naked capitalism

Submitted by Tyler Durden of Zero Hedge

Complete collapse in foreign interest for GSE debt: North American holdings of the latter have increased from 50% to 80% of total notional in one year!

Primary Dealers are selling corporates in droves in order to purchase Treasuries and MBS under the Fed’s gun. Primary Dealers now have a record $368 billion in Corporate, Agency, MBS and Treasury inventory. And the vast bulk of PD holdings of agency debt has less than a 3 year maturity.

The Fed has bought $103 billion in Agencies, almost half of which matures in the next 3 years. Amusingly, the roll coincides when roughly $1 trillion of CRE debt comes due. Good luck.

And just in case you are curious who it is that purchases all those low, low coupon MBS out there: the Federal Reserve has bought almost half a trillion at a coupon less than 4.5%. Does Ben Bernanke honestly believe that taxpayers generating a 4.5% return is enough to continue to finance the homeownership mania? With housing prices still collapsing, it is only a matter of time before taxpayers take collosal principal losses on all these MBS, compliments of yet another completely failed risk assesment by the Federal Reserve.

hat tip Richard

Submitted by Tyler Durden of Zero Hedge

If there is one post you read today, this month, or this year, this should be it. Absolutely brilliant summary of the predicament interventionism has gotten us into. If you are looking for insight that will save you money when the market turns, this is it.

Submitted by Tyler Durden of Zero Hedge

In the week ended May 22, NYSE program trading dropped to a statistically significant low of 2.9 billion shares, down from 3.3 billion the week before, and from a 3.8 billion prior 52 week average. As for specific actors, no surprise, Goldman leading the government’s SLP team with a 7:1 ratio of principal to facilitation/agency.

As for today’s market close, with a literally parabolic jump in the last minute of trading, if anyone still thinks this market trades based on anything resembling normal behavior (unless someone had a very Jerome Kerviel-esque fat delta hedging finger or one/two moderate/large quants who had a huge index hedge imploded), I have some BBB+ rated CMBS to sell to you at par. One culprit could be hiding in the huge drop of agency trading, which this week dropped to a several month low of 1.875 billion shares.

So as essentially no institutional or retail clients are trading any more, it is just a few desperate computers trying to front run each other. And, of course, for the biggest beneficiary of this PT principal bonanza, look no further than the chart below.

Going back to today’s ridiculous close, the chart below shows it all: the complete tape painting volume spike at the very end of the day speaks for itself. And as computers now simply issue forced stock recall orders to each other, painting the tape wet with manipulative intent and volume spikes into the last 20 minutes of trading every day, their human creators are left on the sidelines, trying to outshout each other as to the reason for why the market keeps rising while the economy keeps tumbling.

Is there ever going to be any transparency in this market again?

Submitted by Tyler Durden of Zero Hedge

White & Case, made famous by its irreverent lawyer Tom Lauria, who led a valiant fight for the non-TARP lender committee until its disbandment after holdout after holdout decided fighting against the US government was not reasonable, has been retained again, this time by Indiana Pension Funds, holders of Chrysler first-lien claims, who are continuing where the non-TARP lenders dropped off.

In several motions with the Chrysler docket earlier, the Indiana State Teachers Retirement Fund, Indiana State Police Pension Trust, and Indiana Major Movers Construction Fund, fiduciaries for “approximately 100,000 civil servants, including police officers, school teachers and their families” have objected to the 363 sale, and demand Judge Gonzalez should block the sale, claiming “the plan is illegal and tramples their rights.“

Among other things, the Indiana Pensioners seek to appoint both a trustee and an examiner in the case (an examiner was eventually retained in the Lehman bankruptcy), claiming that the company “has ceded control over their business and their restructuring efforts to the United States Treasury Department” which is using the Chapter 11 process to reward creditors that the “government deems politically important.”

Not only that, but lawyers added that “the Treasury Department has taken constructive possession of Chrysler and is requiring it to adopt a sale plan in bankruptcy that violates the most fundamental principles of credit rights.“

Whereas before it was easier to scapegoat certain evil, vicious hedge fund managers who could much easier be stripped of their fiduciary obligations and painted for the greedy, disgusting animals they are, Obama and Rattner will have a much more difficult time playing the blame game on this occasion, where the actual impaired party is so much closer to the people for whom it is a fiduciary, in this case, as the filing notes, roughly 100,000 ordinary men, women and children in the state of Indiana.

Lastly, this could significantly derail any plans for a fast and streamlined 363 sale: hopes were high that with the dissolution of the non-TARP committee it would be smooth sailing for Fiat and for the administration to get everything they wanted. With this last minute objection coming completely out of left field, Chrysler and its advisors will be stumped which lever in the media blame game to use now.

Submitted by Tyler Durden of Zero Hedge

For readers who have the time and interest to follow up on the topic Zero Hedge commenced yesterday discussing money liquidity and the shadow banking system, the best place to start is with Friedrich Hayek’s seminal Prices and Production, published in the depression days of 1935. Curiously Hayek discerned the critical role of the shadow banking system long before the advent of securitization, derivatives and other products that today have caused the monetary supply problem to reach a screaming crescendo. A very salient sample is presented below:

“There can be no doubt that besides the regular types of the circulating medium, such as coin, notes and bank deposits, which are generally recognised to be money or currency, and the quantity of which is regulated by some central authority or can at least be imagined to be so regulated, there exist still other forms of media of exchange which occasionally or permanently do the service of money. Now while for certain practical purposes we are accustomed to distinguish these forms of media of exchange from money proper as being mere substitutes for money, it is clear that, other things equal, any increase or decrease of these money substitutes will have exactly the same effects as an increase or decrease of the quantity of money proper, and should therefore, for the purposes of theoretical analysis, be counted as money.

In particular, it is necessary to take account of certain forms of credit not connected with banks which help, as is commonly said, to economize money, or to do the work for which, if they did not exist, money in the narrower sense of the word would be required. The criterion by which we may distinguish these circulating credits from other forms of credit which do not act as substitutes for money is that they give to somebody the means of purchasing goods without at the same time diminishing the money-spending power of somebody else. This is most obviously the case when the creditor receives a bill of exchange which he may pass on in payment for other goods. It applies also to a number of other forms of commercial credit, as, for example, when book credit is simultaneously introduced in a number of successive stages of production in the place of cash payments, and so on. The characteristic peculiarity of these forms of credit is that they spring up without being subject to any central control, but once they have come into existence their convertibility into other forms of money must be possible if a collapse of credit is to be avoided.”

Great 500+ page read for a Sunday afternoon. As for some more generic, brief (and modern) thoughts, I provide a few personal observations.

First, a run through the orthodox framework.

A basic account of money supply starts with the monetary aggregates that matter most for CPI inflation: in the case of the US this includes cash balances in aggregates such as the M2 (total deposits) or MZM (zero maturity money/cash plus bank claims and money market funds). The traditional recent definition of “available stock” of money consists of the cash notional of money printed by the central bank (outside money) and how much the banking system has created by making loans (inside money). Of course, due to the deposit multiplier effect, the inside money is much bigger than outside money. For the purposes of this narrative, the impact of securitization and derivatives (tier 3 and 4) will not be discussed currently as the complexity involved would take a big turn for the uglier. It will, however, be a topic pursued in the future.

The chart below shows the relative composition of inside money (mostly deposits) was almost ten times the outside money (monetary base) prior to the recent crisis.

Furthermore, as the historical chart demonstrates below, while rare, it has occurred, most notably during the Great Depression, that the broader money stock and monetary base moved in opposite directions.

A looking at the other side of the equation: demand, is the desired cash balances held by the public. Money demand rises via transactions demand with a growing economy, and falls when interest rates rise as zero-yielding cash becomes less attractive. Some math: money demand is the inverse of the velocity of money. If MV=PY (where M is money stock, V is velocity and PY is nominal GDP), then (1/V) = (M/PY), which is the level of money stock relative to nominal GDP. For households, 1/V can be represented as the desired money holdings as a share of nominal income. If a household decided to increase their money holding to 9 months of income from 6 months (a process occuring pervasively in the current environmen tof job and otherwise insecurity and lack of trust), V would fall to 1.33 from 2x.

This is, in simple terms, the standard approach. As the bolded section of Hayek’s quote demonstrates, however, it does not go far enough. What he is trying to convey, is that the economy, like any other constantly shifting “ecosystem” can create its own media of exchange in order to “economize” on the use of inside and outside money for use in the purchasing of assets. Once assets themselves can serve as collateral, allowing for leverage purchases, they also take on money-like properties. And, herein lies the rub, when financial assets serve as collateral for borrowing to purchase yet more assets (margin purchasing), this kind of shadow money becomes especially potent in driving asset price overshoots and bubbles. The chart below demonstrates the various parts of the credit cycle from the perspective of shadow money.

