bizzXceleration: Performance, Value and Profit

General & Special

O'Neal's Agony, or, in the Bunker With Stan When a big Wall Street firm loses a huge pile of money, it's often hard to figure out exactly what happened.

S&P500 ex-Risk ? Here's an issue I have been mulling over, without a satisfactory answer:  There have been many investment thesis (thesii?) over the past few years about the market which supported the bullish side of the ledger: Earnings were high, stocks were cheap, risk was moderate, the Fed model favored stocks over bonds. Regardless of whether you found these arguments persuasive or not, global markets have gone higher. While the U.S. indices may have lagged the rest of the world's bourses, they too, have powered higher.  Here's the odd factor: It turns out that many of the arguments made in favor of U.S. domestic growth have been based on an assumption that turned out to be false. To wit: The Financials, the largest sector in the S&P500, had legitimate, sustainable, normalized risk-based earnings. That basic premise turned out to be wrong. What's truly astounding is that we may only be seeing the tip of the iceberg. Its possible that the big brokers and banks have $1 trillion in toxic debt on their books to be written down. That would equal decades -- not years -- of profits to be wiped out. To paraphrase the WSJ, "the financial crisis is becoming Shakespearean comedy."

Global credit squeeze Global investors succumbed to a new bout of jitters amid concerns that a host of big western financial institutions are nursing additional, serious problems related to America’s troubled mortgage markets. [a Special Section from the Financial Times that is extensive, insightful and well-written].

• "Worst banks crisis" says Deutsche CEO Global credit markets are deep in the worst crisis of Deutsche Bank chief Josef Ackermann's 30-year career, but he does not see any further writedowns for Germany's flagship bank. "If you go back to the Asian crisis, the Latin American crisis, the Russian crisis, these were pretty regional," said Ackermann, who also heads global banking organization the Institute of International Finance. "(This) is psychologically the worst crisis that I have seen in my 30 years," he told journalists at the Reuters Finance Summit. "What is really new and unexpected is that we had a phase of excessive liquidity. It is not a shortage of liquidity. It is a shortage of demand. The liquidity was hoarded under the pillow."

Markets & Investing

Bear season not over yet U.S. stocks are poised for more weakness next week, after a slide in the Nasdaq wiped out hopes that technology shares could pull the market out of the subprime pain felt by financial institutions on Wall Street.

After dashed hopes of tech-led upturn, market turns focus to retailers. Analysts see little good news on horizon as fallout from high oil, weak dollar, subprime write-downs still spreading. The selling that plagued the financial sector of the market for the last two months formally spread to the rest of the market on this past Thursday. That's when tech shares began selling off in earnest upon a lower-than-expected revenue forecast from industry giant Cisco Systems, which fueled worries that corporate spending on technology products going into next year.

The Fed's newest chief is a wuss Ben Bernanke's Fed, like that of his predecessor, can't abandon reason fast enough. It caves in to Wall Street's demands regardless of long-term consequences. So why did the Federal Reserve instead cut interest rates, further damaging the inflation-fighting credentials of the Bernanke Fed? As best as I can figure out, the Fed didn't stand pat on interest rates because Wall Street -- by odds of 4-to-1 -- had decided that the Fed would cut rates. And the Fed decided that the financial markets were so fragile that dashing those expectations would make a bad situation worse. If that's what the Federal Reserve was thinking, it's rubbish. It's not that the debt markets are back to normal, because they aren't. And it's not that there aren't more hedge funds and structured investment vehicles on the edge of imploding, because there are. And it's not that Wall Street -- from mortgage bank to investment bank -- isn't hoping to avoid writing off billions in illiquid debt, because it is. Given the problems in the debt market, the prices of stocks are too high and the risk premium on bonds still too low. If the debt market is on the edge of melting down, if Citigroup (C, news, msgs) is tottering, if the economy is about to slip into recession, nobody seems terribly worried, judging from stock prices here and overseas. But, gol' dang it (fill in your expletive of choice), investors ought to be scared. There's at least one more debt-market shoe to drop when the current wave of credit-rating downgrades turns into selling, which will force institutions with portfolios stuffed with questionable paper to mark their assets to market prices. Moody's (MCO, news, msgs), Fitch Ratings and Standard & Poor's all downgraded billions of dollars in mortgage-backed assets in October. Credit downgrades last month from the three rating companies hit $100 billion of asset-backed paper. More shocking than the total, however, was the distribution: Many of these downgrades hit AAA-rated mortgage securities. These securities were supposed to be the safest part of the mortgage-backed debt market. Turns out they're not.

Fire on the mountain There were plenty of warning signs along the path that led to the current conflagration in credit markets. Similar to what we've seen in California, the possibility exists that this past period will move from the front pages to a rebuilding process. After billions of dollars of damage sunk costs associated with any tragedy a recovery phase will eventually emerge with lessons in tow. Before we issue the all clear, however, it is necessary to understand the root cause of the financial fires. While it doesn't change the fact that homes and livelihoods were lost, it may help us understand how and why this seemingly unnatural disaster began in the first place. Wall Street has long profited from repackaging risk. At the core of brokerage business models, they benefit from the chasm between what people know and what they can charge for advice. Many of the positions on trading desks around the street have no listed proxy with which to guide or gauge their valuation. Many Wall Street firms are assigning estimations of where they believe these securities should be trading but as we know, something is only worth as much as what someone else is willing to pay for it.

