NEW YORK (AP) - Wall Street pulled back in erratic trading Monday as investors grew more concerned about a deteriorating housing market and the widening impact of soured debt after Citigroup Inc. warned it plans to book $8 billion (euro5.52 billion) to $11 billion (euro7.59 billion) in additional losses.
Citi's expected losses came on top of the $6.5 billion (euro4.49 billion) in asset markdowns and other credit-related losses the company recorded in the third quarter.
The re-emergence of credit concerns - like those that pummeled Wall Street this summer - comes as the market is also contending with concerns about housing and the health of consumer spending, and with rising expectations that the Federal Reserve is leaning away from cutting interest rates when it meets next month.
Meanwhile, a central banker's warning Monday that the subprime mortgage market will likely deteriorate further added to the pressure on stock prices. Fed Gov. Randall Kroszner told the Consumer Bankers Association Fair Lending Conference in Washington that "conditions for subprime borrowers have the potential to get worse before they get better.''
The problems may be spreading.
A Federal Reserve survey of banks showed that lenders are making it harder to get a home loan, even for borrowers with good credit.
About 40 percent of respondents said they had tightened lending standards on prime mortgages during October, up from just 15 percent in July.
"We're at the point now where more and more evidence is starting to emerge that the next 12 months are going to be more difficult,'' said Joe Battipaglia, market strategist with Stifel Nicolaus & Co.'s private client group.
"Problems in housing market are getting deeper and more treacherous,'' as home inventories rise and sale prices fall.
The Dow Jones industrial average fell 51.70, or 0.38 percent, at 13,543.40.
The Dow was down nearly 150 points early in the session and briefly popped into the plus side in the late afternoon.
The late-session buying was likely the result of short covering, when traders buy stock to cover bets they made earlier that the market would decline.
In short covering, traders are not looking to economics or other market fundamentals when they decide to buy.
"I think we're seeing a market that is probably absorbing all the negative news out of subprime and staying in a trading range now,'' said Peter Cardillo, chief market economist at brokerage house Avalon Partners Inc.
"When we get down to certain technical levels, buying comes in and we're seeing that today.''
Broader stock indicators also fell.
The Standard & Poor's 500 index fell 7.48, or 0.50 percent, to 1,502.17, and the Nasdaq composite index fell 15.20, or 0.54 percent, to 2,795.18.
The Russell 2000 index of smaller companies fell 7.34, or 0.92 percent, to 790.45.
Bonds prices fell, with the yield on the benchmark 10-year Treasury note rising to 4.34 percent, up from 4.32 percent late Friday.
A snapshot of the service sector appeared to briefly soften some investor concerns that the troubles in the financial sector would prove onerous enough to spill into other areas of the economy.
The Institute for Supply Management said the service sector grew at a faster-than-expected pace in October amid strength in new orders.
The ISM's index gauging the health of non-manufacturing industries rose to 55.8 from 54.8 in September.
A reading above 50 signifies economic expansion.
The unease over Citi's debt follows the widely expected decision by Charles Prince to resign as the company's chairman and chief executive at an emergency meeting of its board Sunday.
Citi fell $1.83, or 4.9 percent, to $35.90 and was the steepest decliner among the 30 stocks that make up the Dow industrials.
Prince's resignation came less than a week after Stan O'Neal stepped down as CEO at Merrill Lynch & Co.
Both Citi and Merrill have struggled with securities they hold that are tied to subprime loans, those made to borrowers with poor credit.
A faltering housing market has made it difficult for those struggling with mortgage payments to refinance and pay off debts.
Now, foreclosure rates are spiking and many banks are left holding loans worth far less than they had once been.
As it had Friday, Merrill Lynch fell amid concerns it would have to make an announcement of further write-downs.
Last month, Merrill Lynch said it would write off $8.4 billion (euro5.8 billion) in losses.
Merrill fell $1.40, or 2.4 percent, to $55.88 after falling nearly 8 percent Friday.
"Financials are struggling with this really unknowable and unending plague of asset quality,'' said John Merrill, chief investment officer at Tanglewood Capital Management in Houston.
He expects that while the big financial houses will likely continue to book write-downs as homeowners default on their mortgages the stock prices of the financials aren't likely to fall precipitously from where they stand.
Citigroup is down about 36 percent since the start of the year while Merrill Lynch is down about 40 percent.
Beyond concerns about debt, political uncertainty over a weekend decision by Pakistan President Gen. Pervez Musharraf to suspend the constitution helped shore up some support for the U.S. dollar as investors sought safety.
