Lehman Talks a Rosy Talk

HEARD ON THE STREET

Walking the Walk May Prove Thornier Than Bank Predicts By DAVID REILLY 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.

Please.

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

LEHMAN LOSSES, CAPITAL NEEDS OUSTRIP FEARS
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.

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.

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 (SeekingAlpha.com)

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).

 

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.

 

Gold Surges Most in Six Months on Jobs Data, Dollar's Slump

 

By Millie Munshi and Halia Pavliva

June 6 (Bloomberg) -- Gold jumped the most in six months after the U.S. jobless rate had the biggest gain in more than two decades, spurring a drop in the dollar. Silver also rose.

The unemployment rate increased to 5.5 percent in May from 5 percent in April, marking the biggest increase since February 1986, the U.S. Labor Department said today. The dollar dropped as much as 1 percent against the euro. Gold has gained 33 percent in the past 12 months as a slump by the dollar boosted demand for the metal as an inflation hedge.

``The dollar is much weaker, and that's what is creating the bounce in the market,'' said Leonard Kaplan, the president of Prospector Asset Management in Evanston, Illinois.

Gold futures for August delivery rose $23.50, or 2.7 percent, to $899 an ounce on the Comex division of the New York Mercantile Exchange. That marks the biggest gain for a most- active contract since Nov. 23.

The jump in the jobless rate was higher than every forecast in a Bloomberg survey of 79 economists, who had estimated a median gain to 5.1 percent. U.S. payrolls dropped by 49,000 last month after a 28,000 drop in April.

``The dollar took a nose dive as soon as this jobs data came out, and that's a big reason we've seen gold move up,'' said Matthew Zeman, a trader at LaSalle Futures Group in Chicago.

The euro reached $1.5751 today. It climbed to a record $1.6019 on April 22.

Energy Costs Jump

Gold also gained as a surge in energy costs added to speculation inflation will accelerate, Kaplan of Prospector Asset Management said.

Crude-oil futures for July delivery jumped as much as $11.22 to a record $139.01 a barrel today. The price was at $138.52 as of 2:31 p.m. in New York. Most-active futures have more than doubled in the past year.

Crude oil's rise ``was the prime catalyst, aside from the jobs data'' for gold's rally, Jon Nadler, an analyst at Kitco Minerals & Metals Inc., said in an e-mail.

Silver futures for July delivery advanced 26 cents, or 1.5 percent, to $17.43 an ounce. The metal is up 27 percent in the past year.

Gold may climb to $930 and silver will rise above $18 by mid-July, Sandeep Rungta, a metals strategist at Proficient Commodities in Kolkata, India, said in a report.

``Today's unemployment number was a big blow for the dollar, and we see the euro making fresh highs,'' Rungta said.

 

 

FDIC's Bair: "Institutions of greater size" May Fail

FDIC's Bair: "Institutions of greater size" May Fail

by CalculatedRisk

From Reuters: Bigger U.S. bank failures may be coming - FDIC (hat tip Ed)

An increasing number of banks face high exposure to deteriorating conditions in commercial real estate and construction lending, [Federal Deposit Insurance Corp Chairman Sheila Bair] told a Senate Banking Committee hearing on the state of the banking industry.

"There is also the possibility that future failures could include institutions of greater size than we have seen in the recent past," Bair said. "Uncertainties in today's economic environment continue to pose significant challenges for the banking industry, households, and bank regulators."

The coming bank failures are no secret:

Feb 25, 2008: FDIC Bracing for Bank Failures

March 17, 2008: Federal Deposit Insurance Corporation Stresses Importance of Managing Commercial Real Estate Concentrations

April 17, 2008: Fed Vice Chairman Kohn Warns on CRE Concentrations at Small banks

Note: The largest bank to fail this year was ANB Financial with $2.1 billion in assets.

Banks' credit crisis solutions have echoes of 1929 Depression

Voltron says: Entertaining article.  I especially like the part about “fiscal self-immolation”  I’m just picturing the CEO of Lehman pouring $4/gallon gasoline over his head and threatening himself with a lit match.

As banks look to shore up their balance sheets in the wake of the credit squeeze, Philip Aldrick asks whether it is all short-term trickery

'We are in the midst of the worst financial crisis since the 1930s," warns the eminent financier George Soros in his latest book, The New Paradigm for Financial Markets. It's a rather extreme view, but the man who broke the Bank of England is not alone in his dark funk. At a recent event, one banker laced Soros's sentiment with a little gallows humour, ruefully predicting "10 years of depression followed by a world war".

Comparisons with the great crash of 1929 are inevitable and the parallels manifold. Then it was an over-inflated stock market that burst before wider economic malaise ushered in the Great Depression.

