Tuesday, September 30, 2008
Monday, September 29, 2008
Date Closing Value Change (points) Change (%)
09/29/2008 10,365.45 -777.68 -6.98%
09/17/2001 8,920.70 -684.81 -7.13%
04/14/2000 10,305.77 -617.78 -5.66%
10/27/1997 7,161.15 -554.26 -7.18%
08/31/1998 7,539.07 -512.61 -6.37%
10/19/1987 1,738.74 -508.00 -22.61%
09/15/2008 10,917.51 -504.48 -4.42%
09/17/2008 10,609.66 -449.36 -4.06%
03/12/2001 10,208.25 -436.37 -4.10%
02/27/2007 12,216.24 -416.02 -3.29%
07/19/2002 8,019.26 -390.23 -4.64%
The housing market just happened to be the chosen arena of exploitation. The public rushed to real estate after the collapse of the internet bubble, buoyed a dovish central bank, loan securitization and the structured asset market, the expansion of niche loan markets (sub-prime, Alt-A) and Government Sponsored Enterprises, increased marketing of certain loan variations (piggy-back, pay-option, ARMs), and the liberalization of underwriting standards (no/little documentation loans).
A house is a manufactured good. It depreciates. Historically, home prices only keep up with inflation (no real return).
I am surprised that this did not pass, but I am not shocked that the Republicans did not turn out for a lame duck President. Loyal reader Flip makes a good point: perhaps the House pressed the vote today so it WOULD fail. The lack of a package pushed the Dow to a 777 point loss today. When voters see their financial assets smacked around in the morning's paper, they might not object as vehemently to the bail out. Without the threat of a voter backlash, the House can pass a revised bill and save face.
Citigroup + Wachovia ------- $688 billion in domestic deposits
JP Morgan + WaMu ---------- $690 billion in domestic deposits
*Bank of America + Merrill - $840 billion in domestic deposits
Total: ------------------------ $2.218 trillion in domestic deposits
Banking Industry Total: ------ $7.029 trillion in domestic deposits
That would be 32% of domestic deposits in the hands of 3 holding companies.
Citigroup + Wachovia -------- $1.295 trillion in total deposits
JP Morgan + WaMu ---------- $1.027 trillion in total deposits
Bank of America + Merrill ---- $1.022 trillion in total deposits
Total: ------------------------ $3.344 trillion in total deposits
Banking Industry Total: ------ $8.573 trillion in total deposits
That would be 39% of total deposits in the hands of 3 holding companies.
Please note that these numbers may be a bit off since they are 3 months old. However, the implication for the banking public is clear: pricing power is building and the consumer is in more trouble than ever before.
* There is an FDIC statute that prohibits an institution from holding more than 10% of domestic deposits via acquisition. The numbers I used included Countrywide Bank, FSB, which does not roll up into the Bank of America holding company. I will research this.
Citi plans on raising $10 billion in capital via common stock offering. In addition, Citi will cut their dividend in half ($1.28 to $0.64 per share)
Citigroup, in essence, buys puts on the mortgage stuff from the FDIC for $12 billion in preferred shares & warrants.
Citi really rescues the bondholders of Wachovia in this trade. More to come later.
Sunday, September 28, 2008
Side note: The New York Times is reporting that Citigroup & Wells Fargo are bidding for Wachovia. Does the winner get Wachovia?
The Wall Street Journal reports that Banco Santander is still considering a bid, but haven't they had enough with that terrible Sovereign Bancorp trade (they bought 20% of the company and calls struck @ $40 for $2.4 billion back in 2005, the calls have since expired)?
Saturday, September 27, 2008
Suppose a speculator believes that interest rates will move higher. The speculator may choose to sell a Treasury note short. If interest rates do move higher, the speculator can buy the Treasury back at a lower price and pocket the difference. On the other side of the trade, another participant initially goes long and will sell the note back to the speculator.
At the end of the trade, both parties have a zero position and one party collects a profit.
