RoR: Forum

In yesterday's news Citibank decided to move $49 billion worth of SIV's onto its balance sheet. So the SIV's were off-balance-sheet, as were the associated commercial paper liabilities. This confirms to some degree my suspicions about questionable accounting. The move will diminish Citibank's capital ratio. On the other hand, it may help when the commercial paper liabilities need renewed, both rate-wise and credit-access-wise.

Above I wrote "borrow-short-lend-long". This is what SIV's were made to do. They sell commercial paper (short-term borrowing) and invest in longer-term securities like mortgage pools (i.e., lend), to capture the higher interest rate on the latter (versus the former). One potential problem with this strategy is that the commercial paper needs to be repaid or refinanced before getting a comparable level of cash back from the investment. Another potential problem, probably under-anticipated when the SIV's were created, is the level of future defaults embedded in the investment.

Folks on this forum may not have much interest in this, since it isn't philosophy or politics. However, it is the real world of capitalism.

Post 1

Friday, December 14, 2007 - 7:47am

I find it far more interesting than presidential politics. I'd rather get into this than the moral status of Ron Paul.

I read plenty on a daily basis. For one thing I guard a Citigroup site. We get the WSJ at 6:00 AM and if we do not get to read it v-e-r-y c-a-r-e-f-u-l-l-y so as not to disturb it, we see it later in the day on its way to the recycler. I clipped a recent story about Citigroup borrowing $4 billion at 6% to tide it over temporarily. And of course, we were all aware via CNN.com of the sudden retirement of Charles Prince the Sunday night it happened. But, there, too, this is just "presidential politics" of a different flavor. Robert Willumstad and James Diman also left abruptly. Life goes on.

Markets fill up and wash out. I do not see much social morality in this, one way or the other. I do note, of course, that each event is another to learn from. When the real estate market was hot-hot-hot, contrarians were making the easy prediction that this was not going to last forever... or even much longer. Everyone just wanted to be the last one to close a deal before it all evaporated. I learned to play "musical chairs" in kindergarten.

Myself, I'm just a wage earner, so I look to tangibles. In fact, I like looking at them so much, I collect different kinds.

Post 2

Friday, December 14, 2007 - 9:27am

Thanks for posting this. Perhaps you can clear something up for me... SIV's are different from SPE's, correct? As I understand it, SPE (Special Purpose Entities) are created by lenders, to issue CDO's (mostly mortgage backed), to investors, whereas the SIV's purchase these securities using funds from issuing commercial paper. Is that right, or have I got it all wrong?

Post 3

Friday, December 14, 2007 - 10:19am

Jonathon,

You're welcome.

Many people, including me, would classify an SIV as a kind of SPE. An SIV might be created by a lender from mortgage loans it has made, or by another party such as an investment bank, from mortgages it has acquired from Fannie Mae, Freddie Mac, or another pool. The assets in an SIV may be other than mortgages, e.g. credit card or auto loan receivables. Corporate notes/bonds and mortgages are the largest chunks.

I think a key feature for each is that the originator creates an off-balance-sheet entity.
I think a key feature for an SIV is "yield curve arbitrage" or "borrow-short-lend-long."

Wikipedia has articles on both.
http://en.wikipedia.org/wiki/Structured_investment_vehicle
http://en.wikipedia.org/wiki/Special_purpose_entity
An SPE may be created for many purposes. Enron used SPEs to hide its losses.

Post 4

Wednesday, December 26, 2007 - 5:29am

I have a question incidental to the subprime mortgages mess, and didn't think it warranted starting a new thread.

Merrill Lynch has written down $7.9 billion in mortgage-related assets, and more are expected. On December 24 Merrill announced it will sell up to $6.2 billion of newly issued common stock at a discount to two investors in order to raise capital. Most will be to a Singapore sovereign fund at $48 per share. Merrill's stock closed at $53.90 on the 24th. The WSJ article reported the $48 as "a 10% discount from the final negotiation date in the middle of last week", implying a price of $53.33 when the terms of deal were made.

There are some caveats. The sovereign fund must hold its shares for a year, and it will get a rebate if Merrill issues more stock at less than $48 within the year.

I don't know what efforts Merrill made to offer shares to other than the two. Of the few secondary offering cases I have read about, most were at prices equal or very close to the current price of the outstanding stock at the time the deal was made. The biggest discount I'm aware of is Gulfport Energy Corp. (GPOR). On 12/7/2007 it priced its secondary public offering at a 6.3% discount to its stock's previous day closing price.

