The Dame of Doom Says UBS and MER to Take Another Big Hit

Ben's 'too big to fail' list is going to get busy.

Hey what about these non-US "banks" that are holding heavy like Bear Stearns? Will the Fed save them too? Or is this going to be a global central bank group effort?

Capability Tim at the NYFed can mail a 'how-to' document to Buba in care of Threadneedle Street. Obvious nationalisation is so déclassé.

Whitney: Merrill, UBS Face New Writedowns
03/27/08 -
09:16 AM EDT
Marketwatch

Oppenheimer analyst Meredith Whitney on Thursday forecast new writedowns and losses at Merrill Lynch and UBS two more investment banks hit hard amid the deep-rooted credit crunch.

Whitney, who last fall issued an early and accurate call that Citigroup would have to cut its dividend, predicted writedowns of $6 billion and $11.1 billion at the two firms, respectively. She issued the note late Wednesday, after shares of the two firms stumbled in the wake of a bearish note on Citi that predicted $13 billion in writedowns.

Shares of Merrill were falling 2% and UBS shares were up 3.6% in premarket trading. Merrill had fallen 7.2% and UBS sank 3.1% Wednesday. Citi fell 5.8% Wednesday.

Whitney expects Merrill to lose $3 a share in the first quarter, down from her earlier prediction of a profit of 45 cents a share. For the full year, she sees a profit per share of 20 cents, down from her earlier forecast of $4 a share.

UBS could lose $2.72 a share in the first quarter, she said, lowering her earlier outlook of a profit of 72 cents a share. For the full year, she sees a profit of 45 cents a share, vs. an earlier view of a $3.72-a-share profit. The two firms have been among the hardest hit in the credit crunch. Merrill wrote down $14.6 billion in soured mortgage-related investments in the fourth quarter, while UBS wrote down $18 billion.

Whitney's note on Citi Wednesday predicted as much as $50 billion in writedowns for the financial sector. The note also cut forecasts for Bank of America, JPMorgan Chase and Wachovia Bank.

...I saw pale kings and princes too,
Pale warriors, death-pale were they all;
They cried—“La Belle Dame sans Merci
Hath thee in thrall!”

I saw their starved lips in the gloam,
With horrid warning gaped wide,
And I awoke and found me here,
On the cold hill’s side.

And this is why I sojourn here,
Alone and palely loitering,
Though the sedge is wither’d from the lake,
And no birds sing. John Keats

Justice Department Sponsored Report Finds KPMG Culpable in Subprime Bankruptcy

What is there about the danger of 'moral hazard' that people don't understand?

Do highly profitable abuses usually stop by themselves, especially when the punishments assessed are a small cost of the price of doing business? When only a few 'outsider' scapegoats get punished while the enablers and insiders move on to corrupt new and larger circles of society?

Is there any decency and honor left in the media and our government and our businesses and our universities? Most everyone has their price, but we are dismayed to find out how relatively little it can be. How easily the rest go along with a few vocal thought leaders and lose their personal and professional souls.

What will it finally take to bring us to our senses?

March 27, 2008
Inquiry Assails Accounting Firm in Lender’s Fall
By VIKAS BAJAJ
NY Times

A sweeping five-month investigation into the collapse of one of the nation’s largest subprime lenders points a finger at a possible new culprit in the mortgage mess: the accountants.

New Century Financial, whose failure just a year ago came at the start of the credit crisis, engaged in “significant improper and imprudent practices” that were condoned and enabled by auditors at the accounting firm KPMG, according to an independent report commissioned by the Justice Department.

In its scope and detail, the 580-page report is the most comprehensive document yet made public about the failings of a mortgage business. Some of its accusations echo charges that surfaced about the accounting firm Arthur Andersen after the collapse of Enron in 2001.

E-mail messages uncovered in the investigation showed that some KPMG auditors raised red flags about the accounting practices at New Century, but that the KPMG partners overseeing the audits rejected those concerns because they feared losing a client.

From its headquarters in Irvine, Calif., New Century ruled as one of the nation’s leading subprime lenders. But its dominance ended when it was forced into bankruptcy last April because of a surge in defaults and a loss of confidence among its lenders.

The report lays bare the aggressive business practices at the heart of the mortgage crisis.

“I would call it incredibly thorough analysis,” said Zach Gast, an analyst at RiskMetrics who raised concerns about accounting practices at New Century and other lenders in December 2006. “This is certainly the most in-depth review we have seen of one of the mortgage lenders that we have seen go bust.”

