The Big Picture

Video: David Einhorn, Greenlight Capital, William Ackman, Pershing Square Capital

Friday, May 09, 2008 | 10:11 PM

in Credit | Derivatives | Financial Press | Video

Every now and again, CNBC puts on a superlative show. Friday morning's Squawk Box was one of those times when they hit the ball out of the park.

As I was heading out the door to work, I heard David Einhorn of Greenlight Capital begin chatting about shorting stock, soft SEC enforcement, and Allied Capital (ALD). CNBC also announced that William Ackman of Pershing Square Capital was coming on in a while.

So before leaving the house, I TiVo'd Squawk, and then headed off to work. I watched the show Friday evening, and it was fantastic. Watch the videos below and see if you agree.

• The Short & Short of It
Short selling can be good for the markets, with Owen Lamont, DKR Fusion, David Einhorn, Greenlight Capital and CNBC's Steve Liesman

click for video

• Whistle-Blowing pt. 1

Activist investors face challenges convinsing regulators to face the facts, with William Ackman, Pershing Square Capital Management and David Einhorn, Greenlight Capital Management

click for video

• Whistle-Blowing, 2
click for video

• Hedging Your Bets

Discussing fraud on Wall St., with David Einhorn, Greenlight Capital Management president

click for video

Fannie Mae is Fantastic !

Wednesday, May 07, 2008 | 06:42 AM

in Credit | Derivatives | Financial Press | Real Estate

At lunch with a journo friend, the question arose as to whether or not yesterday's front page NYT article on Fannie Mae (FNM) was inflammatory or not.

I am not sure if inflammatory was the correct word, but the Times certainly got the gestalt right of how bad things are at the mortgage GSE these days.

Consider these Fannie Mae facts:

• Their loss of $2.2B was 4X greater than expected ($-2.57B v.s. $-.640m expected)
• FNM accounted for 81% of the home-loan market in Q1 2008
• Shareholder equity dropped to less than zero for the first time in 15 years (from $20.5 billion in Q4)
• Subprime exposure: $51.2B
• Alt-A exposure: $344.6B
• Fair market value of assets dropped to $12.2 billion last quarter from $35.8 billion in December. This includes $56.1 billion in Level 3 assets;
• Moody’s downgrades FNM’s financial strength one level to ‘B’
• Credit and derivative losses rose fivefold to $8.9 billion; expects bigger credit losses in 2009;
• Estimates for credit losses in 2008 were boosted to 13 basis points to 17 basis points (up from 11 to 15 basis points). Each basis point, 0.01%, = 15 cents of earnings/sh (Morgan Stanley)
• Company issued $6B in securities to shore up balance sheet
• FNM cut their dividend to preserve capital
• Fannie Mae warns the housing slump will persist into next year.
• CEO sees 7-9% decrease in home prices in 2008 (previous estimate: 5 - 7%)
• FNM’s regulator, Office of Federal Housing Enterprise Oversight (OFHEO), said it will lower surplus capital requirements to 15 percent from 20 percent. Hence, this should allow more (not less) lending into the troubled mortgage market.
• Ofheo also lifted its consent order -- imposed in 2006 after $6.3 billion in accounting errors;
• Barney Frank’s (approved by BB) proposed mortgage bailout boosted FNM -- it rallied 15% from opening lows.

Hence, the cure for too much leverage and a lack of mortgage lending standards is more leverage and increased lending.

Note: We no longer have any short positions in FNM . . .

As the old cliche goes: "It's not the news; it's how the markets react to the news that matters." We agree.

click for larger graphic

courtesy of NYT

Sources:
Doubts Raised on Big Backers of Mortgages
CHARLES DUHIGG
NYT, May 6, 2008
http://www.nytimes.com/2008/05/06/business/06fannie.html

Fannie to Boost Capital After Posting Big Loss
JAMES R. HAGERTY
WSJ, May 7, 2008; Page C2
http://online.wsj.com/article/SB121007526280870313.html

Another Tool for the Fed ?

Tuesday, May 06, 2008 | 10:00 PM

in Credit | Federal Reserve | Finance

Have you ever even thought about this?

"The Federal Reserve is formally asking Congress for authority -- starting this year -- to pay interest on commercial-bank reserves, in an effort to gain better control over interest rates and more leverage to battle the credit crunch...

In 2006, Congress gave the Fed permission to pay interest on reserves -- the sums banks keep on deposit at the Fed -- but it delayed the effective date of the legislation until 2011 to postpone the cost to the Treasury.

