Unprecedented Coordinated Central Bank Interventions Stoke Stock Rally

Whisper rumors in the financial markets suggest that a major European bank was on the verge of collapse while we in the US were asleep last night. This was a massive coordinated intervention today by the central banks of China, Japan, Europe, Switzerland, and the United States. 37 major global banks' debt was downgraded yesterday by S&P shortly after the market closed.

Congressman Ron Paul released this statement this morning. I think he is absolutely correct in this. I couldn't have said it better if I was divinely inspired:


"Rather than calming markets, these arrangements should indicate just how frightened governments around the world are about the European financial crisis. Central banks are grasping at straws, hoping that flooding the world with money created out of thin air will somehow resolve a crisis caused by uncontrolled government spending and irresponsible debt issuance. Congress should not permit this type of open-ended commitment on the part of the Fed, a commitment which could easily run into the trillions of dollars. These dollar swaps are purely inflationary and will harm American consumers as much as any form of quantitative easing." -- Congressman Ron Paul
The Dow is up 400 points at this moment. Folks, do NOT misunderstand. This huge stock market rally today is a bet on INFLATION, not prosperity! This is an unprecedented intervention in the global financial markets by the central criminals -- also known as bankers -- as a panic move to stop what could be an imminent global banking meltdown.

This stock market rally is not due to expectations of renewed recovery. It is an oversized bet on massive inflation that will be the natural consequence of the excessive money creation and debt monetization that is being created.

Central banking and other monetary policy authorities are desperately trying to prevent what they see as certain calamity without such broad, coordinated, and extreme measures. What they fail to see in this short-sighted strategy is that with each succeeding threat of catastrophe, the magnitude and impact of it increases. They are just kicking the can down the road, with a bigger and more leaden can reappearing each time they do it. Don't be surprised if we see runs on banks before this crisis is resolved. They are already seeing bank runs (I've seen the photos) in parts of Europe right now just like the ones in the classic Jimmy Stewart movie, It's a Wonderful Life!

IMF's Lagarde Warns of New Crisis

The Managing Director of the IMF, Christine Lagarde has warned politicians and policy makers from across the globe they must unite and take bold action to avoid a financial meltdown. Tough economic decisions such as tax hikes must not be delayed for the sake of electoral expediency, she said.

New Global Banking Crisis Emerging, With Epicenter in Europe

A new liquidity and banking crisis appears to be breaking. 

excerpt from WSJ:
"Federal and state regulators, signaling their growing worry that Europe's debt crisis could spill into the U.S. banking system, are intensifying their scrutiny of the U.S. arms of Europe's biggest banks, according to people familiar with the matter.
"The Federal Reserve Bank of New York, which oversees the U.S. operations of many large European banks, recently has been holding extensive meetings with the lenders to gauge their vulnerability to escalating financial pressures. The Fed is demanding more information from the banks about whether they have reliable access to the funds needed to operate on a day-to-day basis in the U.S."

and from Zero Hedge last night:
"In one sign of how European banks may be having trouble getting dollar funding, an unidentified European bank on Wednesday borrowed $500 million in one-week debt from the European Central Bank, according to ECB data."

List of Bad Banks Grows, But So Do Profits

It's troubling to me that the only reason profits rose is that banks are setting aside fewer reserves for loan losses. Considering that the entire industry earned $14.5 billion, and expected losses for the foreclosure mess are now expected to hit nearly $750 billion, we're still is very deep trouble!

from Fox Business:

U.S. bank industry earnings fell by almost $7 billion in the third quarter but were far better than a year ago as the industry continues to recover from the financial crisis.

The Federal Deposit Insurance Corp announced on Tuesday that net income for the banking industry was $14.5 billion for the third quarter, which compares to $21.4 billion in the second quarter and $2 billion in the third quarter of 2009.

The agency said that third-quarter earnings would have reached a three-year high had it not been for a $10.4 billion goodwill charge taken by Bank of America during the quarter for its card business.

"The industry continues making progress in recovering from the financial crisis," FDIC Chairman Sheila Bair said in a statement. "Credit performance has been improving, and we remain cautiously optimistic about the outlook."

The banking industry has been setting aside less money to guard against losses, helping to boost earnings.

The amount of bad loans, those 90 days or more past due, declined for the second consecutive quarter, the agency said in its latest quarterly report. The balances for these loans declined by 2.1%, or $8.3 billion, in the third quarter.

The number of banks on the agency's "problem list," however, grew from 829 to 860, which is the highest number since March of 1993 when there were 928 institutions on the list.

More Bank Funk, Dow Off 100

Here Comes Mortgage Meltdown, Act 2 (part 2)

part 2 from John Mauldin:


At the end of last week's letter on the whole mortgage foreclosure mess, I wrote:
"All those subprime and Alt-A mortgages written in the middle of the last decade? They were packaged and sold in securities. They have had huge losses. But those securities had representations and warranties about what was in them. And guess what, the investment banks may have stretched credibility about those warranties. There is the real probability that the investment banks that sold them are going to have to buy them back. We are talking the potential for multiple hundreds of billions of dollars in losses that will have to be eaten by the large investment banks. We will get into details, but it could create the potential for some banks to have real problems."
Real problems indeed. Seems the Fed, PIMCO, and others are suing Countrywide over this very topic. We will go into detail later in this week's letter, covering the massive fraud involved in the sale of mortgage-backed securities. Frankly, this is scandalous. It is almost too much to contemplate, but I will make an effort.
But first, let me acknowledge the huge deluge of emails I got over last week's letter, the most I can ever remember. I thought about just making this week's letter a response to many of them, but decided I needed to go ahead and finish the topic at hand. Maybe another time. As a side note, I quoted a letter that came to me anonymously via David Kotok. I said if I found out who wrote it, I would give them credit. It was originally written by Gonzalo Liro, at www.gonzalolira.blogspot.com.
Many of you wrote to point out that his argument about the tracking of title was not correct, but others pointed out many other issues as well. This is one of the most complex problems we face, and I got a lot of good information from readers. It just makes me wish I had our new web site finished so you could avail yourselves of the wisdom among my readers. We are close, down to final changes. And now, on to today's letter.

