Investment Fraud Lawyer Blog

In her March 30 “Fair Game” column in the New York Times Business Section, veteran reporter and columnist Gretchen Morgenson reviewed the latest developments in the plight of thousands of individual investors stuck with auction-rate securities that their brokers had told them were “as good as cash.”

As we now know, auction-rate securities are debt obligations of an issuer – usually a municipality, non-profit or closed end mutual fund – whose interest rates are set at regular auctions, typically held every seven to thirty five days. With the gridlock in $330 billion auction-rate securities market, investors cannot get out of these investments while the auctions continue to fail. They have limited choices: They can hope that the issuers of the auction-rate securities offer to buy them back, they can hope to sell them in the secondary market, they can hope the market unfreezes or they can sue the brokers who sold them the securities, often with a promise that they could be cashed in weekly.

Investors in auction rate securities issued by municipalities or non-profits are probably best positioned. Most such auction rate securities provide for much higher default rates when auctions fail. Accordingly, the issuers have strong incentives to seek refinancing to redeem their auction rate securities. Already various such issuers have announced their intent to refinance.

Continue reading " Auction Rate Securities:"Liquid Assets" That You Can't Sell " »

If you own auction rate securities, you may wind up holding on to them a lot longer than first envisioned. Auction rate securities, which were generally sold as liquid money market or cash equivalents, may now be long-term investments. Most of the auction rate securities market has been frozen since mid-February. To compound the problem, municipalities, non-profits, mutual fund companies, and other issuers have no obligation to redeem the auction rate securities, even though these were sold as safe and liquid as money market funds, according to Bloomberg.com.

Prior to late last summer auctions had rarely failed during the past twenty years. The auction rate market grew rapidly to the point where Bank of America Corp. estimates it is currently worth $330 billion. Of that amount, approximately $60 billion was sold by closed-end funds and most of the remainder by municipalities and non-profit organizations.

The auction rate freeze has far-reaching implications for thousands of small companies and individuals. As reported by Rebecca Buckman in the Wall Street Journal, Silicon Valley start-up companies are starting to feel the pinch. Many of these closely held companies had placed their cash into auction-rate instruments believing that these securities were safe and nearly the same as cash. Then when they needed the money to make payroll or fund operations they found they couldn’t get it. Similarly, many individual investors have placed tax monies, retirement funds and “rainy day” funds in auction rate securities only to find these funds frozen. In many cases, this can result in serious financial hardship to such individuals.

Continue reading " Auction Rate Securities Update " »

The $330 billion auction-rate securities market is still frozen solid. Since February 13, hundreds of auction failures have occurred each day. The results can be devastating: The issuers are forced to pay high penalty interest rates. The investors are unable to extricate themselves from these investments, even though their brokers sold the securities as if they were as liquid as cash or cash equivalents. To add insult to injury, the brokerage firms continue to get paid by the issuers to hold the auctions that fail.

As many have recently – and painfully – learned, auction-rate securities are long-term bonds intended to behave like short-term debt. They have been sold by brokers as liquid investments and categorized as cash and cash equivalents. The rates are set through a bidding process managed by investment banks and are usually held every seven, 28 or 35 days.

In mid-February, the auction rate market collapsed as investors stopped buying these securities based on fears about the creditworthiness of the bond insurers who guaranteed the debt. At that time, the investment banks ceased stepping in and covering the shortfalls in demand by purchasing the auction rate securities for their own accounts.

Continue reading " $330 Billion Market for Auction Rate Securities Frozen, Yet Brokers Still Get Paid: Regulators Investigate " »

Is the commercial mortgage-backed securities market the next shoe to drop? The U.S. economy is suffering serious financial stress as a result of complex derivative credit securities and inadequate risk analysis. While the federal government seems aggressively intent on providing enough liquidity to the banking system to avoid a financial meltdown and eventually regain control of the markets, can they accomplish it in time?

According to a March 19, 2008 article in the Co-Star Group Real Estate Newsletter, Wall Street’s wild swings and the turmoil in the credit markets are confounding the commercial real estate industry. In recent weeks, the CMBX indexes that follow commercial mortgage-backed securities suggests that such securities have lost roughly 20% of their value.

Continue reading " Commercial Mortgage-Backed Securities Are Losing Value " »

In a somewhat shocking announcement Thursday afternoon, Bloomberg.com reported that, on March 25, 2008, James Cayne, former Chairman of Bear Stearns had sold his entire 5.66 million share stake in the company for $61 million ($10.84/share). The sale surprised many observers who expected competing bids for Bear Stearns. In fact, Cayne and Joseph Lewis, another major shareholder, had tried to drum up competing bids for Bear as late as last week.

The “get out while the getting is good” sale suggests that Cayne himself may have concerns about Bear’s underlying value. The Bear has been notoriously difficult to value because of its intricate involvement in a broad array of complex derivative arrangements, many of which are illiquid. In addition several of Bear’s core business segments have significant exposure to volatile market conditions. Since it would be logical to expect that Cayne would want to maximize the value of his huge holding in the Bear, apparently he concluded that $10.84/share was close to its maximum value.

Continue reading " Former Bear Stearns Chairman Sells All of His Stock: What Does He Know That We Don't? " »

Carrington Capital Management, LLC, a $1 billion hedge fund, is looking for a few good investors. The fund, which specializes in mortgages, is asking investors to lend it as much as $200 million with an 18 percent interest rate on new preferred shares.

Carrington is raising the money to replace bank loans but maintains that its relationship with traditional lenders Citigroup and JP Morgan Chase remains “good.”

