Disingenuous Begging By Paulson

Treasury Secretary Paulson made a long winded and disingenuous speech on the U.S. Housing and Mortgage Market before the National Association of Business Economists. Let's tune in to the highlights:

Today, 93 percent of American homeowners – 51 million households - pay their mortgages on time. Many are on tight budgets, sacrificing other things in order to make that payment. Only 2 percent are in foreclosure.

Most of the proposals I've seen would do more harm than good --- bailing out investors, lenders or speculators who, instead of getting a free-pass, should be accountable for the risks they took. Let me be clear: I oppose any bailout.

Translation: Paulson opposes any bailout except for the bailouts he personally sponsors. See point number 1 of last Thursday's Five Things Paulson Urges Bailout, Dismisses Bailout for more on Paulson's personally sponsored bailouts. Also see Poole, Paulson, Bernanke on Bailouts for Poole's objections to bailouts because of moral hazards.

Second, this is a shared responsibility of industry, government and homeowners. We in government are working to expand options through the FHA, and we've worked with the industry to reach as many homeowners as possible to let them know that help is available. There is more that government and industry can do, and our efforts will continue to evolve.

Translation: We are attempting to bail out the banks, as much as possible, by shifting the risk to the FHA where taxpayers will be expected to pick up the costs.

Third, the current public discussion often conflates the number of so-called "underwater" homeowners – that is, those with mortgages greater than the value of their house – with projections of foreclosures. Let's be precise: being underwater does not affect your ability to pay your mortgage, nor create a government responsibility for assistance. Homeowners who can afford their mortgage should honor their obligations --- and most do.

Homeowners who can afford their payments and don't have to move, can choose to stay in their house. And let me emphasize, any homeowner who can afford his mortgage payment but chooses to walk away from an underwater property is simply a speculator – and one who is not honoring his obligations.

Translation: Paulson is attempting to play a "morality card" when banks showed greed, not morals by making loans they had no business making in the first place. Furthermore, Paulson and banks are showing no morals by asking for bailouts from taxpayers. Obviously, morality is a one way street for Paulson.

Morality vs. Business Decisions

But this is not about morality at all. This is about business decisions. See Moral Obligations Of Walking Away and The Business of Walking Away for more on the morality vs. business decisions.

In a nutshell, banks made business decisions to lend money to people to buy houses that banks knew people could not afford. Banks also made business decisions to lend with no money down. Banks knew there were risk to these strategies but they took the risks anyway.Those were bad business decision for banks. Banks, not taxpayers should pay the price.

Paulson is now begging people to do something that may not be in their best interest to do. My recommendation is simple. If it benefits you to walk away, then walk away.

Note too that walking away is not one sided. Banks and businesses "walk away" all the time when it suits their best interest. Deals are being broken as I type and banks are paying breakup fees. See Businesses Advised To Walk Away for more on this topic.

The "breakup fee" for homeowners walking away is a bad mark on their credit report and loss of their down payment. In many cases the down payment was zero. Banks have only themselves to blame for setting the breakup fee too low.

Bubbles, greed, and bailouts, not walking away, are the real moral hazards. And if enough people do walk away (forced or unforced), banks will be more careful about who they lend to next time and what the breakup fees (down payments) need to be. If and when banks (and the Fed) are more careful, fewer bubbles will get blown, and the better off we all will be.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Margin Calls Force Selling of Assets, Falling Prices

Margin calls are picking up steam. Many are not being answered. The Telegraph is reporting Ex-Goldman stars liquidate Peloton funds.

The credit crunch has forced Peloton Partners, a $3bn (£1.5bn) hedge fund run by former Goldman Sachs star traders, to liquidate its two investment funds, leaving its founders millions of pounds out of pocket. Ron Beller and Geoff Grant decided to sell off the assets of Peloton ABS (asset-backed securities) and the Peloton Multi-Strategy Fund about 10 days ago when it became apparent that they could no longer meet margin calls from investment banks.

Peloton's ABS fund was one of last year's best performers, netting returns of 87pc after betting against the riskiest types of sub-prime debt, but it began to face difficulties after the market for even highly-rated asset-backed securities froze last year. The Multi-Strategy Fund had a 40pc stake in the ABS fund and could not continue to trade once it was closed.

Excessive Leverage Results In Fire Sales

What went wrong at Peleton was not asset quality, but rather excessive leverage in an illiquid market.

It was not that the fund was invested in weird or wonderful sub-prime, collateralised, etc; its problem was that it appears to have been leveraged to buy reasonable quality but now illiquid asset-backed securities.

With the credit crunch draining away cash, the company was unable to finance the exposure and was forced to find buyers at any price. With no buyers, it was forced into what appears to have been a fire sale.