Banks are required by law to hold a certain fraction of their deposits in reserve accounts at the Fed, but receive no interest on these deposits. Having the authority to pay interest would solve two technical headaches for the Fed.

If they earned interest from the Fed, banks would have no incentive to lend out excess reserves for less. That would make the Fed's benchmark federal-funds rate, which banks charge on overnight loans to each other, less likely to plunge below the Fed's official target -- now 2% -- on days when the banking system was awash in cash.

I'll bet this sort of stuff never even entered your thinking . . .

Source:
Fed Seeks Approval to Pay Interest to Banks
GREG IP
WSJ, May 7, 2008
http://online.wsj.com/article/SB121011673771072231.html

Disconnect

Tuesday, May 06, 2008 | 07:04 AM

in Credit | Finance | Markets | Psychology/Sentiment

Today, we are going to go to Bill King, a long time observer of the stock markets. Bill writes the daily “Independent View of the News”, for institutional clients (you can contact him here).

This morning, he wryly observes:

"Despite the braying about the credit crisis being over, the economy about to rebound and stocks entering a new bull market, the fundamentals not only remain crappy, they are worsening.

Months ago, Goldman’s CFO said there was a historic disconnect between the stock market and the credit market. But that’s not the entire story. There is also a historic disconnect between L’Affaire Bear and the credit markets and the economy.

Because the US financial system did not implode when Bear was rescued, people assume all is well in the credit markets and financial system. This is a gross miscalculation. The Fed proved this last Friday when it expanded its record credit-creation gimmicks and loosed collateral standards to a new all-time low.

Bloomberg: The Federal Reserve said the proportion of U.S. banks making it tougher for companies and consumers to borrow approached a record in the past three months as the credit crunch deepened. A net 70 percent of banks increased loan rates over their cost of funds for commercial and industrial borrowing, according to the central bank's quarterly survey of senior loan officers released today in Washington. That compares with 45 percent in the January survey, the Fed said.

As we stated several missives ago, there is no way the US economy, which has never been more dependent on debt to generate GDP, can flourish without an enormous amount of debt creation. If debt is now being curtailed or rationed, there can be only one direction for the US economy.

Morgan Stanley economist Richard Brenner: DISCONNECT - The economic fallout begins: Financial turmoil peaked six weeks ago, but the economic downturn is only beginning. It’s still a recession, in our view, and that’s no longer in the price. Indeed, reflecting higher energy quotes and slipping growth abroad, we see weaker US growth over the next few quarters than we did a month ago

The Times of London: After the crunch, a crisis in banking confidence Credit risk – that of borrowers not repaying loans – was cited as the next-biggest risk after liquidity. Consumer indebtedness was also a worry. A senior banker in an American bank said: “Consumers are in worse shape than most observers appreciate … their failure rate will look like a tsunami to those lollygagging on the financial beaches.”

Bill adds a pretty astute trading call each day: Example:

Today – Traders will play for a Turnaround Tuesday to the upside. But S&Ps must hold 1400; oil and commodity must behave and FNM (-.64 exp) cannot issue a disturbing report…There is no economic news or impact events to worry about.

Great stuff -- thanks Bill.

Sources:
The King Report
M. Ramsey King Securities, Inc.
Bill King
Tuesday May 6, 2008 – Issue 3869
http://www.mramseyking.com/index.html

Fed Survey Shows More U.S. Banks Tighten Loan Terms
Scott Lanman
Bloomberg, May 5 2008
http://www.bloomberg.com/apps/news?pid=20601087&sid=a45nIbT1eKLo&

After the crunch, a crisis in banking confidence
Patrick Hosking
Times Online, May 6, 2008
http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article3876856.ece

Snow, Bies, Poole, Mobius, Faber Discuss U.S. Economy

Friday, May 02, 2008 | 03:30 AM

in Credit | Economy | Federal Reserve | Inflation | Video

click for Video:

Bloomberg:

Former Federal Reserve officials William Poole and Susan Bies said it wouldn't be wise for policy makers to cut the benchmark U.S. interest rate below the current 2 percent. "We have an adjustment in housing that has to take place,'' Poole, former president of the St. Louis Fed, said during a one- hour Bloomberg Television special, "Surviving the Slowdown,'' yesterday. "I do not think rate cuts are going to solve the basic problem.''

The former Fed officials' remarks underscore the risk that more rate reductions may fan inflation, which is accelerating because of rising prices of food, energy and other commodities. The Fed said "uncertainty about the inflation outlook remains high'' and indicated it's ready to pause its rate cuts by dropping a reference to "downside'' risks to growth.

