Geithner, Paulson to address meltdown probe

Meltdown probe hears from bailout architects Paulson, Geithner on ‘shadow banking’

Daniel Wagner, AP Business Writer, On Thursday May 6, 2010, 12:57 am EDT

WASHINGTON (AP) — A special panel investigating the financial crisis is preparing to hear from two key architects of the government’s response: Former Treasury Secretary Henry Paulson and Treasury Secretary Timothy Geithner.

Geithner and Paulson will provide their perspectives on the so-called “shadow banking system” — a largely unregulated world of capital and credit markets outside of traditional banks. They will describe their roles in selling Bear Stearns (BSC) to JPMorgan Chase & Co. (JPM) after pressure from “shadow banking” companies made Bear the first major casualty of the crisis.

The pair will testify Thursday morning before the Financial Crisis Inquiry Commission, a bipartisan panel established by Congress to probe the roots of the financial crisis. It is the first time the panel has heard from either of the men who called the shots in late 2008 as the global financial system nearly collapsed.

The panel is looking at nonbank financial companies such as PIMCO and GE Capital that provide capital for loans to consumers and small businesses. When rumors spread in 2008 that Bear Stearns was teetering, these companies started what former Bear Stearns executives described Wednesday as a “run on the bank,” drawing so much of its capital that it could not survive.

Then-Treasury Secretary Paulson and Geithner, as president of the Federal Reserve Bank of New York, engineered Bear’s rescue. The New York Fed put up a $29 billion federal backstop to limit JPMorgan’s future losses on Bear Stearns’ bad investments.

Bear Stearns was the first Wall Street bank to blow up. Its demise foreshadowed the cascading financial meltdown in the fall of that year.

The panel is investigating the roots of the crisis that plunged the country into the most severe recession since the 1930s and brought losses of jobs and homes for millions of Americans.

In earlier testimony before the House Committee on Oversight and Government Reform, Paulson defended his response to the economic crisis as an imperfect but necessary rescue that spared the U.S. financial market from total collapse.

“Many more Americans would be without their homes, their jobs, their businesses, their savings and their way of life,” he said in testimony prepared for that hearing.

Private rescue of CIT marks shift in crisis

Denied federal bailout, CIT taps $3B private rescue; may be strategy for other troubled banks

By Daniel Wagner and Stevenson Jacobs, AP Business Writers
Tuesday July 21, 2009, 12:44 am EDT

WASHINGTON (AP) — With bondholders coming to the rescue of troubled commercial lender CIT Group Inc. (CIT), and not the government, a new reality is setting in for investors.

With federal bailouts drying up and the economy still in distress, many more financial firms could face bankruptcy. When they do, it will be major private lenders that will have to decide whether to rescue the companies or allow them to fail.

It signals a return to the traditional path for financially troubled firms after nearly a year of government aid.

“It wasn’t clear that Treasury wanted this to be a turning point, but that’s the way it’s worked out,” said Simon Johnson, a former chief economist with the International Monetary Fund, now a professor at the Massachusetts Institute of Technology’s Sloan School of Management.

Johnson said the markets took so kindly to CIT’s quest for private-sector cash that the government “would feel pretty comfortable about” threatening bankruptcy for firms with less than $100 billion in assets.

Bondholders’ $3 billion rescue of CIT marks the first time since the banking crisis erupted that private investors have stepped in to save a big financial firm without federal help or oversight.

The lifeline for CIT, whose clients include Dunkin’ Donuts franchises and clothing maker Eddie Bauer, aims to sustain the company long enough for it to rework its heavy debt load, which includes $7.4 billion due in the first quarter of next year. It does not guarantee CIT will avoid bankruptcy.

CIT said late Monday that the rescue includes a $3 billion secured term loan with a 2.5-year maturity, which will ensure that its small and midsized business customers continue to have access to credit. Term loan proceeds of $2 billion are committed and available immediately, with an additional $1 billion expected to be committed and available within 10 days.

The short-term financing comes at a high price — an interest rate of about 10.5 percent, said a person close to the negotiations who was not authorized to discuss the matter publicly.

Phases of fear and elation in the VIX

Here we show a nice relationship between the VIX and the SPX.  While this is a commonly referenced pairing, many still challenge the value of using the VIX as a market indicator.  There are numerous ways too use the VIX and almost everyone has their own tweaks.  This chart shows a very clear inverse relationship with several distinct “phases” discernible in the value of the VIX.  These “phases” correlate well with the action in the SPX.  We have labled these phases “euphoria”, “fear” and “panic”.  We also included the 400 day moving average (equivalent to the 80 week) which we discussed previously in The Significance of the 400 day (80 week) moving average.  This bull/bear market reference point matches up very well with the action in the VIX, as the VIX moves into the “fear phase” just as the 400 day is coming under assault, before eventually breaking.  A final test of the 400 day from below, which we highlighted in late April 2008, was accompanied by one last dip into the “euphoria” zone for the VIX.  That was the “last chance” to get out before the drop gathered steam as the SPX then dropped over 50% in less than 12 months.

We added the notes on Bear Stearns and Citigroup for a consensus of the “expert” opinion at the time.

