Housing Lenders Fear Bigger Wave of Loan Defaults
By VIKAS BAJAJ Homeowners with good credit are falling behind on their payments in growing numbers, just as the problems with subprime mortgages have begun to level off.

• Times Topics: Mortgages and the Markets | Banks and Banking
• Mortgage Troubles Spread

Who's to blame for this credit mess? A trio of theories
Minneapolis Star Tribune - Minneapolis,MN,USA
Economic depression may then follow." Elliott and Atkinson go so far as to speculate about a crisis prompted by attacks on Iran's nuclear facilities and ...
See all stories on this topic

Bank Withdrawals 2008 Style





Posted On: Sunday, August 03, 2008, 3:18:00 AM EST

Graduates' Frustrating Job Hunts: As Economy Slows, the Class of 2008 Struggles to Break Into a Tough Market (Post, August 3, 2008; Page F01)

The Bubble
In a three-part series on the U.S. housing bust, Washington Post reporters Alec Klein and Zachary A. Goldfarb explore the roots of the credit crisis.

A Shock to the Collective Psyche: Bad News and Bank Runs - by Mike Whitney - 2008-08-03

Deutsche Bank Writedowns Exceed $11 Billion - 2008-08-02

New Wave Coming:
"Subprime Was The Tip Of The Iceberg"

Planned Layoffs Rise In July
Quick Read

Economic Woes Are Mounting Across America
Quick Read

Hedge Funds' Year Gets Worse
Quick Read

The Bear's Lair, by Martin Hutchinson

The collapse of consumer spending
August 04, 2008 The Gross Domestic Product and employment figures released Thursday and Friday appeared at first sight to show a US economy that had returned to a measure of stability. However when examined more closely they painted a much darker picture, of an economy in which a sharp decline in retail spending is likely to cause substantial overall economic contraction over the next several quarters.

Second quarter GDP, announced Thursday, came in at 1.9% growth, which at first sight is an un-alarming number. However, it is questionable both what quarterly GDP measures, and whether it measures it accurately. In 2006-08, according to this month’s figures, three quarters of sub-par growth averaging 0.8% (recessionary given 1% US population growth) were followed by two quarters of enthusiastic 4.8% growth, which have now been followed by another three quarters of growth averaging 0.8%. During the two quarters of enthusiastic expansion in mid-2007, the largest credit crisis in decades exploded. Certainly, nobody noticed this expansion at the time.

The reality is that the current expansion in GDP is caused almost entirely by the inexorable expansion of government and a modest rebound of exports, led by the weak dollar, from their previous abysmally low levels. Real federal government consumption rose 6.7% during the quarter and real exports rose 9.2%. Meanwhile personal consumption rose only 1.5% in real terms, even though real personal income rose over 4%, all of which was accounted for by the $150 billion tax rebates, the great bulk of which arrived during the quarter.

The unemployment figurer announced Friday was equally pregnant with meaning. The market welcomed it, as the job total declined only 51,000, but the real situation was demonstrated by the unemployment rate, which rose to 5.7%. While a job loss rate of 50,000-70,000 per month is not extreme, the fact remains that this is the seventh successive month of such declines, during which the employment total has risen by over 500,000, in a country where because of population growth around 150,000 jobs should be created each month to keep the employment percentage stable.

Not every factor in the US economy is negative. House prices nationwide are probably now nearer their bottom than their peak, helped by the huge amounts of money the Fed has pumped into the system. The Case-Shiller house price index announced last week was treated by the market as yet another negative, but in fact the monthly rate of decline lessened, suggesting that the “second derivative” of house prices had turned positive. With prices already down over 20% nationwide, it seems reasonable to assume that we are more than halfway to the bottom – a total drop of 40% would not be consistent with gradually rising nominal incomes and continued low interest rates. Of course, once interest rates are raised to a more reasonable level, say 2-3% above the current inflation rate of about 7%, house prices will undergo a further decline, but that will be cushioned by the inflation itself. Nevertheless, the drag on the economy that housing has formed will lessen over the next year, if only because housing has become a smaller share of output.

The more difficult assessment is how much construction redundancy has still to be shaken out. Most of the larger homebuilding companies accumulated so much fat in the good years that they are not yet in true financial difficulty. Furthermore, the commercial building sector was strong until the end of last year, and so has as yet lost relatively few jobs. Hence, while 550,000 jobs have been lost in the construction sector since the peak, we are likely still to be closer to the top than the bottom in terms of job losses, with multiple major bankruptcies of construction companies and massive redundancies still to come.

Exports also will probably continue to be a positive factor in economic growth, at least while interest rates remain low and the dollar weak. However, US exports tend not to be very labor-intensive, so expansion in the export sector does not produce much additional employment, at least relative to the decline in construction employment. Moreover, the collapse of the Doha round of trade talks suggests that the world is swinging towards protectionism, so that the growth in trade as a percentage of world GDP that we have seen in the last several decades will at least temporarily halt or even reverse. Thus while higher global interest rates and slower growth in the US and worldwide are likely to continue narrowing the US payments deficit, it is not at all clear that they will do so by increasing US exports rather than by reducing imports. The export sector cannot therefore be relied upon for much in the way of additional employment.

While the effect of the housing recession may in some respects lessen in the months ahead, difficulties in the automobile industry seem likely to become more severe. General Motors’ second quarter loss, reported Friday, of $11 per share is truly alarming for a company whose share price is currently only $10. Ford and Chrysler are in similar difficulties; it would seem that none of the US “Big Three” have sufficient resources to survive a recession lasting beyond the end of 2009. Should the US-owned automobile industry declare bankruptcy, it would doubtless be bailed out by the US taxpayer like everything else, but the effect on business confidence would be severe. In any case, the redundancies caused by even a partial closure of US automobile manufacturing facilities would themselves add very substantially to unemployment, with older workers being particularly badly affected.

There thus remain two vortices sucking the US economy into a pit of depression: employment and retail spending. While output rises so sluggishly and all sectors involved with real estate continue to shed jobs at a rapid rate, it seems unlikely that the US can create significant jobs overall. Hence whether or not there is an official “recession” by the eccentric GDP figures, unemployment will continue to rise. Since the peak unemployment rate was 6.3% in the 2001-02 recession, it is almost certain that the unemployment rate this time will rise beyond that level (unemployment is, after all, a lagging indicator of economic activity.) The peak in 1990-92 was 7.8%; a rise beyond that level is by no means out of the question, although the peak unemployment rate in the 1980-82 recession of 10.8% will probably remain unchallenged unless the US-owned automobile industry is allowed to disappear altogether. Nevertheless even a rise in the unemployment rate to 8%, historically a fairly mildly recessionary level, will cause a huge amount of heartburn among a US working population that has seen nothing like it in more than a generation.