Source:
Poole, Bies Say More Fed Rate Cuts Wouldn't Stem Slowdown Much
Vivien Lou Chen and Kathleen Hays
Bloomberg May 1 2008
http://www.bloomberg.com/apps/news?pid=20601068&sid=aWAYs4brrVwM&

Rhodes of Citigroup Says Credit Crisis `Half Way' Over

Monday, April 28, 2008 | 04:30 AM

in Credit | Derivatives | Video

click for video

William Rhodes, vice chairman of Citigroup about the outlook for the U.S. economy and financial markets, trade policy and his expectations for China's growth.

Source:
Rhodes of Citigroup Says Credit Crisis `Half Way' Over
Kathleen Hays
Bloomberg April 25 2008
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=avGIXeWKBadQ

Nobel Laurelates on the Economy

Sunday, April 27, 2008 | 09:30 AM

in Credit | Economy | Financial Press | Psychology/Sentiment

CNBC had three Nobel winners on Friday morn -- Joseph Stiglitz, Robert Engle and Edmund Phelps -- discussing Housing, Credit, and the state of the US economy. It was terrific television, and showed how good the medium can be when it sets its mind on it.

Incidentally, longtime readers may remember our amusing encounter with Prof Robert Engle back in 2003. If you haven't seen that, its definitely worth reading.

Joseph Stiglitz, 2001 Nobel Prize winner and Columbia University professor

"The real important point from an economic perspective is the gap between the economy’s potential growth and its actual growth. And without a doubt, there’s a big gap. I think we’re probably in a recession. The real concern is how long, how deep. This is one of the worst—clearly going to be the worst ... downturns since the Great Depression.”

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Robert Engle, Nobel Laureate Economist winner 2003 and New York University professor

"I think that we've got a lot of strength that's going to come out of the export sector, the technology sector. We've seen good earnings reports from some of them. They're thriving on this weak dollar. It's giving them a chance to sell goods all over the world. And I think that's going to probably pull us out."

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Edmund Phelps, Nobel Prize winner in economics 2006

"The rise of the unemployment rate has been mild, and it started from a very, very low level of 4.3 just ten or twelve months ago. By that metric, this is a mild downturn.”

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Related:
A funny thing happened to me on the way to the studio tonight . . . http://bigpicture.typepad.com/comments/2003/11/a_funny_thing_h.html

Source:
Where's the Economy Going? Nobel Winners Weigh In
CNBC.com 25 Apr 2008
http://www.cnbc.com/id/24313079/site/14081545

Report on UBS' $37 Billion Writedown

Saturday, April 26, 2008 | 07:06 AM

Kids, we have some fascinating reading in store for you this weekend.

The "conservative" Swiss banking giant UBS -- and I put that in quotes for obvious reasons -- wrote down a previously unimaginable $37 Billion dollars. Their shareholders were (ahem/cough) quite perturbed. So the nice folks at UBS, with an assist from KPMG, put together a 50 page report detailing the hows and whys UBS took such a humungo hit.

For what you would expect to be a dry report, it is absolutely compelling reading. It explains much more than the subprime fiasco. The report implies that management didn't really understand what the hell they were getting into with their purchases of Warburg/Dillon Read Capital Management. This unit eventually became UBS' internal hedge fund (it has since been shut down).

I wonder if management ever truly understands the nuts and bolts of these large acquisitions. We will find out if JPM knew what they were ~~getting into~~ getting the Fed into with the Bear Stearns (BSC) acquisition.

The report includes an indictment of the firm's compensation packages. The current structure -- big salaries and bigger bonuses -- encourages the riskiest and most short term of strategies. Prudence, risk management, and long term thinking were not money makers for employees. When the time came for the company to take its writedowns, many of these bad actors were long since gone. Go on, take the money and run.

You may not be surprised to learn that external consultants were involved and recommended "streamlining of risk processes." I don't know if these unnamed consultants were McKinsey & Co., but the whole description has a faint Enron-like smell to it.

A few other questions arise from the report:

Why do very risky strategies seem to end up in Fixed Income ?

How did Risk Control fail so badly?

Why was there an "Absence of risk management" and "Incomplete risk control methodologies" ?

Who created these compensation system ?

Again, this is just the tip of the iceberg in terms of asking what went wrong.

I wonder if this the inevitable banking equivalent of the Minsky moment. Perhaps these megabanks are simply too big, too unwieldy to be appropriately managed as hedge funds, rather than sleepy conservative banking institutions. The perverse incentives encourage reckless behavior.

Fascinating stuff . . .

