Whitney on Wall Street Meltdown

Amidst all the hyperbole that passes for finanical journalism, sometimes something worth listening to, actually gets through. As noted here previously, Meredith Whitney has been ahead of the curve for some time when it comes to US financial companies. In an interview today, in her usual straight forward style, she pulled no punches on the outlook for US financial companies.

Future Of Wall Street

Forget the Broker Dealers, Bigger Problems Loom

Away from the noise of Wall Street, ordinary citizens are going about their business as usual. However if you are in any way connected to or interested in financial markets, these are indeed interesting times.

6 months ago there were five large independent broker dealers in the US. Today there are only two. How many will there be in another 6 months? Nouriel Roubini thinks none of them will independent.

Does it really matter? Do we really need them? I would argue not. What benefit have these institutions brought to the economy? They have proved themselves incompetent by losing every dollar they have ever made. And this is not the first time.

What good are institutions that leverage themselves to the hilt, slice and dice dubious pieces of paper in the name of financial innovation and then infect all corners of the financial markets with their toxicity? Absolutely nothing and good riddance to them.

Besides, there are bigger problems out there in the form of AIG, Washington Mutual and Wachovia - and they are just the ones we know about. Citigroup itself is hardly out of the woods and it is doubtful if they survive in their current form.

The latest on AIG and WaMu is that their ratings have taken another hit. From marketwatch.com:

WaMu, AIG downgraded

Washington Mutual shares (WM) stumbled 9.4% to $1.82 after Standard & Poor's late Monday cut its ratings on the company and its Washington Mutual Bank unit because of increased market turmoil. S&P cut the counterparty credit rating on Washington Mutual Inc. to BB-/B from BBB-/A-3 and the rating on Washington Mutual Bank to BBB-/A-3 from BBB/A-2. The outlook is negative....

....Fitch on Monday evening downgraded AIG's rating to A from AA-, and said the company has an "extremely limited" ability to raise capital for its holding company

That doesn't sound good for AIG. from Bloomberg:

AIG's Ratings Cut by S&P, Moody's, Threatening Quest for Funds

American International Group Inc.'s credit ratings were downgraded by Standard & Poor's and Moody's Investors Service, threatening efforts to raise emergency funds to keep the company afloat.

The ratings reductions occurred after two people familiar with the situation said that the biggest U.S. insurer by assets is seeking $70 billion to $75 billion in loans arranged by Goldman Sachs Group Inc. and JPMorgan Chase & Co. to replenish capital.

$70-$75 billion, jaysus! On the weekend it was $40 billion. Also an AIG failure would not be good for anyone it seems:

"I don't know of a major bank that doesn't have some significant exposure to AIG," said Kenneth Lewis, chief executive officer of Bank of America Corp., in a CNBC interview. An AIG collapse would "be a much bigger problem than most that we've looked at," he said.

Why is that?

"The bigger problem here is that AIG is a bigger balance sheet, the tentacles go further and we don't have the same relationship between the Fed and an insurance company as we do with some of the others," said Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. in a Bloomberg Television interview.

That's about it in a nutshell. Isn't this wonderful world of interconnected global financial markets marvelous? Hank containment Paulson was careful not to rule out government intervention. My bet is that AIG will qualify for the 'too big to fail' doctrine if it does indeed come to that.

How about Australia? There seems to be almost eerie silence form our banks and other financial institutions. It would be wishful thinking to assume our banks will be unscathed. We already know ANZ has CDS exposure to some major US corporate names. I think it's safe to say that BNB and all it's satellite companies are toast. MQG will find it tough to stay in one piece and there have been some rumblings about SUN's portfolio of assets.

But forget about the sideshow surrounding the Broker Dealers. The main event is the main street banks and insurers. If a couple of these go belly up in short order, we could be in for some real fireworks.

US Financial Crisis Goes from Bad to Worse

Let's have a look at the main stories on Friday from the US. I could link any number of articles on Lehman butwhat is the point? They're gone, whether that is being bought out, or selling off assets or bankruptcy remains to be seen but they're gone.

Also, Washington Mutual's problems are being compounded by those ever behind the curve ratings agencies.

Fitch Downgrades Washington Mutual to 'BBB-'; Outlook Negative

Fitch Ratings has downgraded the long- and short-term Issuer Default Ratings (IDRs) of Washington Mutual, Inc. (WaMu) as follows:

--Long-term IDR to 'BBB-' from 'BBB';

--Short-term IDR to 'F3' from 'F2'

Fitch has also taken the following rating actions on Washington Mutual Bank (WMB):

--Long-term IDR affirmed at 'BBB''

--Short-term IDR downgraded to 'F3'
from 'F2'.