FDIC May Run ‘Bad Bank’ in Plan to Purge Toxic Assets

By Robert Schmidt and Alison Vekshin

Jan. 28 (Bloomberg) — The Obama administration is moving closer to setting up a so-called bad bank in its effort to break the back of the credit crisis and may use the Federal Deposit Insurance Corp. to manage it, two people familiar with the matter said.

U.S. stocks gained, extending a global rally, on optimism the bad-bank plan will help shore up the economy. The Standard & Poor’s 500 Stock Index (SPX) rose 3.1 percent to 871.70 at 2:40 p.m. in New York. Bank of America Corp. (BAC), down 54 percent this year before today, rose 84 cents, or 13 percent, to $7.34. Citigroup Inc. (C), which had fallen 47 percent this year, climbed 17 percent.

FDIC Chairman Sheila Bair is pushing to run the operation, which would buy the toxic assets clogging banks’ balance sheets, one of the people said. Bair is arguing that her agency has expertise and could help finance the effort by issuing bonds guaranteed by the FDIC, a second person said. President Barack Obama’s team may announce the outlines of its financial-rescue plan as early as next week, an administration official said.

“It doesn’t make sense to give the authority to anybody else but the FDIC,” said John Douglas, a former general counsel at the agency who now is a partner in Atlanta at the law firm Paul, Hastings, Janofsky & Walker. “That’s what the FDIC does, it takes bad assets out of banks and manages and sells them.”

Bank Management

The bad-bank initiative may allow the government to rewrite some of the mortgages that underpin banks’ bad debt, in the hopes of stemming a crisis that has stripped more than 1.3 million Americans of their homes. Some lenders may be taken over by regulators and some management teams could be ousted as the government seeks to provide a shield to taxpayers.

Bank seizures are “going to happen,” Senator Bob Corker, a Tennessee Republican, said in an interview after a meeting between Obama and Republican lawmakers in Washington yesterday. “I know it. They know it. The banks know it.”

Laura Tyson, an adviser to Obama during his campaign, said banks need to be recapitalized “with different management” so they start lending again. “You find some new sophisticated management unlike the failed management of the past,” Tyson, a University of California, Berkeley, professor, said today at the World Economic Forum conference in Davos, Switzerland.

Still, nationalization of a swath of the banking industry is unlikely. House Financial Services Chairman Barney Frank said yesterday “the government should not take over all the banks.” Bair said earlier this month she would be “very surprised if that happened.”

Treasury, Fed continue extensive bailout efforts

Monday November 24, 2:33 pm ET
By Christopher S. Rugaber, AP Business Writer

Nothing a few more billion can’t cure: Treasury, Fed take more steps to fight meltdown

WASHINGTON (AP) — The government’s latest effort to address the financial crisis is a $20 billion investment in banking giant Citigroup Inc. (C), along with an agreement to guarantee hundreds of billions of dollars in possible losses.

The step, announced late Sunday, is the latest in a long list of government moves to counter the financial meltdown:

–March 11: The Federal Reserve announces a rescue package to provide up to $200 billion in loans to banks and investment houses and let them put up risky mortgage-backed securities as collateral.

–March 16: The Fed provides a $29 billion loan to JPMorgan Chase & Co. (JPM) as part of its purchase of investment bank Bear Stearns (BSC).

–May 2: The Fed increases the size of its loans to banks and lets them put up less-secure collateral.

–July 11: Federal regulators seize Pasadena, Calif.-based IndyMac (IMB), costing the Federal Deposit Insurance Corp. billions to compensate deposit-holders.

–July 30: President Bush signs a housing bill including $300 billion in new loan authority for the government to back cheaper mortgages for troubled homeowners.

–Sept. 7: The Treasury takes over mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), putting them into a conservatorship and pledging up to $200 billion to back their assets.

–Sept. 16: The Fed injects $85 billion into the failing American International Group (AIG), one of the world’s largest insurance companies.

Government unveils bold plan to rescue Citigroup

Monday November 24, 1:51 am ET
By Jeannine Aversa, AP Economics Writer

Government unveils plan to rescue Citigroup, including taking $20 billion stake in the firm

WASHINGTON (AP) — The government unveiled a bold plan Sunday to rescue troubled Citigroup (C), including taking a $20 billion stake in the firm as well as guaranteeing hundreds of billions of dollars in risky assets.

The action, announced jointly by the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp., is aimed at shoring up a huge financial institution whose collapse would wreak havoc on the already crippled financial system and the U.S. economy.

The sweeping plan is geared to stemming a crisis of confidence in the company, whose stock has been hammered in the past week on worries about its financial health.

“With these transactions, the U.S. government is taking the actions necessary to strengthen the financial system and protect U.S. taxpayers and the U.S. economy,” the three agencies said in a statement issued late Sunday night. “We will continue to use all of our resources to preserve the strength of our banking institutions, and promote the process of repair and recovery and to manage risks.”

The move is the latest in a string of high-profile government bailout efforts. The Fed in March provided financial backing to JPMorgan Chase’s (JPM) buyout of ailing Bear Stearns (BSC). Six months later, the government was forced to take over mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) and throw a financial lifeline — which was recently rejiggered — to insurer American International Group (AIG).

Critics worry the actions could put billions of taxpayers’ dollars in jeopardy and encourage financial companies to take excessive risk on the belief that the government will bail them out of their messes.

