Frannie From Pan to Fire (Update2): Rescue Me...Us...the System ?
A little earlier this evening an interesting and very major story just came out on the WSJ online that Fannie and Freddie are about to have the Treasury impose a "rescue" plan of some sort or another. We'll see what happens over the weekend but it looks like the long-delayed other boot (Paul Bunyan's spare) is about to be dropped. This is good news and bad news. You might want to review a little history (Bad Times, Really Bad Behavior, Bad Trouble: Fannie/Freddie and Perdition Road). This is ironic since the markets, after reacting in what we consider a properly rational way to an abysmal employment report, rallied back today to close in positive territory for the non-tech businesses. Guess what - it was the Financials, the Homebuilders and Consumer Discretionary that were up. All the things that a metastasizing credit credit crisis and an accelerating slowdown are going to hurt the worst. The continued triumph of delusion over analysis IOHO. Ironically in the after-hours markets the Frannie Twins were down about -20%+ ! Though to be fair, if very confused, XLF was up almost 5% and XHB up almost 3%. Clearly the weekenders think Frannie is toast but it bodes well for the financials and the homebuilders. BtW Barry Ritholz has obviously been up and reading as his excellent summary of the news is here: Roundup: Fannie & Freddie Bailout. His opinions about socialist bailouts are another thing IOHO.
Weekend Updates and Summaries: BigPicture, CalculatedRisk and Matt Trivvsanno & crew have come thru with summaries analysis and consequences that you should have in you reading lists.
BigPicture: Fannie & Freddie Weekend Wrap Up/Linkfest,Treasury Takeover of GSEs: 10 Key Points
CalculatedRisk: Fannie & Freddie Thoughts
Matt Trivisonno: The Fan-Fred Short-Squeeze Rally
Update2: More interesting news below in the readings section detailing the behind the scenes on the Frannie rescue AND the impact on the Housing markets. Plus an assessment of widespread the problems with banking capital shortfalls are. Confirm our themes and "worsen" them in essence.
Let us try and disabuse everyone of those notions that a) a Frannie bailout is pork-barrel politics, b) that the Financials are /will be in good shape and c) it's safe to get back in. And do so by complementing all the news roundups with our usual focus on the structural context and consequences. In other words , what's the lay of the land and what's the weather therein.
State of the Credit Markets
Starting by looking at the state of the credit markets using some of our standard indicators. What you see here are three different credit/money market measures the can tell us quite a bit about what's going on. First up is the spread between FedFunds and 10Yr Treasuries - which mixes instruments a bit - but is still telling us that the Yield Curve is "market favorable". That is short-term money is cheap, which generally encourages investing because borrowing is inexpensive. And longer-term money ain't that expensive at around 4% and dropping. But the really interesting thing about that spread is the abrupt switch around Nov. from no spread, indicating a flat/inverted yield curve and tight short-term money, to now. In this puzzle-palace world the short-term drop was Fed policy at work but why the long-term rates are staying up is....dollar ?
More interesting though is the spread between 3Mo Treasures and corporate commercial paper, which is still very elevated over last year and appears to be rising. An indicator that there's still a lot of fear and uncertainty in the market. Finally is the inflation-adjusted monetary base which tells us the effective supply of money is growing or shrinking. Normally it shrinks during downturns and this time is no exception ...except it's been shrinking longer and farther than the economy's been downturning so far ! The reason - it's called credit tightening. In other words the credit markets are working but under enormous pressures. If you'd like to see a really cool and implicitly informative history of how the yield curve works and relates to the markets try this: Dynamic Yield Curve. And in case you're wondering why you care Wikipedia has a decent, thorough and balanced description.
Frannie's Failures and Consequences 
After the break you'll find a largish collection of readings that bear on all this from the news that the Chinese banks have backed away from Frannie, for what now seem like sound, rational reasons. Which makes the rates they have to pay to borrow higher, funding harder to get and so on. Which leads us to one of the gray-headed potential triggers - though it's been months/years in the making. Bill Gross's latest newsletter talked about a financial tsunami freezing up and then collapsing the markets and specifically the need to rescue Frannie on Thur. But he wasn't alone - Paul Volcker, perhaps the most respected central banker in seven decades, came out flatly the same day and said the system is broken, more write-offs are coming and we need to re-engineer it. He further added he's never seen a crisis this complex or painful.
