Almost one month ago to the day, Federal Reserve Bank of Dallas President Richard Fisher suggested to an audience of Texas mortgage bankers that the fallout from the meltdown in the subprime finance sector would remain "contained," according to the Wall Street Journal. Unfortunately, based on the flurry of reports that hit the newswires over the last 48 hours, Mr. Fisher may eventually regret having giving the impression, at least, that he is somewhat out of touch with reality. Among the more notable developments:
"GM Quarterly Profit Plunges 90% on Mortgage Losses" (via Bloomberg):
General Motors Corp. said first-quarter profit plunged 90 percent, dragged down by bad loans at the GMAC LLC finance unit and continued automotive losses in North America.
Net income dropped to $62 million from $602 million a year earlier, the Detroit-based automaker said today. Revenue declined 16 percent to $43.9 billion, largely reflecting the November sale of a majority of GMAC. GM shares fell the most in almost seven months and its bonds also declined.
GM's going to have to pay very close attention to this housing market because that's obviously a big drain on their profits,'' said Bradley Rubin, an analyst with BNP Paribas in New York. "The restructuring program did seem to help, but GM should be making money in North America by now."
"UBS Scraps Costas's Hedge Fund After Mortgage Losses," (via Bloomberg):
UBS AG, the world's biggest asset manager, is winding down John Costas's hedge-fund unit after 11 months of trading and returning client money because of losses attributed to the U.S. mortgage market.
UBS will close Dillon Read Capital Management LLC amid losses of 150 million Swiss francs ($124 million). Costas, 50, who previously ran the bank's securities unit for almost four years, gained control of the hedge fund in June 2005 as an incentive to stay. Trading started a year later. Costas will stay as an adviser to the executive board, UBS said today in a statement.
"It's been an embarrassment," Christopher Wheeler, an analyst at Bear Stearns Cos. in London, said of Dillon Read. "They never raised enough money for it to do more than break even."
UBS has been hurt by hedge funds before, losing about $700 million in 1998 when Long-Term Capital Management LP collapsed. Dillon Read was slow to start the fund and raise capital, and its challenges culminated with a shakeout in the subprime lending market, Costas said today in an interview. More than 50 lenders to the riskiest mortgage borrowers have gone bankrupt or sought buyers since early 2006, according to Bloomberg data.
"Bond Investors' Lament Fallout as Moody's, S&P Cut Ratings on Issues Tied to Subprime Loans" (via the Wall Street Journal):
More challenges are hitting bond investors who own securities backed by risky mortgages.
Over the past two weeks, Moody's Investors Service cut credit ratings on more than 30 bonds that were issued in 2006 and backed by pools of "subprime" mortgages, home loans made to consumers with troubled or sketchy credit histories. The downgrades came as more borrowers defaulted on their mortgages and caused losses to spike among the pools.
More than half the bonds that were downgraded were originally rated "investment grade" but were cut to "junk" status, because they now are viewed as much more likely to lose money. A few bonds with weak ratings already have been eroded by losses, which means investors in those bonds probably won't be repaid.
"It's unusual to see downgrades in subprime deals so soon after they were issued," said Jay Guo, a director of asset-backed securities research at Credit Suisse Group. "This is not a normal phenomenon and is a cause of concern."
The downgrades also are focusing attention on the role of credit-rating companies in the subprime downturn. Their ratings play an important part in the process of creating the bonds and in how they are valued by investors."It's embarrassing for a ratings company to downgrade bonds so quickly" after the bonds were issued, said Paul Ullman, chief executive of HFH Group, a New York hedge fund active in the mortgage market. "It reflects poorly on all parties in the underwriting process and their judgment of the credit-worthiness of the bonds."
The recent downgrades affected mostly bonds that were backed by speculative mortgage loans known as "second liens," including some that were made by units of troubled lenders Fremont General Corp. and New Century Financial Corp and were packaged and sold by Wall Street firms.
These second mortgages, which are taken out on properties that already have a first mortgage, are often used by borrowers to buy homes with little or no money down. Such loans are seeing high delinquencies because many people stretched themselves financially to take them out or were speculators betting on a rise in home prices. Lending standards were also especially loose last year.
