inclined to come out with lower ratings because they don't want to upset the firms that pay them.

If more agencies rated companies without being paid by them, this potential conflict could be reduced.

"Unsolicited ratings allow agencies to demonstrate their abilities, even when they don't have any monetary interest in the outcome," Mason said. "Any bias gets washed out of the system pretty quickly. Right now that bias is in the system."

Ratings agencies also get confidential information from companies to help them produce more accurate ratings. But when companies restrict information to some agencies, as MBIA is doing with Fitch, the system may become even more skewed.

One way around that is to introduce rules that require equivalent disclosure. When a company provides information to one rating agency, it has to give that to all other regulated agencies too -- probably via some sort of database, Mason explained.

MBIA's request that Fitch destroy information suggests the company is very keen to stop the agency from rating it in future, Mason said.

"It's expected that this information would remain confidential, but to ask that it be destroyed is really going the extra mile to stop Fitch rating them on an unsolicited basis," Mason said.

"This betrays the bias that's currently in the system," he added. "MBIA is saying that because you're not financially tied to us anymore, we really don't want you rating us."

Sean Egan, president of Egan-Jones Ratings, an agency that's paid by investors rather than issuers, goes further, arguing that any confidential information given to ratings agencies should be disclosed to all investors.

MBIA doesn't provide Egan-Jones with the information it requests "because we're bearish on them," he noted.

MBIA spokesman Jim McCarthy said Egan-Jones has never asked the bond insurer for any information.

Egan responded later on Monday that Egan-Jones has asked MBIA for information and will incorporate any new data into its assessment of the bond insurer. The agency encourages companies to disclose that information to the rest of the market too, he said.

"No firm should have preferential access to information. It should be available to everyone in the market," Egan said. "There's no reason why rating firms should be treated differently than other market participants."

"This whole controversy highlights the problems that exist with the industry structure, whereby a company can silence a rating firm if that company doesn't like the rating that's being generated," Egan said.

MBIA CEO sees $200 million in losses coming

MBIA said Monday that it expects $200 million in mark-to-market losses from its credit-derivative business and said Fitch's insurer-financial-strength ratings, or IFS, can cause "serious volatility" in how the Armonk, N.Y.-based company is viewed in the equity markets.

Brown said it was an appropriate time to ask the credit-rating agency to no longer provide its IFS ratings. He added that he had, "very little idea why Fitch's capital model produces the charges it does, and why it can change so rapidly at any point in time when there is no obvious change in our circumstance or in the credit market at large."

Shares of bond insurers such as MBIA and Ambac Financial Group have plunged of late as investors question their ability to survive the credit crunch and maintain their all-important AAA credit ratings. The companies wrote policies insuring billions of dollars of collateralized debt obligations and other mortgage-related debt that could go into default.

In order to rating a company properly, agencies need as much information as possible. They get confidential information about companies, but agree not to divulge that to the market.

However, some agencies get more information than others, Mason explained.

"One of the main constraints to this practice of unsolicited ratings is the lack of information given to some agencies," he said. "MBIA's request that information be destroyed by Fitch is an example of this."

"The good news is that we are starting to write some business in the new issue market," Brown wrote in the shareholder letter, dated March 9.

The CEO, however, acknowledged MBIA has made missteps.

"Make no mistake about it, we wrote some business that in hindsight we wish we hadn't, and those decisions have certainly had an impact on the market's confidence in MBIA," Brown wrote. He was addressing the wide spread on credit default swap contracts written by MBIA, despite the recent AAA ratings affirmations by Moody's and S&P.

"Given our robust financial position at MBIA Inc., I would certainly argue that the existing spread in the short term is illogical," the CEO said.

Among other possibilities, Brown said the spread could be the result of MBIA "being used as a ping-pong ball in a high stakes games by the big guys." Hedge funds and other traders have made money shorting shares of MBIA and other bond insurers that have suffered as a result of the credit-market turmoil.

Brown pointed out the company doesn't have any principal payments pending on its debt until 2010. He said it's "highly improbable" MBIA will default over the next year.

MBIA's shares, down nearly 50% since the beginning of the year, lost more than 5% to change hands at $11.36 Monday morning.

Scandal met with disbelief on Wall St

By Francesco Guerrera, Aline van Duyn and Daniel Pimlott in New York

One investment banker thought it was a joke and carried on with his meeting.

Others sat speechless, unable to avert their eyes from the television screens broadcasting the end of the career of one of Wall Street’s most feared foes.

News of Eliot Spitzer’s alleged involvement in a prostitution ring, and his possible resignation as governor of the state of New York, were met with stunned disbelief in the wood-pannelled offices and trading floors of downtown and midtown Manhattan.

Some could not resist taking a swipe at a man who, as New York’s attorney general, had castigated Wall Street for its ethical shortcomings.

“It’s a complete shocker,” a senior banker said. “Everyone is gossiping about it. And plenty of people on Wall Street are saying he deserved it.”

But others stressed that Mr Spitzer’s alleged personal shortcomings ought not to tarnish his legacy as a regulator.

“This is stunning. This is like finding out that Mother Teresa had been taking kick-backs,” said Henry Hu, a law professor at the University of Texas. “But I don’t think this undermines his achievements. This behaviour has got nothing to do with what motivated him to go after Wall Street”.

Some bankers noted that Mr Spitzer’s downfall had come at time when he had been co-operating with some of his former enemies on Wall Street to try to bring atability to the troubled municipal bond sector.

Harnessing his widespread contacts from his time as attorney-general, he had been making numerous phone calls to chief executives of top banks such as Citigroup, Credit Suisse and UBS in behind-the-scenes efforts to secure fresh capital to bail out bond insurer Ambac.

Eric Dinallo, the New York insurance regulator who was appointed by Mr Spitzer and who has been working extremely closely with him on the Ambac rescue, did not know about the allegations until he saw the news coverage on Monday, people working with Mr Dinallo said.

The many executives felled by Mr Spitzer’s investigations - from Hank Greenberg, former chief executive of the insurer AIG, to Richard Grasso, former chairman of the New York Stock Exchange - remained tightlipped on Monday.

But ordinary New Yorkers, as it is their wont, could not resist opining on Mr Spitzer’s situation.

Standing outside the third avenue building where Mr Spitzer had delivered his terse statement, Eric, a 36-year-old web developer from Brooklyn, drew a parallel between the financial crisis gripping Wall Street and the personal tragedy of his hitherto nemesis.

“It’s a time of reckoning for the financial industry and everyone else on top who’s shirking their responsibilities,” he said. “I thought he was one of the righteous politicians. It’s disappointing.”