The list of funds not permitting withdrawals is getting bigger and as it rises so the rate of redemption closedown may increase as those still with a departure route see heavy withdrawals at a time when they are unable to sell the assets (at a reasonable price), which have been bought on the back of the margins placed by their backers.

A bit of an Armageddon scenario I'm depicting and we are, of course, nowhere near this situation yet…but….the vulture funds are circling.

Implosion Fears At Hedge Funds

Implosion fears are rising as Focus Capital slashes positions.

Focus Capital, an award-winning US-based hedge fund, has liquidated some of its biggest positions, raising fears of another implosion in the high-rolling sector.

The fund, which is run out of New York and Geneva, has caused turmoil as it dumped large positions in a raft of Swiss small cap stocks in recent days.

Unanswered Margin Calls at Bank of Montreal

After taking a series of significant writedowns over last couple of weeks, the Bank of Montreal is facing still another $500 million in writedowns after failing to meet margin calls on two of its trusts.

These moves guarantee more BMO writeoffs are coming and they threaten a proposed bailout of $33 billion in frozen Asset Backed Commercial Paper.

I wrote about this story at length over the weekend. Please see Bank of Montreal Misses Margin Calls for more details.

Thornburg Mortgage Hit With Margin Calls

More writeoffs at Thornburg are on the horizon. Thornburg's $300 million margin-call is proof enough.

Thursday's disclosure from Thornburg Mortgage (TMA) that it was forced to pay $300 million in new margin calls is the first warning bell of what might be another spiral of write downs -- and thus more dilution to come -- in the financial sector.

The Thornburg situation is significant for several reasons. During the "go-go" days of the subprime boom, Thornburg represented the gold standard of conservative underwriting standards for the whole sector. It kept only the highest-quality assets on the balance sheet, and thus when the whole subprime sector caught a fever last summer, TMA was widely believed to be a "thriving oasis" in the subprime desert.

But when the commercial paper market effectively shut down back in August, Thornburg's share prices tumbled from the high $20s into the teens in a matter of days. Because of their heavy reliance on short-term financing in a form of commercial paper, Thornburg was forced to sell some of their best assets at a huge discount to meet margin calls, which triggered more write downs and thus more margin calls. Unfortunately, as the most recent announcement from TMA and UBS confirms, it looks like we might be in for another round of the same troubles.

Fingers Point In Wrong Direction

Hedge fund managers who herded into illiquid one way bets pushing risk premiums to all time lows, need to look into a mirror to see where the problem is. Instead, Hedge Funds Blame Wall Street Instead Of Themselves.

Hedge funds blaming Wall Street is a lot like banks blaming people for "walking away" instead of themselves for making $500,000 loans based on stated incomes everyone knew were lies. Now that risk is blowing sky high at banks and hedge funds, few are willing to look into the mirror to see their role in the mess.

Cash Is King

For years people have been telling me that there is no difference between money and credit. This action proves otherwise.

When things are liquid, money and credit "look" the same. It's all an illusion. For starters, credit can (and is) is being withdrawn, even against hard assets. See Countrywide And Chase Shut Off The Cash Spigot for details on home equity lines of credit.

And unlike credit on bank balance sheets, cash in the bank may be "worth less" tomorrow but it is extremely unlikely to be "worthless" tomorrow.

As banks and brokerages are scrambling for more cash, hedge funds and others are getting migraines trying to produce that cash. By now it should be plain to see: Liquidity is a coward. It runs away at the first sign of trouble. Cash however, is hoarded in times of trouble. Cash, not credit, is king. It's important to understand the difference.

Finally, Gold is the ultimate form of cash. It represents a true flight to quality. Gold is the only money that is not someone's liability. It's no wonder that gold has been soaring. However, to the extent that hedge funds may be over leveraged in gold (or commodities in general), a sharp pullback could easily be coming. One possible trigger might be an across the board margin hike on all commodity futures.

Excessive leverage everywhere needs to be unwound, and it will be. Those expecting more margin call migraines will not be disappointed.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Getting Harder To Keep On Truckin'

Rising costs and stagnant freight rates are driving some truckers off the road. As fuel costs rise, Independent truckers are suffering.

Trucker Robert Griffith is on the road three weeks out of four, pulling oversize loads like crane booms, railroad ties and air conditioning ducts. One of his biggest worries: How he’ll find the money to buy his daughter a prom dress.

My Comment: Excuse me, but this attitude is exactly what's wrong. When someone's biggest biggest worry is over prom dresses, priorities are not set quite straight.

“I had to learn to live totally different,” said Griffith, 41, of Lebanon, Tenn.