This time, in the words of Intermediate Capital managing director Tom Attwood, sub-prime was merely "a catalyst" for the inevitable pricking of the credit market bubble as "disciplines were bypassed in favour of loan book growth at almost any cost". Again the talk is of recession, certainly in the US and possibly in the UK.

Perhaps the most intriguing parallel, though, is the crude attempt at self-preservation made by the investment trusts in 1929 and the banks now.

In the great crash, investment trusts with vast cross-holdings in each other tried to stem their collapse by buying up their own stock in what the economist JK Galbraith in his book, The Great Crash 1929, described as an act of "fiscal self-immolation". At the time, "support of the stock of one's own company seemed a bold, imaginative and effective course," Galbraith wrote, but ultimately the trusts were just "swindling themselves".

Modern economists have compared the trusts' actions with what the banks are now doing. "They seem to be just papering over the cracks," says Brendan Brown, chief economist at Mitsubishi UFJ Securities.

To free their books of the estimated $1,000bn (£505bn) of sub-prime assets and $340bn of leveraged loans banks have been left carrying since the credit markets shut down last year, lenders are offering to sell these damaged assets cut-price and - crucially - are willing to lend investors the money to buy them. In other words, the banks are providing new debt for the old debt they no longer want.

At first glance, as with the investment trusts, the arrangement seems little more than trickery - recycling a bank's own funds back into its own assets. As one senior industry expert described it: "It is like walking through a hall of mirrors in a fairground. There are far fewer people who really understand it than profess to understand it. Even the central bankers don't know where all the risk is ending up."

Sandy Chen, banks analyst at Panmure Gordon, is not convinced the arrangements are anything more than "clever accounting". He said: "In the case of leveraged loans, if the underlying company gets into difficulties and can't service the cash flow, then it's back to square one for the banks."

It's an opinion that the credit markets seem to reflect. Despite clear indications that this is how the banks intend to deal with their problems, credit default swaps - the clearest measure of perceived risk - have not narrowed.

But today's banks are far more sophisticated than the investment trusts of early last century. They claim their actions are an attempt to tackle capital shortfalls and liquidity risk. If they can reduce their credit risk in the process, that's an added bonus.

There have been two big public deals where the banks have provided funding for the purchase of the debt or sub-prime assets they own. UBS sold a $22bn portfolio of sub-prime assets to US fund manager BlackRock and a consortium of banks that financed last year's £9bn Alliance Boots merger offloaded £2bn of the debt to private equity.

Less publicly, bankers say "everyone is looking at this". Citigroup and Deutsche Bank are each believed to have off-loaded $10bn-$12bn of US leveraged loans in recent months, part-funding the purchase themselves. The same banks, as well as Merrill Lynch, have found buyers for tens of billions of dollars of their sub-prime debt, with similar funding arrangements.

The incentive for private equity is clear. The debt in the Alliance Boots case, for example, is being sold at 91 per cent of face value and the interest rate is being lowered. The UBS sub-prime sale is even more extreme. Having written the assets down to $15bn, BlackRock is enjoying a 32 per cent discount. If the debt or assets perform, there is a large potential upside.

The banks hope to benefit in four ways. The first is through capital relief. UBS may be providing $11.25bn of the $15bn BlackRock is paying for the sub-prime assets, but it does mean the Swiss bank is insured against the first $3.75bn of deterioration in the portfolio. With Alliance Boots, the banks are lending the private equity buyers just 80 per cent of the purchase price of the debt.

Because the banks can argue that this is a genuine transfer of risk, they can reduce the amount of capital the rules require them to set against the assets. UBS says that the move will provide 0.2-0.25 percentage points of capital relief - lifting its tier one ratio, a key measure of financial strength, above the current 10.5 per cent.

The second benefit for banks is asset diversification. In the case of Alliance Boots, debt in a retailer is transferred for debt in private equity - the buyers of the £2bn of loans being Apollo, Blackstone and TPG. As private equity is invested in a variety of sectors, its bonds are viewed as safer under the Basle II rules on capital adequacy. The result, again, is a reduction in capital required to be set aside.

The third benefit is the chance to rewrite loan covenants. Covenant-lite arrangements at the peak of the credit boom left banks carrying much more risk than would normally be accepted at very low prices. By reselling the debt, albeit at a discount, the banks have a chance to renegotiate covenants.

The fourth opportunity this provides banks is the chance to crystallise losses and draw a line under their sub-prime or leverage loan positions. By selling the assets, they set a firm market price to use when marking down the rest of their portfolios, providing some stability.

The point of it all is to "tidy up the balance sheet", as one banker explained. Banks desperately need to improve their capital positions, which can be achieved either through fundraisings or shrinking the balance sheet.

