bizzXceleration: Performance, Value and Profit

Culture, Crime and Punishment

`Cityboy' Unmasks World of Analysts Pushing `Gibberish,' Wrong Stock Bets As a utilities analyst at Dresdner Kleinwort, Geraint Anderson was advising clients how to invest. At the same time, through an anonymous London newspaper column, he was telling readers how analysts wrote ``utter gibberish.'' Anderson, 35, announced on June 2 in his Cityboy column in TheLondonPaper that he'd quit and ended a 12-year stockbroking career: ``I've been wasting my precious time for far too long, working my sweet a** off in a rat race with no end in sight.'' He revealed his identity in the newspaper this week. While for 22 months he used his column, the newspaper's most popular, to describe colleagues as ``degenerate'' and himself as ``boring the pants off clients,'' Anderson also was writing a book about London's financial workers. ``Cityboy: Beer and Loathing in the Square Mile'' will be published next week, and scourges brokers through composite characters and banks. ``We didn't invent greed, us City boys, but we have certainly become its finest exponents,'' Anderson said in an interview. He was ranked the No. 1 stock picker in the U.K. and Ireland for utilities by StarMine Corp. in 2005. London `Cityboy' Says Greed, Arrogance Rife in Banks

Our Tarnished Banking Titans Until about a year ago, the main complaints about investment banks concerned conflicts of interest. By collecting all kinds of financial business under one roof, they created all kinds of opportunities to take advantage of customers. Investment-bank brokerage departments execute buy and sell orders on behalf of outside clients, supposedly at the best price possible. But the proprietary trading desks make money by trading the banks' own capital; the temptation to use knowledge of outside clients' strategies to boost prop-desk profits is, shall we say, considerable. Long-Term Capital Management, the hedge fund that blew up in 1998, was partly a victim of brokers who were copying its trades, making them impossible to exit in a crisis. In 2000, the tech and telecom bubble burst, revealing further conflicts of interest. But the bursting of the credit bubble has conjured fresh concerns: not about banks' treatment of customers, but of their own money. We now know that the models banks have used to measure their investment risks are flawed, to put it charitably. They base assessments of future risk on how markets have performed in the most recent few years, so the inflation of a bubble causes the models to proclaim that the world is growing more stable. Even more bizarrely, the models factor in market behavior only during normal times -- explicitly excluding the most extreme 1 percent of past experience.

Hundreds Swept Up in Mortgage Fraud Arrests More than 400 real estate industry players have been indicted since March -- including dozens over the last two days -- in a Justice Department crackdown on incidents of mortgage fraud nationwide that have contributed to the country's housing crisis. The FBI put the losses to homeowners and other borrowers who were victims in the schemes at over $1 billion. Since March 1, 406 people have been arrested in the sting dubbed "Operation Malicious Mortgage" that saw 144 cases across the country. Sixty people were arrested on Wednesday alone, including in Chicago, Miami, Houston and a dozen other regions policed by the FBI. In a separate sweep, two former Bear Stearns managers in New York were indicted Thursday, becoming the first executives to face criminal charges related to the collapse of the subprime mortgage market. Across the country, reports of mortgage fraud have soared over the past year as the subprime mortgage market collapsed and defaults and foreclosures soared.Banks reported nearly 53,000 cases of suspected mortgage fraud last year, up from more than 37,000 a year earlier and about 10 times the level of reports in 2001 and 2002, according to the Treasury Department's Financial Crimes Enforcement Network. The most common type of mortgage fraud was misstatement of income or assets, followed by forged documents, inflated appraisals and misrepresentation of a buyer's intent to occupy a property as a primary residence. Over the last several months, the FBI has been investigating an estimated 1,300 mortgage fraud cases -- including 19 involving subprime lending practices by U.S. financial institutions. The Justice Department also is expected to ask Congress for more money to help combat mortgage fraud as part of a larger funding request to curb white collar crime and violent crime.

