December 22, 2024

Fair Game: In MF Global, Sad Proof of Europe’s Fallout

That old line from the Marx Brothers came to mind last week as MF Global, the brokerage firm run by Jon S. Corzine, was felled by over-the-top leverage and bad derivative bets on debt-weakened European countries.

Suddenly, all of those claims that American financial institutions have little to no exposure to Europe rang hollow.

You can understand why Wall Street wants to play down the threats from Europe. Its profits depend on the market’s confidence in the products it sells — and on the belief that the firms that sell those products will be around tomorrow.

But MF Global provides two lessons. The first is that our financial institutions are not impervious to Euro-shocks. The second is that when those problems reach our shores, they usually ride in on a wave of derivatives.

“The problems that we’ve had since the inception of the credit derivatives market have never been solved in any meaningful way,” said Janet Tavakoli, president of Tavakoli Structured Finance and an authority on these instruments. “How many times do we want to live through this?”

MF Global’s debacle was a result of complex swaps deals it had struck with trading partners. While those partners owned the underlying assets — in this case, government debt — MF Global held the risk relating to both market price and default.

These arrangements at MF Global underscore two big problems in the credit derivatives market: risks that can be hidden from view, and risks that are not backed by adequate postings of collateral.

These are the same market flaws that helped hide the problems at the American International Group — problems that arose from insurance that A.I.G. had foolishly written on crummy mortgage securities.

The International Swaps Derivatives Association, an industry lobbying group, contends that the market in credit default swaps is far more transparent than it was in 2008. For example, the Depository Trust and Clearing Corporation compiles figures on the number and dollar amount of swaps outstanding on its trade information warehouse.

The numbers are pretty mind-boggling. As of Oct. 28, for example, the warehouse reported $24 billion in net credit default swaps outstanding on debt issued by France, up from $14.4 billion one year ago. Some $17 billion in net credit default swaps were outstanding on Spain, up from $15.5 billion in 2010. Net swaps on Italy were $21.2 billion at last count, down from $28.5 billion last year.

The amount of net credit default swap exposure on the imperiled nation of Greece was much smaller: $3.7 billion late last month. It was $7 billion a year earlier. Officials at the I.S.D.A. say these bets are manageable because they are probably backed by substantial collateral.

MOREOVER, because of the “voluntary” nature of the Greek restructuring deal, which would require private holders of the nation’s debt to write off half its value, the I.S.D.A. predicts that the arrangement should not qualify as a default.

Therefore, the insurance that has been written on all this Greek debt will not cover investor losses generated by the 50 percent write-down — a disturbing consequence to those who thought they were buying insurance against that very risk. Given this turn of events, it’s hard to imagine why anyone would continue to buy credit default swaps.

In any case, the figures compiled by the D.T.C. don’t show the entire amount of credit insurance that has been written on Greece and other nations. D.T.C. says it believes its figures capture 98 percent of the market, but credit default swaps are often struck privately; not all of them are reported to regulators.

Consider an investment vehicle known as a credit-linked note. In these deals, investors buy a note issued by a special-purpose vehicle that contains a credit default swap referencing a debt issuer, like a government. That swap provides credit insurance to the party buying the protection, meaning that the holder of the note is responsible for losses in a so-called credit event, like a default.

Credit-linked notes are very popular and have been issued extensively by European banks. Many are governed by I.S.D.A. contracts, which define the terms of a credit event and require a ruling by the association on whether such an event has occurred.

But some deals have different definitions or contractual language overriding the I.S.D.A. agreement. “The people writing these contracts may say, ‘I would like to be paid if there is a voluntary restructuring of debt, or if Greece goes back to the drachma, or if Greece goes to war with Cyprus,’ ” Ms. Tavakoli said. “I can declare a credit event where I am entitled to get paid if any of those events happen.”

Cash calls can also be generated by declines in the market price of the notes or increases in the cost of insuring the underlying sovereign debt issue, according to credit-linked note prospectuses.

The other party has to agree to these terms up front. But, given the nature of these so-called bespoke deals, we don’t know the full extent of the insurance that investors have written on troubled nations or the circumstances under which the insurance must be paid. Neither do we know who may be facing severe collateral calls or demands for termination payments on the contracts.