Sources:

Shareholder Report on UBS's Write-Downs
18 April 2008
http://www.ubs.com/1/e/investors/agm.html

UBS ShareholderReport.pdf (download)

Related:

A good name sliced, diced and traded
John Gapper
FT, April 24 2008 03:00 | Last updated: April 24 2008 03:00
http://www.ft.com/cms/s/0/51099762-1198-11dd-a93b-0000779fd2ac.html

How UBS came undone
Roderick Boyd
Fortune, APRIL 23, 2008: 4:38 PM
http://money.cnn.com/2008/04/23/news/companies/ubs_deflates.fortune/

Too many risks, too few controls, says UBS report on write-downs
David Gow in Brussels
The Guardian, Tuesday April 22 2008
http://www.guardian.co.uk/business/2008/apr/22/ubs.europeanbanks

Bagehot's Lessons for the Fed

Friday, April 25, 2008 | 09:25 AM

in Credit | Economy | Federal Reserve | Fixed Income/Interest Rates | Inflation

Apropos to our earlier criticism of the US Central Bank is this piece by Stanford prof Ronald McKinnon, titled Bagehot's Lessons for the Fed.

In today's WSJ, McKinnon writes:

"By slashing interest rates too much in 2007-2008, the Fed has accentuated the foreign drain and thus made the alleviation of the domestic drain more difficult. Yet, despite this mistake, Bagehot would approve of other actions the Fed has taken to deal with the domestic drain by unblocking specific impacted domestic markets. These include (1) swapping Treasury bonds for less safe private bonds, (2) opening its discount window to shaky borrowers, and (3) maybe even rescuing Bear Sterns. He would also approve of the relaxation of capital constraints on Fannie Mae, Freddy Mac and so on, for mortgage lending. Yet these measures will be insufficient if the foreign drain continues.

To repeat Bagehot's Rule: "very large (domestic) loans at very high rates are the best remedy for the worst malady of the money market when a foreign drain is added to a domestic drain." The Fed, and the U.S. government more generally, have so far got it only half right."

The entire piece is worth a read . . .

Sources:
Bagehot's Lessons for the Fed
RONALD MCKINNON
WSJ, April 25, 2008
http://online.wsj.com/article/SB120908336730343529.html

Unrealized Level 3 Gains

Thursday, April 24, 2008 | 08:13 PM

in Corporate Management | Credit | Derivatives | Earnings

If it weren't for the large non- cash profits on "hard-to-value" holdings, Goldman Sachs (GS) wouldn't have had much profit last quarter. Lehman Brothers (LEH) would have had significantly less. And Morgan Stanley (MS) wouldn't have had any.

That's according to Bloomberg's Jonathan Weil:

"Here's Rule No. 1 from Wall Street's public-relations playbook: If the company you run has big losses on hard-to-value assets, scream your head off about the accounting rules.

And what if the squishy values result in huge gains instead, as they have in the not-so-distant past? Rule No. 2: Stay mum about it for as long as the rules allow.

For months, we've seen a growing parade of executives and politicians complain that fair-value accounting rules are to blame for financial institutions' imploding balance sheets. Even the International Monetary Fund got in on the act in an April 8 report, suggesting the need for "some latitude in the strict application of fair value accounting during stressful events.''

There has been no commensurate outrage about fuzzy mark-to-market accounting that lets companies post unrealized gains on illiquid balance-sheet items."

Go read the full article . . .

Source:
Goldman, Morgan Stanley Hit `Level 3' Jackpot
Jonathan Weil
Bloomberg, April 23 2008
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a0ZGtAQHLpiA

Student Loans?

Wednesday, April 23, 2008 | 04:00 PM

in Credit | Economy

Amusing:

Must Read: Triple-A Failure

Wednesday, April 23, 2008 | 03:00 PM

in Credit | Real Estate

Do-not-walk-run to read Roger Lowenstein's piece coming out in this Sunday's NYT Magazine about the rating agencies, titled, Triple-A Failure.

There is so much good stuff here, almost any random paragraph is worth quoting:

"Mortgage volume surged; in 2006, it topped $2.5 trillion. Also, many more mortgages were issued to risky subprime borrowers. Almost all of those subprime loans ended up in securitized pools; indeed, the reason banks were willing to issue so many risky loans is that they could fob them off on Wall Street.

But who was evaluating these securities? Who was passing judgment on the quality of the mortgages, on the equity behind them and on myriad other investment considerations? Certainly not the investors. They relied on a credit rating.

