The Bald, The Beard & The Ugly (Inside Job, The Movie)

This was posted back in November 2008, and published in StarBiz as well. Well, they finally made a movie of the subprime mess. It was superbly done, I must say. Matt Damon was the narrator. I loved the many interviews, especially the ones fronting for the bad guys twitching and lying through their teeth ... Funny thing was, the bad guys are not just your usual suspects, they included many economist professors of high regard.

To watch the movie and to read my dated posting, I think I should have made the movie myself... lol.

I was watching the uncomfortable grilling by the US lawmakers on Ben Bernanke and Henry Paulson on the US rescue plan. Pity those two guys. They are trying to fix a problem which was inherited and they have to suffer the embarrassment of trying to persuade the lawmakers to approve the funds.

But who really are the culprits that brought about such a calamity? I shall try to ascribe blame to the relevant parties. But please note, it’s a highly subjective issue and everyone has a different opinion. Here’s my two cents worth (and rapidly diminishing two cents in value):

The blame game:

30% - Management of Investment Banks & Mortgage Lenders

They were greedy and overpaid. They had thrown risk management out the window. When the going is good, they pocket more than their fair share.

Paulson (left) and Bernanke could have tried to reverse the damage in their early days as they basically inherited a huge problem.– AP

The worst punishment they got was to walk out the door with nary an apology. The vast amount of liquidity in the system and the thirst for mortgages prompted them to “invent” new fangled instruments to package these loans and resell them, with little regard to the leverage effect.

Lenders kept pushing adjustable-rate and subprime mortgages, while investment banks bundled millions of risky loans and resold them to investors.

It was when these investment banks started to buy these same instruments that they really decimated their capital.

15% - Alan Greenspan

He will continue to deny it was his doing, but since 2001, he advocated lowering interest rates and continued a strong money supply growth policy.

That prompted the public to buy properties and even speculate in them. Greenspan was well known for lowering rates aggressively to counter any crisis €“ the query was that by doing that markets were never allowed to adequately correct the imbalances.

This led to the credit explosion.

He must have noticed the deterioration in the credit market back in 2003 and 2004 or was just plain blind. But he hadn’t warned lenders of using the “non traditional mortgages” now seen as a precursor to the credit crisis which unravelled as early as December of 2005, shortly before Greenspan resigned.

The excessive liquidity in the system was not just owing to the Fed’s measures. Major central banks were guilty of pumping vast amount of money supply into the system. Back in 2004, Greenspan opposed tougher regulation of financial derivatives, and actually praised adjustable-rate mortgages and refinancing for homeowners.

35% - Ratings Agencies

They are the unwitting culprits. (I am being nice here). They rated loans and bonds based on these mortgages AAA status, which caused many buyers to believe in their assurance that they were buying solid AAA papers.

The ratings agencies again acted too late to downgrade these papers €“ long after the damage is done.

They had earlier accorded high ratings and analysis which fuelled interest in these instruments to be hawked to unsuspecting investors. It is also this that led the investment banks to boldly pile up these instruments.

What kind of value-added analysis are the issuers paying these rating agencies for? It’s obvious that the analysts knew that a bulk of the packaged loans consisted of subprime.

Were the fees too enticing? Were the ratings agencies trying to curry favour with the banks? If these agencies cannot do their jobs without fear or favour, then how can investors rely on these ratings?

Maybe the US should empower the government to rate bonds, especially if the government requires certain kinds of fund managers to own only officially-rated bonds.

15% - The Regulators

The financial markets and the various instruments have their respective regulatory units.

You may include the Fed, the CFTC (Commodity Futures Trading Commission), the SEC (Securities and Exchange Commission), FDIC (Federal Deposit Insurance Corp), even the FASB (Financial Accounting Standards Board) into the fold.

They are supposed to regulate and oversee the markets and the financial instruments.

But where was the voice of reason? The last six years’ housing and subprime mortgage bubble and bust had little to do with excessive government intervention.

Instead, they had all to do with the lack of any basic sensible government regulation of the mortgage market.

They should have instituted new guidelines and rules to govern these CDOs (collateralised debt obligation), credit default swaps, and the leverage aspect of financial firms and their capital at risk.

Even now, they are mainly silent.

5% - US Treasury chief Henry Paulson & Federal Reserve chief Ben Bernanke

They could have tried to reverse the damage in their early days as they basically inherited a huge problem.

But only now, they are talking about having proper mechanisms to regulate derivatives and new instruments. Sigh.

There were institutions and people appointed to do these jobs; it’s just that they did not do their jobs properly. I am still waiting for some of the culprits to be prosecuted for what they did or didn’t do.

At the end of the day, it appears that what some of them didn’t do would be more punishable.