No more $150 family outings to Shogun sushi. No more weekly washes for his Western Star 4900 EX truck. No more health insurance for him and his family.

“It hurts,” he said. “I’m a man who’s trying to make a living for my family and I’m not succeeding.”

My Comment: If you were saving instead of spending $150 on family outings to Shogun Sushi, then perhaps you could have afforded to buy your daughter a prom dress. In fact, had you saved all those weekly truck washes and Shogun Sushis, perhaps you would not see a need to cancel health insurance for your family. Talk about skewed priorities.

About nine percent of the nation’s 3.4 million truck drivers are independent owner-operators, according to the Department of Labor. Without the independents, trucking will turn into a group of “regional and national oligopolies” that would send shipping prices higher when the economy improves, said John Saldanha, who teaches logistics at Ohio State University.

My Comment: John Saldanha needs to consider timeframes when the economy improves and how low things get in the meantime.

Rumors of a nationwide truck strike are a nearly annual occurrence — but this year an effort in January generated more talk than usual on MySpace and the Sirius Satellite Radio show “Freewheelin”.

My Comment: Let them strike. Those who do will suffer. The economy is slowing in case “Freewheelin” did not notice. The time to strike (if indeed there is such a time at all) is when things are going well and you are needed, not when things are sour and people are clamoring for jobs to stay alive.

Nanette Jenkins Rudd, 40, a third-generation trucker based in Mapleton, Ill., kept her five trucks off the road the week of the strike.

“I pray that this strike is successful, so that we only have to stop rolling for a week — and not forever,” she said.

Like other truckers, she’s hoping for government help. “The government stepped in and helped the farmers when they were in trouble,” she said. “Why? Because the farmers feed America, the farmers put food on the table. But who do you think delivers that food?”

My Comment: Truckers deserve as much government "help" as anyone else. That is to say none. Government "help" is exactly what has destroyed this economy. The government needs to get the hell out of the way.

Truckers say they want caps on diesel prices, or tax credits for truckers, as well as increased regulation for the middlemen who broker truck loads.

My Comment: Price caps do not work. If they did Zimbabwe would be an economic success. How many times do we have to prove price caps do not work?

Does anyone remember Nixon's wage and price controls? There has never been wage or price controls in history that have worked. Price controls are nonsense.

Michael Bloomberg Loses Mind

If the haulin' business did not have enough problems already Michael Bloomberg just added to them with this announcement: New York City to make hybrid private hire limos mandatory from 2009.

New York City Mayor Michael Bloomberg announced yesterday that the city’s Taxi and Limousine Commission (TLC) will require ‘black cars’ that service corporate clients to increase fuel efficiency standards to levels currently achievable only by using hybrid technology, though these (25 mpg by 2009, 30 mpg by 2010) could be met by some European diesel cars if they were permitted.

Black cars currently release 272,000 tons of CO2 equivalents annually, which make up 2% of the City's transport-related emissions. Under the new standards, emissions from black cars will be cut in half.

My Comment: To cure 2% of the "problem" all black car limo drivers will need new vehicles. Does this make any sense anywhere but Bizarro World?

To help drivers finance the down payment associated with buying a new car, the City has worked with partners in the financial sector, dealers, and black car fleets to develop a range of solutions that will finance the higher down payment.

My Question: How much did black car fleets, dealers of hybrids, etc., contribute to the campaigns of those sponsoring this fiasco?

After consultation with users, fleets, and drivers - including demonstrations of the new vehicle types - the Mayor's Office of Long-term Planning and Sustainability and the TLC have identified several models that will have widespread acceptance, including: Toyota Camry Hybrid, 33mpg (city); Toyota Highlander Hybrid, 27mpg (city); Nissan Altima Hybrid, 35 mpg (city); and Mercury Mariner Hybrid FWD, 34 mpg (city). Other models may include: Lexus Rx400h AWD, Ford Escape Hybrid AWD, and Toyota Prius.

My Comment: It appears GM was not a proud sponsor of this campaign. If GM was included in the list, it would have been a proud sponsor of the campaign. If for some reason GM is a sponsor of this campaign, then I am overlooking an angle that involves GM. It's as simple as that.

If government would simply stop micro-managing the problem, the free market would find a solution, sooner, rather than later. It's Getting Harder (and more expensive) To Keep On Truckin', and government is the primary reason. Misguided ethanol policies, the war in Iraq, and debasement of the US dollar all contribute. It's disappointing to see this non-solution from Michael Bloomberg.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Is Belt Tightening a Threat?

Let's take a look at "belt tightening" starting with a Washington Post article Businesses Tightening Their Belts.

U.S. businesses are holding off on hiring, delaying new investments and trimming expenses, creating a new threat to the nation's economy.

