Tag Archives: Goldman Sachs

Bankers Reject Free Market Ideology and Call for More Regulations and Protections for Investors

Free-market ideologues tend to blame most economic problems on government interference in the market.  And their response to economic crisis is invariably to call for the reduction or elimination of government regulations.

But free-market ideologues are usually pundits, professors, and politicians, and not capitalists themselves.

Real capitalists care less about ideology, and more about what is actually important — that is, capitalism.

That’s why it should come as no surprise that in the face of the potentially catastrophic crisis that is now gripping the banking industry, it is the bankers themselves who are calling for more, rather than less, government regulation.

As the Financial Times reports, “Many of the world’s biggest banks are proposing reforms that would limit the size and scope of their businesses in one of the most dramatic responses to the credit crisis. The proposals would hold down the number of investors who can buy complex financial products, bring large swathes of the derivatives markets into regulators’ sights and call on banks to spend more on technology and risk management.”

“Backed by banks including JPMorgan Chase, Merrill Lynch, Citigroup, HSBC, Lehman Brothers and Morgan Stanley, the proposals are being delivered to global regulators in the hope of producing rules for credit markets that would cut risk of contagion and restore confidence.”

Here is the story:  Last week, a panel of high-power bankers calling themselves “Counterparty Risk Management Policy Group III,” lead by Goldman Sachs managing director E. Gerald Corrigan, issued a report to Treasury Secretary Henry M. Paulson Jr. and Mario Draghi, chairman of the international Financial Stability Forum, calling for more regulation and governmental oversight of the banking industry and new standards for monitoring and managing risk.

The Washington Post reports that the bankers’ panel “suggested that big investment houses regularly perform ‘liquidity stress tests’ to measure their expected flexibility in the face of a crisis. It also urged firms to make sure they have accurate snapshots of their exposures to institutional trading partners, with the ability to compile detailed reports within hours.”

“In the current crisis, ‘some of the worst failures were in risk monitoring, which was before you even got to risk management,’ Corrigan, a former chief executive of the Federal Reserve Bank of New York, said in an interview.”

Included in the panel’s recommendations is a prohibition on selling high-risk and complex financial products to anyone except “sophisticated investors.” 

According to the Financial Times, under the panel’s recommendations “even pension funds and other institutional investors would no longer be automatically allowed to buy bonds backed by assets such as subprime mortgages. All but the wealthiest retail investors would be barred from buying structured products, such as auction rate securities, a $330bn market used by municipalities and student loan providers to raise funds.”

Corrigan said “the ‘markets had been sandbagged by complexity’ and suggested the new rules would help ensure sophisticated financial products were only sold to investors with the resources and skills to understand and monitor them.”

We agree with the panel’s report and recommendations. 

It is long overdue that investors in financial products have at least the kind of “qualified investor” protections that exist under the Securities and Exchange Act — both for the sake of the investors and the stabiliity of the financial markets.

And it is good to see that real capitalists care more about preserving the world’s financial markets than about preserving some ideologically pure notion of free-market capitalism.

On other hand, in the short term, it would not be good for the economy if the banks used these recommendations as a rationale to further restrict the availability of credit to qualified borrowers.

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Terrible News Again for Herbst and the Casino Industry

The news is terrible again for Terrible Herbst.

Standard and Poor’s Ratings Services has lowered its rating on Herbst Gaming’s 8.125 percent senior subordinated notes to ‘D’ from ‘C’, following Herbst’s failure to make an interest payment on June 1, 2008.

The bad news for casinos is not limited to Herbst properties.  Bloomberg News reports that “Casino bonds are generating the worst returns for investors as companies from Apollo Management LP’s Harrah’s Entertainment Inc. to Herbst Gaming Inc. risk bankruptcy under the weight of their debt.”

Bloomberg also reports that “Herbst Gaming, operator of 8,400 slot machines in Nevada, stopped paying interest last month, Tropicana Entertainment LLC and Greektown Casino LLC filed for bankruptcy in May and bond prices show Harrah’s and Station Casinos, which piled on more than $25 billion of combined debt in the past year to go private, are also at risk of default.”

The culprit is a deadly trifecta of sharply falling revenues and property values combined with an enormous debt overload.

According to the Nevada Gaming Control Board, casino gambling revenue on the Las Vegas Strip fell 4.8 percent to $517.5 million in March, the third consecutive monthly drop.  Similar losses were experienced in Atlantic City, the second-largest U.S. gambling center, where casino revenue fell 6.7 percent this year through April after a 5.7 percent drop in 2007.

