28JAN09:
Q1-09 DOW: 8900
Q2-09 DOW: 7250
Q3-09 DOW: 5810
Q4-09 DOW: 3960
CITI NATIONALIZED
OBAMA GETS SICK 27AUG09:
Mini Crash 21SEP09 Predicted correctly:
Bailout=Bonuses
Demise of Bear Stearns
Demise of Lehman Bros.
Demise of AIG
Subprime would cause problems
Date of 2007 crash
CRAs were to blame
G20 riots were a party
Northern Rock run
Northern Rock Nationalization
HBOS and RBS demise
UBS really was Useless
This is the new order thanks to the wild man with the beard. Back room boy Bernanke has really shown us how to calm the markets. We thought these sort of draconian measures were only ever undertaken in times of serious threats to the world economy like LTCM blowing up and after 9/11? So we have a few boys and girls complaining the commercial paper market is dead, a ranting Jim Cramer, and some debt-junky's complaining and suddenly a quick freebie of crack cocaine is handed out to ease the nerves until the next fix becomes due. Roller coasters are for kids, not economists.
Sentinel goes into Chapter 11 - Questions are posed that Citadel bought their assets cheaply.
Why are German banks so useless? Another one is saved - Sachsen LB.
Prime Brokerage is a big boys game - Lehman and Bear Stearns lose clients.
Hedge Funds are being squeezed by Lenders and Investors.
Jim "Bernanke's Boy" Cramer to stand as president.
New to the Job, Bernanke's About-Face Is Weighed (nytimes) For the last month, the stock market has gyrated as every other day seemed to bring more bad news about the housing and credit markets. Traders awaited a signal from the Federal Reserve and its chairman, Ben S. Bernanke, now in his sophomore year at the helm of the central bank.
Fed chief Ben Bernanke and his colleagues cut the discount rate as turmoil in the markets grew.
On Aug. 7, Wall Street got its first answer. The Fed said in a statement that it was watching the housing meltdown with concern, but that it believed the broader economy was on a steady path of growth. The words did nothing to calm the markets.
Ten days later, the Fed significantly changed its tone. In an extraordinary action between board meetings, the Fed lowered one of the two interest rates it controls and issued a statement expressing concern about the markets and the possibility of a downturn in the economy.
The hand of Mr. Bernanke was clearly behind both statements, and some economists and traders shook their heads at the apparent flip-flop. But Mr. Bernanke, a student if not necessarily a devotee of the British economist John Maynard Keynes, was probably mindful of a remark by Keynes after he was accused of reversing his views on government intervention in markets during the Great Depression.
“When the facts change, I change my mind,” Keynes said. “What do you do, sir?”
Mr. Bernanke, grappling with his first crisis since taking over as Fed chairman in February 2006, is being intently watched to see how he handles the reins of the economy. Some accused him of dawdling and then acting with an excess of caution (“Bernanke's baby steps” was the headline of a Merrill Lynch analysis published Friday).
David A. Rosenberg, North American economist at Merrill Lynch, wrote that the Fed noted that the risks to the broader economy had increased “appreciably.” If that is the case, Mr. Rosenberg asked, why are Mr. Bernanke and his colleagues not acting more boldly?
“It does indeed leave one wondering why the Fed didn't bite the bullet and get more aggressive today by cutting the funds rate outright if the Fed has altered its risk assessment over the economic outlook that much,” Mr. Rosenberg wrote.
Others saw Mr. Bernanke as handling the upheaval with aplomb.
“The way he has handled this is completely in character,” said Mark Gertler, chairman of the economics department at Columbia University and a longtime colleague of Mr. Bernanke's. “What's going on is in many ways a textbook financial disturbance and nobody I know understands these things better than he does.”
Mr. Gertler endorsed both Mr. Bernanke's early restraint in dealing with the crisis and his recent moves to address it. That said, he added that Mr. Bernanke, the markets and the economy are still in peril. “It's a tightrope and they're still up there on the tightrope,” Mr. Gertler said.
Although a Republican who served briefly on President Bush's White House economic team, Mr. Bernanke has shown himself to be no laissez-faire ideologue or partisan gunslinger.
A fellow member of the Fed's board of governors, speaking on background, called Mr. Bernanke “a technocrat of the highest order,” which he meant as the ultimate praise. He said that one of the missions that Mr. Bernanke has set for himself is to end the cult of personality that grew up around Alan Greenspan, who preceded him and served as chairman for 17 years.
In that he appears to have succeeded. He and his wife, Anna, a public high school teacher in Washington, lead a low-key private life, in contrast to Mr. Greenspan and his wife, the television correspondent Andrea Mitchell, who for years have been fixtures on the Washington social circuit.
Mr. Bernanke came to government from one of the tallest spires of the ivory tower, the chairmanship of Princeton's economics department. He earned his doctorate at the Massachusetts Institute of Technology, where his adviser was Stanley Fischer, now the governor of the Bank of Israel and the former No. 2 at the World Bank.
But to understand Mr. Bernanke's worldview, one must go back to his hometown, Dillon, S.C., which sits athwart Interstate 95 about halfway between North Jersey and South Florida. Dillon is known as the home of South of the Border, the Tijuana-themed tourist stop and a Mecca of American roadside kitsch.
Mr. Bernanke, 53, grew up in Dillon in the 1950s and '60s, the son of the local pharmacist and a member of one of the few Jewish families in the largely agricultural region. He says his home was the only kosher household in a 50-mile radius. His mother had meat delivered from a butcher in Charlotte, N.C., where his parents live now.
Being a member of a minority taught him about discrimination and prejudice. “There was more than one request to see my horns,” he said years later.
He also watched the struggles of small farmers, who drove mule-drawn carts down the main street of town and had trouble paying their bills even in good years. His father granted credit for purchases at the drugstore, keeping records on small cards he kept in a drawer. Many of the debts were never repaid. As Mr. Bernanke grew older, the textile mills that had supported the area closed and moved overseas in search of cheap labor.
Mr. Bernanke worked construction jobs and waited on tables at South of the Border during the summer while an undergraduate at Harvard University.
“I was impressed by these experiences,” Mr. Bernanke said last fall at a ceremony in his honor on the steps of the neoclassical courthouse in Dillon, “and I think they were an important reason I went into economics, which a great economist once called the study of people in the ordinary business of life.” He has written extensively about the Great Depression and the policy blunders made by the Federal Reserve that spread the distress. Asked to explain his fascination with the Depression he said, “If you want to understand geology, study earthquakes. If you want to understand the economy, study the Depression.”
Ed Yardeni, president of Yardeni Research, said that Mr. Bernanke's studies of the Depression and other financial catastrophes have taught him that the Fed's role is not only to keep inflation in check, but also to deal with upheavals in the markets.
But Mr. Yardeni said Mr. Bernanke might have misread the market's signals and acted too timidly at first. He said the Aug. 7 statement gave too rosy an outlook. “That's really where there was a credibility issue,” he said. “At that point, most observers had already come to the conclusion that things were coming unglued pretty rapidly and the Fed had to act.”
Mr. Bernanke's compassion for the common man has not made him a populist or a protectionist, nor even a Democrat. His study of economics has led him to believe that free markets and unfettered trade offer the greatest opportunity for the greatest number of people. But in a speech on growing income inequality earlier this year, he endorsed programs to provide job retraining for displaced workers and new laws to improve the portability of health and pension benefits between employers.
As central banker of the world's largest economy, Mr. Bernanke's freedom of speech is circumscribed by custom and by the magnified effect his words have on global markets. He will not talk about the value of the dollar or future interest rate decisions or specific tax or budget measures. Less than three months into the job, Mr. Bernanke stubbed his toe by casually telling CNBC that Wall Street had misread the Fed's signals, touching off a market frenzy.
Mr. Bernanke now refers to his first few months as a “break-in period,” and has been much more circumspect in his remarks since.
