bizzXceleration: Performance, Value and Profit

Finance Industry Outlook

Who Doesn't Understand the Pending Home Sales Index? I'll make this as simple as possible. (If you are a journalist that covers this area, you best read and UNDERSTAND this). The NAR release makes clear (in the footnotes) that the Pending Home Sales Index was a NEGATIVE REPORT. This was not a positive, despite what you may have read. Here are 4 details you need to understand: 1. The Pending Home Sales Index is down 12.3% Y/Y. As the NAR notes itself, it is the annual data, not the monthly number, that matters most. 2. 30-40% of these pending sales were distressed/ foreclosure sales. Many of the ‘pendings’ are short sales -- bought for much less than the amount owed amount owed on the mortgage. The majority of these will not get approved by either the seller (REO Bank) or the financer (mortgage orignator). 3. There is a growing gap between PHSI and actual closings (See NT chart below). 4. The monthly rise is nothing more than regular seasonality.

Mortgage Delinquencies Accelerated During 2007 Mortgages issued in the first part of 2007 are going bad at a pace that far outstrips the 2006 vintage, suggesting that the blow to the financial system from U.S. housing woes will be deeper than many people earlier estimated. An analysis prepared for The Wall Street Journal by the Federal Deposit Insurance Corp. shows that 0.91% of prime mortgages from 2007 were seriously delinquent after 12 months, meaning they were in foreclosure or at least 90 days past due. The equivalent figure for 2006 prime mortgages was just 0.33% after 12 months. The data reflect delinquencies as of April 30. Yet the data from the FDIC and others suggest that lenders didn't substantially tighten standards until at least July or August 2007, when credit jitters hit Wall Street and financial stocks began to swoon. Until these bad loans are fully digested, "foreclosures will remain at record highs, the financial system will be under severe stress and the broader economy will sputter," said Mark Zandi, chief economist of Moody's Economy.com. One piece of good news, he said, is that loans originated in the fourth quarter of 2007 and early 2008 appear to be performing better.

Morgan Stanley Freezes Home-Equity Credit Lines for Thousands of Customers Morgan Stanley, the second-biggest U.S. securities firm, told thousands of clients this week that they won't be allowed to withdraw money on their home-equity credit lines, said a person familiar with the situation. Most of the clients had properties that have lost value, according to the person, who declined to be identified because the information isn't public. The New York-based investment bank will review home-equity lines of credit, or HELOCs, monthly from now on, the person said yesterday. Wall Street firms including Morgan Stanley are ratcheting back on risks after the collapse of the subprime mortgage market and ensuing credit contraction saddled banks and brokerages with almost $500 billion of writedowns and losses. Consumers fell behind on home-equity credit lines at the fastest pace in two decades in the first quarter, the American Bankers Association reported last month.

U.S. Economic & Interest Rate Outlook: Base Case vs Checkmate (NT): Year-over-year U.S. financial corporation profits from domestic operations also are now contracting (see Chart 21). With house prices continuing to fall, losses on residential mortgage securities will continue. In addition, losses will start to mount on credit card debt, auto loan debt, commercial real estate debt and high-yield corporate debt. This will erode the capital of financial institutions at a time when the regulators are likely to require higher capital ratios.Thus, inadequate capital at financial institutions will retard their ability to extend new credit to the private sector. Concrete manifestation of this “credit crunch” can be seen in the recent behavior of commercial bank credit. On a three-month annualized basis, growth in U.S. commercial bank loans and securities soared to 17% last summer as banks were forced to take onto their balance sheets assets that had formally been financed with commercial paper in offbalance sheet entities. However, bank credit growth in recent months has collapsed. In the three months ended June, bank credit has contracted at an annualized rate of 5.8% -- the second largest contraction in bank credit in the history of the series, which began in January 1947 (see Chart 22). Given that assets equal liabilities plus net worth and given that the asset side of the banking system’s balance sheet is contracting, we would expect that bank deposit growth – a component of the liability side – would be weakening. In the early 1990s, U.S. commercial banks suffered from capital inadequacy and the U.S.economy suffered from bank credit inadequacy. Throughout the decade of the 1990s, Japanese banks suffered from capital inadequacy and the Japanese economy suffered from bank credit inadequacy. History is rhyming again.