Thus the agencies became the de facto watchdog over the mortgage industry. In a practical sense, it was Moody’s and Standard & Poor’s that set the credit standards that determined which loans Wall Street could repackage and, ultimately, which borrowers would qualify. Effectively, they did the job that was expected of banks and government regulators. And today, they are a central culprit in the mortgage bust, in which the total loss has been projected at $250 billion and possibly much more."

Go.

Hat tip Paul.

Source:
Triple-A Failure
Roger Lowenstein
NYT, April 27, 2008
http://www.nytimes.com/2008/04/27/magazine/27Credit-t.html

This article will appear in Sunday's New York Times Magazine.

Is The Worst of the Credit Crunch Behind Us?

Monday, April 21, 2008 | 06:47 AM

in Credit | Derivatives | Federal Reserve | Psychology/Sentiment

One of the more common refrains we keep hearing is that the worst of the credit crisis is behind us. Not only that, but banks have written down so much bad debt, that there is an upside surprise ahead of us!

I'm not so sure about that. As to the first part, credit spreads, mortgage rates, and the actions of the Bank of England strongly imply we are still in the thick of it. As to the latter, I simply doubt management has been that forthcoming.

I am not the nly one with such doubts. The WSJ looks at the specific accounting quirks that allow banks to write down much less bad debt -- about 20% less -- than they actually have:

"Outsize losses reported last week by Citigroup Inc. and Merrill Lynch & Co. could have been a lot worse except for a quirk in the way companies account for different types of securities.

Citigroup took $15 billion in write-downs and credit charges, leading the big bank to report a first-quarter loss of $5.1 billion. But $2.3 billion in other write-downs didn't hit the company's income statement.

The same was true at Merrill. The broker had $6.6 billion in write-downs, leading to a loss of $1.9 billion. But Merrill took at least $3.1 billion in other write-downs that didn't count toward its loss."

Best of all, its all legal according to the accounting rules:

"So, where did those other charges go? Into a special bucket in shareholders' equity called "other comprehensive income." The beauty of this bucket is the charges land on the balance sheet, but don't dent the companies' bottom line.

It all gets down to how a company classifies a security. A company can say it plans to hold a security until it matures, that it is available for sale or that it is being actively traded. Securities being held to maturity are held at their original cost and their value is written down only if they are deemed to be impaired. Securities that are traded are always marked to market, and gains or losses immediately hit profit.

The available-for-sale category is a middle ground in which the value of the securities is written down or up depending on market prices, but the loss or gain ends up in the "other comprehensive income" bucket. It stays there until the change in value is considered more permanent. At that point, a company finally takes the losses out of the bucket, and they hit the bottom line.

How much worse the balance sheets of the major banks and brokerages will get before the credit crunch is fully behind us is still anyone's guess. Those of you who have been trading the beaten up banks best be nimble enough to reverse course if another leg down starts.

As to BoE, their announcement today of a plan to swap about "50 billion pounds ($100 billion) of government bonds for mortgage-backed securities to lower credit costs" shows the global impact of the credit crunch remains unabated:

The plan will "unfreeze the situation we've got at the moment,'' Chancellor of the Exchequer Alistair Darling said yesterday in an interview with the BBC, without specifying how much would be made available. "What the Bank of England will do is, in effect, lend the banks that money. In the meantime, the Bank of England will take a security.''

Prime Minister Gordon Brown's government is trying to encourage lending after a surge in borrowing costs prompted banks to withdraw their best mortgage offers, threatening to exacerbate the worst housing downturn since 1992. The plan is a change of approach by the Bank of England after three interest-rate cuts since December failed to ease the logjam."

Some people have been calling the banks an opportunity of a lifetime. I am far less sanguine about the sector over the intermediate and longer term. This remains a troubled sector, with its losses not fully realized yet.

Related:
Credit crisis a "global calamity"--Kaufman
John Parry
Reuters, Fri Apr 18, 2008 11:40am EDT http://www.reuters.com/article/ousiv/idUSN1845613820080418

Sources:
A Way Charges Stay Off Bottom Line
DAVID REILLY
WSJ, April 21, 2008; Page C1
http://online.wsj.com/article/SB120873768772029985.html

Bank of England Will Unveil Swap to Ease Home Lending
John Fraher and Gonzalo Vina
Bloomberg, April 21 2008
http://www.bloomberg.com/apps/news?pid=20601087&sid=a1Xcc.MQyy.g&

Fear of Missing A Rally

Friday, April 18, 2008 | 02:15 PM

A friend who is a fund manager asked me the following question today: What's the greater fear, missing a rally, or owning equities that go down?