Still, it is possible to discern something of his roots and inclinations from his speeches and Congressional testimony. In a speech last fall in Washington, he expressed worry that the short-sightedness of the current generation will weaken Social Security and Medicare for their children and grandchildren.
In a commencement address at M.I.T., he delivered a rather dry lecture on the relationship between technological change and productivity growth. But he also told graduates “the world has more to offer than money” and encouraged them to pursue offbeat careers, charitable work and public service jobs.
In June, in remarks on the troubles in the housing and subprime lending markets, Mr. Bernanke voiced sympathy for homeowners who had been foreclosed or unable to obtain new loans. He said that it was difficult to predict how widely the problem would spread, but expressed confidence in the underlying economy.
“At this point,” he said on June 5, “the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system.” The Fed held to that position, publicly at least, for two more months.
Kenneth R. Manning, a professor of the history of science at M.I.T. who graduated from high school in Dillon four years before Mr. Bernanke, predicted that his friend would excel as Fed chairman, in part because he has not forgotten where he came from.
“A lot of times, you have good theorists in economics but they don't have a feel for the world, they don't have a feel for politics,” Professor Manning said. “He has that.”
Mr. Bernanke's mother Edna recalled the tribute to her son last autumn with a bit of embarrassment. “They put up a huge tent and they had about 500 people there and the governor came,” she said in a phone interview. “I think they were just excited that someone from Dillon went somewhere.”
Fintag says Well that makes me feel much better. Still I may lump Bernanke into the same bucket of useless arrogant financiers like Jimmy "Scratch" Cayne and his team of never there SMDs, but day traders and spread betters haven't had so much fun since the turn of the century.
Bernanke may think he knows why the great depression was so badly handled but this time is very different. Firstly, we do things much faster and secondly risk is much more diversified and complex. However, despite what your average quant would say, the markets are run on a gas called sentiment and sometimes this doesn't act very rationally.
Fed action spurs Asia stocks rally (ft) Shares in Asia-Pacific rebounded sharply on Monday, posting some of their biggest one-day gains this year as the Federal Reserve's half-percentage-point cut in the US discount rate on Friday soothed last week's fears of a US-led slowdown affecting the region.
South Korea rallied by more than 5 per cent while Singapore, Malaysia, Taiwan and Indonesia rose by more than 4 per cent during morning trading.
Japanese shares rose too as the yen pulled back sharply, with the Nikkei 225 soaring 3.7 per cent to 15,836.57 by midday. Late morning in Tokyo the dollar was worth Y114.4, compared with Friday's low of Y111.6.
“Today there's a huge sense of relief in equity markets,” said a senior trader in Singapore. “The rally may even extend for a few more days. But it may take a couple of months before we're back to normal conditions.” The Fed's loosening was welcome, he said, but added that when markets and economic conditions were this uncertain, “you don't solve things in a few days.”
Fintag says Sometimes it is pointless watching what the Asian or European markets do. Whatever the US does, Asia just follows. When the European markets open, they don't actually do anything until the US markets open at the end of the day when they follow the opening bell.
So what happens this week? Well it will be jittery, that is for sure.
Prime brokers have seen a flight to quality by hedge fund clients, who have transferred up to $50bn (€37bn) of assets from higher-risk banks to the prime brokerage operations of commercial banks with bigger balance sheets and better credit ratings.
The transfer of business in the past two weeks, which according to prime brokers and hedge funds has hit Bear Stearns and Lehman Brothers, marks the start of a shake-out in the lucrative and competitive prime broking industry.
This is dominated globally by Morgan Stanley, Goldman Sachs and Bear Stearns and accounts for an estimated 15% to 20% of revenues for investment banks, according to a survey by Dresdner Kleinwort.
Recent turmoil has alerted hedge fund managers to the credit and counterparty risk of their banks. The $3bn US firm Sowood Capital collapsed last month because it failed to meet bankers' rising margin calls, held as collateral against loans it had taken out to finance trading positions.
While hedge funds have not started to sack their prime brokers, many have transferred some of their balances. Bear Stearns, which in June reported heavy losses in two of its hedge funds exposed to sub-prime mortgages, has seen the largest net outflows of assets held as collateral for loans, according to rival bankers. Bankers said Lehman Brothers had also seen net outflows, although it has also won business. The bank declined to comment.
A spokesman for Bear Stearns said: “Given the market environment there are a lot of flows both ways. We are also getting new business and balances are up year on year.” At the end of June, Bear Stearns reported $326bn of equity in client accounts for its global clearing services, most of which had been deposited by hedge funds using the bank as their prime broker.
The main beneficiaries have been commercial banks including Deutsche Bank, UBS and Citi - counterparties with significantly bigger balance sheets and better ratings, according to hedge fund managers. These banks have invested heavily for four years to win market share from the top three prime brokers, but until now have mainly been restricted to winning business from new hedge fund managers.
One indicator of a bank's credit worthiness is the cost of insuring its debt against default in the credit default swap market. Between last Monday and Thursday, that risk rose to a 52-week high for almost all US investment banks.
The biggest spread widening was on Lehman's debt, where credit default swap spreads rose 50% to 182 basis points, meaning it costs $182,000 to insure $10m of debt over five years. The Lehman figure compares with a 44% widening on Bear Stearns' debt to 197 basis points.
Credit default swap spreads on Goldman Sachs increased 22% to 93 basis points. Two hedge fund managers said they had been concerned, as counterparties, to see Goldman tie up $2bn of its $10bn most liquid assets by investing last week in a hedge fund run by Goldman Sachs Asset Management. Goldman declined to comment.
Clients have moved to commercial banks in search of lower financing costs. The higher credit rating of these banks means they have greater access to cheaper credit, from which their clients expect to benefit.
Fintag says Given the big boys are very picky about who to take on, I doubt the transfer will be as quick as this article says. Prime Brokers are chosen for many reasons including access to decent shorts and this maybe the real reason as shorts are in hot demand.
EBAY
Sentinel Sold to Citadel Too Cheaply, Customers Say (bloomberg) Money market funds were invented 37 years ago to offer investors better returns than bank savings accounts while providing a high degree of safety. Most of the $2.5 trillion sitting in these funds is invested in such assets as U.S. Treasury bills, certificates of deposit and short-term commercial debt.
Unlike bank accounts, money market funds aren't insured by the federal government. They almost never fail.
Unbeknownst to most investors, some of the largest money market funds today are putting part of their cash into one of the riskiest debt investments in the world: collateralized debt obligations backed by subprime mortgage loans.
CDOs are packages of bonds and loans, and almost half of all CDOs sold in the U.S. in 2006 contained subprime debt, according to a March report by Moody's Investors Service.
U.S. money market funds run by Bank of America Corp., Credit Suisse Group, Fidelity Investments and Morgan Stanley held more than $6 billion of CDOs with subprime debt in June, according to fund managers and filings with the U.S. Securities and Exchange Commission. Money market funds with total assets of $300 billion have invested in subprime debt this year.
The danger of owning even highly rated CDOs containing subprime loans was thrown into sharp relief in June, when two Bear Stearns Cos. hedge funds that were holding subprime CDOs collapsed.
Bear Stearns Manager
At the center of that storm was Ralph Cioffi, a senior managing director at Bear Stearns who ran the hedge funds. Cioffi, 51, wore another, less publicized hat. He managed more than $13 billion of CDOs, according to Fitch Ratings -- and money market funds and other investors bought all of it.
Cioffi-managed CDOs filled with subprime debt have been purchased by money market funds run by Invesco Plc's AIM Investment Service, Marsh & McLennan Cos.' Putnam Investments and Wells Fargo & Co.
In August, New York-based Bear Stearns fired Warren Spector, the firm's co-president for fixed income and asset management. Cioffi stayed with the bank. Bear Stearns spokesman Russell Sherman says Cioffi's stewardship of the bank's CDOs ended in late June.
``There is a team of portfolio managers running them now,'' Sherman says. ``Ralph still serves as an adviser.'' Cioffi didn't respond to telephone and e-mail requests for comment.