• Not Even 2% Fed Funds Help Municipal Borrowers as Bond Rates Reach Record Bond Default Rate May Rise to 10% Worldwide as Growth Slows, Moody's Says
• Birinyi Says Financials May Need to Be Sold After Gains, David Joy Says It's `Too Early' to Invest in Financials

Wall Street Report Tries to Dissect Financial Meltdown A group of Wall Street executives released a report on Wednesday that outlined how the industry failed to foresee the financial meltdown of the last year and what companies can do to improve risk management. The 172-page report, written by chief risk officers and senior executives at banks like Lehman Brothers, Merrill Lynch and Citigroup, also provides suggestions about technical issues at the same time as it offers a bit of a mea culpa. “Virtually everybody was frankly slow in recognizing that we were on the cusp of a really draconian crisis,” said E. Gerald Corrigan, a managing director at Goldman Sachs and a chairman of the Counterparty Risk Management Policy Group III , which released the report. Wall Street failed to anticipate how wide-reaching problems with mortgage bonds would spread into seemingly distant corners of the financial markets, the report said. Awash in easy money, banks doled out credit without sufficiently charging for the risk. Wall Street also created complex structures that masked connections between asset classes as well as compensation incentives that pushed traders to take risky steps for short-term gain. The industry’s failings have now translated into pain for the broader economy, the report said.In many ways, the report acknowledged shortcomings that have already been raised by Wall Street’s critics. Panel Proposes Market Reforms

• Ex-Fed Official: Crisis Toughest in Postwar Period
• Why Changing Wall Street Paychecks Won’t Change Wall Street
• Quote of the Day: John Paulson on Financials

Institutional Breakdowns and Cultural Barriers

Confessions of a risk manager IN JANUARY 2007 the world looked almost riskless. At the beginning of that year I gathered my team for an off-site meeting to identify our top five risks for the coming 12 months. We were paid to think about the downsides but it was hard to see where the problems would come from. Four years of falling credit spreads, low interest rates, virtually no defaults in our loan portfolio and historically low volatility levels: it was the most benign risk environment we had seen in 20 years. As risk managers we were responsible for approving credit requests and transactions submitted to us by the bankers and traders in the front-line. We also monitored and reported the level of risk across the bank’s portfolio and set limits for overall credit and market-risk positions. The possibility that liquidity could suddenly dry up was always a topic high on our list but we could only see more liquidity coming into the market—not going out of it. Looking back on it now we should of course have paid more attention to the first signs of trouble. In May 2005 we held AAA tranches, expecting them to rise in value, and sold non-investment-grade tranches, expecting them to go down. From a risk-management point of view, this was perfect: have a long position in the low-risk asset, and a short one in the higher-risk one. But the reverse happened of what we had expected: AAA tranches went down in price and non-investment-grade tranches went up, resulting in losses as we marked the positions to market. This was entirely counter-intuitive. Explanations of why this had happened were confusing and focused on complicated cross-correlations between tranches. In essence it turned out that there had been a short squeeze in non-investment-grade tranches, driving their prices up, and a general selling of all more senior structured tranches, even the very best AAA ones. That mini-liquidity crisis was to be replayed on a very big scale in the summer of 2007. But we had failed to draw the correct conclusions. As risk managers we should have insisted that all structured tranches, not just the non-investment-grade ones, be sold. But we did not believe that prices on AAA assets could fall by more than about 1% in price. A 20% drop on assets with virtually no default risk seemed inconceivable—though this did eventually occur. Liquidity risk was in effect not priced well enough; the market always allowed for it, but at only very small margins prior to the credit crisis.

