Sunday, February 22, 2009

Citigroup/Volcker/AIG Financial Products/Governor Pawlenty's Blather/

Citigroup is on the ropes.  The WSJ is reporting tonight that this bank is in talks with the government to convert its preference shares into common shares. WSJ.com
Why would the bank want to do that?  The only reason that makes sense to me is to avoid paying a 5% dividend on some of the preferred shares and 8% on others.  This indicates weakness to me.  It would also dilute existence shareholders.  If that is necessary for survival of the bank, then the bank is in really bad shape which is already indicated by its less than $2 per share price.  The Obama administration has apparently not indicated whether it will support such a conversion in what amounts to a non-income producing security, paying just 4 cents a share a year in dividends.

Paul Volcker, one of the few economists that I take seriously, noted that the rate of decline in industrial production around the world was more steep than at the onset of the Great Depression.  CNBC.com
I respect Volcker.  I do not view him as an ideologue which was my baseline opinion of Greenspan.   At this point, however, I do not see any useful purpose for him to make statements with such dire observations since many people would take him far more seriously than any politician. It would be much better for Volcker to just keep his opinions to himself for the next year or so, and just share them with the beanpole.  It might be best also to put a gag on Senator Dodd too who was undermining the administration downplaying nationalization last Friday.    Courant.com

The comments by George Soros were far more ominous than those of Volcker.  Soros stated that the world's financial system has disintegrated and the turbulence is more severe than the Great Depression. Reuters

The chief technician at S & P says that the market is showing few signs that have marked previous lows in the indexes.   washingtonpost.com

The Washington Post has a new article about the AIG Financial Products Unit which destroyed the company and help to both facilitate and accelerate the world's current predicament.   washingtonpost.comThe wizards who ran this unit pulled down hundreds of millions for themselves by betting the company, AIG, that took all of the risks.   Their actions of this limited group of individuals would probably rank among the top ten causes of the worst financial crisis since the Great Depression.  The damage caused by them is more than just destroying the world's largest insurance company which is in itself a major achievement.  Personally, and this is just me apparently, I do not think the destruction of a 200+ billion dollar company is worth a few hundred million to a select group of egomaniac wizards.  The credit default insurance products written by them, based just on the AAA credit rating of AIG initially, allowed other financial institutions to take risks that could not be economically justified, nor were the investments made by those institutions prudent, which in itself contributed to the severity of the current crisis by feeding the credit bubble. 

Sweden refused to bail out Saab, which filed for bankruptcy, finding its plan to restructure its money losing operations was not realistic. WSJ.com
Since GM invested it Saab in 1990, it has rarely turned a profit. NYTimes.comGM restructuring forces Saab bankruptcy (Corporate Dealmaker)

GM's Opel subsidiary is requesting a bailout from the German government.  GM's Daewoo unit was turned down for aid by Korea.  

Perma bear Alen Abelson, who was bullish for a couple of months in the early 1980s and bearish for the other many, many months of his life, displays a helpful chart in his column this week, showing the median house price divided by median family income. Double Trouble – The Fall of the Market and the Economy - Barrons.com   For most of periods between 1960 to 2000, the chart was meandering in a range between 2.4 and 2.8.  If you could say that a chart had a comfort level, then this chart was content to float around 2.8.  Starting in 2000, the chart displays an upward move from about 2.8 to 4 reached in 2006, which is just too high and has since corrected to around 3.26 by December 2008.  I would suspect that it has fallen some more this year.  Rather than drawing pessimistic conclusions from the chart, this would be an indicator that the price of homes is falling to an affordable level.  I would add that these kind of charts also have a wide margin of error given that it tries to incorporate current information about tens of millions of families, their incomes and the value of homes nationwide.   I would also like to see a chart like this one that excludes Florida and California.  In the heartland, prices of homes never went parabolic and the correction in prices relative to income may very well be complete or near completion. So, it may be helpful for the beanpole to start engaging in some happy talk, or at least more hopeful and inspirational than downbeat and gloomy, and maybe some of the "animal spirits" will return at least where it makes sense.   Buying a closet condo in Miami for 2 million never made much sense. 