Under SEC rules, money market managers must invest in securities with ``minimal credit risks.'' Joseph Mason, a finance professor at Drexel University in Philadelphia and a former economist at the U.S. Treasury Department, says subprime debt in money market funds is far from safe.
`Tremendous Risk'
``This creates tremendous risk for today's money market investors,'' says Mason, who wrote an 84-page report on CDOs this year. ``Right now, I'm not comfortable investing anything in CDOs.''
Global financial markets were rocked in July and August, first by the collapse of the Bear Stearns hedge funds and then when banks and insurance companies worldwide disclosed their U.S. subprime debt holdings.
On Aug. 9, BNP Paribas SA, France's biggest bank by market value, froze withdrawals on three investment funds with assets of 2 billion euros because the bank couldn't find a way to value its U.S. subprime bonds and other assets. CDOs aren't bought and sold on exchanges and their trading has little transparency.
During the first two weeks in August, central banks in Europe, Japan and Australia and the U.S. Federal Reserve lent more than $300 billion to banks to stem a collapse in credit markets.
On Friday, the Federal Reserve lowered the interest rate it charges to banks to 5.75 percent from 6.25 percent in an attempt to contain the subprime mortgage collapse.
`It's Inappropriate'
Money market funds have become a staple for investors. There are 38.4 million money market fund accounts in the U.S., according to the Investment Company Institute.
People use a money market both to hold savings and serve as an account to buy securities and place the proceeds of sales. Bruce Bent, who in 1970 created the first money market fund, The Reserve Fund, says no money market fund should invest in subprime debt.
``It's inappropriate,'' Bent, 70, says. ``It doesn't have a place in money market funds. When I created the first money market fund, I said you have to have immediate liquidity, safety and a reasonable rate of return. You also have to have a situation where you're not giving people headline risk.''
Seeking Safety
Investors have sought safety during the subprime meltdown by moving their holdings to U.S. Treasuries and money market funds. On Aug. 8, just after the Bear Stearns hedge funds filed for bankruptcy protection, U.S. money market fund total assets reached a record high of $2.66 trillion, with investors pouring $49 billion into such funds in one week, according to the ICI.
As a sign of stability, money market funds never allow their share price to rise above or fall under $1 for each dollar invested.
A money market fund that invests in subprime debt increases the risk that its share price could drop below $1. If 5 percent of a fund's holding is subprime debt, and in a worst-case situation that asset collapses, then the value of the fund could drop to 95 cents.
Even if a fund's value dropped below a dollar, banks and fund companies wouldn't allow investors to lose money, says Peter Crane, founder of Crane Data LLC, the Westborough, Massachusetts-based publisher of the Money Fund Intelligence Newsletter.
`Virtually Nil'
``Fund companies will support the funds,'' he says. ``They won't let them break $1 a share. The odds of money market funds breaking the buck are virtually nil.''
Just once has a money market fund failed. In 1994, a fund run by Community Bankers Mutual Fund of Denver invested in securities that defaulted. Investors were paid 96 cents a share, and the fund was liquidated.
The fund had invested 27.5 percent of its assets in adjustable-rate securities, whose values were tied to interest rate changes, the SEC found. The fund lost money as interest rates increased.
Until recently, CDOs had been the fasted-growing debt market -- outpacing corporate and municipal bond sales by dollar total -- with about $500 billion sold in 2006, up from $99 billion in 2003, according to Morgan Stanley.
CDO Slump
About a quarter of the content of all CDOs sold last year in the U.S. was made up of securitized subprime mortgage loans. CDO sales slumped to $11.9 billion in July from $36.9 billion in June, according to JPMorgan Chase & Co.
SEC Chairman Christopher Cox told Congress in June his agency was conducting about a dozen probes related to the marketing of subprime CDOs to investors.
Lynn Turner, chief accountant of the SEC from 1998 to 2001, says the SEC will likely look into money market funds investing in CDOs, particularly because the value of subprime collateral of CDOs can collapse suddenly.
``I'm betting some people at the SEC will be concerned,'' he says. ``And they'll be more concerned in six months. How quickly did the Bear Stearns hedge fund evaporate?''
Each time a bank or financial firm creates a CDO, it forms a free-standing company incorporated offshore, usually in the Cayman Islands, which doesn't tax corporations. All CDOs have a trustee, usually a bank, that prepares monthly reports on the changing contents of the debt package.
From Mortgage to Fund
The trail that connects subprime debt to money market funds usually starts with a mortgage broker who makes a loan to a homebuyer with poor credit. A middleman then bundles hundreds of these subprime mortgages into so-called asset-backed securities.
Next, a CDO manager buys hundreds of these securities for collateral for a CDO. Some CDOs issue commercial paper, and brokers can then sell that paper to money market funds. Commercial paper, which is typically issued by banks and large companies, is debt maturing in less than 270 days.
Commercial paper pays relatively low interest rates, which averaged about 5.3 percent in June and July, because it rarely defaults. There have been occasional exceptions, such as paper issued by Enron Corp. and WorldCom Inc., both of which filed for bankruptcy earlier in this decade.
CDO commercial paper, often loaded with subprime debt, pays higher returns than corporate paper, and it paid as much as 6.5 percent in August.
This year, CDOs have sold more than $11 billion in the form of investment-grade commercial paper to money market funds, SEC filings show. The paper has the highest credit rating because Fitch Ratings, Moody's and S&P give AAA or Aaa ratings to the top portions of CDOs, which are the source of all CDO commercial paper.
`An Unpleasant Surprise'
Satyajit Das, a former Citigroup Inc. banker and author of 10 books on debt analysis, says those ratings are very misleading. ``I don't think the typical money market investor, in his wildest dreams, would assume he has exposure to the risk of subprime CDOs,'' he says. ``They may be in for an unpleasant surprise.''
Money market managers buy CDO commercial paper even when prospectuses warn of the risks.
Zurich-based Credit Suisse, Morgan Stanley in New York and San Francisco-based Wells Fargo are among money market managers that poured more than $1 billion into commercial paper issued by the Buckingham series of CDOs managed by Chicago-based Deerfield Capital Management LLC.
`Do Not Exist'
``Reliable sources of statistical information do not exist with respect to the default rates for many of the types of collateral debt securities eligible to be purchased by the Issuer,'' say both the 2005 and 2006 CDO prospectuses backing commercial paper held in the funds.
Deerfield's three Buckingham CDOs have directed $1.5 billion, or 40 percent of their $3.8 billion in assets, into subprime debt, according to their trustee reports. Billionaire Nelson Peltz's Triarc Cos. agreed to sell Deerfield in April.
Morgan Stanley spokesman Mark Lake and Wells Fargo's John Roehm declined to comment.
Tim Wilson, head of Credit Suisse's cash management portfolio desk, says he's comfortable with CDO commercial paper because it has the highest credit ratings and because his funds hold the debt for only one to three months.
`We're Watching'
``We don't have any concerns these are going to have any defaults in 90 days,'' he says. ``We're obviously watching.'' The paper matures within three months, and after that the fund doesn't hold any subprime debt, unless Wilson decides to buy more.
Vanguard Group Inc., the second-largest mutual fund company in the U.S., has a policy of never buying CDO commercial paper for its $90 billion in money market funds or $325 billion in fixed-income mutual funds.
``It really gets down to transparency questions,'' says John Hollyer, risk management director at Valley Forge, Pennsylvania-based Vanguard. ``Can you understand what you have? And can you measure it appropriately? We haven't been comfortable that we could.''
Bank of New York Mellon Corp.'s Dreyfus unit has banned CDO commercial paper from its $110 billion in money market funds because it has found that analyzing subprime holdings in CDOs is too difficult.
The firm's money market investment committee decided in 2005 that such paper was too risky, Dreyfus spokeswoman Patrice Kozlowski says. ``The committee questioned the fundamental structure of commercial paper of CDOs,'' she says. Dreyfus has never purchased CDO commercial paper, she says.