Today's rip-roarin expiration day market rally might help answer that question. The fear of missing the rally certainly appears to be the much greater sin -- at least to most professional managers today.

Now consider this interesting variation (This one should definitely get the attention of trend followers).

John Roque -- the very smart technical analyst for Natixis Bleichroeder -- John relates how he continues to hear on CNBC and from clients that “financials are cheap…we’re doing selective buying.” Or, “We’re buying financials down here. They’ve been destroyed.” Or, “The financials are raising capital and getting the deals done. The worst is over. We’re buying some good ones.”

Now, compare that attitude with typical investor interest/sentiment about oil, food commodities, or natural resource stocks. Extended! Overbought! Driven by speculation!

So if you are looking for a true contrary trade, which do you choose:

- The one in a long-term uptrend with no sign of any technical weakness, widely disbelieved the whole way up?

- Or, do you go for the relentlessly beat up, long term down trend -- the one if you are buying here, you are merely guessing the worst is over.

Thanks to John Roque of Natixis Bleichroeder, here's the relative Market Cap of S&P Energy versus S&P Financials:

courtesy of Natixis Bleichroeder

Word of the Day: homedebtor

Thursday, April 17, 2008 | 02:00 PM

in Credit | Real Estate

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homedebtor n. A homeowner with an extremely large mortgage, particularly one that he or she is unlikely to ever pay off.

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Unfortunately, for many people the word homedebtor is a more accurate word than homeowner. It refers to those people who are living in houses with "no skin in the game," little or no equity, and a mortgage they are not likely to repay, and may possibly not be able to afford.

Homedebtor (a.k.a. "recent homebuyer") is alsi defined thusly: Perpetual debtor/serf who will probably never own the home outright, thanks to cyclical refinancing (used to fund conspicuous consumption) and property taxes. —Patrick Killelea, "Housing Bubble Glossary," Patrick.net, August 12, 2005
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In the end, millions of homedebtors will lose their homes, the homes they told everyone they "owned", the homes everyone told them would "be a great investment".
—Bruce D. Stewart, "US foreclosure rate soars 43%," belairhomesforsale.com, November 2, 2006

Source:
Homedebtor
WordSpy, April 16, 2008
http://www.wordspy.com/words/homedebtor.asp

Kryptonite Caused GE's Miss

Thursday, April 17, 2008 | 07:26 AM

in Corporate Management | Credit | Derivatives | Earnings

The sub-prime problem is Kryptonite to GE.

I'll get to that in a minute, but before I do, a brief review. Last week, I questioned CNBC's embarrassingly softball interview of GE CEO Jeff Immelt. As noted, it would have behooved Immelt to demand his reporters ask him tough questions in order to protect the NBC/CNBC brand.

I suggested ordering the anchors not to go soft on him: "I expect you to maintain our reputation as the pre-eminent business news channel, and if you are too soft on me, it costs the company its reputation. Ask me tough questions. Raise difficult issues. Challenge me as if this were 60 Minutes. Anyone who pulls their punches or throws me a softball question is fired."

That did not happen.

Now, less than a week later, both the WSJ and the NYT are questioning GE's strategies. And even more intriguingly, analysts are rethinking their decade of unswerving support about this whole industrial conglomerate thingie.

As is so often the case, many of the fundie guys completely miss the point. They seem to barely get just why GE missed so badly this quarter. Even worse, they misunderstand how GE was such a wonderfully consistent and predictable beat-by-a-penny machine for so long.

The answer to both of these issues can be summed up in two words: GE Capital.

Over the years, GE Capital was this wonderful black box straight from planet Krypton. It had super powers under the Earth's yellow sun that other merely mortal companies did not. Jack Welch played the role of Superman, with an ability to make this enormous global conglomerate meet or beat every quarter, regardless of economic conditions. His unearthly powers were unmatched by other companies.

Transparency? Ha! No analyst ever really knew what was going on in there. It was a highly leveraged hedge fund, but that never really mattered, just so long as GE kept up the illusion that these profits were the result of ordinary industrial -- rather than leveraged financial -- operations.

Unfortunately for Immelt, he is facing not just a run of the mill domestic slowdown, but a much more important problem for GE: The credit crunch and subprime debacle. This has hamstrung GE Capital's ability to pull a penny or two out as necessary.

In other words, sub-prime is Kryptonite to GE. Not only has it lost its ability to fly and repel bullets -- i.e., beat every quarter, regardless -- but it actually weighed the company's earnings down with its losses.

