Ice In The Fall

Consumers have largely been ignored in the Trouble Assets Relief Program as Treasury Secretary Henry Paulson has embraced the questionable “trickle down” notion of helping the big boys at the top to create liquidity in the markets as the money “flows down.” We know it didn’t flow.

Big financial institutions (with banking capacity) used cheap money from the Federal Reserve and the potential of the bailout funding to “de-leverage” – reduce the proportionate debt on their books to comply with regulations that required saner debt loads since some of these big boys became real banks (Goldman Sachs, Morgan Stanley, American Express – banks have stricter controls), to create cash reserves for possible losses and to provide money to buy “valuable failures” (their less-than-prudent competitors) and consolidate the financial industry. The result: with a few scattered local exceptions (small banks that didn’t play the stupid loan game and didn’t get bought out by loan-happy big boys), the only real banking taking place in America right now is with the mega-institutions at the top. JP Morgan Chase, CitiGroup, Wells Fargo and Bank of America.

There’s been an election since with a clear message – the emphasis will be on the consumer, the employee and the homeowner. With the writing on the wall, and a little bit more than two months until there is a change in Administrations, Henry Paulson seems to be waking up to the reality that the fixing at the top has had virtually no impact on most Americans with financial issues created by this meltdown. Since the change in focus is now inevitable, Paulson announced on November 12 that Treasury will no longer use the $700 billion bailout funding to buy troubled assets from troubled banks.

Instead, with writing on the wall morphing into screaming voices, Treasury will use $250 billion of the bailout fund to buy stock in functioning non-banking lending institutions as well as banks (specifically to bolster their balance sheets and encourage them to resume ordinary lending and in support of restoring the real estate market). Paulson also noted that the government was looking at a major expansion of the program into the markets that provide support for credit card debt, auto loans and student loans.

Wow! Two months since the first mega-fall of the markets and well after everyone knew about the subprime meltdown, the Department of the Treasury seems to have discovered that ordinary human beings are actually suffering in a way that makes it impossible to stabilize even the biggest financial institution. With crashing real estate values, plunging retail sales, rapidly escalating unemployment figures. I guess no one told him that 70% of economic activity in this country is based on consumers. Dirty little secret.

I’m Peter Dekom, and I approve this message.

ICE IN THE FALL

Consumers have largely been ignored in the Trouble Assets Relief Program as Treasury Secretary Henry Paulson has embraced the questionable “trickle down” notion of helping the big boys at the top to create liquidity in the markets as the money “flows down.” We know it didn’t flow.

Big financial institutions (with banking capacity) used cheap money from the Federal Reserve and the potential of the bailout funding to “de-leverage” – reduce the proportionate debt on their books to comply with regulations that required saner debt loads since some of these big boys became real banks (Goldman Sachs, Morgan Stanley, American Express – banks have stricter controls), to create cash reserves for possible losses and to provide money to buy “valuable failures” (their less-than-prudent competitors) and consolidate the financial industry. The result: with a few scattered local exceptions (small banks that didn’t play the stupid loan game and didn’t get bought out by loan-happy big boys), the only real banking taking place in America right now is with the mega-institutions at the top. JP Morgan Chase, Wells Fargo and Bank of America .

There’s been an election since with a clear message – the emphasis will be on the consumer, the employee and the homeowner. With the writing on the wall, and a little bit more than two months until there is a change in Administrations, Henry Paulson seems to be waking up to the reality that the fixing at the top has had virtually no impact on most Americans with financial issues created by this meltdown. Since the change in focus is now inevitable, Paulson announced on November 12 that Treasury will no longer use the $700 billion bailout funding to buy troubled assets from troubled banks.

Instead, with writing on the wall morphing into screaming voices, Treasury will use $250 billion of the bailout fund to buy stock in functioning non-banking lending institutions as well as banks (specifically to bolster their balance sheets and encourage them to resume ordinary lending and in support of restoring the real estate market). Paulson also noted that the government was looking at a major expansion of the program into the markets that provide support for credit card debt, auto loans and student loans.

Wow! Two months since the first mega-fall of the markets and well after everyone knew about the subprime meltdown, the Department of the Treasury seems to have discovered that ordinary human beings are actually suffering in a way that makes it impossible to stabilize even the biggest financial institution. With crashing real estate values, plunging retail sales, rapidly escalating unemployment figures. I guess no one told him that 70% of economic activity in this country is based on consumers. Dirty little secret.

I’m Peter Dekom, and I approve this message.

Bar Tab Up in a Down Market

Morgan Stanley canceled its Christmas parties this year. The November 3, 2008, New York Times wrote about on the trading floor of the New York Stock Exchange: “Of the 1,366 broker’s licenses available for an annual fee of $40,000, only 553 are being used. In 2006 there were 3,534 people working on the floor; today there are 1,273…‘The stress now is the lack of business,’ says Benedict Willis III, 48, a senior broker who started here in 1982. Moments later he is interrupted by applause. It is the sound of a lost job: a floor broker of 20 years has just been laid off from a major firm, and now his colleagues are showing their respect.” The laid off trader escaped to the bar across the street.

Other “professionals” on the Street – the big “private equity” funds I’ve written about in the past – remember the days when they looked for “undervalued” public companies with lots of free cash flow that they could buy. Why? Because companies with free cash flow can carry debt, and being able to carry lots of debt meant you could borrow lots of money. Buying a company that had borrowing power meant you could put a small sum down, much less than normal, and cause the acquired company to borrow itself into oblivion to finance the rest of the purchase price. They called it “leveraging” – pushing a company to the edge of its borrowing ability to finance its own purchase.

