Dick Fuld

People Who Needed Hugs

From The Metro:

Kate Ogg and her husband, David, were told to say their goodbyes to Jamie when he was born prematurely at 27 weeks, weighing just 2.2lb (1kg). His twin sister, Emily, survived but Jamie was declared dead by the doctor who delivered him after 20 minutes trying to get him to breathe. But after two hours of being spoken to, cuddled and held, he began showing signs of life. Then, after being given breast milk on his mother's finger, he began breathing regularly.

Mrs Ogg has now told how vital 'skin-on-skin' care can be. She said on Australian TV: 'After just five minutes, I felt him move as if he were startled, then he started gasping more and more regularly. A short time later he opened his eyes. It was a miracle.'

From NY Mag:

It was time for White to leave [Lehman Brothers]. [Dick] Fuld stood up and came around to the other side of his desk to shake White's hand. He put his hand out, then pulled it back. "Nah, f*ck that," he said. "Give me a hug. I need a hug."

Before White knew it, Fuld, the man whose gruff, brutish manner had given him the nickname "the Gorilla," was embracing him. Then, White said, Fuld started crying. "Kevin, you're the first person to say thank you to me."

When his cheeks were dry, White asked Fuld if he'd be joining Barclays. "F*ck that," Fuld said. "I'm not going to Barclays. F*ck that."

Arbitrage opportunity

From a reader's letter in the FT:

Lehman Brothers senior secured debt is currently trading at about 15 per cent of its face value, indicating that the bondholders are likely to lose 85 per cent of their investment. This indicates that those ranked below the senior bondholders, including equity holders, will lose everything.

However, Lehman Brothers equity, which is traded on the over-the-counter market, is currently trading at 15 cents, which indicates that equity traders believe that after all outstanding claims are paid off there will be cash remaining for the equity holders.

As the reader points out, "the price is not always right": the people trading in shares are considerably more optimistic about the outcome of the liquidation than those trading in the bonds. The first group assumes that enough assets will be recovered so that bonds will be repaid in full and the second group assumes that they won't. Although both may be making a reasonable guess, they can't both be right.

So, assuming that the facts as stated in the letter are correct, what's the arbitrage opportunity? Click and highlight to reveal:

Sell the shares short at 15 cents and buy the bonds at 15 cents.

The first 100 cents that the liquidator collects will be used to redeem your bonds. If he collects less than 15 cents, you lose on the bonds but win a larger amount on the short sale as the shares will fall to nil. The next 85 cents are used to redeem the bonds, reaping you a potential 85 cent profit on the bonds and a 15 cent profit on the short sale.

If the liquidator collects more than 115 cents, then you start losing money on your short sale, but he would have to collect 200 cents before you actually make a loss overall, which is at least fifteen times as much as the markets are expecting so this would seem highly unlikely.

"Morgan Stanley in 20% stake sale"

As predicted on this very 'blog*, once you net off all the debits and credits, the ultimate source of finance for our cheap loans was China, Japan etc, and seeing as we can't repay them in cash, we'll let them gradually take over our banks.

One story I missed from July was Barclays issuing more shares to The China Development Bank and other SFW's. Which is mighty chucklesome; the self same bank invested £1.5 billion in Barclays just over a year ago, and has, presumably, lost one third of its money, even after the recent upward tick.

See also Nomura to buy Lehman's Asia business.

* See here or here.

Quote of the day

In an article titled "Lehman Brothers' Close Ties to Gore, Hansen and Carbon Trading":

A year ago they couldn’t predict their bankruptcy but were predicting the climate 100 years ahead.

Via MalcT at HPC.

Sorting out the 'credit crunch'

I am, as you may have noticed, an accountant, so I like to look at both sides of every equation - for example; for every reckless borrower there is a reckless lender; and for every overstretched buyer there is a vendor laughing his or her way to the bank. Similarly, the credit bubble was the cause and the effect of the property price boom; and the credit crunch is the cause and the effect of the property price crash. It's not just correlation; they are two sides of the same coin - you can't have one without the other.

MSM reporting of the whole credit crunch debacle - and the politicians' response thereto - has been muddled to say the least. I suspect because they haven't bothered to understand things properly, which are, if you follow the logic through, quite simple. But - be warned - like all simple things, it has to be explained and understood step-by-step.

The basic, fundamental, simple problem underlying all this Lehman Brothers/Northern Rock nastiness is that first-time-buyer households with an income of £30,000 have overstretched themselves with a mortgage of five-times-income to buy a home costing £150,000 at the peak of the market last year. Once the mortgage market returns to normal, the lending multiple will fall to three-times-income and property prices will fall by 40%, so in this example, the price of the first-time-buyer properties will fall to £90,000. (These are UK figures, but similar principles apply in the USA, Spain, ANZ or anywhere else that's had a credit/property price boom/bust).

In a simple world, without interbank lending, the building society lent an FTB £150,000 for a 100% mortgage in mid-2007 and credited the vendor with a deposit of £150,000. By the time house prices have fallen 40% from their peak, the poor FTB will be kicking himself, as he has overpaid by £60,000. Unless he wriggles out of that debt by declaring himself bankrupt, he will end up paying £977 a month until 2032 (assuming 6% interest, 25-year repayment mortgage), unlike a canny buyer who will wait until the bottom of the market in five years' time, use the money he has saved by renting not buying to pay a 20% deposit and pay £523 a month until 2032 (6% interest, 20-year repayment mortgage).