Our fear is that once we move beyond the perennial Pollyannas and into more realistic territory there's still a limited grasp of what a breakdown in Frannie, let alone the whole system, would mean for the economy. Shucks...:) We're not even sure we get it and we've been flapping our gums for months. Certainly if the XLF keeps getting run up like this though our fears of a major breakdown are very far afield from the common understanding. In other words there's still a lot of piping to pay for and Bill and Paul are telling us the bill's coming due.
There's a bunch of other readings we think are worth your time including some more on the lingering after-effects and some very good discussion, similar to questions we've raised but now done in a wider venue by somebody who's very knowledgeable, about the future down-sizing of the industry. Plus some interesting stories of folks who have been or are navigating these storms thru what we'd call business acumen, guts and discipline.
The one story though we really urge you to click thru, read, download think about is Robert Solow's review of Kevin Phillips book on "Bad Money". His shrill polemic against the Finance Industry. While there's a lot wrong he apparently didn't bother to figure out what worked but dug up some 100 year old anti-capitalist conspiracy theory stuff from William Jennings Bryan and his "cross of gold" speeches and re-furbished them. Now we're not denying there's a lot broken and a lot of malfeasant behavior since we've been arguing that as well. What Solow - btw, one of the best 100 economists of the last sixty plus years and a Nobel winner - does is is take you on a detailed tour and analytical dissection of the industry and the roles it plays and why it's so necessary. While also discussing what's wrong and thoughts about fixing it.
Final Words: Frannie, Systemic Risk and Malfeasance
There's a lot of words being bandied about that this is yet another example of socialist intervention in the markets. Instead they screwed up, let them fail. Well this is disingenous at best and also ignorant both of how one thing leads to another and what underpins markets. Here are some things to think about that'll help you correct that.
1. First put out the fire and save the women and the children, don't lock the door because they aren't correctly dressed to appear in public.
2. Use this crisis to make structural repairs that regulators, the Fed (Greenspan) and others have been trying to make for years, if not decades, as Frannie increasingly spiraled out of control thru lobbying and corruption of Congress to protect its' interests and in the name of greed.
3. We all benefited from that greed and wallowed in it. The only thing that held up the US economy after the '01 downturn was Housing and what drove housing was debt securitization. There is no single one of us who's investments, incomes, jobs and general well-being didn't benefit some way or another. Old sayings come to mind...either when you eat at the King's table be loyal to your salt...or bring your own taster. Or both.
4. As the chart makes clear a Frannie failure would turn a nightmare Housing market into a catastrophic collapse and be a systemic threat to the entire financial system. BSC was a Sunday park stroll as compared to the Mongols' visit to Baghdad in comparison. But that's not the worst of it - because the full faith and credit of the US government was involved and exploited the credit-worthiness of the US Treasury was and is at stake and the Chinese have fired more than one public warning shot. For a fuller discussion of the consequences Jim Jubak does a beautiful job: The huge threat to the US economy
5. Markets don't exist in a vacuum but rely on a whole host of hidden infrastructure from a legal system to enforce contracts to security forces to make sure that one is free to trade and exchange as well as to defend the property you're trading and filing law suites over. The financial markets wouldn't exist without the regulatory framework that's been evolved to ensure their smooth, orderly and honest functioning over the last eight decades. That machinery is creaky and aging and needs a major overhaul. But to pretend it doesn't exist nor that it isn't in the public interest is ill-informed, to say the last (again we refer you to Solow's review).
With all the ideological ranting and raving you'll make better decisions if you understand the organic dependency of markets on government instead of pretending it doesn't exist. With that in mind here's the readings to back up some or all of those assertions.