My Comment: This is of course ass backwards. The reason we are in this mess is because businesses expanded with reckless abandon, well above and beyond the fundamentals of birth rate and immigration. That expansion itself created artificial demand which made it appear the economy was on good footing. We now see the foundation was quicksand.

Corporate America is reacting to a pullback by consumers and the crisis in the financial system. Businesses are acting defensively, seeking to avoid the massive layoffs and dramatic falloff in profits like those in 2001, when they were in less sound financial shape.

My Comment: Massive layoffs are coming regardless of what they do, and the financial shape of banks has never been worse.

The cutbacks are large and small, but it is the cumulative effect that has economists worried. Business belt-tightening is likely to create an additional drag on the economy, contributing to the period of slow growth that economists almost uniformly expect and to the recession that some fear.

My Comment: Talk of slow growth and upcoming recessions is silliness. We are already in a recession and the odds are overwhelming it will be a severe one.

"For the last few years, the emphasis has been on looking for ways to grow," said Mark Toon, chief executive of EquaTerra, a Texas-based consulting firm that advises large companies. "Since August, companies have been looking for ways to reduce costs."

My Comment: Ah Yes. The sudden attitude change. Consumers changed their attitude and that forced businesses to change their attitudes. It's a downward spiral of attitudes. For more on this theme please see Keeping Down With The Joneses and Credit Lines Dry Up, Homeowners In Withdrawal.

An index of optimism among small business owners fell in January to its lowest point since 1991, according to the National Federation of Independent Businesses. Several surveys of chief executives report confidence in the future at multi-year lows. And purchasing managers at non-manufacturing firms expect a sharp contraction in business activity, according to a January survey by the Institute for Supply Management.

My Comment: Does that look like a recession is coming or does it look like we are in one?

So far, this is a more gradual, tentative pullback than the corporate sector experienced in the 2001 recession. Then, businesses had overexpanded -- which was the major cause of the slump -- and consumers and firms in the financial sector were the collateral damage. This time, consumers and the financial sector are cutting back, and businesses are the collateral damage.

My Comment: So far, a man who did a swan dive off the top of a tall building 1 second ago is still alive. How many times did we hear "so far it's only subprime" before realization set in? Any talk that that businesses did not overexpand more than 2000-2001 is absurd. Back then it was a dot-com, telecom, fiber bust. Now it is residential housing and commercial real estate. Given that consumers are 70% of the economy, this overexpansion is far worse.

"The corporate sector is not what brought you to the edge, but it could push you over," said Joel Naroff, an economist who has advised businesses for decades.

My Comment: Corporate overexpansion followed residential overexpansion with a lag. On that basis residential brought us to the cliff. But let's not downplay the role of corporate overexpansion. It was very significant. In fact, unsustainable retail spending accounted for a huge percentage of jobs.

Businesses entered this period of distress in far better shape than in the last downturn. In the third quarter, just before the economy started its slide, nonfinancial businesses had liabilities that were 3.5 percent higher than their financial assets, according to data from the Federal Reserve. In the comparable period of the last downturn, the fourth quarter of 2000, their liabilities exceeded assets by 24 percent.

My Comment: Banks are clearly in far worse shape and the credit crunch and inability to roll over corporate debt at reasonable rates is going to crucify all but pristine corporate debt. Sadly, there is very little pristine corporate debt. The idea that businesses are in far better shape is a mirage.

As companies pull back, the effects ripple through the economy. Rebecca Barnes, co-owner of Bargain Boxes Moving and Storage in Manassas, routinely replaces her truck fleet. This year, "I'm not even considering it," she said.

"If I'm not buying a new truck every two years, then Cowles Parkway Ford is not getting my sale on a regular basis," Barnes said. "Everything has an effect on everything else."

My Comment: "Everything has an effect on everything else" is exactly correct. And with that thought, here are a few things to consider:

• Grim News in Arizona State Budget and Sacramento City Budget
• Quarterly Banking Profile Is Bleak
• Poole, Paulson, Bernanke on Bailouts and Bank Failures

Things We Don't Need

• We do not need more Steak n Shakes (SNS), Pizza Huts (YUM), McDonald's (MCD), Panera Breads (PNRA), Starbucks (SBUX) or any other restaurants for that matter.
  
  
• We do not need more Wal-Mart (WMT), Target (TGT), Lowes (LOW), Home Depot (HD), Best Buy (BBY), or Bed Bath and Beyond (BBBY) stores.
  
  
• We do not need more Toyota (TM) dealers, GM dealers, or Ford (F) dealers).
  
  
• We do not need more nail salons, dry cleaners, movie rental places, storage facilities, etc.
  