How good can the bank relationships be when you have to pay investors 18% interest to borrow money? The hedge fund’s inability to obtain credit from its traditional lenders and the high rate of interest it is being required to offer in its efforts to raise capital indicate a “rocky road ahead.’

Merrill Lynch, which has already written down approximately $24.5 billion on its subprime securities investments, is anticipated to write down additional investments in the first quarter of 2008. Noted stock research firm, Sanford C. Bernstein & Co., estimates that Merrill Lynch will write down an additional $4.5 billion on collateralized debt obligations (“CDOs”). Merrill Lynch reported that it held approximately $30.4 billion in CDOs at the end of 2007 and the values of CDOs have fallen sharply since that time.

Bernstein analyst, Brad Hintz, believes that Merrill’s problems associated with subprime securities and other related derivative instruments will continue to impact the firm for the foreseeable future. Hintz said “It will take at least several years for Merrill to fully divest itself of these troubled assets.”

Continue reading " Merrill Lynch's Subprime Problems to Continue " »

Well-respected banking analyst, Meredith Whitney of Oppenheimer & Co., predicts that Citigroup may be facing additional writedowns of $13.1 billion on collateralized debt obligations and leveraged loans. In addition, Ms. Whitney now anticipates that Citigroup will lose $.15/share during 2008.

Previously, Citigroup had written down approximately $18 billion on its subprime securities investments and was forced to cut its dividends. As a result, the company has been in a serious cost cutting mode, eliminating 4,200 jobs with plans for additional cuts. Previous estimates have suggested that thousands of additional Citigroup employees are at risk of losing their jobs.

Continue reading " Analyst Expects More Big Subprime Losses for Citigroup " »

Investors across the country with accounts in Charles Schwab Corp. have learned the hard way that their so-called "money market fund" wasn't as safe as they thought it was. The fund in question, Schwab's High Yield Plus Select Fund (SWYSX) has declined twenty-two percent since January 2, 2007 due to excessive investments by the fund in subprime mortgage-related products. Unfortunately, many financial advisors put their clients' short-term money into the fund. Many of the advisors have complained that they believed the fund was essentially a low-risk money-market fund and, indeed, Schwab and other firms have often promoted these funds as cash alternatives since 2003 when money market rates hovered at around one percent. The problem is that neither Schwab nor advisors buying the fund for their clients highlighted the extra risk in the fund, preferring, naturally, to highlight only the extra yield the fund could achieve while simultaneously accepting higher commissions. As Peter Crane, Editor of Money Fund Intelligence of Westboro, Massachusetts, pointed out in a recent article in Investment News, "Nobody gets paid to put investors in cash."

Continue reading " Schwab Fund Sold as Money Market Drops by Twenty-Two Percent " »

As a result of the subprime securities crisis and the ensuing credit crunch, a “run on the bank” at Bear Stearns forced the company to sellout to J.P. Morgan for just $10 a share, far below its reported book value. Once the country's fifth-largest investment bank, the sudden collapse of Bear is the latest sign that America’s financial system has overheated.

In a desperate attempt to get the financial markets humming again, the Federal Reserve is trying to stabilize the credit market before a failure of confidence contaminates the entire financial system. Otherwise, further economic decline could spread to other banks and beyond.

Steve East, chief economist for FBR Capital Markets says, "As far as Wall Street securities houses go, Bear Stearns wasn't too big to fail. It was too interconnected to fail."

Continue reading " Bear Stearns' Collapse Affects Main Street America " »

Experts fear that Wall Street firms will cut thousands of additional jobs in the coming months as liquidity concerns spread. Jo Bennett, an executive search firm specialist in New York, estimated that job cuts by Wall Street firms “could be more than 100,000 in a few years.” Similarly, USA Today reported that New York City, alone, could lose over 20,000 jobs in the financial sector during the next 2 years.

Already, Wall Street firms have aggressively cut jobs in an effort to get costs under control. Bloomberg.com reports that more than 34,000 jobs have been cut in the last nine months as a result of the subprime crisis and ensuing credit crunch. The job cuts have impacted a wide array of firms with at least eleven firms having eliminated over 1,500 jobs. The largest job cuts have taken place at Citigroup, Lehman Brothers, Bank of America, Morgan Stanley, and Merrill Lynch.

Continue reading " Wall Street Expected to Pare More Jobs as Liquidity Concerns Spread " »

Over recent months, the list of major hedge funds that have halted investor withdrawals and/or appear to be on the brink of collapse has been growing rapidly. These developments underscore the liquidity problems being experienced by the major hedge funds. This poses a major threat to the financial markets. Hedge funds are typically among the biggest and most active players in the financial markets and further deterioration of these funds could be disastrous. Moreover, many hedge funds are intricately involved in the explosion of derivative investments that have bonded various firms and hedge funds together in ways impossible to predict. Thus, the ramifications of major hedge funds imploding presents far reaching risks to other market participants.

This impending problem was summarized in an article in The Wall Street Journal by Liz Rappaport and Justin Lahart entitled “Debt Reckoning: U.S. Receives a Margin Call.” In pertinent point, the article concludes “The resulting blow to confidence threatens to further weaken lending, borrowing, spending and investment in the U.S. economy. ‘Hedge fund blow-ups have so far been one-off situation. One worry is that we’ll cross some line and there’ll be a systemic wave of fund failures. It’s a reason why the market is so nervous’ says John Tierny, credit derivatives strategist at Deutsche Bank.”