A good form summary of a credit bubble is presented below, compliments of Credit Suisse:

It starts with some genuine investment opportunity almost always related to a real improvement in technology or fundamentals. As strong price performance turns into a boom, optimistic investors desire to buy more on margin. They leverage up, usually using the buoyant asset itself as collateral. Lenders are all too willing to benefit by funding these purchases – after all, in the worst case, they will be holding valuable collateral. Borrowing terms such as haircuts, loan-to-value ratios, or margin requirements get easier. New money flows in, and associated financial assets begin to take on money-like attributes.

As buying on leverage accelerates, prices and credit conditions blow past what is warranted by fundamentals. There is a monetary expansion in the broad sense of shadow money, but when the bust comes this is quickly reversed. Lending conditions tighten, collateral prices plummet, and highly leveraged optimists are wiped out. Now cash is king; investors do not want houses, stocks, tulips or asset-backed commercial paper. To accommodate this demand for cash the government/central bank must quickly and forcefully expand the monetary base or else the increase in money demand can lead to a painful general deflation.

Meanwhile, the sudden disappearance of good collateral in the financial system has created a dangerous de-leveraging that could feed on itself. The government may respond by increasing its own debt, since public collateral in the forms of treasury bills and such do still have funding liquidity, and by flooding the market with government paper the leverage collapse can be better managed. In this example effective money (meaning shadow money plus the conventional money stock) falls sharply, but it would have fallen much more without aggressive policy actions.

As shadow money is a pro-cyclical, boom-time phenomenon, serving as a medium of exchange to finance a bubble, it affects asset prices directly, but only indirectly affects goods and services prices. An approach to estimate shadow money is calculating the immediate cash embodied in various debt securities: this can be done using asset haircuts in repo markets as well as current market values at FMVs in four points in time: early ’07, 2008 Pre Lehman, 2008 Post Lehman, and currently.

If the market had outstanding securities worth $100 billion and repo haircuts of 5%, then effective money would be $95 billion. If prices fell 50% and repo haircuts rose to 20%, effective money would be ($100* 0.5)*(1-20%) = $40 billion. Some asset haircuts are presented below in the attempt to determine effective money.

The exhibit below estimates the size of effective US money stock as a sum of inside and outside money as well as shadow money, broken by private and public.

A simplified breakdown of public and private effective money stock is presented on the next chart.

Lastly, in order to demonstrate the dramatic outflow in private shadow money in the immediately pre/post Lehman economy, and just how effectively subdued the public shadow money response has been in dealing with the pull back of the private sector. Credit Suisse estimates that since 2007 the shadow money in private debt securities (IG, HY bonds, non-agency RMBS, CMBS and ABS) has fallen by 38% or $3.6 trillion to $5.9 trillion, mostly due to a drop in market values, a scarcity of new issuance and, most importantly, a huge increase in repo haircuts. To compensate for this, public shadow money represented by treasuries, agency bonds and agency RMBS, has risen by $2.8 trillion, driven by an unprecedented ramp up in treasury and MBS issuance, and an increase in relevant asset prices.

It is immediately obvious that the expansion of public shadow money is no match for the massive contraction seen in the private side. In this light, the question of the efficacy of the QE rollout and other public shadow money expansion has a tinge of futility to it, and not just in terms of money supply inflection points. The continued risk aversion by banks means inside money contraction, and not outside money expansion, is the threat. Not just the wilful allowance of rising inflation by policy makers, but, much more relevantly, a recovery in loan creation is needed. As Keynes noted, in assessing money demand, in addition to interest rates and growth, the subject of “liquidity preference” is critical – the desire by the public to hold (often abnormally large) cash balances as buffers in times when bad economic outcomes are feared, such as currently. As liquidity preference is a mass psychology phenomenon, it is impossible to quantify and predict. A huge increase in cash demand at a time of weak growth is a rare, dangerous and deflationary occurrence, and tends to occur exactly at financial crises such as this one. The administration’s, and the media’s, massaging of mass psychology through the constant and repeated message that all is well, in order to rekindle the liquidity preference by the general public, makes all the sense in the world, as absent its intangible “benefit” the road to recovery is doomed from the onset.

But is even this propaganda machine doomed, in a more subversive way? As households whose HELOCs have been cut or whose home equity has diminished, firms whose commercial property has collapsed in value, and banks whole ability to borrow in collateral markets to raise cash has fallen, all face the same problem: as the ability to raise cash has fallen, actual cash holdings must rise. And, unfortunately for the Obama administration, this is not a temporary hoarding, this is a permanent rebalancing in the trillions of dollars order of magnitude. As money demands skyrockets, the velocity of money plummets.

In the pro-cyclical boom of 2002-2007 many components of everyday lives became a derivative of the shadow money system: repo lending became critical to credit creation; home equity extraction became a key means to smooth consumer spending during period of low or no income; off-balance sheet funding of various assets became a major earnings generator for commercial banks. Yet the process appears not to have affected money demand and supply: regular bank loan growth was limited, keeping money stock from soaring, and money demand was held back by beliefs in easy availability of borrowing against collateral. Most dangerously, economic policy, first through Greenspan then Bernanke, was complicit in allowing the boom by emphasizing price level inflation and not effective money. With regular M2 and MZM money supply and demand effected only indirectly by the credit boom and a massive output gap following the 2001 recession, it was never an issue that inflation would soar. A similar credit boom occurred with no inflation in the 1920s also, another period where a major collateralized credit pyramid was built virtually on top of a reasonably stable money stock. The reason, then, as now, key decision-makers did not notice a massive credit pyramid was being built, is because traditional money indicators, which this post argues are essentially useless in the context of today’s much more sophisticated from a money and liquidity perspective economy, were fairly stable. If there is one “crime” for which the most two recent chairmen of the Fed should be held in ridicule in hsitory books, it is precisely this. And yet while Greenspan may be somewhat forgiven due to his less academic nature, Bernanke, who was a depression “specialist”, should have seen our current predicament coming from miles. That he failed to do so is why future historians and market pundits will not spare him the criticism of being among the primary culprits for the current, multi-generational crisis. In the meantime, the propaganda issuing from every media source is to be expected (and in some ways welcomed) – it merely demonstrates that the administration finally grasps the severity of the problem, and the need for confidence to rematerialize, even if it is through the current meme of Green Shoots (whose very existence is flawed flawed upon more than a cursory examination, whether it is due to seasonal factors, subsequent economic data adjustments, or outright misrepresentations).

Yet now that any hope of a preventative approach has failed and we are stuck with the consequnces, what happens? In order for there to even be hope of recovery, money stock has to rebound. Not only Bernanke, or Geithner, but Obama himself has now demontrated that he is on the same page with regard to explanding the shadow money stock (while presumably providing better oversight and supervision).

For now, the immediate focus should be on whether confidence can return: in collateral, in lending, in risk taking, in entrepreneurship. In the meantime, any talk of inflation is premature. The deflationary shock has to wear off first, and in many asset classes it has not even accelerated yet.

It is ironic that shadow money and credit are not just the dynamo that drives the free market, but also its Achilles heel. While most of the time they serve a useful purpose, currently their purpose is a destructive one as long as they continue to trendline away from recent asymptotes. If history is any indication, the overshoot to the downside will likely be just as severe as the upside overshoot was protracted. In that case, nothing the Fed does can accelerate inflation. Also, while possible that Bernanke has something up his sleeve, it is improbable.

Thus while the market continues trading on a sepculative basis and conjecture rooted in the casino psychology that has gripped equity markets (and recently credit markets as well), the long term picture is much less sanguine as the excesses of the credit cycle from the past 60 years wear off and not only asset prices but also repo haircuts find a new equilibrium.

What is certain is that the near-term economy will be driven in spurts and starts as mass psychology shifts from one extreme to another. The next catalyst in my view will be the interplay of the impact of stimulus spending coupled with the failure of the green shoots materializing into anything worthwhile. And while this will make the life of daytraders interesting, the traditional buy and hold approach to asset accumulation must be delayed indefinitely, until the critical equilibrium discussed above is achieved. Until that happens, anyone who claims the economy is headed in the right direction (either much higher or much lower), is merely spreading their own agenda or has an opinion that is fundamentally not rooted in actual facts.

Thanks to Credit Suisse for primary observations and ideas and hat tip to Gunther.

Submitted By Tyler Durden of Zero Hedge

As we initially reported nearly two months ago, the main reason why the banks’ fixed income trading desks generated phenomenal profitability in January and February had nothing to do with actual trading of fixed income and everything to do with AIG’s hamheaded (and loss-generating) unwind of its CDS book, which by implication generated one-time, massive profits for counterparties to the trade (read: the banks, which are now doing all they can to issue shares in the open market day in and day out on the coattails of the phenomenal short squeeze that this unwind generated).

