Banks face $325 billion dollar systemic margin call

ReutersBanks face "systemic margin call," $325 billion hit: JPMSaturday
March 8, 9:24 am ETBy Walden SiewNEW YORK (Reuters) - Wall Street banks are
facing a "systemic margin call" that may deplete banks of $325 billion of
capital due to deteriorating subprime U.S. mortgages, JPMorgan Chase & Co
(NYSE:JPM - News), said in a report late on Friday.JPMorgan, which sent a
default notice to Thornburg Mortgage Inc. (NYSE:TMA - News) after the lender
missed a $28 million margin call, said more default notices and margin calls
were likely. The Carlyle Group's mortgage fund also failed to meet $37 million
in margin calls this week."A systemic credit crunch is underway, driven
primarily by bank writedowns for subprime mortgages," according to the report
co-authored by analyst Christopher Flanagan. "We would characterize this
situation as a systemic margin call."

The JPMorgan report included a revised bleaker forecast for subprime-related home prices. The bank now sees prices falling 30 percent, from its prior 25 percent forecast. Those prices have declined 14 percent since mid-2006, JPMorgan said.

My take:

The bad news just keeps on coming. JP Morgan is now predicting a 30% drop in home prices. The credit crisis keeps getting worse. Thornburg is pretty much BK now as they failed to meet a margin call.

What is happening is the banks are holding onto CDO's that keep dropping in value. This forces them to sell good bonds in order to cover margin calls. when they run out of good paper to sell they are forced to come up with cash in order to shore up the bad debt. The new accounting rules are forcing them to come up with the cash(aka margin calls).

Thornburgs CEO explains it here in Fortune magazine:

"The company’s CEO, Larry Goldstone, blamed a quirk of fair value accounting for Thornburg’s plight. “The turmoil in the mortgage financing market that began last summer continues to be exacerbated by the mark-to-market accounting rules which are forcing companies to take unrealized write-downs on assets they have no intention of selling,” he said Monday. “In this environment, the current market price of assets has become disconnected from their underlying recoverable value, resulting in increased volatility and imprecise quarter-to-quarter comparisons of asset valuations.”

Under these new accounting rules, banks are now forced to come up with cash to shore up the near worthless AAA CDO debt as well as good assets that are falling in value due to detiorating credit market thats scared to death and doesn't want top buy. These new accounting rules are making it costly for banks to hold onto this bad debt.

The reason the banks don't want to sell these CDO's is because they will either be forced to take the full loss on the CDO, or the CDO is worth more then what it can be sold for but because their is so much fear in the credit markets no one will offer fair value. As a result they would rather face margin calls then sell these bad or good assets because they might be worthless or they are worth more then what they are selling for in a frightened marketplace. My guess is if some of these banks had to write down all of their loans they would essentially be insolvent because they own so much bad debt.

The fact that these margin calls have risen to 325 BILLION dollars tells me we are getting close to the point where these CDO's will all be sold because the banks can't continue to face margin calls like this. There will be a point where the banks will be forced to sell all of this paper so we can start over with a healthy credit market and affordable homes. It will be a systemic reset of the whole housing system.

The problem is when this happens, you will see a systemic disaster that will be a financial event unlike anything any of has ever seen seen before. Banks will go under, lending will come to practically to a halt and housing is going to get crushed.

When this is all done my prediction is loans will only be done by banks and the lending will go back to the way it was. A 20% down payment with a good credit/job history. These homes are nowhere near priced where they need to be when these old lending standards are put in place.

Sit back and enjoy the trainwreck we are watching in the housing market. Watch your investemnts and check out the strength of your bank We are getting very close to the housing time bomb explosion and prices will be in a freefall soon. This 325 billion dollar writedown just takes us one step closer to the explosion.

How Housing has put the whole economy at risk

I will post a video below of Art Cashin who I believe is one of the smartest guys on the street. He has 30 plus years in the market and is the head of trading for UBS.



If you have watched CNBC over the last 5 years they love to call this economy the "goldilocks" economy, meaning everything is fine and dandy and people like Larry Kudlow have repeatedly said that the housing problem is "contained" and has not spread into other parts of the economy.



Well it is becoming increasingly obvious to Art Cashin that "goldilocks" has had a "heart attack" and needs a "parachute" and needs to go to "rehab" in order to be saved.



Another comment that's becoming increasingly popular with Art and others on the street is "we don't know what we don't know". I find this to be extremely important. The subprime problem has spread into everything. This is called contagion. Contagion is the thesis that one problem like suprime can spread into many parts of the economy and wreak havoc in areas you never thought would have problems.



Many people are thinking where should I safely invest in the economy as the housing market implodes? Well because of contagion some areas of the economy that people have always considered to be safe are now potential time bombs. My biggest area of concern here is the money markets. This is where many people go when the economy gets bad in order to protect themselves. Well subprime has no longer made money markets safe. Why? Because many of them bought CDO's!!



AAA rated CDO's were offering 10% returns. As a result many money market funds got greedy and bought many CDO's with that 10% return they would then payout the average MM return of around 5% thus making a 5% spread or profit on the difference.



So when these CDO's started blowing up due to foreclosures many were marked in value to zero. So now some money markets owe more to their customers then they can payout because they have been forced to write off many of the CDO's that they used to make a 5% profit spread on.