`Refuse to Fund'
CDOs create what is supposed to be a safety net for buyers of their commercial paper. CDO managers reach agreements with banks to purchase their paper when nobody else will, so the CDO can pay off debt when it's due.
Some fund companies, including Dreyfus, say those contracts don't reassure them because they're conditional and they aren't guarantees. ``The banks can refuse to fund,'' Kozlowski says.
CDO paper has other risks, former banker Das says. ``CDO commercial paper has a lot more moving parts than other kinds of commercial paper,'' says Das, who wrote ``Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives'' (FT Prentice Hall, 2006).
``There's a lot more that can go wrong,'' he says. Das says that because so much subprime debt is held by CDOs, there is constant risk that the value of the investment can drop or collapse.
The Credit Suisse Group Institutional Money Market Fund Prime Portfolio held 8 percent of its $22.8 billion of assets in commercial paper secured by subprime home loans as of June 30.
`It's There'
Fund manager Wilson says he's not worried about the $1.8 billion in subprime content because the term of the debt is so short. ``Lots of clients are uncomfortable owning commercial paper with `CDO' in the name,'' Wilson says.
He monitors his CDO holdings by analyzing the monthly reports that CDO trustees publish, listing all holdings. ``I think there are some investors not doing the work and relying on ratings,'' Wilson says. ``If you're willing to do the work, it's there.''
Credit rating companies don't just rate CDOs; they play an active role in assembling them, says Charles Calomiris, the Henry Kaufman professor of financial institutions at Columbia University in New York. Fitch, Moody's and S&P participate in every level of packaging a CDO, says Calomiris, who has worked as a consultant for UBS AG, Bank of America and Citigroup.
A CDO manager gathers hundreds of loan securitizations or bonds to use as collateral for the CDO. The debt supports an assortment of CDO sections, ranging from the riskiest non- investment grade to AAA or Aaa rated. CDO managers consult with analysts from the rating companies when creating a CDO, negotiating the highest credit ratings for each level, or tranche.
The Credit Raters
Most of the dollar value of all CDOs, as much as 90 percent, gets a credit rating of AAA or Aaa. The higher the credit rating, the lower the return that's demanded by investors. The CDO commercial paper bought by money market funds always has a top credit rating, even when it's backed by subprime debt.
In the past three years, Fitch, Moody's and S&P have made more money from evaluating structured finance -- which includes CDOs and asset-backed securities -- than from rating anything else, including corporate or municipal bonds, according to their financial reports.
The companies charge as much as three times more to rate CDOs than to analyze bonds, their cost listings show. The three rating companies say these fees are higher because CDOs are so complex.
Close Relationship
The close working relationships between CDO managers and rating companies -- and the fees that change hands -- mean money market funds shouldn't rely on ratings to evaluate CDOs, says Harvey Pitt, who was SEC chairman from 2001 to 2003.
Pitt says fund managers should do their own research on CDOs by reading the hundreds of pages of prospectuses and the monthly trustee reports. Some managers may not have been doing their homework.
``Relying on rating agencies for investment advice is dicey,'' he says. ``Their reliance on rating agencies left them a day late and several dollars short.''
Two money market funds run by AIM have gotten the message. They stopped buying CDO commercial paper. ``In today's market, you really can't trust any ratings,'' says Lu Ann Katz, AIM's director of cash management research.
As recently as June, two AIM money market funds owned $2.64 billion of CDO commercial paper that was invested in subprime debt. The debt made up 10.2 percent of the AIM STIT-Liquid Assets Portfolio and 4.5 percent of AIM STIT-STIC Prime Portfolio.
Mistrust of Ratings
Katz says she's stopped buying CDO investments because she doesn't trust credit ratings and she thinks CDO paper in money market funds is too risky. AIM's funds had included more than $1 billion of CDO commercial paper issued by CDOs managed by Bear Stearns before its hedge funds collapsed.
Fidelity Investments, the world's biggest mutual fund company, owned $2.3 billion in CDO-issued commercial paper in two money market funds as of May 31, according to spokeswoman Sophie Launay. The biggest money market fund in the U.S., Fidelity Cash Reserves Fund, had 1.5 percent of its $98.2 billion assets invested in CDO commercial paper backed by subprime debt.
The Fidelity Institutional Money Market Portfolio had 2.3 percent of its $32.3 billion in assets in such commercial paper. Boston-based Fidelity fund manager Kim Miller says he's holding off on buying more CDO debt.
`Dust to Settle'
``There's been a lot of volatility,'' he says. ``I think people are waiting for the dust to settle, and we're doing the same.''
Money market managers are required to determine that their investments are safe and have high credit ratings, according to Rule 2a-7, a 1997 addition to the Investment Company Act of 1940.
``The money market fund shall limit its portfolio investments to those United States dollar-denominated securities that the fund's board of directors determines present minimal credit risks,'' the rule says.
Money market managers buy CDO commercial paper to boost returns and make their fund more attractive to investors, which in turn increases their income, money market fund inventor Bent says. ``The higher rates sell more easily,'' he says. ``They're doing it to suck the people in.''
Fund managers are paid based on the total dollar amount invested in their funds, so more assets mean higher pay for managers.
``Trying to outguess the market makes no sense at all,'' Bent says about money market funds. ``That's not the risk you're looking for.''
Higher Yields
The subprime-backed commercial paper in money market funds offers some of the highest yields managers can include in their investments because such funds are prohibited by SEC rules from buying junk-rated debt.
The Bear Stearns hedge fund implosion demonstrated how misleading credit ratings of CDOs can be. The two funds had avoided buying the riskiest CDOs, sticking with tranches awarded AAA and AA grades, or the highest available, from Fitch, Moody's and S&P.
In July, the funds filed for bankruptcy protection as the investment bank halted withdrawals from a third fund, Bear Stearns Asset-Backed Securities Fund, after investors sought to extract their money.
Bear Stearns High-Grade Structured Credit Strategies Master Fund Ltd. and Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd. lost a combined total of about $1.5 billion in the second quarter as home prices slumped and subprime loan foreclosures jumped 62 percent from a year earlier because borrowers stopped making mortgage payments.
Cioffi
Cioffi had total control of Bear Stearns CDOs, according to a Fitch report dated Aug. 3. ``In lieu of a formal committee process, ultimate decision making lies with Ralph Cioffi,'' Fitch wrote.
Cioffi joined the bank as a bond salesman in 1985, seven years after earning a bachelor's degree in business administration at Saint Michael's College in Colchester, Vermont. Apart from his job managing funds, Cioffi also ran the Klio and High-Grade Structured Credit CDOs, which are rated mostly AAA.
AIM, Putnam, Wells Fargo and other fund managers bought more than $4 billion of Klio and High-Grade commercial paper backed by subprime home loans.
In June, the three Klio CDOs held 37-41 percent in subprime mortgage securities, according to trustee reports. The original $5 billion in collateral for Klio II's CDOs, purchased in 2004 and 2005, came from a source very close to home: Cioffi's own High-Grade Structured Credit Strategies Fund.
Low Risk?
AIM's Liquid Assets Portfolio held almost $900 million in Klio commercial paper on May 31, SEC filings show. Putnam Money Market Fund owned $119 million of Cioffi-managed paper on March 31, amounting to 3.5 percent of the Putnam fund's $3.41 billion in holdings.
``By investing in high-quality, short-term money market instruments for which there are deep and liquid markets, the fund's risk of losing principal is very low,'' Putnam wrote in its first-quarter report to shareholders.
``Putnam Money Market Fund holds a much smaller amount of CDOs than it did in March,'' Putnam spokeswoman Laura McNamara says. ``Putnam is comfortable with the structures we currently own.''
Seven money market funds run by Federated Investors Inc., the third-largest U.S. manager of money market funds, owned more than $1 billion of commercial paper issued by Bear Stearns- managed CDOs at the end of June, according to Federated's Web Site.