  
• We do not need more houses from Toll Brothers (TOLL), Beazer (BZH), Hovnanian (HOV), Lennar (LEN), Pulte (PHM), Centex (CTX) or Ryland (RYL) . Inventory of houses is at an all time high.

Given that we do not need any of those things, can anyone tell me where the jobs are going to come from to support the economy?

Before you start emailing me about alternate energy, please think about timeframes, why the jobs will be in the US as opposed to elsewhere, and how many jobs we are really talking about compared to the massive overexpansion of housing and retail stores.

Before you start emailing me about infrastructure, think about what the costs will be, property taxes, "small" things like municipalities going bankrupt, and once again how many jobs can reasonably be provided.

Belt tightening is not a threat, it should be embraced! We are in this mess because we failed to tighten belts. The real threat is we continue our spendthrift ways. Postponing the inevitable will only make matters worse.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Grim News in Arizona State Budget and Sacramento City Budget

Sacbee is reporting Sacramento aims to cut staff by 10%.

The city of Sacramento announced Friday it is trimming its work force by more than 9 percent and, in an effort to avoid massive layoffs, it is offering buyouts to as many as 200 employees.

Assistant City Manager Gus Vina said the city has eliminated 204 jobs through a hiring freeze, attrition, layoffs and other measures. But to stanch its fiscal hemorrhaging, the city intends to eliminate about 300 more jobs and make cuts in service.

Now, with the potential of more layoffs looming, the city and labor unions have proposed an employee buyout plan, hoping up to 200 workers will voluntarily give up their jobs.

In the fiscal year beginning July 1, the capital city is facing a $58 million budget shortfall in its $450 million general fund, Vina said.

The city's financial crisis is caused by unexpectedly low revenue and escalating costs, budget officials said. Sales tax revenue is below estimates. Also, the downturn of the housing market and rising unemployment are likely to mean a significant slowdown, or even a loss, in property and utility users tax revenue.

I have news for Sacramento: This is round one. More layoffs will be coming.

Layoffs cannot be good news given the Sacramento region's unemployment rate is the highest in 11 years.

The Sacramento region's unemployment rate shot up a half-point in January to 6.4 percent, the Employment Development Department reported Friday. Although the increase was due mainly to seasonal cutbacks, it was also clear that the Sacramento area is getting clobbered by the soft real estate market.

Unemployment in greater Sacramento is nearly a point higher than a year ago, and the highest it's been since the 6.6 percent rate recorded in January 1997. Back then the region was shaking off the lingering effects of the early 1990s recession.

Statewide unemployment in January held steady at 5.9 percent, but 20,300 jobs vanished. The loss was largely the result of the TV and movie writers strike, which shut down much of Southern California's entertainment industry, said Howard Roth, chief economist at the state Department of Finance.

But while the show-business jobs are likely to return, gloom continues to spread across other industries. EDD's annual revision of its statistics show that California's employers added just 40,700 jobs last year, a growth rate of only 0.3 percent. The uptick was only about half as strong as previously reported.

Vallejo Unions Agree To Cut Wages

In Vallejo, cops, firefighters agree to cut raises.

Vallejo police and firefighters have tentatively agreed to forgo raises amounting to millions of dollars in savings as part of concessions aimed at staving off bankruptcy for the cash-strapped city.

The deal, which will be considered Monday for approval by the City Council as part of an emergency financial plan, doesn't necessarily end debate over whether the city should seek bankruptcy protection.

Vallejo is expecting to go over its $80 million general fund by $13 million and is looking to dramatically trim its spending to keep it from becoming the state's first sizable city to seek bankruptcy protection.

The 8.5 percent salary increase scheduled for fiscal 2008-09 would be cut to 2 percent. The starting salary of Vallejo firefighters is about $85,000, a union official said.

For more on Vallejo please see Vallejo California On Brink Of Bankruptcy and State, Municipal Governments Feeling Pain.

No wonder Vallejo is in trouble. A starting salary of $85,000 for firefighters is absurd. The starting salary for New York City Firefighters was $36,400 (2006 data). Chicago starting firefighter salary is $40,000+ (2006 data).

The best thing for Vallejo taxpayers would be bankruptcy and compete renegotiation of union contracts.

Dramatic Drop In Arizona Revenue

With a tip of the hat to Credit Bubble Stocks, the Arizona Joint Legislative Budget Committee report shows grim January data.

Total January General Fund revenue collections were $849.3 million, or (16.1)% below January of last year. This amount was $(226.2) million below the forecast based on the June enacted state budget.

