March 23, 2023

High & Low Finance: Portent of Peril for Muni Bondholders

Large municipal bond disasters have been rare, but I suspect there will be more. The Jefferson County bankruptcy may serve as a precedent for forcing bondholders to take losses in bankruptcy. Despite lots of legal protections, loans to municipal governments can be just like loans to people and companies: if the borrower truly can’t afford to pay what was promised, it won’t be paid.

Jefferson County’s problems involve corrupt politicians and bad luck, but they also include a longstanding reluctance to face facts about the county’s sewer system — and a bond market that failed to face the facts about the county and kept lending money long after it was prudent to do so.

The corruption involved was breathtaking. More than 20 people, including politicians, contractors and influence peddlers, have been convicted. JPMorgan escaped criminal charges, but the Securities and Exchange Commission penalized it for paying bribes through local middlemen.

That corruption was important and no doubt raised the financing costs for the county. But the basic financial decisions about the structure of the county’s debt were different only in scale from what many other municipalities did.

The disaster provides an example of how derivative securities can be oversold. Not all risks can be hedged, and certainly not at acceptable costs, but that is something Wall Street salesmen tend to overlook when they make their pitches. When such contracts are written, you can be sure that the Wall Street firm will make sure it will come out O.K., even if that increases the risk that the customer will not.

The county’s sewer debt used to be long-term, fixed-rate debt. The county would have been better off if that had not changed. But Wall Street persuaded it, and a lot of other municipalities, that such debt was too costly. The county could save some money by issuing what the salesmen called synthetic fixed-rate debt.

And what is that? The county issued long-term variable-rate debt, where the interest payments would fluctuate based on short-term market rates. Just doing that would have left the county at risk if interest rates surged, so JPMorgan also entered into an interest rate swap. That provided that the county would pay a long-term rate to JPMorgan, which would pay a short-term rate to the county.

The net cost of that was a little lower than the cost of fixed-rate debt would have been.

There was an important catch: the swap payments were not based on what the county actually had to pay. They were based instead on indexes that might, or might not, move in the same way that rates moved on the county’s actual debt. It was not really “fixed rate,” the title notwithstanding.

Another risk, probably never considered, was that the monoline insurance companies, which routinely guaranteed munis for a fee, would collapse.

Those risks were not necessarily large, and if Jefferson County had not structured 90 percent of its debt that way — rather than the 10 or 20 percent some advisers recommend — they might not have become crucial. But in the credit crisis, a lot happened that had not been expected.

Jefferson County issued two types of variable-rate debt, both of which blew up.

The largest was auction-rate debt. That debt paid rates that were set every week at auctions. The risk to investors was that an auction could fail and they would be stuck with the bonds. If that happened, the county would pay a penalty rate, often twice the London Interbank Offered Rate, known as Libor.

When auctions began to fail, that penalty rate was not enough to attract investors, but it was high enough to raise the financing costs for the county significantly. The interest rate swap did not protect it because it was based on an index, not on the actual cost the county was paying. Suddenly the “fixed rate” went up.

Floyd Norris comments on finance and the economy at

Article source:

E-Commerce Companies Bypass Middlemen to Build Premium Brand

But what if they left out most of those people? “I had been to the factories and knew what it costs to manufacture glasses and knew the cost didn’t warrant a $700 price tag,” said Neil Blumenthal, a founder of the company. Inspired by glasses they found in their grandparents’ attics, the founders sketched a few frames, hired the same Chinese factories that make designer glasses and started selling directly to consumers online. By doing so, they eliminated enough of the cost to charge customers just $95 a pair.

Warby Parker is part of a wave of e-commerce companies that are trying to build premium brands at discount prices by cutting out middlemen and going straight to manufacturers. They make everything from bedding (Crane and Canopy), to office supplies (Poppin), nail polish (Julep), tech accessories (Monoprice), men’s shoes (Beckett Simonon) and shaving supplies (Harry’s).

The result is generally cheaper products for consumers and higher profit margins for the companies.

Big retailers discovered long ago that controlling the supply chain benefited their bottom lines, which is why companies like Wal-Mart and Whole Foods sell many products under their own brands. At Macy’s and Kohl’s, such “private label” brands make up almost half of their sales.

Start-ups have traditionally struggled to match those efforts. They do not have as much brand recognition as big retailers, and persuading consumers to take a chance on, say, Warby Parker eyeglasses instead of Prada’s can be difficult.