In a derivative laden finance-based economy, the banks, brokers and other financial service companies simply serve as wicks to the much broader brush. Stocks across a wide swath of sectors derive earnings from financial-based operations and that is reason for economic concern regardless of whether the fans are flamed.

• Fitch Press Release: Credit Uncertainty May Begin Affecting U.S. Non-Mortgage ABS
• More banks are tightening lending standards for home buyers with good credit, a Fed survey of loan officers found. Citigroup Credit Swaps Trade Near Five-Year High as Bank Debt Deteriorates

·         Markets fear banks have $1 trillion in toxic debt, Why Street Bankers Get Away With Repeating Old Mistakes, Fears intensify for prolonged turmoil, Bloodbath expected to claim more victims , Auditors set for tough talks with clients –

·         Money Quotes

• A new phase in the credit crunch, one of “$1 trillion losses” seems to be dawning. The crisis at Citigroup and renewed doubts about some of the world’s leading banks disquieted stock markets on both sides of the Atlantic yesterday, with the fractious mood set to continue.

o        Fears are growing that the turbulence in the financial sector will be more protracted than expected as big US and European banks come under intensifying pressure due to losses on US subprime mortgage securities.

• Shares in banks and insurers continued to tumble on Monday as analysts warned that losses from mortgage securities could leave some institutions short of capital.
• Most of all, however, the disclosures from Citi and Merrill – which last month reported much heavier losses than it had warned of a few weeks before – have left investors with the impression that the valuations banks are putting on their subprime exposures cannot be trusted.

o        Don't let those on Wall Street fool you by saying "this is the natural cycle of things." Does it really have to be? Unlike virtually any other industry, Wall Street shakes, twists, and hammers on its innovations until they break. What would happen if Boeing Co. or Johnson & Johnson rolled out products with similar defect rates? Ratings downgrades -- defects, really -- have hit about 10% of the subprime related derivatives, known as collateralized debt obligations. The number is expected to rise in the weeks ahead

• Fundamentals, not liquidity conditions, are behind MBS crash Many banks, if not financial institutions in general, would have you believe that the current rout in mortgage-backed debt is largely being driven by irrational fear. A few bad subprime debts buried around the structured universe are scaring buyers out of markets. But, said CreditSights, in a note to clients on Wednesday, current pricing levels reflect fundamentals, even for the most highly-rated debt. Mortgage securities across the board are overrated and overvalued:

·         Morgan Stanley Says Value of Subprime Mortgage Assets Fell by $3.7 Billion Morgan Stanley, the second-biggest U.S. securities firm, said its subprime mortgages and related securities lost $3.7 billion in the past two months, after prices sank further than the firm's traders expected. The decline may cut fourth-quarter earnings by $2.5 billion, the New York-based company said in a statement today. The figure is subject to change until the end of this month, Morgan Stanley said. The average estimate of analysts surveyed by Bloomberg is for a $1.93 billion profit in the quarter. AIG Net Falls 27 Percent on Losses From Mortgage Securities; Shares Slide

·         Asset-Backed Commercial Paper Market in U.S. Shrinks by Most in Two Months

$500 Billion: The Mother of All Write-Down Estimates Write this down: five hundred billion dollars. That is how much one analyst thinks the tally of the carnage in the fixed-income markets ultimately could be. Royal Bank of Scotland Group chief credit strategist Bob Janjuah put out a report today estimating that the credit crunch will cause $250 billion to $500 billion of losses at banks and brokers around the world. As Bloomberg points out in this story on the report, the estimate includes not just losses on subprime mortgage-related bonds but also the effect of a new accounting standard that goes into effect Nov. 15 known as Financial Accounting Standards Board’s rule 157. It will force companies to put values on opaque securities and could lead to write downs of as much as $100 billion at firms including Morgan Stanley and Goldman Sachs Group, according to Janjuah. Should the estimate prove accurate, it would mean the credit-market storm that began this summer is just beginning. The total of write-downs already announced by Citigroup, Merrill Lynch and the other Wall Street firms is only about $30 billion to $40 billion. Big as those numbers are, they still don’t come close to the last major crop of write-downs, when another accounting change prompted eye-popping losses at companies including AT&T and AOL Time Warner in 2002. The media-and-Internet conglomerate had write-downs that year for goodwill and soured Internet assets of roughly $100 billion. Still, Janjuah’s number is in a league by itself. Not only is the upper end of his range roughly what the U.S. has spent on the Iraq War, it is about equal to the market caps of the three largest U.S. banks, Citigroup, J.P. Morgan Chase and Bank of America, combined.