Two Sides to Every Story Make Wall Street a Parable in Cioffi Tale at Bear The arrests of former Bear Stearns Cos. hedge fund managers Ralph Cioffi and Matthew Tannin yesterday show how Wall Street bankers may look out for themselves while hiding bad news from customers. Cioffi, 52, and Tannin, 46, were charged by federal prosecutors with misleading investors about two hedge funds whose collapse last year helped ignite the subprime-mortgage crisis. A companion Securities and Exchange Commission civil suit accuses Cioffi of redeeming $2 million from the funds while Tannin mocked as ``silly'' at least one investor who wanted to get out. In the credit meltdown this year, at least 24 proposed class-action lawsuits have been filed since mid-March against brokerages over claims that investors in auction-rate securities were told their holdings were almost as liquid as cash. The Bear Stearns action ``has similarities with the research-analyst cases, where the government tried to prove analysts said one thing privately but said something different publicly,'' said Michael Missal, a former SEC lawyer now with Kirkpatrick & Lockhart Preston Gates Ellis LLP in Washington. The SEC alleges that Cioffi and Tannin downplayed the risk in their investments. While the funds' monthly summaries typically said about 6 percent to 8 percent of their portfolios was directly tied to subprime mortgages, an internal report in April showed that total exposure, including indirect bets on mortgage-backed securities, amounted to about 60 percent, the SEC said. The men misled clients about the funds' performance and holdings after one of them lost money for the first time in February last year, prosecutors said. During a meeting in early March, Cioffi urged Tannin and two colleagues not to discuss difficulties with others, according to the indictment. Campbell Reviews Charges Facing Ex-Bear Stearns Managers, Cioffi Fund Hoisted in Vodka Toast With Tannin Began Bear Stearns Endgame

Crime and delusion on Wall Street Prosecutors allege two ex-Bear Stearns hedge fund managers misled investors. Perhaps, but Wall Street has long been kidding itself about the credit crunch. The case against Cioffi and Tannin will take a while to play out. But what's clear today - and appears to be central to the managers' defense - is that the Bear Stearns managers were far from alone in failing to warn investors of the sea change in the credit markets. Indeed, top guns on Wall Street have spent a lot of time deceiving themselves about the depth of the mortgage mess. The bad news at Bear should have warned others on Wall Street to dig into their exposure to risky mortgage-related bets. Yet even as the collapse of the High Grade funds was being dissected in the press, other big subprime-writedown losers such as UBS (UBS), Merrill Lynch (MER, Fortune 500) and Citigroup (C, Fortune 500) remained in denial - initially underestimating eventual losses and eroding investor confidence by citing supposedly unforeseeable market conditions. Top execs were forced out at all three firms. Even now, a year after the High-Grade funds started to wobble and months after the house cleanings that cost Chuck Prince and Stan O'Neal their jobs, those simple lessons are still being learned. At AIG (AIG, Fortune 500), CEO Martin Sullivan was forced out after he oversaw two record quarterly losses just months after blithely reassuring investors the insurer's subprime exposure was limited. At Lehman Brothers (LEH, Fortune 500), two top execs were demoted last week after the firm insisted it wouldn't need to raise more capital to offset future losses, only to later do so twice. In both instances, the firms claimed they had a handle on their mortgage-related problems, only to admit otherwise later - at great cost to shareholders. Now Cioffi and Tannin will serve as the criminal test case. And however it ends, the events of the past year have shown that people who should have known better were all too willing to be misled.

Breakdowns and Rebuildings

Big brokers threatened by crackdown on shadow banking system A network of lenders, brokers and opaque financing vehicles outside traditional banking that ballooned during the bull market now is under siege as regulators threaten a crackdown on the so-called shadow banking system. Big brokerage firms like Goldman Sachs, Lehman Brothers, Morgan Stanley and Merrill Lynch, which some say are the biggest players in this non-bank financial network, may have the most to lose from stricter regulation. The shadow banking system grew rapidly during the past decade, accumulating more than $10 trillion in assets by early 2007. That made it roughly the same size as the traditional banking system, according to the Federal Reserve. While this system became a huge and vital source of money to fuel the U.S. economy, the subprime mortgage crisis and ensuing credit crunch exposed a major flaw. Unlike regulated banks, which can borrow directly from the government and have federally insured customer deposits, the shadow system didn't have reliable access to short-term borrowing during times of stress. Such vulnerability helped transform what may have been an uncomfortable correction in credit markets into the worst global credit crunch in more than a decade as monetary policymakers and regulators struggled to contain the damage. Unless radical changes are made to bring this shadow network under an updated regulatory umbrella, the current crisis may be just a gust compared to the storm that would follow a collapse of the global financial system, experts warn.