The speculator could also pay fixed in an interest rate swap to achieve a similar exposure to selling the note short. The difference is that the position is frequently closed by entering into a new, but principally offsetting, position. Periodically, the dealer community will net positions together and transfer payments based on the net present value of the trades. But at any given time, the number of contracts outstanding may not be an accurate reflection of an institution's risk.
This short post does not do the topic justice, please drop me a line if you would like to discuss further.
---- $25 billion in loans to U.S. automobile manufacturers
---- $488 billion for the Department of Defense
---- $23 billion for hurricane assistance, elderly assistance and home heating subsidies
About the loans for the auto manufacturers: It is Section 129 of the bill. Of the $25 billion, it authorizes $10,000,000 for the administration of the loan program. The loans are subsidized by the Federal Government, meaning the loans will carry an interest rate that would be substantially lower than the interest rate the financial markets would charge the auto companies (assuming they could borrow in the first place). An Associated Press article estimates that the subsidy will cost the taxpayer $7.5 billion.
Biden did not vote
Obama did not vote
McCain did not vote
Clinton did not vote
Of course, both NJ Senators voted yea
My estimate of potential losses was too high. JPM also assumed secured debt of the WaMu Banks. Instead of $20 billion, I am guessing $7 - $10 billion. I may adjust this again as more data on deposit amounts and other goodies become available.
Washington Mutual, Inc. is, of course, still toast. The holding company and an investment subsidiary have filed their Chapter 11 paperwork. Although I am obviously thrilled about the $0 bill from the FDIC, this is a total demolition of equity holders and creditors. I would love to see this become the new model for failures.
This has essentially shut down the interbank market, not that the money was flowing like wine before this. According to some sources, Wachovia 30 year subordinated debt is trading @ 45 cents on the dollar. So the credit markets are closed too. What they need is a massive inflow of cash with very few strings attached and a Wall Street insider to pass out the checks.
Friday, September 26, 2008
Thursday, September 25, 2008
-- Alan H. Fishman, upon his appointment as WaMu’s CEO on September 8, 2008
Courtesy of Bloomberg, L.P.
-- FDIC Press Release
WaMu was closed tonight by the OTS & FDIC. JPM acquired the banks only (Washington Mutual Bank & Washington Mutual Bank FSB), leaving common share holders, preferred share holders and debt holders holding the bag. The $1.9 billion payment was made to the FDIC as receiver of the failed institutions.
No losses to the FDIC, finally some good news for the taxpayer. Although how there will be no losses absorbed by the insurance fund is a wonderful question. Details about the plan are not plentiful at this point.
Anyway, CVS Caremark was added this morning. Yep, that is the holding company for all of those pharmacies. Not that I am a conspiracy fan, but the only possible reason for this is to mess with hedge funds. CVS is working on acquiring Longs Drug Stores (LDG). Typically, an investor would short CVS and buy LDG to make a convergence bet. Upon announcement of an acquisition paid for in stock, the prices of the two equities in question would begin to converge to the stated payment ratio. This does not happen all at once because there is some risk that the deal may fall through (remember the Sprint & MCI deal, hedge funds lost on that one). So a small, but high return on capital, profit can be made on this bet.
And.........economic reports today: durable goods orders fell more than expected, initial jobless claims were higher than expected, GE lowered earnings guidance and equity futures were higher.
Strange days indeed.
Wednesday, September 24, 2008
I sense that am going to rail on and become incoherent because I am truly upset by the amount of execution risk that talking heads are arrogant enough to assume. So, I'll stick to the facts:
U.S. Government General Fund Debt: $ 9.7 trillion
Office of Management & Budget 2009 Deficit Estimate: $ 482 billion
That brings the debt to roughly $ 10.2 trillion next year. Assuming GDP growth is 4% (yeah, I know. But I'll run with the Budget Office's estimate.), the debt to GDP ratio would be 68%. The last time we hit that high water mark, President Eisenhower was working hard to pay off the WW II debt.