Stocks tumble as bailout plan fails in House

Monday September 29, 5:05 pm ET
By Tim Paradis, AP Business Writer

Stocks plunge as financial bailout plan fails in House vote; Dow fall 777, biggest drop ever

NEW YORK (AP) — Wall Street’s worst fears came to pass Monday, when the government’s financial bailout plan failed in Congress and stocks plunged precipitously — hurtling the Dow Jones Industrials (INDU) down nearly 780 points in their largest one-day point drop ever. Credit markets, whose turmoil helped feed the stock market’s angst, froze up further amid the growing belief that the country is headed into a spreading credit and economic crisis.

Stunned traders on the floor of the New York Stock Exchange, their faces tense and mouths agape, watched on TV screens as the House voted down the plan in mid-afternoon, and as they saw stock prices tumbling on their monitors. Activity on the floor became frenetic as the “sell” orders blew in.

The Dow told the story of the market’s despair. The blue chip index, dropped by hundreds of points in a matter of moments, and by the end of the day had passed by far its previous record for a one-day drop, 684.81, set in the first trading day after the Sept. 11, 2001, terror attacks.

The selling was so intense that just 162 stocks rose on the NYSE — and 3,073 dropped.

It takes an incredible amount of fear to set off such an intense reaction on Wall Street, and the worry now is that with the $700 billion plan fate uncertain, no one knows how the financial sector hobbled by hundreds of billions of dollars in bad mortgage bets will recover. While investors didn’t believe that the plan was a panacea, and understood that it would take months for its effects to be felt, most market watchers believed it was a start toward setting the economy right after a credit crisis that began more than a year ago and that has spread overseas.

“Clearly something needs to be done, and the market dropping 400 points in 10 minutes is telling you that,” said Chris Johnson president of Johnson Research Group. “This isn’t a market for the timid.”

The plan’s defeat came amid more reminders of how troubled the nation’s financial system is — before trading began came word that Wachovia Corp. (WB), one of the biggest banks to struggle due to rising mortgage losses, was being rescued in a buyout by Citigroup Inc (C). It followed the recent forced sale of Merrill Lynch & Co. (MER) and the failure of three other huge banking companies — Bear Stearns Cos. (BSC), Washington Mutual Inc. (WM) and Lehman Brothers Holdings Inc. (LEH); all of them were felled by bad mortgage investments.

WaMu is largest U.S. bank failure

Thu Sep 25, 2008 11:24pm EDT

By Elinor Comlay and Jonathan Stempel

NEW YORK/WASHINGTON (Reuters) – Washington Mutual Inc (WM) was closed by the U.S. government in by far the largest failure of a U.S. bank, and its banking assets were sold to JPMorgan Chase & Co. (JPM) for $1.9 billion.

Thursday’s seizure and sale is the latest historic step in U.S. government attempts to clean up a banking industry littered with toxic mortgage debt. Negotiations over a $700 billion bailout of the entire financial system stalled in Washington on Thursday.

Washington Mutual, the largest U.S. savings and loan, has been one of the lenders hardest hit by the nation’s housing bust and credit crisis, and had already suffered from soaring mortgage losses.

Washington Mutual was shut by the federal Office of Thrift Supervision, and the Federal Deposit Insurance Corp was named receiver. This followed $16.7 billion of deposit outflows at the Seattle-based thrift since Sept 15, the OTS said.

“With insufficient liquidity to meet its obligations, WaMu was in an unsafe and unsound condition to transact business,” the OTS said.

Customers should expect business as usual on Friday, and all depositors are fully protected, the FDIC said.

FDIC Chairman Sheila Bair said the bailout happened on Thursday night because of media leaks, and to calm customers. Usually, the FDIC takes control of failed institutions on Friday nights, giving it the weekend to go through the books and enable them to reopen smoothly the following Monday.

Washington Mutual has about $307 billion of assets and $188 billion of deposits, regulators said. The largest previous U.S. banking failure was Continental Illinois National Bank & Trust, which had $40 billion of assets when it collapsed in 1984.

New world on Wall Street

Goldman Sachs and Morgan Stanley to face more oversight from the Federal Reserve. Change provides more funding and opens door to more mergers.

By Tami Luhby, CNNMoney.com senior writer
Last Updated: September 22, 2008: 7:19 AM EDT

NEW YORK (CNNMoney.com) — And then there were none.

Federal regulators converted Wall Street’s remaining stand-alone investment banks – Goldman Sachs (GS) and Morgan Stanley (MS) – into bank holding companies Sunday night.

The move allows Goldman and Morgan to scoop up retail banks and to streamline their borrowing from the Federal Reserve. The shift also is aimed at removing them as targets of nervous investors and customers, who brought down their former rivals Bear Stearns (BSC), Lehman Brothers (LEH) and Merrill Lynch (MER) this year.

But it also puts Goldman and Morgan under the Fed’s supervision, increasing the agency’s regulatory oversight and possibly forcing them to raise additional capital. As banks, Morgan and Goldman will be forced to take less risk, which will mean fewer profits.

And it brings to a close the era of the Wall Street investment bank, a storied institution that traded stocks and bonds, advised mergers and showered lavish bonuses on its executives.

“The separation of investment banking and commercial banking has come to an end,” said Bert Ely, an independent banking consultant.