The WSJ article included this: "At least one person close to Merrill said . . . that the discount to current value is in line with what it would likely have paid if it had issued common to the public in a stock offering. It hasn't received a fairness opinion on the price."

I am sceptical that this is fair, at least to the existing shareholders. Why shouldn't they be entitled to buy at $48, too? A fairer method would be an auction, or more open public offering. If they aren't willing to buy at $48, that's fine, but I think they should have the opportunity.

To anticipate one possible objection, I do not view this as similar to a business offering a senior discount to customers. In that case the business is dealing with its own property, and the discount probably adds to profits, benefitting shareholders (if any). But in the Merrill case, its executives are fiduciaries to its shareholders, and the deal will add nothing to profits.

One might counter that the discount is justified by the one-year-hold condition. (A put option to hedge that would cost roughly $5 per share.) I don't buy that argument, not because the condition is irrelevant to the price, but because the price was not set by auction or the offering made wider. It seems like a "sweetheart deal."

One might counter that a wider offering would cost Merrill more, and/or the route it took was quicker. The latter might be deemed very important given the market circumstances. I'm not convinced that a wider auction could not have been done about as cheaply or as fast.

This is sort of a mirror image of greenmail, which was common in hostile takeovers in the 1980's. A raider would secure a large block of stock of the target company. Instead of completing the hostile takeover, the greenmailer offered to end the threat to the target by selling his shares back to it at a substantial premium to the fair market price. While benefitting the greenmailer, the target company's other shareholders were disadvantaged. How is it fair that the company offers only the greenmailer the premium price, with other shareholders excluded?

Does anyone else have an opinion on Merrill's act? If the $48 price doesn't bother you, then what if it been $24 (with twice as many shares) instead? My aim is not simply to discuss Merrill, but the principle.

Post 5

Sunday, March 16, 2008 - 3:26pm

Debt Reckoning: U.S. Receives a Margin Call

The article doesn't explain the title of the article. I think it's a good metaphor, though, and will try to explain it.

For readers who don't know what a margin call is, I'll give an example. Suppose you buy some stock from a broker, but don't pay the full cash price. You make a down payment (collateral) and borrow the rest of the money from the broker. If the trading price of the stock falls enough, the broker starts worrying about your repaying the loan. So the broker asks you to add cash (collateral for the loan) to your account. That's a margin call.

The scenario can also happen when investing in bonds. The U.S., more specifically the Fed, is an issuer of U.S. Treasury bonds. The Fed is increasing its potential liabilties by assisting J.P. Morgan and Bear Stearns by issuing more U.S. Treasury debt, much of it being sold internationally. The increased supply of U.S. Treasuries depresses their price in terms of a foreign currency, e.g. the Euro, as does incumbant holders of $US or U.S. Treasuries selling. In other words, the Euro/$US ratio decreases (the $US/Euro ratio increases). In effect, foreign lenders to the U.S. are saying fork up more $US to cover your account in the international currency market. In other words, it's a "margin call."

Anybody else see it any differently?

Post 6

Monday, March 17, 2008 - 6:15am

JPMorgan to Buy Bear for $2 a Share
http://biz.yahoo.com/ap/080317/jpmorgan_bear_stearns.html

How ironic. That's no bull! :-)

�This is like deja vu all over again.� - Yogi Berra.

J. P. Morgan stepped in to avert a crisis in 1907. See the 4th paragraph here.
http://en.wikipedia.org/wiki/Panic_of_1907

I can't wait for 2109. I'll be shorting like crazy. :-)

The markets weren't open Saturday. It could have been another "Ides of March." :-)

(Edited by Merlin Jetton on 3/17, 6:22am)