Frannie Into the Fire
China Pulls Back From Fannie, Freddie China's big banks, having trimmed their holdings of U.S. mortgage-related debt, are facing increasingly difficult decisions about how to invest their sizable foreign-currency holdings. Amid jitters about the future of Fannie Mae and Freddie Mac, China's four biggest listed banks have pared back their holdings in debt related to the two U.S. mortgage giants. At the end of June, the four banks held a combined $23.28 billion of debt issued or guaranteed by Fannie and Freddie. That's a small fraction of the trillions of dollars outstanding, but the reductions attracted interest as a possible gauge of broader sentiment toward such securities. In earnings conferences in recent days, several Chinese banks said they had trimmed their Fannie and Freddie portfolios since June. Bank of China Ltd., by far the largest holder of Fannie and Freddie securities among the four big banks, said it had sold or allowed to mature $4.6 billion of the $17.3 billion it held as of June 30 -- which was down from more than $20 billion at the end of last year. The shift away from Fannie and Freddie debt further reduces an already dwindling array of attractive foreign-currency investment options, with meager returns on low-risk instruments like U.S. Treasuries and continued instability in major stock markets. Because most developed economies are expected to slow further this year, the global investment climate is unlikely to improve soon, analysts said. China's banks have significant overseas funds to deploy. Bank of China had $240 billion of overseas assets at the end of June, while the other three big lenders had a combined total of $219 billion. Some analysts said they see merit in Chinese banks expanding their foreign-currency loan businesses. They have lots of liquidity as many Western institutions are squeezed by the credit crisis, so the Chinese banks may be able to pick up market share in lending to attractive companies.
Plan Near for Fannie, Freddie The Treasury Department is close to finalizing a plan to help shore up mortgage giants Fannie Mae and Freddie Mac, according to people familiar with the matter. Precise details of Treasury's plan couldn't be learned. The plan is expected to involve a creative use of Treasury's authority to intervene in the two companies, which it won earlier this year, and could involve a capital injection into the beleaguered giants. The plan also includes a management shakeup at both companies, according to one person familiar with the plans. Daniel H. Mudd, chief executive of Fannie Mae, and Richard Syron, his counterpart at Freddie Mac, are expected to step down from their posts. An announcement could come as early as this weekend. Some details are still being worked out, which means terms of the arrangement could change. Treasury's move would represent perhaps the most significant intervention by the government in the financial industry since the housing bust touched off turmoil in the credit markets a year ago. From the $168 billion economic-stimulus package in February through the bailout of investment bank Bear Stearns Cos., the Bush administration and the Federal Reserve have taken an increasingly aggressive stance in responding to what has become one of the worst financial crises in decades. The likely move would mark a remarkable comedown for two of Washington's most powerful and feared institutions, known for their financial clout and no-holds-barred lobbying prowess. Fannie and Freddie shares, which were up during the regular session Friday, dropped 25% and nearly 20% respectively in the after-hours session. Treasury's likely plan is supported by Federal Reserve Chairman Ben Bernanke and James Lockhart, chief of the two companies' regulator, the Federal Housing Finance Agency, according to people familiar with the matter. On Friday afternoon, Messrs. Syron and Mudd were summoned to a meeting at the offices of the agency. Also attending were Mr. Bernanke and Treasury Secretary Henry Paulson.
`Financial Tsunami' to Engulf Markets Unless Treasury Steps In, Gross Says The U.S. government needs to start using more of its money to support markets to stem a burgeoning ``financial tsunami,'' according to Bill Gross, manager of the world's biggest bond fund. Banks, securities firms and hedge funds are dumping assets, driving down prices of bonds, real estate, stocks and commodities, Gross, co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co., said in commentary posted on the firm's Web site today. ``Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami,'' Gross said. ``If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury.'' The government needs to replace private investors who either don't have the money to buy new assets or have been burned by losses, Gross said. Pimco, sovereign wealth funds and central banks are reluctant to fund financial firms after losses on investments they made to support the companies, Gross said. The world's biggest banks and brokers have raised $364.4 billion in new capital after more than $500 billion in writedowns and credit losses since the beginning of last year. As Fannie and Freddie, banks, securities firms and hedge funds shrink, yields on all debt assets will rise compared with benchmark rates and volatility will increase, Gross said. The declines will end once sellers have depleted their assets and sufficient capital has been raised, Gross said. Unless ``new balance sheets'' emerge, prices of almost all assets will drop, even those of ``impeccable'' quality, he said. ``There is an increasing reluctance on the part of the private market to risk any more of its own capital,'' Gross said. ``Liquidity is drying up; risk appetites are anorexic; asset prices, despite a temporarily resurgent stock market, are mainly going down; now even oil and commodity prices are drowning.''