A spokeswoman for KPMG, Kathleen Fitzgerald, took strong exception to the report’s allegations. “We strongly disagree with the report’s conclusions concerning KPMG,” she said. “We believe an objective review of the facts and circumstances will affirm our position.”

The report zeros in on how New Century accounted for losses on troubled loans that it was forced to buy back from investors like Wall Street banks and hedge funds. Had it not changed its accounting, the company would have reported a loss rather than a profit in the second half of 2006.

The report said that investigators “did not find sufficient evidence to conclude that New Century engaged in earnings management or manipulation, although its accounting irregularities almost always resulted in increased earnings.”

Even so, the profits were the basis for significant executive bonuses and helped persuade Wall Street that the company was in fine health when in fact its business was coming apart, the report contends.

In bankruptcy court, creditors of New Century say they are owed $35 billion. The company’s stock peaked at nearly $65.95 in late 2004; it was trading at a penny on Wednesday.

A spokesman for New Century, which is being managed by a restructuring firm under the supervision of the bankruptcy court, said the company was pleased that the report had been published.

The investigation was led by Michael J. Missal, a lawyer and former investigator in the enforcement division of the Securities and Exchange Commission who was hired by the United States trustee overseeing the case in United States Bankruptcy Court in Delaware.

Mr. Missal, who also worked on an investigation of WorldCom’s accounting misstatements, concluded that KPMG and some former New Century executives could be legally liable for millions of dollars in damages because of their conduct.

In the aftermath of the collapse of Enron, Arthur Andersen was indicted and convicted on obstruction of justices charges. The conviction was overturned by the Supreme Court in 2005, long after the company had ceased doing business.

Mr. Missal drew an analogy to Enron and said there was evidence that KPMG auditors had deferred excessively to New Century.

“I saw e-mails from the engaged partner saying we are at the risk of being replaced,” Mr. Missal said in a telephone interview about a KPMG partner working on the audit of New Century. “They acquiesced overly to the client, which in the post-Enron era seems mind-boggling.”

Ms. Fitzgerald of KPMG countered, “There is absolutely no evidence to support that contention.”

In one exchange in the report, a KPMG partner who was leading the New Century audit responded testily to John Klinge, a specialist at the accounting firm who was pressing him on a contentious accounting practice used by the company.

“I am very disappointed we are still discussing this,” the partner, John Donovan, wrote in the spring of 2006. “And as far as I am concerned we are done. The client thinks we are done.”

KPMG said Wednesday that a national standards committee had approved the practice in question.

The accounting irregularities became apparent when a new chief financial officer, Taj S. Bindra, started asking New Century’s accounting department and KPMG to justify their approach, beginning in November 2006.

Most of the mortgage company’s executives from that period have resigned or been laid off. A spokesman for two of the company’s three founders, Edward F. Gotschall and Robert K. Cole, said both had cooperated with the investigation but had not yet reviewed the report. A lawyer for Bradley A. Morrice, the third founder who was president and chief executive in 2006 and part of 2007, did not return a call.

The three founders together made more than $40.5 million in profits from selling shares in the company from 2004 to 2006, according to an analysis by Thomson Financial.

The company and its executives are the subjects of a federal investigation by the Justice Department. Investors have filed numerous civil lawsuits against the company

Is the Federal Reserve Accountable? Quis Custodiet Ipsos Custodes?

Is it a moral hazard to prop up financial institutions made insolvent through reckless speculation and probable fraud without required reforms or remedial actions? Is it appropriate to fail to take the necessary steps towards writing down assets and allowing the final cure of price discovery to occur? Are the banks using their respite to further spread the risk of their misadventures to the naive public?

Is the Fed a willing party to the continuation of one of the greatest financial frauds since The South Sea Bubble and the Mississippi Company?

Perhaps the truth will come out when Senator Chris Dodd convenes his hearings into the Bear Stearns bailout. Perhaps we will not. But we can look to the precedents.

In 1836, Jackson forced the closing of the Second Bank of the U.S. by revoking its charter for their abuses in the issuance of the nation's currency.

"Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the [public] bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves."

The Debt Shuffle
by Jesse Eisinger Mar 20 2008
Conde Nast Portfolio

Wall Street cheered Lehman's earnings, but there are questions about its balance sheet.