They Knew What They Were Selling

It's hard to know where to start. There is just so much here. So let's begin with testimony from Mr. Richard Bowen, former senior vice-president and business chief underwriter with CitiMortgage Inc. This was given to the Financial Crisis Inquiry Commission Hearing on Subprime Lending andnd Securitization andnd Government Sponsored Enterprises. I am going to excerpt from his testimony, but you can read the whole thing (if you have a strong stomach) at http://fcic.gov/hearings/pdfs/2010-0407-Bowen.pdf. (Emphasis obviously mine.)
"The delegated flow channel purchased approximately $50 billion of prime mortgages annually. These mortgages were not underwriten by us before they were purchased. My Quality Assurance area was responsible for underwriting a small sample of the files post-purchase to ensure credit quality was maintained.
"These mortgages were sold to Fannie Mae, Freddie Mac [We will come back to this - JM] and other investors. Although we did not underwrite these mortgages, Citi did rep and warrant to the investors that the mortgages were underwritten to Citi credit guidelines.
"In mid-2006 I discovered that over 60% of these mortgages purchased and sold were defective. Because Citi had given reps and warrants to the investors that the mortgages were not defective, the investors could force Citi to repurchase many billions of dollars of these defective assets. This situation represented a large potential risk to the shareholders of Citigroup.
"I started issuing warnings in June of 2006 and attempted to get management to address these critical risk issues. These warnings continued through 2007 and went to all levels of the Consumer Lending Group.
"We continued to purchase and sell to investors even larger volumes of mortgages through 2007. And defective mortgages increased during 2007 to over 80% of production."
Mr. Bowen was no young kid. He had 35 years of experience. He was the guy they hired to pay attention to the risks, and they ignored him. How could a senior manager not get such an email and not notify his boss, if only to protect his own ass? They had to have known what they were selling all the way up and down the ladder. But the music was playing and Chuck Prince said to dance and rake in the profits (and bonuses!). More from his testimony:
"Beginning in 2006 I issued many warnings to management concerning these practices, and specifically objected to the purchase of many identified pools. I believed that these practices exposed Citi to substantial risk of loss.

Warning to Mr. Robert Rubin and Management

"On November 3, 2007, I sent an email to Mr. Robert Rubin and three other members of Corporate Management... In this email I outlined the business practices that I had witnessed and attempted to address. I specifically warned about the extreme risks that existed within the Consumer Lending Group. And I warned that there were 'resulting significant but possibly unrecognized financial losses existing within Citigroup.'"
And now taxpayers own 75% of Citi, and our losses to them are huge. They are going to get worse, as we will see.
Now let's turn to the testimony of Keith Johnson, who worked for various mortgage companies and in 2006 became the president and chief operating officer of Clayton Holdings, the largest residential loan due diligence and securitization surveillance company in the United States and Europe. This is testimony he gave before the Financial Crisis Inquiry Commission. Part of the testimony is by his associate Vicki Beal, senior vice-president of Clayton. The transcript is some 277 pages long, so let me summarize.
Investment banks would come to Clayton and give then roughly 10% of the mortgages that they intended to buy and put into a security. Clayton rated them on whether the documentation was what it was supposed to be, not as to whether they thought it was a good loan. Still, 46% of the loans did not have proper documentation (out of a pool of 9 million loans) and 28% had what was determined to be level 3 disqualifications that simply had no mitigating circumstances. Understand, these were loans that were already written, and there was no effort to check the facts, just the documentation.
And ultimately 11% of these loans (39% of the level 3's) were put back in by the investment bank. And what happened to the loans that were rejected? (This might require an adult beverage and a few expletives deleted.)

Popping Through

They were put back into another pool, where again only 10% of the loans were examined. Quoting from the testimony:
"MR. JOHNSON: I think it goes to the 'three strikes, you're out' rule.
"CHAIRMAN ANGELIDES: So this was a case of - okay, three strikes.
"MR. JOHNSON: I've heard that even used. Try it once, try it twice, try it three times, and if you can't get it out, then put -
"CHAIRMAN ANGELIDES: Well, the odds are pretty good if you are sampling 5 to 10 percent that you'll pop through. When you said the good, the bad, the ugly, the ugly will pop through."
Yes, you read that right. If a loan was rejected a second time, it went back into yet another pool for a third try. The odds of coming up three times, when only 5 or 10 percent are sampled? About 1 in a thousand. Popping through, indeed.
Clayton presented their data to the ratings agencies, investment banks, and others in the industry. They were frustrated that no one was really paying attention or taking heed of their warnings.
Here is what Shahien Nasiripour, the business reporter for the Huffington Post, wrote (his emphasis). For those interested, the entire article is worth reading. (http://www.huffingtonpost.com/2010/09/25/wall-street-subprime-crisis_n_739294.html):
"Johnson told the crisis panel that he thought the firm's findings should have been disclosed to investors during this period. He added that he saw one European deal mention it, but nothing else.
"The firm's findings could have been 'material,' Johnson said, using a legal adjective that could determine cause or affect a judgment.
"It's unclear whether the firms ended up buying all of those loans, or whether Wall Street securitized them all and sold them off to investors.
"'Clayton generally does not know which or how many loans the client ultimately purchases,' Beal said. That likely will be the subject of litigation and investigations going forward.
"'This should have a phenomenal effect legally, both in terms of the ability of investors to force put-backs and to sue for fraud,' said Joshua Rosner, managing director at independent research consultancy Graham Fisher & Co.
"'Original buyers of these securities could sue for fraud; distressed investors, who buy assets on the cheap, could force issuers to take back the mortgages and swallow the losses.
"'I don't think people are really thinking about this,' Rosner said. 'This is not just errors and omissions - this appears to be fraud, especially if there is evidence to demonstrate that they went back and used the due diligence reports to justify paying lower prices for the loans, and did not inform the investors of that."
"Beal testified that Clayton's clients use the firm's reports to 'negotiate better prices on pools of loans they are considering for purchase,' among other uses.
"Nearly $1.7 trillion in securities backed by mortgages not guaranteed by the government were sold to investors during those 18 months, according to Inside Mortgage Finance. Wall Street banks sold much of that. At its peak, the amount of outstanding so-called non-agency mortgage securities reached $2.3 trillion in June 2007, according to data compiled by Bloomberg. Less than $1.4 trillion remain as investors refused to buy new issuance and the mortgages underpinning existing securities were either paid off or written off as losses, Bloomberg data show.
"The potential for liability on the part of the issuer 'probably does give an investor more grounds for a lawsuit than they would ordinarily have', Cecala said. 'Generally, to go after an issuer you really have to prove that they knowingly did something wrong. This certainly seems to lend credibility to that argument.'
"'This appears to be a massive fraud perpetrated on the investing public on a scale never before seen,' Rosner added."