The contagion part of this thesis is CDO's were also bought by pension funds, college endowment funds, and banks based on their lucrative return because they were AAA rated by S&P and Moody's. This is turned out to be a joke because Wall St. was paying these agencies to give these bonds a AAA rating. This is where the biggest fraud is IMO. It may go down as one of the biggest frauds in history. How can a rating agency rate credit independantly when their customers are the Wall St. banks? These agencies obviously felt pressure to rate bonds AAA because Wall St. was paying them to do so. This is a total conflict of interest. One of the changes I expect going forward is these rating agencies will be paid in different ways for rating debt either through the buyers of credit or an independent agency.



So folks "we don't know what we don't know" meaning until all of these pension funds, banks,endowment funds admit how involved they got into CDO's or any other AAA rated debt that really isn't true AAA debt. FYI, AAA debt is supposed to never go bad. EVER. Well the crooked rating agencies destroyed this trust because they were being paid by the people who were structuring this debt and a lot of it should NEVER have been rated AAA rated because most of it is laced with small pieces of subprime mortgages which are garbage.



Until we know what we need to know and these institutions come clean I would avoid the stock market. "goldilocks has had a heart attack and needs a parachute" according to Art Cashin. If you watch CNBC/CNBS, pay attention to this guy. He can save you a lot of money and tells you whats really going on versus these "permabulls" who tell you day after day that "Now is the time to buy!!"



Art also comments on the psychologic aspect of this market which I think is extremely important. FEAR is dominating Wall St. and until these financial institutions come clean, WE DON"T KNOW WHAT WE DON'T KNOW. As a result I would buy fixed income investments like CD's, treasuries, and safe Money market funds like Vanguard who are very conservative and stayed away from CDO's and ride out this storm.



Cash will be king after this mess subsides and houses will dirt cheap and easy to buy if you have cash. The smart guys on the street are talking about "capital preservation" versus trying to make big returns in the stock market in 2008. Why do you think short term treasuries are returning only 1.5% instead of the normal 3-4%. This tells you what the smart money is doing. They are flying to cash in treasuries instead of buying stocks thus knocking down the returns down to 1.5% and riding this storm out.



So my advice is to preserve capital in a lot of fixed income and have money to invest when you feel this market is finding a bottom. IMO the bottom is still very far awy. We are only half of the way there because during the average recession stocks drop 28%. We have only corrected about 15% so far.



If you platy defense whats your worst case scenario with this playbook? you make 3% returns versus the average 8-10% return during the bull market. With all hell breaking loose in the markets I am more then willing to give up an extra 5% in returns when I think the downside risk is 30%. If stofcks turn and I miss the first leg up its ok. I will have saved 30% on the downside. This just gives me more money to invest when things turn around because I preserved capital.



My bottom line is similiar to Art's. Until we know what we need to know its stupid to buy into this market. We will know soon what all of these financials did and what their exposure is and when we do know the losses it will be time to throw some money back into selective names that are good companies.



This capital preservation will allow you to put a nice down payment on your cheap house after the bubble pops. The time bomb is about to explode and make sure you protect your assets so that you are ready to take advantage of buying a house at bargain basement prices.



Here is Art:



http://www.cnbc.com/id/15840232?video=676450995

1 Trillion dollars needed to stop the house price slide

March 7 (Bloomberg) -- The $11 trillion U.S. home-mortgage market
needs about $1 trillion in new investment to halt a slide in prices that began
last year, according to analysts at Friedman, Billings, Ramsey & Co.
``There is an imbalance between housing debt and the capital base and the
quick way to return to equilibrium is for asset prices to adjust downward,'' the
Arlington, Virginia-based analysts led by Paul J. Miller Jr.
wrote in a report today.

Mortgage-asset prices are tumbling partly because investors are borrowing
less, as banks rein in both how much they lend and how much they borrow for
their own investments, the analysts wrote. Carlyle Capital Corp.,
Carlyle Group's mortgage-bond fund, is among investors saying bond-secured
lending is tightening."

My take:

Well Paul pretty much describes why house prices are falling in one quote. Many people ask why are house prices falling? The only way they can keep rising is for more money or debt to be available. As you can see in order for the ponzi like housing game to stabilize, we need an additional ONE TRILLION dollars in order to stop the slide. If you want housing to go up another 20% this year then add twenty percent to that 1 Trillion dollar number.

So one of either two things happen. Either banks lend out an additional 1 trillion dollars in order for prices to stabilize(yeah right) or they stop lending as much and houses drop in value. So if you are a bank and you have just loss billions of dollars in subprime lending what choice do you make??

Citibank gave you the answer yesterday. they announced they are cutting their lending by $45 billion which is basically a 50% reduction from the 90 billion they allocated towards this business in the past. Expect most institutions to do the same. Citibank was one of the largest lenders in the country and is the 5th largest bank in the US.

Merrill Lynch(MER) announced yesterday they were closing their subprime business unit and getting completely out of subprime lending and layed off the 650 people in the business unit. This is another example of Wall St. redcuing their exposure to the housing bubble.

So you can't expect the trillion dollars to come from the banks. In fact, a more frightening conclusion is they might decide to lend out less money then they did before. What happens to prices if the banks decide to lend 1 trillion LESS then the trillion needed to only STABILIZE prices in order to stay solvent after getting hit with massive writedowns. This is what Citibank has decided to do. Others will follow, especially the banks in Florida and California who most likely did many subprime loans as housing because unaffordable in these areas.

So now this could be a 2 trillion dollar problem.

In a nutshell the money simply isn't available to lend from the banks to keep housing stabilized. If anything its decreasing by a significant amount. The ONLY solution to all of this is a massive drop in prices unless everyone starts paying for houses in cash. I'll say it again. NOW IS NOT THE TIME TO BUY.