September 4 – 10, 2008

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September 4, 2008

            Things have been quiet the last ten days with the exception of the commodities markets where traders have come to the sudden realization that a global economic slowdown is around the corner.  A medium sized hedge fund, Ospraie, which specializes in commodities, just closed their doors this week after YTD losses of about $3 billion of the $7 billion they have under management.  The price of a barrel of oil is also falling like a stone – dropping from an all-time (?) high of $145 a barrel this August to its current level of about $107.  As commodities are falling, the value of the US dollar in increasing – it’s now trading about 1.42 USD per euro vs. about 1.60 USD per euro in late July.  While the commodity and currency price action is causing angst for participants in those markets, the trends are certainly welcome from my perspective here at the U.S. central bank.   Recent commodity pricing suggests that inflation is not an immediate concern, unlike the prospects for a looming global economic meltdown?  Such an event would be particularly challenging for peripheral European countries, such as Spain and Ireland, which had a real estate bubble burst and now they can’t devalue their currency since they use the euro.  That situation could turn ugly in the periphery of the Euro area if massive unemployment results from a precipitous decline in domestic demand.  In that scenario, there will be a widespread shortage of jobs and money  L.

            Meanwhile back in the States, the market is becoming somewhat sanguine to the fate of the two public / private mortgage giants, Fannie and Freddie.  They can still issue debt at reasonable levels, despite a super-shaky capital base.  Everyone is wondering if this relaxed attitude towards them will last until a new president takes the oath of office in January.  Probably not, is my guess.  

The S&P 500 index was down 3.0% today and Lehman was down 10%, perhaps on news of a rise in weekly jobless claims. Lehman is no doubt scrambling on how to put a positive spin on their pending earnings announcement for their third quarter that just ended in August.  They are due to make a statement on their earnings around the middle of this month and the rumor mill has started that they will: a) sell off a large part of their commercial real estate portfolio; b) sell off their profitable money manager, Bernstein Capital; c) sell a substantial amount of equity, possibly even a majority ownership interest, to a financial third party such as the Korean Development Bank, or perhaps a large Japanese bank.   At some point, Lehman announces that they have pushed back the date of the press release by a few days, presumably to give them more time to make a deal, potentially with the Korea Development Bank.

September 8, 2008

            So much for the market waiting for the next president.  The main editorial of today’s WSJ was titled, “Weekend at Henry’s”, referring to Treasury Secretary Henry Paulson putting together a rescue package for both Fannie and Freddie.  The plan was generally perceived to be welcome and pro-active, not a bad combination, but it did cause some immediate, sharp price action.  For starters, Treasury will be replacing both Fannie and Freddie in “receivership” and will fire the CEO’s of each company.   Additionally:

  1. Treasury agrees to purchase as much as $100 billion of new issue senior preferred stock that pays a coupon of 10%.  If issued, these shares will be senior to both existing preferred stock and common stock.  The coupon is also so high that issuance may wipe out the common stockholders, a potential sad ending to the previously heralded public / private partnership paradigm.
  2. Speaking of Fannie and Freddie ownership, Treasury will also obtain warrants that will convert to 79.9% of the common stock of either or both companies for a nominal price.  Regardless of the potential dilution from 1) above, Treasury now effectively owns 80% of Fannie and Freddie.
  3. Treasury, at its discretion, can lend directly to Fannie and Freddie at least until December of next year.  The loans from Treasury will be collateralized by their assets and will pay interest at LIBOR + 50 basis points.
  4. In an attempt to be proactive, Treasury now also has the authority to purchase new origination MBS securities directly from Fannie and Freddie until December 2009.  This gives Treasury the opportunity to increase Fannie and Freddie’s immediate presence in the housing market, allowing the housing giants to continue to originate new mortgages.  After December ’09, the GSE’s will then be required to reduce their asset sizes by at least 10% annually.

The most immediate price action in the aftermath of the “Weekend at Henry’s” announcement was that Fannie and Freddie’s stock price immediately fell to trading around $1.00 a share.  Also, both entities had already issued a considerable amount of preferred stock (which is in a senior position to the common stockholders, but now junior to any new senior preferred that would be issued) that is now very impaired.  Of course, price discovery is difficult as these preferred stock securities have probably stopped trading, just like they have already stopped paying dividends.

            On the personal front, my boss returned from his vacation today and my group is literally disintegrating as one of my few remaining peers officially resigned.  Originally there was my boss, three credit analysts and a legal analyst, with this news the other two credit analysts have left.  My boss told me not to be surprised if the group is disbanded, so at least he’s paying attention.  My uncertain career path is right in line with the huge uncertainty in markets.

September 10, 2008

            Details emerged that the Korea Development Bank is not interested in acquiring a stake in Lehman.  Lehman’s share price dropped 10% on Monday with the GSE announcement.  Quite surprisingly, to me anyway, Lehman’s stock dropped 45% yesterday, to $7.50 a share, on the Korean Development Bank news.  So instead of delaying their earnings announcement, Lehman’s management moves it forward.  

            Lehman’s released third quarter earnings today showing a ($3.9 billion) net loss, with gross mark-to-market losses of ($7.8 billion).  Management tries to put a good spin on the results by announcing the creation of a “good Lehman” and “bad Lehman” split.  They are planning to “spin off” their troubled commercial real estate portfolio, $25 – $30 billion worth, to existing shareholders in shares of a separate company, the bad Lehman, which will have its own capital. They plan to complete the spin-off by the first quarter of 2009.  The good Lehman will also initially lend money to bad Lehman to keep financing the assets until they are sold or mature.  Presumably, “bad Lehman” wouldn’t acquire new assets.  The idea is to give “bad Lehman” enough capital to absorb potential losses that might occur as the assets wind down, while insolating the rest of Lehman from all the incessant mark-to-market losses from their real estate portfolio.      I looked at Lehman’s third quarter 2008 earnings statement soon after it was released.  I thought, “it’s bad, but not terrible”, and the stock price rebounds a little in initial trading.  By mid-morning, however, equity analysts started commenting that Lehman’s proposed restructuring doesn’t really accomplish anything except a promise to spin off real estate assets.  Meanwhile large losses accrue each quarter.  This was enough to bring the stock price into negative territory by the end of the day. Lehman management’s positive spin on the situation didn’t last one trading session. 

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