Continue reading " Faltering Hedge Funds Threaten Financial Markets " »

Investors in conservative U.S. Bond Funds should be on the alert for possible risks in such funds due to the existence of so-called "credit default swaps" in the fund's portfolio. These investments - essentially a futures contract tied to whether a bond issuer's credit rating will get better or worse - are not strictly regulated by the Securities and Exchange Commission and details regarding their risks are not typically explained in the fund's prospectus.

Many bond fund managers use these swaps as a way to achieve a slightly higher yield for the fund. Unfortunately, there are various significant risks associated with these types of arrangements. For example, if the bond issuer defaults, the fund, which has essentially agreed to insure against default, is required to pay for the loss. This could result in the fund manager having to sell other fund assets, thereby dragging the fund's performance. Additionally, credit default swaps are carried at values that are unreliable and may result in overstatement of the fund’s Net Asset Value. The price of credit default swaps is based on a "fair value estimate" that may or may not be realized when it comes time to have to sell it. Thus, the valuation of these instruments is inherently unreliable. Finally, fund managers are exposed to the risk that the institution on the opposite side of the transaction, "the counter party" may experience financial problems that would interfere with its ability to pay the premium for insuring the bonds.

Continue reading " Credit Default Swaps Pose a Risk to U.S. Bond Funds " »

Not surprisingly, some financial advisers are more inclined to exploit a client’s fear during a bear market than during a bull market. In periods of turmoil, such advisors encourage so called “safety net” investment vehicles.

The term “safety net” is used to describe an investment that promises the upside of a market with little or no risk. In some cases, guarantees such as a minimum income or principal protection are offered. Sometimes a bonus of at least 7% of the account value is also promised when an agreement is signed.

When an advisor pitches a safety net investment, it usually involves an insurance product, e.g. equity indexed annuity or variable annuity with living benefit guarantees. The downside of safety net investments is that while agent commissions are high, returns are low - averaging about 2% to 3% annually. Also, a surrender charge or exit fee of 6% is incurred if money is withdrawn within the first six to eight years. Finally, in many cases, the promised bonus is illusory.

Continue reading " Investors: Beware the "Safety Net" Trap Associated with Equity Indexed Annuities and Variable Annuities " »

According to analyst Richard Bove, Bank of America may take a $6.5 billion loss provision in the first quarter of 2008. Bove anticipates that this loss provision would be established to cover possible future losses in Bank of America’s subprime mortgage portfolio and home equity portfolio.

Recent reports have predicted that both of these segments of the market are likely to experience serious difficulties in 2008 and 2009. In late January, Business Week published an article, “The Home Equity Crisis Ahead” by Mara Der Hovanesian which described the deterioration of the $850 billion home equity market. In this article, Amy Crews Cutter deputy chief economist at Freddie Mac, was quoted as stating “The home-equity lender is going to get hosed.” Similar opinions have been expressed regarding the subprime mortgage market. In its March 31, 2008 edition, Fortune quotes Princeton economist Paul Krugman stating “I think there’ll be $1 trillion of losses on mortgage –backed securities showing up somewhere.” To date, securities firms and banks have disclosed only about $195 billion in losses related to the mortgage markets.

Continue reading " Bank of America: More Subprime Problems Ahead? " »

Last week when J.P. Morgan announced a Fed-supported acquisition of Bear Stearns for the fire sale price of $236 million (roughly $2/share), it unleashed a frenzy of activity in various corners of the financial markets which will play out over the coming months. The transaction has already resulted in strong dissention from shareholders, in legal claims against Bear Stearns, in government investigations, and in competition over how Bear Stearns’ carcass will be devoured.

The background of Bear Stearns’ demise has been well publicized. Beginning at least as early as late 2006 and continuing through 2007 Bear Stearns experienced an array of problems arising out of the subprime securities crisis that lead to the ensuing credit crunch. Throughout this period, Bear Stearns consistently maintained that its finances and liquidity were more than adequate to sustain its business. As recently as the week of March 10 2008, Bear Stearns maintained that its book value remained at approximately $84/share. At the same time Bear Stearns CEO Alan Schwartz appeared on CNBC and stated “we don’t see any pressure on our liquidity, let alone a liquidity crisis.” Bear Stearns’ stock was trading at around $60/share. Several days later, Bear Stearns needed money to sustain operations. Still the value of Bear Stearns shares only dropped to about $26/share. Then came the announcement that J.P. Morgan, with support from the Fed, had agreed to buy Bear Stearns for $2/share.

Continue reading " Bear Stearns Fire Sale Creates a Frenzy in the Financial Markets " »

Bear Stearns' pending acquisition by J P Morgan Chase has caused investors to question how Bear, which had nearly $400 billion in assets and $12 billion in shareholder equity, went from normalcy to near bankruptcy in seven days.

Some experts blame Bear's fall on opaque assets, derivatives exposure and liquidity demands. The fact however remains that a “run on the bank” led to the company’s sudden demise.

"If the market is driven by an irrational fear, then it's very difficult to come up with a strategy that can quell that," says Kris Niswander of SNL Financial.

Continue reading " Can Other Firms Avoid Bear Stearns' Fate? " »

According to the Financial Times, J P Morgan Chase will be “forced to improve its offer [to acquire Bear Stearns]--driving shares in the beleaguered [Bear Stearns] to nearly three times the price at which J P Morgan agreed to take it over.”

Investors bet that opposition from shareholders, which include Bear Stearns employees who own about a third of the shares, could force the takeover price to be raised. Meanwhile, J P Morgan executives express confidence that the deal will be approved.

