This post first appeared on Minyanville and on our sister site Cirios Real Estate.
The bailout is done! Time to breathe a sigh of relief.
Or is it?
As details emerge about the financial bailout package that was jammed through Congress over 10 days of political theater at its most nauseating, there’s still a striking omission from the plan to right American’s economic ship.
The failure of bureaucrats and regulators to propose a realistic solution for the foreclosure problem is emblematic of their inability to treat the root cause of an issue, focusing instead on simply applying band-aids to the visible symptoms.
The bailouts of Bear Stearns, Fannie Mae (FNM) and Freddie Mac (FRE), and AIG (AIG) all claimed to remove the cancer - but all they did was hasten the patient's demise.
Treasury's plan will deliver money into the banking system to sop up toxic assets sitting on the balance sheets of our financial institutions. This is a necessary -- albeit unfortunate -- step, but it still doesn't address the root of the rot: Milions of homes are worth less than the outstanding balance of the owner's mortgage.
Billions of dollars in negative equity are destroying Main Street’s balance sheet even as it devours Wall Street, eroding the value of the very securities Taxpayers are about to start buying.
As long as Washington tries to fight foreclosures with ineffective loan modification programs that simply prolong the problems, foreclosures will continue to set records. Modifying a mortgage for someone who is barely scraping by is sort of like rescuing him from the side of a cliff, only to leave him on the edge, dangling by one arm.
Foreclosures are often blamed for spiraling home prices and the resulting collapse in value of securities tied to the mortgages used to buy those houses. According to Bloomberg, the government’s aid package is designed to support “financial companies reeling from the record number of home foreclosures.”
Foreclosures don't cause houses to lose their value. Foreclosures happen when a home loses value such that it’s worth less than the mortgage used to buy it, and the homeowner can’t sell or refinance if his interest payments become overwhelming.
Defaults become delinquencies, which become foreclosures, which become evictions, which become repossessions, which flood the market, depressing prices as supply outstrips demand.
Back in what seems like ancient history, when home prices only went up, banks weren’t too concerned with defaults, since homeowners could almost always sell themselves out of a problem. Foreclosures stayed low because the liquid, appreciating housing market bailed out troubled homeowners on its own. That's part of the reason the industry is so ill-equipped to handle the scope of the current problem: it never had to before.
But now, with so many borrowers underwater -- owing more on their house than it's worth -- defaults result in not only eventual liquidation of the property, but profound distress in the homeowner’s life and real losses for investors. Furthermore, delinquent borrowers are less inclined to pay for upkeep or security, and many foreclosed homes are seriously damaged by the time a bank is able to take possession of it.
Being underwater is debilitating. To sell, not only does a homeowner have to pay a Realtor 6% whether he gets a raw deal or not, but he has to pay the bank the difference between where his home sells and the outstanding balance of his loan.
For many who have seen the value of their homes fall hundreds of thousands of dollars, this is an impossibility. Most homeowners, once they’re upside down, just want to stay in their homes.
A more effective plan to curb foreclosures would require an independent reviewer to evaluate each delinquent mortgage, determine the borrower’s ability to pay going forward and the amount, if any, of negative equity that needs to be destroyed to bring the loan amount back under the home’s value.
Since the notion that buying Wall Street’s toxic assets will result in windfall profits is a willfully distributed fallacy aimed at getting the public on board for the bailout, Taxpayers would be well-served dumping money into a blender that’s at least in their own backyard.
British Prime Minister Gordon Brown recently proposed a similar plan, where the government will buy delinquent mortgages from banks for the outstanding balance of the loan. The home is then rented to the existing tenant or a new one and managed by a local housing association.
The government would absorb the difference between the loan amount and the resale value, which would hasten increase sales activity, clearing out the glut of homes listed too high for the simple reason that the owner can't afford to sell at a lower price.
This type of personalized bailout, unfortunately, reeks of moral hazard. Many individuals who made bad financial decisions will get to keep their homes, albeit without actual ownership. But the current socialization of our free markets is simply moral hazard be design, so if Congress is so hell-bent on bailing out Wall Street, why not share the spoils with Main Street.
If Congress wants this bailout to help the American people and keep the financial system in tact, a sizable portion of the funds should be directed at fixing the asset that’s at the center of this turmoil: the residential property.
Home prices need to come down further. They will come down further. It’s only a matter of time. We can either let home prices bleed down, slowly eroding the value of the securities they support and violently uprooting families, or the government can plug the hole.
Washington Mutual (WM) is already off the field, as JP Morgan (JPM) continues to play widowmaker for the financial system. Wachovia (WB) isn't likely to remain independent for long. The sooner the rebuilding process begins, the better.
This crisis, and the resulting ebb and flow of what remains of the free market has already tipped the scales, started us sliding down a path of deflation in everything from stock prices, to cereal boxes, soda bottles, not to mention homes.
This is a good development. The hardest lesson Americans will learn from this crisis, should learn from this crisis, is that sometimes it’s necessary to live within our means. There is virtue in simplicity. More is not always better. Bigger is not always better. Sometimes, amazingly enough, less is often better.
This progress is the only true way we'll make it out of this mess.
Showing posts with label wm. Show all posts
Showing posts with label wm. Show all posts
Monday, September 29, 2008
Friday, September 19, 2008
Fed Amputates Invisible Hand
This post first appeared on Minyanville.
A week ago, the United States had the most efficient capital allocation system in the world.
Our free-market economy enabled money, credit and resources to be sent to the economic players who needed it. Entrepreneurs could raise money to start new, innovative businesses; researchers could seek out cures for diseases that touch millions of lives, as well as those that afflict just thousands; firms that made enough bad decisions went bankrupt.
The job of regulators was to ensure the system functioned and to set up rules by which honest business could be conducted. It wasn't a perfect system, but it was better than the alternative.
This is the alternative.
When government invades free markets to the extent it has -- specifically in the last 24 hours -- the system ensuring capital gets where it needs to be breaks down. Money is instead doled out to the firms well connected enough in Washington to lobby for handouts.
Beltway bureaucrats have been trying to rewrite this country's economic rules and protect Wall Street from its own mistakes for over a year. Still, the free market prevailed, punishing the firms that made the most egregious bets during the housing boom: Countrywide, Bear Stearns, IndyMac, Merrill Lynch (MER), AIG (AIG), Lehman Brothers, National City (NCC), Washington Mutual (WM) and Wachovia (WB).
According to our once-free market, these firms needed to be wiped out, gobbled up and liquidated, so real economic growth could take hold from a stronger foundation.
