The Fed is Wrong and Paulson has Panicked

As I read each day how the Fed has subjugated it’s own rules to extend more and more “liquidity” to the failed credit markets, I get more furious that the Fed, SEC, Treasury and Congress continue to ignore the elephant in the room. Hedge Funds, unregulated financial institutions that control around $1.5 Trillion in liquid assets and over $30 Trillion indirectly through leverage, no longer have a role to play or a legitimate right to exist on Earth. These organizations sued the SEC to stay out of their books. The Fed and Treasury were recently saying to “regulated” banking institutions in the US, “I am going to lend you billions of short term money and I want you to extend this credit to non bank financial instructions, read unregulated Hedge Funds and Wall Street investment banks.” Now they are saying “I am going to lend directly to unregulated Wall Street investment banking institutions with the understanding they will extend credit to their unregulated clients, read “Hedge Funds” again.

Lets look at what the Fed has been doing with collateral. First they dumb down the collateral to allow AAA mortgage assets from banks, now they are allowing these same assets from unregulated investment banks. Where are they going next? Read, “The Fed is going to buy mortgage bonds directly!” So the Fed is going to take an industry that went awry and created worthless paper and worthless loans to keep their stream of easy money and profits going for approximately 30 months after the housing industry priced itself completely outside of the realm of sustainability and buy their junk? Commercial paper has not collapsed yet but the Fed will join in this party directly. I read this. “Yesterday, the Fed expanded collateral eligible for its auction of Treasuries to include bundled mortgage debt and securities linked to commercial-property loans.” According to Bloomberg, Fed by 21 March the Fed had lent $28 billion to securities firms and made $30 billion available for the Bear Sterns (read Bull Sh--) bail out by JP Morgan Chase.

I am furious to say the least. This line of thinking is crazy. We will bankrupt the Fed with this logic. Bush Jr. has already piled on $3.5 Trillion additional debt in his 7 destructive years raiding the Treasury under the noses of an impotent Legislative Body of Government. With $7 Trillion in debt on the books and a Baby Boomer generation about to retire and eat into the nations cash flow with unsustainable medical costs, (not to mention soon asking the Fed to bail out their 401k’s along with their imploding real estate as their depleted social security accounts prove worthless in an inflationary world with a weak dollar) this is not the time to think about buying worthless paper off the books of unregulated financial institutions.

I will repeat, “The Unregulated Hedge Fund Industry no longer has a constructive role to play in the world of finance or a legitimate right to exist on Earth”. With over 6 billion people and the technology in place to move trillions of “dollars” around daily, the global population has no need for a bunch of Ivy League 72 degree preppies banging away at computer programs trying to squeeze 30% annual returns out of any piece of paper, commodity or security they can manipulate using ever more exotic and esoteric products that are indecipherable beyond mathematicians with no respect for the underlying economic viability of their models nor for the destructive capacity of their speculation.

There is simply too much money in the unregulated financial world and this industry needs to be completely shut down and brought under the world of regulated finance.

Who enjoyed all this debt?

I start with this quote from Dow Jones News Wire:

JPMorgan later said first-quarter charge-offs in its home equity portfolio may nearly double to $450 million compared with the fourth quarter. The firm's charge-offs on its $95 billion home equity portfolio had been rising steeply all year, reaching $564 million by the end of 2007, compared with $143 million in 2006.

The increase in charge-offs from home equity loans is "appears to have been driven by a higher incidence of no-equity walkaways given declining prices in geographies such as California and Florida," Bear said.

Who had fun in all this, the people walking from the houses? I should say, only the salespeople on Wall Street and at the mortgage companies and real estate companies who made millions selling overprices homes, worthless mortgages and worthless mortgage based paper did.

Those people and those responsible for lending money on inflated property values made millions. Now employees of these firms are told they will not have to “pay” for their reckless lending. In fact, they keep all the money they made from the reckless lending AND their bonus structure this year will also strip out all of the losses associated with that reckless lending their companies and shareholders are taking a beating for and instead pay them bonuses on other areas of business!

Storey in WSJ and Seattle Times on Washington Mutual, one of the largest mortgage lenders in the US:

Among the changes WaMu's board approved for 2008 is abolishing earnings per share as one of the four weighted factors used in calculating bonuses. In last year's bonus plan, earnings per share represented 40 percent of the potential bonus.

The 2008 bonuses will be based on these criteria:

--Net operating profit, 30 percent -- with loan losses and expenses related to foreclosed real estate excluded.

--Noninterest expense, 25 percent -- again, excluding expenses related to business restructuring and foreclosed real estate.

--Fees from retail banking -- a new factor, weighted at 25 percent. Many banks including WaMu have been increasing fees for services such as ATM withdrawals by noncustomers to compensate for losses in other areas.

--Customer-loyalty performance, 20 percent -- an increase from 10 percent in the 2007 bonus plan.

Bank statement

In a prepared statement, WaMu said, "The success with which credit costs are managed will unequivocally continue to be a major part of the board's final deliberations."