List of government bailouts in past century

Sunday September 21, 5:18 pm ET
By The Associated Press

List of government bailouts in past century includes banks, corporations and industries

A look at some U.S. government interventions and bailouts in the past century:

1932 — The Hoover administration creates the Reconstruction Finance Corp. to facilitate economic activity by lending money in the Great Depression.

1933 — The Roosevelt administration creates the Home Owners’ Loan Corp. to buy $3 billion in bad mortgages from banks and refinance them to homeowners to stem a rise in foreclosures. The government makes a small profit.

1971 — Congress saves Lockheed Aircraft Corp., the nation’s biggest defense contractor, from bankruptcy by guaranteeing the repayment of $250 million in bank loans.

1979 — Congress and the Carter administration arrange for $1.2 billion in subsidized loans to bail out automaker Chrysler Corp., then the nation’s 10th-largest company. There ultimately was no significant cost to the government, since the loans were repaid.

1984 — Congress effectively takes over the ailing Continental Illinois National Bank and Trust, which failed with $40 billion of assets. The Federal Deposit Insurance Corp. injects $4.5 billion to buy bad loans.

1989 — Congress establishes the Resolution Trust Corp. to take over bad assets and make depositors whole. Resolving the S&L crisis takes six years and $125 billion in taxpayer money — roughly equal to $200 billion in today’s dollars.

1998 — The government brokers a $3.6 billion private bailout in the collapse of the Long-Term Capital Management hedge fund, although no government money is involved.

Govt trading ban could have unintended results

Friday September 19, 5:07 pm ET
By Marcy Gordon and Stevenson Jacobs, AP Business Writers

Big SEC step to ban short-selling of financial stocks could have unintended consequences

WASHINGTON (AP) — The government’s unprecedented move Friday to ban people from betting against financial stocks might be a salve for the market’s turmoil but could also carry serious unintended consequences.

In a bid to shore up investor confidence in the face of the spiraling market crisis, the Securities and Exchange Commission temporarily banned all short-selling in the shares of 799 financial companies. Short selling is a time-honored method for profiting when a stock drops.

The ban took effect immediately Friday and extends through Oct. 2. The SEC said it might extend the ban — so that it would last for as many as 30 calendar days in total — if it deems that necessary.

That window could be enough time to calm the roiling financial markets, with the Bush administration’s massive new programs to buy up Wall Street’s toxic debt possibly starting to have a salutary effect by then.

The short-selling ban is “kind of a time-out,” said John Coffee, a professor of securities law at Columbia University. “In a time of crisis, the dangers of doing too little are far greater than the dangers of doing too much.”

But on Wall Street, professional short-sellers said they were being unfairly targeted by the SEC’s prohibition. And some analysts warned of possible negative consequences, maintaining that banning short-selling could actually distort — not stabilize — edgy markets.

Indeed, hours after the new ban was announced, some of its details appeared to be a work in progress. The SEC said its staff was recommending exemptions from the ban for trades market professionals make to hedge their investments in stock options or futures.

“I don’t think it’s going to accomplish what they’re after,” said Jeff Tjornehoj, senior analyst at fund research firm Lipper Inc. Without short sellers, he said, investors will have a harder time gauging the true value of a stock.

“Most people want to be in a stock for the long run and want to see prices go up. Short sellers are useful for throwing water in their face and saying, `Oh yeah? Think about this,'” Tjornehoj said. As a result, restricting the practice could inflate the value of some stocks, opening the door for a big downward correction later.

Stocks surge on report of entity for bad debt

Thursday September 18, 4:19 pm ET
By Tim Paradis, AP Business Writer

Stocks end sharply higher on report that government will create entity to hold banks’ debt

NEW YORK (AP) — Wall Street rallied in a stunning late-session turnaround Thursday, shooting higher and hurtling the Dow Jones industrials up 400 points following a report that the federal government may create an entity that will take over banks’ bad debt.

A report that Treasury Secretary Henry Paulson is considering the formation of an entity like the Resolution Trust Corp. that was set up during the savings and loan crisis of the late 1980s and early 1990s left investors ebullient. Investors hoped a huge federal intervention could help financial institutions jettison bad mortgage debt and stop the drain on capital that has already taken down companies including Bear Stearns Cos. (BSC) and Lehman Brothers Holdings Inc (LEH).

Worries about financial land mines on companies’ books have hobbled the world’s financial markets and led to the intense volatility in the markets this week.

“It’s going to take a lot of the bad debt off the balance sheets of these companies,” said Scott Fullman, director of derivatives investment strategy for WJB Capital Group in New York, commenting on the possibilities of an entity akin to the RTC. It could alleviate many of the pressures causing the credit crisis, he said, and open up the credit markets again. But Fullman noted, “the devil’s in the details.”

“Bear markets are very sensitive to news. And on a scale of 1 to 10, this one is a 13,” he said.

The report gave direction to a market that had bolted in and out of positive territory for much of the session as investors shuttled between the safety of Treasury bills and gold and the bargains posed by stocks that have been pounded lower.

Stocks tumble after government bailout of AIG

Wednesday September 17, 5:54 pm ET
By Tim Paradis, AP Business Writer

Wall Street sinks again after Fed bails out AIG, Barclays buys Lehman businesses; Dow down 450

NEW YORK (AP) — Wall Street plunged again Wednesday as anxieties about the financial system ran high after the government’s bailout of insurer American International Group Inc. (AIG) and left investors with little confidence in many banking stocks. The Dow Jones industrial average lost about 450 points, giving it a shortfall of more than 800 so far this week.