Even more of a downdraft will be provided by retail sales. These have been weak even in a period when they have been subsidized by Uncle Sam. Uncle Sam’s wallet is now empty (or, more properly, his banks have taken to making incessant whining phonecalls during mealtimes). Hence retail sales will be exposed to the full force of the current economic situation, which for them is dire indeed.

· First, the decline in house prices and the tightening in lending standards have eliminated for homeowners the possibility of a mortgage refinancing that can be spent on goodies. The decline in home sales has also removed the desire for monstrous and unnecessary home improvement projects, to the great detriment of Home Depot and the like.

· Second, the decline in home values and stock market prices, and the lousy stock market returns obtained since 2000 are beginning to demonstrate to the baby boomers that they are grossly ill-prepared for retirement. This has been true for a decade or more, but the specter of old age is looming ever closer as the largest bulge cohorts near 60. All across America, aging baby boomers are resolving to lead lives of austerity and saving, hopefully with more chance of success than their diet resolutions.

· Third, to the extent redundancies occur in declining industries such as automobile manufacturing, they will be concentrated in the older cohort of workers, who are much less prepared for them than were their depression-reared parents a generation ago. The revival of export industries may offset this to some extent for those blue collar baby boomers who have managed to hang onto jobs in the right manufacturing exporters.

· Fourth, since returns on saving are so poor, the amounts that must be saved in order to meet retirement or other goals will be substantially greater than expected. Again, this will hit retail sales.

· Finally, much of the retail sales ebullience of recent years derived from the top 1% of income-earners, whose share of national income rose enormously during the loose-money period since 1994. Since these people were earning far more than they had ever expected, and saw no reason why their earnings should ever decline, they saved very little, preferring instead to devote their resources to overpriced homes, expensive toys and bling. It now seems almost certain that their income share will revert over the next few years to around its 1994 level, little more than half its level in 2006. Over the last year, they have covered their “needs” by increasing debt; over the years ahead their resources will of necessity be devoted to debt repayment and saving, causing an icy winter in the luxury goods sectors of the economy.

The gradual increase in unemployment and decrease in real estate and equity values will be important drags on the economy even while interest rates remain at their current low levels. Needless to say, the resurgence in inflation to which negative real interest rates are already leading will eventually force interest rates to be raised, as I discussed two weeks ago. When that happens, the unemployment effect will be significant, as over-borrowed private equity-controlled companies will find themselves unable to survive. Conversely, the retail sales effect may be somewhat mitigated, as consumers find they can meet their savings goals more easily in an environment where they are at last granted a positive real return on the amounts they save. Stock market and real estate investments may still disappoint, but at least bank deposits and short term investments will provide a real return much higher than has been customary, restoring some equilibrium to the financial positions of the US public.

While the market is already aware of the gradual increase in unemployment, it has not yet taken into account the effect of the recession on retail sales. Hence we can expect sharp reactions as the full extent of the retail downturn is revealed. Retail sales figures, not GDP, interest rates or employment, are now the economic numbers to watch.


-0-
(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
--
Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005) -- details can be found on the Web site www.greatconservatives.com

http://www.prudentbear.com/index.php/BearsLair

Unlikely it's different this time
August 04, 2008 Bob Hoye is a market historian and editor of Institutional Advisors, a provider of research to financial institutions, mining, and petroleum companies internationally at www.insitutionaladvisors.com.


Some have asked why we dwell so much upon the probability of things going wrong.

This contrasts with the Wall Street consensus that policymakers are well-informed and wise in judgment. That is reasonable in a world of normal growth and normal business cycles. On the latter when a recession happened it was always deemed as a policy "overshoot" with too much stimulation during the boom, and without a breath of irony, the recession was a result of an "overshoot" on attempting to temper inflation at the top.

For those who have been active in research for over six such business cycles this is tedious nonsense. The marketplace sets the peaks and troughs of the business cycle and all that intervention does is exaggerate the rate of currency depreciation on the way up the booms. Without deliberate depreciation the business cycle would continue much as it has with reliable documentation back to the early 1500s.

This record also includes two centuries of chronic depreciation--the hundred years ending in the early 1600s and the hundred years, perhaps ending in the first part of this century. The end of each such century was marked by a bitter struggle between authoritarian government with its clamoring clientele and the productive portion of the public. Persuasions have ranged from the "Genius of the Emperor" in Roman times, the "infallibility" of the Vatican when it was power mad in the 1500s and the "genius" of the Politburo until the 1980s and in the West, of central banking, until recent.

According to textbook nostrums this credit contraction should not only not be happening, but it shouldn't be so violently encompassing. The problem is that the revered "lender of last resort" has been on a bender of last resort. Moreover, recklessness was built in with the notion that manipulating interest rates and currency depreciation would always be beneficial. Both theory and practice have been reckless, but the belief in the system accumulated to the point that with such perfection there was no risk and participants leveraged up accordingly. The unwinding of unsupportable positions has been ugly and if the past continues to guide, it is not over yet.

However, there is something policymakers could do to end the contraction right now. All they have to do is get all participants in the credit markets to behave as recklessly as they were two years ago. This, of course, is impossible now that the street has discovered risk. Eventually the public will discover just who have been the real agents of risk all along.

It will take some time and a lot of pain before the public demands un-manipulated currency.

In the meantime, its timely to review our approach. The inverted yield curve indicated the boom was on and it was likely to reverse to steepening last May-June. It did in such a convincing manner that in that fateful July we concluded that "The greatest train wreck in the history of credit" had begun. This would be a "new" paradigm to those unfamiliar to the violent history of credit.

Within those who are familiar with credit is the Austrian School and from around March to August we ran "The Dearth Of Credit" by von Mises about three times. The nub of this piece is that for a contraction to occur bankers need not call loans--just become a little concerned and stop making them.

Wednesday's WSJ reported: "Developer John Thomas says he had nearly finished building a 222-unit condominium and hotel project in California, when his lender wouldn't release the final $6 million from his $40 million construction loan.". This seems to fit the recipe.

This contraction seems to be fitting Austrian School theories, as well as the model provided by five previous outstanding eras of asset inflations since the first big one in 1720.