If the offer goes through, Bear's shareholders will incur huge losses on the value of their investments. If Bear's board recommended another offer, the company would have to issue 20% of its share capital to J P Morgan at approximately $2 a share. Furthermore, even if the deal falls through, J P Morgan will be able to purchase Bear's Madison Avenue headquarters for $1.1 billion.

Continue reading " Investors Bet On Rival Bear Bids " »

Major law firms representing both investors and financial institutions have been bracing for a flood of lawsuits resulting from the subprime mortgage meltdown. While the tsunami has yet to occur, the storm does appear to be picking up steam.

Business Week reporter Michael Orey examined this situation in the March 24, 2008 issue. Mr. Orey concluded that, while the volume of litigation that most market participants and their attorneys had anticipated has not yet hit, there is also the strong sense that it is coming.

Observers believe that there are various reasons behind the more deliberate approach to claims than often seen in the past. Most cite the differences in the types of victims and the complexity of the securities as primary reasons behind the deliberate approach. The lack of transparency of both marketplace and specific securities is also a contributing factor.

Continue reading " Subprime Lawsuit Tsunami On The Horizon " »

Bond insurer Security Capital Assurance, LTD, which has been stripped of its AAA bond insurance rating, is trying to cancel insurance it wrote on certain collateralized debt obligations or CDOs. It was reported on March 14, 2008 by Jody Shenn at Bloomberg.com that Security Capital was seeking to terminate seven contracts on CDOs with an entity that it said had not met its obligations under the contracts. At that time Security Capital declined to identity the other entity that was disputing the termination.

Subsequently, Merrill Lynch sued a Security Capital subsidiary to prevent the bond insurer from canceling $3.1 billion in contracts on CDOs. Merrill, which has already taken $24.5 billion in writedowns on mortgage-related debt, faced additional losses if the insurance is cancelled.

According to Saskia Scholtes of Financial Times Online, Merrill Lynch saw its share price fall 11% on concerns that it may have to take further writedowns. These concerns were apparently fueled by Merrill’s recent lawsuit against XL Capital, the Security Capital subsidiary. Scholtes reported that Merrill’s lawsuit alleged that XL Capital improperly terminated seven derivative contracts “without any basis and under a pretext based entirely on rank speculation.... Apparently, in light of the current dramatic downturn and deterioration in the credit markets, defendants are having ‘sellers’ remorse’ and are seeking to avoid their potential obligations of up to $3.1 billion under the credit default swaps at issue.”

Continue reading " Merrill Lynch And Bond Insurer Fight It Out In Court " »

Wall Street brokerage firms and investment banks are desperately struggling to raise large amounts of cash to stabilize their operations after the recent adverse events relating to the subprime meltdown and the resulting credit crunch.

Many banks are selling loans, especially leveraged buyout loans, at deep discounts. Such actions raise cash and remove these loan liabilities from the firm’s balance sheet. The banks’ holdings of LBO loans have dropped from $163 to $129 billion since the beginning of the year. Banks are breaking ranks from their lending groups and offering their portions of the LBO loans for a fraction of their face value. Goldman Sachs, for example, is selling its piece of the Chrysler $7 billion in loans for as little as 72 cents on the dollar.

In addition to selling loans, some banks are selling off business. Citigroup is reported to be selling its Australian retail brokerage unit. It is also reported that Citi will close branches in Taiwan and merge others in Singapore and Hong Kong. UBS AG, the large Swiss bank, is also reported to be considering selling business units to raise cash. To date, UBS has denied reports that it is selling its PaineWebber brokerage unit in the United States.

Continue reading " Wall Street Firms Scramble To Raise Cash And Stabilize Operations " »

On the heels of the sale of Bear Stearns at the fire sale price of $2 per share, Wachovia Corp. analyst Douglas Sipkin surprised many by stating that Merrill Lynch “is the riskiest” of the remaining large U.S. investment banks, as reported today by Bloomberg.com. Sipkin said that Merrill has $30.4 billion in subprime holdings and has the “worst” liquidity ratio of 52 percent.

Wachovia’s analysis was surprising because recent speculation had been that Lehman Brothers was the brokerage firm on the shakiest ground due to its mortgage and fixed income exposure. In recent days, the market price of Lehman shares had been dropping dramatically while the cost of credit default swaps on its debt obligations had soared.

These developments underscore the uncertainty affecting brokerage firms as the entire marketplace seems to be asking who holds the risk and how much risk is being held. The lack of transparency has been aided by the proliferation of complex derivatives, the existence of off-balance sheet items and the major impact of unregulated players in the financial marketplaces.

The Federal Reserve’s actions to bail out Bear Stearns have far reaching implications for all investors and taxpayers. Two well-respected columnists at the New York Times – business reporter Gretchen Morgenson and Op-Ed columnist and Princeton economist Paul Krugman – have strongly criticized the Federal Reserve’s decision to bail out Bear Stearns.

Morgenson, whose column appeared on Sunday morning March 16 before the announcement of the purchase of Bear Stearns by JP Morgan at a fire sale price of $2 per share, wrote of the possible consequences of living in a world where regulators will rescue “even the financial institutions whose recklessness and greed helped create the titanic credit mess....” She predicted that such consequences could include a weaker currency, rampant inflation, a continuation of the year-long slow bleed at banks and brokerages firms, or all of the above.

By agreeing to a 28-day credit line to Bear Stearns on Friday, the Federal Reserve Bank of New York all but admitted that its doctrine is “Rescues ‘R’ Us” and that no sizable firms with a book of mortgage securities or loans out to mortgage issuers could or would be allowed to fail.