Since the plan summary presented to Congress included a request to increase the debt limit by $ 700 billion, it is safe to assume that Treasury securities will be issued to fund the acquisition plan. Hmmm, borrowing money to buy crap bonds.....sounds like a winner.
That now brings the debt to $ 10.9 trillion or 72.7% of GDP. The S & L Crisis took roughly six years to clean up, a pretty impressive feat. This resolution is bigger and messier, so I'm going to guess eight years. More guessing: half will be funded by T-Bills, 30% in 2 year notes, 15% in 5 year notes and the remainder in ten year notes.
Remember, the Treasury is kind of, sort of on the hook for Fannie & Freddie stuff. Based on GSE debt rolling off in 2009, we need to add $400 billion. I'll ignore credit losses for now, I don't have the models.
$ 11.3 trillion
75% of GDP
Wow. There is no margin for error. If you think the Chinese government played games with our debt markets before, what on Earth is next? Where will the capital come from after the Treasury itself sucks up the liquidity? I'm going to sleep.
I could be misreading this, but IBM is now on the no short list? Why?
I have been trying to confirm this, but I have not been able to thus far. Anybody know?
Berkshire Hathaway will buy $5 billion of perpetual preferred stock
The coupon will be 10%, it is callable anytime at a 10% premium
Berkshire will also receive 5 year warrants to buy roughly 43.5 million shares @ $115.00
So, Buffet can double his money in 7 years on the preferred shares alone if the market is flat and he participates on the upside. On the downside, he is clearly depending on the acquisition fund to support the overall market.
Separately, GS will sell $2.5 - $5.0 billion in common shares to solidify their equity position.
(Totally separate, Capital One Financial will sell 14 million shares today. So Goldman & Cap One can sell short their own shares but I can't?)
- How was the held to maturity value determined?
- Who determined that value?
- Will the U.S. Treasury be able to verify these prices in a timely fashion?
As a tax payer, I want the lowest price possible. As an economics student, I understand that a concession is necessary. As a prudent person, I want a market to determine the price.
One more thing: this is not a "bail out". The pending legislation would authorize a sum of money ($700 billion or so) for the purchase of assets. These assets could appreciate in value and hopefully result in some benefit to the tax payers down the road. The key elements of the plan should be pricing, size of fund, eligible participants and management.
Tuesday, September 23, 2008
Bear Stearns - 3/14/08
The Federal Reserve Bank of New York provided JP Morgan with a $29 billion loan to facilitate JPM's acquisition of Bear Stearns. The loan is backed by mortgages and mortgage backed debt. It is a non-recourse loan: if the stated mortgage collateral is insufficient to pay back the loan (should JPM not repay), The Federal Reserve can't lay claim to any other JPM assets. This is not a U.S. Government rescue since the Federal Reserve is not part of the U.S. Government
Fannie Mae & Freddie Mac - 9/7/08
Fannie & Freddie were placed into conservatorship, run by the Federal Housing Finance Agency. Conservatorship is established by a court order and cedes legal control of an entity to the conservator. It does not eliminate the rights of shareholders and management (such as in a receivership), it simply transfers those rights. The U.S. Treasury Department commits $200 billion dollars to acquire preferred stock in Fannie & Freddie. The preferred stock will pay a 10% dividend. In addition, the U.S. Treasury Department will receive 20 year warrants representing a 79.9% equity stake each entity. The debt of Fannie & Freddie, as well as the mortgages they guarantee are NOT explicitly guaranteed by the Federal Government in this action. The "implicit"guarantee is strengthened. As such, the Federal Government is committed to at least the $200 billion used to acquire the preferred stock and at most the $6.1 trillion in Fannie & Freddie debt and guarantees. The taxpayer is on the hook for this one, this is a Government rescue.