The woman who called Wall Street's meltdown Whereas her peers keep searching for some sort of light at the end of the tunnel, Whitney thinks the tunnel is about to collapse. Bank stock investors will get crushed if they jump back in now, she contends, because the banks are facing much, much bigger credit losses than what they've reported so far. Moreover, Whitney is convinced that the economy is about to sink into an "early 1980s-style" recession that will devastate the 10% of the population that became overextended during the housing boom. Whitney's insights haven't always translated into lucrative investment picks. Based on the performance of her buy and sell recommendations relative to her industry peer group - what analyst tracker Starmine refers to as an analyst's "industry excess return" - Whitney's stock picking ranked 1,205th out of 1,919 equity analysts last year and 919th out of 1,917 through the first half of 2008. That said, evaluating Whitney solely on the timing of her buys and sells misses the point. It's not just that she's bearish on the entire banking industry. What makes Whitney so interesting is the brutality of her arguments and the evidence she summons in making them. Another eye opener for Whitney has been how gracious most wrestlers are - at least when the cameras aren't rolling - in comparison with the viper-pit culture on Wall Street. It sounds absurd - the world of high finance being less collegial than an industry in which employees belt each other in the face. But based on the time I spent backstage before the Great American Bash, Whitney has a point.The wrestlers I met - from John Cena to Mark Henry to Paul "Big Show" Wight - all greeted Whitney like family. Henry, who plays a particularly nasty brute in the WWE story line, could not have been any nicer. For Whitney the upshot is this: She's much less inclined to take guff from Wall Streeters intent on berating her for predictions they don't like. "Life's too short," she says.

Financial Cowboys Need to Be Lassoed, Corralled: David Pauly Maybe the $30 billion in new money Merrill Lynch & Co. has raised still isn't enough. In any case, Merrill and its three big Wall Street rivals must be required to have fixed amounts of capital, certainly more than they would maintain on their own. Goldman Sachs Group Inc. and the others also must be forced to switch much of their short-term debt to long-term bonds. Bank of America Corp. and all other banks must be told to increase their capital, too. Fannie Mae and Freddie Mac, which own or guarantee $5.2 trillion of the nation's $12 trillion in home mortgages, should be forced to hold as much capital as banks. While we're at it, Fannie and Freddie should be split into four companies -- and their ties to government eliminated. Now that the Federal Reserve, Congress and the U.S. Treasury have saved the banking system and propped up the mortgage industry, they should insist that financial companies curb their wanton ways. The government must make rescues less likely. There has been much moaning about the government bailing out companies caught in the subprime crisis. But the government did what it's supposed to do and what the markets couldn't do after the financial giants' mortgage securities blew up. Investors had pulled their money from Bear Stearns Cos. when the firm needed it most. Bear's inability to pay its debts would have led to runs on other investment firms and banks. Money managers abandoned Fannie and Freddie shares and even looked askance at their bonds, which have the government's implied backing. Without the support of these two government- sponsored enterprises, mortgage rates might have skyrocketed. The next step: If the government is to be the lender of last resort for financial companies, it has to demand more control over their daily business. Not too much regulation, just more.

SEC Probes `Vomitorium' While More Patients Gag If you have been perusing recent news reports that chronicle Wall Street's latest crop of outrageous, investors-be-damned e-mails and wondering where the regulators were, I've got news for you. The regulators were there. The problem is it just didn't make any difference. Massachusetts Secretary of State William Galvin brought an administrative action on Aug. 1 against Merrill Lynch & Co., releasing e-mail gems that included a doozey written Aug. 16, 2007. ``Come on down and visit us in the vomitorium!'' wrote Frances Constable, a managing director, to a Merrill colleague. Constable's aptly named locale was the Merrill Lynch auction-rate securities desk, which Constable ran, and which by this time last year must have been a sickening sight. The auction-rate market may have been in crisis mode. But that didn't stop Merrill from selling the securities for months after, with Constable even pushing a bond analyst to tone down a negative report lest it scare away customers, according to the state action. Tone down a negative report? Didn't we already watch this show? It was five years ago when 10 securities firms reached a $1.4 billion settlement with regulators that was supposed to wipe out the conflicts of interest that infected Wall Street research. A little caveat: The global research-analyst settlement, as it was called, didn't apply to fixed-income research. Nor to any other research -- technical, commodities or quantitative -- for that matter. Just stocks.