Bear Stearns collapsed for two reasons. It had a short-term funding crisis where lenders pulled their loans and customers pulled their cash. But it also had a longer-term leverage problem. Last week’s crisis didn’t happen in a vacuum; that leverage eventually led to the collapse in confidence.

After the collapse, Wall Street’s attention naturally turned to the other investment banks, especially Lehman Brothers, perceived as the most vulnerable. So, investors were thrilled when Lehman topped earnings expectations on Tuesday — as the firm took pains to reassure the markets that it has plenty of cash to ride out the turbulence.

Yet aside from a smattering of attention here and there, investors and the media mostly overlooked the balance sheet. In other words, they forgot what happened mere hours earlier with Bear Stearns. Wall Street’s short-term memory is notoriously lousy, but this must set a record. (Could Jimmy Cayne be sharing his stash with his hedge fund buddies?)

What actually happened to Lehman’s balance sheet in the first quarter? Assets rose. Leverage rose. Write-downs were suspiciously minuscule. And the company fiddled with the way it defines a key measure of the firm’s net worth. Let’s look at the cautionary flags:

Lehman’s balance sheet isn’t shrinking, as we’d expect.

Lehman finished the first quarter was total assets of $786 billion, up almost 14 percent from the previous quarter and 40 percent from a year earlier. Other financial institutions are taking down their exposure right now amid the market turmoil to be prudent. Lehman says it wants to. It is not.

Lehman got more leveraged, not less.

The investment banks “gross” leverage hit 31.7 times equity, up from the fourth quarter and way up from last year’s 28.1. According to Brad Hintz, an analyst with Bernstein Research, Lehman’s leverage reached its highest point since 2000. Lehman, like all the investment banks, prefers to look at net leverage, excluding hedges, and that went down. And the firm says that the asset rise was mainly a result of increases in short-term items that have low risk. But we’ve heard a lot of that lately across the financial world. It’s quite simple: The more leverage Lehman has, the less room assets have to fall to wipe out its equity.

Lehman includes debt in its calculation of equity. Say what?

It’s always worrisome when a company changes a key definition of a closely watched measure of financial performance. In a note in its earnings release, Lehman said it has a new definition of “tangible equity,” or the hard assets that it has left over after subtracting its liabilities. This is a measure of net worth, the yardstick by which investment banks are valued. Lehman’s new definition allows for a higher portion of long-term subordinated borrowings (which it calls “equity-like”) in tangible equity. Previously, it had a cap on the percentage of “perpetual preferred stock,” a form of equity-like debt that doesn’t have a maturity date, in its equity. Now, it doesn’t have a cap. Think of it this way: If you borrow money from your parents to make your down payment on your house and they don’t expect to get paid back right away (at least not before you pay your mortgage off) is it equity in your house? No, it’s a loan. And Lehman hasn’t borrowed from mommy and daddy.

Lehman says it is merely conforming to the Securities and Exchange Commission’s definition of tangible equity and had contemplated making the change for a while. And the firm says the change didn’t result in any difference to its net leverage ratio.

Lehman reaped substantial earnings gains because investors thought it is more likely to go bankrupt.

For several quarters, all the investment banks have been taking gains on their liabilities. Say you owe $100 to your friend. But you run into severe problems and your friend starts to figure you can only afford to pay back $95. If you were an investment bank, the magic of fair value accounting dictates that you could get to reduce your liability. What’s more, that $5 gain gets added to earnings. Because investors thought Lehman was more likely to default, its liabilties fell in value and Lehman garnered earnings from this. How much did Lehman win through losing? $600 million in the quarter. How much was its net income? $489 million.

Lehman and all the other investment banks are following the accounting rules on this, but that $600 million is hardly the stuff of quality earnings. Indeed, Bernstein’s Hintz called the bank’s earnings quality “weak.”

Lehman’s write-downs seem tiny.

Lehman finished the quarter with $87.3 billion of real estate assets. These include residential mortgages and commercial real estate paper. The bank only wrote these assets down by 3 percent. And its Level III assets —the hardest to value portion of these instruments—were written down by only the same percentage. The indexes and publicly traded instruments and companies that serve as proxies for these securities generally fell more than that in the quarter. Lehman points out that took larger gross write-downs and then made money through hedges, for a smaller net number.