As investors fled stocks, they sought the safety of hard assets and government debt, sending gold, oil and short-term Treasurys soaring.

The market was more unnerved than comforted by news that the Federal Reserve is giving a two-year, $85 billion loan to AIG in exchange for a nearly 80 percent stake in the company, which lost billions in the risky business of insuring against bond defaults. Wall Street had feared that the conglomerate, which has extensive ties to various financial services industries around the world, would follow the investment bank Lehman Brothers Holdings Inc. (LEH) into bankruptcy. However, the ramifications of the world’s largest insurer going under likely would have far surpassed the demise of Lehman.

“People are scared to death,” said Bill Stone, chief investment strategist for PNC Wealth Management. “Who would have imagined that AIG would have gotten into this position?”

He said the anxiety gripping the markets reflects investors’ concerns that AIG wasn’t able to find a lifeline in the private sector and that Wall Street is now fretting about what other institutions could falter. Over the past year, companies including Lehman and AIG have sought to reassure investors that they weren’t in trouble, but as market conditions have worsened the market appears distrustful of any assurances.

“No one’s going to be believing anybody now because AIG said they were OK along with everybody else,” Stone said.

The Shakeout After Lehman, Merrill, AIG…

As credit stays tight, power shifts to Bank of America, Barclays, hedge funds, and private equity—and regulators will keep a more watchful eye

by David Henry and Matthew Goldstein

Once-mighty Wall Street has turned into the Boulevard of Broken Dreams. From Bear Stearns (BSC) and Lehman Brothers (LEH) to Merrill Lynch (MER) and AIG (AIG), the punishment for years of bad decisions has been shockingly swift and brutal. As firms wobble, markets gyrate, and investors quiver, the question is: When will the pain end?

The signs aren’t encouraging. Sure, the Federal Reserve’s dramatic bailout of American International Group prevented the full-out global panic that might have unfolded with the collapse of the largest U.S. insurer. But AIG’s sudden lurch toward bankruptcy also showed how dangerously intertwined the financial system has become.

For years that interconnectedness masked enormous underlying risks, but now it’s amplifying them. As each new thread from the crazy web has unwound during the 13-month credit crisis, a fresh problem has emerged. How bad things will get from here depends on how cleanly the losing firms and toxic investments can be extricated from the rest. With each passing day the task seems to grow more difficult. By the end of the credit bust, the total losses, now $500 billion, could reach $2 trillion, according to hedge fund Bridgewater Associates. What’s likely to be left when the Great Unwind is finally complete? A smaller, humbler, highly regulated Wall Street barely recognizable from its heady past, where caution reigns and wild risk-taking is taboo.

Plenty of Skeletons

Merrill’s ties to AIG show just how difficult it might be to untangle the financial system. During the mortgage boom, Merrill churned out billions of dollars worth of dubious collateralized debt obligations, those troublesome bonds backed by pools of risky subprime mortgages. To cut down its own risk, Merrill bought insurance contracts from AIG called credit default swaps, which pay off if the mortgages blow up. Merrill holds $5 billion worth of guarantees from AIG alone. In all, AIG insures $441 billion of CDOs, including $58 billion with the subprime taint. It’s unclear which firms bought those guarantees, but AIG sold many to big European banks.

The perils of leverage

by Martin Hutchinson
September 15, 2008

The investment bank Lehman Brothers (LEH) spent last week teetering towards the sort of bankruptcy which like that of Bear Stearns (BSC), Fannie Mae (FNM) and Freddie Mac (FRE), may require a “bailout” by the long-suffering US taxpayer. All four of these institutions shared a common feature: they had far too much leverage, i.e. they had borrowed far too much money to be compatible with their modest capital bases. Excessive leverage is currently a characteristic of the US economy as a whole, and we are in the process of paying the price for it.

Investment banks traditionally had a leverage limit (total assets to shareholders’ equity) of about 20 to 1. That limit was fudged to a certain extent with subordinated debt, but fudging was limited by investors’ unwillingness to buy subordinated debt of such intrinsically unstable institutions. However, while investment bank assets traditionally consisted of commercial paper, bonds and shares that trade every day and can be valued properly, they have now come to include investment real estate, private equity stakes, hedge fund positions, credit default swaps and other derivatives positions that do not even appear on the balance sheet. Thus even 20 to 1 in modern market conditions is excessive. Adding in subordinated debt, and claiming that say Lehman has an “11% capital ratio” works fine in bull markets, but not when things get tough.

Scaling that 20 to 1 up to 30 to 1, as Lehman had at its November 2007 year-end, is asking for trouble. Even if the off-balance sheet credit default swaps and other derivatives don’t lead to problems, and there are no assets parked in “vehicles” that have to be suddenly taken back on balance sheet, an institution that is 30 to 1 levered needs to see a decline of only 3.3% in the value of its assets before its capital is wiped out. Such a decline can happen frighteningly quickly – it represents only a 10% decline in the value of a third of the assets.

Lehman’s leverage is not exceptional among Wall Street investment banks. At the last quarterly balance sheet date (May or June) while Lehman’s leverage had been brought down to 23.3 times through asset sales, Morgan Stanley’s (MS) was still 30.0 times, Goldman Sachs’s (GS) 24.3 times and Merrill Lynch’s (MER) an astounding 44.1 times (or to be fair, 31.5 times at its December 2007 year-end, before new losses appeared.)