AIG CEO Ed Liddy provided some more fire for this hypothesis today during his testimony before the House Financial Services Subcommittee. In a very odd twist, Liddy, who in March had disclosed that AIG-FP had unwound over $1.1 trillion in CDS notional (from $2.7 trillion to $1.6 trillion – a ridiculously large amount), today noted that the financial black hole had succeeded in only unwinding an additional $0.1 trillion in the last 2 months, from $1.6 trillion to $1.5 trillion.

The obvious question that arises here is why did AIG slow down its CDS unwind process so much?

Some potential answers: i) the banks do not need any taxpayers gifts now as much as they did in January and February; ii) the financial blogosphere (and to a much smaller extent, the mainstream media) is now fully aware of the taxpayer thuggery that AIG committed when it unwound the $1.1 trillion in no time, and iii) Andrew Cuomo is monitoring every CDS transaction at AIG-FP under a microscope now, so wholesale dumping could be a “tad” more problematic.

The logical implication is that if banks need to break the taxpayer piggybank again, it will be next to impossible to abuse the taxpayer funded rainy day fund. Therefore banks better all raise equity stat or else the pain in Spain will soon be unbearable: ergo a wholesale, orchestrated short squeeze rally.

I provide the full transcripts from March and May for compare and contrast purposes.

Update: some interesting thoughts from Denninger. Good read.

Full May transcript below.

Submitted by Tyler Durden, publisher of Zero Hedge

In an interview of momentous importance, WJR’s Frank Beckmann interviews Tom Lauria, the Head of Restructuring at law firm White & Case, in which the lawyer, who represents Chrysler hold-out hedge funds Stairway Capital and Oppenheimer Funds, discusses on the record the amazing treatment by the White House of Perella Weinberg, which initially had been a transaction hold out but after threats by the White House (not my words) was forced to drop their objection and go with the administration. Says Lauria:

“One of my clients was directly threatened by the White House and in essence compelled to withdraw its opposition to the deal under threat that the full force of the White House press corps would destroy its reputation if it continued to fight…That was Perella Weinberg.”

In the clip below, fast forward to the two minute mark, where the Obama administration’s negotiating tactics become very, very clear.

What is very odd is that Perella Weinberg could possibly have veered away from the administration’s path in the first place: Zero Hedge readers know that P-W is the very firm advising the rapidly sinking FDIC “on transactions and strategies to stabilize the banking system, and also on the proper way to dispose failed institutions and how to handle delinquent securities assumed from banks, as well as the creation of the aggregator bank.”

This leads to the conclusion that this was really the work of one Dan Arbess, who runs the recently acquired by P-W, Xerion Capital, but nonetheless does not explain the lack of strategic integration at this most critical of advisors to Sheila Bair, and by implication the U.S. administration. How it is possible that one’s core advisor would go against its client, even if offset by a Chinese Wall, is likely the big story here, and speaks volumes about the chaos behind the scenes currently occurring with regard to Wall Street’s sentiment for the ruling administration.

Incidentally, Zero Hedge is considering launching a FOIA to Ms. Sheila Bair to disclose the compensation structure for Perella Weinberg as it continues to advise the FDIC on the “proper” shuttering and liquidation of bank after bank. After all, we have already seen 31 bank failures for 2009, a number that will likely hit the 100s, and it is every taxpayer’s right to understand the motivations behind Perella-Weinberg’s recommendations to the FDIC and to the White House, especially ahead of next week, when the stress test results could potentially lead to the closure of some of the “too big to fail” systematically important financial institutions.

The full interview with Tom Lauria below is a must hear for everyone as it discloses not only the administration’s strong arming tactics in black and white, but also discloses some other critical facts that the president on his regular TV appearances has failed to mention such as:

- First lien holders were willing to accept a 50% discount on their positions, however the 71% demanded by the administration was seen as too much.
- The cash going to Junior claims (creditors below the first liens) will be between $10 and $20 billion, a number which in practice should satisfy a par recovery for the 1st liens if the Absolute Priority Rule was actually withheld.
- Among the creditors are not just vulturous hedge funds but “pensioners, teachers, credit unions, college endowments, retirement plans, and personal retirement accounts.”

In conclusion, Lauria summarizes the developing Chryslerf#%k best:

“The President is trying to abrogate contractual rights; if he will attack that contractual right, what right will he not attack?”

Hat Tip Steve

Submitted by Tyler Durden of Zero Hedge

It is no secret that the administration, and especially Barney Frank, has made public enemy number one out of the rating agencies (and particularly Moody’s), mostly in line with populist rhetoric and scapegoating. Of course, when the rating agencies satisfied a role that helped housing prices go higher, keep people happier and officials like Barney Frank in office longer, all was good. When things turn sour, the Franks of the world know to keep the attention away from Washington.

Well, Barney et al may want to be careful not to antagonize the RAs too much, as, in yet another twist of fate, the success of the New Economic Order plan hinges ironically on the rating agencies and their continued rating complacency, particularly with regard to that Plan Of All Plans, the TALF.

While recently perusing Moody’s Weekly Credit Outlook, I came across an interesting observation from the RA regarding the most recent TALF credit card securitization deals. Moody’s had this pretty standard language to say about the issuance:

Last Tuesday, two TALF-eligible credit card transactions were completed in the second round of TALF issuance. Credit card issuers Cabela’s and WFN issued $425 million and $560 million, respectively. As we had anticipated in our Special Comment of March 31,5 these early stage issuances under TALF are modest relative to the size of the market and to the TALF budget ($1 trillion). Meanwhile, however, these transactions are interesting for the information they provide on the early steps of the much-anticipated price discovery that we expect TALF to trigger.

Both credit card deals have three-year maturities and are priced comparatively wider than the Citibank TALF credit card transaction executed last month. As shown below, the estimated ROI for TALF investors ranged from a low of 14% for the Citibank transaction to a high of 24% for the WFN transaction.

So far so good – hedge funds have so much money on the side (allegedly) that they can throw it in any money pit they want, including credit card securitizations. Their problem. However, reading further down the Moody’s piece and a few scary things appear. First of all, while the kinks are being ironed out in allowing any piece of floating garbage to be eligible for the TALF, for now only AAA-rated credit card securitizations are eligible for the program. Moody’s acknowledges this as well “TALF requires triple-A ratings.” However, and here is the rub, Moody’s does not rate either Cabela’s or WFN’s other credit card debt AAA. Now this becomes a problem as allowing a non-AAA rating as part of the TALF structure would immediately render it ineligible. So what happens? In Moody’s own brief and cryptic words: “Moody’s rates WFN and Cabela’s other outstanding credit card ABS at less than Aaa. We were not asked to rate these TALF deals.“

Yup, folks – turns out the survivorship bias of the AAA-rating is back in town. If the government wants a AAA rating to peddle it garbage to “private” investors and is aware it will not get it, it simply chooses to bypass that particular rating agency which disagrees with the government’s assessment on the pristineness of the collateral. Sure enough: the Cabela’s deal gets a AAA rating from the three other gov’t pets: S&P, Fitch and DBRS. No wonder Egan-Jones is nowhere to be included in this fray: their objectivity would royally screw with the purpose of picking the top three ratings out of the hat of four rating agencies eligible for pandering to Barney Frank and the PPIP.

Either way, this selective affirmative bias presents a new wrinkle in the rating agency conflict of interest: if there is advance information that a given RA will underrate and not provide the AAA seal of approval on any given TALF issue, the powers that be simply decide to bypass it entirely, relying on its more easily manipulated peers. Although this also means that Frank will have to be careful to focus the public anger on Moody’s as he has already started, and not stray far and blame S&P and Fitch for essentially the same transgressions, as if these last two bastions of “every collateral is fabulous” opinions decide to stop playing ball, the current version of TALF will simply evaporate, and the government will be forced to redraft TALF so that even C+ rated collateral can be packaged into it.

And just as the housing bubble ended the way it did with the rating agencies’ complacency, this new development will inevitably leave the naive private investors who are taking advantage of the government’s TALF “benevolence” in the same boat as Iceland, who was oh-so-keen to believe that non AAA-rated RMBS is “safe”.

Submitted by Tyler Durden, publisher of Zero Hedge

Zero Hedge regularly gets visits from the SEC and FINRA, and we can only hope they are taking some of the troubling behavior we have identified seriously. Today’s case looks like a clear regulatory violation.