Post 7

Wednesday, March 19, 2008 - 6:38am

Volcker: Fed�s �Extreme� Intervention �Raises Some Real Questions�

Former Federal Reserve Chairman Paul Volcker said the Fed�s decision to lend money to Bear Stearns Cos. to keep it from collapsing is unprecedented and �raises some real questions� about whether that�s the appropriate role for the Fed. The wisdom of the decision depends on �how severe this crisis was and their judgment about the threat of demise of Bear Stearns,� Mr. Volcker said on the Charlie Rose Show on Tuesday evening. �That�s a judgment they had to make and an understandable judgment.� It is �absolutely� not �what you want for the longstanding regulatory support system.�
Excerpt:
Volcker: We�ve seen the Federal Reserve take more extreme measures in some respects than any that have been taken in the past to deal with a financial crisis, which raises some real questions about not only for the Federal Reserve and its authorities, but for the structure of the financial system� The Federal Reserve is designed to lend to banks. And the banks were considered to be at the center of the financial system, and lend liquidity, provide cash in return for good assets, when a bank got in trouble. Now they found in this case, where some of the investment houses were in trouble, and prototypically Bear Stearns � it�s lightly regulated by the SEC or some other, but not for the same reasons. They haven�t got the concern over the stability of those things�.We�re going to lend to them and protect them, shouldn�t they be regulated?
Source: http://blogs.wsj.com/economics/2008/03/18/volcker-feds-extreme-intervention-raises-some-real-questions/

I take Mr. Volker to draw a line between retail banks and investment banks. The Fed's regulatory purview is retail banks. Bear Stearns is an investment bank. JP Morgan Chase is both kinds. More detail on distinction: http://en.wikipedia.org/wiki/Bank#Definition

The interview can be seen temporarily here: http://www.charlierose.com/home

(Edited by Merlin Jetton on 3/19, 5:27pm)

Post 8

Thursday, April 3, 2008 - 8:14am

Government's role in the subprime mortgage mess.
http://www.townhall.com/columnists/JerryBowyer/2008/04/01/meet_barry_obama,_fair_housing_lawyer
I'm not well-informed about all of it, but it makes sense.

Post 9

Thursday, April 3, 2008 - 9:57am

Merlin - I always thought that fair housing stuff was utterly absurd, especially if it meant giving loans to people who had no business getting the loan. I have no problem with not including someone's race on an application, of course it should be neutral and look at their ability to pay only, but to say you must lend people money based on arbitrary quotas and wreck the whole banking system? Wow, amazingly bad, we are getting closer to communism every day.

Post 10

Thursday, July 31, 2008 - 7:53am

Looking at financial news this a.m., I found the following about Alan Greenspan:

"With its new-found influence, Paulson & Co [a hedge fund manager] has been able to sign up Alan Greenspan, a former head of the Federal Reserve, as an adviser and he is likely to be helpful to the new fund in assessing the capital needs of the banking sector for which he was once the chief regulator. The appointment raised a chuckle in dealing rooms across Wall Street when it was announced in January, since Mr Greenspan is being damned as the architect of the housing market's disastrous bubble." (link)

For more about hedge funds buying distressed debt at deep discounts, see here.

Post 11

Thursday, July 31, 2008 - 9:21am

Merlin:

Thanks for this.

"Financial companies have written off more than $460bn since the collapse in the debt markets began last summer, and Mr Paulson believes that is barely one-third of the final total that will be lost. At a conference in Monaco last month, he said writedowns could ultimately reach $1.3 trillion." (emphasis mine)

It's important to note that there are two Paulsons.

Sam

Post 12

Thursday, July 31, 2008 - 12:48pm

Alan Greenspan was just on CNBC with Maria Bartiromo in an extended interview. Greenspan thinks that the housing crisis if far from bottoming out. The Fed had no choice in backing Freddy and Fannie. The deficit is very worrying.

Greenspan Says Housing Prices Not Yet Near Bottom

Here's the full video

Sam

(Edited by Sam Erica on 7/31, 1:42pm)

(Edited by Sam Erica on 7/31, 1:52pm)

(Edited by Sam Erica on 7/31, 1:53pm)

Post 13

Monday, December 29, 2008 - 6:28am

Saying Yes, WaMu Built Empire on Shaky Loans

This is a story of the reckless lending that WaMu did. It's what can happen when the mortgage originator can avoid keeping risky mortgages on its balance sheet. The originator makes an immediate profit on up-front fees, in contrast to profiting from an interest differential that trickles in over many years.

Post 14

Thursday, February 12, 2009 - 6:13pm

BB&T's Allison: A Free Market Could Have Prevented This

Post 15

Friday, February 13, 2009 - 8:18am

Roots of the Banking Crisis

The article includes:

"So, why did intelligent bankers make so many bad loans?" The answer is government intervention and coercion.

I would add: They could sell off the bad loans via securitization and used the proceeds to originate even more loans. Every loan made generates revenue for the lender in the form of points and/or origination fees (plus future servicing fees).