Hank the Great? Paulson Takes a Page From Frederick With Covered-Bond Plan In 1769, short of funds to rebuild Prussia after attacks by Russia, Sweden and Austria, Frederick the Great let aristocrats, churches and monasteries raise money by pledging their estates as security to investors. From those beginnings emerged what today is Europe's $3 trillion market for covered bonds -- securities backed by assets such as mortgages as well as the seller's promise to pay. Now U.S. Treasury Secretary Henry Paulson, faced with carnage in the housing market that led to $480 billion of losses and writedowns at the world's top financial institutions, is using a similar strategy to help America's banks turn assets into cash. While the European market has grown for 250 years, Paulson's plan confronts obstacles Frederick never faced: Besides competition from the biggest U.S. housing-finance companies, the debt would be tied to mortgages and banks that are sliding in value with America's homes and economy. ``Not every bank is going to be able to do this,'' said William Isaac, the chairman of the Federal Deposit Insurance Corp. from 1981 until 1985. ``Even the banks people are not concerned about are probably only going to be able to do it in a limited amount right now.'' Covered bonds get higher ratings than notes sold by banks and pay less in interest because they augment the issuer's repayment pledge with assets that can be sold in a default. Paulson's blueprint, unveiled last month, allows banks to sell bonds backed by mortgages made to homeowners who provide down payments of 20 percent and are current on their loans. U.S. covered-bonds might yield as much as 0.75 percentage point less than unsecured bank debt over time, according to analysts at New York-based JPMorgan Chase & Co. Federal Deposit Insurance Corp. Chairman Sheila Bair has said that the U.S. needs covered bonds because the ``originate- to-sell'' model led to a market bubble that now is collapsing. By keeping loans with lenders, covered bonds provide incentives for banks to improve their standards on loans that don't meet the guidelines to be purchased by Fannie or Freddie or insured under U.S. government programs. Other types of lending have ground to a near halt, fueling the crisis.

AIG: Blindsided by Blindness

AIG's huge 2Q loss shows credit market woes linger American International Group Inc. posted its third straight quarterly loss, a rude awakening to investors hoping that troubles in the insurer's mortgage market investments were starting to level off. The world's largest insurer suffered a deficit of $5.36 billion in the second quarter after losing $5.56 billion, or $3.62 billion after taxes, in what are called credit default swaps, and writing down $6.08 billion, or $4.02 billion after taxes, in the value of other investments. Some analysts believe AIG may have more losses ahead of it. "Management either seems unaware or unwilling to admit the full level of the company's exposure to risky assets," said Byron MacLeod of Gradient Analytics. He noted that the collateral AIG has put up to offset unrealized losses, related primarily to the credit default swaps portfolio, has risen to $16.5 billion in the second quarter from $9.7 billion in the first quarter and from $5.3 billion in the fourth quarter. "There's no quick fix here for the company," MacLeod said. "Things are still deteriorating for AIG's assets, so it's really hard to call a bottom at this point." Back in May, having posted two consecutive quarterly losses, AIG decided to raise capital in an effort to improve its financial standing. AIG said Wednesday that it raised approximately $20 billion in capital through the sale of $7.47 billion of common stock, $5.88 billion in equity units and $6.91 billion in certain fixed-income securities. AIG Posts Third Straight Quarterly Loss on Housing, AIG Tumbles Most Since 1987 Crash After Third Straight Loss on Writedowns

The Lessons of AIG Nobody knows AIG better than Maurice "Hank" Greenberg, the man who built up this insurance empire and ran it for decades. So maybe investors should have paid more attention when, during the course of 2007, the former chairman sold stock like it was going out of fashion. In a sense, it was. From a high of $72 in early 2007, AIG has now collapsed to just $24.40. That follows an eye-watering plunge today, following dismal second-quarter results and some fears about the balance sheet. This is not a minor financial story. In sense, everyone in America is a loser. AIG is one of the most valuable companies in the world. If you have a pension plan or money in any stock mutual funds, the odds are strong that you have lost money on this stock. The question remains whether the latest plunge is the time to buy, or whether, in that unhappy Wall Street phrase, things are going to get worse… before they get even worse.