Lehman rescue fails, BofA seen buying Merrill

Sunday September 14, 10:58 pm ET
By Joe Bel Bruno, Christopher S. Rugaber and Martin Crutsinger, AP Business Writers

As Lehman’s future dims, Fed and banks offer cash lifeline to financial system

NEW YORK (AP) — A failed plan to rescue Lehman Brothers (LEH) was followed Sunday by more seismic shocks from Wall Street, including an apparent government-brokered takeover of Merrill Lynch (MER) by the Bank of America (BAC).

A forced restructuring of the world’s largest insurance company, American International Group Inc. (AIG), also weighed heavily on global markets as the effects of the 14-month-old credit crisis intensified.

A global consortium of banks, working with government officials in New York, announced late Sunday a $70 billion pool of funds to lend to troubled financial companies. The aim, according to participants who spoke to The Associated Press, was to prevent a worldwide panic on stock and other financial exchanges.

Ten banks — Bank of America, Barclays (BCS), Citibank (C), Credit Suisse (CS), Deutsche Bank (DB), Goldman Sachs (GS), JP Morgan (JPM), Merrill Lynch, Morgan Stanley (MS) and UBS (UBS) — each agreed to provide $7 billion “to help enhance liquidity and mitigate the unprecedented volatility and other challenges affecting global equity and debt markets.”

The Federal Reserve also chipped in with more largesse in its emergency lending program for investment banks. The central bank announced late Sunday that it was broadening the types of collateral that financial institutions can use to obtain loans from the Fed.

Federal Reserve Chairman Ben Bernanke said the discussions had been aimed at identifying “potential market vulnerabilities in the wake of an unwinding of a major financial institution and to consider appropriate official sector and private sector responses.”

Futures pegged to the Dow Jones industrial average fell more than 300 points in electronic trading Sunday evening, pointing to a sharply lower open for the blue chip index Monday morning. Asian stock markets were also falling.

Govt, Wall Street races to try to save Lehman

Saturday September 13, 4:57 pm ET
By Jeannine Aversa, AP Economics Writer

As financial world frets, government and brokerage leaders try to hash out Lehman rescue

WASHINGTON (AP) — The financial world held its collective breath Saturday as the U.S. government scrambled to help devise a rescue for Lehman Brothers (LEH) and restore confidence in Wall Street and the American banking system.

Deliberations resumed Saturday as top officials and executives from government and Wall Street tried to find a buyer or financing for the nation’s No. 4 investment bank and to stop the crisis of confidence spreading to other U.S. banks, brokerages, insurance companies and thrifts.

Failure could prompt skittish investors to unload shares of financial companies, a contagion that might affect stock markets at home and abroad when they reopen Monday.

Options include selling Lehman outright or unloading it piecemeal. A sale could be helped along if major financial firms would join forces to inject new money into Lehman. Government officials are opposed to using any taxpayer money to help Lehman.

An official from the Federal Reserve Bank of New York said Saturday’s participants included Treasury Secretary Henry Paulson, Timothy Geithner, president of the Federal Reserve Bank of New York, and Securities and Exchange Commission Chairman Christopher Cox. The New York Fed official asked not to be named due to the sensitivity of the talks.

Citigroup Inc. (C)’s Vikram Pandit, JPMorgan Chase Co. (JPM)’s Jamie Dimon, Morgan Stanley (MS)’s John Mack, Goldman Sachs Group Inc.(GS)’s Lloyd Blankfein, and Merrill Lynch Co. (MER)’s John Thain were among the chief executives at the meeting.

Representatives for Lehman Brothers were not present during the discussions.

They gathered on the heels of an emergency session convened Friday night by Geithner — the Fed’s point person on financial crises.

Bernanke the Magnificent? or The Amazing Bernanke?

Well, our president may not have a magic wand, but it looks like our Fed Chairman does.

This weekend Big Ben got together with his govt. cronies and they whipped up a wicked brew that is the antidote to the housing crisis and savior of all things financial. The SEC put the clamps on the shorts, the Treasury got into the mortgage underwriting business and Big Ben opened the Fed money faucet a little wider.

Hooray!??

Let’s see, that’s $30B for Bear Stearns, $8B for Indy Mac & now $5T worth of mortgages at Fannie and Freddie. I wonder if the cost of printing dollars has gone up with the increased raw material costs?

Our LD President Bush danced on the scene with an empty promise to drill the OCS for a few hundred thousand Bpd in 10 years and the world was right again.

Oil plunged, bank stocks soared. It must have brought a smile to their faces.

But is it reality? Have the finance gods truly been appeased?

Mean girls

Commentary: Pssst … rumor is truth on Wall Street
By David Weidner, MarketWatch
Last update: 12:01 a.m. EDT July 15, 2008

NEW YORK (MarketWatch) — Wall Street, like a girl in junior high school, has come home crying.

It seems the Mean Girls in the marketplace keep spreading nasty rumors, and everyone’s cell phones are alight with SMS messages. “OMG did you hear Bear Stearns can’t meet its obligations?” they whisper. “Fannie (FNM) and Freddie (FRE) r FSBO.