Once a mania goes through the period of soaring prices against the inverted curve and then the curve reverses to steepening there is no record of the senior central bank preventing a severe contraction. Maybe, as the saying goes, "this time it is going to be different". Doubtful.

http://www.prudentbear.com/index.php/GuestCommentary

WASHINGTON (MarketWatch) -- The windfall of cash from Washington in June got eaten up by the worst inflation in nearly three years, Commerce Department data showed Monday. Nominal spending grew 0.6% on the month, but the increase was all due to higher prices, which spiked 0.8%. Adjusted for inflation, June's real spending fell 0.2%, the first decline since February. Real consumer spending is up just 1.2% from a year ago, the weakest performance during this business cycle. "Despite the fiscal stimulus, consumers are starting to pull back under the weight of tight credit, falling home values and a weakening labor market," wrote Michelle Meyer, an economist for Lehman Bros. "We expect this trend to continue." Consumption will probably only rise at a 0.5% annual rate in the second half of the year, said Harm Bandholz, an economist for UniCredit Markets. "Soaring inflation, notably higher food and energy prices, has eaten up part of the fiscal payments." The impact of the tax rebates on personal incomes was reduced in June: After getting $48.1 billion from the government in May, individuals received $27.9 billion. Personal incomes rose 0.1% after a 1.8% surge in May. Economists surveyed by MarketWatch had been looking for nominal spending to rise 0.5% and incomes to fall 0.1%. See Economic Calendar. Real disposable incomes fell 2.6% in June, reversing gears after a 5.2% gain in May. Congress approved some $110 billion in tax rebates in order to boost the flagging economy. It appears that consumers are spending some of the money, but much is being saved, at least for a while, as the personal savings rate jumped to 4.9% in May and 2.5% in June. Inflation surged in June. The personal consumption expenditure price index rose 0.8% compared with May, the most since Hurricane Katrina hit in September 2005. Moreover, inflation's up 4.1% in the past year, the largest rate of growth in 17 years. Core prices, which exclude food and energy prices, rose 0.3% in June. The increase was as expected. Core prices thus are up 2.3% on a year-over-year basis, significantly higher than the 2% ceiling the Federal Reserve would like to see. Details Monday's data are likely to have little impact on the Federal Open Market Committee's meeting on Tuesday. The Fed seems committed to keeping its interest-rate target steady at 2%, in an effort to balance the risks of a more severe economic slump against the risks that inflation could get out of hand. The June income and spending report highlights both sets of risks in bold letters. Real spending on durable goods fell 1.6%, the biggest drop in a year, while real spending on nondurable goods slipped 0.4%. Real spending on services rose 0.2%. Income from employee compensation rose 0.2%, while proprietors' income increased 0.6% and rental incomes rose 14.2%. Transfer payments fell 1.1% as income from assets dipped 0.2%. Rex Nutting is Washington bureau chief of MarketWatch.

Yes, That's $2 Trillion of Debt-Related Losses
Barron's -
So far, this latter-day prophet of doom has been on the mark, though time will tell about the recession part. A Turkish native who grew up in Italy, ...
Nouriel Roubini InvestmentNews
Hundreds of banks will fail, Roubini tells Barron's Reuters
all 16 news articles »

Repel The Calls To Contain Competitive Markets - Alan Greenspan, FT
The Risk of Conceding Recession - John Hussman, Hussman Funds
'Leveraged Bailout' Won't End Mortgage Madness - J. Wasik, Bloomberg
Bottom-Fishing Among Financials - Robert Lenzner, Forbes
Yes, That's $2 Trillion of Debt-Related Losses - R. Blumenthal, Barron's

Messages from Merrill’s Misfortunes

By Vincent R. Reinhart Tuesday, August 5, 2008

Filed under: Economic Policy
Last week’s big announcement by a Wall Street investment giant contains dark warnings about our economic future.

The business shows turned up the volume last week when investment giant Merrill Lynch announced write-downs of asset values and its intention to raise equity capital. Such a story can easily pass by the general public, as it involves the alphabet soup of high finance. Beneath the dollar signs, however, are dark warnings about our country’s economic future. Merrill’s announcement teaches lessons that are important for everyone, even those whose favorite acronym about business finance is MEGO (“my eyes glaze over”).

The U.S. financial sector is in the process of absorbing a large economic loss. As a country, America simply built too many houses. The bubble was inflated by governmental encouragement of home ownership, accommodative interest rates, and outsized expectations of capital gains on properties. When the scope of this excess became evident a year ago, house prices started falling. Capital losses and the dashed hopes of getting rich quick convinced some borrowers to walk away from their mortgages. That is the basic economic loss.

But there is more. Mortgages are the raw material of finance, serving as the collateral backing for a variety of securities. When the value of this collateral goes down as more and more mortgages slip into default, so too does the value of those securities. Indeed, the price decline exceeds the economic loss associated with elevated defaults.

We must accept the fact that our national economy is hostage to the financial system.

Merrill’s announcement indicates the scope of these losses. The firm recognized that a significant portion of securities backed by loans and other assets nominally valued at $30 billion had gone up in smoke, which is why it sold them to a private investor for 22 cents on the dollar. Acceptance is part of the grieving process. But not all firms are as far along in that process. Merrill had valued those securities at 40 cents on the dollar in its second-quarter financial statement, issued just one month ago.

How could this happen? Mortgage-related securities can be complicated, and their values are often approximated by financial models rather than measured in markets. Indeed, fear has dried up the market for many such structured obligations, increasing the reliance on approximations in pricing. And with the application of judgment comes differences in accounting, both across firms and over time.

Merrill’s travails reveal yet another key lesson about financial markets: even though a large financial institution holds complicated instruments, managers do not always control the balance sheet; sometimes it controls them.

This can be seen in the criticism now being leveled against John Thain, Merrill’s chief executive. As recently as July 17th, Thain told the investing public that “we believe that we are in a very comfortable spot in terms of our capital.” Less than two weeks later, Merrill was raising another $8.5 billion of capital. It is unlikely that Thain was intentionally misleading people, and more likely that his comfort spot turned hot in a hurry.

As the Merrill episode suggests, there are still significant mortgage-related losses that have yet to be recognized, spread across financial firms that are exposed to the U.S. real estate market. Many of those firms have had a hard time calculating the full extent of their plight. Others are using the discretion provided by accounting rules to delay recognition of the problem.

Until those financial firms admit their losses and find new capital, they will exist in a state of financial limbo. They will be suspicious of firms known to have similar problems; and those firms, in turn, will be suspicious of them. All of these companies will be tentative in supporting markets and making new commitments. Private borrowing rates will remain elevated, new loans will be hard to get, and economic expansion will be hindered.

Perhaps more firms will follow Merrill’s path and seek to raise new capital. But aggregate financial losses may wind up dwarfing private-sector resources. In that case, the health of the U.S. economy may require an injection of government funds into the financial sector. One lesson of the savings-and-loan debacle of the late 1980s—and also a lesson of banking crises worldwide—is that delaying such a government capital injection will raise the overall tab. With federal resources already stretched thin and many national priorities unfulfilled, the idea of sinking still more money into large financial firms seems distasteful. But we must accept the fact that our national economy is hostage to the financial system.