AIG Has a Tough Choice Robert Willumstad needs to cauterize American International Group's wounds and move on.For nearly a year, AIG has grudgingly acknowledged higher and higher losses on the insurance the firm wrote for complex mortgage-backed debt instruments. But it has failed to get ahead of the curve. The question now is whether Mr. Willumstad, the new CEO, will attempt to rid the firm of these troublesome holdings, no matter the cost. Or if he will hunker down and allow AIG to hold fast to its view that the ultimate cash losses won't be anywhere near those implied by current, depressed market prices. Either step has big risks. Unloading the instruments could lock in losses that mightn't ultimately be realized. Holding on could jeopardize the firm's capital, requiring more dilutive capital calls after the firm recently raised $20 billion. In coming to an answer, Mr. Willumstad needs to consider that AIG has consistently misread the severity of the housing downturn and the impact this will have on the insurance, or credit default swaps, it wrote on collateralized debt obligations backed by mortgages. Given that, the new chief should start taking some cues from the market. The firm also would have to overcome internal resistance to the idea that the swaps will eventually record big losses. AIG has consistently argued otherwise, although it has been proven wrong at every step. Last August, AIG argued that the U.S. would have to have a shock twice as bad as the Great Depression before the swaps showed losses. At the first quarter's end, it said final losses could come in between $1.2 billion and $2.4 billion. Now the firm has upped that estimate to between $5 billion and $8.5 billion.Yet that is still below a $9 billion to $11 billion estimate made this spring by an outside firm hired by AIG. In a research note Thursday, Morgan Stanley estimated the losses could come in at $13 billion. Granted, those figures are well below the about $25 billion in losses implied by market prices. But the market's extreme pessimism has been more on the mark than AIG's blind optimism.

Fannie & Freddie: Malfeasance Run Wild ???

Homey Virtues: Fannie Mae and Freddie Mac remain steady growers in an uncertain market (Barron’s, May01): Fannie and Freddie are belting out their same old earnings song, an upbeat tune that sounds mighty sweet in the face of a sour stock market. That's despite a few discordant notes sounded by investment icon Warren Buffett, whose Berkshire Hathaway sold off some of its holdings in the two federally chartered mortgage companies last year because of his perception that they're becoming risky. But they have managed to all but drown out a small chorus of critics who charge Fannie and Freddie expose the taxpayers to massive risk while using implicit federal guarantees to unfair advantage against private competitors.

Fed Bank Official Seeks Curb On Fannie Mae, Freddie Mac (WSJ, Mar03):In a broadside attack aimed at shaking up the regulatory environment for Fannie Mae and Freddie Mac, a prominent Federal Reserve policy maker warned of a potential "crisis" if steps aren't taken to rein in the giant, rapidly expanding mortgage companies.Fannie Mae and Freddie Mac, the highly profitable public companies that operate under government charters, own or guarantee $3.1 trillion in mortgages, or 45% of residential debt outstanding in the U.S., compared with 25% as recently as 1990. Speaking at a housing symposium held by the Office of Federal Housing Enterprise Oversight, William Poole, the St. Louis Federal Reserve Bank president, made two recommendations that cut to the heart of Fannie Mae's and Freddie Mac's immense profitability. First, he suggested Fannie Mae and Freddie Mac boost their capital reserves to help survive any potential shock to their operations. Second, he called on the federal government to more formally distance itself from the companies, including possibly withdrawing lines of credit Fannie Mae and Freddie Mac have to the U.S. Treasury, long viewed by investors as signs the companies would be bailed out in case of an emergency.

Big loss, grim outlook at Freddie Mac Mortgage finance giant Freddie Mac on Wednesday reported a much bigger-than-expected loss, slashed its dividend and warned of more problems ahead for the battered housing and credit markets. Company executives, in a sobering forecast about the nation's housing woes, said nationwide home prices are likely to drop another 7% to 9%. Those declines, and other problems in the economy, are likely to cause additional losses on the $1.8 trillion worth of single-family loans that Freddie guarantees or owns. Freddie's year-to-date losses of nearly $1 billion are far below the $3.7 billion it lost the second half of 2007 as it took charges for the value of its loans portfolio. The current losses are driven by the rapidly rising costs of loan defaults and rising provisions for future losses that are certain to rise. "While we may be roughly half way through the eventual decline, we are still in the early stages of realized defaults," said Patricia Cook, the company's chief business officer. "Most of the expected losses are yet to be realized." Since the start of 2007, Freddie's portfolio of single-family home loans suffered credit default costs of nearly $2 billion. Three months ago the company estimated that those defaults could end up costing between $15 billion and $20 billion during the life of the loans. But with steeper home price declines now being forecast, and the increasing rate of mortgage foreclosures and delinquencies, Freddie expects those costs to go higher - to as much as $42 billion in what it says is a worst-case scenario.