A few weeks ago I noticed Merrill Lynch/Bank of America on an epic quest to underwrite equity follow on offerings for a vast majority of the lowest quality REITs including Kimco, ProLogis, Duke Realty and others. I say lowest quality, because Merrill’s own analysts had a Sell rating on these names as recently as March 31 (for Kimco) and January 6 (for ProLogis). How the global economy has really changed for the better of REITs since then is still a mystery to me. But I digress.

Yet, as much as I want to keep focusing on Merrill Lynch, it is another company that piques the interest on this occasion. The company at hand is smallish Wachovia, which, at least, in theory does not exist anymore as an entity separate from its recent acquiror, Wells Fargo.

First, I present the back cover page of the WRI prospectus through which Weingarten Realty sold 28 million shares at $14.25, where one can clearly see the prominent role of Wachovia/Wells Fargo.

Also don’t let the date on the prospectus fool you: the formal dilution press release announcement came out at 4:13 pm on April 16.

Why is this relevant: As the prospectus itself says in the Use of Proceeds section: “Affiliates of Merrill Lynch, Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities Inc., Wachovia Capital Markets, LLC, BBVA Securities, Inc., and J.J.B. Hilliard, W.L. Lyons, LLC are lenders under our unsecured credit facility and will receive a share of the net proceeds from this offering used to repay borrowings under the credit facility proportionate to their respective commitments under the facility.“

How much longer will banks keep offloading their REIT credit exposure to unwitting equity investors? Yes, the i’s are dotted with this terrific one sentence disclaimer, however we don’t get it. If these companies are such great and worthwhile investment prospects, why are banks rushing to offload their credit exposure, which by the way is the least risky part of the capital structure, while investors are buying equity to pay down the banks credit exposure, and taking on the first-loss risk in the balance sheet? The use of proceeds in every single REIT follow-on offering has been to pay back the banks that have underwritten it. Is it that complicated to see this for the bait-and-switch it is?

Zero Hedge tries to preserve investors what little capital they may have left. However, some just seem hell bent on throwing their money into the CRE fire pit.

But I digress… again. Back to Wachovia. As readers can recall, Zero Hedge had some heartfelt words for Merrill analyst Schmidt, who the day of the ML/BofA offering, decided to upgrade Kimco stock from a Sell to a Buy. Ok, one can structure conspiracy theories about this event, but for all intents and purposes it is not outright illegal… regardless of how many Ambien CRs said analyst has to take at night to sleep soundly. However, taking a look at the WRI offering, some much more serious questions come to mind: like does Wachovia/Wells Fargo have a compliance department and is it aware that its REIT analyst is issuing an upgrade on the stock, a day before Wachovia/Wells Fargo will issue stock in the upgraded company in order to repay Wachovia/Wells Fargo’s credit facility.

The facts: on April 15th, a day before the WRI stock offering, Wachovia/WF analyst Jeffrey Donnelly, CFA, releases an upgrade report on WRI with the following title “WRI: Upgrading To Market Perform, More Confident In Capital Plan Raising Estimates On Possibility Of Shallower Near-Term Trough.” Donnelly had downgraded the stock to a Sell a mere two months prior, on February 23, providing a 2009 FFO target of $2.25/share (his upgrade, as seen below, upward adjusts his 2009 FFO target by a whopping 7 cents to $2.32/share which in any book is worthy of an upgrade).

It is unfathomable how Mr. Donnelly would not be restricted by his compliance department, by his research supervisor and by his capital markets desk from publishing a material, stock moving report 24 hours ahead of a follow on offering in which his bank is a key underwriter. The first rule for any sell-side analyst is do not publish research reports that could get you in hot water with the regulators. Wachovia squarely broke that rule. The only logical (and legal) explanation is if the WRI offering was put together so haphazardly and hurriedly, that the bank really had no idea it would be an underwriter until the day of the offering and thus did not even give Donnelly the change to get restricted. Of course, this possibility only spells doom for any investors who got caught in the manic rush to catch the last minute window of capital markets access as underwriters were scrambling to allocate share blocks to their respective syndication desks, knowing full well the window would close within hours (not days) and the stocks would come tumbling down. However, both possibilities reside strongly in the ethical twilight zone, with the first one likely being so in the legal zone as well. It is, again, shocking, that Wells Fargo’s compliance team did not catch this report before it came out, as its publication will inevitably cause serious headaches for all parties involved, especially if WRI stock proceeds to crash over the next several days and the class action lawsuits start trickling in.

Adding insult to injury, WRI management itself came out on April 17th and stated that it now expects its 2009 FFO (see above) to be in the $1.83-$2.06/share range, after giving effect to the offering (yes it is diluted, and yes it is a about 20% lower than Donnelly’s $2.35/share target, serving as the basis for his upgrade report).

Speechless.

And of course it doesn’t end there.

JP Morgan and Wachovia announce yesterday they are doing a follow on offering for Regency Centers Corporation, another small REIT. What is the use of proceeds? Yup, you guessed it: “We intend to use approximately $205 million of these net proceeds to repay outstanding indebtedness under our line of credit. Our line of credit matures in February 2011 and currently has a variable interest rate equal to LIBOR plus 40 basis points, which as of April 17, 2009 was 0.96%.”

Zero Hedge wonders yet again, just which banks benefit from new investors parting with their money so that banks can minimize their secured credit exposure to yet another REIT. Come to think of it, it is about time FINRA and the SEC did too.

Submitted by Tyler Durden, publisher of Zero Hedge

With articles like this coming out of Time magazine, it is inevitable that in the immediate future, the United States will be split into two partisan camps. However, this will not be the traditional schism of republicans vs. democrats, contrary to Mr. Barney Frank’s attempt to start ideological partisan warfare. The real split will be of naive, easily-manipulated, small-time mom and pop investors, who only care about looking at their daily yahoo finance screens and 401(k) statements, seeing more black than red, and only focusing on what happened in the immediate past, and the forward looking taxpayers, who see the upcoming budget deficit fiasco, the social security ponzi scheme, the Medicare/Medicaid debacle, the ridiculous underfunding in public and corporate pension funds, the rising city and state taxes, the shuttering factories, the rising unemployment, the plummeting American production base, the “seasonally” upward-adjusted economic data coupled with consistently downward revised prior economic releases, the increasing savings rate and the multi trillion discrepancy in consumer purchasing power. The taxpayers are becoming angrier and angrier at the net present value destruction of future opportunities of being a U.S. citizen, while investors cheer every piece of information (whether or not supported by facts) that provides a push to their current net worth, ignorant of what this may mean for the future. There will come a point where this schism reaches a boiling point, in the meantime, the paradox is that so many of the taxpayers are also investors, who are caught in a tug of war with themselves on what the proper response to the crisis should be: happy as a result of bear market rallies, or sad when they put the facts into perspective.

Speaking of facts, Time contributing author Douglas McIntyre may have considered presenting some to justify his thesis that the “the great banking crisis of 2008 is over.” Pointless regurgitation of secondary viewpoints serves no purpose in the mainstream media, especially not in formerly reputable mainstream media such as Time (Zero Hedge’s subscription is running out with no plans for renewal). It is even worse when the MSM represents as “facts” the disinformation by banks, who claim that the downward inflection point has been reached and ignore the full context: a much weaker mark-to-market methodology, the FDIC and SEC aiding and abetting wholesale “pennies on the dollar” blue light specials of bankrupt banks such as Wachovia and Washington Mutual, taxpayer funnels such as AIG being used to pad the top and bottom line, a financial system balance sheet which has over 70% of its assets guaranteed by the Fed and the Treasury, and lastly, a spike in commercial real estate deterioration to unprecedented levels. Mr. McIntyre’s article is childish and unsubstantiated to the point of generating derisive laughter from his readers. Then again, a casual glance of his self-description in Seeking Alpha is enough to put his opinion into perspective: Mr. McIntyre “knows technology cold, has a sharp understanding of what’s priced-in to [sic] stocks, and writes extremely well (as you’d expect).” How a self-ascribed technology specialist (who writes “so well” that he makes grammatical mistakes in the very same sentence making that claim) ends up stating “the financial crisis is over” is beyond Zero Hedge’s meager attempts at comprehension. What Zero Hedge is not beyond, however, is presenting the facts and not perpetuating the disinformation fallacy.

The cold facts – “When you stare into the abyss long enough, the abyss stares back at you.”

Why is everyone so afraid to stare at the proverbial abyss? Readers of Zero Hedge know all too well, about my fascination with the economic fundamentals, and my desire to expose the real abyss in all its deep glory.

I dare anyone: McIntyre, Kudlow, Geithner, Obama, to look at the chart below and tell me we are in a V shaped recession. Yes, ISM may be bottoming (at record low levels which is not indicative of much), and unemployment may soon be bottoming (it has not, yet somehow the market believes it is just a matter of time), however one look at the chart of accelerating commercial real estate delinquencies and what they mean for the multi-trillion commercial real estate market should stop any V-recovery fans dead in their tracks.