Financial System Breakdown
Volcker Says Finance System `Broken,' Losses May Rise Former Federal Reserve Chairman Paul Volcker said the U.S. financial system, dependent upon securitization rather than traditional bank loans, is broken, and may contribute to the weakest expansion since the 1930s. ``This bright new system, this practice in the United States, this practice in the United Kingdom and elsewhere, has broken down,'' Volcker said today at a banking conference in Calgary. ``Growth in the economy in this decade will be the slowest of any decade since the Great Depression, right in the middle of all this financial innovation.'' The former Fed chief projected ``a lot'' more losses from the collapse in the mortgage-backed debt market, after the more than $500 billion tallied so far, should the U.S., European and Japanese economies fail to pick up. He urged changes in financial regulations, echoing calls among sitting officials and legislators. ``It is the most complicated financial crisis I have ever experienced, and I have experienced a few,'' said Volcker, who has endorsed Democratic presidential candidate Barack Obama. Volcker ran the Fed from 1979 to 1987, and engineered an increase in interest rates to 20 percent to quell inflation that exceeded 10 percent. Fed Chairman Ben S. Bernanke said on Aug. 22 that financial turmoil has ``not yet subsided,'' and is contributing to weaker growth and higher unemployment. Policy makers will ``continue to review'' the Fed's measures to ensure liquidity to determine ``if they are having their intended effects,'' Bernanke said. ``Changes are going to have to be made'' to the global financial system, Volcker said. Banks three decades ago accounted for about 60 percent of U.S. credit; that later declined to about 30 percent as securitization -- where financial firms package assets into bonds and other instruments and sell them on to investors and other companies -- spread.
Consequences of credit crunch are far-reaching, likely to linger WE ALWAYS HAVE the poor with us, Jesus said. One year on, it may seem like we'll always have the financial crunch with us, too. Certainly, a sense of numbness has descended on financial markets. Investors seem resigned to more bank failures, falling house prices and yet more deleveraging. They barely blinked at the recent prospect that Fannie Mae and Freddie Mac, with their $5 trillion of loans and guarantees, would be nationalized by Uncle Sam. But the numbness doesn't mean normality. When will normality return? Probably not for at least a year. That's what will be needed for house prices on both sides of the Atlantic to hit bottom and for the great deleveraging wave to work its way through the system. It could take even longer if the recent unexpected strength of the U.S. economy fades or weakness in Europe and Japan persists, as banks would then be faced with yet more holes in their balance sheets. But even when normality returns, it won't be the same normality that investors or financiers got used to in the heady days of the bubble. There will be three main differences. First, governments will have bigger fiscal deficits. They will have been bloated by slow growth, bank rescues and other programs designed to keep the wolf from the door. The long-term consequence is likely to be higher taxes. Second, the world will have inherited higher inflation, at least partly spurred by the loose money central banks have sprayed around to float the financial industry off the rocks. Deleveraging and the recent decline in oil prices will eventually bring some relief to inflation, but we won't get back to the old days of low inflation and high growth for many years. Finally, within the financial industry itself, employment will take several years to recover to its pre-bubble level. Bonuses and returns on equity will take even longer to recapture those peaks. The financial crunch won't always be with us. But its consequences will certainly linger for a long time.