Indeed, financial bailout packages may have to take precedence over grand new spending programs and further tax cuts. Our elected officials should be considering how to engineer those bailouts at the lowest possible cost, how to avoid setting bad precedents, and how to prevent the need for such bailouts in the future.

Vincent R. Reinhart, former director of monetary affairs at the Federal Reserve Board, is a resident scholar at the American Enterprise Institute.
http://www.american.com/archive/2008/july-...19s-misfortunes

Unsafe Havens
U.S. money market funds have invested $11 billion in subprime debt, much of it managed by Bear Stearns.

By David Evans
Bloomberg Markets October 2007


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.

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.

"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.

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."

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.

"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 fastest-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.

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.

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.

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.

"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 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.

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.

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.

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.

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.

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.

"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."

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 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.

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.

"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.

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.

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 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.

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.


http://www.bloomberg.com/news/marketsmag/mm_1007_story2.html

BUSINESS | August 5, 2008
Inflation Takes Steam Out of Rise in Spending
By CATHERINE RAMPELL (NYT) News
Consumer spending increased 0.6 percent in June, but prices rose 0.8 percent, the government reported, indicating months of challenges to come. OPINION | August 4, 2008
OP-ED COLUMNIST; A Slow-Mo Meltdown
By PAUL KRUGMAN (NYT) Op-Ed
Even a slow-mo economic crisis can do a lot of damage if it goes on for a year and counting.

NEW YORK REGION | August 4, 2008
Experts See Albany Ills as Problem, Not Crisis
By DANNY HAKIM (NYT) News
Few budget analysts consider New York’s fiscal situation an emergency, but they do worry that global economic gloom could cause the state’s outlook to worsen considerably.

BUSINESS | August 3, 2008
STRATEGIES; The Stars Have Yet to Align for Stocks
By MARK HULBERT (NYT) News
The rally that began three weeks ago is fully supported by investor sentiment and not by fundamentals, suggesting that the bottom of this bear market has not yet been reached.

Holding Back the Flood


The fiction of corporate transparency


Housing Lenders Fear Bigger Wave of Loan Defaults


A Slow-Mo Meltdown

How Low Will Housing Market Go? Much Lower, Say Experts
Quick Read

Henry Paulson
has lost control
US Treasury Secretary Henry Paulsons claims that the US's banking system is sound - a remarkable description when the debts of "the only functioning part of the home loan market" are greater than its assets. The country's middle-class and blue-collar workers have a better grasp on reality. - F William Engdahl

The woman who called Wall Street's meltdown
Star bank analyst Meredith Whitney says the economy is about to sink into a deep recession.By Jon Birger, senior writerLast Updated: August 4, 2008: 11:53 AM EDT
"I feel like I'm at the epicenter of the worst financial crisis in history," says Meredith Whitney, at home in New York City. Whitney, in Central Park, where she often runs, made her name with accurate predictions of losses and write-downs. Whitney met her husband, pro wrestling star John Layfield, when they were both talking stocks on Fox News. Whitney, in a luxury box, watches the wrestling action at the WWE's Great American Bash at the Nassau Coliseum in July.
(Fortune Magazine) --

It's the first time I've seen Wall Street's toughest analyst look rattled. I'm sitting ringside at the WWE's Great American Bash at New York's Nassau Coliseum with Meredith Whitney - the Oppenheimer & Co. analyst renowned for her smackdowns of America's biggest banks. Though she and I are there to see her husband, pro wrestling star John Layfield ("JBL"), the evening's most compelling match turns out to be not Layfield's but a brutal-looking showdown between rivals Chris Jericho and Shawn Michaels. Midway through the bout, Michaels appears to suffer a bloody cut near his eye and begins stumbling around the ring as if he's just been lobotomized.

I'm more bemused than worried - every match thus far has ended with the vanquished looking broken and semiconscious. Whitney, however, is shielding her eyes. Maybe it's because her husband once sustained a cracked vertebrae during a match, but she's absolutely convinced that this time around, the semichoreographed mayhem in the WWE ring has taken a sickeningly painful turn. "No, I'm telling you, it's real," Whitney says of Michaels's injuries, which included (or so Jericho would claim) a detached retina. Or maybe not: "He's fine," WWE vice president Gary Davis would later tell me.

Good thing for investors that Whitney takes a more skeptical approach to banks than to pro wrestling. In less than a year she has transformed herself from a Wall Street backbencher - someone once known less for her research than for her marriage to Layfield and her stint as a stock commentator on Fox News - into the most influential stock analyst in America. And certainly the most bearish.

Whitney's rise to prominence began last October when she dropped jaws from New York to London with her audacious (yet spot on) prediction that Citigroup (C, Fortune 500) would be forced to cut its dividend to prop up its leaky balance sheet. She followed that call with forecasts of more losses and write-downs at the likes of Bank of America (BAC, Fortune 500), Lehman Brothers (LEH, Fortune 500), and UBS, as well as some insightful tangents on how the implosion of the bond insurers would threaten banks' bottom lines. Sometimes she seems steps ahead of management. On a Merrill Lynch conference call in mid-July, she asked CEO John Thain why the company wasn't unloading damaged assets and boosting capital. Thain demurred, but less than two weeks later, Merrill (MER, Fortune 500) did just that. It agreed to sell more than $30 billion of CDOs (collateralized debt obligations) for 22 cents on the dollar and sold stock to raise $8.5 billion in fresh capital.

Whereas her peers keep searching for some sort of light at the end of the tunnel, Whitney thinks the tunnel is about to collapse. Bank stock investors will get crushed if they jump back in now, she contends, because the banks are facing much, much bigger credit losses than what they've reported so far. Moreover, Whitney is convinced that the economy is about to sink into an "early 1980s-style" recession that will devastate the 10% of the population that became overextended during the housing boom. "It feels like I'm at the epicenter of the biggest financial crisis in history," says Whitney.

This isn't ego talking. "She definitely moves markets," says Gus Scacco, an institutional fund manager for AG Asset Management. An executive with a top hedge fund goes so far as to compare Whitney's influence to that of former Goldman Sachs chief strategist Abby Joseph Cohen in the late 1990s. "It's gotten to the point," the executive says, "where Meredith can't opine or write anymore without moving stocks."

