Today's Crunch: Amex/Merrill/Countrywide Oh My

I've been trying to figure out what the FED intend to accomplish by lowering rates is it:

- to keep resets lower when ARMS adjust? Since the mortgage market is pricing in the risk, will mortgage rates be much lower. Even when fed rate was 1%, the 30, 15 year fixed rates didn't tumble
- are they trying to re-flate the bubble? are they trying to encourage people to buy homes they can't afford without using non-fixed loans
- are they trying to create MAJOR inflation so the people in debt can simply inflate the debt away at the cost of the USD and financial responsible people

.. or finally, do they really not care about housing and are just acting to protect banks?

ha, who the hell knows. I would bet the fed is trying to:

1. limit the severity. keep the recession from turning into a year long event.

2. put a floor on asset deflation. A world with asset deflation and commodity inflation is not a good one.

If you say so, Mr Soury McSourster!

Noah...I really hope you are wrong about the Fed being the puppeteer here, but I'm afraid your right. When Norther Rock a major mortgage lender in the UK melted down this summer there was literaly a "run on the bank". Depositors lined up outside to withdraw their funds.....the same happened to bank of Boston in the early 1990s if memory serves correctly. These incidents were somewhat common in credit cycles of the Pre War period and prior century. Obviously they can cause wide spread hysteria.....which the fed does not want. Note that Countrywide owns a bank with $61B in deposits (they pulled in $2.3B of these in December)...could be a long line. The Fed is all about keeping people calm right now - even if it means Ben B dropping money from a helicopter. As you can see from my article on bank losses, even with the writedowns for the very large banks and investment banks....your everyday bank is in good shape with regard to bad loans on their books. They can borrow from the government at increasingly low rates and make loans to creditworthy borrowers all day long. While the loan losses will rise, most of the stupid mortgage losses will accrue to hedge funds, pension funds, insurance companies and bond funds who were the investors in the mortgage backed securities, so banks not in the securitization business should only be hit by a normal recession impact of worsening credit quality...they have a lot of room for now. Confidence is the key to not having a major recession break out and really put the banking system under pressure.

Greenberg guesses that the Fed is behind this deal. Hmmm...

The Fed is not a dealbroker. What the Fed CAN do is encourage a transaction of this type in order to ensure the safety & soundness of both banks, not nec to influence/stablize markets. At the end of the day it's up to the banks to agree.

The deal still has to undergo regulatory approval by the Fed, OCC, various states, Dept of Justice, etc. which could take weeks. The regulators would look favorably upon this deal if the pro forma would result in a stronger instutition. In other words, if it looks as if BofA could effectively absorb CFC with minimal impact.

The regulators also know this is a high profile deal and would therefore be extra cautious about any decisions made. That said I'd be very surprised if the government would "agree to guarantee BofA against any losses".

I see the BAC deal exactly how I called a buyout of Countrywide yesterday.

BAC sees a business where Countrywide is about to go belly up because it's cost of funding is more than the loss adjsted rate of return on the mortgages it has written.

BAC can come in and make this same business very profitable using it's much lower cost of funding supported by it's huge balance sheet.

It has further strengthened Lewis' strategy of being the US's biggest bank having now convincingly beaten Citi. In the small print it also allows it to exceed 10% of the nations deposits by using Countrywide's Thrift.

All clever stuff and to top it all, it's basically paid loose change - $4bn.

Very simple math. As the Wall Street Journal's headline says to day. BAC are simply making a bet on the future of the economy.

BAC would NOT do anything uneconomic simply because the Fed asked them to. You may argue that Countrywide collapse would have not done BAC any good as this is partially the case, but to make the next leap that the Fed arranged the deal is speculative at best.

sorry Hank, I mean Herb, I mean Hank..

no wait..Herb! Anyway sorry!

Noah,

Do you think one of the "Big Three" US banks will implode by mid-year? I have heard this is possible, and with reports that Citi is deep in the s**t, I fear it could be them. I hear that they are limiting ATM withdrawals due to "ATM tech problems".