Moody's Investors Service, a unit of Moody's Corp., is reviewing 81 bonds for potential downgrade, including a few with double-A and triple-A ratings, where risk was supposed to have been minimal. The ratings company lowered a handful of ratings on 2006 bonds earlier in the year, but the recent series of downgrades and reviews has affected many more bonds and has been more severe.
Standard & Poor's, a unit of McGraw-Hill Cos., has downgraded 43 bonds backed by subprime mortgage loans from last year and is reviewing more than 60 for downgrades.
Susan Barnes, a managing director in S&P's residential mortgage-backed securities group, said most of the bonds affected by her firm's downgrades were initially assigned "junk" ratings. She said S&P has been trying to be more proactive about issuing downgrades and reviews as it sees conditions in the subprime market worsen.
Brian Clarkson, chief operating officer at Moody's Corp., said his company is committed to having "the most accurate opinions out there at all times," and the recent downgrades reflect that. "When we assigned the ratings originally, we made an assessment about how we thought they would perform going forward based on the information we had," he said. "At the end of the day, it's a credit opinion and not a guarantee of how the bonds would perform."
In all, nearly $1 billion in bonds issued in 2006 have been downgraded or are being reviewed for downgrades because losses have risen in the pools of mortgages backing them. That still is a small portion of the roughly $483 billion of bonds that Wall Street created from subprime mortgage loans last year, according to data from Inside Mortgage Finance, an industry newsletter. Around $36.5 billion in bonds backed by second-lien mortgages were issued in 2006.
The ratings companies say they foresaw subprime problems last year, and around midyear began requiring larger loss-absorbing cushions for newer bonds they rated. That could limit future downgrades. They also say the majority of investment-grade bonds rated "A" and higher -- which constitute more than 90% of all subprime bonds -- should be adequately cushioned from losses.
"A Third of US Homebuilders May Be Downgraded -S&P" (via Reuters):
More than a third of all U.S. home builders are vulnerable to rating downgrades over the next two years as a downturn in the housing market lingers, data released by Standard & Poor's this week showed.
"The sector is now about one and a half years into what we believe may be a roughly three-year downturn," S&P said in a report. "Our home-builder rating bias is emphatically negative, as the sector is in the midst of an inventory correction of uncertain -- and potentially protracted -- duration."
About 13 percent of U.S. home builders were on review for a possible downgrade by S&P at the end of the first quarter, while 22 percent had negative outlooks, meaning a downgrade is likely over the next two years.
Ratings weakness is concentrated in junk-rated home builders; all eight investment-grade home builders have stable outlooks, S&P noted.
While investment-grade home builders appear to have adequate liquidity, "we will be looking for these companies to pare their inventory and demonstrate an ability to operate profitably at lower volumes," S&P said.
The U.S. housing market has been cooling off as home finance costs climb and subprime borrowers struggle to keep up with payments, raising foreclosure rates.
Pending sales of existing U.S. homes fell in March to a four-year low as a decline in subprime lending took its toll, data from the National Association of Realtors showed on Tuesday.
Maybe Mr. Fisher was only kidding, right? I can't wait to hear his next speech on the topic.
Look no further than the 80th legislative session for the Ritter and Thompson Bills to see who runs this state. Even Democrate Ritter changes sides for "some" reason?
History seems to repeat itself in the great state of Texas. Housing and substandard construction and homes that are built unihabitable seem to be welcomed insted of distained. The Attorney General turns a blind eye. We have become subjects we are no longer citizens.Once upon a time, in the land of pay and play, a wicked story began. It did not commence with a secret or clandestine meeting. There was no cloak and dagger stuff, like in a game of CLUE. There were no whispers of a deep throat. Nevertheless, this horrible story is repeated all over Texas. Misdeeds are committed without shame. They are cruel, open, arrogant, and ongoing. Peoples' lives are destroyed as if they are inconsequential. Their numbers grow and are reported on a daily basis like the body bag count from a war.