When those collateral calls start coming, market values assigned to the securities that have been provided as backup can decline significantly. And when a company’s credit rating is downgraded, as MF Global’s was in late October, cash demands from skittish trading partners become even greater.

“At this late date we still don’t know the risks that are out there,” Ms. Tavakoli said. “This market is opaque, bespoke, and the regulators don’t know what they’re doing.”

At least regulators didn’t deem MF Global too big to fail. That’s a plus. But given the billions at stake in these markets, more transparency is needed about market participants, their financial soundness and their ability to withstand liquidity crises like the one that wiped out MF Global.

Article source: http://feeds.nytimes.com/click.phdo?i=75aa19019496c5345515c6484e3927f5

Wall St. Slides After Bleak Jobs Report

Many investors had sold stocks ahead of the Labor Department’s jobs report, which analysts in a Bloomberg News survey had forecast would show a gain of 68,000 nonfarm payrolls.

The monthly report showed there was no job growth in the United States in August, and the flat performance had a direct impact on stocks in market-sensitive sectors.

The August jobs figure was down from a revised 85,000 new jobs added in July. The unemployment rate stayed at 9.1 percent in August, the department said.

Philip J. Orlando, chief equity market strategist at Federated Investors, said the jobs report was “very disappointing. It was much weaker than expected. We were thinking that if today’s jobs number was poor, we would start to see a pullback.”

In addition, analysts said financial stocks were hurt during the day by the prospect that a federal agency was set to file lawsuits against more than a dozen big banks over their handling of mortgage securities. Regulators filed the suits on Friday.

The suits by the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, are aimed at Bank of America, JPMorgan Chase, Goldman Sachs, Citigroup and Deutsche Bank, among others.

“This is not good news from the perspective of the banking sector,” Mr. Orlando said.

When the stock market opened, all three major Wall Street indexes slid lower and stayed there. The Dow Jones industrial average closed down 253.31 points, or 2.20 percent, at 11,240.26. The Standard Poor’s 500-stock index was down 30.45 points, or 2.53 percent, at 1,173.97. Both indexes ended the week lower, the Dow by 0.3 percent and the S. P. 500 by 0.2 percent.

The Nasdaq composite index ended the day down by 65.71 points, or 2.58 percent, at 2,480.33. But it managed to squeeze out a 0.2 percent gain for the week.

The Treasury’s benchmark 10-year note rose 1 8/32, to 101 6/32, and the yield fell to 1.99 percent from 2.13 percent late Thursday.

Kate Warne, investment strategist at Edward Jones, said the jobs report raised fresh concerns about whether the economy might be headed for a new recession.

“Clearly, stocks are responding to the very disappointing jobs report,” Ms. Warne said. “It is one more piece of bad news that is really leading to a reassessment of the possibility of even slower economic growth.”

Though she said she did not believe there would ultimately be a double-dip recession, “the risks probably have risen.”

Financial stocks were affected by the jobs report because of its implications for the real estate market, retailing and consumer lending. The financial sector slid by 4 percent, dragging down the broader market, with the five most actively traded banks in the sector each down by 4 percent or more. Bank of America was more than 8 percent lower at $7.25. Wells Fargo was down 4 percent at $24.20 and JPMorgan was down more than 4 percent at $34.63.

Ms. Warne said that the impending lawsuits meant the banks would face additional legal troubles from lending that took place before the last recession. “There are not just concerns about weak growth, but increased worries that those problems are not behind them,” she said.

Industrial shares fell more than 3 percent. General Electric was down by 2.7 percent at $15.76. CSX was down 4.5 percent at $20.56.

Lower market results in the United States came after declines in Asia and Europe. The Euro Stoxx 50 index closed down by 3.69 percent. The DAX in Germany lost 3.36 percent and the CAC 40 in France fell 3.59 percent, while the F.T.S.E. in Britain was down by 2.34 percent. In Asia, the Shanghai, the Nikkei and the Hang Seng indexes each closed down by more than 1 percent.