This morning, we heard many claim the government's actions -- temporarily banning short selling, the creation of a Treasury Department distressed-asset hedge fund, the establishment of a federal backstop for money markets, to name but a few -- were necessary to prevent a wider financial and economic crisis. The shortsightedness of this argument is astounding.
A couple hundred years ago, Charles Darwin opined that nature has long been engaged in weeding out the weak, protecting the strong. This natural ebb and flow of dominance according to a given species' inherent characteristics has governed the world's socioeconomic landscape for more than 4 billion years.
The actions taken overnight seem to refute Darwin's claim that Mother Nature can manage her own backyard. Adam Smith's invisible hand is capitalist Darwinism, moving the weak aside so the strong can survive.
To take that power away from the market is tantamount to shoving God aside and rewriting the evolutionary playbook.
The effects of these actions, this fundamental ideological shift from capitalism towards socialism, represents a seismic shift in the history of this country. The events of the past week -- and what it says about our collective ability to take our lumps, drink our medicine and recognize that the path to the ultimate goal is one littered with hairpin turns and drop away cliffs -- will not be lost on future generations.
The events of the upcoming months and years, whether we're content to continue to hand over more and more power to the few, elected and non-elected alike, will show the true mettle of the American spirit.
A week ago, the United States had the most efficient capital allocation system in the world.
Our free-market economy enabled money, credit and resources to be sent to the economic players who needed it. Entrepreneurs could raise money to start new, innovative businesses; researchers could seek out cures for diseases that touch millions of lives, as well as those that afflict just thousands; firms that made enough bad decisions went bankrupt.
The job of regulators was to ensure the system functioned and to set up rules by which honest business could be conducted. It wasn't a perfect system, but it was better than the alternative.
This is the alternative.
When government invades free markets to the extent it has -- specifically in the last 24 hours -- the system ensuring capital gets where it needs to be breaks down. Money is instead doled out to the firms well connected enough in Washington to lobby for handouts.
Beltway bureaucrats have been trying to rewrite this country's economic rules and protect Wall Street from its own mistakes for over a year. Still, the free market prevailed, punishing the firms that made the most egregious bets during the housing boom: Countrywide, Bear Stearns, IndyMac, Merrill Lynch (MER), AIG (AIG), Lehman Brothers, National City (NCC), Washington Mutual (WM) and Wachovia (WB).
According to our once-free market, these firms needed to be wiped out, gobbled up and liquidated, so real economic growth could take hold from a stronger foundation.
This morning, we heard many claim the government's actions -- temporarily banning short selling, the creation of a Treasury Department distressed-asset hedge fund, the establishment of a federal backstop for money markets, to name but a few -- were necessary to prevent a wider financial and economic crisis. The shortsightedness of this argument is astounding.
A couple hundred years ago, Charles Darwin opined that nature has long been engaged in weeding out the weak, protecting the strong. This natural ebb and flow of dominance according to a given species' inherent characteristics has governed the world's socioeconomic landscape for more than 4 billion years.
The actions taken overnight seem to refute Darwin's claim that Mother Nature can manage her own backyard. Adam Smith's invisible hand is capitalist Darwinism, moving the weak aside so the strong can survive.
To take that power away from the market is tantamount to shoving God aside and rewriting the evolutionary playbook.
The effects of these actions, this fundamental ideological shift from capitalism towards socialism, represents a seismic shift in the history of this country. The events of the past week -- and what it says about our collective ability to take our lumps, drink our medicine and recognize that the path to the ultimate goal is one littered with hairpin turns and drop away cliffs -- will not be lost on future generations.
The events of the upcoming months and years, whether we're content to continue to hand over more and more power to the few, elected and non-elected alike, will show the true mettle of the American spirit.
Monday, August 25, 2008
FDIC Passes Around Collection Plate
This post first appeared on Minyanville.
Poor, poor FDIC - ever the Treasury Department’s whipping boy.
The latter gets to smack the former around like a badminton birdie because the FDIC’s primary responsibility is to clean up the Treasury’s messes. And these days, there are messes aplenty.
It goes like this: The Treasury oversees a regulatory body called the Office of Thrift Supervision, or OTS, that’s tasked with keeping tabs on federal thrifts (which are just mortgage companies moonlighting as federally chartered banks).
Until recently, the OTS was responsible for monitoring IndyMac Bancorp, which collapsed last month under the weight of misplaced mortgage bets. The FDIC is now sorting out the mess. The OTS also oversees such thriving institutions as Washington Mutual (WM), BankUnited (BKUNA) and Downey Savings (DSL).
Since the OTS’s idea of regulation is apparently to wake up late, sip a latte and spend the day diligently ignoring the wildly unsafe lending practices of its member banks, the FDIC is up to its ears in barely solvent financial institutions.
The FDIC charges deposit-taking institutions fees about $0.05 per $100 in deposits to display the group’s goofy logo (which dates to its Depression-era roots). This is meant to assure customers their money's safe, even if the bank’s risk management policies aren't.
When banks go belly up, the FDIC steps in and covers depositors up to $100,000. In the case of IndyMac, this could cost up to $8 billion. The FDIC’s insurance fund stood at just $53 billion pre-IndyMac, and is now so low it’s been forced to come up with an action plan to raise more money.
The options aren't exactly palatable.
It could jack up the fees it charges member banks, but with so many teetering on the edge of insolvency, they don’t exactly have a lot of cash to spare. The FDIC also has a $30 billion line of credit from the Treasury Department, but it’s loath to tap into it, lest it appear desperate.
Finally, it could borrow from the Federal Reserve, and join other flailing institutions like Lehman Brothers (LEH) and Merrill Lynch (MER), both of which have submerged themselves the warm bath of cheap Federal money.
As the credit crunch migrates outward from its epicenter on Wall Street and infects Main Street, local banks and thrifts are becoming ensnared in troubles previously reserved for complex securities firms. Small banks are often heavily levered to construction firms, small businesses and individuals in their surrounding communities, and are particularly vulnerable to regionalized economic slowdowns.
Downey Savings (in Orange County) and BankUnited (in South Florida), for example, are at the heart of the housing bust. Their local economies are sagging under the weight of job losses in both the construction and mortgage industries, as well as fallout from plummeting home prices. Both banks bet heavily on ill-fated Option ARMs during the boom, and neither is likely to survive the current crisis.
Now, the FDIC's challenge is to raise sufficient funds to cover the coming wave of bank failures - without putting undue stress on the already shaky banking system or igniting fears that it would need to tap taxpayers' money to protect, well, taxpayers' money.
Poor, poor FDIC - ever the Treasury Department’s whipping boy.
The latter gets to smack the former around like a badminton birdie because the FDIC’s primary responsibility is to clean up the Treasury’s messes. And these days, there are messes aplenty.