It's Time for Some Putback Payback

Investment banks large and small originated a lot of subprime garbage in the 2005-2007 era. This week PIMCO, Black Rock, Freddie Mac, the New York Fed, and - what I think is key and no one has picked up on - Neuberger Berman Europe, Ltd., an investment manager to a managed-account client, came together and sued Countrywide for not putting back bad mortgages to its parent, Bank of America. This is the first of what will be a series of suits aimed at getting control of the portfolio and peeking into the mortgages. (Text of lawsuit at http://www.ritholtz.com/blog/2010/10/full-text-of-letter-to-bofa-from-ny-fed-maiden-lane-freddie-mac-pimco-western-asset-mgmt-neuberger-berman-kore-advisors/)
Basically, if buyers of 25% or more of a mortgage-backed security can come together, they have standing to sue the mortgage servicer to do its duty to the investors and make putbacks of bad mortgages, and if they fail to do so the plaintiffs can take control of the process and take the issuer to court directly (that's a very simplistic description but roughly accurate).
There are two key take-aways. First, note that a European entity is involved. Hundreds of billions of dollars of this junk was sold to European banks and funds. And these guys get together at conferences (sometimes they even invite me to speak). So Helmut will be talking to Lars who will talk to Jean Pierre and they will realize they all own some of this junk. They will be watching with very real interest to see how the big boys at PIMCO and Black Rock and the New York Fed fare in their efforts. And then you can count on them all piling on (more later on this).
Second, little noticed this week was the fact that The Litigation Daily wrote that Philippe Selendy of Quinn Emanuel Urquhart & Sullivan has been retained by the Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, to investigate billions of dollars in potential claims against banks and other issuers of mortgage-backed securities.
Who? Not on your celebrity list? Just wait. He will soon be getting the best tables everywhere. He and his firm are the guys representing MBIA in all their cases against Countrywide and Merrill Lynch. And they are kicking ass. Slowly to be sure, but very steady. That means Fannie and Freddie are getting ready to get serious.
They were sold well over $227 billion of the subprime garbage issued in 2006 and 2007. And the bad stuff started before then. But they have one advantage that the guys at PIMCO, et al. don't have: they (or actually the FHFA) are a federal agency. That means they have subpoena power. The agency has sent 64 subpoenas to issuers of mortgage-backed securities, and although they have not said who they went to, they obviously include almost everyone and clearly all the big players. (They couldn't have ignored Goldman, could they? Naah. Too obvious.)
From American Lawyer.com (I know, this website is probably already on your favorites list, but for those souls who actually have a life I provide the text):
"Through those subpoenas, the agency could gain access to the loan files for the mortgages that backed the securities it bought and thus establish whether the mortgages were what the issuers represented them to be in securities contracts. According to the Journal, the difficulty of obtaining loan files has been a big obstacle for investors trying to force issuers to repurchase bonds.
"If the FHFA were to decide down the road to initiate litigation, it would still have to have the support of a percentage (usually 25 percent) of its fellow bondholders for each issue. But given what the agency and its Quinn lawyers will be able to see before bringing suit, it probably won't be too hard to get other investors on the bandwagon." (http://www.quinnemanuel.com/media/183456/hurricane%20warnings%20fannie%20mae%20and%20freddie%20mac%20hire....pdf)
It is tough not to jump to the conclusion, but we need one more piece of the puzzle before we get there.

The Worst Deal of the Decade?

Arguably Bank of America had Merrill shoved down their throats, but no one can say that about the acquisition of Countrywide. And Countrywide could end up costing BAC $50 billion or more in losses. That may prove to be a serious candidate for worst deal of the decade. (Although WAMU is a leading candidate too!)
Let's look at a report by Branch Hill Capital, a hedge fund out of San Francisco. And before we start on it, let me point out they are short Bank of America. You can see the full PowerPoint at http://www.businessinsider.com/bank-of-america-mortgage-report-2010-10#-1.
(And let me say a big thanks to the author of the report, Manal Mehta, for all the background material he sent me and his help with this week's letter. It helped make it a lot better. Of course, any erroneous conclusions or outrageous statements are all mine.)
First, they point out that the potential size of Bank of America's (BAC) liabilities is $74 billion (with a B). And that is just for Countrywide. That does not include Merrill, which is also large. Against that they have set aside $3.9 billion. You can count on more suits than just the PIMCO, et al. mentioned above.
In the MBIA case, the judge has ruled that the suit can proceed even though BAC has denied responsibility. Although on appeal, this is high-stakes poker. Countrywide originated over $1.4 trillion of mortgages in 2005-2007. MBIA alleges that over 90% of the defaulted or delinquent loans in the Countrywide securitizations show material discrepancies. Care to take the under in the over/under bet on that?
Further to the case on BAC, Merrill was the largest originator of subprime CDOs during the housing boom, for another $120 billion, along with about $255 billion of residential mortgage-backed securities.
And then there are all those CDOs (collaterized debt obligations). Merrill did a lot of those that went sour. This deserves it own leter, but a gentleman named Wing Chau went from making $140k a year to $25 million in just a few years, putting together CDOs from Merrill, some of which were completely bankrupt in just six months.
Countrywide has already settled with the New York pension funds for $624 million, one of the largest securities fraud settlements in US history. And the line is growing longer.
Of course, BAC CEO Brian Moynihan denied this week that there is a problem. Let's look at Moynihan's statements at the last earnings call and compare them to what the judge in the case said earlier. Moynihan:
"... we execute repurchases on a loan by loan basis... And as we learn more, and again, our perspective on this - we're going to be quite diligent as I said in defending the interest of our shareholders. This really gets down to a loan-by-loan determination and we have, we believe, the resources to deploy against that kind of a review."
Back in June the judge on the case (a Judge Bransten) said (from the transcript):
"I think that it makes all the sense in the world that you can use a sample to prove the case because otherwise I can't imagine a jury listening to 386 thousand cases. Even if you have that available, nevertheless you are not going to present that to a jury or even to a judge. I'm patient but not that patient. So therefore it is going to be a sample in the end..."
OK, let me get this straight, Brian. Your company committed fraud, with robosignings and all the rest, and you won't man up and take responsibility? You and your lawyers want to thrash this out, case by case, fighting a trench-warfare, rear-guard action? Well I'm afraid that's not going to work out for you. There are so many examples of Countrywide outright fraud that it is going to be hard to convince a jury that BAC is not on the hook. Will it take years? Of course.
You can read the PowerPoint for details. Bottom line: BAC is probably liable for putbacks that could total over a hundred billion. And that is just BAC.
Think Citi. And any of the scores of mortgage originators and investment banks. There were a couple of trillion dollars in these securitizations issued. Plus how many hundred of billions of second-lien loans? And can we forget CDOs? And CDOs squared?
And let's not forget all those completely synthetic CDOs that were written at the height of the mania. Most of it AAA, of course. Frankly, anyone stupid enough to buy a synthetic CDO should lose their money, but that is not what the courts will base their decision on. It is all about representations and warranties. And maybe a little fraud.
I picked on BAC because that is the analysis I saw. But it could be any of dozens of banks. Look at this list from the Branch Hill PowerPoint.