I don't mean to feed the rumor monger mill, but have you heard similar, and do you even think it's possible for Citi to crumble?

uwsider -

this is obviously bothering me as well. From a policy standpoint, I really believe that what's happening is close to what you said in your third point:

"- are they trying to create MAJOR inflation so the people in debt can simply inflate the debt away at the cost of the USD and financial responsible people"

Look, we are a debtor nation. In spades. But not just as a government borrower. As individuals (i.e., voters), we have been experiencing significant negative savings in recent years and I would guess (I don't have stats) are on average heavily indebted as individuals. You, me, others who have scrupulously saved and invested - i.e., the "financially responsible" - are now relatively dispensible for the greater good. Choosing therefore between the evil of a slower economy and the evil of inflation, it's a no-brainer for the Fed - reinflate, reinflate, reinflate.

In short, there are more financially irresponsible people than financially responsible people. Which group will the Fed/Congress/Bush try to please?

There's nothing to fear but fear itself Ghan. I want to revise my "puppeteer" comment. I agree with Anonymous Banker that the Fed likely did not orchestrate this deal. But I believe that the normal regulatory scrutiny this deal would have gotten, will be lessened due to the credit crunch and the possible need for a rescue of Countrywide. My guess is BAC has gotten a wink and a nod on this deal already. By the way it also occurs to me that since the government seems to really want to revise some of the terms of many of th mortgages that have been written in recent years to help forestall further bankruptcies it can only be a huge plus that one of the biggest servicers of mortgages, owned by the #1 originator of mortgages, will be bought by the biggest bank...who would like to co-operate with the government in any way they can to get this deal done. It's a big bet by BAC on the future, which may cause pain for BAC in the intermediate term, but seems like a better deal than some of the sovereign funds are getting in their capital injection deals.

what do you consider top 3? Citigroup, Bank of America, JPMorganChase? We also have Wells & Wachovia up there, and Washington Mutual.

Citigroup is in worst shape of the top 3 and possibly BOA after this countrywide deal. But I dont see one going under. Foreign wealth funds will put money to work here. I think smaller ones will see the implosion and get bought out.

I've got to say that I have some reservations about this description of the smart and prudent people who haven't overspent as "financialy responsible". I think that there is a HUGE number of people who are not making it because of the BASIC expenditures, some of which do not show up in our CPI. Housing, health care, fuel are all so expensive that the percentage of people who can comfortably exist on their salaries and benefits is shrinking monthly.

And, as we all know, a large number of people have home-related costs that have been artificially created, and are blowing up

Brenda - not sure I follow you. No need to take offense - it's quite possible to be "financially responsible" and still squeezed.

If someone can't live within their means even after taking all the necessary measures to do so, then yes that's something that should be helped. We have what are called "entitlement programs" to assist them.

I would not, however, consider as "financial responsible" someone who (1) is spending beyond their means (and can live within their means), (2) has borrowed beyond their means, (3) on terms that they either didn't understand or didn't properly consider, (4) in order to finance more than they can chew. I do feel bad for folks who bought more house/car/yacht/pool/vacation home/gameboy than they can afford. That is, well, irresponsible.

Bottom line: don't buy what you can't afford. If you do, don't make me pay for you through a bailout or a weakening of the dollar when the sh*t hits the fan.

If in your first sentence you are also saying that smart and prudent people who haven't overspent shouldn't be considered "financially responsible", then I don't follow you at all.

Finally, the inflation you allude to in your post is exactly the consequence of our overborrowing in the first place, and the effort to rectify it by throwing more money at the problem.

sorry, Brenda, meant to say:

I do *NOT* feel bad for folks who bought more house/car/yacht/pool/vacation home/gameboy than they can afford.

i know that savings are protected up to 100k inbanks.....if someone has more..ie lets say 300k at citi, would they lose 200k if citi went under....should people be withdrawing their savings from citi and placing elsewhere?

michael - you know I was wondering about that. I dont think its so easy to lose your money like that, but then again, I never lived through one of these situations so I have no idea.

great question. I would think highly unlikely. Its more a confidence thing and if people start withdrawing, reserves for the bank must be refunded and that causes more problems for liquidity

Ghan, Citibank limited its customer ATM withdrawals in response to recent fraud in the NYC are. It has nothing to do with the institution's overall standing.

Michael, if you have an account at any bank with insured deposits (and almost all do), your $$ is insured for up to $100k per account. If you have more than that you're probably keeping your cash in more than one account, or you should.

Banks are the most regulated institutions in our country. As a standard course of action the Fed, OCC et al have likely been addressing these issues with all major banks in order to ensure their safety and soundness.

Citi has its issues to address... but to completely crumble? As likely as pigs flying.

thanks Beth!