For the first 7 months of FY 2008, General Fund collections are down (3.5)% when compared to last year, and are $(619.2) million less than the enacted forecast. When factoring in Urban Revenue Sharing, year-to-date collections are (5.1)% below last year.

The January decrease represents the largest percentage year over year decline since April 2002. The dramatic drop in January revenues was across the board in all 3 main revenue categories:

• Sales tax collections were down (7.5)% compared to January 2007, and were $(71.9) million short of the monthly forecast. This is the largest percentage year over year decrease since at least FY 1991.
• Individual income tax collections were down (11.9)%, which was $(98.7) million below forecast.
• Corporate income tax collections were (138.9)% below last year, and $(35.7) million below the forecast.

City by city, state by state there are going to be budget shortfalls. These shortfalls are going to get worse over time. Unions are not going to like it, but contracts are going to have to be renegotiated.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Bank of Montreal Misses Margin Calls

On February 19th the Bank of Montreal Took C$325 Million in Writedowns.

Bank of Montreal, Canada's fourth- largest bank, will report writedowns of about C$325 million ($323.9 million) in the first quarter and replace its chief risk officer after combined trading losses and other costs topped C$1 billion over the past year.

The costs stem from debt transactions with bond insurer ACA Capital Holdings Inc., as well as trading losses and a writedown on investments in two Canadian asset-backed commercial paper trusts administered by Bank of Montreal, the Toronto-based bank said today in a statement.

The new costs will reduce earnings per share by about 70 cents for the quarter ended Jan. 31, or almost half its expected profit for the period, based on a Bloomberg News survey. The writedowns add to the C$440 million recorded last year for natural-gas trading losses, and about C$260 million in debt writedowns and other costs in the fourth quarter.

Bank of Montreal also said it will provide financial support capped at $11 billion for the structured investment vehicle Links Financial Corp., and as much as 1.2 billion euros ($1.77 billion) for Parkland Finance Corp. The assets of both SIVs, which sell short-term debt and invest the proceeds in higher-yielding securities, have been reduced since July 31.

"Rather than putting the SIV issue behind it, today's announcement sets the stage for it to migrate onto BMO's balance sheet over time," Blackmont Capital analyst Brad Smith said today in a note, in which he downgraded the stock to "hold" from "buy".

"This action increases the potential for additional losses should asset sales prove more challenging than currently anticipated."

Margin Calls Missed

On February 28 Bank of Montreal Commercial Paper Trusts Were Cut by DBRS

Two Bank of Montreal commercial- paper funds were downgraded to junk by DBRS after the funds failed to meet margin calls for collateral, raising the prospect of more writedowns for the bank.

DBRS, the Canadian credit-ratings service, downgraded notes of the Apex and Sitka trusts to R-5, its lowest short-term debt rating, and CCC, its fourth-lowest speculative long-term rating, after the bank said Apex failed to find buyers for all of its notes that came due. DBRS said a default by Apex would result in a default by Sitka.

Bank of Montreal, Canada's fourth-largest bank, has said it would face additional pretax writedowns of about C$495 million ($506 million) if the funds aren't restructured. Bank of Montreal has been in talks with several companies on "restructuring alternatives" for the two trusts, the Toronto- based bank said Feb. 19. The lender has already taken C$210 million in writedowns related to Sitka and Apex, the bank said.

"The total amount of collateral that is due is significant," DBRS said in a statement today.

Trust Writedowns Looming

On February 29 the Bank of Montreal Starts Talks to Avert Trust Writedown.

Bank of Montreal had its biggest one-day decline in more than six years after the lender said it's in talks to restructure two of its commercial-paper funds to avert a C$495 million ($505 million) writedown.

The bank repeated it will write down its investments in the Apex and Sitka trusts if efforts to restructure them fail, adding to the C$210 million writedowns already taken, according to a statement today.

The potential writedowns may force the Toronto-based bank to withdraw support for a plan to restructure about C$33 billion in non-bank commercial paper that hasn't traded since August, the Globe and Mail reported today.

Impossible To Avoid Writedowns

Regardless of what kind of "restructuring talks" the Bank of Montreal is in, or who those talks are with, further writedowns are coming.

I want to know is: How the heck did the Bank of Montreal keep this hidden for so long? Was this a misguided prayer that this garbage was somehow going to catch a bid? Of course MBIA (MBI), Citigroup (C), Lehman (LEH), Morgan Stanley (MS), and countless other financial institutions kept stuff hidden off the books in the United sates. The same is going on in Germany and the UK right now. In this case, it's hard to keep a missed margin call quiet.