Could we see a hundred billion in losses to the major banks? In my opinion we will for sure, over time. $200 billion? Probably. $300 billion? Maybe. $400 billion? It depends on how organized the investors in the securities get and what gets settled out of court. Out of a few trillion dollars in securitizations? It's anybody's guess. I just made mine.
But let's not forget the $227 billion sold to Fannie and Freddie. Taxpayers are on the hook for $300-400 billion in losses. Those putbacks could save us a lot. Will this threaten the viability of some banks? Maybe. But most will survive. BAC made $3 billion last quarter. A steep yield curve (with the help of the Fed) can cure a lot of evils. But it will absorb the profits of a lot of banks for a long time.
And that of course, will come back to haunt the rest of us as banks have to raise more capital and get more conservative.
Anyone who owns stocks in banks with relatively large MBS exposure is not investing, they are gambling that the losses will not be more than management is telling them. There will be no bailouts (at least I hope not) this time around. Fool me once, shame on you; fool me twice, shame on me. There will be little sympathy for shareholders or bondholders this time, if it comes to that.
One more sad point. The FDIC (read taxpayers) is liable for some of this, as they took over some of these institutions. It just keeps on coming.
Final rant. If you were part of a group that knowingly created or sold flawed and fraudulent mortgage-backed securities to pensions and insurance companies and took home tens of millions in bonuses, up and down the management chain, maybe you should consider moving yourself and your money to a country that does not honor US extradition, because my guess is that, as all this comes out, you may have to hire some very expensive lawyers and get measured for pinstripes.
And the Mozilo agreement was a sham. Sigh. That would be the equivalent of fining me $10,000 and letting me keep my tanning bed. I don't have the space to go into the fraud at Countrywide, but their internal documents show they all knew what was going on.

More Big Bank Bad News Coming?

from CNBCBig US banks are nearing the end of another disappointing quarter for their trading businesses that has deepened fears over job losses on Wall Street.

The first two weeks of September failed to deliver a meaningful pick-up in trading activity on markets, hitting bank profits at a time when they are already under pressure from a sluggish economy. Trading desks remain the critical source of revenue at investment banks Goldman Sachs and Morgan Stanley, and can still make or break a quarter at big lenders such as JPMorgan Chase and Bank of America.

More European Debt Worries

from Fox Business:

Stock futures pointed to a lower open Tuesday as traders return to work after last week’s strong performance and the long holiday weekend.

As of 6:20 a.m. in New York, the Dow Jones Industrial Average futures were down 60 points, or 0.58%, to 10394, the S&P 500 index futures lost 7.8 points to 1095.70 and the Nasdaq 100 futures were down 8 points to 1859.00.

It’s a quiet start to the trading week with no major economic data and only a few company earnings reports this morning.

Stocks were weighed primarily down by a buoyed U.S. dollar, which in turn put pressure on dollar-denominated commodities such as oil.

In early trading, the dollar was down 1% against the euro and 1.4% against the Japanese yen. The British pound lost 0.9% against the dollar.  Traders cited a lack of news and lingering debt concerns out of Europe as the reasoning behind the dollar-based rally.

Oil was sharply lower in electronic trading, falling $1.67 a barrel, or 2.24%, to $72.93 while gold was down $3.70 to $1,247.40 a troy ounce. Copper futures were down 2.3%.

The energy and mining companies were the early decliners in U.S. equities, led lower by Exxon Mobil (XOM: 61.34 ,0.00 ,0.00%), BP (BP: 37.40 ,0.00 ,0.00%), Freeport McMoRan (FCX: 78.52 ,0.00 ,0.00%) and BHP Billiton (NYSE:NYSE:BHP).

Shares of the banks, most notably Barclays (BCS: 20.27 ,0.00 ,0.00%) may trade heavily today after the company announced that its CEO John Varney will step down and will be replaced with investment-banking head Robert Diamond.

from Bloomberg:

Even after a 750 billion euro ($960 billion) bailout for the weaker economies in the euro zone, investors are skittish about sovereign debt -- and about the banks that hold the region’s government bonds.
A default by Greece could trigger the collapse of banks with large sovereign-bond holdings, says Konrad Becker, a financial analyst at Merck Finck & Co. in Munich. “A default by one EU country would lead to an evaporation of trust in banks,” he says. “If investors aren’t willing to invest in banks anymore, then many banks will go bust in months, not years.”
The new concern about the fragility of the region’s banks comes as politicians and regulators are eager to claim progress in fixing the global financial system, almost two years after credit markets cracked, Bloomberg Markets magazine reports in its October issue.
The European Union has stress tested 91 lenders, giving 84 of them passing grades. In the U.S., President Barack Obama in July signed the biggest package of new U.S. banking laws since the Depression. The Basel Committee on Banking Supervision, meanwhile, is readying new capital and liquidity rules for world leaders to agree upon when the Group of 20 meets in Seoul in November.
Europe, however, faces a special challenge in righting its banks: the sovereign-debt crisis. Europe’s largest financial companies hold more than 134 billion euros in Greek, Portuguese and Spanish government bonds, according to a tally in May by Bloomberg News based on interviews and company statements.
Greek Debt
Even after the EU and International Monetary Fund worked out the rescue plan in May, investors are still demanding a high premium for buying Greek debt. As of Sept. 3, the yield was 11.28 percent on 10-year Greek bonds compared with 2.34 percent on similar German bonds. At the end of August, the gap between the two, the yield spread, was the widest it has been since the peak in May, just before European leaders agreed on the bailout.
Yields on Irish bonds jumped after Standard & Poor’s on Aug. 24 cut the country’s credit rating one step to AA-, citing concern that the rising cost of supporting Ireland’s struggling banks will increase its budget deficit. The yield spread versus German bonds climbed to the highest in at least 20 years.
The hesitancy among investors also shows up in the spreads on bank bonds, with some European institutions paying higher borrowing costs compared with their U.S. counterparts.
As of Sept. 2, buyers demanded an extra 383 basis points, or 3.83 percentage points, over the yield on government debt to own 5- to 10-year bonds sold by Paris-based BNP Paribas SA, according to Bank of America Merrill Lynch index data. The comparative premiums were 275 basis points for Citigroup Inc. bonds and 192 basis points for JPMorgan Chase & Co. bonds; both of those banks are based in New York.
‘Still Badly Damaged’
“We face a banking system that is still badly damaged and which is still trying to repair its balance sheets,” Bank of England Governor Mervyn King said on Aug. 11 at a press conference in London. “It has to raise funding at very high costs, and that makes it difficult for banks to lend.”
Lenders have been slow to raise the capital they need. With yields on European bank debt so high, the market has shrunk. The region’s banks, including U.K. lenders, sold about 18 billion euros of debt in August, the smallest amount for the month since 2004.
Many European institutions continue to rely on central banks for funding. In July, the European Central Bank loaned 132 billion euros for three months to 171 financial institutions. ECB President Jean-Claude Trichet on Sept. 2 extended emergency lending measures for banks into 2011. The bank will keep offering unlimited one-week and one-month loans until at least Jan. 18, and will offer additional three-month funds in October, November and December.
Parking Money
Wary of lending to each other, banks are also using the ECB to hold record amounts of their cash. On June 9, euro-zone lenders deposited a record 369 billion euros overnight at the ECB, more than in October 2008, during the credit meltdown.
“The amount banks have parked at the ECB is just outrageous,” says Florian Esterer, a fund manager at Zurich- based Swisscanto Asset Management AG who invests in financial stocks, including Commerzbank AG and Royal Bank of Scotland Group Plc.
The bank-stress-test results, published on July 23, should help restore investor faith in the region’s financial industry, Trichet said at a press conference on Aug. 5. Still, those examinations fell short of addressing the possibility of a default by a euro-zone country.
Not Tested
Regulators believe the May bailout will succeed, says David Green, who was head of international policy at Britain’s Financial Services Authority from 1998 to 2004. “It would be quite perverse for governmental agencies to assume that the program isn’t going to work,” he says.
The tests covered government bonds held by banks for possible sale -- not those held as reserves on their balance sheets. Europe’s banks only have to write down sovereign debt in their reserves if there’s significant doubt about a country’s ability to repay in full or make interest payments. The region’s lenders have about 90 percent of their Greek sovereign debt on their balance sheets, according to a survey by Morgan Stanley.
Europe’s governments can’t afford to question the quality of bonds they’ve sold to banks, says Chris Skinner, chief executive officer of Balatro Ltd., a financial industry advisory firm in London. “Bankers have got Europe’s governments in their pockets, primarily because politicians cannot change the way lenders do business without undermining confidence in sovereign debt,” he says.
Toxic Assets
While they’re stuck with their government bond holdings, Europe’s banks are also still carrying much of the troubled assets they had during the 2008 meltdown. Euro-zone lenders will have written down about 3 percent of their assets from the peak of the credit crisis by the end of 2010, compared with 7 percent for U.S. banks, the IMF estimated in April. The steeper writedowns by U.S. banks are partly because they held a higher proportion of securities, the IMF said.
That doesn’t excuse the lack of candor shown by many European lenders about the unsellable assets on their books, says Raghuram Rajan, a finance professor at the University of Chicago. “European banks haven’t owned up to the large amounts of toxic debt that they hold,” says Rajan, who was chief economist at the IMF from 2003 to 2007.
“The stress tests weren’t severe enough,” says Julian Chillingworth, who helps manage $21 billion at Rathbone Brothers Plc, an investment firm in London. “Many bond investors aren’t convinced the Greeks are out of the woods.” And if the Greeks haven’t emerged from their crisis yet, then neither have the European banks that hold their debt.