Jack Welch went on CNBC yesterday, and again today, to defend the GE conglomerate model; it was a futile effort to those who know how GE managed their earnings for so many years during the Welch regime. His appearance only served to remind viewers of how wonderful life was when Jack's magic black box had all its superpowers. Even worse, Immelt is stuck with a superhero -- but no superpowers.

GE Capital has been exposed to Kryptonite, and as everyone knows, when exposed to particles of its home planet, Superman becomes powerless.

As has GE Capital. . .

Previously:
Surprise: Gee! No, G.E.
http://bigpicture.typepad.com/comments/2008/04/gee-no-ge.html

Sources:
G.E.’s Shortfall Calls Credibility Into Question
NELSON D. SCHWARTZ and CLAUDIA H. DEUTSCH
NYT, April 17, 2008
http://www.nytimes.com/2008/04/17/business/17electric.html

Embattled GE CEO Defends Strategy
Immelt Scolded By Welch on TV; Appliance Sale?
KATHRYN KRANHOLD and CAROL HYMOWITZ
WSJ, April 17, 2008; Page A1
http://online.wsj.com/article/SB120839179207621423.html

Could the US Lose its Triple AAA Credit Rating?

Tuesday, April 15, 2008 | 12:30 PM

in Credit | Fixed Income/Interest Rates | Politics

That's the issue raised by a S&P report on government-sponsored enterprises (GSEs) -- Fannie Mae (FNM), Freddie Mac (FRE) & Sallie Mae (SLM)

The performance of government-sponsored enterprises like Fannie Mae and Freddie Mac could have a direct impact on the national economy and, more importantly, U.S. credit standing.

So-called GSEs enjoy implicit government guarantees and could cause the U.S. to lose its sterling triple-A rating if the government were forced to come to their rescue, Standard & Poor's said in a report Monday.

"Even though...credit damage from GSEs is unlikely, the greater risk to the U.S. lies with them than with broker-dealers," the report noted. . . . While this credit crunch has hurt financial markets, S&P notes that it hasn't threatened the standing of the nation's credit quality upon which U.S. Treasurys and debt priced off this government debt depend. But should a protracted recession cause Fannie and Freddie to buckle, the U.S. rating would be in danger.

To be blunt, I don't think Standard & Poor has the stones. Their original ratings on RMBS/CDOs shows they are a pay-for-play institution, and their cowardly refusal to downgrade the ~~mono~~ duolines is further proof of their cowardice.

They wouldn't/couldn't downgrade Treasuries, as it would cost the U.S. government so much more in financing costs as to cause a depression -- estimates are for between 1-1.5 trillion dollars.

Source:
Fannie, Freddie Could Hurt U.S. Credit
PRABHA NATARAJAN
April 15, 2008; Page C2
http://online.wsj.com/article/SB120818189112412691.html

How Greenspan & Bernanke Invalidated Friedman

Monday, April 14, 2008 | 03:01 PM

in Credit | Derivatives | Economy | Politics

Hedge fund manager Scott Frew is a friend and occasional fishing partner. He had a few words to say about this morning's discussion re: Volcker and Bernanke:

I wanted to flesh out some of what Barry wrote earlier about former and current Fed Chairs Volcker and Bernanke. We must begin with Bernake’s now infamous Deflation speech. It is certainly “The Speech.” And I think in many ways it’s a terrifying document.

I am, by the way, in total agreement that Greenspan’s the guy who’s responsible for all of this; the particularly insidious quality of bubbles is that once you’re in one, the future is more or less pre-ordained.

An ironic corollary of that thought is that it pretty much invalidates the entire, mainstream (most certainly including Bernanke and Greeenspan), Milton Friedman-inspired critique/view of the Great Depression as having resulted from bad monetary policy on the part of the Fed as the bubble burst. They needed, according to that critique, to be much looser than they were, and all the problems would have been avoided.

So, in a sense, Bernanke’s an acolyte of that same church (recall him saying to Friedman, at some dinner or something honoring him, Never again; i.e., as a result of the lessons learned, taught by Friedman, the central bank would never repeat those Depression errors,), can’t fall back himself on a “It’s Greenspan’s fault” defense, because that’s antithetical to their whole view of history.

I see The Speech itself as a terrifying document, although it’s also an absolute blueprint for what’s going on today -- you’ve got to give Ben credit for foresight; he’s running down the checklist he provided there, item by item, line by line. Too bad none of it’s working, at least to date, but instead is exacerbating the problems.

