Here is a copy of Bill Ackman’s latest letter on the monoline mess, dated January 30, 2008,  to the New York State Insurance Department.  AMBAC exposed to $11.61 BILLION losses; MBIA loss exposure $11.65 BILLION.  A “must read.”  →     ackman131ltr.pdf

PORT-AU-PRINCE, Haiti, Jan. 30, 2008

This is a big issue, and Moody’s tried to explain.  A municipal security apparently will then carry whichever rating is higher (its own or the monoline).

“If a security is wrapped by a financial guarantor, and has a published underlying rating that is higher than the guarantor’s rating, what is the Moody’s rating on the security?

A: The Moody’s rating is the higher of (i) the guarantor’s financial strength rating and (ii) any published underlying rating (i.e., absent consideration of the guaranty) on the security. For US municipal securities, we also consider any enhanced rating based on a state credit enhancement program. For structured finance securities, we also consider any published rating on a pari passu (i.e., at the same level of seniority) non-sequential tranche or more junior tranche of the same transaction.”  Read the entire Moody’s explanation on the Bond insurers/monolines page.

We all know the monolines (bond insurers) are a huge mess.  Although they insure massive amounts of debt, they themselves appear to lack the assets to honor those obligations. How best to fix this mess? 

Bill Ackman’s recent presentation is highly recommended reading.  It has an A to Z analysis of how the bond insurers do business, financial condition, and — go to page 134 of his analysis — a very cogent outline of how the scenario will play out.  Spoiler:  he says downgrades, bankruptcy, receivership.

Here it is:  howtosavethebondinsurers.pdf

You scratch my back; I’ll scratch yours.  The Securities & Exchange Commission has announced it is changing the rules for the banks’ reporting of bad/questionable debt instruments.  As Bloomberg reports, this amounts to letting banks out of certain arcane accounting rules with the result that they do not have to reflect the full extent of the damaged credit on their balance sheets:  http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_weil&sid=aPSScH5rRBLM  (more…)

Moody’s, whilst maintaining its high ratings of the monolines, issued a stern sounding almost Puritanical caution to the nations of the Arabian Gulf (Kuwait, Qatar,  Saudi Arabia, Bahrain, Oman, and UAE ). 

Moody’s is worried that these nations are making and spending so much money (driving inflation).  Moody’s issued Speccial Announcements on the Governments of the Arabian oil producing countries — implying that if they keep on their path of making and spending lots of money, their national credit rating will be scrutinized and may be downgraded.  And this is at the very same time that the U.S. is deep into deficit spending.  Hmmm.

Excerpt: ”Gulf States’ Spending Hikes Could Have Future Ratings Impact”

 ”Moody’s acknowledges that, over the short to medium-term, the robust creditworthiness of GCC governments is unlikely to be undermined by strong spending growth. This is because oil prices remain at historically high levels, generally wide fiscal surpluses are being maintained despite spending increases, and GCC governments have accumulated large cushions of net assets with which to meet potential future liabilities.”

“However, there could be longer-term adverse implications: the danger is that governments will find themselves dependent on ever higher oil prices to balance their budgets, making it more difficult for them to adjust in the event of a downturn in revenues. Large increases in current expenditure are of particular concern as they are more difficult to reverse than hikes in capital spending in the event of a potential downturn in revenues.” 

Does anyone else think this is a funny way for Moody’s to be spending its time nowadays?

Today IMF released its latest report on global financial markets (well worth a read - see link).  Financial markets have worsened as evidenced by pressure on bank balance sheets, and problems will broaden as credit deterioration widens.  IMF recommends transnational stabilization efforts.  Direct link to report:

    imf01292008.pdf

The median price of existing homes in the U.S. dropped by 1.8% during 2007.  This is the first time it has declined in the 40 years data has been kept and likely ever since the Great Depression of the 1930s.  See NAR table of cities: msapricesf.pdf

Dec. 2007 data:  http://bp1.blogger.com/_ym8Q9yxUg34/R5i9pD2bdCI/AAAAAAAAB7c/67o8VtsVV34/s1600-h/ehs1207rollup.JPG

Click  to Bloomberg: http://bloomberg.com/apps/news?pid=20601087&sid=aDBJGL77XCI0&refer=home