Problem Banks Continue to Increase

ECB Warns of 2nd Wave of Loan Losses, Financial Crisis

FRANKFURT/MADRID (Reuters) - The European Central Bank warned on Monday that euro zone banks face up to 195 billion euros in a "second wave" of potential loan losses over the next 18 months due to the financial crisis, and disclosed it had increased purchases of euro zone government bonds.
As the euro recouped losses but remained on the back foot after a cut in Spain's credit rating and China warned that the global economy remained vulnerable to sovereign debt risks, Spain assured investors it would reform its rigid labor market even if employers and trade unions cannot agree.
The ECB said euro zone banks would need to make provisions for further losses this year of 90 billion euros, and 105 billion in 2011, on top of some 238 billion euros in bad debts written off by the end of 2009. That was the first time it has given an estimate for next year.
Although total write-downs from bad loans and securities between 2007 and the end of 2010 were likely to be lower than previously expected, the ECB said in its latest Financial Stability Report, write-downs this year and next year would be still larger if heightened sovereign debt risk and the impact of government belt-tightening dragged down economic growth.
The ECB began buying up mostly Greek, Portuguese and Spanish bonds on May 3 in a contentious move to calm debt markets and support an $1 trillion stabilization package for the euro agreed by the European Union and the International Monetary Fund.
The central bank said in a statement it had settled 35 billion euros in bond purchases by May 28, up from 26.5 billion a week earlier. It did not detail the nationality of the debt but ECB officials have said it is mostly from south European countries hardest hit by financial market turmoil.
The ECB acknowledged in its report that euro zone debt tensions may force it to delay a phasing-out of cheap lending operations designed to help banks through the financial crisis.
After Lehman Brothers collapsed in September 2008, the ECB began offering euro zone banks unlimited, flat-rate loans in a bid to revive inter-bank lending and keep credit flowing to the real economy.
ECB governing council member Axel Weber, president of Germany's powerful Bundesbank, urged a tight cap on the bond buying program and said the extraordinary steps taken to ease the euro zone debt crisis posed a risk to price stability.
"The purchases of government bonds in the secondary market should not overshoot a tightly-capped limit," Weber said in a speech prepared for delivery in Mainz, Germany. He did not suggest a figure.
Spain, the fourth-largest euro zone economy, saw its credit rating downgraded a notch by Fitch Ratings agency from the maximum AAA to AA+ late on Friday after a 15 billion euro austerity program squeaked through parliament by a single vote.
Market reaction to the downgrade was limited, partly because U.S. and British markets were closed for holidays on Monday.
The euro recouped losses incurred after the Spanish debt downgrade to trade at around $1.23 but remained on the back foot as the downgrade highlighted ongoing structural weaknesses in the euro zone. The 10-year Spanish-German bond spread widened only slightly but Spanish stocks fell 0.7 percent while the index of leading European shares gained 0.4 percent.
Labor Reform
Spanish Economy Minister Elena Salgado told a conference in Madrid that the government aimed to pass a much anticipated labor market reform by the end of June with or without consensus with the unions and business representatives.
The minority Socialist administration extended the deadline for an agreement by one week from Monday but officials have said the social partners are still far apart.
The left-leaning daily El Pais said the government planned to allow companies to make greater use of cheap work contracts for a broader range of employees, reducing redundancy payments and making it easier to fire workers.
Trade unions have threatened to strike if the government imposes the reform by royal decree, a move that would set the ruling Socialists on a collision course with their traditional allies in organized labor.
In a sign of continued international concern about the impact of Europe's problems, China warned that Europe's struggle to contain ballooning debt posed a risk to global economic growth, raising the specter of a double-dip recession.
Premier Wen Jiabao, addressing business leaders during an official visit to Japan, issued his warnings a day after France admitted it would struggle to keep its top credit rating.
"Some countries have experienced sovereign debt crises, for example Greece. Is this kind of phenomenon over? Now it seems that it's not so simple," Wen said. "The sovereign debt crisis in some European countries may drag down Europe's economic recovery.
He added it was too early to wind down stimulus deployed during the 2007-2009 financial crisis.
Governments around the world ran up record debts during the $5 trillion effort to pull the economy out of its deepest slump since the Great Depression and now face a tough balancing act: how to reduce debt without choking off growth.
ECB Governing Council Member Mario Draghi warned that austerity programs by European governments could snuff out a fragile recovery unless they were coordinated internationally.
Economic sentiment in the euro zone fell in May, defying analysts expectations of a slight improvement, in part due to the wave of austerity announcements.
However, ECB President Jean-Claude Trichet said the economy may expand more than expected in the second quarter.
The fact that not just fiscally weak southern European countries, but also nations such as France and Germany at the euro zone's core are under pressure to cut debt and deficits amassed during the financial crisis, is adding to concerns.

Big Banks Carrying Far More Risk Than They Want Us to Believe

from WSJ:
Three big banks—Bank of America Corp., Deutsche Bank AG and Citigroup Inc.—are among the most active at temporarily shedding debt just before reporting their finances to the public, a Wall Street Journal analysis shows.
The practice, known as end-of-quarter "window dressing" on Wall Street, suggests that the banks are carrying more risk most of the time than their investors or customers can easily see. This activity has accelerated since 2008, when the financial crisis brought actions like these under greater scrutiny, according to the analysis.

Euphoria Short-Lived, European Bourses Fall As Optimism Wanes

I couldn't help but notice that the Dollar gained yesterday, closing higher, as the Euro slumped. The confidence-building capacity of the European Central Bank apparently lack credibility. Even a Fed intervention didn't help much. How ironic that it supposedly takes more Dollars to prop up the Euro!Even $1 trillion bailouts are falling short to prop up the house of cards.

May 11 (Bloomberg) -- The euro lost all of yesterday’s gains on concern the $1 trillion bailout will hurt European economic growth. Stocks fell, paring the MSCI World Index’s biggest advance in a year. Chinese shares entered a bear market.
The euro weakened 0.8 percent against the dollar at 10:41 a.m. in London, trading below the level it was at before the European Union-led aid package was announced early yesterday. The Stoxx Europe 600 Index fell 1.2 percent, after rising 7.2 percent yesterday. Futures on the Standard & Poor’s 500 Index dropped 1 percent. Copper traded below $7,000 a metric ton.
The European Union’s unprecedented bailout package is unlikely to be a “long-term solution” for the region, Marek Belka, the director of the International Monetary Fund’s European department, said in Brussels yesterday. Inflation in China accelerated to an 18-month high, the nation’s statistics bureau said today, increasing pressure on the government to raise interest rates in an economy that has been an engine of growth through the global financial crisis.
“The euphoria of 24 hours ago has passed,” Derek Halpenny, European head of global currency research at Bank of Tokyo Mitsubishi UFJ Ltd. in London, wrote in a report today. “We are in little doubt that steps taken will offer the euro little support and the aid package does not change the fact that Spain and Portugal in particular will still have to undergo further painful austerity measures.”
Yen, Treasuries Gain
The euro fell against 14 of its 16 most-traded peers, dropping as low as $1.2670, compared with the $1.2755 level at which it closed last week. The yen strengthened against all 16 of its major counterparts as investors sought the relative safety of the Japanese currency. The dollar advanced versus 13.
U.S. Treasuries rose, snapping a two-day decline, with the 10-year yield sliding 4 basis points to 3.5 percent and the two- year yield dropping 2 basis points to 0.86 percent. German 10- year bund yields fell 3 basis points to 2.92 percent, while two- year yields were also 3 basis points lower, at 0.58 percent.
Traders are betting the plan to rescue debt-laden governments from Greece to Portugal will fail to reverse the euro’s worst start to a year since 2000, forcing the European Central Bank will keep interest rates at a record low for longer. Economic growth in the nations that share the euro will lag behind the U.S. by almost 1.5 percentage points next year, Bloomberg surveys of economists show.