Read It Here First: Half of Wall St. Profits Are Gone (So Far) Last year, we looked at the issue of risk adjusted gains for the S&P500, and most especially for the Financial sector. At the time, Financials were the largest sector in the S&P500, and had what were described as legitimate, sustainable, normalized risk-based earnings. Since then, we have learned that their earnings were anything but. And, they are no longer the largest S&P500 sector, having been supplanted Technology in Q2 2008. Societe Generale's Jame Montier notes that, even with the loss of leadership, financials remain an exceptionally large component of the market itself. As the chart below shows, today's 17% of market cap may be well off the high of nearly 25% but remains a long way above the levels before this bubble started: CHART Note the correction in Financials in 1987, 2000 and then again in 2007-08. The gains in these big run ups appear particularly vulnerable -- much more so than the rest of the market. These are likely a function of the 35X leverage employed. Note also that a good part of the rise over recent decades has been fueled on assumptions about risk that turned out to be incorrect. The NYT discusses this:"Only a year ago, Wall Street reveled in an era of superlatives: record deals, record profit, record pay. But a mere 12 months later, nearly half of the profits that major banks reaped during that age of riches have vanished.

The numbers are staggering. Between early 2004 and mid-2007, a period of unprecedented wealth on Wall Street, seven of the nation’s largest financial companies earned a combined $254 billion in profits.

But since last July, those same banks — Bank of America, Citigroup, JPMorgan Chase, Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley — have written down the value of the assets they hold by $107.2 billion, gutting their earnings and share prices. Worldwide, the reckoning totals $380 billion, much of which reflects a plunge in the value of tricky mortgage investments."

The write-downs are ongoing, and if we are to believe what the Philly Banking Index -- now making multi-year lows -- is implying: We are not nearly through this. That chart above also reflects the US moving from an industrial economy to a services based one. The underlying question is how much mean reversion will happen as deleveraging occurs and risk management returns to normalized levels. CHART

Analysts Slash Bank Estimates as Credit Worsens It's not just banks that have persistently underestimated the scope of the credit crisis afflicting them. So have the Wall Street analysts paid to warn their clients what to expect. Since the start of the year, analysts have slashed their earnings estimates on Standard & Poor's 500 (^SPX - News) financial companies by a respective 41 percent, 28 percent and 25 percent for the second, third and fourth quarters, according to Lab Thomson, a Thomson Reuters research publication. Merrill Lynch & Co's Edward Najarian was the latest to turn more downbeat, amid mounting credit losses and growing uncertainty over banks' abilities to preserve capital and pay out dividends. He slashed his earnings estimates for 12 U.S. banks by an average 22 percent for 2008 and 19 percent for 2009. Najarian joins rivals at Credit Suisse, Deutsche Bank Securities Inc, Goldman Sachs & Co and Lehman Brothers Inc among those in June to slash their outlooks for banks and project more capital raising.Regional banks may face at least three further rounds of capital raising, Credit Suisse said. Goldman, meanwhile, projected that U.S. banks will raise $65 billion of additional capital to cope with credit losses.

• Merrill calls capitulation on bank stocks, slashes outlooks Analysts at Merrill Lynch on Friday said investors appear to be capitulating with regards to banks stocks, frustrated into selling them down to levels below their real values as the credit crisis continues to wreck balance sheets. The analysts also slashed their earnings outlooks for several large regional banks and said they will continue boost loss reserves and cut dividends.

More big bank dividend cuts lie ahead 7:33am:  After a sharp selloff in their stocks, some think BofA, Wachovia and other high-yielders may need to cut their payouts before long. Falling bank stock prices are a warning to investors not to get too attached to those fat dividend checks. The latest struggling lender to sock shareholders is Cleveland-based KeyCorp (KEY, Fortune 500), whose shares tumbled 24% Thursday after the bank said it would slash its quarterly dividend in half to conserve $200 million annually. But with inflation worries driving up interest rates and house prices still tumbling, the market is betting Key won't be the last bank to cut its dividend. Unusually high dividend yields could point to coming dividend cuts at banks ranging from giants Bank of America (BAC, Fortune 500) and Wachovia (WB, Fortune 500) to regionals such as Fifth Third (FITB, Fortune 500) and Regions Financial (RF, Fortune 500). The yield is the result of dividing the annual stated dividend payout by the current stock price. A higher number is typically better for investors, of course, because it means a bigger income stream relative to how much they've invested. But in a credit crunch-obsessed market, a high dividend yield can actually be a warning signal. That's because an increase in the bank's dividend isn't the only factor that can cause the dividend yield to rise. So can a decrease in its stock price. And with banks facing sharply reduced earnings prospects due to rising credit losses and tightening lending standards, a high yield can spell trouble ahead.  Bank Industry Stock comparisons (chart)

• Following the Money Selling in regional bank stocks has intensified today. Details with CNBC's Matt Nesto.