Lehman remains exposed to lots of dodgy mortgages, including a group labeled: “Prime and Alt-A.” Prime mortgages represent loans to good quality borrowers; Alt-A loans go to borrowers a mere step up from subprime, and represent an area with almost as many problem loans as subprime. The total amount of such mortgages on Lehman’s balance sheet was $14.6 billion in the first quarter and it actually rose from $12.7 billion in the previous quarter. Is this the time to be increasing exposure to questionable mortgages? More ominously, only $1 billion of that figure is prime and the rest is Alt-A, according to Hintz’s estimate.

The picture emerging is that of an investment bank that is dancing as fast as it can. If Lehman can keep piling up more assets, and if these assets come back, Lehman comes out a big winner. But if it didn’t properly mark down those assets during these bad times, the investment bank’s returns —and therefore its profitability—will be much lower in the future.

And that’s the good case. If the assets do not recover, then time is against the firm.

There is a larger, monetary policy issue here. The Federal Reserve has announced that it will lend to investment banks for the first time since the Depression, acting as a lender of last resort. At the very least, regulators should be demanding that the investment banks bring down their leverage and reduce their risk. Are the regulators sending a stern-enough message to Lehman? If so, it’s not getting through.

The implications of the Fed's actions in the case of Bear Stearns are enormous. It has radically extended its scope of regulation and activity beyond traditional banking to investment banks, non-members of the Federal Reserve System, and set itself up as the lender-of-last-resort to the entire financial community. This needs to be examined closely by the Congress, in addition to the specific actions with regard to Bear Stearns.

Four Largest US Banks Earnings Outlooks Slashed

Four largest U.S. banks' outlooks slashed: Oppenheimer
Wed Mar 26, 2008 1:22am EDT
By Jonathan Stempel

NEW YORK (Reuters) - The earnings outlooks for the four largest U.S. banks have been slashed by Oppenheimer & Co analyst Meredith Whitney, who said there is "no clear end in sight" to downward pressure on the sector's profits.

In a report late Tuesday, Whitney said Citigroup Inc the largest U.S. bank by assets, might lose $1.15 per share in the first quarter, four times her prior forecast for a 28 cents per share loss. She expects the bank to lose 15 cents per share in 2008, after earlier seeing profit of 75 cents per share.

Whitney in October correctly predicted that Citigroup would cut its dividend and raise $30 billion of capital.

The analyst on Tuesday also lowered her first-quarter profit per share forecasts for Bank of America Corp to 35 cents from 92 cents, for J.P.Morgan Chase & Co to 70 cents from 86 cents, and for Wachovia Corp (WB) to 55 cents from 78 cents.

She cut her 2008 profit per share forecasts to $3.25 from $3.65 for Bank of America, to $2.90 from $3.20 for JPMorgan, and to $2.70 from $3.05 for Wachovia. The new forecasts are below analysts' average forecasts compiled by Reuters Estimates.

"Despite cutting estimates for financials by over 30 times since November, we are confident this will not be our last reduction in 2008," Whitney wrote. "As key mark-to-market indices trend lower, the housing market worsens, and the U.S. consumer comes under increasing pressure, we anticipate further downside to both estimates and stock prices."

She added: "We anticipate the current credit cycle to be the worst in generations."

The analyst left her profit per share forecast for Wells Fargo & Co (WFC.N: Quote, Profile, Research), the fifth-largest U.S. bank, unchanged at 55 cents for the first quarter and $2.15 for the year.

Whitney expects Citigroup to suffer $13.12 billion of write-downs in the first quarter, on top of $18.1 billion of write-downs and costs tied to subprime mortgages in the fourth quarter.

The analyst said the bank's first-quarter write-downs might include $9 billion for collateralized debt obligations, $1.97 billion for commercial mortgage securities, and $2.15 billion for "leveraged" loans used to fund corporate buyouts.

She said Bank of America might suffer $4.29 billion of write-downs, including about two-thirds from CDOs.

JPMorgan might suffer $2.83 billion of write-downs, with nearly half from leveraged loans, while Wachovia faces a possible $1.53 billion of write-downs, with about half tied to commercial mortgages, she said.

Whitney rates Citigroup "underperform," and the other three banks "perform." These reflect how shares may perform relative to the Standard & Poor's 500 .SPX over 12 to 18 months.

In Tuesday trading, shares of Citigroup closed at $23.42, Bank of America at $40.97, JPMorgan at $46.06 and Wachovia at $30.04. The shares are down a respective 55 percent, 21 percent, 5 percent and 47 percent since last March 26. The S&P 500 is down 6 percent over that time.

(Editing by Tomasz Janowski)