Titanic Blunder for Royal Caribbean

This post first appeared on Minyanville.

Think its tough to get a mortgage these days? Try financing the biggest cruise ship ever built.

Royal Caribbean (RCL), the second largest cruise-ship operator in the world, is currently scrounging up money to purchase the Oasis of the Seas, a 5,400-passenger, 16-deck, $1.2 billion monstrosity under construction by STX Europe’s Finnish shipyards. In normal times, the company would have no trouble assembling a team of lenders to finance the purchase. But now, with credit markets frozen solid, loans are more difficult to navigate than an ocean strewn with icebergs.

According to Bloomberg, Royal Caribbean is petitioning the Finnish government for help. Already, state-owned Finnerva has agreed to guarantee 80% of the loans needed to buy the Oasis and its sister ship, Allure of the Seas. The Finnish government says its given out larger guarantees in the past, but isn’t terribly keen on this one unless circumstances are "exceptional."

Meanwhile, Royal Caribbean and rival Carnival Cruise Lines (CCL), are reeling from the economic slump and the worldwide decline in tourism. And with the likes of Citigroup (C) and Bank of America (BAC) becoming increasingly reliant on government funds for survival, extravagances like the biggest cruise ship ever built will be increasingly hard to justify.

The Finnish government's dilemma underscores a growing dilemma for countries all over the world: Prop up industries begging for federal assistance, or preserve funds and maintain the integrity of the sovereign balance sheet? Volatility in the foreign exchange markets (the yen's recent tumble, for example), is evidence that investors are becoming increasingly worried that government is getting out over its skis.

With tax revenues falling, trade grinding a halt, and social-program obligations ballooning, lawmakers are opting to take a more active role in economic governance. Many, in fact, are moving toward central economic planning.

This is an unwelcome shift, but one we're being told is necessary to stave off some unnamable economic catastrophe.

The similarities between the Titanic's moniker -- "unsinkable" -- and the belief that certain banks are too big to fail would be ironic, if it weren't so sad. Given that ill-fated vessel, we should be wary of the notion that anything is invincible - especially when the path through the icebergs is growing increasingly difficult to find.

Banks Brace for Stress Tests

This post first appeared on Minyanville.

As financial markets reel, equities probe lows unseen in over a decade, and optimism wanes on Main Street, President Obama and Treasury Secretary Tim Geithner are rolling out a series of so-called “stress tests” to firm up confidence in the country’s banks.

The tests, designed to ensure banks will survive even if economic conditions continue to deteriorate, focus on the books of 20 of the country’s largest banks. According to Bloomberg, the stress tests begin today.

The approach harkens back to tactics used during the Great Depression - yet another reminder of just how bad things have gotten for the US banking system.

Last week, Federal Reserve Chairman Ben Bernanke explained how a similar approach in 1933 solidified confidence in the nation’s banks:

“Roosevelt shut down the banks for a week and said we are just going to check the books and open them up only when we think they are solvent. And a lot of the banks opened up pretty quick. So, it's not really clear how much they really looked through the books, but when they opened them up again, people felt much more comfortable, and more confident in the bank.”

The current plan doesn’t just aim to “check the books.” Instead, regulators will evaluate the strength of banks like Citigroup (C), Bank of America (BAC) and JPMorgan (JPM), already up against the ropes, based on how the'll perform if put through a more “stressful” economic test.

In other words, what happens if the wheels really fall off the wagon.

For example, let’s assume most economists believe housing prices, which have already corrected more than 20%, will stabilize after having fallen 30%. The last 10% of declines would have a certain effect on residential mortgage losses (among other assets), so Treasury bean-counters try to estimate whether banks could withstand the losses such a scenario would create.

The next step is to assume things get worse than expected - say, a 40% peak-to-trough decline in property values. More losses would ensue, and, after tallying each bank’s projected losses, officials can try to determine how much capital banks need to to remain solvent through this “worst-case scenario.”

After injecting the requisite capital to keep banks alive if things get really, really bad, newfound confidence could entice private capital back into the market. At least, that's the theory. If instead they find out certain banks wouldn't survive without massive amounts of capital, they could then become targets for nationalization.

Myriad troubles arise with this approach, bold as it may be. A few to consider:

First, selecting the “worst case” is problematic, particularly since conditions during this crisis have gotten worse than almost anyone expected. Anyone in Washington, that is, since many private commentators had been saying the sky is falling for years. Still, regulators have to make guesses about how bad things could possibly get, and their guesses could be wrong.

Second, any assumptions about future losses are based on guesses based on assumptions based on guesses based on assumptions based on wild stabs in the dark. In short, the complexity of the global financial system, the unintended consequences of various government actions, and a general difficulty predicting the future, make predictions exactly that - predictions.