The Rating Outlook is Negative.

Today's actions reflect Fitch's expectation for continuing asset quality challenges amidst market conditions that are considered the most difficult in several decades for U.S. retail banks, particularly those with a concentration in residential mortgage assets.

Washington Mutual is adamant that they are OK and do not think the downgrade is justified. If that were the case, you have to wonder why they are in 'advanced talks' with JP Morgan.

JPMorgan Chase in Advanced Talks to Buy Wamu: Sources

JPMorgan Chase is in advanced discussions to buy Wamu, sources said Friday. While a deal has not been struck, and could fall apart, talks are ongoing at the highest levels ...

Whilst the media seems to be obsessing about Lehman, I think WaMu is much more important. If WaMu were to go down the toilet, it would be by far the biggest bank failure in history. A failure of this company alone would force the FDIC to go hat in hand to the Tresaury for more money to cover the insured deposits at WaMu.

At the end of 2Q08 WaMu had $25 billion in capital, that might sound like a a lot but with potentially $40 billion in losses coming down the pike over the next few years it's just a matter of time before these guys fold.

The good news is that there are suitors circling. I think the balance of probabilities suggests that neither Lehman nor WaMu file for bankruptcy, they both have assets that other financial companies want. However, there is no doubt that these institutions will not exist in the current form in the near future.

But we are not done yet. Also on Friday, AIG, formerly the largest insurance company in the world by market value fell -31% as the cost of their credit default swaps rose to record levels, prompting them to hold a conference call this coming Monday:

AIG May Hold Analyst Call As S&P Threatens Downgrade

On Friday, credit-ratings firm Standard & Poor's threatened to downgrade American International Group Inc., citing the significant decline in the company's share price and the increase in credit spreads on the company's debt. Meanwhile, AIG will likely hold an analyst call Monday morning and could announce a series of steps aimed at reassuring investors, including possible asset sales, a person familiar with the matter said.

And last but not least, Merrill Lynch stock fell -38% this week. As Lehman gets taken out the market has decided that it's next victim is Merrill.

We have consistently heard over the last 6 - 9 months that the worst is over and the botom is in but things continue to deteriorate. As I said back in August, this will not be resolved in a year, it will be several. The real question that everyone would like to know the answer to is 'when does the stockmarket price it all in?' I wish I knew, but from where I sit there still seems to be too much denial and complacency out there to signal a bottom just yet.

Australian Labour Market Resilient in August

The Australian labour market added a net 14,600 jobs in August, well ahead of market expectations. Before we start popping champagne corks and declaring the possibility of an Australian recession dead in the water, we should remind oursleves of what labour market data tells us.

Firstly employment is a lagging indicator. From the graph above you can see that the moving average was still positve at the beginning of the last two sessions. By the time the employment numbers confirmed the recession, it was half over.

In a recession you would expect to see several consecutive months of job losses exceeding -20k. However as stated above if you wait for those kind of numbers you will have missed the boat.

So job ads remain the best forward looking indicator for the job market and although they have weakened considerably over the last six months they would need to worsen a lot more to get near recessionary levels. If we do get several consecutive monthly eclines in payrolls it's likely not to be until the first half of 2009.



As stated above the Australian economy need to creat between 15 -20k jobs a month just to keep the unemployment rate constant. However, the unemloyment rate dropped from 4.3% to 4.1% in August. This simply reflects the fact that the number of people looking for work fell in the month of August as shown in the fall in the particpation rate.

WaMu Dead Man Walking

Whilst a lot of focus in the last few days has been on Lehman Brothers (LEH) and the new wave of socialism gripping the United Satates, Washington Mutual (WM) has been quietly making a march toward bankruptcy.

Back in July of this year when IndyMac Bankcorp went belly up, I asked the question "Who's Next?" At that time I suggested Washington Mutual would be the most likely candidate. The stockmarket now seems to think the same. WM stock tumbled -28% yesterday after a -22% fall the previous day.