Not `Comfortable'
``We were never real comfortable with the whole program to begin with,'' says Deborah Cunningham, chief investment officer of Pittsburgh-based Federated's money market funds. ``We wanted to monitor it more and keep a little tighter rein on it.''
She says that's why Federated has never held Klio paper for more than 90 days.
Bank of America's Columbia Cash Reserves and Columbia Money Market Reserves funds owned more than $600 million of Bear Stearns's Klio CDO paper on June 30, according to Boston-based Columbia Management, the investment division of Bank of America, which is based in Charlotte, North Carolina.
``The funds are permitted to invest in asset-backed securities,'' Bank of America spokeswoman Faith Yando says.
Three Wells Fargo money market funds held $886 million in Bear Stearns-managed CDO commercial paper on June 30. The funds held a total of $1.5 billion in CDO commercial paper on that day, according to Wells Fargo spokesman John Roehm.
Trimming CDO Holdings
The Wells Fargo Advantage, Advantage Cash Investment and Advantage Liquidity Reserve funds held the subprime-backed debt. The funds' holdings of all CDO commercial paper ranged from 4.1 percent to 6.9 percent of their assets, Roehm says.
Wells Fargo trimmed its money market funds' CDO holdings to $680 million by July 31, Roehm says. He declined to comment further.
Wells Fargo money market funds also held more than $120 million of commercial paper issued by CDOs managed by Deerfield Capital Management on June 30. That CDO firm was controlled by billionaire Peltz, 65, who owns the Arby's fast-food chain and sold Snapple Beverage Corp. to Cadbury Schweppes Plc for $1.45 billion in 2000.
Peltz agreed on April 20 to sell Deerfield to an affiliate, Deerfield Triarc Capital Corp., a publicly traded real estate investment trust with no employees, for $290 million, SEC filings show.
Deerfield Triarc hired Bear Stearns in March for $2.4 million to provide a so-called fairness opinion, which concluded that the acquisition price was acceptable. Bear Stearns spokesman Sherman declined to comment on the fairness opinion.
SEC Inquiry
Deerfield Triarc disclosed in a July 13 regulatory filing that the SEC was conducting an informal inquiry into collateralized mortgage obligations and had made two information requests to Deerfield as part of its probe.
That filing was made more than two months after Triarc announced the sale of Deerfield Capital Management. Triarc noted the federal probe on page 21 of the filing as part of a list of risks for investors.
Peltz didn't respond to e-mail and telephone requests for comment.
Commercial paper from CDOs, laced with subprime home loan securitizations, made up 5.1 percent of the $11.4 billion Wells Fargo Advantage Money Market Fund as of June 30. The holdings included $96 million of Buckingham CDOs.
Morgan Stanley
Morgan Stanley money market funds held more than $330 million of Deerfield's Buckingham commercial paper on June 30, according to the bank's Web site. Credit Suisse money market funds owned more than $700 million in April, according to SEC filings.
The Morgan Stanley Institutional Liquidity Funds Prime Portfolio held $235 million of Buckingham commercial paper on June 30. Morgan Stanley spokesman Lake declined to comment.
Deerfield's CDO track record isn't reassuring. Since 2000, six of the 14 CDOs Deerfield manages have had tranches downgraded from investment grade to junk. Valeo Investment Grade I and II, Mid Ocean 2000 and 2001, Ocean View and North Lake include sections that lost their investment-grade ratings.
In May, Fitch said 39 percent of Mid Ocean CDO collateral was distressed, and it expected all of a $44 million Mid Ocean tranche to be a total loss. Moody's still rates Mid Ocean investment grade, or Baa3, one notch above junk.
Deerfield Capital Senior Managing Director John Brinckerhoff and Bear Stearns spokesman Sherman declined to comment.
Regulation
While CDOs aren't regulated by the SEC, mutual funds -- including money markets -- are. The SEC disclosed in June it's begun looking at some CDO investments, without releasing further details.
Former SEC Chief Accountant Turner says investors have cause to be concerned about money market funds' holding subprime debt. ``It doesn't make you feel real good in the gut,'' Turner says. ``This stuff takes on a life of its own when it starts going south.''
Investors are accustomed to treating money market funds as if they were bank savings accounts. The last thing they expect is that the subprime debt turmoil would enter their safe cash havens. And now it has.
Fintag says I have to admire Citadels's decision making process and quick execution. Of course it will be near impossible for anyone to prove they bought the assets too cheaply and they will do very well from this. As Citadel are becoming the "hoover" of the distressed hedge fund market, I am sure their inbox is quite full at the moment.
Bloody and Bloodier (nymag) The subprime-lending crisis is worse than you think, and could crush financial and real-estate markets for years.
You're losing money right now. This very minute. You're losing money if you own an apartment. You're losing money if you own a country home. You're losing money if you own a stock or bond mutual fund. You're losing money if you have a pension plan. You're probably losing money here or there, you're probably losing money everywhere (except maybe from your savings account and wallet). But this is no Dr. Seuss story. It's more of a John Steinbeck tale, and we are the victims, a new generation of Tom Joads, and it's the damn bankermen who broke us. No, there won't be a police officer to investigate, and the government, at least this federal government, won't save us.
Our tale of woe starts not in New York but in flashy places like Las Vegas and South Beach and faraway onetime Okie haunts like Riverside, San Bernardino, and Ontario, California. In these towns, and dozens more like them, housing companies erected colossal communities of homes. Eager homebuyers and speculators fought each other for these properties, armed with cheap financing, courtesy of Alan Greenspan, who wanted to boost an economy reeling from 9/11 and create a legacy of homeownership for all, including those who could not document steady income or, for that matter, citizenship.
We think of him as Saint Alan now, but in a few years he will be known as the reckless Fed chairman who encouraged the creation and use of exotic mortgages that required you to put down very little money, odd creations like the “2 and 28,” an adjustable mortgage with low interest payments the first two years that explode into gargantuan fees for the next 28. Don't have the money to pay for the 2 before the 28? Go “piggybacking”: Take out a home-equity loan against your new house to meet those minimal payments.
Where did the money come from? Banks lent it, mortgage brokers lent it, and even home builders themselves got into the act. The housing markets were so hot the lenders barely had time to check if their buyers were deadbeats, cheats, speculators, or actual honest-to-Betsy hardworking people who wanted nothing more than what Tom Joad wanted 70 years ago. Oh, and the buyers didn't have time to check out the terms, either; the value of the houses was going up too fast. Gotta close now! Nor did the regulators tap the brakes—whoops, there were no regulators. If something went wrong, who cares? The buyers could always sell their ever-appreciating home to the next guy on the reservation list or the ten after him. The builders, brokers, and bankers then shipped these mortgages east to the big Wall Street firms, which bundled them together and merchandised them as high-yielding bonds often backed up by nothing more than the full faith and credit of, well, no one.
Over and over, Greenspan hailed these fabulous financial breakthroughs that gave everyone a chance at the American Dream (or multiple dreams, in the case of speculators who took down homes and flipped them). And why not? Don't homes always increase in value? Won't there always be willing buyers armed with ARMs?
Except that wasn't how it went down. The same guy who prescribed the mortgage elixir for all Americans then laced it with seventeen straight interest-rate increases, increases that brought rates to levels so high that legions of people who bought a home with a teaser rate couldn't afford the payments. Between 2004 and 2006, just as interest rates started spiking and homes kept being churned out in these saturated areas, 14 million families purchased houses, many taking advantage of teasers and piggybacks. Given that the average home went for about $250,000, that's hundreds of billions in loans that cost a lot more per month than when they were taken. Now these people are stuck. They can't refinance because the rates are too high, and they can't sell their homes to repay their mortgage, either. In every area of this country—and in particular, in the once-hot markets like the ones I mentioned earlier—there are just too many other homes for sale and too many new homes still being pumped out.