Whitney's insights haven't always translated into lucrative investment picks. Based on the performance of her buy and sell recommendations relative to her industry peer group - what analyst tracker Starmine refers to as an analyst's "industry excess return" - Whitney's stock picking ranked 1,205th out of 1,919 equity analysts last year and 919th out of 1,917 through the first half of 2008. That said, evaluating Whitney solely on the timing of her buys and sells misses the point. It's not just that she's bearish on the entire banking industry. What makes Whitney so interesting is the brutality of her arguments and the evidence she summons in making them.

Whitney warned last year - and continues to warn today - that the "incestuous" relationship between the banks and the credit-rating agencies during the real estate bubble will have a long-lasting impact on banks' ability to recover. With Moody's and Standard & Poor's now trying to make up for past wrongs, the pace of downgrades on mortgage securities shows no sign of slowing: There were $85 billion in mortgage securities downgraded in the third quarter of 2007, $237 billion in the fourth quarter, $739 billion in the first quarter of this year, and $841 billion in the second quarter of 2008.

This is a problem, because every time their portfolios are hit by significant credit downgrades, banks are forced to improve their capital ratios. Often that means issuing reams of new stock, which leads to serious dilution, something shareholders at Citi, Merrill Lynch, and Washington Mutual (WM, Fortune 500) can unhappily attest to. "You're going to have this stealth pressure on bank balance sheets until you start to see the ratio of downgrades to upgrades change," says Whitney. "It's something people don't talk about."


Obviously the financial companies she covers aren't thrilled with all the dire talk. Whitney got an earful from Wachovia (WB, Fortune 500), she says, when she downgraded the stock to "underperform" in July. Investors aren't always thrilled either. She says she's received one death threat and hundreds of abusive e-mails and phone calls. But at least now there's a grudging respect for her work. "What do you do when your biggest tormentor keeps being right?" one ex-Citigroup executive asks when queried about Whitney. "You got to give it to her - she figured it out."

Despite her unremitting bearishness, Whitney has probably never had better access to bank management. This is a bit surprising, given that being a renegade bank analyst used to be a one-way ticket to the unemployment line. (Just ask industry vets like Michael Mayo.) Nevertheless, Whitney has been landing one-on-one meetings with the likes of Bank of America CEO Ken Lewis, Merrill Lynch CFO Nelson Chai, and American Express CEO Kenneth Chenault.

Of course, a cynic might counter that it's hardly shocking that a bunch of middle-aged male bank executives would spare time for a glamorous analyst with a megawatt personality and a jock-celebrity husband. "She always had more personality than anyone else," offers former Commerce Bancorp CEO Vernon Hill.

But this explanation for Whitney's influence and access is belied by her following among money managers who treat her latest research reports like gospel. "What I like is, she's got conviction," says Scacco. "She was early, she was right, and she wasn't shy about saying it." The most recent conference call Whitney hosted for Oppenheimer's institutional clients drew as many callers - about 500 - as Exxon Mobil typically gets on its quarterly earnings calls.

Plus, as warm and engaging as Whitney can be in person, she's an utter killjoy when the conversation turns to banking and the economy. "What's ahead is much more severe than what we've seen so far," she warns a standing-room-only crowd of money managers at a May lunch meeting. Once she gets rolling, Whitney morphs into a kind of dark sage - the anti-Abby Joseph Cohen, if you will - whose doom-and-gloom views capture the prevailing mood of today's market about as perfectly as Cohen's unapologetic bullishness caught the exuberance of the late 1990s. When one shell-shocked lunchgoer presses Whitney for a glimmer of hope, she has none to offer. Asked by another money manager whether she has any doubts, Whitney concedes only one: "While my loss estimates are much more severe than those of my peers, my biggest concern is that they're way too low." That was May. By mid-July, bank stocks were down another 20%. Today, of the 14 financial stocks she covers, she rates five underperform and the rest market perform.

Just who is Meredith Whitney, and how the heck did a little-known analyst from a second-tier firm become the oracle of the bear market? The first question is simpler to answer. Whitney, 38, grew up in Bethesda, Md., one of three daughters born to Richard Whitney, a venture capitalist and onetime official in Richard Nixon's Department of Commerce (but not part of the famous Whitney clan that includes Eli and John Hay Whitney), and Barbara Gentry, an executive recruiter. She prepped at Lawrenceville, graduated from Brown University in 1992 (Whitney and I overlapped at Brown but didn't know each other), and has been working in Wall Street research pretty much ever since. Her only break from the Street was her stint at Fox's Bulls and Bears from 2003 to 2004. She took the TV gig, she says, after a noncompete with a former employer barred her from immediately accepting another analyst job.

Older sister Wendy Taylor says Meredith has always been one part workaholic and one part Ms. Popularity. It isn't an easy combo to pull off, but Whitney perfected the balancing act at a young age. Case in point: She was once the youngest paper carrier in Washington Post history, landing the job at age 8. A self-described "route baron" - she grew her earnings to $200 a week by buying up other kids' paper routes - Whitney hit on a creative way to cope with the extra workload on Sundays, when the heftier papers took longer to deliver. "I would have slumber parties on Saturday nights, so I had a work force to help me in the morning," she says. "We'd play music, and Mom would make pancakes in the morning." Did she pay her friends for their help? "No way. But they kept coming back."

Thirty years later little has changed. Whitney still works weekends but takes her fun seriously too. "I always tell people Meredith has never met a conga line she didn't lead," says Taylor, who can't visit her sister in Manhattan without being dragged out dancing till the wee hours of the morning. "She's truly larger than life."

Where does Whitney get all her energy? Exercise and (relatively) clean living, she says. She recently gave up coffee, and she works out twice a day, often under the supervision of rapper 50 Cent's personal trainer, whom she met last year at Bikini Boot Camp. (It's a fitness retreat, not a reality show. That said, Whitney's longtime friend Mary Fitzgibbon reveals that she and Whitney almost became reality-show fodder 15 years ago. A Lawrenceville buddy who was a producer for talk show host Maury Povich persuaded them to appear on a "when good girls go bad" episode. "Meredith thought it would be funny," Fitzgibbon recalls. Whitney's mom did not and talked them out of it just hours before taping. "Her mom called up and said, 'Are you girls out of your minds? You're just starting careers!'")

Whitney is fond of playing matchmaker, but she wasn't making much headway in her own personal life until she met Layfield. In addition to playing one of the WWE's most entertaining villains - he's basically the J.R. Ewing of pro wrestling - Layfield moonlights as a stock market pundit on Fox News, which is where he and Whitney first met. The relationship got off to a rocky start when Whitney mocked Layfield on air for recommending bank stocks at a time when the Fed was hiking rates. But Layfield wasn't discouraged - he's taken worse hits - and the couple married in 2005.