“But what about the American borrowers/homeowners,” you ask? Shouldn’t they too shoulder some of the blame? I left them out of the above equation for various reasons listed below:

a) I do think there should be an element of “personal responsibility” but it seems to me that they are already paying the cost of their foibles. Many have had their homes foreclosed, they have lost their deposits and payments made on these loans.

It seems to me, they are THE ONLY group that has actually “really lost” materially and has been punished.

b) The bailouts do not really bailout the end borrowers. They simply extend the life of the companies.

Maybe the bailouts will allow the companies more time to foreclose these properties in an orderly manner. Very few of those will be able to renegotiate their existing loans on decent terms to allow them to continue to fund their mortgages.

Most of the loans were priced at a time when property values were at least 30%-40% higher than now. Perhaps, it’d be better to declare bankruptcy than to continue to reconfigure the loan?

c) The public are not equipped to regulate themselves. That is why there are agencies created with “capable people” to regulate and monitor the markets.

You cannot expect the majority of borrowers to understand in detail CDOs, credit default swaps, or whether the brokers are leveraging themselves to the hilt.

You instead get assurance from top ratings agencies that brand certain papers as top notch grade. Who will really pore over hundreds of pages in a report, examine if these debt papers/bonds consist of thousands of small mortgages spread out over the country or how to value the price trends and affordability ratios of borrowers?

d) The public often acts in herd-like mentality and like most people, they are driven by the pursuit of wealth.

They see people making 50% in two years from speculating in properties and they, too, want to be part of it. Then they apply for loans, and were probably even more shocked that mortgage lenders were more than willing to lend to them.

The markets are often characterised by bouts of insanity; if you stir them up with enough incentives and carrots, people will act irresponsibly.

The regulating agencies are there to ensure an orderly market and to quell excesses. The people cannot do it themselves.

The ones who got out early will think they are very smart. The ones who got hit will think they were unfortunate victims. Both are wrong in their perception of their actions, financial decision making and brain power.

Both groups are closer to each other in every aspect than they would care to admit. It’s like a game of financial musical chairs “ the winners and losers are those who act the fastest/slowest when the music stops“ not how smart you are.

PS: In case you haven’t figured the headline out: The bald, the beard & the ugly are Paulson, Bernanke & Greenspan.

p/s photos: Ema Fujisawa (my date in Tokyo)

56 Cents To The Dollar = $1,000 Billion Additional Writedowns

Banks may need to write down another $1,000 billion, and this is already widely hinted in the markets. I would rather not take this as a negative but a positive. Additional capital will not be lost, its to boost the balance sheets. US regulators may force Bank of America, Citigroup and at least a dozen of the nation’s biggest financial institutions to write down as much as $1 trillion in loans, twice what they’ve already recorded, based on past Federal Deposit Insurance Corp. Assets sold under the Legacy Loans Program may be worth an average of 56.3 cents on the dollar, based on the results of FDIC auctions at failed banks over the past 15 months. In view of the potential losses, reports emerge of banks trying to game the system by bidding each other's asset prices up.

• GoldmanSachs and Mike Mayo report in their analysis that most banks carry unsecuritized loans at 92-98 cents on the dollar on their books. Moreover, most of the assets in the PPIP are loans.
• Details of past FDIC distressed assets auctions: The FDIC’s average auction value of 56.3 cents on the dollar for residential and commercial loans is based on 312 sales worth $1.1 billion since Jan. 1, 2008, according to the FDIC. The average for 348 commercial loans for which borrowers stopped paying was 32 cents on the dollar. Auction prices ranged from 0.02 cent to 101.2 cents on the dollar, according to the FDIC.
• Writedowns would total $1 trillion if the program buys $500 billion in loans at 32 cents on the dollar, the average for non- performing commercial loans in the FDIC sales.
• Banks failing Federal Reserve evaluations of loans this month may be ordered to make sales worth as little as 32 cents on the dollar, according to FDIC data. That would be less than half of the 84 cents on the dollar the Treasury Department suggested was a possible purchase price. Some of the bank- insurance agency’s auctions brought 0.02 cent on the dollar.
• The FDIC would auction assets after the Office of the Comptroller of the Currency, Office of Thrift Supervision or the Fed signals that a bank is in danger of failing.
• Treasury spokesman Isaac Baker said in an e-mail that the program is voluntary. "Past auctions cannot reliably predict asset prices in the Public Private Investment Program, as we are creating a new market that has not previously existed to help value these assets, and offering financing to help investors purchase them."
• The FDIC is considering allowing banks to share in future profits on loans sold to public-private partnerships to encourage healthier lenders to participate. The regulator is seeking comments through April 10 on the program.
• Banks have almost $4.7 trillion of mortgages and $3 trillion of other loans that aren’t packaged into bonds, according to the Fed. The vast majority are carried at full value because they don’t need to be written down until they default.
• While regulators don’t intend to publish the details of their stress tests, the results will effectively become known once banks announce how much capital they need to raise. Regulators will then give lenders six months to obtain funds from investors or taxpayers as a last resort.
• The government’s toxic assets plan will force banks such as Citigroup, Bank of America and Wells Fargo to take large writedowns on their loans, requiring them to raise more capital from taxpayers or investors.
  