AIG - 9/16/08
The Federal Reserve Bank of New York provided AIG with an $85 billion 2 year loan. The Federal Reserve will receive warrants representing a 79.9% equity stake in AIG. The interest rate on the loan is 3 month LIBOR + 8.50% (roughly 11.4% for the first set). The collateral on the loan is comprised of the total assets of AIG, non-regulated and regulated subsidiaries included. This is not a U.S. Government rescue since the Federal Reserve is not part of the U.S. Government
Note: The Federal Reserve Bank of New York is the main operating entity of the Federal Reserve System. Open market operations are conducted by the New York branch on behalf of the entire System. The System is owned by private banks and is charged by the U.S. Government to conduct monetary policy. It is supplied with a credit line from the U.S. Treasury Department.
As I have mentioned before, the sale of these poor quality assets will depress the amount of capital on the seller's balance sheet. The amount of capital depletion depends on the difference between the most recent marked to market price and the execution price. As a result, the seller may reveal the fact that they are insolvent. It is also a signal to regulators that the institution has risk management issues. Information of this type is quite valuable. When (if?) short selling is allowed, speculators would easily see the target on the backs of these banks.
Therefore, in order for the process to get rolling, the Government would actually have to pay a premium to the seller to compensate them for the follow through effects of the sale. This is where Game Theory comes into play: how much of a premium do the Feds pay?
Side note: Paulson just finished his testimony in front of Congress. He sounded pissed.
Breaking the buck hasn't happened often. LEH & AIG short term debt and commercial paper falling off the cliff was the culprit. The panic that ensued pushed T-Bill yields to essentially zero. Bernanke admitted that last Thursday was the closest we have been to a total meltdown.
Meredith Whitney cut estimates again for the money center banks.
Equity futures are modestly higher, gold is down a bit, oil is down a bit (remember, we rolled out of the Oct contract).
Wait and see mode.
Monday, September 22, 2008
Bank stocks were hammered as the interbank market has, quite simply, stopped functioning. Any day now, 3 month LIBOR will carry us over the turn. This will probably be the messiest turn since 1998.
Posted below is my comment from last Friday:
This is a shameful day in the history of the U.S. financial markets. What makes us any different from the shady characters that run the Russian, Chinese or Pakistani capital markets? Changing rule on the fly to suit the needs of the connected few and hurt legitimate traders, remove the ability of an American to have an opinion.
It is now impossible to short the stock of 799 financial companies. Some of these companies' shorts as a percentage of float was as small as 5%, tough to claim short sellers were depressing the price. ETFs have been halted. Since you can't short, option traders are hamstrung. They can't hedge puts, so how can they sell them effectively.
On Black Monday (Oct, '87) the Dow fell 20%. ONE DAY !!!!! 20% DROP !!!! No short selling ban was instituted. The Dow has dropped 20% in 10 months and we need to destroy our integrity? Why shouldn't poor management in the financials be punished by the same forces that made them multi millionaires?
- This does not replenish the capital of these financial institutions, some of whom were not even rated (so you can't claim that shorting damaged collateral agreements). Several of these companies will still need to add capital because THEY OWN CRAP on their books.
- A financial company bail out will have the following impacts: mark to market and equity dilution. The new RTC (or whatever it will be called) is not going to buy the paper at par. They will buy it or transfer it to their books at however many cents on the dollar the paper warrants. No more mystery pricing will be possible, the paper will only have a new home, not par pricing. If there are bail outs, guess what? Equity dilution. Why are people bidding stocks higher when the only possible scenario is dilution in the near future? i don't know either.
- Pakistan initiated a similar short selling ban in June of this year. the market rallied from 11,000 to 12,000 in 2 sessions. it is now trading at 9,000.
Massive short covering is the explanation for the outperformance of the near contract. The October contract expires today and the down leg in crude prices over the last few weeks led to establishment of bearish positions. In addition, I would imagine that liquidations by hedge funds and broker-dealers helped push prices below $100.
The message form the markets is clear though. The only way for the US to get out of this financial mess is to reflate the economy: Treasuries are off, the Dollar is off, commodities are higher.