It goes like this: The Treasury oversees a regulatory body called the Office of Thrift Supervision, or OTS, that’s tasked with keeping tabs on federal thrifts (which are just mortgage companies moonlighting as federally chartered banks).
Until recently, the OTS was responsible for monitoring IndyMac Bancorp, which collapsed last month under the weight of misplaced mortgage bets. The FDIC is now sorting out the mess. The OTS also oversees such thriving institutions as Washington Mutual (WM), BankUnited (BKUNA) and Downey Savings (DSL).
Since the OTS’s idea of regulation is apparently to wake up late, sip a latte and spend the day diligently ignoring the wildly unsafe lending practices of its member banks, the FDIC is up to its ears in barely solvent financial institutions.
The FDIC charges deposit-taking institutions fees about $0.05 per $100 in deposits to display the group’s goofy logo (which dates to its Depression-era roots). This is meant to assure customers their money's safe, even if the bank’s risk management policies aren't.
When banks go belly up, the FDIC steps in and covers depositors up to $100,000. In the case of IndyMac, this could cost up to $8 billion. The FDIC’s insurance fund stood at just $53 billion pre-IndyMac, and is now so low it’s been forced to come up with an action plan to raise more money.
The options aren't exactly palatable.
It could jack up the fees it charges member banks, but with so many teetering on the edge of insolvency, they don’t exactly have a lot of cash to spare. The FDIC also has a $30 billion line of credit from the Treasury Department, but it’s loath to tap into it, lest it appear desperate.
Finally, it could borrow from the Federal Reserve, and join other flailing institutions like Lehman Brothers (LEH) and Merrill Lynch (MER), both of which have submerged themselves the warm bath of cheap Federal money.
As the credit crunch migrates outward from its epicenter on Wall Street and infects Main Street, local banks and thrifts are becoming ensnared in troubles previously reserved for complex securities firms. Small banks are often heavily levered to construction firms, small businesses and individuals in their surrounding communities, and are particularly vulnerable to regionalized economic slowdowns.
Downey Savings (in Orange County) and BankUnited (in South Florida), for example, are at the heart of the housing bust. Their local economies are sagging under the weight of job losses in both the construction and mortgage industries, as well as fallout from plummeting home prices. Both banks bet heavily on ill-fated Option ARMs during the boom, and neither is likely to survive the current crisis.
Now, the FDIC's challenge is to raise sufficient funds to cover the coming wave of bank failures - without putting undue stress on the already shaky banking system or igniting fears that it would need to tap taxpayers' money to protect, well, taxpayers' money.
Monday, July 28, 2008
Two More Banks Go Belly Up
This post first appeared on Minyanville.
The Federal Deposit and Insurance Corporation's (FDIC) $53 billion war chest is under attack.
Already forced to use almost 10% of its stash to repay depositors at now-defunct IndyMac, the FDIC will cough up another $860 million from its deposit insurance fund after seizing two more banks over the weekend.
On Friday, regulators took control of First National Bank of Nevada and First Heritage Bank of Newport Beach, California. Both are units of First National Bank Holding Company, headquartered in Scottsdale, Arizona. The FDIC, however, was able to avoid an IndyMac-style bank run by selling the failed institutions to Mutual of Omaha, a Nebraska bank.
All retail branches opened for normal business this morning, under the Mutual of Omaha name, avoiding check-cashing problems that still plague some IndyMac customers. Last week, after news leaked the FDIC wouldn’t cover a portion of uninsured IndyMac deposits, Washington Mutual (WM) and Wells Fargo (WFC) balked at IndyMac checks, placing a hold on deposits until their value could be verified.
While small in comparison to IndyMac’s $32 billion in assets, the two banks had almost $4 billion in combined assets, making the failures large by historical standards.
Working with the FDIC, the Office of Comptroller of the Currency issued a statement saying First National Bank of Nevada "was undercapitalized and had experienced substantial dissipation of assets and earnings due to unsafe and unsound practices." First Heritage was simply called “undercapitalized.”
Both banks were active issuers of subprime mortgages. Now, with losses that outweigh capital reserves, regulators have taken preemptive action and seized the banks to prevent panic.
While the FDIC is aggressively staffing up in advance of more failures, its Chairman, Sheila Bair, is moving to assuage concerns it won’t be able to live up to its obligations. In a press release last week, Bair reiterated the rights of American depositors and sought to inject confidence into the country’s banking system:
“The banking system in this country remains on a solid footing through the guarantees provided by FDIC insurance. The overwhelming majority of banks in this country are safe and sound and the chances that your own bank could fail are remote. However, if that does happen, the FDIC will be there -- as always -- to protect your insured deposits.”
The FDIC expects hundreds of banks to fail as a result of the current credit crisis, straining the cash its saved up to protect depositors. The seven failures so far this year tops the number of banks than went bust from 2004 through 2007, but is nowhere near the thousands that failed during the Savings and Loan crisis of the 1980s and 90s.
Today’s financial system, however, bears little resemblance to 20 years ago. The shadow banking system and the vast interconnectedness of the world’s financial institutions means no one bank can fail without potentially infecting its neighbors.
The FDIC has a tough road ahead.
The Federal Deposit and Insurance Corporation's (FDIC) $53 billion war chest is under attack.
Already forced to use almost 10% of its stash to repay depositors at now-defunct IndyMac, the FDIC will cough up another $860 million from its deposit insurance fund after seizing two more banks over the weekend.
On Friday, regulators took control of First National Bank of Nevada and First Heritage Bank of Newport Beach, California. Both are units of First National Bank Holding Company, headquartered in Scottsdale, Arizona. The FDIC, however, was able to avoid an IndyMac-style bank run by selling the failed institutions to Mutual of Omaha, a Nebraska bank.
All retail branches opened for normal business this morning, under the Mutual of Omaha name, avoiding check-cashing problems that still plague some IndyMac customers. Last week, after news leaked the FDIC wouldn’t cover a portion of uninsured IndyMac deposits, Washington Mutual (WM) and Wells Fargo (WFC) balked at IndyMac checks, placing a hold on deposits until their value could be verified.
While small in comparison to IndyMac’s $32 billion in assets, the two banks had almost $4 billion in combined assets, making the failures large by historical standards.
Working with the FDIC, the Office of Comptroller of the Currency issued a statement saying First National Bank of Nevada "was undercapitalized and had experienced substantial dissipation of assets and earnings due to unsafe and unsound practices." First Heritage was simply called “undercapitalized.”
Both banks were active issuers of subprime mortgages. Now, with losses that outweigh capital reserves, regulators have taken preemptive action and seized the banks to prevent panic.