I will present some more factual glances of the abyss, courtesy of the good folk at Realpoint.

Through the February 2009 reporting period, the delinquent unpaid balance for CMBS increased by a substantial $1.2 billion, up to a trailing 12-month high of $11.99 billion. Overall, the delinquent unpaid balance grew for the sixth straight month, up over 244% from one-year ago (only $3.48 billion in February 2008) and now over five times the low point of $2.21 billion in March of 2007. While a slight decline was noted in the 30-day and 60-day delinquent loan categories, the distressed 90+-day, Foreclosure and REO categories grew for the 15th straight month – up over 216% in the past year. This increase took place despite another $53.9 million in loan workouts and liquidations reported for February 2009 across 20 loans. Ten of these loans at $19.1 million, however, experienced a loss severity near or below 1%, most likely related to workout fees, while the remaining 10 loans at $34.8 million experienced an average loss severity near 46%. As additional pressures are placed on special servicers to maximize returns in today’s market, loss severities are expected to increase while liquidation activity is expected to slow further as fewer transactions occur. This would be the result of reduced or distressed asset pricing, lower availability of funds, and increased extensions of balloon defaults through the end of 2009 and into 2010.

The total unpaid balance for all CMBS pools under review by Realpoint was $837.78 billion in February 2009, down from $842.8 billion in January. Both the delinquent unpaid balance and delinquency percentage over the trailing twelve months are shown in the chart above and the one below, clearly trending upward for the timeline.

The resultant delinquency ratio for February 2009 increased to 1.431% from 1.281% one month prior. Such ratios above 1% reflect levels not seen in since April 2005. What is more concerning, however, is that the delinquency percentage through February 2009 is more than three times the 0.399% reported one-year prior in February 2008. The increase in both delinquent unpaid balance and delinquency ratio over this time horizon reflects a slow but steady increase from historic lows through mid-2007.

Assumptions based on three-month historical data:

• Over the past three months, delinquency growth by unpaid balance has averaged roughly $1.65 billion per month, while the outstanding universe of CMBS under review has decreased on average by $3.5 billion per month from pay-down and liquidation activity.
• If such delinquency average were again increased by an additional 25% growth rate, and then carried through the end of 2009, the delinquent unpaid balance would top $32 billion and reflect a delinquency percentage slightly above 3.8% by December 2009.
  
• In addition to this growth scenario, if one adds the potential default of the $3 billion Peter Cooper Village / Stuyvesant Town loan and the $4.1 billion Extended Stay Hotel loan, the delinquent unpaid balance would top $39 billion and reflect a delinquency percentage near 5% by December 2009.

“V-shaped recovery” indeed. But let’s continue:

Special servicing exposure has also been on the rise, having increased for the 10th straight month to $17.11 billion in February 2009 from $14.38 billion in January 2009 and only $12.78 billion in December 2008. The corresponding percentage of loans in special servicing has also increased to 2.04% of all CMBS by unpaid balance, up from only 0.50% in both February 2007 and 0.67% February 2008. The overall trend of special servicing exposure since January 2005, by both unpaid balance and percentage, is presented in Charts 3 and 4 below.

Realpoint’s default risk concerns for the more recent 2005 to 2007 vintage transactions relative to underlying collateral performance and payment ability are more evident on a monthly basis. Both the volume and unpaid balance of CMBS loans transferred to special servicing on a monthly basis continues to raise questions about underlying credit stability in today’s market climate for these deals, as evidenced by attached table. An additional 117 loans at $2.28 billion issued from 2005 through 2007 were transferred to special servicing in February 2009, mostly (but not only) for delinquency. Such figure reflected 71% of the current month’s transfers and 13% of total special servicing exposure in February 2009. Furthermore, over 51% of delinquent unpaid balance through February 2009 came from transactions issued in 2006 and 2007, with over 27% of all delinquency found in 2007 transactions. Extending a review to include the 2005 vintage, an additional 16% of total delinquency is found meaning over 67% of CMBS delinquency comes from the 2005 to 2007 vintage transactions. The chart below shows the increased delinquent unpaid balance relative to these three vintages over the past six months, clearly reflecting the increasing trends highlighted in recent months.

Throughout 2009, it is expected to see high delinquency by unpaid balance for these three vintages due to aggressive lending practices prevalent in such years. Also some loans from the 2008 vintage are expected to show signs of distress and default in cases where pro-forma underwriting assumptions fail to be met at the property level.

Focusing on deals that have seasoned for at least one year, the investigation reveals the following:

• Deals seasoned at least a year have a total unpaid balance of $822.94 billion, with $11.661 billion delinquent – a 1.42% rate (up from 0.5% six months prior).
• When agency CMBS deals are removed from the equation, deals seasoned at least a year have a total unpaid balance of $793.3 billion, with $11.656 billion delinquent – a 1.47% rate (up from 0.52% six months prior).
• Conduit and fusion deals seasoned at least a year have a total unpaid balance of $701.2 billion, with $10.78 billion delinquent – a 1.54% rate (up from 0.54% six months prior).

Other concerns/dynamics within the CMBS deals monitored which may affect the overall delinquency rate in 2009 include:

• Balloon default risk related to upcoming anticipated repayment dates (ARD’s) or term maturity from highly seasoned transactions for both performing and non-performing loans coming due in the next 12 months that may be unable to secure adequate refinancing due to current credit market conditions, lack of financing availability, or further distressed collateral performance.
  
• Refinance and balloon default risk concerns from floating rate transactions, as many large loans secured by un-stabilized or transitional properties reach their final maturity extensions, or fail to meet debt service or cash flow covenants to exercise such extensions.
  
• Aggressive pro-forma underwriting on loans with debt service / interest reserve balances declining, more rapidly than originally anticipated, on a monthly basis.
  
• Further stress on partial-term interest-only loans that begin to amortize during the year that already have in-place DSCRs hovering around breakeven.
• The unpaid balance related to loans underwritten in the past three years with DSCRs between 1.10 and 1.25 is very high, and any decline in performance in today’s market could cause an inability to make debt service requirements.
  
• A decline in distressed asset sales or liquidations as traditional avenues for securing new financing is becoming less available.
  
• Additional stress on both the retail and lodging sectors as consumer spending declines and the U.S. economy weakens.

Monthly CMBS Loan Workouts and Liquidations

The rate at which liquidated or problematic CMBS credits are replenished by newly delinquent loans remains a concern, especially regarding further growth to Foreclosure and REO status (evidence of additional loan workouts and liquidations on the horizon for 2009). Through February 2009, newly reported CMBS delinquency continued to outpace monthly liquidations by a very high ratio, raising concerns for further deterioration in the market.

In February 2009, 10 loans for $34.8 million experienced an average loss severity near 46% – a clear reflection of true loss severity in today’s credit climate. Higher levels of loss severity will be the norm in 2009 for those loans that experience a term default where cash flow from operations is not sufficient to support in-place debt obligations.

Since January 2005, over $7.52 billion in CMBS liquidations have been realized, while 44 of the trailing 49 months have reported average loss severities below 40%, including 21 below 30%. While average loss severity increased slightly for the 12 months of 2007 when compared to 2006, monthly loan liquidations by unpaid balance declined significantly in 2007 when compared to 2006 (by 43% year-over-year). Liquidations in 2007 totaled $1.094 billion at an average severity of only 32.8%. Liquidations in 2006 totaled $1.93 billion at an average severity of only 30.2%, while 2005 had $3.097 billion in liquidations at an average severity of 34.2%.

Comparison by property type:

• The highest loss severities in 2006 were found in healthcare (55%) and industrial (34.5%) collateral; multifamily collateral remained highest by balance before liquidation ($606.7 million), but reported the lowest severity (24.5%).
• The highest loss severities in 2007 were found in industrial (50%) and healthcare collateral (44%); multifamily collateral was again highest by balance before liquidation ($356 million), but reported the fourth lowest severity (32.5%).
• The highest loss severities in 2008 were found in mixed-use / other (36%) and multifamily collateral (31%); multifamily collateral was again the highest by balance before liquidation ($576.97 million).

Future Workouts – Delinquency Categories

The total balance of loans in Foreclosure and REO increased for the 16th straight month to $2.696 billion from $2.39 billion in January 2009, despite ongoing liquidation activity. These figures had declined steadily for some time through mid-2007, reflective of expedited loan work outs, but continue to be replenished with new loans due to aggressive special servicing workout plans. The chart below also shows the rapid growth of loans reflecting 30-day delinquency in the later half of 2008, transitioning rapidly into more distressed levels on a monthly basis, thus supporting the use of 30-day defaults as an early indicator of workouts to come in 2009.