For public shareholders of the acquired company, they enjoyed the premium paid to take that stock off their hands. They were long gone when the private equity firm stepped in to “create efficiencies of scale,” “eliminate the dead wood,” “spin-off” valuable assets and lay off the “unnecessary” layers of actual workers. Their goal? To “flip” that company back into the marketplace – leaner, meaner and at a significantly higher share price. The profit trail was long and glorious. Young MBAs and senior partners of these private equity firms worked long hard hours and were paid king’s ransoms for their services. Many billionaires were made. Leveraging was king!

Sound familiar? A bit like the subprime borrowers who took on massive debt with little or no down? Almost, with one huge difference. On Wall Street, the debt was not incurred by the private equity firm – that pleasure was relegated to the “asset” (the acquired company). With all that free cash flow, servicing the debt might have been fine in a growth marketplace, but just like the subprime debacle, when the markets crashed and no one could take a company back public, as the “asset” sat on a private equity shelf, the debt still had to be serviced.

The private equity firms now have “assets” with lower values, but they’ll still be around for the long haul, but those “assets”… well… the names of the acquired companies, many listed in the Times, are brands we all know, including: Neiman Marcus, Metro-Goldwyn-Mayer, Toys “R” Us, resorts like Harrah’s Entertainment and lenders like GMAC, the financing arm of General Motors as well as a few that have already filed for bankruptcy like Linens ’n Things, Mervyn’s and Steve & Barry’s. Private equity firms, until a few finally went public, were built by investments from very wealthy individuals, investment funds and, most sadly, money from pension funds.

Because they were built on the investments of “big boys,” private equity was one of the least regulated categories in the financial sector. And now, as these “assets” lose revenues in a terrible market, all that debt has to be restructured in a world that no longer allows pigs free access to the debt trough.

The Times continued with this quote: “There’s absolutely going to be a lot of pain to go around [in the world of private equity and their "assets"],” said Josh Lerner, a professor of investment banking at Harvard Business School. “The big question is how apocalyptic it will be.” Same issue that killed Lehman, Bear Stearns, subprime borrowers with little down, and a whole host of companies and people who thought that growth never ends.

It would have been okay if the negative impact stuck only to those who caused the problem, but now, people who never borrowed too much, worked hard for a living and bought their dream homes on a solid basis, are watching their pensions erode, their jobs disappearing, their businesses fail for lack of credit and their home values crash (sometimes losing the homes in a foreclosure resulting from a job loss). So much for “free market deregulation.” When we fix the system as we must, overleveraging – for both people and companies – has to be toast!

I’m Peter Dekom, and please vote tomorrow. It is a very important election.

The Hoard Mentality

We know that a whole lot of the big financial players, mostly those that are licensed as banks (which now includes Morgan Stanley and Goldman Sachs), took advantage of their ability to borrow cheap money at the Federal Reserve discount rate (as the Fed was cutting rates and making money even cheaper) – a rate drop that was intended to trickle cash into the small business/consumer credit markets, and shore up payrolls and receivable financing. We know these big money guys bought Treasury bills (government paper) instead, thus hoarding the cash. Why?

Some think that all this hoarding was to have a cash reserve to bottom feed on the remnants of a crashed stock market, but their own stock was tanking as well and they did not use their hoarded cash to buy back their own stock at steep crashed-market discounts. There’s something happening, maybe, that most folks aren't thinking about?

Remember a blog a few weeks ago when I discussed the “credit default swap” (CDS) instrument –where a lender who is worried about the creditworthiness of a borrowing corporation can pay out some of the interest upside – through a tradable CDS – in exchange for “default-insurance” from a solvent party able to stand behind the loan? In other words, the issuer of the default insurance is paid a chunk of the interest payments (big money when you do a lot of this) – i.e., the lender is literally paying a piece of the interest being generated to this CDS issuer… as long as the borrower is making interest payments. If the borrower defaults, the lender calls on the issuer of the CDS to make good on the defaulted loan.

As long as you don't have lots of defaults, and those CDS instruments are generating real money, they trade like diamonds. But who were those borrowers? There is currently an estimated $55 trillion in CDSs still out in the world market. This CDS paper covered loans to companies like Bear Stearns, Lehman Bros., AIG, to name a few, although the vast pool of guaranteed companies have not defaulted and probably won't default (we hope!).

Although there is no real way to know exactly who owes what and who is covering how much of which risk, it seems that the very financial companies that took the default risk (issued the CDS paper), earning the big bucks from the CDS payments, are the same companies that are borrowing all that money from the Fed and hoarding the borrowings. Here is how today’s thedeal.com described the issue: “Fear that settlements of Lehman Brothers Holdings Inc.'s credit default swaps could unhinge markets are looking to be unfounded as the final day to settle them winds to a close [today]. It's been unclear exactly since [that] investment bank filed for bankruptcy on Sept. 15 what the total [default] exposure would be, as estimates ranged from $6 billion all the way up to $400 billion in swaps.

“A few weeks ago, there were major concerns that exposure could be in the hundreds of billions. But in a statement last week, the Depository Trust & Clearing Corp., which clears most [CDS] trades in the over-the-counter market, estimated that ‘net funds transfers from net sellers of protection to net buyers of protection are expected to be in the $6 billion range,’ which seems to have tamped down much of the fear.”

“But with markets still jittery, there was speculation that banks and other sellers of CDSs were hoarding their cash in order to pay out on losses of slightly more than 91% on Lehman contracts.” So it’s simple terror that motivated the hoarding, and perhaps as the lack of a stampede suggests that perhaps some of that hoarded money can slide down to the companies that need receivable loans to guarantee their payrolls. I might suggest to the Department of the Treasury that they use “cattle prods” if necessary. We're dying down here!

I’m Peter Dekom, and I approve this message.