With most of these tales, it's the beauty who reforms the beast, not the other way around. And yes, Layfield does credit his wife for smoothing out some of his Texas-country-boy rough edges. "I know what fork to use now at the dinner table, and I drink my beer from a glass," he told the Sunday wedding section of the New York Times back in 2005. Of course, as with anything WWE-related, it's not always clear where reality ends and fable begins. Layfield didn't exactly grow up the son of a dirt farmer - his dad was CEO of a community bank - and when I ask him about the fork-and-beer story, Layfield smiles and concedes he might have been exaggerating.

Whether any of Whitney's upper-crust upbringing actually rubbed off on Layfield, it's apparent the WWE has rubbed off on Whitney. Her insider's view has given her great respect for pro wrestlers' work ethic and their willingness to lay everything on the line as performers, athletes, and stuntmen. What might have seemed risky - e.g., putting out a critical report on a sacred cow like Citi - no longer feels so dicey. "I think when you're around successful people like that, it makes you more renegade," she says.

Another eye opener for Whitney has been how gracious most wrestlers are - at least when the cameras aren't rolling - in comparison with the viper-pit culture on Wall Street. It sounds absurd - the world of high finance being less collegial than an industry in which employees belt each other in the face. But based on the time I spent backstage before the Great American Bash, Whitney has a point.

The wrestlers I met - from John Cena to Mark Henry to Paul "Big Show" Wight - all greeted Whitney like family. Henry, who plays a particularly nasty brute in the WWE story line, could not have been any nicer. For Whitney the upshot is this: She's much less inclined to take guff from Wall Streeters intent on berating her for predictions they don't like. "Life's too short," she says.

About that second question: How did Whitney go from virtual anonymity to Wall Street stardom in a matter of months? Her Citigroup call was certainly the launching pad, but Whitney's ascent didn't happen in a vacuum. Her prominence may be the best proof yet of how much the equity research game has changed since the start of the decade.

The catalyst was the settlement imposed on Wall Street in 2003 by then - New York Attorney General Eliot Spitzer, who alleged that the lure of underwriting and M&A fees was preventing analysts from giving honest appraisals of companies that were also their firms' investment-banking clients. Spitzer's solution: Erect a legal barrier that prevents analyst compensation from being tied to investment-banking revenue.

Since 2002 the percentage of ratings that are buys has fallen from 75% in 2000 to 50%, according to Starmine and Bloomberg data. The percentage of sells has risen from 1.5% to 6%. Nevertheless, it's hard to assess how much credit for this turnabout should go to the now disgraced former attorney general. The increase in sell ratings coincided with a downturn in IPOs and other stock offerings, meaning there's less for analysts to be conflicted about. "Now that corporate finance has dried up, research is freer to express its opinion," says Richard Bove, a bank analyst with Ladenburg Thalmann & Co. and a 30-year Wall Street veteran.

Another factor emboldening analysts has been the emergence of hedge funds as the biggest source of trading-commission revenue. Hedge funds crave "actionable" information, and unlike mutual fund managers, they're just as happy betting that a stock will fall as they are betting that one will rise. So, says Bove, "the analyst had better tell them what they don't like as well as what they like."

Of course, what Whitney doesn't like is just about everything these days. Her bearishness has deep roots. In fact, she was the first analyst to sound the alarm loudly about subprime mortgages, predicting back in October 2005 that there would be "unprecedented credit losses" for subprime lenders. The problem, as she saw it, was that loose lending standards and the proliferation of teaser-rate mortgage products had artificially inflated the U.S. home-ownership rate to 69% from the more natural level of 64%.

A lot of the new homeowners were in over their heads. They'd put little or no money down and thus had little incentive - and often little ability - to keep making their monthly payments when home prices started to fall and their teaser rates got bumped up. "Low equity positions in their homes, high revolving-debt balances, and high commodity prices make for the ingredients of a credit implosion, particularly at this point in the consumer cycle," Whitney wrote. That report didn't turn her into a star - though it should have - but it did land her an invitation to present her findings to the FDIC.


What Whitney didn't fully appreciate back in 2005 was how the proliferation of interest-only, negative-amortization, and other exotic mortgages would transform many prime borrowers into subprime credit risks. As she wrote last December, the crucial mistake many lenders made was relying on FICO credit scores to gauge default risk, regardless of the size of the down payment or the type of loan. Many prime customers who took on mortgages with 90% or 100% loan-to-home-value ratios (LTVs) are now "performing closer to subprime loans," she wrote. The reason: Any borrower who's upside down in his mortgage - i.e., the size of his mortgage is bigger than the value of his home - is likely to make car and credit card payments before paying his home loan. "The hierarchy of payments has totally shifted," Whitney now says.

One of Citigroup's problems was that of all the banks, it had the greatest exposure in dollar terms to high-LTV mortgages. When housing prices turned south, the delinquency rate on Citi's home loans soared - rising 53% during the third quarter of 2007 (over the third quarter of 2006). Whitney says it was obvious that Citi would have to shore up its balance sheet. The bank's $10.8 billion in annual dividend payments was a clear source of potential savings. Less than three months after Whitney put out her report, Citi announced a 41% dividend cut designed to save the company $4.4 billion a year.

Whitney's current concern is that banks aren't slashing costs and cutting losses in their loan portfolios fast enough. On the cost side, she says, banks have yet to come to terms with the disappearance of the securitization market, which she believes will stay in hibernation for the next three years.

Why does this matter? From 2001 through 2005, for every dollar of bank capital used to make mortgage loans, ten were supplied via investors in mortgage securities. All that secondary-market capital is now sidelined, but the staffing levels of bank lending departments don't yet reflect it. By Whitney's reckoning, banks have laid off about 7% of their employees; she thinks the cuts need to reach 25%. "These companies have got to resize their businesses," she says. "Right now their expenses do not match their revenues."

She also argues that banks need to "get real" about how they're valuing their problem mortgage-related debt, much as Merrill Lynch has now done. And her idea of "real" is pretty drastic. Whereas most banks are estimating 20% to 25% peak-to-trough declines in housing prices, the Case-Shiller housing futures traded on the Chicago Mercantile Exchange portend a much steeper 33% decline, she points out. In fact, Whitney thinks the actual declines will be worse - closer to 40% - because of the loss of the securitization market and the paucity of mortgage credit available. And that means more defaults: "The consumer's ability to refinance his way out of trouble has diminished greatly."

This is where Whitney's critics start licking their chops. Thomas Brown, a veteran bank analyst and co-founder of bankstocks.com (with Hill, coincidentally), disagrees sharply with Whitney's contentions that banks need to rid themselves of problem loans and that their stocks won't rebound until the write-downs abate.

