5/14/08…what’s it all about?
May 14, 2008
Today’s Topics:
1. Freddie Mac
2. Derivatives -Credit Default Swaps
3. Regulation
4. AIG and Wachovia…strange bedfellows or the gang that can’t shoot straight
…Alfie? That seems to be the question as yesterday concern for financial stocks reared its ugly head again. Why it took them this long to ‘get it’ is beyond TB.
1. Freddie Mac. Joining AIG on the hall of shame this morning is Freddie Mac (FRE) reporting a 66 cent a share loss in Q1 and increasing the provision for credit losses by $1.2B. They will raise $5.5B in core capital (that should be grounds for a rally, right?), who cares if it means more common and preferred issuance, half in each category? Get this: they said that housing and economic environment are affecting performance…see what rocket scientists they are? Note the earnings included $225M of prior reserved losses…this is their third straight quarterly loss. Oh, here is some good news: regulator OFHEO is cutting their mandatory surplus to 15% from 20%…is this aiding and abetting their ability to pay the dividend? The estimated ‘credit guarantee’ to their portfolio is $1.8 trillion! TB could go on after all there are three full pages of bullets on Bloomberg news for FRE this morning! Yep, stock is rallying in overnight market!
2. CDS. While we are on the topic of trillions, the organization that manages structured derivatives had a conference last week and said the people are overreacting to the size of the credit default swap (CDS) market which is $44 trillion…after all that is the notional amount and the real exposure is only 2%. OK, TB can buy that…in other words, $880 billion…of course it doesn’t help when one of their, and regulators (although they are unregulated), concerns is there is no control over this market and it takes far too long for a swap to be ‘effected.’ It might take as long as a month and in the meantime it is not in force. Also they want total fees disclosed over the life of the contract…and notification if the contract is sold to the other counterparty. They propose an exchange that would trade like other securities and would allow ‘netting’ out of contracts. This is all much more complicated than it sounds…trust TB on this.
Of course having your own governing group, which is without teeth by the way, spout all these ideas is great PR but it doesn’t do anything. For years, we were told by the Mortgage Bankers Association and the National Association of Realtors (remember David Lereah’s wonderful comments?), that all was well with the housing market…that subprime lending was only about 6% of the total market and foreclosures were rare…well guess what, Robert Schiller was right and they were wrong. TB will never forget the CNBC…you can’t make this stuff up…debate(?) with Schiller vs. Lereah and the rest of the pack, all who stood to gain from the continued real estate boom…had Schiller not been right about the stock market bubble they would have made him look like a blithering idiot…but having been down this path once before he just sat their with s slight grin as they blasted his data. IF CNBC was a credible reporter they would air the debate again…in entirety! It might prevent the next bubble! By the way foreclosures increased by 45% in April!
Meanwhile, we have everybody in Washington spouting ideas about some form of housing bailout. All of which are unworkable! Take the FDIC plan that was offered up (thanks to Joan McCullough for pointing this out). IF lenders will write-down the mortgages to the point where the borrower can qualify by the payment being no more than 35% of their income, and pay the cost of the protection offered for five years, they will buy the loan…at no cost to the taxpayers…right there you know we have a problem as there is no place in government for anything that it at no cost to the taxpayers. Counting the plan in Congress there have been no less than five suggestions offered and of those implemented total failure, except when you hear the Administration spin it…after all they are reaching out and that takes time.
All of the above begs the question for what was the money machine of the financial sector: assuming that all the losses are in, and we know that they are not…especially as subprime problems morph to Alt-A and Option ARM’s and are now being felt by the guy who paid his 20% down and has a conforming loan but has watched not only his equity evaporate (assuming he didn’t end up being caught up and taking it all back out himself, which is a stretch), but is now upside down on his loan…where will the replacement revenues come from…you know the ones that justify those p/e’s?…and don’t forget how many financial institutions like Citi, Merrill, UBS, BofA, Wachovia have diluted shareholders equity, and in many cases cut the dividend…oops, forgot we don’t use the dividend discount model anymore.
3. Regulation. Douglas Elmendorf of the Brookings Institution was on CNBC this morning discussing the need for regulation…I said he was from Brookings, not the Hoover Institution (did anyone ever wonder why they named anything after a man who presided us into a depression?), but his approach was logical: more than six years of regulatory neglect have created chaos…markets need to be regulated…unlike the Kudlovian approach that says that markets must be free to prosper…if you believe this you must be one of the few, the wealthy, the ones who benefited from this debacle when it was a boom period. As he said moderate regulation would have prevented this…and TB agrees. Now we will hit Wall Street with a sledgehammer and that will slow the recovery process. You could call it benign neglect, but it is anything but benign.
4. AIG/Wachovia. AIG is holding their shareholder meeting today…lucky Thompson…and it is going to be every bit as ugly as the Wachovia meeting a few weeks ago. TB’s questioning of increasing the dividend when they are raising additional capital will undoubtedly be an issue as well as calls for a total board resignation. Then there is their lack of credibility by surprising the market with the depth of the loss.
By the way, Wachovia is now being investigated by the SEC as well as state regulators and has now been subpoenaed for information on auction rate securities and how sales and auctions were conducted. Remember that TB said IF a major bank is to fail his bet is on Wachovia…a big word ‘if.’ More likely it would be forced to merge…but who would want it and its acquisition Golden West Financial?
Miscellaneous…from today’s WSJ:
*Ahead of the Tape discusses how inflation may not be the problem it has been made out to be. This is what TB and others have been saying since the full costs of rising food and energy costs are not being passed on and are instead reducing margins…so the problem is for companies…got it?
*Heard on the Street is about the ‘art’ of stock valuations and how much $100M invested in GM in 2005 would be worth…ranges from $75M to $90M depending on assumptions. Think Kerkorian.
It’s a wonderful day in the neighborhood…
TB
Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and do not necessarily reflect the views of anyone other than his own. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Hope you find it useful.
Copyright TBD Capital LLC May 14, 2008
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