Funding the purchasers of their debt may make banks look like fiscal contortionists, but doing so also makes them appear stronger. As such, counterparties in the money markets will be more willing to accept their bonds as collateral for loans, improving the banks' liquidity profiles. Liquidity, or the lack of it, is what did for Bear Stearns and Northern Rock.

But questions remain as to whether these clever solutions are anything other than a short-term fix.

As Brendan Brown points out: "Creditors are far more attuned to how the rules work now, and will want to look at what the risks actually are in a bank. These actions are not going to do much to reduce the real problem: their credit exposure."

 

NYTimes on Lehman's battle with short seller

http://www.nytimes.com/2008/06/04/business/04lehman.html

Major rating agencies near deal on reforms-reports

June 4 (Reuters) - The three major credit rating agencies are near a settlement with New York Attorney General Andrew Cuomo to reform some of their core business practices, including how they collect fees, the Wall Street Journal and the New York Times said Wednesday, citing people familiar with the matter.

The Journal said an announcement of a settlement involving Moody's Corp's (MCO.N: Quote, Profile, Research) Moody's Investors Service, McGraw-Hill Cos' (MHP.N: Quote, Profile, Research) Standard & Poor's and Fimalac SA's (LBCP.PA: Quote, Profile, Research) Fitch Ratings could come this week. The Times, meanwhile said the talks may still fall apart.

Neither the rating agencies nor Cuomo's office immediately returned calls seeking comment.

A settlement could result in big changes for the roughly $5 billion-a-year credit rating industry, similar to changes to analyst research engineered by Cuomo's predecessor, Eliot Spitzer.

In 2002 and 2003, Spitzer pushed the financial services industry to separate analyst research from investment banking activity. This has resulted in stock research analysts becoming much more likely to assign hold and sell ratings. In the wake of the U.S. subprime mortgage crisis and ensuing global credit crunch, investors, regulators and politicians have criticized the agencies for failing to properly analyze securities backed by mortgages before assigning top ratings.

Agencies have been criticized for feeding the U.S. housing slump and credit market problems by long assigning high ratings to securities they should have known were risky, and then downgrading them quickly once the risks surfaced.

Under the proposed settlement, a rating agency will charge fees in stages for various analytical tasks, disclose every three months all transactions they were asked to rate and actually do rate, the Times said.

The agencies are also mulling a change to the way they charge fees for ratings, making it harder for investment banks to pit one agency against another in order to obtain better ratings, the Times said, citing people familiar with the matter.

In addition, the agencies will assist in Cuomo's broader probe into how Wall Street packaged mortgages into securities, in exchange for immunity from prosecution, the Times said.

The rating agencies will also establish new standards for how investment banks review mortgage loans, the Times added.

 

Is It Getting Personal at Lehman?

Barron’s

 

UP AND DOWN WALL STREET DAILY  

 

By RANDALL W. FORSYTH

The broker buys back shares when it was thought to be issuing equity. Recall the CEO's vow to "hurt the shorts."

Voltron says: “Bring it!”

IS IT BUSINESS OR IS IT PERSONAL? In The Godfather, the distinction was clear. On Wall Street, sometimes it isn't.

Tuesday evening, our sister site, WSJ.com, reported that Lehman Brothers Holdings (ticker: LEH) went into the market to buy its own shares -- less than 24 hours after the investment bank reportedly was mulling issuing $3 billion to $4 billion in common equity.

This would mark a turnabout bordering on the bizarre. One day, a company is in need of additional capital to shore up its balance sheet being rent by losses and writedowns. The very next day, this same company has a surfeit of capital that cannot be economically put to work, arguing for money to be returned to common shareholders. Or so finance textbooks would assert.

Can a corporation be under-capitalized one day and over-capitalized the next? Not likely. But perceptions about Lehman's financial strength continue to be in flux.

Rumors flew Tuesday that the broker had borrowed from the Federal Reserve, to avail itself of a privilege only recently expanded beyond commercial banks. "We did not access the Primary Dealer Facility," as the Fed's loan program to investment banks is called, Lehman's treasurer, Paolo Tonucci, said.

That reassurance helped to lift Lehman shares off their lows, from a loss as much as 15% Tuesday, to a decline of 9.5%, or 3.22, to 30.61, on massive turnover of over 133 million shares, more than four times. Still, over just the past three days, Lehman's stock has fallen 18%, bringing it to its lowest level since August 2003.

Buying in stock when its price is low makes sense on the surface, but not necessarily for a financial institution employing substantial leverage and dependent on access to financing a balance sheet with assets of uncertain value in a dicey market.

But there can be other motivations.

At Lehman's annual meeting in April, just a month after the deal for Bear Stearns to be taken over by JPMorgan was announced, CEO Richard Fuld declared: "I will hurt the shorts, and that is my goal." The shorts are traders who have borrowed Lehman shares and sold them short in the expectation of buying them back at a lower price.