Brown counters that the numbers Whitney keeps trotting out are actually lagging indicators. "During the last credit crisis the stocks hit bottom in November 1990, and the losses and nonperforming assets didn't peak until well into 1991," he says. "Every cycle there's one analyst who races to be the most bearish, and this time it's her. Honestly, I think we'll look back and see that Meredith Whitney's credibility peaked on July 15" - the day many bank stocks hit their low point for the year (so far at least).

Brown goes a step further, alleging that it's "incredibly arrogant" of Whitney to tell banks and investment banks either to unload their problem loans and mortgage securities or to "get real" about how they're valued. He says there's plenty of history to indicate that holding tight may be the wisest course of action. "In the last cycle," Brown says, "Morgan Stanley made a fortune buying written-down commercial real estate assets from banks at 40 cents on the dollar." What peeves Brown most about Whitney is her unwillingness to assign a fair market valuation for the stocks she's trashing: "The only explanation I can see is, she has no idea how to evaluate the possible downside risks."

To be fair, Whitney has never said bank stocks are worthless. She would buy Wachovia at $5, for instance. (It's now $16.) But with his salvo Brown has actually restated, albeit pejoratively, a core part of Whitney's thesis. If she has no idea how to properly value bank stocks right now, it's because the metrics don't work. Price-to-earnings ratios are useless when earnings are nonexistent. And valuing banks on price-to-book ratios is just as futile. Those book values - which reflect underlying assets and liabilities - are moving targets. "Citibank has lost 50% of its book value since last year," Whitney says. "The point is, I do not think we are near the end of write-downs, so I continue to see capital levels going lower, capital raises diluting existing shares further, and stocks going lower."

Another negative: two little-talked-about regulatory changes Whitney says will stymie banks' recoveries. One is a new accounting rule known as FAS 141R. Given the depth of the crisis, Whitney expects to see bank regulators arranging shotgun marriages between well-capitalized institutions and foundering ones. Problem is, any such deals would have to happen before FAS 141R takes effect in December. The new rule, she says, "will make it almost impossible to do bank mergers." The rule demands that an acquirer not only immediately mark to market the portfolio of the company being bought - and remember, bids for mortgage assets are now few and far between - but also mark to market its own portfolio as well. "Nobody's going to want to do that," Whitney says.

Another regulatory change that may wreak havoc: Starting next year, the Office of Thrift Supervision will bar credit card issuers from using outside credit information to reset interest rates. For instance, Wells Fargo couldn't increase the rate on your Visa just because you were late on an electric bill. While Whitney thinks the OTS proposal is well intentioned, she's convinced that it will force banks to reduce the amount of credit they extend to consumers, dimming a business that has been a rare bright spot. With their credit lines trimmed, consumers will cut back even more on spending, deepening the recession. "When this takes effect," she says, "it's basically going to amount to a pay cut for the average American consumer."

Whitney's ability to find consumer peril in a proposal ostensibly so consumer-friendly speaks volumes about the darkness of her view. Indeed, she's so far out on a limb and so unequivocal in her bearishness, it's hard to envision how she could reverse course without losing credibility. It's a predicament similar to the one Abby Joseph Cohen faced in 2000 and 2001 - one that left her with egg on her face when the stock market faltered.

Fitzgibbon says she recently asked Whitney how it would all end, and Whitney's answer was fatalistic: "I'll make a bad call, and that'll be it." When I ask Whitney what's next for her, career-wise, she isn't sure. Getting into management holds some interest. Joining a hedge fund - a common next step for star analysts - does not. "All I know is, I want to do something big. I want to earn the right to be at the table with the smartest people."

Whatever her future holds, Whitney says she doesn't spend time fretting about whether her epic call on banks might be wrong. "Look, I always worry about what I might have missed, which is why I work so many hours and get so little sleep," she says. "But the numbers speak for themselves. And what they're all saying is, this is far, far from over."

http://money.cnn.com/2008/08/04/magazines/...sion=2008080411

Inflation and the New World Order
by Richard C. Cook / August 6th, 2008

DANBY, VERMONT — The sunlight on the lake sparkles at dawn. As they have done for millions of years, the rounded tree-shrouded shoulders of the Green Mountains loom above the still waters. A loon calls from the next lake over. Who would guess that that not far from such serenity the world’s most powerful nation was teetering on the brink of disaster? Though here in the bosom of nature one wonders why we should be surprised. Nations and empires come and then they go.

ARE THINGS REALLY THIS BAD?

Just before we left Washington, D.C., the …

(Full article …)

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Wall Street Report Tries to Dissect Financial Meltdown
August 6, 2008, 11:58 am A group of Wall Street executives released a report on Wednesday that outlined how the industry failed to foresee the financial meltdown of the last year and what companies can do to improve risk management.

The 172-page report (PDF), written by chief risk officers and senior executives at banks like Lehman Brothers, Merrill Lynch and Citigroup, also provides suggestions about technical issues at the same time as it offers a bit of a mea culpa.

"Virtually everybody was frankly slow in recognizing that we were on the cusp of a really draconian crisis," said E. Gerald Corrigan, a managing director at Goldman Sachs and a chairman of the Counterparty Risk Management Policy Group III , which released the report.

Wall Street failed to anticipate how wide-reaching problems with mortgage bonds would spread into seemingly distant corners of the financial markets, the report said. Awash in easy money, banks doled out credit without sufficiently charging for the risk. Wall Street also created complex structures that masked connections between asset classes as well as compensation incentives that pushed traders to take risky steps for short-term gain. The industry's failings have now translated into pain for the broader economy, the report said.

In many ways, the report acknowledged short-comings that have already been raised by Wall Street's critics.

Mr. Corrigan, a former president of the New York Federal Reserve, formed the group in April to develop a private-sector plan for minimizing future problems in the financial markets. He said in an interview that he hoped the report's suggestions would be adopted industry-wide within two years.

Go to Article from The New York Times »
Go to Counterparty Risk Management Group Report (PDF) »

http://dealbook.blogs.nytimes.com/2008/08/...ncial-meltdown/

OpEdNews

Original Content at http://www.opednews.com/articles/The-Good-...080805-848.html

August 6, 2008

The Good and the Bad and the Truly Ugly

By Lord Stirling

In a couple of days the Olympic Games begin. The modern Olympics can truly be called one of the best things that we humans do in terms of our international relations. The Games represent peaceful completion with nations sending the best of their young people ~ a "good" event and happening.