HUD is offering at least 120 houses in Cleveland for sale at $1 each.  I don’t think fiscal stimulus will fix this, but it does help to answer the question of how low can home prices really go.

http://blog.cleveland.com/metro/2008/01/the_foreclosure_crisis_what_it.html

Interested in a glimpse of things to come?  Cleveland’s housing bust started early - read here Mother Jones’ “Prime Suspect” — a compelling description of life in Cleveland’s Slavic Village area was already like in 2006.  This may be what neighborhoods all over the U.S. will be like as housing prices decline:  http://www.motherjones.com/news/feature/2006/09/prime_suspect.html

Satyajit Das opines that the tools available to central banks are inadequate to address the scope of the global economic problems we face.  The black box or shadow economy may involve the unwinding of “innovative” financial products/derivatives such that monetary and fiscal policy simply will not work this time. 

http://www.boston.com/bostonglobe/ideas/articles/2008/01/27/the_black_box_economy/

Clayton Holdings, the largest provider of due diligence review of mortgages for the major mortgage bankers, has been given immunity by NY Attorney General Cuomo.  It appears from this news that the mortgage bankers wanted the due diligence reviews to find fewer “lending exceptions” in the subprime loans than actually existed.  It is suggested that the actual figure is 50%-80% of the loans had lending exceptions.  The due diligence reviews may have been limited to small numbers of loans within the portfolios, so that when the loans were bundled and securitized they would appear to be higher quality credits than they actually were. 

This is interesting for a number of reasons, including the question of the rating agencies’ culpability and the monolines’ liability.  Read the NY Times  story here: (more…)

Way back when he was “just” a Fed Governor, in 2002, Bernanke gave an amazing speech detailing what he would do to prevent or cure deflation.  I read him as saying that he doesn’t think the U.S. will go into deflation because our financial system (banks and household balance sheets) are so healthy (forget that now!).  The other reason he gives is that the Federal Reserve can itself prevent or cure deflation.  Bernanke gives a list of the steps he would take — and it looks as if he’s already several steps down on the list with the TAF auctions.  But never fear, as a bottom line Bernanke thinks we should all be comforted by the fact that if all else fails, he’s got a printing press (oops, a copy machine) to print lots of dollar bills and reinflate the economy. 

It’s true, and worth another close read: 

http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/#f8

Government intervention in the stock market is one of those well-known-yet-unacknowledged facts.  Check this Washington Post piece from 10 years ago and then, below, the New York Post in Jan. 2008. 

Plunge Protection Team 

By Brett D. Fromson
Washington Post Staff Writer
Sunday, February 23, 1997; Page H01
The Washington Post

It is 2 o’clock on a hypothetical Monday afternoon, and the Dow Jones industrial average has plummeted 664 points, on top of a 847-point slide the previous week.

The chairman of the New York Stock Exchange has called the White House chief of staff and asked permission to close the world’s most important stock market. By law, only the president can authorize a shutdown of U.S. financial markets.

In the Oval Office, the president confers with the members of his Working Group on Financial Markets — the secretary of the treasury and the chairmen of the Federal Reserve Board, the Securities and Exchange Commission and the Commodity Futures Trading Commission. (more…)

This 2005 report details government manipulation of the financial markets.  Read full text here (it’s well-worth the time):

thevisiblehand.pdf

From Goode Value Investing  http://www.goodevalue.com/2008/01/22/bill-ackmans-letter-to-rating-agencies-regarding-bond-insurers/:  Bill Ackman is apparently asking the ratings companies the questions we all want answered.  It’s an excellent letter with a concise explanation of the facts, and the consequences of the facts.  The letter observes it is unlikely that MBIA, Ambac and other insurers will be able to continue as going concerns. Finally, the letter asks the ultimate question:  When the rating companies look at themselves in the mirror, how can they possibly say that MBIA and others deserve their highest (Triple A) rating? 

Here is text of the letter: 
January 18, 2008

Mr. Raymond McDaniel Mr. Stephen Joynt
Executive Chairman and CEO CEO and President
Moody’s Corp. Fitch Ratings
99 Church St. One State Street Plaza
New York, NY 10007 New York, NY 10004

Mr. Deven Sharma
President
Standard & Poor’s
55 Water Street
New York, NY 10041

Re: Bond Insurer Ratings

Ladies and Gentlemen:

As a Nationally Recognized Statistical Rating Organization, Moody’s, S&P, and Fitch
have been granted a level of authority that capital market participants and Federal and
State regulators have historically relied upon in evaluating the safety and soundness of
corporations, regulated financial institutions, and structured finance securities. To state
the obvious, because of your critical role in the capital markets, it is essential that the
ratings you publish are the result of comprehensive and accurate analysis.