One would assume that this state would have learned something from its history and not allow it to keep repeating itself. Past events include the 1954, $100 million, Veterans’ Land Board Scandal that was entangled in attempted murder, bribery, and political intrigue. This debacle involved none-other-than the governor, the attorney general, senators, and representatives; there were over 250 indictments handed down. How can things be allowed to get this out of control? Who says they don't do it bigger in Texas? Have we so soon forgotten Enron? The ill-effects of Texas greed and corrupt politics are not so easily forgotten by those whose lives are ruined. And now once again, this same sort of pond-scum is allowed to take control. Do all of this state's mistakes have to reach Texas-size portions to be addressed?
These moneychangers are lead stories in magazines, written about in the Newspapers, and some make the 6 o'clock news. Then there is silence and nothing more. It is as if everyone develops amnesia, right after the information is disseminated. It is as if no one can acknowledge what is right-in-front of his or her eyes. The culprits and henchmen continue: as if no one sees anything is wrong, and God is in his heaven, and all is right with the world.
Sitting here, reading Texas Monthly Magazine, I am stunned. The article is titled, Bob Perry Needs a Hug. It is a powerful piece on the housing crisis, political power, intimidation, and injustice. It is all spelled out clearly; and it is written simply so, no matter what your level of education, you cannot miss the point. The story is actually a postscript to the November 2005 issue, Hurt? Injured? Need a Lawyer? Too Bad!, by Mimi Swartz. No one got sued because these articles told the truth. It is in black and white for anyone to read; and no one seems outraged, or even ashamed. Worst of all, it is ongoing; and no one is even stopped or punished. It is just dually noted in the text.
In another venue, is the new book, Blocking the Courthouse Door, by Stephanie Mencimer, Chapter Three; Mess with Texas: George W. Bush and the Texas Tort Moguls. It reads like chapter one from the starship, Enterprise ... but it is all true! It is an eye-popping look at the people in power, who spun tort reform like cotton candy and handfed it to us. This exposé is an in-depth assessment of the incredulous and ongoing assault on the American consumer. An assault that began right here in the great state of Texas. Is this state now the breeding ground for infamy? ( Infamy: evil reputation brought about by something grossly criminal, shocking, or brutal 2: an extreme and publicly known criminal or evil act 3: the state of being infamous) How well defined must these actions be?
Government agencies are bought and paid for, and the owner's name is mentioned as off-handedly as if it were in the society page. The same names appear that are found in the magazines and the newspapers, and these people are allowed to continue to stomp down any fear of reprisals with their checkbooks? Have we, the people, just given up? If we no longer think we matter then we don't.
It is all so absurd; it makes me think it is a bad dream or has to be make-believe. It brings to mind a fairy tale by Hans Christian Anderson called "The Emperor's New Clothes". Remember it? The emperor is narcissistic, powerful, and vain. He struts around in new clothes to gain the admiration of his subjects. His only passion is his attire. He is so bad that he attracts swindlers to his court, and they play on his vanity. They sell him on the idea that they, for a price, can weave cloth so magnificent and elaborate... that it has special power and is completely invisible to everyone who is stupid or not fit for his post. The emperor, even-though he cannot see this material, cannot admit it because he would be, in essence, admitting he is stupid and unfit for his post. So he sends for his 'yes men'. They, fearing reprisal, tell him what he wants to hear. They assure him they see the fabric, and it is as magnificent as befits a man of his station. He somehow has convinced himself that their approval of his preening, condones his ridiculous behavior.
His aids suggest that he should have new clothes made from this splendid material for the great procession that was the following day. Throughout the night, the swindlers made motions of looming and weaving, cutting and sewing... nothing. All the while, attesting to the king that it was the most exquisite outfit every to be worn. There was great excitement in the kingdom as every one had heard of the emperor's unbelievable threads. The rascal swindlers lifted up their arms to the emperor as if they were holding something. They proceeded with their scheme and asked the king to remove all his clothes so they could help him on with the new ones. They gave him the make-believe trousers and mantle. They remarked that the fabric was so light, it was as if he were wearing nothing, but remarked that - was the beauty of it.