Ghan, Citi limited its ATM withdrawals because of recent fraud in the NYC area - it has nothing to do with tech problems or the subprime mess.

Banks are the most regulated institutions in the US. My guess is that that regulators have been meeting with Citi, BofA et all specifically to address their subprime-related issues. If Citi - or any other major bank - crumbles I'm sure pigs will fly.

Michael, you're correct, almost all banks insure deposits for accounts >$100k. If you have more than that with any bank you should hold more than one account or invest the rest (which would give you a bigger return than holding it in a savings acct, but that's another matter). Keep in mind these are saving/checking account deposits, not brokerage or IRA's.

oh, so its Per account that you are insured at each bank...so if i had 5 accounts of $100k each at citi i would be insured on all 5 accounts BUT if i had 1 account for $500k at citi, i would only be insured on $100k of the the $500k? thanks

anon -
I must not have been communicating effectively. That's exactly my point also. Smart and prudent people are also unable to pay for their basic expenditures these days. The only way most people can be smart and prudent is to be rich.

Brenda - I think this discussion comes down to the folowing question:

What are basic expenditures?

Answer depends on one's lifestyle and the choices they make. NYC is expensive, and if one cannot afford the basic expenditures in NYC, then it makes the most sense to move to another city or adjust their lifestyle accordingly. Affording NYC isn't and shouldn't be a given.

By definition, smart and prudent people find a way to live within their means. Even if that requires changing one's lifestyle, not having 4 kids, sending their kids to public school, not having 2 cars, not living in the most expensive city in the country. Those are smart and prudent decisions.

Sometimes people's lifestyles and choices don't work out or are no longer prudent - costs become too high, they lose their jobs, sh*t happens. It's happened to me. I don't ask that the rest of the world (or the government) adjust to my circumstances. On the contrary, individuals need to adjust to their own circumstances.

If you're not "rich", adjust.

Countrywide is losing money now, but it originated $408 billion in new mortgages last year. And despite all the bellyaching about the subprime mortgage crisis, try to think about it from a fatcat banker's perspective. Bank of America just can't wait to get its hands on the 93% of Countrywide's mortgage portfolio that is still being paid on time.

I'd like to correct a statement that Beth made above - because Michael has gotten the wrong idea. Please see below from the FDIC site:

The basic insurance amount is $100,000 per depositor per insured bank. Certain retirement accounts, such as Individual Retirement Accounts, are insured up to $250,000 per depositor per insured bank.

That is per DEPOSITOR per INSURED BANK!!! Not PER ACCOUNT!

URL for this info: http://www.fdic.gov/deposit/deposits/insuringdeposits/index.html

Susan - ex Citi-banker

That is correct. It is per depositor per bank. If you spread $400K across 4 accounts at BofA, you're still only insured for $100K. If you spread $400K across 4 accounts at Citi, BofA, WaMu and Chase, then you're okay.

Regarding the inflation front, it really seems that the FED have been forced to abandon inflation (due to market and political strong-arming) at the very time commodity inflation looks a HUGE inflation ..

this makes me very VERY VERY scared, much more scared than a full-on depression as I have been responsible and have a lot of my hard-earned money.. basically having money stolen from me and have no control over... a carton of milk will be 10 dollars at this rate!

Am I forced to buy gold and commodities or am I being VERY paranoid. Any ETFs or stocks to play commodities?

uwsider - I am right there with you. I vacillate between the same fear of hyperinflation and the belief that there is no way in hell the Fed would allow everybody's spending power to depreciate so rapidly.

Problem is, the Fed is doing exactly what I fear. And all of the candidates are talking about economic stimulus packages that simply throw money at the problem. Either way, we're feeding the fire with new money (the Fed) or deficit spending (the candidates), both of which are inflationary.

When you think about these current economic problems, coupled with the pending funding issues of our entitlement programs (Medicare/SS), it's enough to make you want to put all your money in Renminbi. Which is one way to hedge. Some other ideas include:

- Gold - but this to me is an 'theoretical' hedge at the end of the day, driven by speculation and not concrete, practical demand. I'm wary given all the recent gold hysteria.
- Oil
- Agricultural commodities
- Currencies of economies that are not dependent on exports for their strength and should experience sound domestic growth
- Inflation-indexed bonds and other inflation-based securities

Just some thoughts. If you have some ideas, would love to hear them.

Susan, thanks for the clarification!