Frozen ABCP Recap

Before we get to latest news on frozen paper, let's recap the story for those not familiar with it. Flashback September 27, 2007: Global Credit Crisis Canadian Style

Canadian Credit Crisis in a nutshell

• $40-billion in ABCP is frozen.
• The Québec Pension Plan (Caisse) and the Ontario Teachers' Pension Plan are on the hook as are 40 other trustholders, mining companies, paper companies, etc all of which thought they were buying short term easily marketable notes.
• What they were really buying was toxic waste from troubled mortgage loans in the U.S.
• A workout plan called the Montreal Accord was originated by Caisse. The proposed solution was to convert short term debt to long term debt some of which stretches out all the way to 2015, just to break even.
  
• While this may suit the needs of Caisse, some companies need money now to fund mine operations and the like. Those companies do not want their money tied up for years.
• "Most noteholders [still] don't know what they're holding."
• Uncertainty over the frozen $40-billion ABCP is spilling over into the rest of the credit market in Canada, driving down demand and forcing companies to cancel projects because of the soaring costs of funding.

The Unfrozen North

Flashback November 15, Commercial Paper In The Unfrozen North. "The Canadian ABCP market was a $40 billion market. Judging from the preliminary results, it is perhaps now a $20+- billion market."

The Abandoned Baby

FlashForward February 29, 2008: Bank of Montreal may abandon debt rescue.

Facing new writedowns of more than $500-million, BMO is considering quitting group that is restructuring frozen ABCP market.

Bank of Montreal has signalled it may pull out of an effort to restructure $33-billion in stranded asset-backed commercial paper, as mounting woes in the global credit market leave the bank facing margin calls of more than $500-million on two of its own ABCP trusts.

According to sources, bank officials recently advised the group of ABCP investors seeking a fix for the market, known as the Crawford Committee, that BMO may no longer be able to honour its commitment to contribute to a $14-billion line of credit.

That credit line is the centrepiece of a plan to swap the frozen notes into new long-term bonds.

BMO's problems are particularly acute, with the bank last week announcing $490-million in writedowns and this week facing as much as $495-million more because of the unravelling of two trusts that it runs.

"We are no longer in the same world that we were in December," said a person familiar with the discussions between the banks and the committee.

"We are struggling to hang on."

BMO's troubles are a vivid illustration of how the disintegration of so-called structured products like ABCP is undermining the financial industry's ability to cure its ills and aid clients stuck with foundering investments. More and more banks are finding that they don't have the capital because all available money is tied up plugging holes in their own balance sheets.

BMO is facing a stark choice. On the one hand, if BMO decided to save its own trusts by anteing up to meet the collateral calls, it would avoid a $495-million writedown. That option comes with a heavy cost, because it would leave the bank with less capital to lend to its clients and for the liquidity line desired by the Crawford Committee.

If, on the other hand, BMO declines to save its own trusts, more money will be free to help the Crawford Committee bail out ABCP sold by smaller, non-bank companies such as Coventree Inc. This move would expose the bank to criticism that it sacrificed its own customers to aid those of other players.

Inability and unwillingness to lend have now gone global, even affecting commodity countries said to be "immune" from a global slowdown.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Poole, Paulson, Bernanke on Bailouts and Bank Failures

In his most recent speech titled How Important Is Moral Hazard? the Fed's William Poole stressed once again the Fed can provide liquidity, not capital. Poole also took a look at the concept of "Too Big To Fail". Let's take a look.

In the context of macroeconomic stability, the main moral hazard issue arises in the context of “too big to fail.” I believe that it was Alan Greenspan who put the issue this way: No firm should be too big to fail but some may be too big to liquidate quickly.

We have known for many years that moral hazard is a potentially serious issue. If a firm believes that it will be bailed out if it gets into trouble, that expectation encourages excessive risk-taking and increases the probability of trouble. There are two complementary ways to deal with moral hazard. First, firms in trouble ought not to be bailed out, unless the bailout takes a form that imposes heavy costs on managers and shareholders. Second, firms subject to government regulation ought to be compelled to maintain adequate capital to reduce the probability of failure. U.S. banks entered the period of turmoil last year pretty well capitalized and have been able to withstand large losses.

I am more skeptical of the financial strength of the GSEs, and believe that we could see substantial problems in that sector. According to the S&P Case-Shiller home value data released earlier this week, as of December 2007 average prices had declined by 15 percent or more over the past 12 months in Phoenix, San Diego, Miami and Las Vegas. We can add Detroit to the danger list as the home price index for that city is down by almost 19 percent over the 24 months ending December 2007. With house prices falling significantly in a number of large markets, many prime mortgages issued a few years ago with a loan-to-value ratio of 80 percent may now have relatively little homeowner equity, which increases the probability of default and amount of loss in event of default.