Continue reading " Bear Stearns' Bailout: The US Is Now Officially On The Road To Becoming "Bailout Nation" " »

Recently, many investors have been trapped in auction rate securities when the auctions for such securities failed. The SEC is now proposing action that will permit local governments to buy their own debt at auction without being suspected of engaging in market manipulation. While the SEC’s aim is to assist local governments who have been paying higher interest rates because of the failure of the auctions, it may also permit investors in such securities to get out of an illiquid investment that had been sold as one that was as liquid as cash.

According to Kara Scannell’s article in the March 13, 2008 edition of The Wall Street Journal, during a congressional hearing on Wednesday, Erik Sirri, director of the SEC’s division of trading and markets, said the SEC is drafting guidance to “clarify that, with appropriate disclosures,” municipalities will be allowed to purchase their own debt at auction without triggering market-manipulation concerns.

The change in guidance comes in response to calls from Congress, Wall Street, and especially from the local governments that were faced with unusually high borrowing costs as auctions for their debt failed and the interest rates re-set to higher levels. More than $80 billion in securities have failed at auction resulting in interest rates as high as 20% for some municipal borrowers.

Continue reading " Will Proposed Changes Provide Any Significant Relief For The Frozen Auction-Rate Securities Market? " »

When Bear Stearns’ officers and directors agreed to sell the company to J.P. Morgan for the “fire sale” price of $2/share ($236 million in total), did they protect the interests of the company’s shareholders and get reasonable value for the stock? This question is likely to be debated in the court system for many months.

While many explanations have been given for why the transaction was necessary to protect the financial markets and keep the financial system running smoothly, no one has explained why bankruptcy was not a far better alternative for Bear Stearns’ shareholders. At the end of its last fiscal year (November 2007) , Bear Stearns reportedly had $11.1 billion in tangible equity. As late as last week, Bear Stearns claimed that its book value was still about $84/share. On Saturday, the Wall Street Journal reported that the Bear Stearns’ headquarters building appeared to be worth $1.2 billion or more. Today, the Journal reported that “J.P. Morgan is essentially getting Bear’s coveted prime brokerage business for free. It is twice the size of Bank of America’s prime brokerage, which is on the auction block for about $1 billion.” In light of these circumstances, shareholders have to question whether they would have been better off with a bankruptcy filing and an orderly liquidation of assets.

Will the subprime crisis and resulting credit crunch claim more victims? The rapid demise of Bear Stearns and its ensuing fire sale to J.P. Morgan has lead to rampant speculation about whether other firms are on shaky ground and likely to experience similar disasters. Recent press articles have stated that Lehman Brothers, a firm that, similar to Bear Stearns, has a substantial exposure to mortgage and fixed income securities, has been the subject of market concern. In recent months, Lehman’s shares have fallen dramatically in value and the cost of insuring its debt has soared.

While Lehman has issued an array of statements to reassure the public of its solid financial foundation and its readily available liquidity, these statements seem reminiscent of similar statements made just last week by Bear Stearns. In fact, on March 12, 2008, Bear Stearns’ CEO Alan Schwartz appeared on CNBC and stated “We don’t see any pressure on our liquidity, let alone a liquidity crisis.” Two days later Bear Stearns needed funds from the Fed to open its doors. Four days later it was sold to JP. Morgan for $2/share. So, unfortunately, it’s impossible to know exactly what Lehman’s position really is. The wide-spread use of complex derivative securities by Lehman and other major Wall Street firms has made it virtually impossible to gauge who has the risk and how much risk they have.

Continue reading " Is Lehman Brothers Next? " »

The recent purchase of Bear Stearns by JPMorgan Chase & Co. for a price of $2 per share will cause a “major negative revaluation” of financial stocks, according to Meredith Whitney, an analyst with Oppenheimer & Co.

As reported on Bloomberg.com, Whitney said, “Financial stocks have further downside of as much as 50 percent based upon 1990/1991 multiples of tangible book values. As we believe we will begin to see goodwill writedowns during the first half of this year, we believe investors will focus more on tangible book value and stocks will quickly revalue to far lower levels.”

As of 7 a.m. EST, Bear Stears was down 88 percent to $3.50. Lehman Brothers Holdings Inc. was down 17 percent to $32.50, JPMorgan was off 1.6 percent at $35.94, and Goldman Sachs Group Inc. was down 7.9 percent to $144.50.

Citigroup’s recent bailout of its Asta and Mat hedge funds once again demonstrates to the investing public and to Wall Street that hedge funds – whether you invest in them or manage them – are not for the faint of heart. Francesco Guerrera wrote in the Financial Times online (ft.com) on March 11, 2008 that Citigroup has been forced to launch a $1 billion bailout of six internal hedge funds because of the turmoil in the once safe municipal bond market. Citigroup has agreed to inject $600 million in additional capital and pledged another $400 million to shore up the funds.

Fear that mounting losses on mortgage-related products might cause bond insurers to lose their coveted triple-A rating has thrown the municipal bond market into disarray. As the price of municipal bonds plunged, the Asta and Mat funds sold to Citigroup brokerage clients and wealthy private bank customers were subject to margin calls by prime brokers.

Continue reading " Citigroup Drops Another Billion To Bail Out Six Proprietary Hedge Funds " »

Many investors are being provided with grossly inflated valuations of their subprime securities holdings because Standard & Poor’s and Moody’s have failed to cut the ratings of many AAA-rated securities even though those securities do not meet the criteria to be classified AAA. The bulk of these securities are believed to be held by banks and insurance companies.

