Opening Bell: When Down Is Up

Market soars on bad news; blame it on the shorts; perilous bank balance sheets; etc.

Stock markets rallied big—again—yesterday on news that two big financial players are taking multibillion-dollar hits. Yes, news has been so bad for so long on Wall Street that things like UBS announcing a $19 billion write-down of its assets and, along with Lehman Brothers, raising billions of dollars in capital to stay afloat, are seen as something akin to good news.

The Wall Street Journal says on A1 that part of the relief is that the banks and investment banks are dropping fewer nasty surprises these days because everyone is already expecting bad news, meaning the markets may have priced in the profit hits. The Dow Jones jumped about 392 points (3.2 percent), while the broader S&P 500 index rose 47.48 points (3.6 percent). Bloomberg says it was the best start to a second quarter since 1938, and the WSJ on C1 says it was the market’s sixth 300-point gain since September, which before then hadn’t had even one since 2002.

Fed-bolstered floor is key

The New York Times notes on page one that the rally was one of the biggest that wasn’t boosted by government intervention, or “Fed steroids” as one investor puts it. But the Federal Reserve’s extraordinary move on the day after the Bear Stearns collapse to open direct lending to Wall Street (it’s easy to make money when you can borrow at rates cheaper than inflation), taking as collateral any old thing the I-banks can dig up, is what’s fueling the upturn. Investors assume, correctly, that the Fed won’t let another big investment bank fail, and that’s put a floor under stocks for now—the S&P is up about 8 percent since that move.

The Dow is now off just 11 percent from its peak six months ago, and investors appear to be betting that this storm will somehow mostly bypass non-financial stocks. The Journal:

Still, the rally, which was also driven by investors looking to put money to work on the first day of the quarter, only brought the market back to where it was a month ago. And credit markets remained frozen despite the efforts of central bankers to get banks to start lending again. The coming first-quarter earnings season is expected to bring yet another wave of billion-dollar write-downs by financial firms.

The WSJ also notes that stocks have tended to rally after these announcements:

Global investors have been fooled by more than one false dawn since the financial crisis began last year. On Oct. 1, shares of Citigroup Inc. gained 2.2% after it announced a $5.9 billion write-down on its subprime-mortgage exposure. On Oct. 5, Merrill Lynch & Co. admitted to a $5.5 billion write-down, sparking a 2.5% rally in its stock. On Nov. 8, shares of Morgan Stanley gained 4.9% after it announced a $3.7 billion loss on subprime exposure. All of those rallies proved premature, as the falling value of mortgage investments forced the banks to take billions of dollars in additional write-downs.

World not ending after all

The Financial Times on its front page (and the WSJ in the C1 story above) questions whether the rally is because investors are more confident or if it’s being driven by short-sellers scrambling to cover their trades. It notes dryly the markets’ seeming schizophrenia:

The uncertainty about the markets’ direction reflected the fact that stocks rose after another round of bank writedowns and capital-raisings—developments that might have been expected to send prices lower.

The rally also appears to be driven by the fact that there’s lots of cash floating around out there that has to be put somewhere and investors have gotten skittish about skyrocketing commodities, which had been seen as a haven for decent returns. We don’t see this noted anywhere. But gold fell to $880 an ounce yesterday, it’s lowest point in six weeks.

“The market has gotten some news that indicates that the world is not going to come to an end, and as a result has been able to rally,” said Gordon Fowler, chief investment officer at Philadelphia money-management firm Glenmede Trust.

Blame it on the shorts

Speaking of those big, bad short-sellers, Lehman Brothers is running to the Securities and Exchange Commission with what it says is evidence that hedge funds have conspired to drive its share price down, the FT reports on its front page, expanding on something the WSJ briefly touched on yesterday.

This comes after Bear Stearns execs whined about similar dark acts:

Lehman’s submission to the SEC follows private complaints by Bear executives that hedge funds conspired to spread rumors about the bank.

These executives say the rumors drove down Bear’s shares and caused creditors and counterparties to abandon the bank, pushing it to the edge of bankruptcy and forcing its sale to JPMorgan Chase.

Companies under duress often blame short-selling hedge funds for their problems but collusion cases are notoriously difficult to make.