What do the woes of these folks have to do with you? Can a housing fire sale in Phoenix or Fort Myers really affect your Hamptons beach house or your newly purchased Upper West Side classic six? Well, yes, and in even bigger ways than you might think. That's because the people who ultimately bought the bonds backed by what now look to be billions in bogus mortgages are those who run most of the big pension-, hedge-, and stock-and-bond-market mutual funds in this country. These suckers bought such bonds because bonds backed by mortgage-payment streams paid a tiny bit more than United States Treasuries, a comparable low-risk, if low-return, vehicle, and were supposed to have very little or no risk themselves. Some managers, however, borrowed huge sums to buy tons of these mortgages to turbocharge their results. And the most aggressive managers bought billions in mortgages given to less creditworthy individuals, the so-called subprime loans you keep hearing about.
Even though these loans have been losing value for years, it wasn't until June 2007 that any of this mattered. That's because of what is known in the trade as the “marks,” the value of a stock or bond as it's “marked” by a firm. You are getting poorer by the second because many of these mortgage bonds were priced way too high because nobody thought that large numbers of borrowers would ever walk away from their homes rather than pay the interest that backed the bonds. Such a disaster had happened only once, in the thirties, and that was before loans were federally secured. The buyers and sellers accounted for the bonds as if they were as reliable as cash, because as long as employment was robust—and it is—they thought they would be fine.
But now all hell's broken loose on Wall Street because of those mismarks. This spring, as many homeowners stopped paying, the mortgage bonds—for the first time—starting losing value. Hundreds of billions in bonds that were thought to be worth more or less the price they were sold at, it turns out, are worthless. That's triggered a chain reaction: Brokers like JPMorgan, Goldman Sachs, and Merrill Lynch that lent money to the firms that bought the bogus loans—most famously, Bear Stearns—basically foreclosed on those firms to get their cash back. But the firms, which are always running full tilt, didn't have the money to pay up. Bear, at the direction of the now-fired former co-president Warren Spector, let one fund just go down the drain. But Spector thought the other was still worth a great deal, so he put up $1.3 billion to pay back what the fund owed to the lenders and take direct control of the mortgage bonds. Spector, maybe one of the best minds in the bond business, genuinely believed that these mortgage-backed bonds still had substantial value. If someone as savvy as Spector thought these bonds were still good when they were actually worthless, that tells you that thousands of other managers are simply dreaming if they think their portfolios are worth anything near what they claim they're worth. In other words, we're looking at the start, not the end, of the lending meltdown.
Now these funds, which were supposed to be brimming with cash—the “liquidity” you hear about all of the time—turn out to have not much at all, and there are virtually no buyers anywhere for these mortgage-backed bonds, because who knows if the mortgages that are in them are worth anything? We only know that each day they are worth less than the day before, because every week, thousands of borrowers are being foreclosed.
Seven million people could lose their homes. New York, where the architects of card houses live, will feel the full force of the storm.
Here's another layer: The panicked managers of these firms were supposed to be the buyers for all of the high-yielding corporate bonds being issued to pay for the private-equity deals of Cerberus, KKR, Blackstone, and other private-equity firms. They were supposed to lap up the paper for all of the leveraged deals that are in the hopper for underperforming companies like Tribune Corporation and Chrysler. The Goldmans and JPMorgans had already promised the money to the Blackstones and KKRs. They are on the hook—“hung,” to use the grisly vernacular—but they can't sell the bonds to their usual pension-, hedge-, and mutual-fund clients because those clients don't have anywhere near the money they thought they had and are facing redemptions from furious investors. Now, pretty much every large financial institution in the country is caught in a web it can't get out of. Bogus mortgage paper is infecting the system, and no one has a cure.
Which brings us back to your money and why you're losing it. Unless you keep your money in cash or Treasuries or CDs or the First National Bank of Sealy, there's a pretty good chance that you're in a fund or funds that are mismarked and worth less than they and you think. If you own a home, you're in the financial crosshairs, too. It's not just that the lending crisis is causing interest rates to rise, jacking up your monthly nut if you have an ARM. It's that the value of your home is endangered because of the hit Wall Street—the industry, if not the stock market—is set to take.
In the past half-dozen years, the major brokerages in New York added hundreds of thousands of jobs in three areas: mortgage-bond sales and trading, private equity, and prime brokerage (the management of hedge funds' brokerage accounts). Each has grown by leaps and bounds each year. Now all three are frozen. There are no mortgages to package and sell and no clients who want them. The private-equity deals are all hung. And the way I see it, the hedge-fund business is liable to be cut in half by the chain of mismarking and redemptions. I think that many of these firms have as many as 30 percent more people than they need right now in these departments, and all of them will be cashiered by the end of the year. The lists are being drawn up; the HR people notified. Not too close to the holidays, please! And for those who are left, sorry, no bonuses. The money was all eaten up by severances. Unlike other times on Wall Street, the jobs will dry up across the board, because so many firms have beefed up the same divisions. This time, get laid off at Bear, no walking across the street to Lehman. The departed will be cut off from billions in disposable income that fuel the New York economy.
What can thaw this nuclear winter? What can cause these markets to defrost fast enough to save the jobs, and home values, of the rich in New York, if not the newly poor and evicted in Rancho Cucamonga? Spooked by the news that major foreign banks are now getting hit by the lending crunch, investors took stocks down sharply last week, prompting Fed chairman Ben Bernanke to order up a quick injection of liquidity into the system on Friday. I think the Fed will also cut interest rates soon—certainly sooner than it otherwise would have. That said, this Fed has been famously inflation-wary, and it may be reluctant to loosen rates too much, lest it overheat the economy, especially since the Fed seems to believe that the nonfinancial economy, the part not connected with home building or lending, is thriving. Of the 30 stocks in the Dow Jones Industrial Average, only two, Citigroup and JPMorgan, are directly connected to this mess. If Bernanke's right, and the rest of the economy is as solid as he seems to think it is, it's possible the lending crisis could be contained to only those who work in and around the credit business. But that's a big if. If the lending debacle keeps spreading, or the rest of the economy heads south, the Fed may find itself too far behind the curve to do much good.
Who else can unlock the jam? Maybe we get some help from overseas, a Chinese buyer of a major brokerage, perhaps? A Middle Eastern purchase of some of a big bank's equity—Washington Mutual, maybe?—wouldn't hurt. That's what saved Citigroup in 1990. Perhaps Warren Buffett can come in and buy a Bear Stearns; hey, he saved Salomon in a different decade. What we need is some deep, untorn pockets to step up and buy some of the good paper that is being thrown away with the bad, so the trading desks can catch their breath and stabilize themselves. Giant losses would still happen, but perhaps not institution-threatening ones.
In other times, you might expect a president or a Treasury secretary to get involved, perhaps to pressure Fannie Mae, the organization set up in the thirties to issue emergency loans to alleviate just the kind of homeowning credit squeeze that we have right now, to lend a hand. But this administration seems to be either totally clueless or totally heartless, or both, and doesn't want to goad Fannie Mae into helping. Maybe they hate that quasi-governmental institution set up by bleeding-heart Democrats to help struggling home buyers of a different, more liberal and compassionate, era. Or maybe they just think that anything short of an FDR-era Agricultural Adjustment Act for homes, where we bulldoze whole housing projects instead of cornfields to get price stability, just won't work.
I fear that the pain and contractions in the housing and credit markets could cause as many as 7 million homeowners who bought houses in the past few years to flee or be tossed from their dwellings, even if the rest of the stock market thrives. It's why I went off the reservation and screamed about this problem on television the other day (my latest unhinged rant). I see what could go wrong. I see how the forgotten man gets forgotten, and I feel helpless because I don't see anyone doing a whole hell of a lot about it.
Thousands of miles from where the walls began tumbling down, New York, the town where the architects of card houses live, will soon feel the full force of the storm. So much of our economy depends on these financial builders and their minions who buy and sell the products that the pain may actually end up being felt worse here than in the epicenters of the problem. You just don't know it or feel it yet. It's all happened too fast, in just a few weeks of another sweltering summer, with the worst, much worse, yet to come. Which is why I bet that in the time it took for you to read this article, the Tom Joad effect just took another few bucks out of your pocket. Get ready, many more dollars will soon vanish before you discover you've been robbed.