“The latest fall follows a highly volatile August period which saw global markets take substantial hits over political uncertainty over the U.S. debt ceiling and subsequent credit downgrade,” John Douthwaite, chief executive officer of SimplyStockbroking, said in a research note.

In August, all three indexes in the United States turned in their worst monthly performance since 2001. Shares took a beating for reasons that included fears of an economic slowdown and fiscal problems in the United States as well as continuing concerns over debt issues in Europe.

Mr. Douthwaite said market turbulence would probably continue in September because of weak economic data from the United States and Europe.

The worse-than-expected jobs report led some economists to predict new action by the Federal Reserve at its meeting on Sept. 20-21.

Economists from Goldman Sachs said that the Fed was more likely to lengthen the average maturity of its balance sheet, with sales of relatively short-dated Treasuries and purchases of relatively long-dated Treasuries. Mr. Orlando said the central bank could also cut the premium on banking reserves to encourage banks to lend more.

Oil futures in New York for October delivery fell 2.8 percent to about $86.45. Energy related stocks declined by more than 2.5 percent.

Gold fell about 2.8 percent to $1,873.70.

Shaila Dewan and Nelson D. Schwartz contributed reporting.

Article source: http://feeds.nytimes.com/click.phdo?i=6666a69de8fe6334cab31a4db99ecec9

DealBook: Goldman’s Shares Tumble as Blankfein Hires Lawyer

Goldman Sachs’ chief executive, Lloyd C. Blankfein, has hired high-profile Washington defense lawyer Reid Weingarten.

News that Mr. Blankfein had hired separate legal counsel immediately raised questions across Wall Street as to whether Mr. Blankfein himself had received a subpoena in connection to the outstanding inquiries. But a person close to the matter but not authorized to speak on the record said the firm is cooperating and no executive at the firm has received an individual subpoena.

Reuters, citing an unidentified government source, earlier reported on Monday afternoon that Mr. Blankfein had hired Mr. Weingarten.

Shares of Goldman, which had been trading around $111 a share all day, fell nearly 5 percent after the Reuters report.

A Goldman spokesman told DealBook: “As is common in such situations, Mr Blankfein and other individuals who were expected to be interviewed in connection with the Justice Department’s inquiry into certain matters raised in the PSI [Permanent Subcommittee on Investigations] report hired counsel at the outset.”

Both Goldman and Mr. Blankfein are facing an array of legal actions stemming from investigations into Goldman’s role in the financial crisis.

In July 2010 the Securities and Exchange Commission reached a $550 million settlement with the bank. The regulator had accused Goldman of duping clients by selling mortgage securities that were secretly designed by a hedge fund firm to cash in on the housing market’s collapse.

Mr. Weingarten, who splits his time between Washington and New York, has represented such prominent defendants as Bernie Ebbers of WorldCom and Mike Espy, the former Agriculture secretary.

On Monday, he was in the Federal District Court in Manhattan with his client Anthony Cuti, the former chief executive of Duane Reade. A judge sentenced Mr. Cuti to three years in prison for a scheme to falsely inflate the income and reduce the expense that the drugstore chain reported. A jury convicted Mr. Cuti in June 2010.

In June, Goldman received a subpoena from the office of the Manhattan district attorney, which is also investigating Goldman’s role in the financial crisis.

The subpoena, a request for information, stemmed from a 650-page Senate report from the Permanent Subcommittee on Investigations, or PSI, that had indicated Goldman had misled clients about its practices related to mortgage-linked securities.

Article source: http://feeds.nytimes.com/click.phdo?i=3cf43fd84639d52dc3afb671fa406ba9

Bank of America Near $8.5 Billion Deal on Mortgage Securities

The company’s board has yet to approve the settlement, but both sides are aiming to get it done by Thursday, according to an individual close to the negotiations. The timing is intended to take place before the second quarter ends.

Bank of America stock jumped 38 cents in after-hours trading to $11.19 a share after news reports of the deal.

The issue of how much the bank would have to compensate investors in mortgage securities it had assembled has been hanging over the shares since last fall. But the company does not anticipate having to raise capital or sell stock to come up with the money for the settlement.