The dollar rose against most other major currencies, while gold prices rose.
Declining issues outnumbered advancers by about 3 to 1 on the New York Stock Exchange, where volume came to 1.53 billion shares, compared with volume of 1.72 billion shares at the close of trading on Friday.
Tuesday, November 6, 2007
Off with their heads
By Chan Akya
If any of you are fortunate enough to be friends with the chief executive officer (CEO) of a Wall Street bank, now may be a good time to get yourselves invited for a cup of coffee, enjoy the views from the top floor office, play a round of golf at the exclusive country club he (I am not being sexist here, they are all men) belongs to, take a trip on the corporate jet and whatever else may grab your fancy. The reason for the time-bound offer is that your friend will most likely be out of his job by Christmas this year.
Following close on the heels of the CEO of Merrill Lynch, Stan O'Neal, who was deposed last week, comes news that the head of Citigroup, Chuck Prince, will also leave his position this week. In both cases, the evisceration of executive ranks engendered by the incumbents has caused the appointment of interim heads - simply put, the boards of both banks don't have a clue who to appoint as a replacement.
Inevitably, these dismissals (and please don't insult anyone's intelligence by calling them retirements or any such euphemism) would be highlighted as the failures of Anglo-Saxon capitalism, where overly grabby CEOs somehow get their just desserts in the middle of a night of long knives. In particular, I would expect some commentaries in Europe and Asia to focus on the relative superiority of their own systems against that of the Americans.
This is wrong. Much as the process of management changes in American banks can be considered rather too newsworthy, the fact of the matter is that it happens all the time. Any system is bound to the values of corporations, and its shareholders: therefore, the search for profits is bound to falter from time to time. With the US banks, sudden changes of CEOs are meant to signal new directions for the companies, often to less volatile or more profitable businesses.
Citigroup is an excellent example. It is a motley collection of businesses ranging from traditional retail banking in the US to significant emerging market businesses as well as a large investment bank. Using the value assigned to peers in different businesses - for example HSBC, Standard Chartered and others, analysts have predicted that the implied value of Citigroup's investment bank is actually negative. In other words, selling or closing or trimming the investment bank will actually increase the share price of Citigroup.
What about diversification? Banks get into a number of businesses because they like to diversify the decline in one area with potential increases in other businesses. That is certainly a good reason to keep an investment bank within a commercial bank, but only so long as the management quality, risk controls and basic trading philosophy gels with the rest of the bank.
It is obvious that the quality of management at Citigroup, Merrill Lynch and other banks fell victim to the rapid expansion of the business, producing too many gaps between acceptable practice and business realities. The CEOs of these banks are ultimately responsible for risk management and ensuring that enough resources are devoted to control functions.
Unnatural losses mean, obviously, that the CEOs have to lose their jobs - the next chap in hopefully learns this lesson, and fixes the element of surprise. That means, in practice that they would insist on comprehensive write-offs that can be blamed on their predecessors, from which they can show progress in coming quarters. These write-offs, while scary, serve the function of keeping markets alive.
Putting things in perspective
The useful comparison, and contrast, here would be the Japanese banks whose failures in the 1990s were essentially hidden. Let us not forget here that what has ailed the share price of American banks is the fear of more write-offs on asset values, that could help wipe billions from shareholder value.
Last week, market reports of billions in further losses to be taken by a motley crew of American and European banks helped to drive share prices sharply lower on Thursday and Friday. When these assets are written down though, we will be left with financial values that are closer approximations of reality. This would in turn start the process of asset trading in earnest.
Take an example of a new community that consists of a large number of houses in some part of California. A company owns the project, and its revenues consist of rents from all tenants. Furthermore, because the company in question wants to develop other properties, it entered into a securitization agreement with a bank, which sold this package of bonds to investors across the world including the friendly Asian central bank that manages your currency. As a goodwill gesture, the investment bank holds some of these bonds on its own books.
Now, with house prices in free fall and vacancies rising sharply, there is a real chance that rents in this development will decline as well, in turn making the cash value of the bonds written on the project more volatile. In this case, the three sides to the transaction - the company on whose name the bond is issued, the investment bank, which arranged the transaction, and the investor who bought some of the bonds - have multiple options, none of which are too nice.
Option number 1: Anglo-Saxon
The investment bank in this case can go out on a limb (especially with its brand new CEO) and say that the value of its bonds, which were bought at 100, are now only 50. This means that the investors have to take similar hits on their portfolios, if their accountants are awake. If their accountants are asleep, of course the investor can pretend that the assets are still worth 100.