Property Type

• Multifamily loans remained a poor performer in January 2009, with over a 2.5% delinquency rate (up from only 0.9% in January 2008 – over a 177% increase).
• Multifamily loans also are the greatest contributor to overall CMBS delinquency, at 0.51% of the CMBS universe and over 35% of total CMBS delinquency (but down slightly for the second straight month).
• By dollar amount, multifamily loan delinquency is now up by an astounding $3.38 billion since a low point of only $903.3 million in July 2007.
• As shown in Chart 7 below, multifamily, retail, office and hotel collateral loan delinquency as a percentage of the CMBS universe have clearly trended upward since mid-2008.
• Only seven healthcare loans at 0.017% of the CMBS universe are delinquent, but such delinquent unpaid balance reflects 5.8% all healthcare collateral in CMBS.
• As a percentage of total unpaid balance, year-over-year delinquencies for all categories increased by triple digits from February 2008 to February 2009.
• In 2009 retail delinquency will increase substantially as consumer spending suffers from the overall weakness of the U.S. economy. Store closings and retailer bankruptcies will continue throughout the year.
• In addition, the hotel sector will likely experience an increase in delinquency as both business and leisure travel slows further.

Geography

• The top three states ranked by delinquency exposure through January 2009 changed as California surpassed Michigan in third position. This remained the same through February 2009. Together with Texas and Florida, these three states collectively accounted for 30% of CMBS delinquency.
• Previously in November 2008, New York had passed Michigan and moved into third place in the rankings, following the reported delinquency of the Riverton Apartments loan at $225 million (CD07CD4). New York is now in the fifth position when ranked by delinquent unpaid balance.
• The 10 largest states by delinquent unpaid balance reflect 62% of CMBS delinquency, while the 10 largest states by overall CMBS exposure reflect 53% of the CMBS universe.
• The state of Texas remains a major concern at over 11.5% of CMBS delinquency, concentrated within the Houston and Dallas-Fort Worth, MSAs (almost 9% of CMBS delinquency); however, such MSAs reflect a fairly low percentage of total exposure in their respective MSAs (at less than 3.4%).
• Four MSAs topped 4% of CMBS delinquency in February 2009 (up from three a month prior).
• The 10 largest MSAs by delinquent unpaid balance reflect 37% of CMBS delinquency, while the 10 largest MSAs by overall CMBS exposure reflect 34% of the CMBS universe.

…And the facts go on and on and on… yet not one of them is mentioned in McIntyre’s “analysis”.

Commercial real estate is nothing more than a proxy for the intersection of the two historically core driving forces in the U.S. economy: real estate values and business conditions. And as the facts above indicate, the deterioration is only starting to pick up.

But what about all the stimulus programs skeptics will ask? The bail out packages? The constant funneling of taxpayer money into every underperforming segment of economy?

The truth is that the more taxpayer money is dumped to try to fill the abyss, it may become marginally shallower, but only at the expense of it getting wider. At some point soon (if not already), the U.S. economy will be unweenable from the trillions and trillions of taxpayer subsidies all the while it becomes more indebted to both its investors and taxpayers, further exacerbating the abovementioned paradox (presumably not without a motive). As the multi-trillion CRE crash continues to deplete the left side of the financials’ balance sheet with an exponentially growing pace (and I have not even touched on the credit card topic), the banks will be left scratching their heads what accounting rules to bend, which insurance companies to implode and get another AIG-like piggybank, how to break REG-FD more and more creatively with select memo leaks, how to manipulate the market, and how to make the Tsy curve becomes even more upward sloping with the compliments of the Fed and the Treasury. In the meantime the disinformation rift between the American taxpayers and investors will keep growing until inevitably, one day, it will escalate to the point where empty promises on prime time TV by the administration’s photogenic representatives will not suffice, and real actions that benefit future American generations will be demanded… What happens after I have no idea.

Disclaimer: Zero Hedge is currently flat in its SRS exposure, after being long from the $50s and unwinding in the $100s

Submitted by Tyler Durden, publisher of Zero Hedge

There was a time on Wall Street when insider trading was rampant, when sellside analysts would pump stocks under the guidance of their superiors only to have their corporate finance colleagues do an equity offer shortly after, when the amount of money a bank’s corporate clients paid would determine its rating, and when analysts said in internal emails a company is worthless, only to issue reports claiming the company was the next sliced bread. Then things changed for the better briefly, when Spitzer came on the stage. However, with his thunderous fall from grace in an act of utter hypocrisy, the behavior he fought so hard to curb started gradually coming back.

Submitted by Tyler Durden, publisher of Zero Hedge

When the man in charge of the second largest borrower in the U.S. is willing to lose his job due to his discomfort with the FASB’s shift in accounting rules, you can bet that the tragic fallout of all the “market buoying” recent events is only a matter of time.

Somehow this noteworthy event, which happened over a week ago, passed substantially unnoticed until Zero Hedge friend Jonathan Weil at Bloomberg dug it up. Charles Bowsher, who was most recently Chairman of the Federal Home Loan Bank System’s Office of Finance and previously served as U.S. comptroller general may be the only truly honorable man in the socialist nexus of politics and finance. The reason for his departure from this critical post – his discomfort in vouching for the banks’ combined financial statements. And as Weil puts it succinctly: “Now the question for taxpayers is this: If Charles Bowsher can’t get comfortable with these banks’ financial statements, why should anybody else be?” Why indeed.

If Bowsher was merely involved with some marginal organization, this could be perceived as a hypocritical attempt to score populist brownie points. However, the FHLB is among the governmental entities at the heart of the current problem. Zero Hedge has written previously about the FHLB and its critical role in the ongoing housing crisis, but in a nutshell “The Office of Finance issues and services all the debt for the 12 regional Federal Home Loan Banks. That’s a lot of debt — $1.26 trillion as of Dec. 31, making the FHLBank System the largest U.S. borrower after the federal government. The government-chartered banks, which operate independently, in turn supply low-cost loans to their 8,100 member banks and finance companies. If any of the FHLBanks were to fail, taxpayers could be on the hook.”

Ah, the poor taxpayer about to get duped one last time. And the immediate reason for Bowsher’s decisions: his concern with the methods used for determining when losses on hard-to-value securities should be included in banks’ earnings and regulatory capital. And it gets much worse:

For the fourth quarter of 2008, the FHLBanks said their total preliminary net loss was $672 million. It would have been many times larger, had they included all their red ink.

The year-end balance sheet at the FHLBank of Seattle, for example, showed $5.6 billion of non-government mortgage-backed securities that it says it will hold until maturity. Yet the estimated value of those securities was just $3.6 billion. The bank, which reported a $199.4 million net loss for 2008, said the declines were only temporary. They’ve been anything but fleeting, though. Most of those securities have been worth less than they cost for more than a year.

The FASB’s rules on this subject, which have never been well defined, are now in flux. Today, after caving in to pressure by the banking industry and members of
Congress, the Financial Accounting Standards Board is set to vote on a plan to relax its rules on mark-to-market accounting, so that companies can disregard market prices and ignore losses on their securities indefinitely.

Bowsher is not new to taking hard political stands:

As comptroller general, he was in charge of the General Accountability Office, the investigative arm of Congress. At his direction, the GAO was among the first to warn the public about the brewing savings-and- loan crisis during the 1980s. He testified before Congress in 1994 that there was an “immediate need” for “federal regulation of the safety and soundness” of all major U.S. derivatives dealers. (How’s that for prescient?)

Most recently, in 2007, he led an independent committee that issued a blistering report on financial missteps at the Smithsonian Institution, whose board of regents included U.S. Chief Justice John Roberts.

And how does the FHLB spin this event?

“Mr. Bowsher has expressed his concerns to me around the complexity of valuing mortgage-backed securities and the process of producing combined financial statements from the 12 home loan banks. I don’t think it’s appropriate for us to speak for Mr. Bowsher.”

So: to paraphrase – one of the men who knows the ins and outs of the financials of banks involved in the mortgage crisis more intimately than even Bernanke and Geithner, let alone Obama, is saying that the newly implemented changes by the FASB will throw the whole system into tailspin and he want none of it.

If this isn’t the most damning condemnation of the Kool Aid the administration, the Treasury, the Fed, the FASB, the FDIC, and all the other alphabet soups are trying to make the common U.S. citizen drink and have seconds, then nothing else possibly could be…. of course until Bowsher is proven right and everything collapses into the smoldering heap of defaulted MBS still marked at par on various liquidating banks’ balance sheets…

Oh and yes, let’s hold a moment of silence for Lehman which held billions of mortgage backed securities that it too was “holding until maturity.” Well, Lehman is no more, and all these securities now trade, in the form of the company’s general unsecured claims, at the generous price of 12 cents on the dollar… Furthermore, one can’t say the market is illiquid – the bid-ask spread is only 1 cent. And as there are over $150 billion of these claims floating around, one can’t say the market is in any way limited from a price discovery standpoint.