Counting Writedowns Replaces Winning Deals as Wall Street's Newest Ritual In the good old days on Wall Street, in 2007, analyst James Hyde didn't write a report about a bank without first checking to see how it ranked among managers of stock sales. Today Hyde says he isn't doing his job right if he doesn't take a peek every other day at a different ranking: the one showing how much banks have lost on their mortgage-related assets. WDCI, the Bloomberg function introduced less than five months ago to track the writedowns, has overtaken LEAG, which ranks bond and stock underwriters, in viewers per day. New York University economics professor Nouriel Roubini forecasts that losses will reach $2 trillion -- about one-seventh the annual output of the U.S. economy -- as problems spread to the U.K., Spain and other countries. More than half that amount may be borne by banks and brokers, Roubini said in an interview last week. The rest will hit governments, pension funds, insurers and institutional investors. Roubini expects some 700 U.S. banks to fail and says he doesn't think the broker-dealers can survive as independent entities. ``Recognition of these losses will continue all of next year and perhaps even into 2010,'' said Roubini, who warned of the credit crisis in February 2007 on his Global EconoMonitor blog. ``When I made the $1 trillion to $2 trillion estimate, people thought I was crazy. Now the $1 trillion looks like a floor, and more analysts are leaning toward the $2 trillion.'' The tally on WDCI already surpassed the top of the range that the International Monetary Fund estimated in April banks would lose during the credit crunch. The IMF is scheduled to publish an update of its Global Financial Stability Report later this month.
Kevin Phillips Gets the U.S. Economy Wrong - In addition to deploring the excesses of the financial system, it is worth noticing also that it often performs useful functions. Businesses finance a substantial fraction of their fixed investment from their own saved profits; but the capital markets do allocate the rest, maybe about half, just as the textbooks say. To take another example, the securitization of home mortgages, despite its obvious potential for toxicity, undoubtedly expanded the supply of capital to the mortgage market and reduced the cost of home ownership. The same financial innovation also permitted or encouraged the selling of some mortgages to predictably unqualified borrowers. Could we redesign the mechanism to achieve most of the benefits of a broader supply of mortgage capital while sharply limiting the scope for predation and instability? This question calls for serious thought; but serious thought is not on Phillips's agenda. Still, it is worth noting--and this is his sort of thing--that when the Federal Reserve recently proposed some fairly anodyne improvements in the regulation of mortgage lending, the industry instantly opposed them as incipient socialism, and claimed implausibly that even the smallest regulatory safeguards would dry up the supply of loans.
Plan Skirts Housing's Biggest Troubles The government takeover of Fannie Mae and Freddie Mac likely will help ease mortgage rates for home buyers, say economists, home builders and housing experts. But it won't cure the housing market's biggest ailments: falling home prices and rising foreclosures. "This is another marginal step in the right direction," says Richard DeKaser, an economist at National City Corp., a large Cleveland bank. "But it doesn't resolve the glut of homes on the market or remove pressure on prices."The housing market is stuck in a vicious cycle. It started with an oversupply of homes that eventually caused prices to plummet. Falling prices led to waves of foreclosures, as homeowners ran into problems refinancing their mortgages or selling their houses. Banks are reluctant to lend when home values keep sinking and defaults are rising, curbing housing demand further and fueling more price drops and defaults. Investors and economists feared that a collapse of Fannie and Freddie would greatly exacerbate the downward spiral by essentially freezing the mortgage market. "The government's move takes that serious disruption to the financial market off the table," says Mark Zandi, chief economist at Moody's Economy.com. Mr. Zandi says that while the takeover of the mortgage giants won't immediately stop the home-price slide, it should limit price declines to 5% to 10% over the next year, rather than the doomsday scenario of additional declines of 15% to 20% that some economists were predicting if Fannie and Freddie failed or pulled back dramatically.