A recent study by Bloomberg concluded that 80 of the AAA securities in the ABX indexes fail to meet S&P’s criteria for AAA-rated securities. The study concluded that, if the ratings standards were accurately applied, at least $120 million in AAA bonds would be downgraded. According to Credit Suisse Group, record home foreclosures have caused AAA debt to fall to 61 cents on the dollar, but those same bonds would be worth only 26 cents if downgraded to AA. If Credit Suisse is correct, investors in just these securities currently rated AAA have an undisclosed loss of at least $42 billion.

Kyle Bass, chief executive officer of Hayman Capital Partners, was blunt about the situation when he said, “The fact that they’ve kept those ratings where they are is laughable. Downgrades of AAA and AA bonds are imminent, and they’re going to be significant.”

Continue reading " Investors Are Being Misled About The Real Values Of Their Subprime Securities Holdings " »

The most recent action by the Federal Reserve is little more than a veiled attempt to foist the losses confronting Wall Street banks off on the American public. Yesterday, the Fed pledged to lend $200 billion in treasury securities to Wall Street banks and accept AAA-rated private label mortgage backed securities as collateral. Sounds reasonable at first blush but there’s a hidden kicker that is likely to cost taxpayers billions.

The real problem is that most AAA-rated private label mortgage backed securities are simply not AAA. To the contrary, many mortgage backed securities currently rated AAA do not meet the criteria of the ratings agencies for AAA securities and should be downgraded significantly. Thus, such securities are significantly overvalued and pose a much greater risk to taxpayers than the Fed would have the public believe.

This situation was well documented in a March 11, 2008 article written by Mark Pittman of Bloomberg.com entitled “Moody’s, S&P Defer Cuts on AAA Subprime, Hiding Loss.” According to Mr. Pittman, none of the 80 AAA securities in the ABX indexes that track subprime securities meet S&P‘s requirements for AAA securities. Mr. Pittman provides several examples of AAA-rated issues which certainly do not satisfy AAA requirements. Mr. Pittman’s investigation concludes that proper evaluation of subprime securities would “strip at least $120 billion in bonds of their AAA status.“ In fact, many experts believe that significant downgrades of many so-called AAA mortgage backed securities are imminent.

Continue reading " Has The Fed Lost Its Head? The Federal Reserve Acts To Pass Off Wall Street Losses To The U.S. Taxpayer " »

In a story posted last week on Bloomberg.com, Christine Richard and Elizabeth Hester reported that the world’s second-largest bond insurer, Ambac Financial Group, Inc., managed to raise about $1.5 billion through sales of shares and convertible units. This capital infusion, which more than doubled the amount of outstanding stock, may have salvaged Ambac’s AAA credit rating. Even though the sale diluted the ownership of existing shareholders, the offering was probably enough to convince Moody’s and Standard & Poor’s to maintain Ambac’s rating. Ambac CEO Michael Callen said existing shareholders, new investors, private-equity firms and banks all purchased stock in the offering.

Cerberus Capital Management LP, a private-equity firm based in New York, invested $50 million in the equity units. Banks purchased $405 million of common stock for 40 percent of the shares. Ambac spokesman Paul Burke said that the Royal Bank of Scotland and BNP Paribas purchased $95 million of shares through a private placement.

Continue reading " Ambac Credit Rating Saved By $1.5 Billion In Capital " »

Investors in securities backed, directly or indirectly, by home mortgages including, in particular, subprime mortgages, may be facing a financial Armageddon. As the credit crunch continues, a virtual “tsunami” of loan defaults and foreclosures looms on the horizon.

Recent reports underscore the problems facing these investors. According to the Mortgage Bankers Association, about 3 million homeowners were behind on their mortgages as of December 31, 2007. Moreover, last week Noelle Knox of USA Today reported that “an additional 1 million-plus borrowers were at risk of imminent foreclosure.” Foreclosure activity has been particularly heavy in states such as California, Nevada, Florida and Michigan where homes were regarded as “highly overpriced” as far back as 2005.

The ongoing decline in home prices nationwide is further exasperating the situation. Moody’s Economy.com predicts that, by the end of March, 8.8 million homeowners will owe more on their mortgages than their home is worth. It is feared that, as prices continue to decline, many homeowners won’t continue paying their mortgages because their home simply isn’t worth the amount of the mortgage. Furthermore, the housing market seems caught in a vicious circle. As more homes are foreclosed, the supply of housing increases, the price of housing declines further and, in many cases, neighborhoods can be destroyed.

All of this paints an unpleasant outlook for investors. More losses, perhaps very significant losses, are forecasted.

Bear Stearns today saw its price per share hits its lowest level since 1999. The stock hit $60.26 earlier today before re-bounding to $63.02 at 3:00 p.m. As quoted in Bloomberg.com, Michael Mainwald, head of equity trading at Lek Securities said, referring to Bear Stearns, “There’s an insolvency rumor and concerns on liquidity, that they just have no cash.”

Even though Bear Stearns denied such rumors, other firms such as Sanford Bernstein advised their clients against purchasing Bear Stearns. An analyst for Sanford Bernstein, Brad Hintz, said that Bear Stearns was likely to see its financial leveraging continue to unravel.

The price of credit-default swaps on Bear Stearns went from 246 basis points to 792, according to data from CMA Datavision for one-year contracts. An increase in this price indicates a weakening perception of Bear Stearns’ credit quality.