I would have to say in passing that Abelson's chart looks different than the one used by Pimco:PIMCO - US Credit Perspectives - May 2008

This is a link to another chart comparing the existing home price from the Case Schiller index divided by median family income as of October. US Existing House Price / Median Family Income | The Big Picture 
A google search brings up data for local areas and these links relate to Baltimore and San Diego.Baltimore
San Diego county has experienced a 45.9% drop in median home price from 11/2005 to 1/2009. Wow!

 The Governor of Minnesota, Tim Pawlenty, is a lawyer in need of an education about the Impairment of Contracts clause in the Constitution.  I listened, for as long as I could stand it, the blather of  four governors, two from each tribe, none of whom were convincing on any matter to this independent.  I do draw a distinction, however, between an unpersuasive argument and an opinion that is based on a factually incorrect premise. When asked about his opposition to Obama's foreclosure plan, the good governor from Minnesota said that the state and federal constitutions had a clause, called impairment of contracts, that prevented the federal government from exercising a heavy hand to abrogate contracts.  Pawlenty must either be unfamiliar with the meaning of  the "impairment of  contract" clause or woefully ignorant of the plan that he was criticizing.  The Obama foreclosure plan does not abrogate or force a change in a private contract, but simply gives incentives to the parties to the contract to agree to modify the terms. 

"Q. Is my lender required to comply?

A. No, but the government is offering lenders incentives if they do. The government expects that most major lenders will participate."

This program would in no way raise an issue of impairment of contacts but this argument from the governor may hold some sway in certain circles and more will be misled by it provided the media is asleep in his state and elsewhere, which is never a surprise. Contract Clause - Wikipedia, the free encyclopedia  A different legal issue would be presented if the government tried to force a substantial change in a CDO mortgage pool against the will of the owners.  This could conceivably raise an impairment of contract issue but there have been instances where the government acting under its police power was able to temporarily halt foreclosures permitted in the private mortgage contract.  FindLaw | Cases and Codes  As Mr. Pawlenty probably knows since he is very confident of his opinions on the subject, Wall Street mucked up the resolution of the mortgage problem by creating large pools of mortgages and then sold interests to investors around the world. Those contracts frequently required consent of the owners before the servicer of the pool could modify the borrower's payment terms. Why modification is hard (The Deal Magazine) Homeowner Bailout Does Reflect Some Market Realities : HousingWire || financial news for the mortgage market 
(the issue of when the servicer would have the right to modify mortgages in a CDO pool under its contract with the owner is beyond the scope of this post). 
Some pools might allow for a change with the approval of a high percentage of owners but not requiring 100%.   This is not a subject of Obama's plan.  Instead, as the governor already knows, the plan reaches mortgages where there is one owner who may or may not agree to a modification of the contract with the borrower,  with the federal government providing incentives to both sides to modify the contract to make it more affordable.   Neither party to the contract is required or forced to do anything. There is factually no basis for any argument based on the government impairing a private contract within the meaning of any state constitution or the U.S. Constitution.   I would just place no reliance on an opinion that is based on clearly erroneous information, or an opinion that omits material factual information that would undermine the opinion being given.  Perhaps the Governor is confusing the bill that he vetoed in mid-2008 that was passed by the Minnesota legislature that would have delayed foreclosures for subprime borrowers in his state.  That state law would force a change in private contractual rights  Foreclosure relief: It's a wonderful life when government is kept in check (the author of the preceding linked article is apparently unfamiliar with Supreme Court precedent on the use of police power to temporarily halt foreclosures without violating the contract clauseFindLaw | Cases and Codes)  But this has nothing to do with Obama's plan the good governor was criticizing so authoritatively  in the panel discussion with Chris Wallace.  I hope that the governor does not mean the authority of a bankruptcy judge to modify or cancel a contract. 

This article summarizes more proof about the flagrant incompetence of the SEC to conduct an adequate investigation in a manner consistent with protecting the public.     Yahoo! Finance

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