Finance Industry
How Much Banking Does America Need? Few will argue with the idea that the U.S. financial services industry is shrinking; the big question is whether the credit crisis marks a cyclical downturn or a long-term change. By most measures, the growth and profitability of banking and financial services in the United States has been astounding in recent years. Through most of the post World War 2 period profits by financial firms averaged about 0.75 percent of gross domestic product (GDP), but tripled to as much as about 2.5 percent as banks moved away from old-fashioned portfolio lending and remade themselves into intermediaries that made loans and sold them on, often to bank-controlled entities. Bank profits have been hit badly in 2008 as house prices tumble, but in the first quarter financial profits were still around 2 percent of GDP, a figure far higher than anything seen between 1947 and the turn of the century. How far that falls and where it settles will have a huge influence on how many people work in the financial industry, what they are paid, what shares in their companies will fetch and even conceivably on the long-term capacity of the U.S. economy to grow. The answers at this point are simply unknowable. We don't know what business model banks and investment banks will follow, for one thing. Will they make and sell loans, slicing and dicing them to make them better matches for what the market wants, or will the ice-cold securitization market prove dead, leaving them as portfolio lenders? We also don't know what the regulatory backlash will be, though it's safe to assume new official oversight will be costly and will make firms, perhaps properly, much more cautious. Ben Inker, director of asset allocation at GMO in Boston, which manages $126 billion, thinks profits in relation to GDP might halve from the recent past, and even that might be an upper estimate. When financials plunged in July they were trading at about Inker's halved level of profitability, but that's not taking into account the potential for substantial future writedowns and the need to raise more capital, he said. "Is it a moderate financial crisis or is it a really serious financial crisis?" Inker said. "If it's an honest-to-god systemic crisis you should not touch financials now or really until current equity holders are more or less wiped out." There is also, of course, the possibility that the growth of financial services reflects a move to a more service-oriented economy, and that greater profits might be fair in comparison to the value they create.Growth of financial value added as a proportion of GDP has been steady and seemingly relentless since World War II, not just during the bubble years. You could argue that, even laying aside the current debacle, people will continue to need to borrow, save and buy and sell companies and will pay a premium price in hopes they come out ahead on the deals. But that will need to be proved and until it is investors, even optimistic ones, will apply a big uncertainty penalty on shares in financial services firms.
No End Yet to the Capital Punishment It's not over. Investors may be tempted to see the government's takeover of Fannie Mae and Freddie Mac as the kind of cathartic action that marks a decisive turning point for the U.S. banking system and the wider stock market. But the chief problem at Fannie and Freddie -- an inadequate capital cushion against losses -- also bedevils large banks in the U.S and Europe more than 12 months into the credit crunch. While the capital shortage may not be as dire as at Fannie and Freddie, private banks can't count on a government rescue. Some will fail. Others will have to issue massive amounts of capital to shore up their shaky balance sheets. Make no mistake, the government's move to shore up Fannie and Freddie will likely give markets a short-term boost, especially if investors believe this can help underpin house prices in the U.S. But this move by the Treasury comes just as a new, more general threat looms: On top of U.S. economic problems, underlined by Friday's jump in the unemployment rate, the rest of the world is slowing. The broader strains now facing the markets are not as easily relieved by central banks or governments as the company specific crises at Fannie and Freddie or Bear Stearns earlier this year. The shakeout of the past year has done almost nothing to improve the average U.S. household balance sheet. So while a government commitment to buy mortgage-backed securities, also announced Sunday, may cause mortgage rates to fall, banks may not want to lend at lower rates because they don't feel they're being compensated for the risks in this uncertain economy. And while banks are reluctant to lend, many are having problems borrowing to fund themselves. That is because the market's assessment of their creditworthiness is darkening.
Stalwarts and Exemplars
Buffett Becomes Real Estate Vulture as HomeServices Gets Deals Black Can't Ron Peltier runs HomeServices of America Inc., the second-largest U.S. real estate brokerage, and unlike No. 1 NRT Inc., his company is making money in the worst housing slump since the Great Depression. HomeServices also has a parent, Warren Buffett's Berkshire Hathaway Inc., with $28 billion of cash to help finance the purchase of brokerages that can't weather the housing recession. By contrast, NRT's parent Realogy Corp., owned by Leon Black's Apollo Management LP, has at least $875 million of debt that has an 89 percent chance of defaulting within five years, credit- default swaps tracked by London-based CMA DataVision indicate. Three years of tumbling U.S. home sales and prices may give Peltier, who says he fields as many as three calls a week to his Minneapolis office from desperate brokerages seeking a buyer, a chance to grab market share. NRT's pace of acquisitions has dropped to four this year from an annual average of 20 since 2002 as its debt ratio -- borrowing relative to earnings before interest, taxes, depreciation and amortization -- increased to 4.9 in June from 3.8 at the end of 2007. Peltier said he expects to spend $200 million in the next two years paying 20 cents to 25 cents on the dollar for distressed brokerages to get HomeServices into new markets. The HomeServices chief executive officer said he couldn't give details on pending deals, though he expects at least one to close by the end of the year. HomeServices spent about $10 million buying companies in the past year, Peltier said. ``Since mid-2006, we've been focusing on tuck-in acquisitions: smaller companies that can be folded into an existing primary market,'' the 59-year-old Peltier said. ``We think we are starting to see signs of the end of the downturn, so our interest is growing in making some very noteworthy acquisitions going forward.'' HomeServices is part of Berkshire Hathaway's Des Moines, Iowa-based MidAmerican Energy Holdings Co. When the housing slump started in 2006, Buffett, who declined to be interviewed for this story, said the market's woes ``should lead to additional acquisition possibilities.'' He said in his annual shareholders letter that year that HomeServices would probably be ``far larger a decade from now.''