All of his ministers cried out in unison, "Magnificent." The emperor looked at himself side to side in the mirror as if to observe the clothes that were not there. No one dared tell him the truth, as they would have declared themselves stupid and unfit for their posts. A canopy was held above him as he strolled out to greet his admiring public. They oohed and aahed along the route as he waved and smiled, confident of his importance. But all at once, a hushed little voice shockingly spoke up from the crowd. A small child gasped, "But he is not wearing any clothes." People began to whisper to one another what the child had said, 'til everyone was saying, "But he isn't wearing any clothes." The emperor himself had the uncomfortable feeling that what they were saying might be true, but he had to go through with the procession. So, he drew himself up and walked with his head higher than before; and the courtiers held onto the train that wasn't there.
The moral of the story ... there are a lot of naked people strutting around in Texas, desperately in need of a child's honesty.
There is a real sickness in today's society when we have to search for that small child's voice in the masses to shed light on the horrendous, disgraceful truth, and finally get some kind of movement started. – Something has to done about defective, atrocious, uninhabitable housing; and stop the homebuilders who shamefully erect them, ignore new homeowners' complaints, change the company name, and go right on building. Something has to be done NOW to protect consumers, the very fabric of the American dream, and halt the resulting wave of decimation throughout our nation's economy. Something has to be done about reversing "Tort Reform" so the system is fair again.
Jordan Fogal
jfogal281@aol.com
google my name for more information
Posted by: Jordan Fogal | May 04, 2007 at 09:12 AM
How are Fisher's comments inconsistent with what's occurred with GMAC and UBS? GMAC owns ResCap (now split with Cerberus) which is one of the largest subprime players out there. ResCap and its subprime loan portfolio represents over 3/4 of the GMAC loan portfolio. If GMAC's loss was driven to a major deterioration in the performance of its prime portfolio, that would lend more credence to questioning Fisher's statements. Also, Costas' key strategy/theme behind his fund at UBS was a long bet on subprime-backed MBS paper. The third article you cite further reinforces subprime issues as opposed to discussing any spreading out beyond that area. So if your readers take that into account, the losses have so far been contained within the subprime sector. I put little value in what public officials say in any regard but the reality is that the subprime problems have largely been contained so far (and i'm short a prime lender so I do believe the problems will spread to higher quality loan books)
Posted by: Amit Chokshi | May 04, 2007 at 04:45 PM
At first glance, one could say you have a point. However, I think it comes down to the inference that any reasonable person might draw from a central banker suggesting that a problem is "contained." From where I sit, that argument suggests little fallout other than foreclosures and losses for the lenders involved.
In reality, the subprime meltdown has tied GM's hands and made it much more difficult for the automaker to come to grips with the serious problems in its domestic auto operations. It is also a major distraction at a time when the carmaker needs to be totally focused on its core business, which is usually a ticket to disaster for a company with financial problems as serious as GM's.
As to the fallout from the Dillon Read fiasco, many investors and analysts are now doubting the company's overall strategy, and there is suddenly a sense that the risk management element Wall Street has claimed is well under control is actually in doubt. Investment banks are large users of borrowed money and have valuable assets that walk out the door every night. As such, the confidence and support of those who make the money and who supply the funds is critical to their continuing success. The market and press reaction to the recent announcement suggest there is an adverse change in sentiment in the air, which will almost certainly have broader implications.
Finally, the reaction of those quoted in the article about the downgrades in subprime-backed bonds suggests a growing element of doubt about the motivation and capabilities of the credit rating agencies, which are critical to the smooth functioning of largely illiquid markets comprised of opaque and often complex over-the-counter securities. Even a small measure of uncertainty, as seems evident here, about what those official ratings mean could quickly develop into a widespread lack of confidence that would cause some markets to seize up.
While your response clearly indicates that I should have fleshed out my original post much more than I did, I stand by my view that recent developments signal that Mr. Fisher is out of touch.
Posted by: Michael Panzner | May 04, 2007 at 08:33 PM