The settlement was less than the tens of billions some investors feared Bank of America would have to shell out, but it will wipe out all of the company earnings in the first half of this year, while heightening the risks that other banks will be sued by investors who hold securities the banks assembled from home loans that have since defaulted.

  “I think this is huge,” said Mike Mayo, a bank analyst with Credit Agricole in New York. “It’s about time the industry resolves issues from the financial crisis and focuses more on righting their companies and improving the economy. This is the most significant step since the financial crisis that helps do that.”

Last fall, analysts warned that the toll from suits by these investors and other private holders could total tens of billions of dollars, but the proposed deal would lift some of that uncertainty. The securities affected by the deal come almost entirely from Countrywide, the subprime mortgage lender whose excesses have come to symbolize the excesses of the housing boom. Bank of America bought Countrywide in 2008.

The $8.5 billion settlement represents just a portion of the bank’s total exposure to faulty mortgage bonds. Analysts say it appears to cover about $56 billion of the roughly $222 billion of troubled loans that were bundled into securities, largely by the Countrywide Financial business in acquired in early 2008.

Other huge risks from the fallout of the subprime mortgage crisis still loom — both for Bank of America and its giant peers.  All 50 state attorneys general are in the final stages of settling an investigation into abuses by the biggest mortgage servicers,  and are pressing the banks to pay up to $30 billion in fines and penalties.

What’s more, insurance companies that backed many of the soured mortgage-backed securities are also pressing for reimbursement,  arguing that the original mortgages were underwritten with false information and didn’t conform to normal standards.

Article source: http://feeds.nytimes.com/click.phdo?i=3136beb1f3a633fa460e9c4115307d62

J.P. Morgan Settles Mortgage Securities Case

In a case that was simultaneously brought and settled, the S.E.C. asserted that J.P. Morgan structured and marketed a security known as a synthetic collateralized debt obligation without informing the buyers that a hedge fund that helped select the assets in the portfolio stood to gain, in most cases, if the investments lost value.

The S.E.C. also separately accused Edward S. Steffelin, an executive at the investment advisory firm responsible for putting together the mortgage security that was sold by J.P. Morgan.

The agency accused Mr. Steffelin of misleading investors into believing that a unit of the firm he worked for, the GSC Capital Corporation, had selected the mortgage securities included in the investment portfolio. Instead, the S.E.C. said, a hedge fund named Magnetar was choosing the assets. A lawyer for Mr. Steffelin said he was reviewing the complaint.

Investors harmed in the transaction, known as Squared CDO 2007-I, will receive all of their money back, according to the S.E.C., an amount totaling $125.87 million. J.P. Morgan also voluntarily paid $56.76 million to certain investors in a separate transaction known as Tahoma CDO I, a similar transaction in which investors lost money. The S.E.C. did not bring any charges related to the Tahoma transaction.

“We believe this settlement resolves all outstanding S.E.C. inquiries into J.P. Morgan’s C.D.O. business,” Joseph Evangelisti, a J.P. Morgan spokesman, said in a statement. In settling the case, the company neither admitted nor denied wrongdoing.

Although the S.E.C. asserted that J.P. Morgan “launched a frantic global sales effort” in 2007 to unload the securities, no executives, traders or salesmen from J.P. Morgan were charged with wrongdoing. That is a contrast to the case that the S.E.C. brought against Goldman Sachs last year, which resulted in a $550 million settlement. That case also accused a trader at Goldman, Fabrice Tourre, who is fighting the claims.

Robert S. Khuzami, the S.E.C.’s director of enforcement, said in a conference call with reporters that the decision not to file charges against any J.P. Morgan executive was based on the evidence in the case.

“We look hard at the conduct of individuals in our cases,” Mr. Khuzami said. “First and foremost, you have to show that an individual is aware that information is not being disclosed, that it is material and that they knew the facts.”

Those elements were present in the company’s conduct, he said. “What J.P. Morgan failed to tell investors was that a prominent hedge fund that would financially profit from the failure of the C.D.O. portfolio assets heavily influenced the C.D.O. portfolio selection,” he said.