“B4 the credit crunch Lehman used 2b QT, but has toxic balance sheet; it could go BNKRPT b4 2MORO,” they snicker.

The Mean Girls buy a bunch of short positions and then collect when the stock tumbles. On June 10, there were 90,000 puts in the first hour of trading in the option market against Lehman shares, after a rumor was floated that Pimco had pulled its business from the investment bank. Even though Lehman Brothers Holdings Inc. (LEH) has been a big put stock in recent weeks, the puts represented two-thirds of the average daily volume for the stock.

Until Pimco shot down the rumors, it was BBB (bye-bye, baby) for LEH.

News travels pretty fast around here. Text messages, cell phones and the old face-to-face method are the shovels used to move dirt. If recent insider cases are any indication, text messages and emails remain popular even though they are recorded.

It’s been a scandalous spring, but now the Mean Girls are getting some payback. First they’ve been exposed by Bryan Burrough in the latest issue of Vanity Fair. In that article, Burrough alleges that rumors either were transmitted to or originated from hedge funds SAC Capital Management, Citadel Investment Group and traders at Goldman Sachs Group (GS) . He suggests that Bear Stearns may have been ruined by rumors, a tactic that some call a “Bear raid.”

Wall Street’s credit crisis heads into second year

Wednesday June 18, 3:59 pm ET
By Joe Bel Bruno, AP Business Writer

More credit losses seen costing global banks $1 trillion as credit crisis hits second year

NEW YORK (AP) — There are new signs that the worst of the global credit crisis is yet to come, and that banks and brokerages caught up in the market turmoil may lose $1 trillion by the time it has passed.

Major U.S. investment banks this week announced yet another painful quarter amid the implosion of mortgage-backed securities and risky credit investments. Regional banks have scrambled to secure fresh capital to stay in business, and by Wednesday there was new talk that embattled investment bank Lehman Brothers might be forced into a sale.

With each passing quarter, Wall Street’s top bankers have indicated that the worst of the market turmoil was over — only to face more pain months later. The uncertainty has caused already battered investors to lose confidence in financial companies, and expectations have increased that more layoffs, asset sales and capital raising will be needed in the weeks ahead.

“We thought this was going to be the kitchen-sink quarter, and we’re finding out that CEOs and CFOs still don’t have a handle on the credit crisis,” said William Rutherford, a former state treasurer of Oregon who now runs Rutherford Investment Management. “We haven’t disinterred all the dead bodies. What else is out there?”

The deepening credit crisis could cost the global financial system some $945 billion by the time it is over, according to a report from the International Monetary Fund. So far, banks and brokerages have written down nearly $300 billion from bad bets on mortgage-backed securities and other risky investments.

Rotation, Rotation, Rotation

Since Bernanke’s bungle (See Wrong Again Ben) in early December, rotation has been everything if you intended to not lose your shirt (possibly even your mind) in this crazy market.

Financials were absolutely the worst sector to be long despite having started to fall as early as April of 2007. Put options on stocks like BSC and LEH and GS proved to be big winners. The XLF Financial Select SPDR ETF fell faster from December to March than it had in all of 2007.

The S&P 500 was not spared, dropping as far as 13.5% from the December Fed meeting to the March bottom.

So where do you hide? Bonds did pretty well relatively.

But commodities really made your money grow!

Here is a comparison of two widely held mutual funds, the Dodge & Cox Stock Fund (DODGX) and the Pimco Total Return Fund (PTRAX). Even though DODGX is a waning fund, crushed by the weight of its own success, the difference here is quite remarkable. By making the switch, a passive buy and hold 401k investor could have saved two years worth of gains (at an average of 8% per year) in only six months. Not to mention the lower stress level that comes with a shallower drawdown in equity.

Update:

What goes around comes around July 17, 2008

Lehman Brothers removes finance, operating chiefs

Thursday June 12, 5:03 pm ET

By Joe Bel Bruno, AP Business Writer

Lehman Brothers shakes up top management as firm takes nearly $3 billion quarterly loss

NEW YORK (AP) — The hope at Lehman Brothers is that a management shakeup Thursday will contain the damage of a stunning quarterly loss — yet some on Wall Street fear this is one more step toward a more dramatic outcome for the embattled investment bank.

The ouster of Chief Financial Officer Erin Callan and Chief Operating Officer Joseph Gregory was an attempt to quell investor anger that Lehman’s leadership has failed them. But, with a four-day stock plunge that wiped $4.5 billion from the investment bank’s market value, it was unclear if the upheaval will be enough to satisfy critics.

“These people deserve to be fired,” said Dick Bove, an analyst with Ladenburg, Thalmann & Co. “Their mistakes cost their shareholders billions of dollars in wealth.” Lehman shares fell 4.4 percent Thursday to $22.70 and are down 30 percent this week. The decline is a blow to investors who bought into a stock offering at $28 earlier this week — including BlackRock Inc. and former AIG chief Hank Greenberg.

Richard Fuld, who took the company public in 1994, has kept a low profile in recent days by refusing interviews and commenting only through a statement about the dismissals. There is growing speculation that Fuld — the Street’s longest serving CEO — might scramble to find a major outside investor or negotiate a sale to avoid his own demise by Lehman’s board.