Fintag says So there you go. Will Jim Cramer stand for president? Is he the new market saviour? How is it one man can rant on CNN and get lots of youtube hits and then force the Fed's hand?
“I have never seen it as bad as this in 16 years. It can't have bottomed out, there are still all those bad loans out there.”
Margaret Massitti is not a Wall Street banker. She is not describing the near10 per cent swing on Wall Street's equity market over the past month, nor is she referring to the tightening credit conditions across American capital markets. Ms Massitti is a real estate broker in Cleveland, Ohio, and she is describing the residential property market there.
“Lenders will not finance any more. They have cracked down so rapidly that a normal person with very little money is having a really tough time.”
She explained that after the 17 successive interest-rate rises over the past two years and huge growth in the number of sub-prime mortgages, whose rates quickly rose above initial teaser rates, there are now a number of properties empty in Cleveland.
* Liquidity panic sends Wall St plunging deeper
* Stock market rout as blue chips lose £60bn
* Bank of Japan switches tack as overnight rate tumbles
* Bank of England breaks silence on credit crunch
* Countrywide calls in $11.5bn cash lifeline
* Credit crisis plunges world markets into the red
* World markets reel under strain of credit crisis
* Central banks take emergency credit crunch action
* Bank of Korea springs surprise rate rise
* Mortgage turmoil forces AHM into bankruptcy
How long is this piece of string?
The underlying dangers are probably not as bad as many people fear; the problem is not knowing what they are Related Links
* US economists look to an island in the storm
* Tremors may reach as far as the White House
* US lawsuits could cost London insurers
“People just walked away from their homes. Now it's worse. One buyer had agreed a mortgage on a two-bedroom home, he had agreed to put down 5 per cent [deposit]. Last week, the lender now says he no longer qualifies.”
Ms Massitti's prediction of a deteriorating housing market in the United States is not just an anecdotal hunch. Last week, the National Association of Realtors (NAR) published US house price statistics and home sales activity for the second quarter of the year. In Ohio, the number of existing homes sold fell by 7.3 per cent over the three-month period.
Over the Midwest region as a whole, activity was down 8.4 per cent compared with the same period the year before, with the average house price in the region down 2.2 per cent to $163,500 (£82,500). Sales of existing homes fell in 41 states during the April-to-June quarter, while average house prices were down in one third of the metropolitan areas surveyed.
Ohio is by no means the worst. In Arizona, the number of existing homes sold during the period fell 23.4 per cent. Florida was down 41.3 per cent. Maryland suffered a 21.1 per cent fall. Nevada slumped 37.5 per cent. California tumbled 19.8 per cent.
While economists and property experts broadly agree on the causes of America's 18-month housing recession, a big row emerges on how long it will last, not least because the grim statistics from the NAR plot housing trends only until the end of June, well before the global sell-off in equity markets across the globe.
During the past few months, some of Wall Street's biggest financial institutions have been trying to work out how much they are exposed to sub-prime mortgages. Under the terms of some of the loans, consumers could borrow as much as 110 per cent of their income, a salary that sometimes was never verified. House prices fell, interest rates rose and some sub-prime borrowers discovered that they had been lured by an initial teaser rate of interest that rocketed during the life of the loan. Not surprisingly, mortgage defaults surged.
The impact of the defaulting loans was felt not just by the mortgage banks who had lent the money. Those mortgages had been sliced, repack-aged and sold on to the likes of hedge funds and pension funds.
Over the past few months, Wall Street's biggest financial institutions have been trying to examine the stress on their loan books. Already it has cost the clients of investment banks, such as Bear Stearns and Goldman Sachs, billions of dollars each. The rest are still to admit their exposure, with an estimated $100 billion of so-called “dead mortgages” in the market.
Wall Street banks became nervous of lending to each other, fearing that one of their counterparts may be sitting on a big loss and may not be able to pay back the funds.
Mortgage lenders have also tightened up their lending criteria and more than 50 of the sub-prime lenders have gone bust, leaving very few sources of funding for the poor. Now economists are debating the impact of this credit squeeze on America's housing market in the future.
The outlook, according to Robert Shiller, Professor of Economics at Yale University, is bleak: “Real estate markets trend for years. It is more likely to keep going down. People keep repeating that the bottom is not far off, but I am assuming that this cycle is going to continue down for years and years.”
Not all economists are so gloomy. Lawrence Yun, the NAR senior economist, reckons that while “recent mortgage disruptions will hold sales back temporarily, the fundamental momentum clearly suggests stabilising price trends in many local markets”.
Part of the disparity between their forecasts may lie in the fact that each of the 50 states in America behaves like a local market. For example, the Northeast of the country was the first to slide into a housing recession 18 months ago, having been one of the first regions to benefit from the housing market boom, fuelled by cheap credit. There is evidence that parts of that region are among the first to recover.
Mr Yun suggests that part of the reason that Florida, Nevada and Arizona have suffered very badly in the last quarter may be because they had a “higher usage of sub-prime mortgages”.
“During the boom, prices in Florida rose so fast that many people saw the only way to buy into that market was to take a sub-prime loan that had a very low introductory rate, in the hope that when the rate increased, the market would have done so as well,” Mr Yun said.
Douglas Addeo, a real estate broker based in Florida, said: “The mortgage situation is complicating things, banks are imposing much harsher conditions and prices have declined substantially.”
Both Mr Shiller and Mr Yun point out that it is difficult to call the bottom of the housing recession because the current US property slowdown is very different from the past two. The slides in the early 1980s and 1990s were triggered by a sharp fall in employment and sustained by high interest rates. In 1982, rates were at 16 per cent.
Mr Yun said: “This recession is unique compared with the past. Before, people lost their jobs and had to sell their homes. This time round the US has had four million job gains. Many homeowners will still have accumulated significant wealth. If people are not desperate to sell and can stubbornly refuse lower prices, we may be nearing the end of the housing cycle.”
To complicate matters still further, some real estate brokers claim that official house sales statistics are misleading and inaccurate. Bob Schwartz, broker based in San Diego, said: “The market is a lot worse than the published figures.
“The big thing is what the numbers don't tell you. For sure, a property might sell for $600,000, but what you don't see in that price are the buyer's concessions. Buyers will now typically say: 'We want $15,000-worth of closing expenses paid by the seller.'
“That's legal fees, loan fees, escrow fees. This has been standard since 2005. So the price the seller actually gets is far lower.”
So how easy will it be to pull out of the housing recession?
Mr Yun says that with the surging cost of rents, now at nearly a 20-year high, potential property owners will be enticed back into the market.
Mark Grinis, a consultant in distressed real estate at Ernst & Young, pointed out that the market has contracted so rapidly with slowing financing and construction that the ability of the market to pick up may be diminished: “It takes time to build homes.
At the moment, there is no movement at all at the bottom end of the market. We are in the very early stages of this slowdown. At best, we are only at half-time.”
He said: “Our commitment and the success we've had in Europe is key to our growth. We often get painted with the brush that we're just a mortgage shop. The business is more diversified than people give us credit for.”
Molinaro said the US bank would continue to recruit for its three main businesses in London: fixed income, equities and prime brokerage. He said its top-ranked prime brokerage arm has not been hurt by the implosion of two hedge funds within Bear Stearns Asset Management, and the bank has not been forced to cut prices.
“The hedge fund and prime brokerage business is strong,” he said.
Molinaro said Bear Stearns is pursuing its growth plan, including in its nascent energy trading business.
In June, the group hired Calyon's former global head of commodities to run its European energy trading business. It also bought the energy trading assets of the Williams Companies.
The bank is also developing its credit business to counterbalance its exposure to mortgages but sees no reason to give up on the mortgage business itself.
“The mortgage business in the US is not going away. It will change, it will evolve, but access to mortgages is key to the US economy and the role it plays is critical,” Molinaro said.