(Edited by Merlin Jetton on 2/13, 8:57am)

Post 16

Wednesday, February 18, 2009 - 6:10am

The following were written by professors at the University of Chicago Booth School of Business.
http://www.igmchicago.org/2009/02/09/we-need-smarter-regulation-not-more/
http://www.igmchicago.org/2009/01/28/the-credit-crisis-conjectures-about-the-crisis-and-remedies/
Hat tip to GS.

I thought both were excellent.

Post 17

Friday, February 20, 2009 - 5:53am

Deregulation and the Financial Panic

Mr. Gramm attributes the financial crisis to the confluence of two factors -- the unintended consequences of a monetary policy (low interest rates) and the politicization of mortgage lending. I agree with those and he gives more detail about the latter than usual.

I don't buy his dismissal of the Gramm-Leach-Bliley Act of 1999 and the Commodity Futures Modernization Act of 2000. Yes, the first name in the first act is the author of the article. His wife, Wendy Gramm, headed the Commodity Futures Trading Commission from 1988 to 1993 and was a director of Enron.

He is technically correct that the Commodity Futures Modernization Act was not "deregulation", since that means undoing regulations already inforce, i.e. decreasing regulation. The effect of the Act was to not increase regulation. He claims that the credit default swap market continues to be healthy. That may be for parts of the market like high-grade corporate debt or municipal debt. However, he gives no evidence that the market is healthy for mortgage-backed debt. Given the failures of Bear Stearns, Lehman Brothers and AIG, and "toxic assets", much explanation would be needed to defend his claim.

Post 18

Monday, July 13, 2009 - 10:52am

Truth In Lending

By INVESTOR'S BUSINESS DAILY

Behind The Meltdown: Many Americans are unaware of the causes of the greatest economic calamity of our lifetime. A new congressional report details how government politicized housing, wrecking the economy.

Rep. Darrell Issa of California, ranking Republican on the House Oversight and Government Reform Committee, has released a report that every American should read.

The analysis details how powerful Democrats in Congress insisted that government-subsidized housing be geared to serve the purposes of social justice at the expense of sound lending.

Here are some highlights of Issa's blow-by-blow account:

� With an implicit subsidy to American homeowners in the form of reduced mortgage rates, Fannie Mae and its sister government sponsored enterprise, Freddie Mac, squeezed out their competition and cornered the secondary mortgage market. They took advantage of a $2.25 billion line of credit from the U.S. Treasury.

� Congress, by statute, allowed them to operate with much lower capital requirements than private-sector competitors. They "used their congressionally-granted advantages to leverage themselves in excess of 70-to-1."

� The two GSEs were the only publicly traded corporations exempt from SEC oversight. All their securities carried an implicit AAA rating regardless of the quality of the mortgages.

� The Department of Housing and Urban Development set quotas for GSE investment in affordable housing.

� Encouraged by an inaccurate 1992 Boston Federal Reserve Bank study charging racial discrimination in mortgage lending, the two GSEs were strongly pressured to "lower their underwriting standards, particularly on the size of down payments and the credit quality of borrowers."

� In 1992, Congress directed HUD to establish multiple quotas requiring mortgage quotes for low-income families.

� In 1995, the Clinton administration issued a National Homeownership Strategy, loosening Fannie and Freddie's lending standards and insisting that lenders "work collaboratively to reduce homebuyer downpayment requirements."

� The administration complained that in 1989 only 7% of mortgages had less than a 10% downpayment. By 1994, it wanted that raised to 29%.

� Reduced underwriting standards spread into the entire U.S. mortgage market to those at all income levels.

� A complete decoupling of home prices from Americans' income fed the growth of the housing bubble as borrowers made smaller down payments and took on higher debt.

� Wall Street firms specializing "in packaging and investing in the lowest-quality tranches of mortgage-backed securities, profited hugely from the increased volume that government affordable lending policies sparked."

� Wall Street firms, homebuilders and the GSEs used money, power and influence to block attempts at reform. Between 1998 and 2008, Fannie and Freddie spent over $176 million on lobbyists.

� In 2006, Freddie paid the largest fine in Federal Election Commission history for improperly using corporate resources to hold 85 fundraisers for congressmen, raising a total of $1.7 million.

As the Issa report points out, "the real tragedy of the government's affordable housing policy is the impact on average Americans, particularly those of modest means.

"Millions of these borrowers, who were supposed to have been helped by federal affordable housing policy, have now been forced into delinquency and foreclosure, destroying their asset base, their credit, and in some cases their families."

Post 19

Monday, July 13, 2009 - 11:49am