The fines in the J.P. Morgan settlement are the largest in an S.E.C. case since the Goldman settlement, which was the largest in the agency’s history.

Article source: http://feeds.nytimes.com/click.phdo?i=e6cca9a95485dd607546294ebcf07897

DealBook: Derivatives Firms Face New Capital Rules

Financial regulators proposed new rules on Wednesday that would require large derivatives trading firms to bolster their capital cushions, the latest attempt to reduce risk in the $600 trillion swaps market.

The rules, proposed by the Commodity Futures Trading Commission, are largely aimed at swaps dealers — brokerage firms, big energy trading shops and Wall Street bank subsidiaries that arrange derivatives deals. The plan also would apply to so-called major swaps participants, companies that are either highly leveraged or have huge positions in swaps contracts.

The agency’s commissioners voted 4 to 1 in favor of advancing the proposal to a 60-day public comment period, after which they must vote on a final version of the rules. Scott D. O’Malia, one of the agency’s two Republican commissioners, voted against the proposal.

The proposed rules are a result of the Dodd-Frank Act, the financial regulatory law enacted last year. The law mandated an overhaul of swaps trading, an unregulated industry that was at the center of the financial crisis.

The commission has already proposed rules that would require many swaps — a type of derivative contract that can be tied to the value of commodities, interest rates or mortgage securities — to be traded on regulated exchanges.

But for months, the commission had declined to say which types of swaps would face the new rules. On Wednesday, after months of deliberation, the commission said its swaps definition would include foreign currency options and foreign exchange swaps and forwards.

The commissioners voted 4 to 1 to propose the definition, which would exempt insurance products and consumer transactions like contracts to purchase home heating oil.

The commission’s separate proposal to build capital cushions in the derivatives industry could help prevent a repeat of the 2008 financial collapse, regulators say.

In the lead-up to the financial crisis, investors bought billions of dollars worth of credit default swaps as insurance policies on risky mortgage-backed securities. When the underlying mortgages soured, American International Group and other companies that sold the swaps lacked the capital to honor their agreements.

Under the commission’s new plan, those firms would have to put aside enough cash to cover unforeseen calamities. Regulators, until recently, had little authority to set any rules for the swaps market.

“Capital rules help protect commercial end-users and other market participants by requiring that dealers have sufficient capital to stand behind their obligations,” Gary Gensler, the commission chairman, said in a statement.

Still, there is no guarantee that enhanced capital levels will avert future disasters. And there is no magic capital number that regulators see as a cure-all; different firms will face different requirements.

Swaps dealers and major trading firms that are already registered with the commission as futures brokers would have to hold at least $20 million of adjusted net capital, on top of existing requirements.

Other firms that are subsidiaries of big banks would have to meet the same capital standards as the parent company, while storing away at least $20 million of Tier 1 capital.

Yet another set of firms would have to keep tangible net equity equal to $20 million, in addition to putting aside funds to cover market and credit risk.

The commission’s proposal covers more than 200 firms expected to register as swaps dealers and major swaps participants.

The commission also voted to reopen or extend the public comment period 30 days on its earlier rule proposals. The agency plans to finalize most Dodd-Frank rules by the fall.

Article source: http://dealbook.nytimes.com/2011/04/27/derivatives-firms-face-new-capital-rules/?partner=rss&emc=rss

DealBook: F.D.I.C. Advances New Rules for Mortgage Securities

Federal regulators voted Tuesday to propose new rules that would prohibit Wall Street banks from unloading packages of risky mortgages on investors without keeping some of the risk on their own books, a leading cause of the financial crisis.

The proposed rule would require banks to retain 5 percent of the credit risk on certain securities backed by mortgages, leaving the banks with so-called “skin in the game” on all but the safest loans.

Wall Street banks, which lobbied to temper the rules, won some limited concessions from regulators. The rules do not apply to so-called “qualified residential mortgages,” conservative loans that meet strict underwriting criteria set by regulators. Banks, under the proposal, also would enjoy leeway in deciding how to retain the risk.

The Federal Deposit Insurance Corporation’s board voted unanimously in favor of the proposal, opening it up to public comment. The proposal was mandated by the Dodd-Frank Act, the financial regulatory law signed by President Obama in July.