Lehman  Rex

Lehman chief feels the heat Callan used Monday's conference call with analysts and investors to tout the firm's efforts to cut risk by reducing the size of its balance sheet. Callan said Lehman was able to rid itself of $130 billion worth of its assets during the second quarter, in a move she told investors meant that Lehman's deleveraging was complete. That's fine as far as it goes, but it's worth noting that the big push reversed just three quarters' worth of asset growth. Lehman's balance-sheet slimming act brings the firm's asset base down to $650 billion - on par with its size at the end of last year's third quarter, ended Aug. 31. In other words, all Lehman has succeeded in doing so far is returning its balance sheet to the size it was at the beginning of the credit crisis last summer.Take note, too, that as the credit market storm was gathering strength, Lehman was adding billions upon billions of dollars in assets. Savvy investors would likely be very interested to know what Lehman's top execs saw that led them to vastly expand their balance sheet even as other investors were backing away from risky debt. Questions about Lehman's handling of the credit crisis have been building for some time. Lehman's Callan had assured investors and the media in March that a $1.9 billion preferred stock sale "took care of our full-year needs" for funding. But several weeks later, as the rumor mill spun furiously with questions about Lehman's health, the firm raised an additional $4 billion. On Monday, the firm raised another $6 billion. All told, survival comes at a stiff price: Investors might suffer up to a 30% dilution, assuming full conversion of the preferred securities into common stock. Lehman's unanswered questions,

So How Did Lehman Delever? A Not-Very-Pretty Possibility The markets responded positively today to Lehman's announcement of its second quarter results, its provision of a financial supplement that gave more detail on its balance sheet exposures and how they had changed over time, and its investor conference call, The stock was up over 5% of the day, although its closing price of $27.20 is still below the offering price last week of $28.00. First, we'll deal with a few anomalies, then we'll get to what is admittedly a rumor, but one if true with pretty serious implications. The last, looming mystery is how Lehman delevered in a crappy credit market. Their quarter ended in May, and March, thanks to the Bear meltdown and the worries about Lehman, would not have been a good time to sell assets. Similarly, one would have expected sales to be concentrated in certain sectors of the market where pricing was more favorable. Lehman went to great pains to show that the sales were spread across product and said they were not concentrated in the highest credit qualty assets either. I received an e-mail from a former Lehman MD yesterday. I am not able to independently verify it, so be warned that this falls in the category of a rumor.

Lehman's Fuld comes out swinging Despite Fuld's confident tone, it's clear that executing a recovery at Lehman won't be easy. Fuld noted that Lehman has a "track record of taking market share coming out of difficult cycles," and finance chief Ian Lowitt and operating chief Bart McDade - the officers who replaced Callan and Gregory - promised the firm would deploy recently raised capital to boost revenue and bring profitability back into line with investors' expectations. But analysts noted during the question-and-answer session that Lehman has a long way to go before its results match up with those promises. Oppenheimer analyst Meredith Whitney asked how the firm could produce a projected 15%-or-so return on equity, reflecting annual profits as a proportion of the firm's net worth, with its quarterly revenue at a recent level of around $4.2 billion. Lowitt conceded that Lehman wouldn't be able to hit that return-on-equity target with revenue at current levels. He said Lehman hopes to get its quarterly revenue up into the $5 billion range, reflecting nearly 20% growth. How does Lehman expect to produce this sort of growth in such a difficult market? Lowitt wouldn't say, noting that "markets continue to be challenging." He also declined to offer a timeline for bringing the ROE figure up to par, though "we're very confident we can get there," he said.

Other Players 

S&P cuts Bank of America to sell from hold Standard & Poor's Equity Research on Friday downgraded shares of Bank of America Corp. to sell from hold amid worries about the mortgage portfolio the bank will inherit when it acquires lender Countrywide Financial Corp. on July 1. "We take unfavorable note of the large Countrywide option-adjustable rate mortgage portfolio that Bank of America will inherit, since we believe this portfolio has yet to be stress tested," S&P said in its action. The agency also said it expects BofA to "significantly" increase its loss provisions to reflect a weakening U.S. consumer and predicted a dividend cut. S&P cut earnings estimates for 2008 for the bank by 51 cents to $2.16 and reduced its target price by $9 to $24.