These Olympics come at a time of growing economic crisis with a possible global economic depression looming. These bad economic times could get really bad if the $1.2 quadrillion in derivatives go into melt down along with collateralized debt obligations (CDOs) and various new structured investments vehicles (SIVs). The resulting global depression is apt to be even worse than the Great Depression of the 1930s.

Worse yet, is the demands of the neo-cons in America, and some European nations, along with the Israeli war hawks, for a war on Iran. A war that could get truly ugly in the extreme. Iran, having hired some of the best and brightest of the former Soviet Union's advanced biowar scientists 15 years ago, is a nation that already possess advanced biological warfare (ABW) with the ability to cause deaths in North America, Europe, and the Middle East on a level of global strategic thermonuclear war. The limited Iranian uranium enrichment program, legal under international law and even in the words of the American intelligence establishment not constituting a nuclear weapons program, is being used as the cover for the next stage of the aggressive neo-con grand strategy.

We are truly in a most interesting period. If sanity rules the day, we will avoid a war with Iran and the likely resulting Third World War. If not, then we are in for a truly horrific next few months.


What we do know for certain is that past recessions and depressions are man created, usually by the very persons/groups that intend to profit from the economic hardship of the many.

A coming "Greatest" Depression would amount to the greatest transfer of wealth in human history, with a small evil elite taking our property and possessions from the rest of us. We also know that it is simply too late in human history for engaging in global war with nations having global strategic weapons of mass destruction ~ that any such war is apt to cause such great world wide destruction as to effectively destroy human civilization.

The elected political leadership in America and much of the western world is so corrupt, so "bought and paid for" by globalist special interest groups, that they are not addressing the grave dangers of either the coming economic super depression or a global war. Somehow, the public had better get its act together and force the powers that be to change directions. If not, the old Chinese curse of "may you live in interesting times" could come true in a most horrific way.

Stirling





Authors Website: http://europebusines.blogspot.com/

Authors Bio: Earl of Stirling, Hereditary Governor and Lord Lieutenant of Canada. Author of CASH FOR PEERAGES: THE SMOKING GUN (Lulu Press at www.lulu.com/content/953682). Web site: http://europebusines.blogspot.com/ Back

Pimco's Gross Says U.S. Will Rescue Fannie, Freddie - Bloomberg (08/06/2008 05:33 PM) Mortgage Failure Rate Rises - WSJ ($) (08/07/2008 05:38 AM) Wall Street Report Tries to Dissect Financial Meltdown - NY Times (08/06/2008 05:34 PM) Mortgage Delinquencies Accelerated During 2007 - WSJ ($) (08/06/2008 07:59 PM) Hedge Funds Chalk Up Losses - WSJ ($) (08/06/2008 08:02 PM) Big banks seek to limit their own risks - FT ($) (08/07/2008 08:24 AM) Big banks prepare to scale back business - FT ($) (08/07/2008 08:36 AM) Citigroup May Pressure Other Firms With Deal on Auction-Rate Securities - WSJ ($) (08/07/2008 05:43 AM)

U.S. Jobless Claims Rose Last Week to Six-Year High - Bloomberg (08/07/2008 07:52 AM) 40% of U.S. homeowners say their houses have risen in value - Dallas Morning News (08/07/2008 05:28 AM) Inflation fears persist as Fed holds rates - FT ($) (08/07/2008 06:09 AM) Highest Unsold Home Supply Since '82 Seen Needing 50% Reduction - Bloomberg (08/07/2008 07:54 AM)

Wall Street Consumed By Doubt
Carl Gutierrez, 08.07.08, 3:55 PM ET



A new bout of bad news from the financial sector and weak consumer-related economic data on Thursday knocked Wall Street for a loop in afternoon trading.

U.S. retailers reported disappointing July sales as the impact of government stimulus checks dwindled and America's cash-strapped consumers cut back on spending.

Appropriately enough, the June retail numbers came on the same day as the U.S. Labor Department reported that the number of American workers filing new jobless claims increased by a seasonally adjusted 7,000, to 455,000 last week, the highest level since late March 2002, and significantly higher than Wall Street’s expectations of around 430,000.

The combination of the increasing number of new claims for unemployment benefits mixed with the decline in consumer spending signals that the outlook for the U.S. economy going forward looks grim.

Same-store sales for bellwether Wal-Mart Stores (nyse: WMT - news - people ), which had performed surprisingly well in recent months, grew just 3.0%, below the 3.4% analysts had expected. Slightly more upscale Target (nyse: TGT - news - people ) July same-store sales fell 1.2%, which was also worse than the 0.3% the Street had forecast.

Investors were also still trading off AIG (nyse: AIG - news - people )'s nasty results late Wednesday. The insurer slid 17.6%, $5.12, to $23.97, in afternoon trading, after it announced $11.0 billion in investment losses in the second quarter, mostly on mortgage investments gone bad. (See "Three Strikes For AIG.")

In afternoon trading, the Dow Jones industrial average fell 1.4%, or 164.06 points, to 11,492.01, while the Nasdaq slid 0.7%, or 16.65 points, to 2,361.72, and the S&P 500 dropped 1.4%, or 18.28 points, to 1,270.91.

One bright spot came from The National Association of Realtors, which released data showing that U.S. home sales contracts signed in June rose across the country, to its highest level since October, although sales were still significantly below year-earlier levels.

In separate news, Moody's reported that the global junk-bond default rate is expected to climb to 6.3% over the next year, and if the U.S. economy slips into a protracted recession, one in 10 issuers could default. For U.S. speculative-grade issuers, the default rate could increase to 5.7% by the end of the year and to 7.2% a year from now, the rating agency reported. The rate in July was 3.0%, up from 2.5% in June and 1.5% a year earlier.

Elsewhere on Wall Street, federal and state regulators are stepping up their efforts to bring Wall Street to justice for misrepresenting products they sold to unsuspecting retail customers. In a settlement with Attorney General Andrew Cuomo of New York and the U.S. Securities and Exchange Commission, Citigroup (nyse: C - news - people ) will offer to buy the long-term securities that were supposed to act like short-term investments that from all of the company's individual investors, small institutions, and charities that purchased them before Feb. 11. The par value of the securities currently eligible for purchase totals roughly $7.3 billion.

Citigroup estimated the difference between the purchase price and the market value to be in the range of $500 million on a pretax basis. Citi will also get to pay $100 million in fines to state and federal regulators. (See "Citi Comes Clean.")

Citi shares did not immediately show much reaction, but in late trading they were down 5.4%, or 41.07, to $18.61, in line with a general decline in financial shares.

Meanwhile, Morgan Stanley (nyse: MS - news - people ) will repay two towns in Massachusetts $1.5 million for their auction-rate investments and review all the company's mu