By marking the books at 50, the investment bank throws open the floor for trading. Now, the benchmark price is 50 - so the company owning the project can for example make some useful comparisons based on actual rent receipt and determines that the bonds are worth more than 50. It can therefore buy back the bonds from the investment bank or the investor. In case this loss is too much for the company, it would declare bankruptcy, and sell its assets, ie, the houses, cheaper to anyone interested, with the proceeds going to pay for the debt previously issued.
Meanwhile, the investor who has taken a 50% loss can decide that this is not a game they want to play, because none of the managers have been to California and what with all the wildfires, wouldn't want to go there either - so they choose to sell their bonds at 50 and put the losses behind them.
With the price at 50, other investors who would not normally care for these assets would get into the picture, with a view to riding the wave to say, 70. Also, with the value of the asset at 50, they can also get loans from banks to fund the purchases. All that trading causes money to flow once again, and market equilibrium is restored. In time, new houses will be built in California, and new bonds be issued once again.
Option number 2: Japanese
Faced with a similar decline in property prices in the 1990s, Japanese banks chose the second option, namely do nothing. Thus, the banks continued to value the assets at 100, and this meant that there were no losses taken initially. Unfortunately though, this also created a logjam between the investors and companies owning the property, as the latter did not want to repurchase their obligations at 100, and investors had no reason to sell at below 100.
With income falling rapidly for these companies, the banks were forced to make new loans to get their interest payments on time (what was known as evergreening) to the companies, in turn making money unavailable for more deserving borrowers. At the economic level, this completely removed the effectiveness of the banking system, creating the specter of "zombies" - companies that were really dead, but were still walking around.
Investors in such companies knew well enough that they had suffered loan losses, but would wait till the last moment before recognizing these losses. That meant they wouldn't have the ability or the willingness to buy any more assets, in effect shutting themselves from new investments.
This is why the Japanese banking system ground to a halt in the middle of the '90s. Even today, these banks boast asset values that pale in significance to their market capitalization, because no investor believes that the assets are actually worth that much to any outsider. This "discount" also forces Japanese banks to avoid any global acquisitions, perpetuating their domestic focus.
Between the two options, the first is clearly preferable, as it keeps the market economy well lubricated and functional. This is the context in which to look at the exit of various CEOs - that the market has more opportunities in the weeks ahead, rather than a protracted period of non-activity. American shareholders have chosen well.
(Copyright 2007 Asia Times Online Ltd. All rights reserved.)
If any of you are fortunate enough to be friends with the chief executive officer (CEO) of a Wall Street bank, now may be a good time to get yourselves invited for a cup of coffee, enjoy the views from the top floor office, play a round of golf at the exclusive country club he (I am not being sexist here, they are all men) belongs to, take a trip on the corporate jet and whatever else may grab your fancy. The reason for the time-bound offer is that your friend will most likely be out of his job by Christmas this year.
Following close on the heels of the CEO of Merrill Lynch, Stan O'Neal, who was deposed last week, comes news that the head of Citigroup, Chuck Prince, will also leave his position this week. In both cases, the evisceration of executive ranks engendered by the incumbents has caused the appointment of interim heads - simply put, the boards of both banks don't have a clue who to appoint as a replacement.
Inevitably, these dismissals (and please don't insult anyone's intelligence by calling them retirements or any such euphemism) would be highlighted as the failures of Anglo-Saxon capitalism, where overly grabby CEOs somehow get their just desserts in the middle of a night of long knives. In particular, I would expect some commentaries in Europe and Asia to focus on the relative superiority of their own systems against that of the Americans.
This is wrong. Much as the process of management changes in American banks can be considered rather too newsworthy, the fact of the matter is that it happens all the time. Any system is bound to the values of corporations, and its shareholders: therefore, the search for profits is bound to falter from time to time. With the US banks, sudden changes of CEOs are meant to signal new directions for the companies, often to less volatile or more profitable businesses.
Citigroup is an excellent example. It is a motley collection of businesses ranging from traditional retail banking in the US to significant emerging market businesses as well as a large investment bank. Using the value assigned to peers in different businesses - for example HSBC, Standard Chartered and others, analysts have predicted that the implied value of Citigroup's investment bank is actually negative. In other words, selling or closing or trimming the investment bank will actually increase the share price of Citigroup.
What about diversification? Banks get into a number of businesses because they like to diversify the decline in one area with potential increases in other businesses. That is certainly a good reason to keep an investment bank within a commercial bank, but only so long as the management quality, risk controls and basic trading philosophy gels with the rest of the bank.