While the FDIC is aggressively staffing up in advance of more failures, its Chairman, Sheila Bair, is moving to assuage concerns it won’t be able to live up to its obligations. In a press release last week, Bair reiterated the rights of American depositors and sought to inject confidence into the country’s banking system:
“The banking system in this country remains on a solid footing through the guarantees provided by FDIC insurance. The overwhelming majority of banks in this country are safe and sound and the chances that your own bank could fail are remote. However, if that does happen, the FDIC will be there -- as always -- to protect your insured deposits.”
The FDIC expects hundreds of banks to fail as a result of the current credit crisis, straining the cash its saved up to protect depositors. The seven failures so far this year tops the number of banks than went bust from 2004 through 2007, but is nowhere near the thousands that failed during the Savings and Loan crisis of the 1980s and 90s.
Today’s financial system, however, bears little resemblance to 20 years ago. The shadow banking system and the vast interconnectedness of the world’s financial institutions means no one bank can fail without potentially infecting its neighbors.
The FDIC has a tough road ahead.
Thursday, July 24, 2008
New Countrywide Suit Tries To Foreclose Foreclosures
This post first appeared on Minyanville.
When Bank of America (BAC) agreed to buy Countrywide, it didn’t just take on a mountain of questionably valued mortgage-related assets. It also took on huge legal liability.
San Diego City Attorney Mike Aguirre, who has a penchant for punitive lawsuits that rarely result in much more than a media frenzy, is accusing Countrywide of defrauding thousands of San Diego homeowners. A lawsuit has already been brought at the state level by California Attorney General Jerry Brown, as well as in several other states, including Washington and Illinois.
San Diego's suit takes aim at Countrywide’s alleged practice of coercing borrowers into risky adjustable rate mortgages (ARMs). Aguirre hopes to make San Diego a “foreclosure sanctuary” by preventing foreclosure proceedings on any property secured by a subprime ARM where the borrower owes more than the home is worth. (For more on what the glut of upside-down homeowners means for the future of the housing market, please read Finding the Bottom in Housing.)
The litigious City Attorney isn’t satisfied with just taking aim at Countrywide (and, by extension, Bank of America). Aguirre said he’s planning similar suits against Washington Mutual (WM), Wells Fargo (WFC) and Wachovia (WB).
While Aguirre’s heart may be in the right place, foreclosure moratoriums aren’t part of the road to recovery for the housing market. Opportunistic mortgage market participants are buying delinquent mortgages on the cheap, forgiving some part of the debt and giving borrowers a fresh start. Government intervention in this process will simply scare off lenders, since they'll have limited recourse if the loan goes sour.
At best, such suits will simply drive up the cost of new mortgages. At worst, they'll bring the recovery process to a standstill.
Foreclosures are nasty, painful and tragic. They are, however, a necessary part of the mortgage process, enabling lenders to recoup losses on bad loans.
Mandating an end to foreclosures is like telling the IRS it can’t go after tax evaders or preventing cops from chasing down burglars. This is not to say victims of foreclosures are criminals or necessarily deserve to be thrown out on the street, but living in a law-abiding society means that contracts must be enforced.
The moment we waive one group’s obligation to honor their collective word, the floodgates are open.
This certainly isn't the last lawsuit we’ll see following the collapse of the mortgage market. In fact, it’s just the tip of the iceberg. A couple years from now, when Option ARMs begin to reset, class action lawsuits will bear down on lenders like a rumbling avalanche rolling down a steep slope.
Banks would be wise to get long on lawyers.
When Bank of America (BAC) agreed to buy Countrywide, it didn’t just take on a mountain of questionably valued mortgage-related assets. It also took on huge legal liability.
San Diego City Attorney Mike Aguirre, who has a penchant for punitive lawsuits that rarely result in much more than a media frenzy, is accusing Countrywide of defrauding thousands of San Diego homeowners. A lawsuit has already been brought at the state level by California Attorney General Jerry Brown, as well as in several other states, including Washington and Illinois.
San Diego's suit takes aim at Countrywide’s alleged practice of coercing borrowers into risky adjustable rate mortgages (ARMs). Aguirre hopes to make San Diego a “foreclosure sanctuary” by preventing foreclosure proceedings on any property secured by a subprime ARM where the borrower owes more than the home is worth. (For more on what the glut of upside-down homeowners means for the future of the housing market, please read Finding the Bottom in Housing.)
The litigious City Attorney isn’t satisfied with just taking aim at Countrywide (and, by extension, Bank of America). Aguirre said he’s planning similar suits against Washington Mutual (WM), Wells Fargo (WFC) and Wachovia (WB).
While Aguirre’s heart may be in the right place, foreclosure moratoriums aren’t part of the road to recovery for the housing market. Opportunistic mortgage market participants are buying delinquent mortgages on the cheap, forgiving some part of the debt and giving borrowers a fresh start. Government intervention in this process will simply scare off lenders, since they'll have limited recourse if the loan goes sour.
At best, such suits will simply drive up the cost of new mortgages. At worst, they'll bring the recovery process to a standstill.
Foreclosures are nasty, painful and tragic. They are, however, a necessary part of the mortgage process, enabling lenders to recoup losses on bad loans.
Mandating an end to foreclosures is like telling the IRS it can’t go after tax evaders or preventing cops from chasing down burglars. This is not to say victims of foreclosures are criminals or necessarily deserve to be thrown out on the street, but living in a law-abiding society means that contracts must be enforced.
The moment we waive one group’s obligation to honor their collective word, the floodgates are open.
This certainly isn't the last lawsuit we’ll see following the collapse of the mortgage market. In fact, it’s just the tip of the iceberg. A couple years from now, when Option ARMs begin to reset, class action lawsuits will bear down on lenders like a rumbling avalanche rolling down a steep slope.
Banks would be wise to get long on lawyers.
Tuesday, July 15, 2008
WaMu's Plea For Calm
This post first appeared on Minyanville.
After leading the banking sector to its largest ever one-day drop yesterday, Washington Mutual (WM), in an effort to assuage concerns that it's facing a cash crunch, released a statement claiming that the bank is "well-capitalized."
Though the stock bucked the trend this morning as the broader financial complex continued its unrelenting sell-off, shareholders aren’t likely to be comforted by the WaMu’s pleas for calm.
The largest savings-and-loan in the country has seen share prices fall below $4 following the seizure of IndyMac (IMB) by benevolent federal banking regulators; investors fear WaMu could be next.
IndyMac was reopened on Monday to handle endless lines of depositors hoping to recover their pennies from the bank’s coffers.
In a stark reminder of just how dicey bottom-picking can be, Bloomberg reminded us that private-equity firm TPG led a consortium of investors in providing the bank with $7 billion in much-needed cash in April, when the stock traded at $13. Those daring saviors have seen most of their investment wiped out.