Maybe if more honest leaders follow in Bowsher’s unique example, the general population will finally start seeing though the everyday lies and misinformation coming out of D.C.

Posted by Tyler Durden, Publisher of Zero Hedge

And Northern Trust thought it had problems when Barney Frank went postal for the company’s House Of Blues romp. A smoking gun lawsuit filed March 30 in Northern Illinois District Court (09-cv-01934) by Joseph Diebold on behalf of the pension scheme of one of the world’s largest companies, Exxon Mobil, alleges Northern Trust breached its fiduciary responsibility under ERISA and claims Northern Trust invested the fund’s capital since 2007 “recklessly and imprudently, by acting disloyally and causing massive losses.”

One could surmise that Northern Trust, despite having pledged to repay its $1.6 billion in TARP funding, should at this point promptly change its mind and keep that cash, as this lawsuit may potentially have staggering adverse consequences.

This could be a seachange in terms of corporate pension funds, who are on the hook for massive losses, turning their anger instead at pension plan custodians and managers.

In a nutshell, the lawsuit purports that collateral collected from lending out of shares, had been invested too riskily by Northern Trust. Pension schemes traditionally use custodians and investment managers to lend out certain securities in their portfolios to hedge funds and other third parties. In exchange, the schemes receive collateral payments that are further invested to create additional returns. As once securities are returned the collateral has to be repaid immediately, investors generically prefer investing in liquid, low-risk assets. It appears this is where NTRS has made a big blunder, and effectively ended up generating losses for the ExxonMobil pension estate.

The Exxon Mobil pension fund, which is represented in the lawsuit by Joseph Diebold, Jr., and is pursuing class action status, was worth $13 billion at the end of 2007, and states in the lawsuit that “defendants inappropriately invested the collateral in collateral pools that were illiquid, highly-leveraged, and unduly risky, containing mortgage-backed securities and other securitized debt instruments. These investments were inappropriately risky for retirement plan investments – especially when compared to the relatively small amount of gains that the plans could expect to receive from securities lending arrangements.”

While no definitive figures have been set for total losses yet, the lawsuit is set for class-action status, and other plaintiffs are being sought to join the class-action suit, according to a news release from the four law firms representing plaintiffs. The suit represents 600 pension schemes for which Northern Trust was carrying out securities lending collateral investment services.

While on one hand it is surprising that NTRS could generate losses on lender arrangements, which traditionally have a 0 lower return bound, what is much more shocking, is that such a large company as Exxon is taking legal action to recover pension losses. This will likely soon become the modus operandi for all major corporate pension schemes that have experienced losses, who piggy back on this example as a means of recouping at least a portion of losses. And taking from Newton’s 3rd law, the defendants will likely end up having to pony up billions of new dollars.

Lastly, as Northern Trust (at least for now), and many of the other collateral custodians, are TARP recipients, this will present a brand new and unanticipated cog in the taxpayer-bank relationship, as banks will end up having to potentially pay out taxpayer money to pension funds, which invest the capital of these very same taxpayers. The circularity is enough to make one’s head spin.

Submitted by Tyler Durden, publisher of Zero Hedge

Zero Hedge is rarely speechless, but after receiving this email from a correlation desk trader, we simply had to hold a moment of silence for the phenomenal scam that continues unabated in the financial markets, and now has the full oversight and blessing of the U.S. government, which in turns keeps on duping U.S. taxpayers into believing everything is good.

I present the insider perspective of trader Lou (who wishes to remain anonymous) in its entirety:

“AIG-FP accumulated thousands of trades over the years, all essentially consisted of selling default protection. This was done via a number of structures with really only one criteria – rated at least AA- (if it fit these criteria all OK – as far as I could tell credit assessment was completely outsourced to the rating agencies).

Main products they took on were always levered credit risk, credit-linked notes (collateral and CDS both had to be at least AA-, no joint probability stuff) and AAA or super senior portfolio swaps. Portfolio swaps were either corporate synthetic CDO or asset backed, effectively sub-prime wraps (as per news stories regarding GS and DB).

Credit linked notes are done through single-name CDS desks and a cash desk (for the note collateral) and the portfolio swaps are done through the correlation desk. These trades were done is almost every jurisdiction – wherever AIG had an office they had IB salespeople covering them.

Correlation desks just back their risk out via the single names desks – the correlation desk manages the delta/gamma according to their correlation model. So correlation desks carry model risk but very little market risk.

I was mostly involved in the corporate synthetic CDO side.

During Jan/Feb AIG would call up and just ask for complete unwind prices from the credit desk in the relevant jurisdiction. These were not single deal unwinds as are typically more price transparent – these were whole portfolio unwinds. The size of these unwinds were enormous, the quotes I have heard were “we have never done as big or as profitable trades – ever“.

As these trades are unwound, the correlation desk needs to unwind the single name risk through the single name desks – effectively the AIG-FP unwinds caused massive single name protection buying. This caused single name credit to massively underperform equities – run a chart from say last September to current of say S&P 500 and Itraxx – credit has underperformed massively. This is largely due to AIG-FP unwinds.

I can only guess/extrapolate what sort of PnL this put into the major global banks (both correlation and single names desks) during this period. Allowing for significant reserve release and trade PnL, I think for the big correlation players this could have easily been US$1-2bn per bank in this period.“

For those to whom this is merely a lot of mumbo-jumbo, let me explain in layman’s terms:
AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam.

In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).

What this all means is that the statements by major banks, i.e. JPM, Citi, and BofA, regarding abnormal profitability in January and February were true, however these profits were 1) one-time in nature due to wholesale unwinds of AIG portfolios, 2) entirely at the expense of AIG, and thus taxpayers, 3) executed with Tim Geithner’s (and thus the administration’s) full knowledge and intent, 4) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.

For banks to proclaim their profitability in January and February is about as close to criminal hypocrisy as is possible. And again, the taxpayers fund this “one time profit”, which causes a market rally, thus allowing the banks to promptly turn around and start selling more expensive equity (soon coming to a prospectus near you), also funded by taxpayers’ money flows into the market. If the administration is truly aware of all these events (and if Zero Hedge knows about it, it is safe to say Tim Geithner also got the memo), then the potential fallout would be staggering once this information makes the light of day.

And the conspiracy thickens.

Thanks to an intrepid reader who pointed this out, a month ago ISDA published an amended close out protocol. This protocol would allow non-market close outs, i.e. CDS trade crosses that were not alligned with market bid/offers.

The purpose of the Protocol is to permit parties to agree upfront that in the event of a counterparty default, they will use Close-Out Amount valuation methodology to value trades. Close-Out Amount valuation, which was introduced in the 2002 ISDA Master Agreement, differs from the Market Quotation approach in that it allows participants more flexibility in valuation where market quotations may be difficult to obtain.

Of course ISDA made it seems that it was doing a favor to industry participants, very likely dictating under the gun:

Industry participants observed the significant benefits of the Close-Out Amount approach following the default of Lehman Brothers. In launching the Close-Out Amount Protocol, ISDA is facilitating amendment of existing 1992 ISDA Master Agreements by replacing Market Quotation and, if elected, Loss with the Close-Out Amount approach.

“This is yet another example of ISDA helping the industry to coalesce around more efficient and effective practices, while maintaining flexibility,” said Robert Pickel, Executive Director and Chief Executive Officer, ISDA. “The Protocol permits parties to value trades in the way that is most appropriate, which greatly enhances smooth functioning of the market in testing circumstances.”

And, lo and behold, on the list of adhering parties, AIG takes front and center stage (together with several other parties that probably deserve the microscope treatment).

So – in simple terms, ISDA, which is the only effective supervisor of the Over The Counter CDS market, is giving its blessing for trades to occur (cross) below where there is a realistic market bid, or higher than the offer. In traditional equity markets this is a highly illegal practice.ISDA is allowing retrospective arbitrary trades to have occurred at whatever price any two parties agree on, so long as the very vague necessary and sufficient condition of “market quotations may be difficult to obtain” is met. As anyone who follows CDS trading knows, this can be extrapolated to virtually any specific single-name or index easily. In essence ISDA gave its blessing for below the radar fund transfers of questionable legality. The curious timing of this decision and the alleged abuse of CDS transaction marks by and among AIG and the big banks, is striking to say the least.

This wholesale manipulation of markets, investors and taxpayers has gone on long enough.