These falling revenues come just when the casinos are committed to paying back tremendous amounts of money that was borrowed when it seemed that the good times would never end.

As Bloomberg reports, the casinos “took on a record debt load before the economy’s latest slowdown. Leon Black’s Apollo, of New York, and Fort Worth, Texas-based TPG Inc. acquired Harrah’s in a leveraged buyout in January for $27 billion.  Station Casinos, owner of 12 Las Vegas-area properties, was taken over for $8.5 billion in November by its management and buyout firm Colony Capital LLC. ‘This would probably be the most leveraged’ the gaming industry has ever been, said Michael Paladino, an analyst at Fitch Ratings in New York. ‘There’s going to be an increase in defaults’.”

“Investors from William Yung, who led Columbia Sussex Corp.’s purchase of Tropicana, to Capital Research & Management Co., the biggest Harrah’s bondholder, are being stung by losses. Debt issued by a group of 10 of the biggest high-yield gaming companies from Las Vegas to Atlantic City and Connecticut will rise to a peak of 6.6 times cash flow this year from 6.5 times in 2007, Deutsche Bank predicts. The total debt for the group will increase to $47 billion from $45 billion.”

When it came to taking on debt, the casinos gambled big.

And this time, the analysts say, the odds are against the house.

 

Who is Still Against Federal Foreclosure Legislation?

As the Congress comes closer to passing legislation to help homeowners facing foreclosure, it is worth taking a look at the opposition to federal foreclosure aid.

Of course, there are those who strictly oppose nearly all forms of government intervention in the economy.  Congressman and presidential candidate Ron Paul and his free market libertarian supporters would be among this group.

Then are those who are opposed to market interventions in general, but will support some government interventions when the stability of the market is at stake.  Most Republicans fit into this group — including Federal Reserve Chairman Ben S. Bernanke.

That’s why it was significant that it was Bernanke who last week made the most convincing argument from a free market perspective for federal aid to homeowners facing foreclosure.

As we noted in an earlier post, Bernanke told an audience at the Columbia Business School that the foreclosure crisis posed the clear and present danger of wreaking economic havoc far beyond the housing market. “High rates of delinquency and foreclosure,” Bernanke said, “can have substantial spillover effects on the housing market, the financial markets, and the broader economy.”

What is at stake, according to Bernanke, is not merely the homes and financial well-being of hundreds of thousands of borrowers, but “the stability of the financial system.”  In this extreme circumstance, even staunch free market advocates, such as Bernanke himself, recognize the need for the government to intervene in the market.

We think, then, that the overwhelming vote in the House of Representives in favor of government intervention to stop the rising tide of foreclosures — legislation that now has the support of many free market Republicans — was rooted at least as much in the economic reality of averting catastrophe as the political expediency of government largess in an election year.

Who then is still opposed to foreclosure aid?

The answer is the apartment owners.

Behind any legislative process is a power struggle of conflicting interests, and very often these interests are economic.  In the case of foreclosure aid, there this now a growing consensus that the foreclosure crisis threatens not merely the borrowers and the lenders, but the economy as a whole and hence the economic interests of almost every sector of the economy.

Except apartment owners.

The National Multi-Housing Council (NMHC) and the National Apartment Association (NAA) have consistently argued that the blame for the foreclosure crisis is what they have called the “misguided” national policy of “home ownership at any cost” and that “People were enticed into houses they could not afford and the rarely spoken truth that there is such a thing as too much homeownership was forgotten.”

The fact is that in sharp contrast to other sectors of the real estate market, the apartment industry has not suffered as a result of the current housing crisis.  Rather, as we’ve noted before, the real estate crisis is forcing the lower end of the single-family housing market back into multi-family rental apartments.  People have to live somewhere — if they can’t afford to live in a house that they own, they will be forced to live in a house that someone else owns, such as multi-family apartment units. As homeowners suffer, apartment owners benefit.

The apartment industry has some very powerful supporters in Congress, including Senator Richard C. Shelby of Alabama, the ranking Republican on the Senate Banking Committee.   Senator Shelby,  who has opposed federal intervention to stop foreclosures, has made millions as a landlord and is the owner of a 124-unit apartment complex in Tuscaloosa called the Yorktown Commons. 

“I want the market to work if it can, and most of the time it will, but not without some pain,”  Senator Shelby has said.

This time, the pain appears to be too great, too wide-spread, and too dangerous, for most other members of Congress, as well as most important players in the economy, to allow it to continue unabated.

Indeed, Shelby has already signaled that he would support a version of the legislation — and that the White House would sign the bill into law.