• Including TARP, the U.S. government and the Fed have spent, lent or guaranteed $12.8 trillion to combat the financial collapse and a recession that began in December 2007. The amount approaches the $14.2 trillion U.S. gross domestic product last year.

p/s photos: Nancy Wu Ding Yan

Some Direction At Last, Some Market Leadership

Well, this post is written after the plan by FDIC and Treasury on Citigroup. So, where are we now? The first thing was Obama made the right choice in appointing Timothy Geithner (please reread posting on the new Treasury Secretary). The market basically rallied over 4% on Friday over the news. Can the appointment alone charge up markets? Yes, especially in the current market situation where there is little confidence, little direction, high volatility, basically no market leadership.

The best thing for Geithner to do is to grab the markets by the neck and tell them "This is the way ahead, follow me and I will guide you towards the light (no pun intended, obviously)". Geithner, as mentioned before is a market interventionist. He was critical in lining up the JP Morgan / Bear Stearns deal, he was instrumental in getting the funding for AIG, he tried to save Lehman but was dissuaded by higher powers ...

The market basically saw in Tim, a person who will not let things get blown out of his control. It was very easy to predict what he would do in a Citigroup situation. The new rescue package for Citigroup was assembled with Tim's input, and it was a package that tries to cover even the most extreme situation Citigroup could find itself in. Naturally there will be many naysayers that will criticise that the package will not work.

To me, its a very substantive package, watch the shorts try to stampede out of Citigroup in a hurry tonight. Why is the package so good? I did mention that Treasure could follow the UK prescription for Royal Bank of Scotland, whereby they injected capital for actual shares, thus controlling the bank. Instead a softer version was adopted, the Swiss version, on how they bailed out UBS. But in reality, the package is a Swiss UBS package with a subsequent evolvement to the UK RBS method as future losses, above the preset levels, will see the government absorbing the loss in exchange of an equity stake in Citi - so prediction stayed true.

First, there is the additional $20bn capital. Two, the guarantee on $300bn of toxic assets, phew. Thirdly Citi is only liable for the first $29bn of losses, as I mentioned earlier, without the package, Citi would probably have to incur losses totalling at least $50bn for the next 3 quarters. Now that has been largely eliminated.

Fourthly, most importantly, confidence is restored. Global bank run on deposits would now start to reverse. Fifthly, no dividends for 3 years (or just 1 cents actually) - this has to come from the government as management has no balls to say no more dividends (Alaweed no happy man, no feel like smiling).

The 8% payment on $7bn to Treasury is a cheap way to raise funds. This move will make it SO MUCH EASIER for Citi to go to sovereign wealth funds to tap additional capital. Mark my words, Citi will easily raise another $10-15bn within weeks, which will further boost its defence system.After the deal, Citi's Tier 1 capital ratio at Sept. 30, on a pro-forma basis assuming the October capital injection and the new capital announced on Sunday, is expected to be 14.8%. Its tangible common equity would be about 9.3% of risk-weighted managed assets, Citi said.

We have market leadership. Expect a sharp revival in Citi, and possibly a new bottom at 8,000 for the Dow.

p/s photos: Haruna Yabuki

FDIC Insures GE Capital's Debt

A follow up to the auto sector and hedge funds write up:

General Electric said Wednesday that the federal government had agreed to insure as much as $139 billion in debt for its lending subsidiary, GE Capital. This is the second time in a month that G.E. has turned to a federal program aimed at helping companies during the global credit crisis.

Until September, GE relied on selling commercial paper to obtain more than 15% of the funding of the finance unit. But investors began shying away from commercial paper after Lehman Brothers Holdings Inc. filed for bankruptcy protection and several other big financial players struggled. GE has said it would reduce its reliance on commercial paper, but it wasn't clear how the company would replace that funding.

GE Capital is not a bank, but granting it access to a new program from the Federal Deposit Insurance Corporation may reassure investors and help the lender compete with banks that already have government-protected debt, a G.E. spokesman, Russell Wilkerson, told Bloomberg News.

“Inclusion in this program will allow us to source our debt competitively with other participating financial institutions,” Mr. Wilkerson said. Joining the program could make it easier for GE to issue new debt in coming months. In recent months, investors have worried about GE's liquidity, and the price it has to pay to borrow money.

The F.D.I.C. program covers about $139 billion of G.E.’s debt, or 125 percent of total senior unsecured debt outstanding as of Sept. 30 and maturing by June 30. GE said Wednesday that under the program, the government will guarantee as much as $139 billion in long- and short-term debt through next June. But, Mr. Wilkerson added, "This does not mean that GE intends to issue this amount of debt."