So last year's FTB has made a £60,000 notional capital loss, kicks self. His mortgage lender in turn, would be prudent to write down (more accurately, "make a general bad debt provision against...") the value of the mortgage advance on the basis that £60,000 of it is unsecured. Sure, that's not the sort of security that I'd want, but the chances of last year's FTB losing his job; falling behind on payments; being repossessed and declaring himself bankrupt is quite small. Even a rabid pessimist would look at a large sample of such mortgage advances and write off fifty percent of the unsecured portion, in our case, that would be £30,000 per FTB, or a write down of 20% of the initial advance.

Using my negative-equity-o-meter, a 40% fall from peak will see just under 3 million households in the UK in nequity. Let's assume average mortgage £150,000, average bad debt provision 20% = £30,000, £30,000 x 3 million = £90 billion (or about one-sixteenth of outstanding mortgages in the UK - which is three times my previous worst-case estimate and so probably wildly overstated).

So we are straight into the realms of double-counting - we have 3 million households kicking themselves that they overpaid by £60,000 (=£180 billion) and banks/building societies kicking themselves that they have to write off £90 billion of mortgage advances.

But it is the same loss! The losses do not add up to £270 billion; the losses are £180 billion. If - taking an extreme example - banks did the decent thing and sent recent FTBs credit notes for £30,000 each on the strict condition that borrowers kept up with repayments in future, that would still leave the banks' losses at £90 billion, but would halve FTB losses from £60,000 per property to £30,000 per property.

And it does not stop there.

The original mortgage lender packaged up those mortgages on overpriced properties to people who couldn't really afford them on a semi-recourse basis to an SIV in the Channel Islands. So the SIV is also booking a potential loss of £30,000 per mortgage.

And some investment bank invested in that SIV, so the investment bank is also booking a loss of £30,000 per mortgage.

And some highly leveraged hedge fund may have borrowed further to buy shares in that investment bank and enticed investors by promising annual returns of 10%. The hedge fund is booking a loss of £30,000 per mortgage.

And the original vendor may have withdrawn his £150,000 sales proceeds from the boring building society current account paying 5% interest and invested in the highly leveraged hedge fund. So that investor is worried about making a £30,000 loss as well.

So, we have the FTB worrying about a £60,000 loss and the building society, the SIV, the investment bank, the hedge fund and the hedge fund investor/original vendor all worrying about a £30,000 loss each. But the total potential losses on each mortgage do not add up to £60,000 plus 5 times £30,000 = £210,000!! The total loss per mortgage is probably in the order of £30,000 (if that) - this has to be split up between the various parties - if all six parties take a £5,000 actual loss on the chin, then they've all learned a valuable lesson and nobody gets wiped out.

Even better - and this parallels a previous post on the merits of Sovereign Wealth Funds - the ultimate source of all this easy credit and cheap finance is The People's Republic Of China and oil rich countries like Russia and the Middle East. So we in the West can pull a fast one, put our banks into receivership (in a controlled and orderly fashion) and tell the bond holders (the PRC and petro-states) "Oops, sorry! We can't repay the full value of those bonds, but hey, we'll issue you new bank shares to the face value of the shortfall." This would, from the banks' point of view convert a short term liability (bonds) into a long-term non-repayable liability (shareholders' capital), so our banks would be recapitalised on the sly without the need for these messy and embarrassing rights issues.

And if you don't like the sound of Johnny Foreigner running our banks, then just move your mortgage and your deposit account to a good old-fashioned British building society! Johnny Foreigner will end up owning bank buildings, thousands of computer terminals and bugger all else. A bank without customers is worth nothing!

Well, congrat's to anybody who's bothered to read this far. And double congrat's to anybody who understood it all.

"Lehman Bros files for bankruptcy"

What's the big deal?

As I commented at C@W;

"... if you look at it sensibly, the losses boil down to good old fashioned unsecured lending* to people who can't repay (primary losses). All these CDOs and stuff are just a way of spreading the risk/losses around (secondary losses), but in theory they don't add to total loss.

It may well be that these losses are sufficient to wipe out the shareholders' capital of all banks, but so what? The banks' core businesses (customer base, computer systems, land and buildings etc) still has some value. And the economy needs banks to function. And the bulk of banks' mortgages haven't fallen in value.

Plan A is to force the banks to raise a bit of capital, write off a bit more of the loans, raise a bit more capital, write off a bit more etc, which is what they have been doing so far but I don't know how much longer they will get away with it.

Plan B must be (short of chaos) for Fed or Treasury or whoever to make banks come clean (in private at least) about losses (primary and secondary so that we can net off double counting) and ask solvent ones to buy up insolvent ones.

To the extent that losses exceed banks' shareholders' capital, you then lop off the next slice of losses from bondholders, if they are wiped out as well, then you only repay depositors** pro rata and so on (so that a solvent bank doesn't get landed with another bank's losses, obviously).

You could fix the whole thing in a few weeks.

* Of course, legally, secured on a house but if the house has fallen in value to less than amount of loan etc.

** I realise that there is a blurred line between bondholders and depositors, but you get my drift, hopefully."

Lehman Brothers is goin' down!

Just saw it on the BBC News. Shares down 40% in the last hour or two after the Korea Development Bank had a look at the books and told them to get stuffed.

Cool!