(more…)

It’s no secret anymore that the monolines really don’t have the wherewithal to properly “insure” credit derivatives such as CDOs.  And the first hand evidence is piling in that the monolines apparently knew all along what they were doing — and kept right on “insuring” CDOs and other junky derivatives.  Why?  Profit, of course.  Where did all that money go?  Wherever it went, it’s high time for someone to go and get it back. 

My idea:  let the ratings companies (Fitch, Standard & Poors, et al.) who bestowed AAA ratings to this mess.  Perhaps they should disgorge all the revenue they collected as a result.  Seems as if they were unjustly enriched at the expense of …. all of us?

So - who spilled the beans?  Well, for one, former ACA Capital honcho (now literally put out to pasture?) as quoted at length in Bloomberg:

“Municipal bond insurers such as MBIA Inc. and Ambac Financial Group Inc. had a good thing going.  For years, they earned some of the highest profit margins in any industry — by writing coverage for securities sold by states and cities to build roads, schools and firehouses. 

(more…)

As we try and get our arms around the ultimate scope and outcome of whatever deleveraging is underway, here is a  ISDA generated document showing the notional amounts outstanding of derivative transactions (note that they’ve already adjusted these figures to avoid double-counting) beginning in 1997: 

 isda-market-survey-historical-data.pdf

 In ISDA’s 2007 survey of collateral, they found that 59% of derivative transactions were secured by collateral agreements, and that 59% of mark-to-market credit exposures were covered by collateral agreements. 

This is the nightmare scenario:  pension funds invested in CDOs and/or other derivatives are swamped by the massive unwinding process underway.   Where then does the money come from to pay retirees? 

This great unwinding has potential consequences not only for U.S. pensioners, but certainly the U.K. and possibly beyond.  Here is a terrific and concise explanation of the relationship between CDO downgrades and U.K. pension funds by Ken Griffin and Jeff Moskowitz: (more…)

It’s bad indeed when Wall Street calls its lawyers in hopeless tears.  What is the lawyer supposed to do about it?  And from the lawyer’s point of view, who’s going to pay for the call?

From NY Post:
 
“January 20, 2008 — Pink slips began in earnest on Wall Street last week - moving grown men to tears and headhunters’ phones ringing off the hook.The worst fourth quarter in Wall Street history, which has wiped out billions of dollars in market capitalization and sent the markets into a tailspin, is now costing folks their jobs.

“In all my years in financial services, I have never seen it this bad,” one high-powered securities industry lawyer told The Post. “I have owners of small firms calling me up saying their liabilities now exceed their assets, which means by law they are required to close down.” (more…)

How would you like to be an employee of a monoline, and being required to invest your 401(k) in company stock?  Apparently that’s exactly what MBIA required its employees to do — and now they are suing in an ERISA class action:

http://www.primenewswire.com/ca/news.html?d=134191

The same issue exists for the subprime lenders.  Are they requiring their employees to invest their retirement funds in company stock (while the company officers and directors dump the stock)?  Here is one example of a retiree of Freemont alleging just that in a recent (and still pending) lawsuit: (more…)

(more…)

* Chinese bank earnings will suffer because of subprime crisis and tighter monetary policy and macro-economic controls

(more…)

Update:  What About the Munis?  → good article:   http://wallstreetexaminer.com/blogs/winter/?p=1348

Is the current credit crisis and resulting loss of asset valuation having an impact on pensions and healthcare benefits?

Yes - see two preliminary reports below.

pew.pdf     ← The Pew Center on the States released a report in December 2007 highlighting the perilous footing of  the states’ funding of their long-term retiree benefits (both pension and nonpension).  Click through to full report.  

(more…)

Milton Friedman died in 2006.  If he were living, what would he say about the current economic situation?