Continue reading " Has Bear Stearns Run Out Of Money? " »

Diya Gullapalli of the Wall Street Journal reported on March 7,2008 that troubles with Structured Investment Vehicles (SIVs) continue to plague taxable money-market funds. SIVs, which issue short-term debt such as commercial paper and medium-term notes to fund investments in long-term securities, are used to subsidize money market mutual funds. These SIV investments are under pressure as a result of the credit crunch.

Investment-management companies and other money-market fund brokers, such as Credit Suisse Group, Janus Capital Group Inc., Northern Trust Corp., and Wells Fargo & Co., recently disclosed that they are buying the assets of troubled SIVs or have pledged to do so if necessary even though such purchases will likely cut into earnings. Observers worry that problems with SIV’s could cause mutual funds to “break the buck” or fall to less than $1 per share, which will precipitate a massive decline in consumer confidence.

Continue reading " Banks Work To Keep Money Funds From "Breaking The Buck" " »

As reported last week in the Wall Street Journal by Carrick Mollenkamp and Alistair MacDonald, for the third time this year a global bank has been caught with trading irregularities. Two weeks ago, it was Lehman Brothers Holdings Inc.’s turn to suspend two traders in its London office pending an equities trading inquiry.

The bank's inquiry focused on how the traders were valuing securities tied to complex equity derivatives. In their simplest form, equity derivatives allow a bank’s clients or in-house trading desk to hedge against volatile stock markets by locking in prices with indexes or specific stocks.

Continue reading " More Problems Valuing Derivative Securities " »

In an Op-Ed piece in the March 5, 2008 edition of The New York Times, Stephen S. Roach, the chairman of Morgan Stanley Asia, offered his thoughts on the dangers posed by the simultaneous bursting of bubbles in the housing and credit markets. Roach believes that the Federal Government’s efforts so far – lowering the lending rate and approving rebates for families and tax breaks for businesses – are unlikely to remedy the country's economic ills. The U.S. economy is not experiencing a standard cyclical downturn. It is in a post-bubble recession—the second in seven years. Roach believes that, for an asset-dependent, bubble-prone economy, a cyclical recovery is simply not guaranteed.

For six years, consumers made up for weak pay increases by withdrawing equity from their homes through cut-rate borrowing made possible by the credit bubble. As Roach wrote, “That game is now over.” Aggressive interest rate cuts have done little to contain the declining credit and capital markets. In fact, the imbalance between supply and demand for new homes may require home prices to fall an additional 20 percent to clear the market.

Continue reading " After The Double Bubbles Burst " »

Not since World War II – when the Federal Reserve began keeping such records – has homeowner equity been lower than 50%. On Thursday, March 6, 2008, USA Today reporter Sandra Block wrote that the Federal Reserve had reported that homeowner equity fell to 47.9% at the end of 2007. In fact, revisions to earlier reports revealed that homeowner equity was below 50% for the last nine months of 2007.

Homeowner equity is the home's market value less the mortgage balance.
While the drop below 50% is partly symbolic, average home equity actually began to decline as the last housing boom peaked in 2005.

A home is the single largest asset most Americans own. Home equity therefore accounts for a large portion of personal wealth. Americans struggling to hang onto their homes as mortgage rates adjust upward and property values decline have become quite cautious. Such conditions have broader implications for consumer spending in the USA's sputtering economy that rose by a rate of only 0.6% in the last quarter.

Continue reading " Wealth Declines For Homeowners As Home Equity Dips Below 50% " »

Greg Farrell and Noelle Knox of USA Today reported on March 7th that, according to a survey by the Mortgage Bankers Association (MBA), nearly 3 million homeowners (6.3%) were behind on their mortgages in the fourth quarter of 2007. Also, more than 1 million borrowers – representing 2% of all loans – were in foreclosure. Residents in California and Florida together accounted for 30% of the new foreclosures.

Amy Hoak of MarketWatch reported that the delinquency rate on loans past due but not in foreclosure is the highest since 1985. Hoak noted that, according to Doug Duncan, chief economist of the MBA, “Declining home prices are clearly the driving factor behind home foreclosures, but the reasons and magnitude of the declines differ from state to state."

Furthermore, the delinquency rate on mortgage loans appears poised to increase, perhaps dramatically. An estimated 1.8 million subprime ARMs are expected to reset to higher rates this year and next. Many such loans are projected to reset in May and June. They could be in default in the 3rd quarter and in foreclosure by the 4th quarter. (Borrowers are considered “delinquent” if they miss one monthly payment. Foreclosure proceedings usually do not start until a loan is 90 days past due.) While a number of ARMs have defaulted even before the reset period takes effect, weak economic conditions including rising fuel prices and declining home values coupled with higher interest rates significantly increase the chances that more homeowners will default.

Continue reading " Foreclosures Reach A Record 1 Million Homes " »

After losing billions of dollars in subprime securities itself and selling subprime securities to investors that resulted in additional billions of dollars in losses, UBS is once again urging investors to buy subprime securities backed by an exotic type of mortgage. According to UBS, subprime securities backed by option adjustable-rate mortgages represent a “great value.”

Option adjustable rate mortgages (“option ARMs”) are exotic mortgages that let the borrowers decide how much they will pay on a mortgage each month. If the borrower decides to pay less than the monthly interest charges, the mortgage balance increases. Generally, if the borrower defers paying interest charges which equal 10 to 15% of the original loan amount, payments become mandatory.