• Banks Face $100 Billion of Writedowns on Level 3 Rule

Fitch May Downgrade Bond Insurers After New Test Fitch Ratings may lower the AAA credit ratings on one or more bond insurers after a new review of the companies' capital takes into account downgrades of collateralized debt obligations that they guarantee. Fitch said it will spend the next six weeks reviewing the capital of insurers including MBIA Inc., Ambac Financial Group Inc., CIFG Guaranty and Financial Guaranty Insurance Co. to ensure they have enough capital to warrant an AAA rating. Any guarantor that fails the new test may be downgraded within a month unless the company is able to raise more capital, New York- based Fitch said today in a statement. In September, Fitch announced the results of a stress test of the bond insurers' capital to demonstrate how much capital insurers would need if conditions in the market were to significantly worsen. The test indicated that FGIC and CIFG would need to raise additional capital under the hypothetical scenario. Fitch said it decided to review the bond insurers after ``broader and deeper'' downgrades of CDOs, which package debt such as subprime mortgage securities and loans. The bond insurance industry has guaranteed more than $1 trillion of bonds issued by U.S. cities and states as well as bonds backed by mortgages, credit cards and other assets, and the guarantee allows borrowers to use the insurers' AAA rating. Shares and debt of the insurers has tumbled on concern the sliding value of subprime mortgages may erode their credit ratings.

• Time to Think the Unthinkable About Bond Insurers, MBIA, Ambac Losses Will Be `Massive,' Egan Jones Says

Next Fear: Corporate Debt Fitch Ratings says downgrades of corporate bonds rose in the third quarter to $92.1 billion, their highest level in two years, a potential sign of rising distress. Financial markets have been hit by a wave of defaults on mortgage loans. Now it might be time to start worrying about a more-remote threat: shaky corporate debt. Amid booming profits and extremely low default rates in recent years, many companies borrowed heavily to make acquisitions, go private, buy back stock or pay special dividends in activities designed to boost shareholder returns. Not long after that binge of borrowing, some cracks are showing in parts of the economy, and the prognosis for corporate balance sheets is looking less rosy. Fitch Ratings says downgrades of corporate bonds rose in the third quarter to $92.1 billion, their highest level in two years. Meantime, interest rates on junk bonds have risen, potentially straining the ability of low-grade issuers to tap the credit markets for fresh loans or to refinance existing debt. Fitch predicts a jump in corporate defaults, from less than 1% of all debt outstanding in 2007 to more than 4% in 2008. If this happens, it will become harder still for companies to borrow. Sensing a turn, "distressed investors" -- who seek to gobble up debt when it has hit rock bottom -- have raised more than $300 billion by some estimates to put to work in the years ahead.

JPMorgan, Citigroup, Goldman to Revive $10 Billion Sale of Chrysler Loans Chrysler LLC's bankers plan to sell $10 billion of loans to investors this week after an attempt in July was shelved when demand for high-yield, high-risk debt dried up, according to people with knowledge of the plan. JPMorgan Chase & Co., Citigroup Inc., Goldman Sachs Group Inc., Morgan Stanley and Bear Stearns Cos. will begin selling the loans tomorrow, said the people, who declined to be identified because the terms haven't been set. The banks provided the loans to help Cerberus Capital Management LP complete its acquisition of Auburn Hills, Michigan-based Chrysler Daimler AG in August. Banks are trying to reduce a backlog of more than $200 billion of loans they weren't able to sell as losses on securities tied to subprime mortgages contaminated credit markets in July and August. The New York-based banks haven't decided whether they need to offer discounts to sell the loans, the people said. The decision to proceed with the offering was made last week, before concerns over bank losses on subprime securities sparked a slump in loan prices, one person said. Citigroup, the largest U.S. bank by assets, said Nov. 4 it may write down the value of its subprime assets by $11 billion and Chief Executive Officer Charles O. ``Chuck'' Prince III resigned.

Private Equity’s Fund-Raising Gusher  U.S. private-equity firms may not be doing a whole lot of deals these days, but that isn’t stopping them from raising more money. PE firms have set a fund-raising record this year, pulling in a total of $263 billion, according to sister publication Private Equity Analyst, up from $258 billion raised last year. With nearly two months left in the year, there is a chance they could surpass $300 billion. It might seem an odd time for private-equitiy firms to set a fund-raising record. After all, the debt markets have curbed new buyout activity. Buyout shops announced just $8.5 billion of new deals in October, roughly a fifth of the $42.2 billion a year earlier, according to Dealogic. Then, there are those pesky economists who lately have been warning of the possibility of recession, which would threaten the health of existing PE-backed companies. Amid such a cloudy environment, Deal Journal can’t help but wonder: Just what would it take to shut off the fund-raising spigot? U.S. institutional investors are smitten with private-equity funds, while Chinese and Middle Eastern sovereign funds have started to pile on as well. They show no signs of stopping. Is its possible that private-equity fund managers themselves might one day need to exercise some restraint and raise smaller funds? Perhaps, but we aren’t holding our breath.