It may be instructive to review what he said about the dot.com bubble in 2000.  Friedman believed that in the event of an equities bubble burst, the Federal Reserve should pour in money to cushion the economy - but not indefinitely.  For example, using the Great Depression as an example, when the bubble burst in 1929, from peak to trough, the equities market lost about 80% of its value over about 3 years.  Friedman believed that had the Federal Reserve followed “correct” policy, the market would have bottomed sooner and not fallen so far.  Friedman was quick to point out that precisely how much and how long to “pour money in” is tricky to figure out, and that the Fed should not pour money in for so long that it creates another bubble. 

Here is part of the transcript from a Hoover Institution (by Peter Robinson) interview with Milton Friedman recorded March 10, 2000:

(more…)

(more…)

comptroller.pdf 

The Honorable David M. Walker, Comptroller General of the United States, has been loud and clear in warning Congress, the administration, academia, and the public that the US economic situation requires urgent and radical measures.  “The status quo is not an option.”   (more…)

Robert A. Kezelis in Capitol Hill Blue 

Tax breaks? No, no, no! a thousand times, NO!

(more…)

Monolines are in deep trouble.  That’s not news -  well-covered by FT Alphaville, Calculated Risk, Reggie Middleton, and Mish’s. 

 FT Alphaville notes today:

In a credit note sent out to clients on Friday, RBS started to outline what it thought was on the horizon for the monolines: (more…)

http://www.huffingtonpost.com/linda-keenan/bernankes-message-to-ame_b_82160.html

The risks of CDO meltdowns have been well-recognized for at least the last decade.  CDOs are necessarily dependent on the underlying collateral portfolio because CDOs necessarily separate the performance of the issuing bank from the performance of the issued notes.  The inherent risks of CDO nonperformance have long been known and discussed.  In her November, 1998 analysis, Karen Spinner gives an exceptionally cogent listing and explanation of these risks.  For example, Model Risk dictates that the investor consider the possibility that the rating agency’s models “may not bee 100% accurate.”  Liquidity Risk means that it is hard for an issuer to unwind a closed CDO structure. 

Her excellent piece is entitled “CDOs Under Fire - What will happen to CDOs if credit fears paralyze financial markets?”.  Too bad more institutional investors and other players apparently did not pay enough attention here.  Apparently the credit fears have now virtually paralyzed the financial markets and we’ll have to observe the actual consequences to these derivative instruments. 

Link to Spinner piece here:

http://www.derivativesstrategy.com/magazine/archive/1998/1198fea1.asp

   Panic selling shuts £2bn fund

· Scottish Equitable acts after slump
· Fears that other funds are at risk

Friday January 18 2008   

The fund, invested in London office blocks and shopping centres across Britain, apparently no longer has sufficient cash reserves to meet demands from investors. Photograph: Martin Argles

One of Britain’s biggest property funds was forced to shut its doors to withdrawals yesterday after the slump in commercial prices triggered panic selling by small investors.

The move prompted fears of a Northern Rock-style run on billions of pounds invested in once high-flying funds which many savers have seen as a safe haven for their pensions.

Scottish Equitable said yesterday that 129,000 small investors in its £2bn property fund will not be able to access their money for up to a year, although payments relating to regular income already being paid, retirements and death claims will not be affected.

It said the fund, invested in London office blocks and shopping centres across Britain, no longer had sufficient cash reserves to meet demands from investors wanting to withdraw their money. Its “buffer fund” was down to 1% of its total assets, instead of the usual 10-15%.

Commercial property values, especially in the City of London office market, have dived amid fears of a recession brought on by the global credit crunch.

In late December another insurer, Friends Provident, halted access to its £1.2bn property fund and last night speculation was growing that Scottish Widows may be on the verge of restricting customer withdrawals on some of its funds. The insurer said last night: “We are looking at all the options, but no decisions have been taken.”

Scottish Equitable’s parent group, Aegon UK, is due to announce the closure of its fund today. It said last night: “Aegon UK has decided to take this step to protect investors following a significant level of customer withdrawals from the UK property fund market.” It blamed “worldwide phenomena relating to concerns over the US sub-prime mortgage market fallout, rising interest rates and talk of recession”.

The Financial Services Authority said it was closely monitoring the situation and had been informed by Aegon of the decision to halt withdrawals.

The crisis in Britain’s commercial property market is now worse than at any time since the early 1990s, when Olympia & York, the company that began the Canary Wharf office development in London, went into administration.