“I think if we reach a compromise,” Shelby said, “it would be acceptable to the White House because, as a Republican and former chairman of the committee, I’m going to do everything I can, work with the administration, to make sure that the program works for those it’s intended to do and make sure we can afford it as a nation.”

In this crisis, even Senator Shelby has other, larger, and more important economic interests at stake than helping the apartment industry.

 

 

Fed Chair Bernanke Warns Foreclosures Could Sink US Economy — Is He Threatening Lenders?

In a speech today at the Columbia Business School, Federal Reserve Chairman Ben S. Bernanke issued his strongest warning to date about the danger of the rising tide of home foreclosures sinking the US economy.

“High rates of delinquency and foreclosure,” Bernanke said, “can have substantial spillover effects on the housing market, the financial markets, and the broader economy.”

Bernanke began by detailing some of the nasty numbers of the foreclosure crisis:

  • About one quarter of subprime adjustable-rate mortgages are currently 90 days or more delinquent or in foreclosure.
  • Foreclosure proceedings were initiated on some 1.5 million U.S. homes during 2007, up 53 percent from 2006.
  • The rate of foreclosure starts is likely to be even higher in 2008.
  • Delinquency rates have increased in the prime and near-prime segments of the mortgage market.

He then warned that the catastrophic effects of these millions of foreclosure proceedings will extend far beyond the parties to the mortgage:

“It is important to recognize,” Bernanke said, “that the costs of foreclosure may extend well beyond those borne directly by the borrower and the lender.  Clusters of foreclosures can destabilize communities, reduce the property values of nearby homes, and lower municipal tax revenues.  At both the local and national levels, foreclosures add to the stock of homes for sale, increasing downward pressure on home prices in general.” 

“In the current environment, more-rapid declines in house prices may have an adverse impact on the broader economy and, through their effects on the valuation of mortgage-related assets, on the stability of the financial system.”

The real threat that the foreclosure crisis posed to the overall economy, Bernanke said, was “the declines in home values, which reduce homeowners’ equity and may consequently affect their ability or incentive to make the financial sacrifices necessary to stay in their homes.”

The responses to the foreclosure crisis specifically endorsed by Bernanke were nothing new —  working with community groups trying to acquire and restore vacant properties; encouraging lenders and mortgage servicers to work with at-risk borrowers; developing new lending standards to prevent abusive lending practices; working with the Bush administration’s Hope Now Alliance; expanding the use of the Federal Housing Administration (FHA) and government-sponsored enterprises such as Fannie Mae and Freddie Mac to address problems in mortgage markets.

But we think that the tone and perspective of his speech signaled that he was far more ready than the current administration to endorse a wide-ranging federal program to aid homeowners who are in default.

Bernanke came close to saying as much:  “Realistic public and private-sector policies must take into account the fact that traditional foreclosure avoidance strategies may not always work well in the current environment.”

We think by “traditional foreclosure avoidance strategies” Bernanke meant voluntary procedures undertaken by the financial market itself; the “non-traditional foreclosure avoidance strategies” that Bernanke suggested might be necessary would then be mandatory procedures imposed on the market.

We therefore think that Bernanke’s speech contained a threat to the very financial institutions that the Fed has been so generous toward for the past six months.

So far, lenders have been asked to voluntarily help stem the foreclosure crisis by working with homeowners.  Now it appears that Bernanke may be close to supporting mandatory restraints on foreclosures.

We think Bernanke may have been saying this to the lenders and the leaders of the financial market: “We’ve made billions of cheap dollars available to you, so that you could stay afloat and so that you could make this money available for new borrowing and refinancing to prevent foreclosures.  You have not kept your end of the bargain.  If you don’t move much further along this path soon,  it is in the interest of the US economy overall to force you to do so.”

The lenders and financial institutions haven’t listened to threats from Congressional Democrats like Barney Frank or taken the voluntary actions requested by the Bush administration.

Maybe they’ll listen to today’s warning by Ben Bernanke.

We think they’d better.

 

 

FBI Expands and Intensifies Criminal Investigation of Mortgage Industry

The New York Times reported today that the federal taskforce established in January to investigate the mortgage industry is intensifying its efforts. 

The initial purpose of the taskforce, comprised of the Federal Bureau of Investigation and the criminal division of the Internal Revenue Service, as well as federal prosecutors in New York, Los Angeles, Philadelphia, Dallas and Atlanta, was to examine mortgages that were made with little or no documentation of the earnings or assets of the borrowers. 

The investigation is now also focusing on how these loans were bundled into securities.