TPG did, however, slip a protective clause into the deal: If the stock drops below $8.75 -- which it clearly has -- TPG is owed the difference, effectively putting the bank on the hook for its own equity losses. While protecting TPG's investment, this feature also makes it considerably more costly, if not impossible, for the bank to raise more capital, which would further dilute shares.
As more details emerge about these and other onerous terms with which banks have been forced to agree in their efforts to raise capital, it's becoming clear just how misguidedly optimistic investors were when such deals were first announced. Banking expert Minyan Peter wrote of the WaMu deal:
“I think the problem for most market participants right now is the assumption [that] what we're experiencing looks something like 'their prior experiences in banking crises.' And to me, that's why we have seen such a big rally over the past two weeks -- because, based on prior experience, a rally feels very right, right about now.
But for all the reasons I shared before, this one is different.”
We’re now seeing just how different this one is.
Professor Depew explained Friday how the Fannie Mae (FNM) and Freddie Mac (FRE) crisis is different from the Long-Term Capital Management failure in 1998: In this case, massive losses by financial institutions around the world are a symptom, not the cause.
A few misplaced bets aren’t to blame for the market turmoil; neither is rumor-mongering. The financial system’s problems, and by extension the economy’s, are rooted in years of mispriced risk and excessive leverage. Markets are now witnessing the destruction of that debt at a rate that’s stomach-churning to the traditional buy-and-hold investor.
The process, though painful, is necessary. The debt will be destroyed, firms will go out of business and the economy will slow, if not contract. All this is healthy. Agonizing, to be sure, but healthy.
As Toddo wrote yesterday on the Buzz and Banter, “The big picture blues will lead to an unfortunate destination, but that’s necessary to rebuild the foundation for sustainable economic growth. Once we get there, those with capital will be in a fantastic position to prosper.”
After leading the banking sector to its largest ever one-day drop yesterday, Washington Mutual (WM), in an effort to assuage concerns that it's facing a cash crunch, released a statement claiming that the bank is "well-capitalized."
Though the stock bucked the trend this morning as the broader financial complex continued its unrelenting sell-off, shareholders aren’t likely to be comforted by the WaMu’s pleas for calm.
The largest savings-and-loan in the country has seen share prices fall below $4 following the seizure of IndyMac (IMB) by benevolent federal banking regulators; investors fear WaMu could be next.
IndyMac was reopened on Monday to handle endless lines of depositors hoping to recover their pennies from the bank’s coffers.
In a stark reminder of just how dicey bottom-picking can be, Bloomberg reminded us that private-equity firm TPG led a consortium of investors in providing the bank with $7 billion in much-needed cash in April, when the stock traded at $13. Those daring saviors have seen most of their investment wiped out.
TPG did, however, slip a protective clause into the deal: If the stock drops below $8.75 -- which it clearly has -- TPG is owed the difference, effectively putting the bank on the hook for its own equity losses. While protecting TPG's investment, this feature also makes it considerably more costly, if not impossible, for the bank to raise more capital, which would further dilute shares.
As more details emerge about these and other onerous terms with which banks have been forced to agree in their efforts to raise capital, it's becoming clear just how misguidedly optimistic investors were when such deals were first announced. Banking expert Minyan Peter wrote of the WaMu deal:
“I think the problem for most market participants right now is the assumption [that] what we're experiencing looks something like 'their prior experiences in banking crises.' And to me, that's why we have seen such a big rally over the past two weeks -- because, based on prior experience, a rally feels very right, right about now.
But for all the reasons I shared before, this one is different.”
We’re now seeing just how different this one is.
Professor Depew explained Friday how the Fannie Mae (FNM) and Freddie Mac (FRE) crisis is different from the Long-Term Capital Management failure in 1998: In this case, massive losses by financial institutions around the world are a symptom, not the cause.
A few misplaced bets aren’t to blame for the market turmoil; neither is rumor-mongering. The financial system’s problems, and by extension the economy’s, are rooted in years of mispriced risk and excessive leverage. Markets are now witnessing the destruction of that debt at a rate that’s stomach-churning to the traditional buy-and-hold investor.
The process, though painful, is necessary. The debt will be destroyed, firms will go out of business and the economy will slow, if not contract. All this is healthy. Agonizing, to be sure, but healthy.
As Toddo wrote yesterday on the Buzz and Banter, “The big picture blues will lead to an unfortunate destination, but that’s necessary to rebuild the foundation for sustainable economic growth. Once we get there, those with capital will be in a fantastic position to prosper.”
Friday, June 20, 2008
Finding the Bottom in Housing
This post first appeared on Minyanville.
The Holy Grail de jour of financial market prognostication is predicting the bottom in housing. It's a fool's errand, however. Investing based on a perceived end to declining property values has so far been a losing proposition.
Unlike equities and futures, the housing market has no central clearing house: The Plunge Protection Team's reach doesn't extend to real estate. Try as they may, Beltway bureaucrats can't create a false bottom in home values.
Nevertheless, economists at UCLA are out with a report that uses a single data point as evidence that California's housing market may be recovering. They call a recent upswing in sales in Riverside County (east of Los Angeles) a "very dim flicker of the light at the end of the tunnel."
That a few bargain hunters are testing the waters isn't a sign of stabilization. Witness Billionaire investor Joe Lewis' failed attempt to call a bottom in Bear Stearns. Values can't fall forever, but to say the market will recover "eventually" isn't terribly helpful.
To hazard an educated guess about when home prices will stop falling, it's necessary to understand the mechanics of a real estate transaction and what still needs to happen for property values to put in a meaningful bottom.
Homebuilders like KB Home (KBH) and Toll Brothers (TOL) continue to clamor for handouts from Washington to stem the decline. Rational market players, on the other hand, recognize that until prices return to more traditional levels of affordability, said bottom will continue to be elusive.
Contrary to what's reported in the mainstream press, the fundamental factor putting pressure on home prices isn't the rising tide of foreclosures. The National Association of Realtors and politicians who pander would like us to believe that banks, saddled with impaired assets, are unloading properties at below market value and exacerbating the downward spiral.
Bureaucrats aren't necessarily wrong in trying to prevent repossessions (the impact of a family being forcibly removed from its home is on many levels costly), but targeting foreclosures is characteristic of government policies that address the symptom rather than the cause.
Minyanville's Mr. Practical has long argued the most visible manifestation of the current financial malaise -- illiquidity -- is just a symptom of the true problem: bad debt. Likewise, foreclosures are the most visible part of a phenomenon that's preventing meaningful price discovery in the residential real estate market.