Freddie's risks all too plain to see Data posted on the company's web site quantify the company's exposure to various types of loans, such as the prime loans made to the most qualified borrowers and the Alt-A loans made further down the credit quality scale. The numbers also offer detail on the delinquency rates associated with loans made before and after the housing market's mid-decade peak. In general, late payments are higher in post-2005 loans, those made after U.S. house prices peaked.One table showed that even if losses on Freddie's mortgage portfolio and mortgage-securities guarantees come in at the top of the company's expectations, Freddie would remain within striking distance of current regulatory capital requirements. Even so, some of the credit quality trends are daunting. Serious delinquencies - measuring loans past due by 90 days or more, or in foreclosure - jumped to 3.72% of Alt-A loans in the second quarter ended June 30. That's more than half again as many seriously delinquent Alt-A loans as Freddie had in the first quarter, and more than triple the year-ago level. Seriously delinquent loans have risen much less sharply in the rest of Freddie's portoflio.

• NYT Hit Job on Freddie Mac , Freddie Fights Back, Another Version of the Infamous Syron Memo Dust-Up
• Freddie Mac Fires Back, Pt. 1 : Inside Freddie Mac, with Richard Syron, Freddie Mac chairman & CEO and CNBC's Maria Bartiromo.
• Freddie Mac Fires Back, Pt. 2 : Inside Freddie Mac, with Richard Syron, Freddie Mac chairman & CEO and CNBC's Maria Bartiromo.

More pain at Fannie - $2.3 billion loss Mortgage finance giant Fannie Mae reported a much larger-than-expected loss in the second quarter and slashed its dividend Friday, more signs that the problems in housing and financial markets are not over.The firm reported a net loss of $2.3 billion, or $2.54 a share. Analysts surveyed by Thomson Reuters forecast a loss of 68 cents a share, compared to earnings of $1.86 a share a year earlier. But large increase in reserves for bad debt and a writedown in the value of its holdings hurt the results. The company warned of billions more in credit losses this year than it had previously forecast, and said the rate of credit losses is likely to get even worse next year. Fannie Mae also gave a gloomier forecast on the battered housing market, saying that the range of price declines is likely to be at the upper end of its previous forecast of a 7% to 9% drop in 2008. Fannie also slashed its quarterly dividend to 5 cents a share, down 86% from its previous level, as the company tries to maintain the capital reserves it needs to operate.Shares were down nearly 13% in pre-market trading after the report. The company announced it would pull out of the so-called Alt. A loan business by the end of the year. Those loans, made to borrowers who do not provide full or any verification of their income, have been responsible for most of the company's losses, even though they are a small percentage of their overall business. The rising loan losses caused Fannie to set aside an additional $3.7 billion for credit losses yet to come. It also saw actual credit losses in the period of $1.3 billion, a jump of more than 400% from a year ago, and up 44% from the first quarter of this year.

Fannie Mae: Q2 Ended in June, but July was Worse “You will recall, by way of background, that even though our second quarter books closed on June 30, subsequent events factor in, and in fact, heavily weight our outlook and our expectations going forward. And those events in July loom significantly in that calculus. That week of July 7 was one of the worst Fannie Mae has experienced in the debt and equity markets. The Treasury-fed backstop plan that was announced on July 13 calmed the market somewhat, and the passage of the Housing bill on the 26th of July added more certainty. But on the downside, July was a tough month for our credit performance. We experienced higher defaults and higher loan loss severities in the markets that were experiencing the steepest home price declines. And that gave us higher charge-offs than we had experienced in any month in the second quarter, and higher than we had expected. We also saw a higher proportion of foreclosures coming from states and products with higher loan balances, which increases the absolute dollar losses. In terms of severity, the loss that we experienced when a loan defaults also increased from 19 basis points in the first quarter to 23 basis points in the second quarter. And that rose again in July to 27 basis points. We are now seeing average initial charge off severities of 40% for loans in California. Home prices have cratered in certain markets since the peak -- Cape Coral, Florida, down 50%; Las Vegas, down 35%; northern Virginia, down 30%; and in California, Modesto, and Stockton, down 50%; Riverside, down 40%. The list goes on. Alt-A foreclosures have doubled in southern California.