But mortgage origination will not fare so well. The bank cut 2% of staff in its Encore Credit unit last week. The jobs, located around the US, were in back office and processing. A source close to Bear Stearns said mortgage divisions in Wall Street banks were overstaffed.
Fintag says Isn't this what Bear said it would do at the start of 2007 - move into Europe? Sounds like a lot of old spin. Still, if you want a free option it may make sense to work for Bear as you maybe working for someone else by the end of the year when BS is taken over. However, looking at my book, the probability of takeover is receding because the other banks cannot borrow so easily the money to take them out
The fund was up 16 percent over the previous 12 months. Blue-chip management was in place, and any risk was well-hedged with a comfortable cushion of financing in place, the fund said in a letter to investors.
But a rocky June turned into a calamitous July, and by the end of the month, Sowood was on the brink of collapse. As the credit market tightened, Sowood had to sell stocks to meet margin calls from skittish banks and add hundreds of millions in cash reserves.
Sowood's manager, Jeffrey Larson, sold the rest of the portfolio seemingly overnight — at a fraction of its initial value — and embarked on what he would later describe as a “deeply painful” process of returning the remaining money to investors and shutting the funds.
As problems that began in subprime mortgage lending have expanded into the broader markets, hedge funds like Sowood have come face to face with the ghost of past financial crises: the one-two liquidity punch from banks and investors.
On the one side, Wall Street banks and brokerage firms, as they did with Sowood, have stepped up their demands for more cash and collateral as they restrict the money they are willing to lend.
On the other, jittery investors seem ready to flee at any sign of trouble, as they did from the Bear Stearns Asset-Backed Securities Fund. The fund had a solid track record, no leverage and little exposure to subprime mortgages, but after it reported losses in July, investors demanded their money and Bear Stearns was forced to suspend redemptions.
Liquidity — the ability to quickly sell an asset at a reasonable value — is the linchpin to markets functioning effectively, and its absence in recent weeks has led to substantial losses in many highly leveraged hedge funds.
“For hedge funds, illiquidity is their Achilles' heel,” said one fund investor who was not authorized to speak to the media.
Pressure from banks to raise margin levels as well as pressure from investors could not have come at a worse time for hedge funds; the prices of the debt instruments they hold continue to fall, if they trade at all. Stocks widely held by hedge funds, from small-cap value stocks to potential targets for leveraged buyouts, have been pummeled. And with volatility in the markets, banks and hedge funds are scrambling to reduce risk and sell those securities that can be easily sold.
“It's not that suddenly everyone is out of cash — they just don't want to lend it or invest it,” said Frederick H. Joseph, a head of investment banking at Morgan Joseph & Company, a boutique investment bank, and the former head of Drexel Burnham Lambert, the investment bank that survived an insider trading scandal but collapsed two years later when banks shut off financing.
A liquidity vacuum is scary for any market player, but it can be particularly hazardous to hedge funds that try to make money by spotting anomalies in the market. When liquidity dries up and fear takes over, prices start to behave abnormally and the funds' bets go haywire.
“Hedge funds can withdraw liquidity rapidly, particularly when facing mounting losses, and this can cause severe market dislocation on the rare occasions when they all head for the exit door at the same time,” said Andrew W. Lo, a professor at the M.I.T. Sloan School of Management.
The dash to sell has been exacerbated by the interconnected nature of the players in the market and the securities they hold.
Because of problems in subprime mortgages, large “multistrategy” funds, those that trade many different kinds of securities or use diverse strategies, faced increased margin calls on their mortgage- or credit-related portfolios.
As banks demanded more collateral, the funds sold stocks. But many funds held the same stocks, including shares of companies known to be headed for a leveraged buyout, or others seen as targets for one.
With no ability to sell risky loans or slices of collateralized debt obligations, the funds started dumping stocks they owned and buying back stocks they had borrowed.
As a result, “high quality” or value stocks, plummeted while popular shorts — stocks that managers bet would fall in price — soared. This phenomenon ran counter to computer-driven or quantitative trading models, and created major losses in the first half of August in funds using those models, including some owned by Goldman Sachs, AQR Capital and D.E. Shaw.
Rumors shook the marketplace about imminent doom for various hedge funds. Some funds facing extensive losses looked to secure additional liquidity.
After steep losses in the first two weeks of August, three Goldman Sachs funds were severely under water. Its Global Equity Opportunities Fund fell 30 percent in one week; Global Alpha, a multi-strategy fund, doubled its losses in a week and ended last week down 27 percent, continuing an 18-month run of poor performance. The North American Equity Opportunities Fund was down more than 40 percent by Aug. 10, according to the HSBC Private Banking report.
With redemption notices approaching, Goldman orchestrated a major injection of liquidity. On Monday, before the market opened, the investment bank said it would team with some prominent investors including Maurice R. Greenberg, the former chairman of the American International Group who now runs C.V. Starr, and Richard Perry of Perry Capital, to inject $3 billion into the Global Equity Opportunities Fund ($2 billion of the total came from Goldman).
According to one investor, by the end of the week the Global Equity Opportunities fund faced “single digit” drawdowns from redemptions, suggesting that Goldman had, for the moment, dodged a bullet. (Investors are allowed to withdraw their money only once a month from the Global Equity fund, so the issue will arise again in mid-September). A spokesman declined to comment.
“The winners will be those who have liquidity and can extend it to those who crave it,” said Alan H. Dorsey, alternative investment strategist at Lehman.
But not everyone has access to capital. And when funds run into problems when liquidity is not available, investors can get nervous and run for the exits.
At United Capital Asset Management, John Devaney, a well-known manager who is selling his yacht, the Positive Carry, said in early July that the fund had received an “unusually high number of redemption requests,” including one from its largest investor that accounted for nearly a quarter of the firm's assets under management.
As a result, he said, the firm suspended redemptions in several funds “in order to protect the interests of our investors.”
Regulators have for years emphasized to banks, which they oversee, as well as to investment banks and hedge funds, which they do not, the importance of managing “liquidity risk,” or the risk that hedge funds or banks wake up one day and cannot sell or borrow.
Yet those warnings often go unheeded. Long-Term Capital Management, for example, collapsed in the late 1990s when securities that the best computer models in the world predicted would not move in a certain direction did just that.
More recently, executives have blamed very unusual events — known to experts as 25-standard deviation moves, things expected only every 100,000 years — for the disruptions that computers could not predict.
And yet such unpredictable movements seem to pop up every few years. And when they do, they cause severe damage, even for big diversified funds with long track records.
SAC Capital's multistrategy fund is down 6 percent for August, one of its worst months ever, one investor said.
Toward the end of the week, Tudor Investment's Raptor Fund was down 7 percent for the year, and Highbridge Capital Management, owned by JPMorgan, was down 4 percent for the month at midweek and up 2.5 percent for the year. Representatives from those firms declined to comment.
Waiting in the wings are the opportunists. Goldman Sachs, in spite of the abysmal performance of its major funds, is raising money for a fund to capitalize on assets that have been beaten down by fear, but whose fundamental value should spike when more normal markets reappear.
It will be Goldman's third Liquidity Partners fund: the first two were raised in 1998 and 2001, two other periods of extreme market conditions. According to a marketing document, Goldman will contribute 10 percent or up to $100 million and the fund will look for “tactical market opportunities” in fixed-income sectors rattled by dislocations.
“Liquidity used to be opportunistic,” said Stewart R. Massey, of Massey Quick, a consulting firm. “Now it's predatory. Many savvy investors are sitting on cash or lines of credit waiting to pounce on distressed sellers.”
Fintag says Lenders are squeezing but we knew this was coming after the Bear Stearns collapse. Consequently many funds have been liquidating positions - a reason the markets have been going down as we all sell at the same time. However, our subscriptions are up. As a multi strategy fund we are seen as a good hedge and many of my mates are also reporting no change on the investor front (unless you are anything to do with fixed income and redemptions are flowing).
facebook
free daily e-mail
feed