Option ARMs are a great leverage tool but, as with all leverage tools, involve increased risks. Such mortgages can easily become “upside down” (the mortgage balance is greater than the value of the house). Such mortgages can be particularly dangerous in environments where housing prices are flat or declining. Furthermore, such mortgages offer high default potential when interest rates increase.

Continue reading " UBS: It Just Doesn't Get It " »

The collateralized debt obligations (“CDOs”) and other subprime securities sold to investors in 2006 and 2007 were virtually guaranteed to pose big problems for investors. The harsh reality is that most of these securities were nothing more than bets by Wall Street that home prices would continue to rise at unrealistic rates in the future. Moreover, even if housing prices rose at their historic norms, the painful truth is that these securities were still likely to fail.

While investors continue to lose millions of dollars as the collapse of the subprime housing market continues to have ripple effects throughout the U.S. economy, many cannot help but question how we ever got into this morass. Indeed, hardly a day goes by without a news report suggesting that credit problems are worsening or that a major economic slowdown, if not recession, looms on the horizon. Surprisingly, the answer may be much simpler than some experts have led us to believe.

The sad fact is that many subprime mortgages issued in 2006 and 2007 -- estimated to total $362 billion -- were in default even before interest rates on these loans reset to new higher rates in 2008. While interest rate adjustments will certainly contribute to the record number of residential mortgage defaults and foreclosures that housing industry analysts predict will occur in future years, they are not the primary cause of the turmoil in the subprime market. The problem is not that when the loan resets, the higher loan payments will be beyond the homeowner’s means. The problem is that the borrower could never afford the home in the first place regardless of the low initial “teaser” interest rate.

Continue reading " CDOs And Other Subprime Securities Sold In 2006 And 2007 -- Doomed From The Start? " »

The credit crunch precipitated by the subprime securities fiasco seems to just keep getting worse for UBS. Not only has the firm suffered billions of dollars in losses from the subprime debacle and been identified as a focus of criminal and administrative investigations relating to mispricing and misvaluing subprime securities, among other things, but individual lawsuits and arbitration claims against the firm are mounting.

Last week, HSH Nordbank AG, a German bank, sued UBS claiming that UBS had dumped troubled mortgage investments on HSH and other investors and had mismanaged a CDO named North Street 2002-4. The lawsuit was described in an article entitled “Did UBS Dump Toxic Assets” in The Wall Street Journal on February 27, 2008. UBS was one of the biggest players in the CDO market.

Continue reading " Investors Sue UBS Over Misconduct Related To Subprime And Other Credit Market Woes " »

Securities backed by Alt-A mortgages are beginning to result in substantial losses for investors. Valuations for securities backed by these mortgages are now falling sharply, forcing certain investment funds to unwind or meet margin calls. Indeed, as a result of the worsening credit market and faltering economy, prices for these securities fell to new lows in February. As Jody Shenn reported in Bloomberg.com on February 29, Standard & Poor’s has indicated that it may cut ratings on nearly $13 billion of securities backed by Alt-A mortgages because of a “persistent rise” in loan delinquencies. This includes 1,887 debt classes tied to loans issued in 2006 and the first half of 2007.

Alt-A residential mortgages -- euphemistically known as “liar loans” in the industry because borrowers were often not required to show proof of income or assets -- have become the latest shoe to drop in the credit crisis threatening the U.S. economy. While many exotic mortgages were issued to subprime borrowers, individuals with slightly better credit ratings also took advantage of these exotic loans. The Alt-A market is highly diverse and includes loans that feature fixed interest rates as well as ‘option’ ARMs, with lower minimum payments. In terms of risk, Alt-A loans are typically characterized as loans that fall somewhere between prime and subprime.

Continue reading " Problems Facing Alt-A Mortgage-Backed Securities Pose Latest Threat To Investors " »

Thomas P. Fitzgerald, the former Chief Operating Officer of H&R Block Financial Advisors, Inc. of Detroit, Michigan, has been awarded $3.9 million in damages based upon the denial of promised employment compensation by a 3-member panel of arbitrators appointed by the Financial Industry Regulatory Authority (FINRA). Fitzgerald claimed the company refused to pay certain compensation and severance benefits it owed him by contract because he refused to sign a two-year non-compete agreement. The contract was presented to Mr. Fitzgerald as a retention package designed to entice him to remain with the company, then known as OLDE Discount Brokerage, Inc., when it was acquired by H&R Block. Several years later, when H&R Block Financial Advisors attempted to get Mr. Fitzgerald to sign a non-compete agreement, he refused, but continued to work for the company for an additional two-and-a-half years under the existing contract before his employment ended. The company then refused to pay his contractual benefits because he would not sign the proposed noncompete agreement.

The arbitration was held in Southfield, Michigan in November 2007. Page Perry partners J. Boyd Page, J. Steven Parker and James A. Nofi represented Mr. Fitzgerald.

Across the nation, credit counselors are noticing an unusual trend, as reported by Kathy Chu in a recent issue of USA TODAY. Financially squeezed borrowers have opted to pay their credit card and car expenses before (and sometimes instead of) their mortgages. This trend suggests that home owners in particular have essentially given up trying to stay current with their mortgages. Economists say if the trend continues, mortgage losses could accelerate and further drag down the economy.

Mark Zandi, chief economist for Moody's Economy.com, says the ballooning of credit card debt is especially noticeable where the economy is weak. California, Florida, Arizona and Nevada are examples.

Job loss and fewer opportunities for overtime hours coupled with an increase in grocery, gas, home taxes, medical expenses and interest rates compel consumers to supplement their income with credit.

Continue reading " Financially Stressed Consumers Use Credit To Stay Afloat " »