As I have emphasized before, the Federal Reserve can deal with liquidity pressures but cannot deal with solvency issues. I do not have any information on the GSEs that the market does not also have. Nevertheless, in assessing the risk of further credit disruptions this year, I would put the GSEs at the top of my list of sources of potentially serious problems. If those problems were realized, they would be a direct result of moral hazard inherent in the current structure of the GSEs.

This is the second time that Poole has point blank stated the Fed can provide liquidity, not capital. Both times were in reference to GSEs.

Previously I discussed liquidity vs. capital in No Helicopter Drop For Failed Banks. Inquiring minds may wish to take a look.

Paulson Urges Bailout, Dismisses Bailout as Bailout, Then Implodes

Treasury Secretary Paulson is in denial about bailouts, especially his own. Professor Depew picked up on this theme in Thursday's Five Things:Congress Inadvertently Passes Economic Save-a-lot Package.

Paulson Urges Bailout, Dismisses Bailout as Bailout, Then Implodes

In an interview yesterday in the Wall Street Journal, Treasury Secretary Henry Paulson branded many of the aid proposals circulating in Washington as "bailouts" for reckless lenders, investors and speculators, rather than measures that would provide meaningful relief to deserving, but cash-strapped, mortgage borrowers.

"I'm seeing a series of ideas suggested involving major government intervention in the housing market, and these things are usually presented or sold as a way of helping homeowners stay in their homes," Mr. Paulson told the Journal. "Then when you look at them more carefully what they really amount to is a bailout for financial institutions or Wall Street."

You know what? The plan is working. For a moment, I almost completely forgot about the bailout proposals Paulson helped engineer last year:

• October 10, 2007: U.S. Announces Major Toll Increase on Road to Serfdom
• November 12, 2007: Paulson on Super-SIV: "Anything Worth Trying"
• December 6, 2007: Homeowner Bailout Plan

The Journal article this morning noted the following caveat from Paulson: "It would be imprudent not to have contingency plans, but we are so far away from seeing something that would have me calling for a bailout that I don't see it."

In other words, the only thing currently separating the Treasury Secretary from those in Congress "calling for bailouts" is the magnitude of the crisis, which is ludicrous on its face. Bailouts are bad because they encourage the very behavior that necessitated the bailout. Period. There is no degree of magnitude to it, and it is both disingenuous and cynical for the Treasury Secretary to try and have it both ways.

Bernanke Expects Bank Failures

Testifying before Congress on Thursday, Bernanke stated Banks should seek more capital.

"I expect there will be some failures," Bernanke told the Senate Banking Committee, referring to smaller regional banks who became heavily invested in real estate.

"Among the largest banks, the capital ratios remain good and I don't anticipate any serious problems of that sort among the large, internationally active banks that make up a very substantial part of our banking system," he said in response to a question during semi-annual congressional testimony.

"They have already sought something of the order of $75 billion of capital in the last quarter. I would like to see them get more," Bernanke said.

"They have enough now certainly to remain solvent and remain ... well above their minimum capital levels. But I am concerned that banks will be pulling back and not making new loans and providing the credit which is the lifeblood of the economy. In order to be able to do that ... in some cases at least, they need to get more capital," Bernanke added.

Bernanke Does Not Understand The Problem

Banks have every reason to decrease lending. There is rampant overcapacity in housing, commercial real estate, and the service sector. In addition there is over-leverage in hedge funds and over concentration of bank loans tied to real estate.

Bernanke wants banks to lend more, but all that will do is increase losses. The man clearly does not understand what the basic problem is. Yes, banks should be raising capital, but not to increase lending. Banks need to raise capital in advance of the approaching tsunamis in commercial real estate and credit card writeoffs, and the continuing tsunami in residential housing, all of which are going to further impair bank balance sheets.

Things We Don't Need

• We do not need more Steak n Shakes (SNS), Pizza Huts (YUM), McDonald's (MCD), Panera Breads (PNRA), Starbucks (SBUX) or any other restaurants for that matter.
  
  
• We do not need more Wal-Mart (WMT), Target (TGT), Lowes (LOW), Home Depot (HD), Best Buy (BBY), or Bed Bath and Beyond (BBBY) stores.
  
  
• We do not need more Toyota (TM) dealers, GM dealers, or Ford (F) dealers).
  
  
• We do not need more nail salons, dry cleaners, movie rental places, storage facilities, etc.
  
  
• We do not need more houses from Toll Brothers (TOLL), Beazer (BZH), Hovnanian (HOV), Lennar (LEN), Pulte (PHM), Centex (CTX) or Ryland (RYL) . Inventory of houses is at an all time high.

Bernanke wants banks to raise more capital so they can do more lending. He never bothered to ask this simple question: For What?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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