The taskforce began with an investigation of 14 unnamed mortgage companies; in March, FBI Director Robert Mueller said that the FBI’s probe into potential mortgage fraud had grown to include investigations into 19 separate mortgage companies and involved an estimated 1,300 home mortgage fraud cases.

It is now believed that the investigation has expanded even further.

According to an unnamed official, the expansion of the probe was triggered by the financial industry’s disclosure last week of additional billions of dollars in write-downs from bad mortgage investments.

“This is a look at the mortgage industry across the board,” the official said, “and it has gotten a lot more momentum in recent weeks because of the banks’ earnings shortfalls.”

 

 

 

The Fed Nears the End of the Rate-Cutting Line — Now its the Banks’ Move

After the Federal Reserve cut short-term interest rates on Wednesday for the seventh time since September 2007 — lowering the federal funds rate to 2 percent, from 2.25 percent, the lowest level since November 2004 — most analysts observed that the Fed’s move showed that it was more concerned with preventing recession than halting inflation.

We’re not so sure that it is a question of recession verses inflation that’s driving the Fed.

We think that the Fed’s real concern right now is neither inflation nor recession, at least not directly, but the lack of liquidity in the financial markets and the lack of funds that financial institutions are making available to borrowers.

So far, the Fed has pumped more than $400 billion into major U.S. financial institutions in the hope that these institutions would make this money available to borrowers. 

And, so far, they haven’t done so, and liquidity conditions in the credit markets have continued to deteriorate. 

Despite the Fed’s inceasing generosity for the past six months, it has been harder, not easier, for businesses (and individuals) to borrow money.

The Fed is nearing the end of its rate-cutting line.  If the financial spigot does not loosen for borrowers based on the latest cuts, there may be no more that the Fed can do, especially since, with rising fuel and food prices, fears of inflation are already starting to overtake fears of recession, in America’s living rooms as well as its Board rooms.

Two members of the Fed’s Open Market Commitee  — Richard W. Fisher, president of the Dallas Fed, and Charles I. Plosser, president of the Philadelphia Fed — which is charged under federal law with overseeing national monetary policy — voted against lowering the rates this time.  And the criticism of the Fed’s policy of lowering interest rates and providing cheap money for the banks is getting broader, louder and more influential.

The banks and major lending institutions have been waiting for the Fed to cut interest rates as far as it possibly would before they start lending.

That moment has probably arrived.

Now it’s the financial market’s turn to make a move.

 

 

More Terrible News for Terrible Herbst — Bonds Ratings Lowered and Still No Deal with Creditors

We wrote a post last month about the likelihood that Herbst Gaming will have to file for Chapter 11 bankruptcy protection from its creditors if it is unable to alter its payment structure for $1.14 billion in debt. 

The company is privately held by brothers Ed, Tim and Troy Herbst, but roughly $371 million of its debt is through publicly traded bonds, which have been negatively affected by the fall-out from the subprime mortgage crisis.

Now there is more terrible news for Terrible Herbst.

On Wednesday, Moody’s Investment Service lowered its bond credit ratings for Herbst Gaming.  The bonds were cut from B3 to Caa2. 

Standard & Poor’s also cut Herbst’s credit rating, from B to CCC. 

In addition, Standard & Poor’s announced that it had placed Herbst Gaming on a “developing watch,” indicating an ongoing reevaluation of the credit quality of Herbst’s debt obligations and the likelihood that its credit rating will be downgraded further.

Bonds rated A (“investment grade”) are judged to be of the highest quality, with minimal credit risk; bonds rated B (“junk bonds”) are considered speculative and are subject to high credit risk; and bonds rated C (also “junk bonds”) are judged to be of poor standing and subject to very high credit risk.

Moody’s said the downgrade took into consideration that Herbst Gaming may not meet its financial obligations in 2008.

“It remains unclear at this time what course of action the lenders may pursue with respect to the event of default,” Moody’s said. “The downgrade acknowledges that the continued volatility in the capital markets along with the high cost of borrowing makes it less likely that a strategic alternative will emerge that does not involve some level of impairment.”

The rating actions came after Herbst Gaming said it had engaged Goldman Sachs for evaluation of strategic and financial alternatives. These alternatives may include a re-capitalisation, refinancing, restructuring or re-organisation of the company’s obligations or a sale of some or all of its businesses.

So far, Herbst Gaming has been unable to negotiate a forbearance agreement with its lenders.

UPDATE:

For the lastest news on Standard and Poor’s Ratings Services lowering its rating on Herbst Gaming’s notes ‘D’ from ‘C’, following the Herbst’s failure to make an interest payment on June 1, 2008, and on the debt crisis across the casino industry, click here