With roughly $600 billion in assets, GE Capital is as big as some large banks. The finance unit last year supplied almost half of GE's profit. But GE Chairman Jeffrey Immelt this September said he would shrink the unit in response to the credit crisis. GE Capital issues loans for everything from aircraft engines to commercial real estate and restaurant equipment.

G.E.’s finance businesses are able to seek F.D.I.C. debt coverage because its GE Capital subsidiary also owns a federal savings bank and an industrial loan company, both of which already qualify. Last month, G.E. started using a new Federal Reserve program aimed at reviving demand for the commercial paper for a wide variety of companies.

Looks like the Treasury and Fed are making all the right moves and pushing the right buttons so far.

p/s photo: Nancy Wu Ding Yan & Sharon Chan Mun Chi

Roach's Take On TARP / The Revised Package

Finance Asia: Stephen Roach, chairman of Morgan Stanley Asia, says the US government’s Troubled Asset Recovery Plan (Tarp), aka the Paulson Plan to bail-out the finance sector to the tune of $700 billion, deserves a grade of B-.Roach’s take: a package needs to deliver the Three S’s: speed, scale and simplicity. In terms of speed, he gives the plan an A- or B+, noting it was churned out very quickly by Washington standards. [It had been; the Republican revolt is a stunning turn against President Bush and Congressional GOP leaders - Ed.]

For scale, he gives Tarp a B- or C+, noting that $700 billion is plenty big, but Congress has decided to dole out funds in tranches, with the first pool only $250 billion. Roach doesn’t think this is going to be welcomed by the market. He is also concerned about some of the red tape and procedures involved in prying out further tranches from Congress. Lastly, for simplicity, he says the original three-page Paulson Plan deserved an A+, but the Congressional bill, at 110 pages over 42 sections, gets a C- or a D+. It includes four new government bureaucracies, including oversight panels, an Office of Financial Stability, an inspector and a schemes administrator. Roach calls this evidence of a “significant regulatory backlash”. “The best grade I can give this is a B+,” Roach says. “The plan does deal with the issues, but in a sub-optimal way.”

Thus, with the fiscal strategy now set forth, attention will turn back to the Federal Reserve Bank, where governor Ben Bernanke will be under pressure to augment Tarp if market confidence doesn’t improve. Roach reckons that Tarp means we are more than halfway through the financial stage of the credit crisis. The real economy in the United States is only partway through. “Most adjustments are yet to come,” Roach warns, “particularly in consumption.”

More ominously, he thinks this crisis will extend to the real economies of Asia – a process that has only just begun. “Asian economies have been the beneficiary of the US consumption boom,” he notes. In 2007, the US consumer accounted for 72% of US GDP growth, thanks to bubbles in property markets, which in turn fuelled bubbles in credit (using home equity loans to borrow, for example). As Americans spend less, it will keep the US economy wobbling at very low growth for a prolonged period of time – and it will hurt Asia.

The US consumer spent $9.7 trillion in 2007, versus only $3 trillion among consumers in China and India combined – and much of that Asian wealth was based on exports. Granted, the US only accounted for perhaps 20% of those exports, but Europe and Japan are also experiencing economic declines as a result of the credit crunch, so Asian export markets worldwide are losing steam. This threatens Chinese GDP growth rates, which have already fallen from around 12% in 2007 to an expected 10% for 2008. A further cut in exports threatens to move Chinese GDP growth to 8%. The government can’t afford to see growth fall beyond that, so it is now cutting interest rates, loosening bank credit rules, and may introduce fiscal stimuli or act against further renminbi appreciation, Roach says.

(MarketWatch) -- The U.S. Senate is scheduled to vote Wednesday on its version of the historic $700 billion Wall Street rescue package, two days after the House of Representatives' stunning rejection of the original legislation.

The move capped a day of behind-the-scenes negotiations to try to salvage some version of the package that the House, defying President Bush and its own party leaders, rejected on a 228-205 vote.

The package before the Senate will be similar to the House version, with these additions, the New York Times reported in its online edition:

• The higher limit for insured bank deposits sought by the Federal Deposit Insurance Corp., which asked to raise the cap to $250,000 from $100,000, to quell opposition by individual and small-business depositors.
• Tax breaks for businesses and alternative energy, part of a package that has been caught in a stalemate in the House of Representatives. The Senate version of the gridlocked tax legislation would cost more than $100 billion and extend and expand many individual and business tax breaks, including tax credits for the production and use of renewable energy sources, like solar energy and wind power, the Times said. It would also extend the business tax credit for research and development, expand the child tax credit, protect millions of families from the alternative minimum tax and provide tax relief to victims of recent floods, tornadoes and severe storms, according to the Times.

p/s photo: Fiona Sit Hoi Kei