Default Swaps Soar to Lehman Levels

May 7 (Bloomberg) -- The cost of insuring against losses on European bank bonds soared to a record, surpassing levels triggered by the collapse of Lehman Brothers Holdings Inc., as the sovereign debt crisis deepened.
The Markit iTraxx Financial Index of credit-default swaps on 25 banks and insurers soared as much as 40 basis points to 223, according to JPMorgan Chase & Co. The index closed at 212 basis points March 9, 2009. Swaps on Greece, Portugal, Spain and Italy rose to or near all-time high levels.
Credit risk rose for a sixth day on concern the Greek debt crisis is spiraling out of control and triggering concern banks may face losses on their sovereign bond holdings. The Group of Seven plans to hold a conference call today to discuss the turmoil, after a global stock rout that briefly erased more than $1 trillion in U.S. market value.
“Financials are caught in a really bad place right now,” said Aziz Sunderji, a London-based credit strategist at Barclays Capital. “Investors are selling bonds, not just hedging with CDS. It shows investors are repositioning portfolios and there’s a more long-term repricing of peripheral risk.”
Pacific Investment Management Co.’s Mohamed El-Erian and Loomis Sayles & Co.’s Dan Fuss said Europe’s crisis may spread across the globe because of investor concern that governments have borrowed too much to revive their economies.
Portugal, Spain
Markit’s financial gauge was trading at 198 basis points at 2:30 p.m. in London, according to JPMorgan. Contracts on Spanish and Portuguese banks rose to records, according to CMA DataVision prices. Portugal’s Banco Comercial Portugues SA increased 53 basis points to 579 and Spain’s Banco Santander SA rose 12 basis points to 253.
In the U.K., swaps on Royal Bank of Scotland Group Plc jumped 41 to 229 after Britain’s biggest government-owned bank posted the only first-quarter loss among British rivals.
The spread between the three-month dollar London interbank offered rate and the overnight indexed swap rate, a barometer of the reluctance of banks to lend that’s known as the Libor-OIS spread, is at 18 basis points, up from 6 basis points on March 15 and near the highest level in more than five months. It’s still far from the record 364 basis points in October 2008, almost a month after Lehman’s bankruptcy.
Swaps on Greece surged 75 basis points to 1,008 before the advance was pared to 950. Portugal climbed 42 to 502 before falling to 430 and Italy rose 24 to 255.5 before dropping to 227 and Spain increased 14 to 288 before trading at 246, CMA prices show.
British Swaps
Contracts on the U.K. rose 8 basis points to 99, according to CMA. Britain’s election produced a parliament without a majority for the first time since 1974, stoking concern the new government will be too weak to rein in its record budget deficit.
European policy makers are under mounting pressure from investors and foreign officials to broaden their response to the Greek fiscal crisis after a 110 billion euro ($140 billion) bailout package failed to ease concerns.
“We do not see a clear sign that markets will calm down in the absence of decisive action by authorities, which so far have ignored the opportunity to convince investors that they are capable of battling the European sovereign debt crisis,” Markus Ernst, a credit strategist at UniCredit SpA in Munich, wrote in a note to investors.
Merkel Meeting
German lawmakers approved their nation’s share of loans to Greece worth as much as 22.4 billion euros before Chancellor Angela Merkel and other euro region governments meet in Brussels to review the bailout and look for ways to stop the burgeoning crisis. The leaders arrive in Brussels about 6:15 p.m. local time and the final press conference is slated for 10 p.m.
The cost of insuring against losses on corporate bonds also rose. Contracts on the Markit iTraxx Crossover Index linked to 50 companies with mostly high-yield credit ratings increased as much as 74 basis points to 625, JPMorgan prices show, the highest since September. The index pared its advance to 611.
The Markit iTraxx Europe Index of 125 companies with investment-grade ratings climbed as much as 29.5 basis points to 152.5, JPMorgan prices show, the highest since April 2009. It was trading at 139.
A basis point on a credit-default swap contract protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year.
Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase signals deterioration in perceptions of credit quality.
The extra yield investors demand to own investment grade corporate bonds rather than government debt jumped 21 basis points from last week to 174, the largest weekly rise in a year, according to Bank of America Merrill Lynch index data. The gauge has also increased 10 basis points from yesterday, the biggest one-day increase since October 2008.

The Debt Contagion Begins to Spread

May 4 (Bloomberg) -- The euro slid to a one-year low against the dollar and stocks tumbled amid concern the European government debt crisis is spreading to Spain and Portugal. Commodities and shares of their producers slid on a slowdown in Chinese manufacturing and fallout from the BP Plc rig disaster.
The euro weakened below $1.31 for the first time since April 2009. The MSCI World Index of 23 developed nations’ stocks declined 1.8 percent at 9:37 a.m. in New York and the Standard & Poor’s 500 Index dropped 1.5 percent, erasing yesterday’s rally. BP Plc slumped to a seven-month low as the costs of containing an oil spill in the Gulf of Mexico mounted. Copper fell to its lowest level in nine weeks, while oil sank 2.8 percent to $83.75 a barrel as the dollar rose against 14 of 16 major counterparts.
Greece’s 110 billion-euro ($146 billion) bailout, approved by finance ministers over the weekend, is failing to ease speculation the debt crisis will spread to nations such as Portugal and Spain. A Chinese purchasing managers’ index declined to 55.4 from 57 in March, signaling government attempts to cool the world’s fastest-growing economy are working.
“There’s spillover effect from China,” said Stanley Nabi, New York-based vice chairman of Silvercrest Asset Management Group, which manages $9 billion. “Spain and Portugal are both endangered species. The attention could shift to one of those countries. In the U.S., it’s no longer news that earnings are better than expected. The stock market has had a great run. I’ve got a feeling that May is going to be a month of consolidation or even of backing down a little bit.”
The S&P 500 erased most of yesterday’s 1.3 percent rally triggered after Warren Buffett defended Goldman Sachs Group Inc. in the wake of fraud accusations against the firm, while reports on manufacturing and consumer spending signaled the economy is strengthening.
“The biggest concern today remains the European peripheral countries and Spain is the big one because there’s fear of another downgrade,” said Sal Catrini, a managing director for equities at Cantor Fitzgerald & Co. in New York. “That’s shaking things up today.”

Could Sovereign Debt Cause Run on Banks?

We ran this chart earlier, but it's worth running again, considering the Europe-wide carnage we saw today.
This is not just about sovereign debt. This is about a major freakout about the banking system.
The word from S&P is that Greek debt holders will take a major haircut on their holdings, and that means serious problems for banks. (See the full list of victims here)
Ths surging CDS of Portuguese and Spanish banks is a major red flag.