Goldman Sachs estimates that 30% of U.S. homeowners will be upside-down on their mortgages by the end of the year. Also known as being "underwater," being upside-down puts a borrower in the unenviable position of owing more on his home than the home is worth.
For the market to find a sustainable bottom, sellers need to reduce their asking prices to levels average homebuyers can afford. For upside-down homeowners, this isn't an option.
To repay the bank in full, an underwater borrower must put up the difference between the sale price and the outstanding balance on his mortgage. Refinancing would require the same out-of-pocket cash - something most troubled homeowners don't have. Many are choosing to simply walk away, a trend Professor Shedlock has covered in detail.
As a result, properties sit on the market for months, the seller unwilling to budge for the simple reason that he can't. This adds to the latent supply on the market and further depresses prices.
The latest in a wave of housing bailouts now making its way through Congress attempts to address this issue. Meanwhile, the free market, as it's apt to do, is solving the problem itself. Market-based solutions will get the job done regardless of the bickering and posturing that goes on in Washington. Those eager to call a bottom and snap up distressed assets would be wise to exercise patience; these workouts take time.
Mortgage market participants are solving the problem of upsided-own borrowers in two primary ways. First, opportunistic investors are buying delinquent mortgages at a discount to par and forgiving part of the borrower's loan balance. They then write a fresh loan for less than the new, lower property value.
If that didn't make any sense, don't worry. If it were easy, everyone would be doing it. Here's an example of how it works.
Let's assume in 2005 Snapper the Turtle bought a brand new McMansion from Cassidy's Craftsman Cottages for $500,000. He made a $50,000 down payment and took out a $450,000 adjustable rate mortgage (ARM) from the Bank of Boo. Unfortunately for Snapper, his lovely 5,000 square foot model home on a 5,500 square foot lot is now worth just $400,000. Snapper's ARM just reset and he's fallen behind on his mortgage payments.
The Bank of Boo's balance sheet is loaded with delinquent mortgages just like Snapper's and management is actively jettisoning non-performing loans. The bank auctions the loan to investors, who bid based on the property's resale value and Snapper's credit profile. Their goal is to buy the mortgage on the cheap and restructure it, turning a profit.
Hoofy's Hedge Fund, a specialist in distressed debt, snaps up the loan for a mere $0.60 on the dollar, or $270,000. Now the owner of Snapper's loan, Hoofy forgives part of Snapper's debt and writes a new mortgage for 80% of the value of the house, or $320,000. Hoofy covers the amount he paid Boo for the mortgage and pockets the difference: $50,000.
So, Hoofy turns a profit, Boo gets a problem loan off its books and Snapper gets a second chance. Since the transaction was completed prior to foreclosure, Snapper's credit is even salvaged.
Hedge funds and other vulture investors have raised vast pools of money to invest in distressed mortgage assets, some trying to execute this strategy with hundreds of millions of dollars. But Ph.D.'s in Greenwich, Connecticut dreaming up complicated structured finance models don't know the first thing about loan workouts. So, hoping they can make up for sloppy implementation with scale, they outsource the logistics, use valuation models to approximate home prices and lower profit expectations. The logic sounds eerily familiar to what got us into this mess in the first place.
As they're extraordinarily labor intensive, loan workouts, like the one described above, work best on a small scale. Successful firms take it one loan and borrower at a time and are conservative in their property valuations. The home's value represents not only the maximum amount for the new loan, but an investor's downside risk should the deal go sideways.
The second method for handling upside down mortgages is old fashioned litigation. Lawyers reach out to troubled borrowers and offer to negotiate with lenders or mortgage servicers on their behalf - for a hefty fee. However, this segment of the market is wrought with fraud, as slick attorneys and shady mortgage brokers can easily prey on desperate homeowners at risk of losing their homes.
Respectable firms, on the other hand, are doing a brisk business. The most successful are targeting lenders who wrote so-called "liar loans," where borrowers weren't required to provide verification of income or assets. The lender (or servicer) then has two choices: Forgive enough principal to bring the loan balance below the new property value, or take a trip to the local courthouse.
The threat of lawsuit hinges on the borrower and attorney proving the bank unfairly coerced the homeowner into taking out a mortgage they could never reasonably afford. The borrower effectively pleads ignorance. With the complexity of exotic loan products cooked up during the boom by the likes of Countrywide (CFC), Bear Stearns and Washington Mutual (WM), it's not a hard case to make. Fearful of the lousy headlines, many banks are more than willing to settle and give the borrower a second chance.
Simple loan modifications like the ones proposed by Hope Now and Project Lifeline don't address the root of the problem. They delay the inevitable, as borrowers are stuck making loan payments despite being upside-down. Houses just sit on the market, which prevents healthy price discovery from clearing out the glut of supply.
Until this inventory is worked through the system, home prices will continue to fall. Rather than watching publicly released housing data for signs of a bottom, watch the spread: When the difference between asking and selling prices returns to rational levels, we've found the bottom.
Until then, let the prognosticators prognosticate, forecasters forecast and economists make educated guesses about bottoms they can't predict. Savvy investors will take advantage of truly undervalued assets. It's just a question of who can be patient enough to wait this out.
The Holy Grail de jour of financial market prognostication is predicting the bottom in housing. It's a fool's errand, however. Investing based on a perceived end to declining property values has so far been a losing proposition.
Unlike equities and futures, the housing market has no central clearing house: The Plunge Protection Team's reach doesn't extend to real estate. Try as they may, Beltway bureaucrats can't create a false bottom in home values.
Nevertheless, economists at UCLA are out with a report that uses a single data point as evidence that California's housing market may be recovering. They call a recent upswing in sales in Riverside County (east of Los Angeles) a "very dim flicker of the light at the end of the tunnel."
That a few bargain hunters are testing the waters isn't a sign of stabilization. Witness Billionaire investor Joe Lewis' failed attempt to call a bottom in Bear Stearns. Values can't fall forever, but to say the market will recover "eventually" isn't terribly helpful.
To hazard an educated guess about when home prices will stop falling, it's necessary to understand the mechanics of a real estate transaction and what still needs to happen for property values to put in a meaningful bottom.
Homebuilders like KB Home (KBH) and Toll Brothers (TOL) continue to clamor for handouts from Washington to stem the decline. Rational market players, on the other hand, recognize that until prices return to more traditional levels of affordability, said bottom will continue to be elusive.
Contrary to what's reported in the mainstream press, the fundamental factor putting pressure on home prices isn't the rising tide of foreclosures. The National Association of Realtors and politicians who pander would like us to believe that banks, saddled with impaired assets, are unloading properties at below market value and exacerbating the downward spiral.