The credit crunch has raised borrowing costs, making many property deals no longer attractive. Financial institutions hit by the fallout are already beginning to cut staff, reducing demand in the City office market in which most of the UK’s property funds are invested. A downturn in consumer spending growth is also making retail shopping developments less attractive to investors.

Small investors have put about £15bn into property unit trusts - £5bn pouring in during 2006 and early 2007 alone. Billions more are invested through pension funds held by millions of company employees. Investors bought into promises of rich returns after a decade in which returns far outstripped gains on shares or bonds.

But the downturn in values since the middle of 2007 has been savage. Shares in British Land, the UK’s leading property company, have fallen by nearly half, and most funds are showing falls of between 20% and 40%. But investors stampeding for the exit are now finding that they cannot access their cash.

The crux of the problem is that the funds are invested in buildings which can take months to sell, and therefore cannot produce the cash to pay out money to small investors if they all want it back at the same time.

Usually the funds hold a cash “buffer” of 10-15% of total assets to meet withdrawals. But Scottish Equitable said yesterday that the cash buffer in the £2bn fund had fallen to just £80m following a wave of redemptions, giving it little choice but to suspend the fund. The only alternative was a “fire sale” of its holdings which could leave investors even worse off.

It emerged yesterday that staff at some of the property managers have been informing key clients in advance that a fund is heading for suspension. The FSA said that such trading may fall foul of its rules regarding treating customers fairly.

Financial advisers continue to recommend that investors take their cash out of the funds that remain open. Jason Hemmings of Albannach Financial Management in Edinburgh said: “There are lots of rumours going about that other providers may be considering following Friends Provident and Aegon.”

The Aegon/Scottish Equitable property funds are managed by Morley Fund Management, which also runs the £4bn Norwich Union Property unit trust, the UK’s biggest property fund. This week Norwich Union said the fund had fallen in value by a fifth over the year, but its cash buffer was at 6.4% after selling office blocks in London and Manchester worth £165m.

Aegon UK added that it believes the “underlying fundamentals of the asset class remain healthy”.

A bit of comic relief during a rather nasty day of economic news

Mainstream media reporting via Steven Pearlstein in “Caught in Downdraft and Starting to Panic” (Washington Post) -  we’ve moved through the various stages of economic grief and moved into panic mode?  Hattip Reggie Middleton

• Willful blindness. (“Bubble, what bubble?”)
• Denial. (“House prices never fall. It’s only those speculators in Las Vegas and the Gulf Coast.”)
• Rationalization. (“Maybe subprime did get out of hand, but it’s really a small part of the market.”)
• Fantasy. (“Things should be pretty much back to normal by the second half of ‘08.”)
• Anger. (“If it weren’t for those yahoos up in structured finance…”)
• Capitulation. (“We might as well take these write-downs now and get it over with.”)
• Depression. (“This is going to get worse before it gets better.”)

and then….PANIC..culminating in unraveling of CDO situation.

My comment:  Never fear:  According to CNBC, this is all simply a self-fulfilling prophesy, not reality-based — and all we need is another Wall Street “innovation” like a new kind of CDO! 

Minsky was an economist at the Levy Economics Institute and perhaps the most famous economist on credit crunches.  Here, the Institute argues that the current crisis differs from the traditional “Minsky Moment” and explains the reasons why it is different this time around.  Agree or disagree? 

The Minsky Moment

Satyajitt Das’s blog has an article of interest on the current movement in U.S. of privatizing gains and socializing losses.  In good times, Wall Street embraces capitalism, but when the tide turns, the Street flips and chooses socialism every time.

Das is a derivatives expert (maybe THE derivatives expert) and author of “Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives” (2006) — a must read.

http://www.wilmott.com/blogs/satyajitdas/index.cfm/2008/1/15/Socialism-for-Wall-Street

Watching this testimony live, without benefit of transcript, Bernanke incredibly is saying there will NOT be a recession!  Forecasting slower growth picking up in late 2008.  Some decent questions from Congresspeople re: why would a rebate actually improve economy?  Shift from pro-savings economy to pro-debt, etc.

Comments? 

Why is Bernanke talking so optimistically (yet looking terrible)?

What will Congress do on fiscal side?

Will Bernanke lower rates on 1/30 and if so why?

Cheers!

Hat tip Liz!

The Return of Negative Equity as House Prices Fall Again? « Stop Repossession Org UK