The law aimed to prevent Wall Street from returning to its old tricks. During the mortgage bubble, lenders churned out bad loans and Wall Street eagerly sold the loans to investors. None of those players had a stake in how the assets ultimately performed.

“This will encourage better underwriting by assuring that originators and securitizers can not escape the consequences of their own lending practices,” Sheila C. Bair, the F.D.I.C.’s chairwoman, said at a public hearing on Tuesday.

But for now, the rules are unlikely to cause much of a shakeup in the mortgage business, as regulators crafted a gaping exemption: Mortgage-backed securities sold or guaranteed by Fannie Mae and Freddie Mac. As long as the government owns Fannie Mae and Freddie Mac, the mortgage giants will not have to retain any risk associated with their mortgage-backed securities.

The two mortgage finance companies, along with several other government agencies that are exempt under the proposal, collectively cover more than 90 percent of the market. The private securitization market dried up during the financial crisis and is only now making a gradual comeback.

The new proposal “pretty much preserves the status quo in the mortgage market,” Jaret Seiberg, an analyst at MF Global’s Washington Research Group, said in a note on Tuesday. “That means few changes in how things work today for mortgage insurers and originators.”

But the rules are not yet complete — and bank lobbyists are only getting started. Banks contend that the new restrictions will cause the private mortgage market to shrink even further, making it harder for consumers to obtain loans.

Ms. Bair contends that will not happen. “The intent of this rule-making is not to kill private mortgage securitization — the financial crisis has already done that,” she said. “Our intent is to restore sound practices in lending, securitization and loan servicing, and bring this market back better than before.”

Still, banks are sure to push for a broader definition of “qualified residential mortgages,” the safer loans exempt from the 5 percent retention requirement.

“I don’t think they’ll go bananas,” said Jason Kravitt, a partner at Mayer Brown and founder of the law firm’s securitization practice. “But the industry will have to work very hard indeed to broaden the definition of qualified mortgages.”

Under the proposal, borrowers must put a 20 percent down payment on their home purchases for a bank to securitize the loan without keeping a stake. The proposal also requires borrowers to be current on other loans and to earn a certain income if a bank wants the exemption.

The proposal would not exempt notoriously risky loans, like interest-only mortgages and adjustable-rate mortgages that feature potentially huge interest rate increases.

Regulators reassured lenders that the government is open to tweaking the requirements or scrapping them in favor of an alternative approach. The proposal includes nearly 150 questions for the industry to address.

But Mr. Kravitt said Wall Street was unlikely to force an overhaul of the proposal.

“Unless the industry makes a strong case that the proposal will prevent the capital markets from having the capacity to finance mortgages, I think it will roughly stay the same,” he said.

Wall Street already won some leeway with regulators. Banks are allowed to pick and choose how they will keep the 5 percent stake. The risk-retention “menu of options,” for instance, features a “vertical” stake, which would allow banks to retain 5 percent of every tranche of a given securitization, according to a summary of the proposal. The industry also can choose a “horizontal” stake, where banks would bear the first 5 percent of losses on the securitization. An additional option is an “L-shaped interest,” which would combine the two other approaches. Yet another alternative allows banks to keep a representative sample of loans from a securitization deal.

The retention requirements fall not on the banks that originate loans, but the firms that package the loans and sold them to investors.

Although the firms, typically big Wall Street banks, would not be able to hedge against the retention risk, under certain circumstances they would be able to pass it on the liability loan originators.

The transfer must be voluntary, and the originator must have contributed at least 20 percent of the loans in a securitization to share in the risk retention.

The proposal was drafted as a joint effort by the F.D.I.C. and five other federal agencies: the Office of the Comptroller of the Currency, the Federal Reserve, the Securities and Exchange Commission, the Federal Housing Finance Agency and the Department of Housing and Urban Development.

The S.E.C. will vote on the proposal on Wednesday before it begins a public comment period. The F.D.I.C.’s public comment period ends on June 10.

Article source: http://feeds.nytimes.com/click.phdo?i=5dce09f09d15f21328d16fea6c5a255f