Third, and possibly most importantly, regulators have lost almost all credibility over the past 18 months.

Some may argue that the guys in charge are different, but that’s just not the case. Ben Bernanke still runs the Federal Reserve, Tim Geithner ran the New York Fed for the past 5 years, Lawrence Summers is back at the economic helm, and Barney Frank and Chris Dodd are still mouthing off on Capitol Hill. Sure, there's a different face in the White House - but by and large the same folks who got us into this mess are now trying to get us out.

The American public recognizes this, investors recognize this, and the world recognizes it.

Even if the stress tests go off without a hitch and Geithner and Obama loudly proclaim the banking system is safe and sound, the market may simply, quietly shrug - and continue heading south.

AmEx to Customers: Take the Money and Run

This post first appeared on Minyanville.

Ask a Manhattanite what a “lease buyout” is, and most will blithely respond that it’s when a landlord pays a tenant to vacate his or her apartment. After all, why wouldn’t that little old lady next door -- the one paying $800 a month for a rent-controlled loft on the Upper West Side -- want to take a hundred grand to go find some new digs?

This phenomenon, formerly reserved for big-city landlords in New York or San Francisco, appears to be migrating to the financial industry.

According to Reuters, American Express (AXP) is offering select clients $300 to close their credit-card accounts. The company didn’t disclose how many such offers it planned to send out - but did say customers will have until the end of the month to accept, and until the end of March or April to pay off their balances. In exchange, they’ll receive a $300 pre-paid American Express gift card.

Rivals Capital One (COF), Discover (DFS) and JPMorgan (JPM) haven’t announced similar programs, but efforts to rein in consumer credit lines are ongoing throughout the industry. The once-steady stream of new card offers that used to fill our mailboxes has finally dried up.

Besieged by higher defaults and rising delinquencies, American Express is regretting its decision a few years ago to start offering cards to customers with sketchier credit records. Once known as card company of the well-to-do, the firm expanded its offerings down the credit spectrum at just the wrong time.

Surprised by a sharp downturn in economic conditions and the new allergy to structured credit card debt, American Express has seen its stock decimated in recent months: Shares are down more than 75% from their high last year. Capital One is off a more dramatic 86% since peaking at over $63 per share last year; Discover is off a mere 72% from its high.

The relative success of the new program could have 2 noteworthy effects. First, if successful, other card companies may rush to mimic AmEx's bold initiative.

Second, consumers' willingness to voluntarily close credit lines, precisely at a time when logic would dictate a desire to keep available as much rainy-day credit as possible, provides stark evidence of the ongoing rejection of debt, credit and excess.

As consumers return to more sustainable, responsible buying patterns -- first by necessity then by choice -- purveyors of the just-not-really-necessary aren't likely to fare well.

But as is the case in a broadly deflationary environment, even purveyors of the kind of things that you stockpile in case of apocalypse are facing hard times. Campbell's Soup (CPB), for example, reported weaker-than-expected earnings and offered less-than-inspiring guidance for 2009.

Consumers, it seems, are just buying less. Of everything. Maybe closing that credit card isn't such a bad idea after all.

Government Moves Into Citi?

This post first appeared on Minyanville.

It may not be nationalization, but it’s pretty close.

Last night, the Wall Street Journal reported the federal government is considering taking a large step closer to outright control of Citigroup (C). Having already sunk tens of billions of dollars into the troubled bank, the Treasury Department may now convert its non-voting preferred stock into Citgroup common stock. This would give government officials voting rights and more control over management's decisions. The Journal reports the government could own as much as 40% of the company, although bank executives are hoping the stake will come out closer to 25%.

And while taxpayers wouldn’t be asked to pump in additional funds, the move would further dilute current shareholders. But there isn’t much left to dilute: The company’s shares traded below $2 Friday, and were off more than 50% as recently as February 10.

Reeling from credit losses and worsening economic conditions in the US and abroad, Citigroup is at the leading edge of the financial storm. And nervous politicians are taking a more active role in bank management, concerned that capital injections, debt guarantees and loss-sharing agreements may not be sufficient to allow banks to retain their independence.

The Obama administration did say on Friday, however, that nationalization isn't in the cards for Citi and Bank of America (BAC). Nevertheless, nationalization calls are being heard loudly across the globe. Politicians, academics and pundits are weighing in, many arguing state control is the system's only hope to survive.

Banks, for their part, claim they don’t need the help: They claim that fear, rather than fundamentals, are driving their shares into the ground. In addition to Bank of America CEO Ken Lewis, JPMorgan (JPM) chief Jamie Dimon and Wells Fargo (WFC) CEO John Stumpf have asserted that their institutions are solvent enough to go it alone.