On Monday Wahington Mutual's CEO resigned and the company entered into an agreement with the Office of Thrift Supervision (OTS):

WaMu replaces CEO, signs agreement with regulator

WaMu also announced that it has entered into a Memorandum of Understanding (MOU) with the Office of Thrift Supervision (OTS) concerning aspects of the bank's operations, principally in several areas of its risk management and compliance functions, including its Bank Secrecy Act compliance program. In addition, WaMu has committed to provide the OTS an updated, multi-year business plan and forecast for its earnings, asset quality, capital and business segment performance. The business plan will not require the company to raise capital, increase liquidity or make changes to the products and services it provides to customers.

So what does that actually mean? Well basically Washington Mutual is in such a state that they can't be trusted to run their business by themselves. It's kind of like telling an 18 year old he can't be trusted to stay home by himself and therefore needs a baby sitter.

Dick Bove of Ladenburg Thalmann & Co. Inc. chimed in late Monday and summarised the situation well;

"The problem is very simple. They made a lot of bad loans and they are absorbing high levels of loan losses. The solution for their problem is to find some mechanism for reducing the bad loans. That can't be done by a new CEO."

How many bad loans did they make? From the same WSJ article we find:

WaMu has $53 billion in option adjustable-rate mortgages ... Of the $53 billion in option ARMs, $14 billion of these are to the riskiest segment in mortgage lending, subprime borrowers.

WaMu also has $62 billion in home-equity loans ...

Mr. Bove predicts that WaMu will lose $40 billion over the next three years on its loan portfolio. If the economy weakens further and losses are even higher, he said, "the future of the company is questionable."

Then on Tuesday, the ever behind the curve ratings agencies cut WaMu's outlook to negative.

I've been talking about the problems at WM for more than a year. For a recap check out:

WM Loan Losses to reach $2.2 Billion in 2007
WM ups loan loss reserves again
WM to Bleed Red Ink in 2008
WaMu's Great Dilution
Nothing but Red Ink for Wamu

Unlike Bove I don't think the company's future is questionable, it's beyond question, this company is a dead man walking.

The Spring Selling Season That Will Not Be

The title above is meant to a prediciton about the upcoming Spring home selling season in Australia. The bull case is that with an RBA rate cut and more on the way, homebuyers will be encouraged to go looking for homes.

The bear case, or as I like to call it - reality is that this Spring selling season will fail to eventuate because of tighter lending standards and an already an embattled consumer up to theri eyeballs in debt and facing the prospect of falling equity in their homes for the first time in many years.

Today the ABS released data on housing finance commitments. Both the number and value of commitements excluding refinancings are off -30% from their highs.


Also today the abs released retail sales data for July showing a tepid rise in retail sales. It should be noted that the abs has reduced its smaple size for the retail sales data and therefore they now recommned that the trend data be used rather than the seasonally adjusted data and that is what is shown below.

As you can see, even in the recession of 91, retail sales never went negative on a year over year basis. Whilst retail sales are clearly weak, on the positive side, tax cuts in July in concert with lower petrol prices may give consumers some support, however I believe that will be offset to some extent by rising unemployment in the months ahead.

Bailout Nation to the Rescue

I'm sure by now you've heard that the United Soviets of America have decided to throw taxpayer money behind the nations biggest hedge funds Fannie Mae and Freddie Mac. There is a multitude of article onlines if you wish to dig through the details. I'll just offer a couple paragraphs from John Hussman who sums up well my feelings on the subject.

With that January 2009 “sunset” provision now gone, I expect that U.S. taxpayers will be on the hook for about $250 billion in losses. Look – 9.16% of U.S. mortgages are already delinquent or in foreclosure, with the likelihood of further delinquencies and foreclosures in the coming quarters. On a $5.2 trillion book of mortgage loans between Fannie and Freddie, and a prevailing recovery rate of 50% on foreclosed properties, an overall loss of about 5% of this book, or about $250 billion, is a fairly conservative expectation.

It's likely that the market will take some initial comfort from this transaction, on the notion that the government has provided a “safety net” under the U.S. financial system. The problem with that interpretation, however, is that Fannie and Freddie always had the implicit backing of the government, and the government is now being forced to save these institutions because private investors have increasingly refused to provide additional capital. Unfortunately, what is true of Fannie and Freddie is most likely also true of other financial institutions that do not enjoy the implicit backing of the government. The prospect of a government bailout of those other institutions isn't at all clear. So by essentially capitulating that Fannie and Freddie have to be taken over, the government is also sending a signal that other financial institutions (particularly investment banks with high gross leverage multiples) may be vulnerable to failure. For that reason, any “knee jerk” enthusiasm about this transaction will probably be misplaced.