Let’s hope the madness induced by their net-worth deflation doesn’t lead to depths.

We’ll put this one in the we’ll-believe-it-when-we-see-it column. Hey guys, when nobody knows what’s mixed in with that murky stew known as your balance sheet, people talk, rumors fly—yes, even false ones.

Clean up your act and you won’t have these problems.

Triumph of hope over experience

The WSJ puts its Heard on the Street column on C2 with a bearish lead that says “Everything indicates that financial stocks have bottomed. Except bank balance sheets.”

The paper notes that there are several reasons to be positive about the banks, most notably the Fed cash dump mentioned above. Our Quote of the Day comes in the second paragraph:

But all of that glosses over the ugliness of balance sheets and the damage that could be done by mounting bad-loan costs and higher-than-expected write-downs from assets that might not have been marked down enough.

“You get these bear market rallies, and they can be pretty sharp,” said Sean Ryan, financial-companies analyst at brokerage Sterne Agee. “This triumph of hope over experience occurs every few weeks—and then there’s another leg down for financials.”

The next leg down could come when banks start reporting first-quarter results later this month.

The Journal says concern is focused on Citigroup and Merrill Lynch, which are both expected to take more multibillion dollar hits to their balance sheets and thus need to raise capital yet again. That means diluting the value of their existing investors’ shares because it’s virtually impossible to sell assets at a decent price, but investors are so concerned that these companies are drowning in debt that they boost their shares anyway.

Merrill Lynch’s debt is thirty times its assets. There’s not much margin for error there.


The FT reports that the collateralized-debt obligation, that arcane enabler of the current mess, is unlikely to ever revive.

The complex debt securities used to repackage the less attractive parts of asset-backed bonds are likely to disappear entirely as a result of the ongoing collapse of the credit market bubble, according to a report from the Bank for International Settlements…

These deals were especially important in helping to inflate the subprime US mortgage market because they provided a source of ready demand for slices of US subprime mortgage-backed bonds.

However, both investors and ratings agencies severely misjudged the safety of the most highly rated bits of ABS CDOs and how drastic their losses in a housing market downturn would be.

The BIS report says the way such deals are tranched, or chopped into different bonds with different risk profiles, ensures that ABS CDO investors are exposed to an “all-or-nothing” risk profile where investors lose everything when underlying assets start to turn bad.

Pardon us while we bust out the sackcloth and gnash our teeth.

Nat City on the block

The Journal has a scoop on C1 about the troubled Ohio lender National City Corp. discussing a sale to fellow Cleveland bank KeyCorp., and a resulting infusion of capital from private-equity firm KKR.

Regional financial institutions are under enormous pressure as a result of the credit crunch. Many of these banks averted the initial subprime-mortgage problems last year, but now face enormous exposure from softening residential real-estate markets. The prospect of a downturn in commercial real estate also bodes poorly for them in coming months.

National City has been one of the hardest hit. Headquartered in Cleveland, National City’s footprint is concentrated in the struggling regions of Ohio and Michigan. It has also suffered from an ill-timed expansion into Florida real estate, and sits on a portfolio of troubled loans. It posted a loss of $333 million in the fourth quarter…

Regional banks are expected to attract great scrutiny in the next couple of weeks as they prepare to report first-quarter earnings. A number of financial institutions—including besieged Washington Mutual Inc.—are desperately trying to raise capital before these reports.

So far the U.S. hasn’t seen any big bank failures, unlike the UK, which was rocked by the collapse and subsequent nationalization of Northern Rock in the first bank run the country had seen in more than a hundred years. But as the WSJ mentions above, the billions of dollars of commercial real-estate loans (confusingly, condo-construction loans are considered commercial real estate) on their books will hurt bad and many think will cause more than a few to fold.

Band-Aid, anyone?

Congress is pushing toward a bipartisan bailout for homeowners, the NYT says on C1 and The Washington Post has it on D1. The plan, Democrats claim, could help refinance up to 1.5 million adjustable-rate mortgages into fixed thirty-year notes, though the White House says that’s baloney. Who’s right? Who knows?

The NYT says one in ten homeowners owes more on his or her house than it’s worth, something that will only increase, and 4.2 million loans are delinquent or in foreclosure.