There have been a vocal cadre of bears on Lehman. They contend it faces further writedowns of assets, notably those related to subprime mortgages, and has to raise additional equity as a result. Thus far, Lehman has shored up its capital by issuing $4 billion in equity and $6 billion in long-term debt.

According to veteran analyst Richard Bove at Ladenburg Thalman, Lehman also has attempted to make its balance sheet more liquid by shortening the maturity of its assets. He estimates Lehman has $34 billion in very liquid assets to protect against a run on the investment bank.

"What the company did not do, and is now attempting to do, is shrink the size of its balance sheet," Bove writes in a research note. "In the first quarter, Lehman actually ballooned its balance sheet to $786 billion from $691 billion. It did this to garner increased earnings by jumping volume on thin spreads. This is a classic maneuver by a financial company and is virtually always a mistake."

Now, however, Lehman is attempting to reverse course and shrink its balance sheet to maintain its credit ratings. "This, of course, compounds the first error," Bove continues. When the Street knows a firm needs to liquidate assets, it exacts a high price. That means Lehman likely will find it tough to sell off assets and will have to take losses, he says.

Bove estimates Lehman only broke even in the quarter ended May 31 owing to bad financial hedges. And that may prove too optimistic. The resulting possible losses could force the company to raise an additional $4 billion in equity, which would result in 15%-20% dilution.

"Lehman is in for a long, tough period ahead," Bove concludes. "It is making too many classic mistakes. What is shocking is that these mistakes are being made by people who should know better."

But if the CEO's avowed goal is to "hurt the shorts," it makes perfect sense to use scarce liquidity to buy back shares, even when prudence would suggest issuing equity.

Lehman buying back its shares -WSJ

Voltron says: Lehman is both buying and selling its own shares.  There is a word for that . . .  oh yeah: Manipulation!

 

SAN FRANCISCO, June 3 (Reuters) - Lehman Brothers Holdings Inc (LEH.N: Quote, Profile, Research) began using its capital to buy back its shares in the wake of its falling stock, the Wall Street Journal reported on Tuesday, citing a person familiar with the matter.

It was unclear how much stock Lehman bought, the Journal said.

Lehman may also look to sell a stake to a group of investors and has held talks in recent days with at least one foreign entity (Voltron says: the word on the street  is South Korea), the Journal reported, citing a source.

Lehman's stock closed Tuesday's session down 9.5 percent, or $3.22, at $30.61 on the New York Stock Exchange.

 

Lehman Can't Shake the Monkey

Portfolio.com

Tuesday June 3, 7:30 am ET

Lehman Brothers may blame its sinking stock price on short sellers and rumormongers, but it is facing its greatest challenge to date as it is about to report its first quarterly loss since going public in 1994.

The issue is credibility. The boasts about liquidity and the talk of transparency haven't dispelled the questions about Lehman's balance sheet and its huge portfolio of debt securities.

Now Susanne Craig of the Wall Street Journal reports that Lehman is considering raising billions of dollars in new capital—perhaps as much as $4 billion, according to analysts and Wall Street executives.

"The amount of new capital under consideration suggests Lehman's quarterly loss could be larger than the $300 million or so that some analysts have been expecting," Craig says.

Felix Salmon points out that Lehman's troubles this quarter are a result of brutal market conditions and because of the firm's difficulty in hedging their positions.

"We've seen this movie before, most memorably at Bear Stearns," Salmon says. "The fact is that during a credit crunch, when you're stuck with illiquid assets, you can't hedge them. You can sell them at a loss."

"Could it be that Lehman, even after seeing what happened at Bear, is making the same mistakes? That it's trying to hedge its positions discretely, even in a market which has systematically slaughtered anybody who's tried to do that for the past year?"

Still, Lehman, unlike Bear, has been aggressive in seeking out new capital, raising $6 billion since February. But a new effort suggests that the worst may not be over.

On Monday, Standard & Poor's lowered its ratings on debt from Lehman and other firms, saying that they are expected to announce additional write-downs on their investments. And Merrill Lynch analyst Guy Moszkowski lowered his rating on Lehman stock to "underperform" from "neutral."

Shares of Lehman dropped 8 percent, for a 48 percent decline so far this year.

"This is adding to the perception that there's a need for more write-offs and capital raisings," Greg Bundy, executive chairman of merger advisory firm InterFinancial Ltd. in Sydney and a former head of Merrill's Australian unit told Bloomberg News.

And there are other signs of investors doubting Lehman.

Ben Bittrolff on the Financial Ninja blog notes that the short position on Lehman, or a bet on a plunge in its stock, is now huge and will pay off only if the firm collapses.

"Either some idiots are going to be out a lot of money come June, July, and October," he says. "Or Lehman implodes before then."