Another FInancial Crisis Coming

from ABC News:

Even as many Americans still struggle to recover from the country's worst economic downturn since the Great Depression, another crisis one that will be even worse than the current one is looming, according to a new report from a group of leading economists, financiers, and former federal regulators.
In the report, the panel, that includes Rob Johnson of the United Nations Commission of Experts on Finance and bailout watchdog Elizabeth Warren, warns that financial regulatory reform measures proposed by the Obama administration and Congress must be beefed up to prevent banks from continuing to engage in high risk investing that precipitated the near collapse of the U.S. economy in 2008.
The report warns that the country is now immersed in a "doomsday cycle" wherein banks use borrowed money to take massive risks in an attempt to pay big dividends to shareholders and big bonuses to management and when the risks go wrong, the banks receive taxpayer bailouts from the government.
"Risk-taking at banks," the report cautions, "will soon be larger than ever."
Without more stringent reforms, "another crisis a bigger crisis that weakens both our financial sector and our larger economy is more than predictable, it is inevitable," Johnson says in the report, commissioned by the nonpartisan Roosevelt Institute.
The institute's chief economist, Nobel Prize-winner Joseph Stiglitz, calls the report "an important point of departure for a debate on where we are on the road to regulatory reform."
The report blasts some of Washington's key players. Johnson writes, "Our government leaders have shown little capacity to fix the flaws in our market system." Two other panelists, Simon Johnson, a professor at MIT, and Peter Boone of the Centre for Economic Performance, voiced similar criticisms.
Federal Reserve Chairman Ben Bernanke and Treasury Secretary Tim Geithner "oversaw policy as the bubble was inflating," write Johnson and Boone, and "these same men are now designing our 'rescue.'"
The study says that "In 2008-09, we came remarkably close to another Great Depression. Next time we may not be so 'lucky.' The threat of the doomsday cycle remains strong and growing," they say. "What will happen when the next shock hits? We may be nearing the stage where the answer will be just as it was in the Great Depression a calamitous global collapse."

The panelists call for major banks to maintain liquid capital of at least 15 to 25 percent of their assets, the enactment of stiffer consequences for executives of bailout recipients and for government officials to start breaking up firms that grow too big.
In the report, Elizabeth Warren, who was chair of the Congressional Oversight Panel, reiterates her calls for an independent agency to protect consumers from abusive Wall Street practices.
"While manufacturers have developed iPods and flat-screen televisions, the financial industry has perfected the art of offering mortgages, credit cards and check overdrafts laden with hidden terms that obscure price and risk," Warren writes. "Good products are mixed with dangerous products, and consumers are left on their own to try to sort out which is which. The consequences can be disastrous."
Frank Partnoy, a panelist from the University of San Diego, claims that "the balance sheets of most Wall Street banks are fiction." Another panelist, Raj Date of the Cambridge Winter Center for Financial Institutions Policy, argues that government-backed mortgage giants Fannie Mae and Freddie Mac have become "needlessly complex and irretrievably flawed" and should be eliminated. The report also calls for greater competition among credit rating agencies and increased regulation of the derivatives market, including requiring that credit-default swaps be traded on regulated exchanges.
With the Senate Banking Committee, led by Chris Dodd, D-Conn., poised to unveil its financial regulatory reform proposal sometime in the next week, the report calls on Congress to enact reforms strong enough to prevent another meltdown.
"Sen. Dick Durbin once said the banks 'owned' the Senate," says Johnson. "The next few weeks will determine whether or not that statement is true."
In response to the report, a spokesman for the Treasury Department told ABC News that the administration's regulatory reform proposals would be the most significant Wall Street overhaul in generations.
"We laid out our strong principles of reform last June and we have been fighting every day since to see them enacted in law," said Treasury spokesman Andrew Williams. "While we have a tough fight ahead, we are getting close to seeing Congress pass the most significant overhaul of the financial sector in our lifetimes."

Lending Still Losing

from WSJ:

A Wall Street Journal report that GMAC Financial Services and the Treasury Department were in advanced talks to prop up the lender with its third helping of taxpayer money was adding to the cautious tone, serving as a reminder of how some battered financial firms remain dependent on government lifelines. Dow Jones Industrial Average futures recently rose three points in screen trade.

Large Bank Losses Triple

And this is an increase from 2008 levels? Ouch!

CHARLOTTE, North Carolina (AP) -- U.S. regulators said total losses from large loans at banks and other financial institutions nearly tripled to $53 billion in 2009, due to a deteriorating economic environment and continued weak underwriting standards.

According to an annual report released by the four federal bank-regulatory agencies on Thursday, credit quality deteriorated to record levels this year.
The report said total identified losses of $53.3 billion in 2009 surpassed last year's total of $2.6 billion, and nearly tripled the previous peak in 2002, when losses totaled $19.1 billion.
"While we expected a year-over-year increase in problem assets, given the weak economic environment, declining (commercial real estate) values, and previously weak underwriting, we were surprised by the magnitude of the increase," wrote FBR Capital Markets analyst Scott Valentin in a research note to clients Friday.

Mortgages Consolidated Into Government, Big Banks

from WSJ:
More than half of U.S. residential mortgages are now being made by just three large banks.
It's a stunning change, but is it good for the housing market, and to what extent will it boost profits over the long-term for this elite trio, Wells Fargo, Bank of America and J.P. Morgan Chase?
Right now, housing remains on government life support. Treasury-backed entities are guaranteeing around 85% of new mortgages, while the Fed buys 80% of the securities into which these taxpayer-backed mortgages are packaged.

Stiglitz: It's Worse Now Than Ever! Trade War Erupting Between U.S., China?

The banking crisis is getting worse! The "too big to fail" banks are growing bigger! The Dow was down nearly 100 points tonight before bottoming! There are also signs of a trade war brewing between the United States and China -- over tires!

From Bloomberg:

Sept. 13 (Bloomberg) -- Joseph Stiglitz, the Nobel Prize- winning economist, said the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc.
“In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,” Stiglitz said in an interview today in Paris. “The problems are worse than they were in 2007 before the crisis.”

from Marketwatch:
HONG KONG (MarketWatch) -- China said Sunday it would launch an anti-dumping investigation into U.S. sales of chicken and auto products, a move apparently in response to Washington's decision to impose punitive sanctions on Chinese tire imports late last week.