“The challenge is, if you’ve never heard of the brand, you wonder, ‘Should I buy it when it’s 20 percent cheaper?’ ” said Raj Kumar, a supply chain consultant at A. T. Kearney. “Or should I buy a brand I trust?”

What is empowering the upstarts now is the Web’s ability to reach lots of consumers without the costs of operating physical stores as well as a change in manufacturers’ willingness to work with small brands.

The founders of Deal Décor, whose model was to sell furniture directly to customers, worked at Target and Home Depot Direct before starting their company. They said they saw an opening after the recession hit.

As home sales in the United States declined, and furniture sales went with them, Chinese furniture factories had excess capacity, said Craig Sakuma, co-founder of the company. Where the factories had previously been unwilling to take small production orders, they were now eager for business — but they were concerned about getting paid, as they were already chasing down payments from errant retailers.

So Deal Décor approached manufacturers with an appealing proposal: it would pay them as the products were shipped, rather than a month or more later.

Unlike traditional furniture retailers, Deal Décor’s model was to sell couches or bookshelves on its Web site before they were in production. It timed the deals for when a factory was producing similar items for other clients and could easily add Deal Décor’s order. Deal Décor ordered the exact quantity it had sold and had the items shipped straight from the factory to customers eight to 16 weeks later.

Because they are not dependent on third parties, these e-commerce companies can also introduce products much more quickly.

Crane and Canopy, for example, releases new duvet covers and sheet sets every other week and designs textiles based on current trends on Pinterest and elsewhere, instead of planning collections seasons ahead of time like most brands, said Karin Shieh, its co-founder.

Article source:

Ex-Indian Air Force Chief Charged in Bribery Case

NEW DELHI — India’s top investigative agency filed a criminal case on Wednesday against a former air force chief and 11 other people on charges of cheating and conspiracy in a $750 million helicopter deal marred by bribery.

The Central Bureau of Investigation filed the charges under India’s corruption prevention laws against Shashi Tyagi, three of his cousins and officials of four defense companies after an investigation revealed that huge bribes were paid to steer the contract to the Italian defense group Finmeccanica’s helicopter division, AgustaWestland.

The agency searched the homes and offices of Mr. Tyagi and his cousins, who it suspects were among those who received bribes to clinch the purchase of 12 helicopters two years ago.

India’s Defense Ministry received three of the helicopters in December but has placed the rest of the contract on hold.

Among the 12 people involved in the case is Satish Bagrodia, the brother of a former federal minister, Santosh Bagrodia, who belongs to India’s governing Congress party.

The C.B.I. said it filed the criminal charges based on evidence it had gathered from the men and from documents it obtained from Italy. The Defense Ministry indicated that alterations were made in the helicopter specifications to favor AgustaWestland.

The inquiry into the helicopter contract began last month after Italian authorities arrested Giuseppe Orsi, the chief executive of Finmeccanica, in Italy on charges that the company paid bribes in India. Mr. Orsi, who has been jailed, denies wrongdoing.

Italian authorities also placed the head of AgustaWestland, Bruno Spagnolini, under house arrest.

Mr. Tyagi has also denied any wrongdoing in the case and said decisions on the helicopter deal were made before he assumed the top job in the air force.

The agency said Finmeccanica paid a commission to three middlemen who channeled the illegal payments through Tunisia and Mauritius to two India-based companies as payments for an engineering contract. Those companies and two Indian men associated with them were among those named as accessories in the case.

India has become the world’s biggest arms and defense equipment buyer in recent years and is expected to spend $80 billion over the next 10 years to upgrade its military.

Arms deals in India have often been mired in controversy, however, with allegations that companies have paid millions of dollars in kickbacks to Indian officials.

In the 1980s, the government of -Prime Minister Rajiv Gandhi government collapsed over charges that the Swedish gun manufacturer Bofors paid bribes to supply Howitzer field guns to the Indian army.

Following the Bofors scandal, India banned middlemen in all defense deals.

The developments in the Finmeccanica case come at a time when New Delhi and Rome are entangled in a diplomatic dispute after Italy’s refusal this week to return two Italian marines facing trial in India for the killing of two fishermen off the southwest Indian coast last year.

The case is also a major embarrassment for Prime Minister Manmohan Singh’s government, which has been buffeted over the past year by a string of corruption scandals ahead of national elections scheduled in the first half of next year.

Article source:

DealBook: Mortgage Refinancing Boom Is Expected to Benefit Banks

A branch of JPMorgan Chase in Manhattan. The bank's mortgage production revenue was up 70 percent in the first half of 2012.Justin Sullivan/Getty ImagesA branch of JPMorgan Chase in Manhattan. The bank’s mortgage production revenue was up 70 percent in the first half of 2012.