Goldman, Morgan Stanley Fixed-Income Earnings Mask Reliance on Commodities On Wall Street, where just about everyone has lost confidence in financial assets, Goldman Sachs Group Inc. and Morgan Stanley are making money the old-fashioned way: Buying and selling commodities. Goldman and Morgan Stanley are expected by analysts to report the best second-quarter earnings of the world's biggest securities firms this week, having limited their losses from the collapsing credit market. They also lead Wall Street in commodities trading, where crude oil futures doubled in the past year and the price of products from gold to corn soared to record highs. Surging prices are attracting investors, as well as companies hedging their positions by buying derivatives. That's played to the strength of Goldman and Morgan Stanley, which dominate the market for commodity derivatives. The two New York-based companies accounted for about half of the $15 billion of revenue that the world's 10 largest investment banks generated from commodities last year… Goldman Earnings Drop Less-Than-Estimated 11% After Gains in Commodities

Willumstad, AIG's New Chief, Says `Nothing Off Table' in Turnaround Plan -- Robert Willumstad, American International Group Inc.'s new chief executive officer, says ``nothing is off the table'' as he tries to win back shareholders' confidence in the world's biggest insurer. Willumstad said he'll meet with AIG's unit heads, business partners and regulators to get a better feel for the company, which has $1 trillion of assets. He worked almost 40 years in banking before joining AIG and was part of Sanford Weill's team that created Citigroup Inc., the biggest U.S. bank by assets, from the 1998 merger of insurer Travelers Group and Citicorp. Jamie Dimon, who also worked with Weill, now runs JPMorgan Chase & Co., the third-largest U.S. bank. Property and casualty insurers in the U.S. may pay more in claims and expenses than they collect in premiums this year as rates drop for commercial coverage, Fitch Ratings said June 11. Insurers cut prices for workers' compensation, commercial property and aviation coverage amid competition for revenue after lower-than-average hurricane losses in 2006 and 2007. AIG made 3.1 cents for every dollar of property and casualty premium it collected in the first quarter, compared with 12.5 cents a year earlier. The decline was driven by losses at its mortgage-insurance unit, which reimburses lenders when borrowers fail to pay. The mortgage unit may be unprofitable the rest of this year, AIG has said. Returns from private equity and hedge funds have been declining because of gridlock in the credit markets. First- quarter income from so-called alternative investments shrank to $197 million from $1.22 billion a year earlier, AIG said in May. The company said hedge funds were ``real laggards.'' Behind the CEO ouster at AIG

Citigroup Will Have `Substantial' Further CDO Writedowns, Crittenden Says Citigroup Inc., the biggest U.S. bank, will have ``substantial'' additional writedowns on its holdings of debt linked to the subprime mortgage market, Chief Financial Officer Gary Crittenden said. The second-quarter markdowns related to subprime mortgages won't be as large as the $6 billion recorded for the first quarter, Crittenden said today on a conference call with investors hosted by Deutsche Bank AG. ``We will continue to have substantial additional marks on our subprime exposure this quarter,'' Crittenden said. ``We may continue to see the magnitude of the marks decline, as the exposures that we have have declined.'' Citigroup has booked more than $40 billion of credit losses and writedowns since the subprime mortgage market collapsed last year. Chief Executive Officer Vikram Pandit, who took over as CEO in December, outlined plans last month for the company to reduce assets by $400 billion over the next two to three years. The company's subprime holdings include collateralized debt obligations, or CDOs, which are securities packaged from pools of loans and bonds. Crittenden said on the call that Citigroup may also have to write down the value of assets backed by so-called monoline insurance companies such as Ambac Financial Group Inc., after they were stripped of their AAA credit ratings.Citigroup last quarter recorded a cost of $1.5 billion to account for the reduced likelihood that the insurers will be able to pay. The company may record a ``similar'' cost in the second quarter, Crittenden said.

• Report: Citigroup to slash investment-banking jobs

Merrill Shares Fall on Rumors of Profit Warning Merrill Lynch & Co (NYSE:MER - News) shares fell 5.5 percent Friday on rumors that the investment bank may issue a profit warning and take additional write-downs on its mortgage holdings, traders said. The rumors also weighed on U.S. and European stocks.The world's largest brokerage is due to announce second-quarter results next month. Investors are concerned about its performance after peers including Lehman Brothers (NYSE:LEH - News) and Morgan Stanley (NYSE:MS - News) posted weak results this week. Merrill has recorded more than $30 billion of write-downs since the 2007 third quarter and has raised more than $12 billion of capital.