Submitted by Tyler Durden, publisher of Zero Hedge

As I dug a little more into the mystery of the amended Bloomberg headline discussing FDIC’s travails, some interesting facts came up. On September 25, 2008, Bloomberg staff reporter David Evans (not to be confused with U2′s The Edge) came out with a piece called “FDIC May Need $150 Billion Bailout as More Banks Fail.” The article reaches its gloomy conclusion based on Chris Whalen’s estimate that by the end of 2009, 100 U.S. banks will fail with collective assets of more than $800 billion, and quotes Richmond Fed director Mark Vaughan in saying “It’s not going to be Armageddon. But it’s going to be bad.” Additionally, Evans discussed the potential fate of uninsured deposits, which he estimated at $2.6 trillion or 37% of the total $7 trillion in deposits held at U.S. FDIC member banks, and concluded that if “the government were on the hook ” to protect these deposits as well, the FDIC’s all in cost for failed bank rescues could swell “to more than $400 billion.”

What is interesting, is that the very same day Evans came out with his FDIC critique, the agency immediately issued a rebuttal in the form of an open letter to Bloomberg News claiming David Evans “does a serious disservice to your organization and your readers by painting a skewed picture of the FDIC insurance fund.” The letter, written by FDIC Public Affairs Director Andrew Gray, makes for a fascinating read as it discloses some curious, and previously undiscovered facts:

Let me be clear: The insurance fund is in a strong financial position to weather a significant upsurge in bank failures.

Even under an amended title, Sheila Bair’s most recent public appearance on March 20, in which she claimed that “Without additional revenue beyond the regular assessments, current projections indicate that the fund balance will approach zero“, does not make it sound like the insurance fund is “in a strong financial position” at all.

The FDIC has all the tools and resources necessary to meet our commitment to insured depositors, which we view as sacred. I do not foresee – as Mr. Evans suggests – that taxpayers may have to foot the bill for a “bailout.”

Luckily for Mr. Gray “do not foresee” will not hold up in court as a determination of guarantees.

Let’s look at the real facts about the FDIC insurance fund. The fund’s current balance is $45 billion – but that figure is not static. The fund will continue to incur the cost of protecting insured depositors as more banks may fail, but we continually bring in more premium income. We will propose raising bank premiums in the coming weeks to ensure that the fund remains strong. And, at the same time, we will propose higher premiums on higher risk activity to create economic incentives for poorly managed banks to change their risk profiles. The fund is 100 percent industry-backed. Our ability to raise premiums essentially means that the capital of the entire banking industry – that’s $1.3 trillion – is available for support.

At the time this letter came out, the TLGP did not exist. However now, in addition to having “the capital of the entire banking industry available for support”, the FDIC, in a poetic flip of words, also has to issue capital to support the entire banking industry. The letter continues:

Moreover, if needed, the FDIC has longstanding lines of credit with the Treasury Department. Congress, understanding the need to ensure that working capital is available to the FDIC to provide bridge funding between the time a bank fails and when its assets are sold, provided broad authority for us to borrow from Treasury’s Federal Financing Bank. If necessary, we can potentially raise very large sums of working capital, which would be paid back as the FDIC liquidates assets of failed banks. As per our authorizing statute, any money we might borrow from the Treasury must be paid back from industry assessments. Only once in the FDIC’s history have we had to borrow from the Treasury – in the early 1990s – and that money was paid back with interest in less than two years.

Interestingly, Chris Dodd’s Depositor Protection Act of 2009 legislation will make it possible for the FDIC not only to borrow from the Treasury but do so with some serious style – to the tune of $500 billion, up from the previous maximum borrowing limit of $30 billion. Somehow I think the FDIC will take a little longer than 2 years to repay that particular loan.

The last part of the letter is most interesting:

Finally, Mr. Evans’ suggestion that the “government” could ever be “on the hook for uninsured deposits” demonstrates a misunderstanding of FDIC insurance. To protect taxpayers, we are required to follow the “least cost” resolution, which means that uninsured depositors are paid in full only if this is the least costly option for the FDIC. This usually occurs when a bidder for the failed bank is willing to pay a higher price for the entire deposit franchise. We are authorized to deviate from the “least cost” resolution only where a so-called “systemic risk” exception is made. This is an extraordinary procedure which we have never invoked. And again, any money we borrow from the Treasury Department must be repaid through industry assessments.

Just what is this Least Cost resolution? And even more so, the ominous sounding Systemic Risk Exception? Here is what a legal dictionary has to say about the former:

§ 360.1 Least-cost resolution.

(a) General rule. Except as provided in section 13(c)(4)(G) of the FDI Act (12 U.S.C. 1823 (c)(4)(G)), the FDIC shall not take any action, directly or indirectly, under sections 13(c), 13(d), 13(f), 13(h) or 13(k) of the FDI Act (12 U.S.C. 1823 (c), (d), (f), (h) or (k)) with respect to any insured depository institution that would have the effect of increasing losses to any insurance fund by protecting:

(1) Depositors for more than the insured portion of their deposits (determined without regard to whether such institution is liquidated); or

(2) Creditors other than depositors.

(b) Purchase and assumption transactions. Subject to the requirement of section 13(c)(4)(A) of the FDI Act (12 U.S.C. 1823(c)(4)(A)), paragraph (a) of this section shall not be construed as prohibiting the FDIC from allowing any person who acquires any assets or assumes any liabilities of any insured depository institution, for which the FDIC has been appointed conservator or receiver, to acquire uninsured deposit liabilities of such institution as long as the applicable insurance fund does not incur any loss with respect to such uninsured deposit liabilities in an amount greater than the loss which would have been incurred with respect to such liabilities if the institution had been liquidated.

[58 FR 67664, Dec. 22, 1993, as amended at 63 FR 37761, July 14, 1998]

And here is an interesting tidbit on the Systemic Risk Exception:

To get a grip on the too big to fail problem, Congress established a difficult-to-trigger systemic risk exception. A least-cost resolution can be foregone – and by implication a resolution method selected that results in uninsured depositors and other creditors being protected – only if the Board Of Directors of the FDIC, The Board of Governors of the Federal Reserve System, and the secretary of the Treasury, in consultation with the president, determine the least-costly approach “would have serious adverse effects on economic conditions or financial stability.”

Personally, I have never encountered any legislative loopholes that need a quorum of these four most critical pillars of the U.S. economy. It is obvious the FDIC and lawmakers realized that there is something of huge value to be protected here in case there is a “systemic risk event.” And while it is likely not deposits over and above the insurance maximum, it might potentially have to do with “other creditors” rights. Which is where, if one were to get conspiracy theory minded, it would be possible to presume that in certain cases bank creditors (maybe even foreign investors who own this debt) would receive a least-cost resolution exemption. But even without that detour, in the case of a consensus that we have crossed the threshold of “systemic risk” (a phrase thrown around a little too freely these days), it is prima facie the case that U.S. taxpayers would be on the hook to bail out not only failed banks’ uninsured depositors but also creditors.

Now while the implications of this very fine print could be potentially staggering to the blissfully ignorant American public, the immediate change in the Bloomberg headline seems to be the least Bloomberg could do to avoid receiving additional angry letters, and to bring the public a step closer to these disclosures. Curiously, all this comes on the heels of Friday’s announcement that the NCUA is putting two massive credit unions into conservatorship after stress-tests disclosed “an unacceptably high concentration of risk from mortgage-backed securities” and the agency’s insurance fund will see a loss of $1.2 billion from the closures, according to spokesman John McKechnie.

Maybe the FDIC was a little early in its allegations that Bloomberg and Evans were doing anyone a disservice, as the reporter’s grim forecast is slowly starting to become reality.

Update:

Didn’t even finish typing this, and the FDIC’s troubles are already growing. This just out:

Washington Mutual Sues FDIC for over $13 Billion

In a complaint filed with the U.S. District Court for the District of Columbia, the thrift’s former parent accused the FDIC of having on January 23 made a “cryptic disallowance” of its claims, prompting the lawsuit.

It also accused the FDIC of agreeing to an unreasonably low price in arranging the a $1.9 billion sale of the banking business to JPMorgan on September 25, when regulators seized Washington Mutual and appointed the FDIC as receiver.

JPMorgan did not buy the parent holding company, which filed for Chapter 11 bankruptcy protection the following day.

In its complaint, Washington Mutual seeks to recover as much as $6.5 billion of capital contributions it said it made to its banking unit from December 2007 through the seizure.

Washington Mutual also seeks the return of $4 billion of trust preferred securities it said were wrongfully transferred to the banking unit, and said it may be entitled to as much as $3 billion of tax refunds. It also seeks damages of $177.1 million related to unpaid loans made to the banking unit.

If successful, this lawsuit will not help out FDIC’s increasingly troubled financial state.