Names from private-equity firm Blackstone Group Inc. to global bank HSBC Holdings PLC have been bandied about as possible suitors should Fuld want to arrange a buyer, though none are commenting on the possibility. Most analysts are confident that Lehman can survive on its own without a suitor, given the underlying strength of its business.

And while Lehman might have bought itself some more time by shaking up its top ranks, the question remains how much it has left.

“I think they have a few options, but they are becoming more and more limited as the stock is pressured,” said Matthew Albrecht, financials analyst for Standard & Poor’s. “It is hard to rule anything out at this point. Confidence in the firm is the paramount issue, and if your counterparties and clients don’t have confidence then you can’t do business in this market.”

Lehman Bros. is Losing More than Money

By STEVEN M. SEARS
barrons.com

The investment bank’s credibility is shot and its put options have gotten red-hot.

ON A DAY WHEN MOST stocks are rising simply because some 90% declined in the previous trading session on Friday, Lehman Brothers (LEH) is an exception.

The stock of the nation’s fourth-largest investment bank fell about 11% in midday trading Monday after the company warned investors that next Monday’s second-quarter financial report will reveal a big loss.

Ineffective hedges, and apparently a breakdown with the bank’s decision making, caused Lehman to unexpectedly announce that it thinks it lost $2.6 billion, and that it will now rebuild its finances by issuing $4 billion of common stock priced at $28 per share and $2 billion of mandatory convertible preferred stock.

Of course, this is just a pre-announcement, and the final results could be different when announced next Monday, said Lehman’s chief financial officer, Erin Callan, in a morning conference call with investors and analysts.

The options and debt markets had expected earnings troubles, though arguably not even the legion of traders aligned against Lehman anticipated a loss of this magnitude. Lehman’s expected second-quarter equals $5.41 per share, markedly higher than the analyst consensus of a loss of 20 cents.

Put options on Lehman, which increase in value when the stock price declines, were obscenely expensive last week in anticipation of Lehman’s weakened position. Today, they are still richly priced, and though they have declined somewhat from last week’s doomsday scenario level, anyone interested in hedging against further weakness in Lehman’s stock will pay a princely risk premium.

Danger Ahead: Fixing Wall Street Hazardous to Earnings Growth

By Christine Harper and Yalman Onaran

April 28 (Bloomberg) — Wall Street’s money-making machine is broken, and efforts to repair it after the biggest losses in history are likely to undermine profits for years to come.

Citigroup Inc., UBS AG and Merrill Lynch & Co. are among the banks and securities firms that have posted $310 billion of writedowns and credit losses from the collapse of the subprime mortgage market. They’ve cut 48,000 jobs and ousted four chief executive officers. The top five U.S. securities firms saw $110 billion of market value evaporate in the past 12 months.

No one is sure the model works anymore. While Wall Street executives and regulators study what went wrong, there is no consensus solution for restoring confidence. Under review are some of the motors that powered record earnings this decade — leverage, off-balance-sheet investments, the business of repackaging assets into bonds through securitization, and over- the-counter trading of credit derivatives. Without them, it will be difficult to generate growth.

“Brokerages will have a tough time for a while,” said Todd McCallister, a managing director at St. Petersburg, Florida-based Eagle Asset Management Inc., which oversees $14 billion. “The main engine of its recent growth, securitization, will be curtailed. Regulation will be cranked up. Everything is stacked against them.”

Last month’s collapse and emergency sale of Bear Stearns Cos., the fifth-largest of the New York-based securities firms, demonstrated the perils of Wall Street business practices developed after the 1999 repeal of the Glass-Steagall Act. The change allowed investment banks and depository institutions to compete with each other.

Level 3 Decimation?

Level 3 Decimation?

October 29, 2007

Martin Hutchinson is the author of “Great Conservatives” (Academica Press, 2005) — details can be found on the Web site http://www.greatconservatives.com

There’s a mystery on Wall Street. Merrill Lynch last week wrote off $8.4 billion in its subprime mortgage business, a figure revised up from $4.9 billion, yet Goldman Sachs reported an excellent quarter and didn’t feel the need for any write-offs. The real secret of the difference is likely to be in the details of their accounting, and in particular in the murky world, shortly to be revealed, of their “Level 3” asset portfolios.

Both Merrill and Goldman have Harvard chairmen – Merrill’s Stan O’Neal from Harvard Business School and Goldman’s Lloyd Blankfein from Harvard College and Harvard Law School. Thus it’s pretty unlikely their approaches to business are significantly different – or is a Harvard MBA really worth minus $8.4 billion compared with a law degree? (The special case of George W. Bush may be disregarded in answering that question!)

We may be about to find out. From November 15, we will have a new tool for figuring out how much toxic waste is in investment banks’ balance sheets. The new accounting rule SFAS157 requires banks to divide their tradable assets into three “levels” according to how easy it is to get a market price for them. Level 1 assets have quoted prices in active markets. At the other extreme Level 3 assets have only unobservable inputs to measure value and are thus valued by reference to the banks’ own models.

Goldman Sachs has disclosed its Level 3 assets, two quarters before it would be compelled to do so in the period ending February 29, 2008. Their total was $72 billion, which at first sight looks reasonable because it is only 8% of total assets. However the problem becomes more serious when you realize that $72 billion is twice Goldman’s capital of $36 billion. In an extreme situation therefore, Goldman’s entire existence rests on the value of its Level 3 assets.