Further information on the company's compensation philosophy and the board's annual compensation-review process will be included in the company's proxy statement scheduled for release later this month, the statement said.

Spokeswoman Libby Hutchinson said the bonus plan covers almost 3,000 people in WaMu management, many of whom are not directly involved in lending.

Consultant's question

But Fred Whittlesey, a Bainbridge Island compensation consultant, questioned why awards for Killinger and the three other top executives named in the plan aren't tied directly to earnings.

"If (they) are not responsible for bank profitability, who is? There's no reason they should be insulated from expenses they created," he said.

The bank has said bonuses, long-term stock awards and other parts of its compensation plan are important to retaining executives.

In January, WaMu said Killinger would receive 3.2 million stock options to vest in coming years, providing him "a strong incentive to restore shareholder value."

But Cannon said WaMu's highest executives shouldn't require such incentives.

"We are somewhat surprised that top management needs extra compensation in order to be retained," he wrote.

"While for lower-level executives ensuring retention is certainly important, for the top four executives named in the 8K (regulatory filing), including CEO Kerry Killinger, we would think that restoring the value of their existing stake in Washington Mutual, as well as the reputation of themselves and the firm, following the downturn in performance in this period would be incentive enough to stay with the firm."

WaMu shares closed Wednesday at $12.80, down 59 cents or 4.43 percent. The stock is down 69 percent in the past 12 months.

So back to the original question: Who had fun in all this borrowing? If you are one of those who’s life was a party borrowing on your inflated house price at next to nothing rates, God bless you. I hope you managed a couple of opulent vacation trips, spent plenty of time and money in fine eating and drinking establishments, had plenty of sex and fun. If you are now walking away from you’re now rapidly descending in value house and ballooning unable to meet mortgage payments, at least you had fun.

For those who were sold a dream give cheap credit and rapidly lived a nightmare and you are also walking away from your home, I feel for you. You were scammed in the greatest American Ponzi scheme ever created. I thought this could only happen in Albania. Nope, it all happened here in the world’s greatest capitalist playground, The US of A.

Now the Carlyle story:

I cannot feel for these guys. The massive amount of money borrowed short term by hundreds if not thousands of “investment” funds and “invested” in long dated mortgage products was nothing more than a “investor” funded Ponzi scheme designed to leverage as much as possible with as little money as possible to rake cash out of an industry that paid high returns in what historically was a secure investment area, mortgages, and put that cash in their pockets and the pockets of those who financed them. They all deserve exactly what they are getting, the idiots who lent the money, and the idiots who set up the firms and the idiots who run them.

Look at this statement about Carlyle published by the Dow Jones Newswire today:

Carlyle Capital as recently as Monday had reassured investors on its funding lines, saying it had $2.4 billion in undrawn repo lines and that it had increased a credit facility provided by the Carlyle Group by 50%, to $150 million.

Its lenders as of Dec. 31 were: Bank of America (BAC), Bear Stearns (BSC), BNP Paribas (13110.FR), Calyon (4507.FR), Citigroup (C), Credit Suisse (CS), Deutsche Bank (DB), ING (ING), JPMorgan (JPM), Lehman Brothers (LEH), Merrill Lynch (MER) and UBS (UBS).

The repurchase agreements outstanding at that date had an average maturity of 20 days. Carlyle Capital's longest-dated repo line is for three months.

The company leverages its $670 million equity 32 times to finance a $21.7 billion portfolio of residential mortgage-backed securities issued by U.S. housing agencies Freddie Mac and Fannie Mae. All of the securities are rated Triple-A and are considered to be implicitly guaranteed by the U.S. government.

Carlyle Capital said Thursday that it has been subject to margin calls and additional collateral requirements totaling more than $60 million over the past week, and had met all calls up until March 5.

Chief Executive John Stomber said that recent margin prices aren't representative of the underlying recoverable value of these securities.

"Unfortunately, this disconnect has created instability and variability in our repo financing arrangements. Management is actively working with the company's repo counterparties to develop more stable financing terms," Stomber said.

Last week, the group said it "can and will do better" after losing 30% of net asset value between listing on the Euronext Amsterdam exchange in July and Dec. 31. Within weeks of the listing, Carlyle Capital was forced to sell a portfolio of leveraged loans to meet margin calls and borrowed $200 million in emergency funding from Carlyle Group. To preserve capital, it has yet to pay a dividend.

On a call with investors Monday, Carlyle Capital Chairman Jim Hance said margin requirements were changing by "tens of millions of dollars" on a weekly basis, and that daily changes as counterparties repriced the securities were "sizable."

"The last thing we want is for them to sell out the collateral," he said, calling it a "daily cash fight."

Would any sane person take money financed on an average of 20 DAYS, leverage it 32 TIMES and use the cash to purchase securities with average maturities of 30 years? These guys are taking down the financial system. There is no government capable of bailing out this “industry”. The Fed and Treasury were asleep at the wheel and have no idea how to sort out this mess.

You tell me. I don’t care how careful or sophisticated their “models” were for how to make money under these terms. These people are greedy fools.