In his public remarks on Friday, Stumpf even managed to sound upbeat about the future. “There is so much to look forward to. I don’t know what we’re going through today, but it will probably define our generation. This can be the next greatest generation.”

Indeed. As Toddo often says, “In order to get through this, we need to go through it.” And with stress tests on tap for the nation's biggest banks, we may soon find out just how much we'll have to go through to get to the other side.

Keepin' It Real Estate: A Real Fix for Housing

This post first appeared on Minyanville and Cirios Real Estate.

While pundits and politicians debate the various aspects of President Obama’s $275 billion housing bailout, one piece of data proves just how misguided federal efforts to revitalize the housing market are: $275 billion could buy more than half of all American homes already in foreclosure.

Such an undertaking would remove distressed homes from the market and spur community revitalization efforts throughout areas desperately in need of the hope they were promised in November.

According to real-estate analytics website Realtytrac.com, foreclosures were filed on 2,330,483 homes in 2008, up 83% from the year before. The median home price in the US is $180,100 - which means 1,526,929 of those homes could be bought with $275 billion. And since foreclosures are centered primarily in areas with low home values, the true number of properties the bailout money could be used to buy is likely much higher.

While the logistics for such an outrageously common-sense solution to the nation’s housing woes are daunting, they’re no less challenging than the massive loan modification efforts already in place. And their results continue to prove underwhelming, at best.

Such a solution also addresses the rapidly mounting discontent over bailing out those homeowners who made bad decisions. Distressed borrowers wouldn't directly receive any taxpayer money - though they would indirectly benefit from the massive government expenditure in their community.

Cash would be funneled down to the local level, where cities and counties could more effectively distribute it. To be sure, local governments can be as bureaucratic and inefficient as Washington -- not to say corrupt -- but by allocating capital to localities, each community would be responsible for its own clean-up efforts.

Private investors, developers, nonprofits and real-estate professionals could compete for business, adding a free-market component to rescue efforts - and even spurring a little sorely-needed economic activity.

Some cities aren't content to wait for federal money to trickle down from the White House. Menlo Park, California, best known for its devotion to the bubble lifestyle, is considering using city money to buy and refurbish foreclosed homes.

The town, like many others in America, is split by a highway that acts as a major dividing line between the haves and the have-nots. While there are just 97 homes in foreclosure in Menlo Park, the vast majority are on “the other side of the tracks,” away from the mansions and quiet, tree-lined streets of West Menlo. The proposal will use money from a $2 million fund already seeded by developers who opted not to allocate units for low-income housing.

The city plans to tap Habitat for Humanity to refurbish the homes, using community volunteers and local experts to oversee the improvements. The president of the local Homeowners Association, Ash Vasudeva, said “When rehabilitation is going on, it uplifts the entire community.” A simple statement, but true.

And while this is one small city undertaking one small project, it could serve as a model for other communities around the country. Not to mention the fact that the mere announcement of $275 billion in real-estate investments would hasten the price discovery the housing market so sorely needs.

Furthermore, banks stand to gain little from such a use of public funds - which could be why such a plan has yet to be proposed on Capitol Hill. When a bank forecloses on a home, JPMorgan Chase (JPM), Wells Fargo (WFC) or Citigroup (C) is forced to write the asset down to at least the amount of the outstanding loan. But since most properties are worth far less than the loan amount, selling the property at market prices would require further writedowns.

So, as banks soak up billions in bailout money under the auspices of massive loan modification efforts aimed at stemming foreclosures, vacant homes lay in disrepair, vagrants loot the pipes - and communities continue to deteriorate.

But instead of allocating funds for such grassroots efforts, Washington continues to issue broad, vague orders aimed at helping many, but in very small amounts. Such programs have failed before, and they'll fail again.

Maybe it's time for a new approach.

Hollywood Hits the Bailout Trough

This post first appeared on Minyanville.

Even as California teeters on the edge of insolvency, state lawmakers are considering tax breaks aimed at lining the pockets of Hollywood filmmakers.

According to the Wall Street Journal, states like Louisiana, Michigan and Minnesota started offering attractive tax incentives for studios to film within their borders. Feature-film production days in Hollywood hit a 15-year low in 2008.

Now, in an attempt to lure big-name producers and directors back to its sunny shores, California is proposing a 25% tax credit of its own. The proposal would reimburse studios for a portion of their expenses, in the hopes that peripheral spending and job creation will help prop up the state’s flagging economy. Besieged by the housing market collapse, California has one of the nation’s highest unemployment rates at 9.3%.

The new proposal could be funded partially out of California’s allocation from President Obama’s economic stimulus package, although it isn’t likely to put money into the pockets of the country’s most downtrodden. High-profile actors aren’t exactly standing on bread lines just yet.