Bureaucrats aren't necessarily wrong in trying to prevent repossessions (the impact of a family being forcibly removed from its home is on many levels costly), but targeting foreclosures is characteristic of government policies that address the symptom rather than the cause.
Minyanville's Mr. Practical has long argued the most visible manifestation of the current financial malaise -- illiquidity -- is just a symptom of the true problem: bad debt. Likewise, foreclosures are the most visible part of a phenomenon that's preventing meaningful price discovery in the residential real estate market.
Goldman Sachs estimates that 30% of U.S. homeowners will be upside-down on their mortgages by the end of the year. Also known as being "underwater," being upside-down puts a borrower in the unenviable position of owing more on his home than the home is worth.
For the market to find a sustainable bottom, sellers need to reduce their asking prices to levels average homebuyers can afford. For upside-down homeowners, this isn't an option.
To repay the bank in full, an underwater borrower must put up the difference between the sale price and the outstanding balance on his mortgage. Refinancing would require the same out-of-pocket cash - something most troubled homeowners don't have. Many are choosing to simply walk away, a trend Professor Shedlock has covered in detail.
As a result, properties sit on the market for months, the seller unwilling to budge for the simple reason that he can't. This adds to the latent supply on the market and further depresses prices.
The latest in a wave of housing bailouts now making its way through Congress attempts to address this issue. Meanwhile, the free market, as it's apt to do, is solving the problem itself. Market-based solutions will get the job done regardless of the bickering and posturing that goes on in Washington. Those eager to call a bottom and snap up distressed assets would be wise to exercise patience; these workouts take time.
Mortgage market participants are solving the problem of upsided-own borrowers in two primary ways. First, opportunistic investors are buying delinquent mortgages at a discount to par and forgiving part of the borrower's loan balance. They then write a fresh loan for less than the new, lower property value.
If that didn't make any sense, don't worry. If it were easy, everyone would be doing it. Here's an example of how it works.
Let's assume in 2005 Snapper the Turtle bought a brand new McMansion from Cassidy's Craftsman Cottages for $500,000. He made a $50,000 down payment and took out a $450,000 adjustable rate mortgage (ARM) from the Bank of Boo. Unfortunately for Snapper, his lovely 5,000 square foot model home on a 5,500 square foot lot is now worth just $400,000. Snapper's ARM just reset and he's fallen behind on his mortgage payments.
The Bank of Boo's balance sheet is loaded with delinquent mortgages just like Snapper's and management is actively jettisoning non-performing loans. The bank auctions the loan to investors, who bid based on the property's resale value and Snapper's credit profile. Their goal is to buy the mortgage on the cheap and restructure it, turning a profit.
Hoofy's Hedge Fund, a specialist in distressed debt, snaps up the loan for a mere $0.60 on the dollar, or $270,000. Now the owner of Snapper's loan, Hoofy forgives part of Snapper's debt and writes a new mortgage for 80% of the value of the house, or $320,000. Hoofy covers the amount he paid Boo for the mortgage and pockets the difference: $50,000.
So, Hoofy turns a profit, Boo gets a problem loan off its books and Snapper gets a second chance. Since the transaction was completed prior to foreclosure, Snapper's credit is even salvaged.
Hedge funds and other vulture investors have raised vast pools of money to invest in distressed mortgage assets, some trying to execute this strategy with hundreds of millions of dollars. But Ph.D.'s in Greenwich, Connecticut dreaming up complicated structured finance models don't know the first thing about loan workouts. So, hoping they can make up for sloppy implementation with scale, they outsource the logistics, use valuation models to approximate home prices and lower profit expectations. The logic sounds eerily familiar to what got us into this mess in the first place.
As they're extraordinarily labor intensive, loan workouts, like the one described above, work best on a small scale. Successful firms take it one loan and borrower at a time and are conservative in their property valuations. The home's value represents not only the maximum amount for the new loan, but an investor's downside risk should the deal go sideways.
The second method for handling upside down mortgages is old fashioned litigation. Lawyers reach out to troubled borrowers and offer to negotiate with lenders or mortgage servicers on their behalf - for a hefty fee. However, this segment of the market is wrought with fraud, as slick attorneys and shady mortgage brokers can easily prey on desperate homeowners at risk of losing their homes.
Respectable firms, on the other hand, are doing a brisk business. The most successful are targeting lenders who wrote so-called "liar loans," where borrowers weren't required to provide verification of income or assets. The lender (or servicer) then has two choices: Forgive enough principal to bring the loan balance below the new property value, or take a trip to the local courthouse.
The threat of lawsuit hinges on the borrower and attorney proving the bank unfairly coerced the homeowner into taking out a mortgage they could never reasonably afford. The borrower effectively pleads ignorance. With the complexity of exotic loan products cooked up during the boom by the likes of Countrywide (CFC), Bear Stearns and Washington Mutual (WM), it's not a hard case to make. Fearful of the lousy headlines, many banks are more than willing to settle and give the borrower a second chance.
Simple loan modifications like the ones proposed by Hope Now and Project Lifeline don't address the root of the problem. They delay the inevitable, as borrowers are stuck making loan payments despite being upside-down. Houses just sit on the market, which prevents healthy price discovery from clearing out the glut of supply.
Until this inventory is worked through the system, home prices will continue to fall. Rather than watching publicly released housing data for signs of a bottom, watch the spread: When the difference between asking and selling prices returns to rational levels, we've found the bottom.
Until then, let the prognosticators prognosticate, forecasters forecast and economists make educated guesses about bottoms they can't predict. Savvy investors will take advantage of truly undervalued assets. It's just a question of who can be patient enough to wait this out.
Friday, June 6, 2008
Mortgage Companies: A Courtroom Drama
This post first appeared on Minyanville.
The City of Baltimore and Wells Fargo (WFC) are engaged in a legal fight over who's to blame for the city's foreclosure problem. The row highlights the broadening search for guilty parties in the collapse of the mortgage industry.
MortgageDaily.com reports Baltimore has filed a lawsuit alleging the San Francisco-based bank is responsible for "tens of millions of dollars" in lost tax revenues. During the past seven years, Wells Fargo accounted for 313 of the 33,000 foreclosures filed in Baltimore. The city claims Wells intentionally marketed predatory loans to minorities, many of which ended up in foreclosure.
As a result of the increased foreclosure activity, Baltimore lost tax revenues, incurred property maintenance costs and had to boost police and fire protection in the affected areas. Despite the relatively small share total foreclosures, the city claims Wells should shoulder part of the burden.
For its part, Wells Fargo dismissed the claim as unfounded. It also countered with the assertion that the city is responsible for its own troubles, largely stemming from its policy of assessing liens for unpaid utility bills. The city sold the tax liens to investors, who then forced borrowers to pay exorbitant fees to keep their homes. In its motion, the bank said homeowners were forced into foreclosure for unpaid water bills as low as $272.
