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Thursday, December 20, 2007

Subprime Contagion: The Bear Flu

Items of interest:

David Henry & Matthew Goldstein / BusinessWeek:
The Bear Flu: How It Spread -- A novel financing scheme used by Bear Stearns' hedge funds became a template for subprime disaster.

When the subprime mortgage market began to unravel late in 2006, global bond markets barely flinched. But when two Bear Stearns (BSC) hedge funds collapsed in June, the event sparked a global credit crisis that has yet to ease. New evidence sheds light on how those hedge funds—and their managers—became star players in the subprime bust, the biggest financial disaster in decades. The revelations also show how other players in the mortgage market adopted the Bear funds' tactics, collectively building a financing structure with many of the hallmarks of a pyramid scheme.

The legal consequences are still unfolding. In recent weeks securities regulators and federal prosecutors have stepped up their investigations into the two funds, probing the fuzzy math used to value the underlying assets, the aggressive sales pitches that portrayed the funds as safe, and frequent trades with other Bear-managed portfolios. On Dec. 19, Barclays (BCS), which lent one Bear fund hundreds of millions, filed a lawsuit alleging fraud over misleading statements about the portfolio's health. Says a Bear spokesman: "We believe that any such lawsuit is unjustified and without merit." [...]

The tab from the mortgage mess could run up to $500 billion, and central bankers are struggling to stave off recession. As investigators sort through the wreckage, the records of Bear Stearns' doomed hedge funds are turning out to be some of the most revealing in an era of financial folly.

comment: So, it all boils down to a sophisticated pyramid scheme that toppled?

related:
Bloomberg:
Rating Subprime Investment Grade Made `Joke' of Credit Experts -- `I'd like to understand why now, when you could have made this move many, many months ago,'' said Steven Eisman, 45, who manages the $1.5 billion FrontPoint Financial Services hedge fund for Morgan Stanley in Greenwich, Connecticut. ``The paper just deteriorates every single month.'' Warrack and Managing Director Susan Barnes, 42, explained S&P's view of the time needed to accurately judge the performance of securities. Eisman cut them off. ``You need to have a better answer,'' he said. [...]

Bloomberg:
S&P Cuts Alt-A Mortgage Bonds; Analysts Warn on Prime
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Businessweek:
China Extends Lifeline to Morgan Stanley -- China Investment Corp. will help the Wall Street firm weather its losses with a $5 billion capital infusion as CEO John Mack agrees to forgo his 2007 bonus.

Morgan Stanley has declared a $9.4 billion fourth-quarter mortgage-related write down and has said China Investment Corporation will invest $5 billion to buy up to 9.9% of the US bank.

Six weeks ago, on November 7, Morgan Stanley indicated it was taking a write down of $3.7 billion of subprime assets based on valuations as of October 31. It has now taken another $4.1 billion of write downs based on subprime trading positions on November 30, taking the total to $7.8 billion. It has attributed the situation to the "deterioration and lack of liquidity in the market for subprime and other mortgage-related securities since August 2007". [...]
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Tim Iacono / Seeking Alpha:
Foreclosures Have Peaked and It's Time To Buy? Not So Fast -- There were some confusing headlines about foreclosures yesterday. This AP report shows foreclosure filings in the U.S. up 68 percent last month, while BusinessWeek says they're down 10 percent. Rick Sharga of RealityTrac explains that both are correct. [...]

Rick Sharga of RealityTrac discusses foreclosuresclick picture to play video
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Felix Salmon / Seeking Alpha:
Morgan Stanley's Horrendous Earnings -- Morgan Stanley's Q3 earnings back in September were bad. "Mack Smacked" was the Portfolio headline, reacting to a lower profit (just $1.54 billion, John Mack's first quarterly earnings decline) and a nasty $940 million write-down on bad loans.

Ah, those were the days. Just look at the Q4 results: an eye-popping $3.56 billion loss, and an even more enormous $9.4 billion write-down on bad mortgages. Many on Wall Street suspected Morgan Stanley's earnings might be bad, but this is literally an order of magnitude worse than expectations:
The loss of $3.61 a share in the three months ended Nov. 30 compares with net income of $1.98 billion, or $1.87 a year earlier. Analysts were estimating a loss of 39 cents, according to a survey by Bloomberg.
I have to say I'm quite flabbergasted at the size of the write-down. Morgan Stanley's meant to be an investment bank, ferchrissakes, not a lender or a bond investor. It has no business holding that sort of quantity of mortgage-backed bonds on its books. And indeed its pure investment-banking business seems to be doing rather well [...]
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Seeking Alpha:
Housing Market Tracker - Subprime Review --

Quotes of the Day
“We need a government loan. This country is falling apart. We need customers. We need some help. So many ‘For Sale’ signs in this neighborhood. People just have to leave their homes and run.” - Marcus St. Marie, owner of the Boston Road Furniture store in the Bronx, on the effects of the subprime crisis in his neighborhood. (NY Times, Dec. 17th)

“Financial innovation is great, but you have to have some basic rules. One of the most basic rules is that a borrower should have the ability to repay.” – Sheila Bair, chairman of the Federal Deposit Insurance Corporation. (NY Times, Dec. 18th)
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CNNmoney.com:
Mortgage applications tumble, MBA says -- Industry trade group's weekly survey says refinance and purchase volumes also declined sharply. [...]

CNNmoney.com:
Hovnanian sees rebound, but Street worries -- New Jersey-based luxury builder says it believes profitability will return, but only with a healthy housing market. [...]
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Mortgage Fraud blog:
31 Defendants Charged in Massive Mortgage Fraud Scheme -- This scheme involved fraudulent mortgage loans obtained for the purchase of 27 properties located in Miami-Dade and Broward Counties, and in the City of Marco Island, Florida. [...]

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