Merrill: Russian Sleigh Ride

Merrill's John Thain's Change From cockiness to capitulation. From distinction to desperation. From pride to panic. Such is the story of John A. Thain as the chief executive of Merrill Lynch. The question is whether the fear Merrill showed this week in dumping securities for pennies on the dollar — and on terms that did not even foreclose the possibility of further losses — is an indication that the stock market bottom has been reached. A man who rose to prominence at Goldman Sachs, where risk-taking is an art and a source of pride, decided that his new firm had to get its pile of collateralized debt obligations off its books. It had ridden them from 100 cents on the dollar to 22 cents, but now it would unload them for little more than a nickel, with the possibility of getting the rest of the 22 cents later. It would give up any claim to profits from a rebound. Since Merrill is booking this as a sale — an accounting treatment that could seem a little optimistic if Lone Star sends the securities back — it won’t have to go through the painful process of valuing them, and taking more losses, every quarter. It appears that Mr. Thain decided he had been embarrassed enough. That could be the kind of capitulation that will later be seen as marking the bottom of despair on Wall Street. It is Wall Street legend that bottoms are made when the most optimistic give up. The stock market reacted as if Merrill’s move was such a sign, although it gave up many of the gains on Thursday, after a disappointing report on growth in the American economy.

• Slim Pickings at Merrill Lynch (WSJ) What if you woke up one morning and had 615 million more mouths to feed? And your fridge? It's half-empty. This is the dilemma for Merrill Lynch's John Thain, who last week unveiled an $8.55 billion sale of new Merrill common stock.

Merrill sees little cash in Bloomberg sale According to Merrill's quarterly earnings report, filed Tuesday, the giant brokerage received just $110 million in cash in the sale of its 20% stake in Bloomberg back to its parent company, which is owned by New York City mayor Michael Bloomberg.That means Merrill is getting less than 3% of the value of its Bloomberg stake in cash, despite the widely-held belief on Wall Street that the investment was increasingly profitable and - unlike so many assets on Merrill's balance sheet - posed little risk to the firm.In addition to the paltry cash payment, Merrill will receive $4.3 billion in 10-year and 15-year notes. Thain had indicated on Merrill's quarterly earnings conference call last month that Merrill would be financing the sale of the Bloomberg stake, though he didn't describe the terms.

How Merrill trampled the little guys I don't care how cheap Merrill Lynch (MER, news, msgs) shares get. Why would any individual investor in his or her right mind buy even one after the scam that CEO John Thain just pulled? I thought the idea of common stock is that everyone buying a share gets an equal piece of the appreciation, if any, and takes an equal piece of the loss. But Merrill has just paid out $2.5 billion to make one great big shareholder, the Singaporean state investment fund Temasek, happier. At the same time, in order to raise $8.5 billion in new capital -- part of it to pay off Temasek -- Merrill's other investors are going to see their holdings diluted by 38%. So on top of the punishment the market has dished out to Merrill shareholders this year -- the stock was down 49% for 2008 as of the close on July 30 -- Thain has just dished out a 38% haircut. After the deal is done, existing shareholders will own 38% less of the shrunken company.

Other Players

Hedge Fund Outlook `Much Worse' Than LTCM's 1998 Collapse, Hufschmid Says The $1.9 trillion hedge fund industry, mired in its worst performance in two decades, faces ``much worse'' conditions than in 1998, when Long-Term Capital Management LP collapsed, a veteran of that fund said. ``It's definitely a trickier environment,'' said Hans Hufschmid, chief executive officer of GlobeOp Financial Services LP, and a former partner at LTCM and co-head of its London office. ``The market is much worse that it was in 1998. Then it was just LTCM, but this impacts everybody.'' Hedge funds are concerned for the first time about risks related to prime brokers after Bear Stearns Cos.' forced merger with JPMorgan Chase & Co., said Hufschmid, 52, whose London-based company is administrator to funds managing about $104 billion. Banks and brokerages have written down $495 billion and raised $356 billion in capital since the start of 2007 as the U.S. subprime mortgage market collapsed. Banks' increasing reluctance to lend has hurt hedge-fund operations, Hufschmid said in a telephone interview yesterday. ``Hedge funds live on credit and leverage and the ability to finance esoteric positions for a long time,'' said Hufschmid. ``To the extent liquidity is drying up as it is now, that becomes more difficult.''

• Blackstone Profit Down 75%
• Barclays profit drops 35%