At a minimum, the bipartisan package was expected to include up to $200 million to expand counseling programs for homeowners at risk of foreclosure, $10 billion in tax-exempt bonds for local housing authorities to refinance subprime loans, $4 billion in grants for local governments to buy foreclosed properties and a $15,000 tax credit for purchasers of foreclosed homes or newly built homes that have been sitting vacant.

The Post says the two parties’ agreement would stiffen “truth-in-lending” laws for the mortgage industry, something that surely is needed as of yesterday.

The NYT also writes on C1 that the White House’s Hope Now plan is not really working out, and when it does it tends to help lenders more than homeowners.

Hope Now says it is succeeding. The group, which also includes nonprofit organizations that advise people on managing their debts, says it has helped more than a million people avoid foreclosure.

But Hope Now does not disclose details about how the loan modifications and payment plans it ostensibly helps to broker actually help homeowners. Many people merely get the chance to catch up on late payments.

Even Hope Now says it is unsure how effective it is. The group does not break out the number of loan workouts that occur as a result of its efforts and those that might have happened anyway. Some people who work with Hope Now say it has done little to keep the housing crisis from deepening.

“Hope Now is a failure,” said Michael Shea, the executive director of the Acorn Housing Corporation, a large counseling agency that is part of the Hope Now alliance. “It’s industry-dominated.”

The WSJ was less skeptical a month ago when it reported that the program had helped a million people keep their homes. The Times notes that the program employs a grand total of three people and just four percent of people who dial its touted toll-free line actually talk to a human housing counselor.

But we’re not sure how most of this stuff this is going to solve the housing crisis, anyway, as it will only be really over when people think home prices have fallen enough (or their incomes rise enough) to justify buying again. Converting ARMs into low-rate fixed notes is a no-brainer, but why not force the mortgage industry to do that rather than have local housing authorities do it? And a $15,000 tax credit for buying a foreclosed house? It seems to us like much of this is a short-term fix that helps put some more air into the deflating bubble—that still has a major leak.

But hey, if bailouts are good enough for Wall Street, might as well hand them out to everybody! After all, even if all these initiatives are signed into law, they’ll probably still total less than the toxic waste the Fed’s taken off of Bear Stearns’ (JPMorgan’s) hands.

And just you wait, taxpayers ain’t seen nothin’ yet. Here’s the Los Angeles Times:

The bill is aimed at stemming the rising tide of foreclosures, a big factor in the nation’s continuing housing slump. Addressing the longer-term causes and fallout, including reforming the mortgage process and dealing with homeowners who are “underwater” and owe more than their homes are worth, will have to wait for more comprehensive legislation.

Global recession?

U.S. manufacturing activity dropped last month to the lowest level in nearly five years, but the decline was at a slower rate than in February. It’s still in recessionary territory, though.

In economic news, construction spending tumbled 0.3 percent in February, but that was less than the 1 percent drop in January. It was the fifth straight decline and was driven by a 1 percent drop in residential construction spending, but year over year that number is down 19 percent.

The International Monetary Fund cut its prediction for 2008 worldwide economic growth to 3.7 percent, which would be the slowest rate in six years. That’s down from the IMF’s 5.2 percent prediction last summer. It says there’s a one in four chance of global recession, which it defines as 3 percent or less for some reason that’s not explained, and predicted growth of just 0.5 percent in the U.S.

The LATreports that luxury car sales dropped 15 percent in March, more than the overall decline of 12 percent.

That decline would buck the conventional wisdom that the wealthy are largely immune to market woes. To some degree that’s true, as the relative stability of $5-million-plus real estate in the face of the housing crisis has shown. But weakness in the “low-priced” luxury auto segment—generally defined as cars costing $35,000 to $60,000—seems to indicate that the country’s financial troubles are creeping into loftier socioeconomic climes.

Zell’s new business model

Finally, whether Sam Zell eventually adds any value to the newspaper industry or not, he’s bringing some much-needed comic relief. The real-estate tycoon, now media baron, had some April Fool’s fun with the Tribune Company’s Web site, adding a “DebtoMeter” and puppy pictures and renaming the company ZellCoMediaEnterprises Inc. for a day.

Our favorite feature: a Tip Jar that said “Hey buddy, help a paper out?”

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.