Federal stimulus has ignited a boom in mortgage refinancing, benefiting both homeowners and banks. And the good times could continue as the government steps up its support of the broad housing market.

The proof will be in the profits.

On Friday, Wells Fargo and JPMorgan Chase, the top two mortgage lenders in the country, are scheduled to report quarterly earnings. Their results — and the wave of other bank reports that follow — will offer clues as to whether the current mortgage boom is sustainable or set to fizzle.

Related Links

“We expect mortgage revenue to continue to be elevated in the third quarter and possibly into next year,” said Jason Goldberg, a banking analyst at Barclays.

In the third quarter, banks probably originated as much as $450 billion of home loans, according to estimates by Inside Mortgage Finance, a publication that tracks the industry. That figure, which includes both refinances of existing mortgages and new loans to purchase a house, would be a considerable jump from the previous period. In the second quarter, banks originated $405 billion, with 68 percent as refinancings.

A branch of Wells Fargo in Daly City, Calif. The bank is scheduled to report quarterly earnings on Friday.Justin Sullivan/Getty ImagesA branch of Wells Fargo in Daly City, Calif. The bank is scheduled to report quarterly earnings on Friday.

Since the financial crisis of 2008, some large banks have found themselves well positioned to make money when the mortgage market gets hot.

It comes down to the advantageous role banks play as the middlemen in the mortgage machine. Instead of holding on to new mortgages that earn interest over a number of years, banks sell nearly all of them to investors after packaging them into bonds. The federal government, through entities like Fannie Mae, attaches a guarantee of repayment on the loans, making the bonds even more attractive to the investors.

When the banks sell the mortgages as bonds, they do so at a profit. This markup has gotten even bigger after the recent moves by the Federal Reserve and the Treasury Department to help the housing sector.

In September, the Fed announced plans to buy large amounts of mortgage-backed bonds. The proposal has driven the price of such securities higher, allowing banks to earn an even bigger financial gain when they sell their mortgages into the market.

A Treasury program makes it easier for homeowners who are underwater, meaning their properties are worth less than their loans, to refinance. This initiative — coupled with the ultralow interest rates — has generated a flurry of refinancing activity, producing a windfall for banks.

Some analysts expect banks to keep churning out profits on mortgages. They think it unlikely that there will be a letup in refinancing anytime soon, given that rates are expected to stay low for a while. The average rate on a 30-year fixed rate mortgage has dropped to 3.36 percent, from 3.95 percent at the end of 2011, according to Freddie Mac figures.

“I estimate that close to half of mortgages have an economic incentive to refinance,” said Paul Miller, a banking analyst at FBR Capital Markets.

Mr. Miller believes the steady stream of refinancings will last for multiple quarters. Some banks are reluctant to expand their mortgage operations, meaning the market can handle only a limited volume of loans at a time.

These banks fear that entities like Fannie Mae, which guarantee the loans, have become a lot more demanding when asking banks to take back troubled loans. The so-called put-backs can quickly prompt losses that can surpass the income that banks originally made on the loans. And though the quality of loans written since the crisis has been high, banks fear they could be swamped with put-backs if the economy slows.

“There’s a lot of uncertainty at the moment, and it does weigh,” said Mr. Goldberg, the Barclays analyst.

If some banks remain nervous about increasing the amount of mortgages they originate, it only tightens the grip of the few dominant lenders, making it easier for them to determine the interest rates ordinary borrowers pay and generate strong profits. Those rates could be well under 3 percent, if the gains banks make when they sell the mortgages were at historical levels, according to a New York Times analysis earlier this year.

Some of the top banks benefited from the wave of consolidation that occurred during the financial crisis. In the first half of 2012, for instance, Wells Fargo, which acquired Wachovia, and JPMorgan Chase, which consumed Washington Mutual, accounted 44 percent of all mortgages, according to figures from Inside Mortgage Finance.

In first half of 2012, Wells Fargo reported gains of $4.83 billion when originating mortgages, a 155 percent increase from $1.89 billion in the first half of 2011. JPMorgan’s mortgage production revenue was up 70 percent.

Still, some analysts are less certain about the strength of the refinancing boom. If Mitt Romney wins the presidential election, he could move quickly to overhaul housing finance in ways that could, at least temporarily, unsettle the mortgage market.

There are more immediate concerns, though.

“The biggest threat is a rise in interest rates,” said Guy Cecala, publisher of Inside Mortgage Finance. For many borrowers, refinancing would no longer make sense if mortgage rates went back up to, say, 3.75 percent.