States and municipalities are stepping up legal proceedings, looking to recoup cash and punish lenders that may have been involved in predatory lending. The State of Massachusetts just filed a similar lawsuit against Option One Mortgage Corporation, a subsidiary of H&R Block (HRB).
Many of the court cases focus on the effect of predatory lending on minority communities. Plaintiffs assert that lenders targeted minorities for loans with higher interest rates than comparable white borrowers. Such discrimination lawsuits have ensnared many of the country's biggest lenders, including Wells Fargo, Option One and Countrywide (CFC). The lenders vehemently deny any wrongdoing.
The lawsuit parade in the aftermath of reckless subprime lending has only just begun. In January of 2006, privately held Ameriquest Mortgage coughed up $325 million to resolve a predatory lending class action lawsuit. Despite the settlement, the company denied the allegations.
Although much of the focus on mortgage-related losses is centered on delinquencies stemming from adjustable rate resets and eroding economic conditions, the potential for massive class action lawsuits could further impede the industry's recovery efforts.
The storm brewing on the horizon is in the form of Option Adjustable Rate Mortgages, or Option ARMs. These loans allow borrowers to choose from a variety of interest payments, some of which result in negative amortization (see number five).
Complicated loan terms were in many cases not fully explained, and falling home values are exacerbating borrowers' already precarious position. Impending rate resets (see chart below, courtesy of Credit Suisse) will set off another wave of delinquencies. Borrowers -- and their attorneys -- will demand retribution.
It's no coincidence that the biggest issuers of these loans, Countrywide, Bear Stearns (BSC) and Washington Mutual (WM), have suffered the most during the mortgage crisis. Wachovia (WB) is also in the hot seat, as its ill-timed and now well publicized purchase of Golden West saddled the Charlotte-based bank with over $100 billion in Option ARMs. 60% of that portfolio is located in California, where property values are falling precipitously.
Future litigation will shape the regulatory response to the mortgage crisis. State authorities are already clamping down on the previously unregulated mortgage brokers and other small originators. Tighter restrictions will thwart some of the predatory practices prevalent during the boom, but they will also increase borrowing costs.
Mortgage industry professionals counter that overly restrictive regulations will lock out borrowers with mediocre credit. Faced with a web of rules and potential legal liabilities, banks just won't lend to anyone on the fringe of traditional loan qualifications.
Lenders need to be held accountable for their transgressions, especially if it can be proven they unfairly discriminated on the basis of race. Regulators will overreact, as they're apt to do. Despite its best efforts to rationalize away the need for tighter lending requirements, the mortgage business will feel the pain from its excesses for longer than many would like to believe.
Tuesday, April 22, 2008
Private Equity Eyes Struggling Banks
This post first appeared on Minyanville.
Mounting losses have forced financial institutions to shed pieces of themselves in order to remain afloat. Dealmakers, meanwhile, smell blood in the water.
Despite mounting data demonstrating financial woes are far from over, private equity firms are beginning to nibble at pieces of troubled banks.
National City (NCC), who yesterday announced that it sold $7 billion in equity to shore up its balance sheet, is the latest in a string of banks to raise capital in this manner. Two weeks ago, Washington Mutual (WM) received $7 billion from private equity firm TPG and others. Last Monday, Wachovia (WB) also took in $7 billion to shield it from future writedowns.
The Wall Street Journal reports private equity firm Corsair Capital LLC bought $985 million of National City's equity offering. Although the stock plunged 28% yesterday to $6.03, Corsair was able to book a paper gain since it bought in at just $5 per share.
These firms are hoping the fire sale prices allow them to ride out near-term trouble so sizeable returns on investment can be realized down the line.
Minyan Peter, however, doubts the wisdom of their bets. He thinks recent investments in private equity is "panic buying," saying:
With most of their current portfolio deals going south, and the prospect of any new leveraged buyout deals more than remote, firms are having to transform themselves quickly into vulture mode. And with many private equity firms now public, suddenly quarter earnings pressure means something to these guys. If you get paid "transaction fees" for doing a deal -- whether it turns out to be good or bad -- you do it because it at least shows you are out there and it buys you time to figure out what your business model is going to be in the future.
Equity markets seem determined to call a bottom in financial stocks. Although the outlook is cloudy at best, investors are counting on recent government intervention to spur economic activity in the second half of the year. With a little luck, bold investments may pay off in the future.
But those intrepid enough to wade into the market would be wise to remember billionaire investor Joe Lewis who last year tried to call a bottom in Bear Stearns (BSC). He lost nearly his entire investment - a mere billion dollars.
Reprinted by Permission copy write 2008 Minyanville Publishing and Multimedia
Mounting losses have forced financial institutions to shed pieces of themselves in order to remain afloat. Dealmakers, meanwhile, smell blood in the water.
Despite mounting data demonstrating financial woes are far from over, private equity firms are beginning to nibble at pieces of troubled banks.
National City (NCC), who yesterday announced that it sold $7 billion in equity to shore up its balance sheet, is the latest in a string of banks to raise capital in this manner. Two weeks ago, Washington Mutual (WM) received $7 billion from private equity firm TPG and others. Last Monday, Wachovia (WB) also took in $7 billion to shield it from future writedowns.
The Wall Street Journal reports private equity firm Corsair Capital LLC bought $985 million of National City's equity offering. Although the stock plunged 28% yesterday to $6.03, Corsair was able to book a paper gain since it bought in at just $5 per share.
These firms are hoping the fire sale prices allow them to ride out near-term trouble so sizeable returns on investment can be realized down the line.
Minyan Peter, however, doubts the wisdom of their bets. He thinks recent investments in private equity is "panic buying," saying:
With most of their current portfolio deals going south, and the prospect of any new leveraged buyout deals more than remote, firms are having to transform themselves quickly into vulture mode. And with many private equity firms now public, suddenly quarter earnings pressure means something to these guys. If you get paid "transaction fees" for doing a deal -- whether it turns out to be good or bad -- you do it because it at least shows you are out there and it buys you time to figure out what your business model is going to be in the future.
Equity markets seem determined to call a bottom in financial stocks. Although the outlook is cloudy at best, investors are counting on recent government intervention to spur economic activity in the second half of the year. With a little luck, bold investments may pay off in the future.
But those intrepid enough to wade into the market would be wise to remember billionaire investor Joe Lewis who last year tried to call a bottom in Bear Stearns (BSC). He lost nearly his entire investment - a mere billion dollars.
Reprinted by Permission copy write 2008 Minyanville Publishing and Multimedia
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