As crazy as it sounds, I went through the FDIC insurance question (and a larger portfolio re-arrangement) this summer when the extent of the sub prime issue started to worry me. A couple of comments. It is true that a depositor is only insured for $100,000 by the FDIC, regardless of the number of accounts they have. However, if you are married you can have an account in each spouses name and be FDIC insured for $200,000 total. Unfortunately, historically if a bank goes under it can take a very long time to get funds from the FDIC....think decades.....according to what I was told. My solution was to make sure I had the most money I could have FDIC insured in a couple of the biggest money center banks (like JP Morgan, Citi, B of A) guys the feds really don't want to see go under. All the rest of my "low risk" money was put into a money market muni fund.....not just a plain money market fund as I was afraid of SIV paper exposure. However, I found out Muni money market funds could have issues with holding bond insurer insured paper that could trade down if the bond insurers like MBIA go under. Read my piece "Tentacles of the credit beast" on this whole subject for more info. However, the record of money market fund management companies is that they bail out these funds if there is a problem so as not to lose their credibility altogether. I chose a Fidelity Funds triple tax free NY Muni Money Market Fund as Fidelity is a large stable enterprise that treasures its reputation. Bottom line there is no riskless asset except U.S. treasuries (and even these have the risk of inflation/currency decline). I would remind people of TIPS as an alternative (inflation indexed US Treasuries). In terms of "risk" money I will be keeping a diversified portfolio including large cap US and International Stocks, particularly dividend payors which should hold up relatively well in a flight to quality. The current pessimism in the world and markets is making me feel like now is a time to move a little of my money market cash into large cap value funds....I love Tweedy Brown for both US and Global value....I've known Chris Brown for longer than I would like to say and these guys almost never lose money....except for rounding error amounts when the world implodes and over time they produce great low risk returns. they just re-opened the Global Value Fund as they see opportunities to deploy new capital.

The easiest hedge against US dollar weakness is perhaps a Euro investment.

I've had sterling deposits earning 5% over the past 3 years and also gained nearly 10% a year on top in fx appreciation. It would have been even sweeter if I'd bet on Euros instead.

I worry about gold. Although it's been a fantastic momentum play but at the end of the day $900 an ounce for a lump of metal that it by and large only being bought for Indian housewives jewellery at the moment doesn't seem that prudent. I suspect we'll see central banks continuing to diversify their asset base away from both the USD but also gold.

hmm, interesting thought anon banker..dont you think fed rate cuts, economic uncertainty in US and lagging world, and safe haven investing will buy gold? Forget the actual global demand for jewelry.

also, inflation adjusted, gold is cheap. Inflation adjusted the price of gold should be just over 2,000. Look at oil's move in 2007. I think gold will make similar move in 2008; unless major stimulus package comes out that may negate the aggressive lowering of interest rates. Its an election year, no investment is safe so I would be extra focused on my major long positions in gold or any other commodity for the unexpected.

Another more comforting way of looking at the inflation issue is as follows:

It's been demonstrated pretty persuasively that the money supply has been extraordinarily inflated in the past few years not by the Fed, but largely by securitizations, which act as multipliers just like the bank reserve requirement ratio. If that's the case, then one could say that (1) we've seen the effects of inflation already - weak dollar, inflated asset prices (gold, RE, commodities - already happened) and (2) the bursting of the credit bubble has been an automatic and severe reduction of this money supply - plummeting value of $-denominated CDOs, etc., is essentially a destruction of the $ money supply. Therefore, the last few months have been massively deflationary, the effects of which we have not yet seen. Fed and congressional stimulus will probably only partially make up for this money destruction.

Anon,

I believe that at times like this its hard to make macro trade calls, because a lot depends on where spec money is already positioned or even over-commited. But I lean towards your way of thinking. We are in a tight money environement, regardless of what central banks do. If China's bubble pops we will be in deflation city. But I think if they keep growing > 10% per year, it will be hard for commodities to get more than "roughed up", which is my current expectation for some period of 2008. That said wage growth will come down, un-employment will increase and so systemic inflation won't be a big worry. Gold in particular is tough to call, due to the explosion in investor interest, which is now the driving force and its perceived "safe haven" status. Note that jewelry demand has been down for 18 mos. or so and is driven by India, which is having its own debt and inflation issues. Although over their they break your legs if you don't pay off your loans.

thanks for that HUGE clarification!