Continue reading "How Greenspan & Bernanke Invalidated Friedman"

Chart of the Day: Spreads Relative to Historical Highs

Monday, April 14, 2008 | 11:45 AM

in Credit | Derivatives | Economy

Interesting chart via a recent IMF report:

The chart above comes from Gary E., who also sends along this commentary:

Angel Gurria, Mexico's external debt negotiator in the 1980's and -90's and later Finance and Foreign Minister, (now Secretary-General of the OECD) used to take a beating from the arrogant bankers he was forced to sit across the table with. Wow, the tide turned! Now the banks are begging the governments they once called "deadbeats" for capital. Beware, my emerging market friends, once (or maybe if) the G7 christens their 'inflation fighting aircraft carrier', the tide will turn.

Not unlike the 1970's, EM is almost purely an inflation trade. And have you seen Eastern Europe's current account deficits? Bulgaria's 21 percent of GDP CA deficit financed by foreign real estate speculators? Nevertheless, look at how the trade of buying historical highs and selling historical lows has paid.

Angel Gurria must be laughing now - about "20-year old traders in tennis shoes."

Source:
Spreads relative to historical highs
January 2008
http://www.imf.org/external/pubs/ft/gfsr/2008/01/pdf/chap1.pdf

Must See TV: Volcker's Speech on Financial Crises

Monday, April 14, 2008 | 04:47 AM

in Credit | Derivatives | Federal Reserve

Paul A. Volcker on the credit crisis, Greenspan, Bernanke, etc.

The rest of the speech touches on Bear Stearns, the Fed's Mandate, past and present Fed chairs, etc.

Volcker: Economic Club of NY Speech Part 2

Volcker: Economic Club of NY Speech Part 3

Volcker: Economic Club of NY Speech Part 4

Volcker: Economic Club of NY Speech Part 5

Thanks to RemiG2006 for uploading these clips.

Our Ass-Backwards Banking System

Sunday, April 13, 2008 | 08:19 AM

in Credit | Economy | Real Estate

As the credit crunch metastasizes its way through the financial system, its worth recalling its simple origins: The lending of money to people who could not afford to pay it back. That error was then compounded, by failing to maintain security for loans by traditional metrics, i.e., insufficient loan-to-value (LTV) measures.

The banking sector's solution to this problem? Cancel loans to the most credit worthy borrowers, including those whose loan-to-value exceeds traditional historical requirements.

Such was today's shocker, as examined in Gretchen Morgenson's column in the Sunday Times:

"The latest example of this is in the mass freezing of home equity lines of credit going on across the country. Reeling from losses on their wretched loan decisions of recent years, lenders are preventing borrowers with pristine credit and significant equity in their homes from tapping into credit lines that they paid dearly to secure.

In the last 30 days, lenders have sent several hundred thousand letters advising borrowers that their home equity lines of credit are frozen, estimated Michael A. Kratzer, president of FeeDisclosure.com, a Web site intended to help consumers reduce fees on home loans.

Major lenders — including Washington Mutual, IndyMac Bank and the Greenpoint Mortgage Unit of Capital One — say that declining property values are prompting the decisions to cut off credit."

While it certainly is in the interest of lending institutions to be cautious with loans where home prices are falling and the LTV no longer protects them against additional loss exposure.

What of regions of the country where property values are rising?

"But these actions are being taken even in areas where property prices are rising, Mr. Kratzer said. What’s worse, the letters provide no explanation for how the lenders determined that the property values underlying the equity lines had fallen.

Frozen home equity lines will surely intensify the consumer spending downturn and put added pressure on an already weak economy. Indeed, on Friday, consumer confidence as measured by the University of Michigan plummeted to its lowest level since 1982. The drop was attributed mostly to higher fuel and food costs, but consumers’ views on their current and expected personal financial situations dropped to their lowest readings since November 1982 and April 1980, respectively."

The timing is perfect: cutting back lending to people who can repay loans just as the economy slips below the waterline.

I should pitch that business idea as a start up to my VC friends: Getting fees from clients for providing no products or services. "And, as you can see in slide 12, this model has an excellent profit margin..."

Here's the sickest part of the entire affair: Borrowers with an excellent credit rating will see their FICO score dinged when their home equity line is frozen. Why? When a lender suddenly caps a $50,000 line at $25,000, it appears that the borrower tapped out the entire amount of the loan. This reduces their score.

The lawyers are -- rightfully -- gonna have a field day with this one!

UPDATE: April 13, 2008 1:31pm

Calculated Risk has a very different read on this: HELOC Nonsense (I'm not sure which offends Tanta more -- the journalistic or banking aspects of this story).

Source:
You Thought You Had an Equity Line
Gretchen Morgenson
NYT, April 13, 2008
http://www.nytimes.com/2008/04/13/business/13gret.html