People's United Hunts for Takeovers, Abandoned Borrowers to `Cherry-Pick' -- People's United Financial Corp., the largest New England-based lender, is seeking acquisitions after steering clear of the subprime-mortgage market, and can ``cherry- pick'' borrowers abandoned by cash-strapped banks. The bank, which raised $3.44 billion in April 2007 before credit markets tightened, has money to purchase companies, Chief Executive Officer Philip Sherringham said. If no acquisitions catch his eye, the bank may buy back stock with the capital, ``returning it to shareholders one way or the other,'' he said. ``Our greatest challenge?'' Sherringham said in an interview on Aug. 25. ``Capital deployment, absolutely.'' As banks and securities firms reeled from more than $500 billion in writedowns and credit losses tied to subprime, People's United consistently reported quarterly profits. The Bridgeport, Connecticut-based company's stock declined less than 1 percent in the last 12 months, holding steady as nine U.S. banks failed and finance companies were forced to raise more than $352 billion in capital. People's United has ``a very clean balance sheet right now,'' said KBW Inc. analyst Damon Del Monte in an interview yesterday. ``The last thing they want to do is acquire a bank that has some unknown loan issues on their books.'' He has a ``market perform'' rating on the shares.
How One Bank Avoided the Meltdown - Not every player in banking is getting clobbered these days. BNP Paribas, which sparked part of the very first global credit-crunch panic when it froze three funds on Aug. 9, 2007, may emerge as the bank least affected by the industry's carnage. The third-biggest bank in Europe by market value, behind Britain's HSBC and Spain's Banco Santander, is the largest bank in the world that has not had to raise any capital since the middle of last year. (Those three funds, frozen because BNP could not decide how to value their securities, re-opened a few weeks later and sustained only small losses.) The once-government controlled bank, headquartered in an elegant eighteenth-century building in Paris's opera district, has not had an unprofitable quarter since the crisis began an honor it shares only with Goldman Sachs (GS, Fortune 500) among comparable financial institutions. Its write-downs and loan losses have been relatively limited: only $3.6 billion worth of subprime-backed debt and leveraged loans out of its $1.8 trillion in assets (vs., say, Merrill Lynch's (MER, Fortune 500) $51.8 billion in write-downs with just half the asset base). BNP now has the highest S&P creditworthiness rating, AA+, of any global bank of its size. As its competitors flail, BNP has moved up to the world's tenth-largest bank by market capitalization. So how did a bank so big manage to avoid the market chaos around it? Unlike many of its peers with sizable investment bank operations, about two-thirds of BNP Paribas's revenues come from retail banking, mostly in France, Italy, and Spain. With substantial retail deposits (about $650 billion at the end of 2007), it can fund its investment-banking operations with existing capital instead of having to tap short-term lending markets or highly leveraging itself. "People have forgotten that retail banking is a good business model," says Lewis Kaufman, a portfolio manager at Thornburg Investments who is long on the bank. Investment banking is seen as an add-on to the core retail business, so BNP Paribas's focus is on client services that generate fees, not trading those assets to make money for itself. By contrast, the Big Five U.S. investment banks (including the late Bear Stearns) generated more than half their revenues from trading in 2006, up from 41% in 2000, a big chunk of that in mortgage-backed securities. But all that, of course, came crashing down in the second half of last year.