And while the initiative could provide employment to gaffers and dolly grips throughout Hollywood, critics argue movie shoots rarely generate long-term, sustainable jobs.

Instead, they argue, bloated payments to actors and eye-popping special effects have raised movie budgets beyond reasonable levels. Meanwhile, states vie for filmmaker dollars with ever-more-outsize kickbacks - kickcbacks that simply perpetuate the unsustainable economics of making movies.

Big studios like Disney (DIS), Universal (GE), Columbia (SNE) and Warner Brothers’ (TWX) are smarting as consumers rein in spending on luxuries of all kinds. Movies do offer a semi-affordable entertainment option.

California's attempts to win back the industry it birthed decades ago is further evidence of the private sector's increasing dependence on government handouts for survival. And while tossing a few bucks to filmmakers to generate local jobs may seem like a worthy trade-off in a rough employment environment, it creates a dependency - and perpetuates unsustainable business practices.

It's no wonder movie budgets soared as states upped their kickbacks: Spending someone else's money is a lot easier than spending your own.

Stanford Takes Page from Ponzi Playbook

This post first appeared on Minyanville.

It turns about Bernie Madoff wasn’t the only one cooking the books: Texas banking icon R. Allen Stanford is the latest to be charged with a massive, multi-billion dollar fraud.

In a story conveniently drowned out by President Obama’s signing of the $789 billion economic stimulus package and the auto industry’s latest plea for taxpayer money, the Securities and Exchange Commission raided Stanford’s Houston headquarters yesterday morning, alleging he perpetrated an $8 billion fraud based on “false promises and fabricated historical data.”

According to the Wall Street Journal, Stanford lured in investors by promising steady, safe returns for cash deposited in a bank he owns in Antigua, one of the many Caribbean banking havens. Instead of investing in liquid, low-risk assets as promised, Stanford allegedly funneled the money into high-risk private equity and real estate deals. Oversight was scant, as decisions were reviewed by 2 people: the bank’s chief financial officer, James Davis, and Stanford himself.

Much like Madoff’s much-publicized Ponzi scheme, consistently high returns that seemed impervious to market gyrations were the hallmark of Stanford’s scam.

The SEC claims Stanford International Bank returned between 6-10% from 1992-2006 on its certificates of deposit, or CDs. Yields on comparable investments issued by American banks like JPMorgan (JPM), Bank of America (BAC) and Wells Fargo (WFC) are significantly lower - but carry FDIC insurance to protect depositors from loss.

Strong returns on its investment portfolio, Stanford claimed, allowed the bank to pay out the oversized returns. In 2008, a year that saw the S&P 500 lose 39%, the bank said its portfolio lost just 1.3%.

The SEC says Stanford used these inflated returns to woo investors, many of which hailed from Latin American countries. Shaky banks in South America led many wealthy individuals to invest with Stanford, believing he could earn them strong returns with little risk.

But as their North American counterparts have learned from the ongoing Madoff affair: Where there’s return, there’s always risk.

This lax attitude towards risk, one that was fostered for decades by the Federal Reserve's overly accommodating monetary policy, was instrumental in sowing the seeds of our current financial crisis. It also helps explain how so many investors around the world were so easily duped by cons that, in retrospect, seem so easy to identify.

“Malinvestments,” a term popularized in recent years by Texas Congressman Ron Paul, occur when cash is poured into assets that return a yield that isn't commensurate with their risks.

When times are good, losses remain low and Washington comes to the rescue of the financial industry every time it gets into trouble, investors become accustomed to earning high rates of return without taking much risk. As this belief becomes the status quo, more and more money is funneled towards these seemingly low-risk, high-return opportunities.

Peddlers of financial instruments, from Madoff and Stanford to Goldman Sachs (GS) and Morgan Stanley (MS), dream up increasingly complex places for investors to park their money. Risk, they claimed, was as low as ever, thanks to their financial wizardry.

When real losses did occur, loan defaults began to rise, and the government wasn't deft enough to stem the tide, investors got burned. Badly.

Assets that suddenly become very risky lost value rapidly, since they carried such a low rate of return. Losses beget losses, which beget more losses. We all know how the story ends.

Meanwhile, even as it acted as enabler to Wall Street's (and Main Street's) incessant greed, the federal government now insists on pointing fingers and acting as savior for a system it was complicit in creating.

Where was the SEC to root out Madoff and Stanford before investors lost billions? Where was the Federal Reserve to act on its own findings about the risks of exotic mortgage lending?

Yet, even now, we're counting on these same institutions and politicians to invest nearly $1 trillion of our money to rescue us.

How low-risk is that investment strategy?