Even if mortgage rates stay low, the big banks might finally start to see more competition. The temptation of bigger mortgage gains may come to outweigh the fears that some banks have.

“If this lasts longer than expected, you will see banks re-enter the game,” said Todd Hagerman, banking analyst at Sterne Agee Leach.


Article source:

Western Funds Are Said to Have Managed Libyan Money Poorly

The document, a September 2010 summary of Libyan Investment Authority assets, showed poor performance by European and American money managers and a Libyan with close ties to the Qaddafi regime. Libyan Investment Authority officials complained that a $1.7 billion investment they made in six different funds generated returns far below the industry benchmark.

“To date, we have paid in excess of $18 million in fees, for losing us $30 million,” the report says at one point, referring to a fund reportedly managed by the son-in-law of the head of Libya’s state oil company.

The report, prepared by the London office of the consulting firm KPMG, shows that a $300 million Libyan investment in Permal, a hedge fund that is a unit of the Baltimore-based Legg Mason, lost 40 percent of its value from January 2009 to September 2010. At the same time, Permal received $27 million in fees. “Consistently negative performance since inception,” Libyan officials said in the report. “Very high fees for no value.”

The Libyans voiced similar complaints about investments in funds managed by European firms that also lost value. Despite producing low returns, the Dutch firm Palladyne received $19 million in fees, the French bank BNP Paribas earned $18 million, Credit Suisse took $7.6 million and the Swiss firm Notz Stucki had $5 million. KPMG analysts also warned that the Libyan Authority’s investment in such funds was too high compared with other types of investments.

Representatives for the firms declined to respond publicly or could not be reached for comment. KPMG declined to comment, but The New York Times was able to independently verify the document’s authenticity.

An official at one firm criticized in the report, who spoke anonymously, blamed the poor investments on middlemen and denied that the firm had received high fees. “It’s not as straightforward a picture as it perhaps should be,” the official said.

In 2008, Goldman Sachs lost more than $1 billion in Libyan Investment Authority money in currency and other trading, The Wall Street Journal reported in May. The Securities and Exchange Commission is investigating whether an offer by Goldman to pay a $50 million fee as part of a package to help the fund recoup its losses violated American bribery laws. Goldman has denied any wrongdoing and declined to comment on Thursday.

Doing business with Libya was legal for American companies from 2004 to 2011. American banks, oil companies and construction companies rushed to do business in Libya after Col. Muammar el-Qaddafi renounced terrorism and halted his attempt to develop nuclear weapons and the Bush administration lifted sanctions in 2004. The Obama administration reimposed sanctions in February after the Qaddafi regime began brutally repressing an uprising in the country.

The creation of the Libyan Investment Authority in 2006 set off a frenzy in banking circles. Leading financial firms scrambled for the opportunity to manage the authority’s $40 billion in assets.

Managing the sovereign wealth funds for oil-rich states — some of which are authoritarian — is an enormous business for Western banks. For example, the Libyan Investment Authority’s total assets grew by $10 billion over three months, to $64 billion in September 2010 from $54 billion in June, according to the newly released document.

The document also showed that the British bank HSBC became the Qaddafi regime’s largest Western banking partner in September 2010, receiving $1.4 billion in Libyan money. The document showed that the amount of Libyan state oil money managed by HSBC soared to $1.42 billion in September 2010 from $282 million in June 2010. The document also corroborated a document leaked by Global Witness in May showing that Goldman Sachs managed about $45 million and JPMorgan Chase about $173 million for the Libyan regime in 2010. Société Générale and other European banks also helped the Qaddafi regime manage oil proceeds.

Under current American and British law, the business relationships between sovereign wealth funds and Western banks can be kept secret. In a statement, Global Witness called for such dealings to be made public so that citizens of oil-rich and Western countries could understand what was taking place.

“Banking secrecy laws still mean that citizens are left in the dark about how their own state’s funds are managed,” said Robert Palmer, a campaigner at Global Witness. “We can’t continue with a situation where information about how a state handles its assets is only made available once a dictator turns violently on his own people and information is leaked.”

Evidence of cronyism appears in the report as well. The state fund invested $300 million in a Palladyne fund managed by the son-in-law of the head of Libya’s state oil company, according to The Wall Street Journal.

Forty-five percent of the $300 million investment was held in cash, the report said. In addition to losing $30 million while charging $18 million in fees, the fund performed 39 percent below a worldwide index of similar funds.

Article source: