Posted by August 8, 2008
This is supposed to be a lucky day in the Chinese calendar and it’s the start of the 2008 Summer Olympics. The people in the South Ossetia region of Georgia probably didn’t feel too lucky though as armed conflict started with their much larger neighbor, Russia. I guess that puts some positive perspective on the one-year anniversary of the financial crisis: it can always be worse.
Fannie Mae reported a second quarter loss today of $25 billion which caused their stock price to drop. What was really interesting was that Fannie’s share price was down about 20% while the rest of the market was up 2%. The 2% rise was attributed to a favorable outlook for the U.S. dollar in light of statements coming out of Europe that suggests that they realize the Euro area economy is slowing. Duh!
Also of note, our old friend, the financial guarantor MBIA, reported very favorable financial results which were mostly due to mark-to-market gains on their liabilities. (What? Hello? Who does this make sense to? Accounting rules were recently changed to have companies book gains (which flow to net income) to offset the declining market value of their liabilities. This improves the book value of their equity. Hello?) MBIA and other financial guarantors continue to exhibit significant stress and they are now trying to settle claims at ~ 25 to 35 cents on the dollar. Still, these developments seem to be creating less stress than they did back in February. Also of note, NY State Attorney General Andrew Cuomo announced that he reached an agreement with UBS to settle the state’s grievance against them for practices in the Auction Rate Securities (ARS) market. More to follow, no doubt.
August 12, 2008
The ARS settlements are now happening fast and furious and dealers are now willing to let their ARS customers off the hook at par. It is happening very quickly too, even though it’s literally six months after the ARS crisis began. Looks like some prodding from the NY Attorney General’s office was all that was needed for the dealers to give their clients their money back. Needless to say, the ARS liquidity issues generated a lot of ill will for dealers with their clients. One thing remains constant, a strong herd instinct on Wall Street.
I’m starting to feel some career angst because it seems like my work has become quite peripheral to the group effort, so I spoke to my boss about it. He basically told me to chill. So, I’ll chill. The boss did offer me the opportunity to work on a “9/10” flex schedule – work an extra hour for nine days over two weeks and get the tenth day off for “free” – and I gladly took it. How does having every other Friday off sound in the middle of August? Fantastic!
The late July / early August period has been quite calm. People are taking vacation and there haven’t been many new developments since Merrill Lynch announced their equity increase concurrent with the financed sale of a CDO portfolio. No one thinks we’re “out of the woods” yet and the potential for a liquidity run on either Merrill or Lehman is quite real. The SEC imposed some restrictions on short selling equities over the past which are about to expire. If they expire, increased short selling activity could renew downward price spirals. Next up, market participants will be particularly attuned to Lehman’s announcement of their earnings for the current quarter ending August 31st.
In the world beyond Wall Street, China opened the 2008 Summer Olympic Games in Beijing and Russian used this unique time of peaceful cooperation in the international community to invade the former USSR territory, Georgia. I’m keeping my fingers crossed on that one. Even though a major energy pipeline runs through Georgia, oil prices are falling like a stone. Over the past 10 days they declined from $145 a barrel to $115. The major driver in the declining oil prices is the apparent recognition in Europe that economic conditions are softening (duh!). Although the economies of the peripheral countries (Greece, Ireland, Spain, etc.) have been declining for some time now, all of a sudden, Germany and France appear to be susceptible to slowing economic conditions. Who knew?
August 19, 2008
Welcome to the second half of August, at least we’ve made it this far. Oil prices have stabilized around $115 a barrel, but the market remains on edge, continuing to focus on the share prices of Fannie Mae and Freddie Mac, both of which dropped about 25% yesterday and another 5% today. Freddie’s share price is around $4.00 now; Fannie’s is around $6.00. It is a widely held view that both Fannie and Freddie are too systemically important to fail, and indeed, Congress just granted the Treasury Department broad authority to support both of them. The immediate problem is that these entities have publicly traded stock and a good portion of the “market” thinks they are technically insolvent – i.e. their share price should be zero. It seems to me that the selling pressure will not relent until the Treasury Department assumes full ownership of the two, as opposed to the “de facto” ownership (via an enormous level of support) that exists today. The fact that Freddie actually has negative equity (more liabilities than assets) from a Generally Accepted Accounting Principle perspective probably doesn’t help their immediate outlook but it does provide the reader with an intuitive sense of what’s going on, i.e. there’s no equity left at Fannie and Freddie, hence the publicly traded share price should be zero.
Today’s WSJ described Lehman’s current situation as a “dilemma”. Lehman has a lot of real estate assets. They would obviously like to sell these assets, “turn the page” and move on. However, they view current prices as distressed and selling at these levels will likely cause losses. These assets are supposed to be routinely “market to market” so their actual value should be already reflected on Lehman’s balance sheet. However, real estate assets are difficult to price accurately, especially during times of illiquidity. A big question is, can Lehman shed these assets at prices that won’t cause losses so big that they severely reduce, and potentially even wipe out, all of Lehman’s equity?
Lehman’s share price has traded in a range since July, but it did drop about 10% today to around $13.00 a share. If Leham could raise more equity the market would be less concerned about their solvency. However, it’s not clear if Lehman can raise new equity now as investors are stick licking their wounds over the recent $28.00 a share issuance that was a disaster. So, the path of least resistance is for equity to continue to decline as losses from their real estate portfolio continue. Lehman has at least one good card to play, however, it owns Neuberger, Berman, a well-respected asset management firm. They are understandably hesitant to sell off this “crown jewel”, but they may have to. If I were them, I would “double down” and try to buy a distressed regional bank. National City Corporation of Cleveland, for example, has a current total market capitalization of less than $4.0 billion.
August 21, 2008
Markets have stabilized the last couple of days, but a sense of uneasiness is growing. It has become apparent that the Treasury Department will have to bail out both Fannie and Freddie and everyone is waiting for the details. Freddie’s share price is now $3.00; Fannie’s is $4.50. What is really interesting is that the government probably can’t easily absorb them for a short period of time, recapitalize them, and then spin them off to the public. Why not? It looks like their business model is flawed. Are they privately owned? – yes. Are they government sponsored? – yes. What are they actually? Seems like when things are going well, they are a private company that makes profits and pay dividends and employee bonuses, etc. But when things aren’t going well, they’re really a public company, one that taxpayers should be happy to support. Yikes! Right now, one thing is clear about Fannie and Freddie, they are a big source of confusion and concern in the market!
I continue to be frustrated by a lack of involvement in the day-to-day information flow that is coming out of the Bank Supervision teams that are “on site” at the dealers and I routinely have to take my boss’ advice and chill and provide value-added where I can. I’m putting together a presentation that will compare the relative secondary market liquidity of the different asset classes that are being pledged in the tri-party platform. The liquidity ranges from being very good (Treasury securities, equities) to almost non-existent (whole loans of mortgages that haven’t been packaged into MBS securities yet). Interesting contrast, right?