It is obvious that the quality of management at Citigroup, Merrill Lynch and other banks fell victim to the rapid expansion of the business, producing too many gaps between acceptable practice and business realities. The CEOs of these banks are ultimately responsible for risk management and ensuring that enough resources are devoted to control functions.
Unnatural losses mean, obviously, that the CEOs have to lose their jobs - the next chap in hopefully learns this lesson, and fixes the element of surprise. That means, in practice that they would insist on comprehensive write-offs that can be blamed on their predecessors, from which they can show progress in coming quarters. These write-offs, while scary, serve the function of keeping markets alive.
Putting things in perspective
The useful comparison, and contrast, here would be the Japanese banks whose failures in the 1990s were essentially hidden. Let us not forget here that what has ailed the share price of American banks is the fear of more write-offs on asset values, that could help wipe billions from shareholder value.
Last week, market reports of billions in further losses to be taken by a motley crew of American and European banks helped to drive share prices sharply lower on Thursday and Friday. When these assets are written down though, we will be left with financial values that are closer approximations of reality. This would in turn start the process of asset trading in earnest.
Take an example of a new community that consists of a large number of houses in some part of California. A company owns the project, and its revenues consist of rents from all tenants. Furthermore, because the company in question wants to develop other properties, it entered into a securitization agreement with a bank, which sold this package of bonds to investors across the world including the friendly Asian central bank that manages your currency. As a goodwill gesture, the investment bank holds some of these bonds on its own books.
Now, with house prices in free fall and vacancies rising sharply, there is a real chance that rents in this development will decline as well, in turn making the cash value of the bonds written on the project more volatile. In this case, the three sides to the transaction - the company on whose name the bond is issued, the investment bank, which arranged the transaction, and the investor who bought some of the bonds - have multiple options, none of which are too nice.
Option number 1: Anglo-Saxon
The investment bank in this case can go out on a limb (especially with its brand new CEO) and say that the value of its bonds, which were bought at 100, are now only 50. This means that the investors have to take similar hits on their portfolios, if their accountants are awake. If their accountants are asleep, of course the investor can pretend that the assets are still worth 100.
By marking the books at 50, the investment bank throws open the floor for trading. Now, the benchmark price is 50 - so the company owning the project can for example make some useful comparisons based on actual rent receipt and determines that the bonds are worth more than 50. It can therefore buy back the bonds from the investment bank or the investor. In case this loss is too much for the company, it would declare bankruptcy, and sell its assets, ie, the houses, cheaper to anyone interested, with the proceeds going to pay for the debt previously issued.
Meanwhile, the investor who has taken a 50% loss can decide that this is not a game they want to play, because none of the managers have been to California and what with all the wildfires, wouldn't want to go there either - so they choose to sell their bonds at 50 and put the losses behind them.
With the price at 50, other investors who would not normally care for these assets would get into the picture, with a view to riding the wave to say, 70. Also, with the value of the asset at 50, they can also get loans from banks to fund the purchases. All that trading causes money to flow once again, and market equilibrium is restored. In time, new houses will be built in California, and new bonds be issued once again.
Option number 2: Japanese
Faced with a similar decline in property prices in the 1990s, Japanese banks chose the second option, namely do nothing. Thus, the banks continued to value the assets at 100, and this meant that there were no losses taken initially. Unfortunately though, this also created a logjam between the investors and companies owning the property, as the latter did not want to repurchase their obligations at 100, and investors had no reason to sell at below 100.
With income falling rapidly for these companies, the banks were forced to make new loans to get their interest payments on time (what was known as evergreening) to the companies, in turn making money unavailable for more deserving borrowers. At the economic level, this completely removed the effectiveness of the banking system, creating the specter of "zombies" - companies that were really dead, but were still walking around.
Investors in such companies knew well enough that they had suffered loan losses, but would wait till the last moment before recognizing these losses. That meant they wouldn't have the ability or the willingness to buy any more assets, in effect shutting themselves from new investments.
This is why the Japanese banking system ground to a halt in the middle of the '90s. Even today, these banks boast asset values that pale in significance to their market capitalization, because no investor believes that the assets are actually worth that much to any outsider. This "discount" also forces Japanese banks to avoid any global acquisitions, perpetuating their domestic focus.
Between the two options, the first is clearly preferable, as it keeps the market economy well lubricated and functional. This is the context in which to look at the exit of various CEOs - that the market has more opportunities in the weeks ahead, rather than a protracted period of non-activity. American shareholders have chosen well.
(Copyright 2007 Asia Times Online Ltd. All rights reserved.)
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