We are coming up on the one-year anniversary of the credit crisis and despite the time that has elapsed, there is a sense that many financial institutions still are not sure exactly what the stuff on their balance sheets is worth. Evidently the pain has become more than Merrill Lynch can take, because this week, the firm announced that it would sell mortgage-backed securities with a face value of $30.6 billion in an effort to “lance the boil” once and for all, according to a person close to the matter.
The fire sale of the securities amounts to a haircut of 78 cents on the dollar, as the buyer, Texas private equity firm Lone Star, will pay $6.7 billion for the assets that Merrill had valued at $11.1 billion as of June 30. According the Financial Times, Merrill is actually providing the financing to Lone Star for 3/4 of the purchase, which means that “in effect, the money Lone Star is putting up itself to take the portfolio off Merrill’s books equates to just over five cents on the dollar of the gross value.” That kind of deal makes you wish you were an investor in Lone Star, not Merrill. The sale is in addition to the $46 billion that Merrill has already swallowed since last summer, giving pause to the notion that “the worst is behind us.”
To help shore up its balance sheet, Merrill also announced that it would sell $8.5 billion in new stock, in addition to the $15 billion it has already raised through common and preferred various common and preferred issues. This week’s move is even more painful for existing shareholders, because their positions will be diluted by approximately 38%. The new stock issuance will also require the firm to make additional payments to Temasek, the Singapore state-owned investment company that bought shares at a much higher price last December.
The problems at Merrill are endemic to many large investment banks. The greed of the last cycle allowed them to dive into ventures without properly assessing the risks involved. Just like the schmo who bought his Florida condo at the top of the market with an adjustable-rate loan, Merrill is now paying for its mishaps in spades. Of course one major difference is that investment bankers were supposed to smarter, more experienced and better prepared than the average schmo who dipped his toe in the real estate market. Merrill’s newly-minted chief, John Thain, continues to distance himself from the problems, but everyone should be asking why the firm did not make this announcement last week when it reported its fourth straight quarter loss.
These actions may lead the way for other financial institutions to purge their problems by slashing the value of similar holdings, although other firms may not have the wherewithal to withstand the process. On one hand, the past year has proved is that the credit and mortgage issues were far more toxic than most observers originally anticipated. But it is amazing that a company can write down billions and still be viable. Sure the stock has been spanked—it closed at decade-low levels this week, as it should, after this kind of dismal performance. Maybe lancing the boil at Merrill will allow the firm to move on, once and for all. Time will only tell.
Wednesday, July 30, 2008
Tuesday, July 29, 2008
Housing Bill Lemonade
If you listened to Saturday’s radio show or read last week’s article entitled “The Bitter Bill” (July 25, 2008), you know that I am not a fan of the housing bill. That said, although the legislation is filled with bitterness for financially responsible Americans across the country, it’s time to make some lemonade out of those lemons, even if you were a complete screw-up in the first place.
Let’s start with the best aspect of the miserable housing bill. At a time when people are preoccupied with their money, there is a refreshing reminder that we are at war and that there are soldiers who are risking their lives so that we can worry about our money. The housing bill requires lenders to wait 9 months, instead of the usual 90 days, before beginning foreclosure proceedings on homes owned by someone returning from the military. Lenders must also wait a year before raising interest rates on a mortgage held by someone returning from military service. That’s about the least we can do!
Let’s say you completely blew it on real estate—you bought near the top and assumed a variable rate mortgage. Well, Congress is rewarding your stupidity by creating a program that may allow you to cancel your old mortgage and replace it with a new fixed-rate loan lasting at least 30 years. Don’t get too excited—there are some hurdles for eligibility on this one. The new loan amount must be no more than 90% of what your property is actually worth now, so the upside-downers may not be able to do it. Also, you need to have originated your troubled loan on or before Jan. 1, 2008 and the loan must be on your primary residence. That means that the slew of people who bought vacation condos in Naples can’t refi and those who thought that they were going to become real estate barons with investment properties are out of luck. Unlike the first time around, you will actually have to verify your income and your monthly housing payment (including the principal on all your various mortgage payments, interest, taxes and insurance) has to have been at least 31% of your monthly household income.
If you do manage to obtain a new loan, you cannot establish a home equity loan for at least 5 years after you obtain the new mortgage, you will have to pay a 1.5% fee each year on the remaining balance and you have to hand over no less than 50% of any appreciation on the home to the government once you sell. Sell the house in less than 5 years, and you will have to turn over as much as all of the gain. This program ends on Sept. 30, 2011 and although it does not officially take effect until Oct. 1, lenders may be willing to start their negotiations with borrowers now.
If you are buying a primary residence for the first time, you are eligible for a federal tax credit of $7,500 or 10%, whichever is smaller. With a tax credit, you subtract the credit amount from the total you would otherwise pay the IRS. If you earn a modified adjusted gross income of more than $75,000, or $150,000 for those who are married filing jointly, the credit phases out. You have to pay back the credit over the next 15 years, in equal amounts each year when you pay your federal taxes. That makes this more like an interest-free loan than a true credit.
The absolute gimmee in the bill is for those homeowners who take the standard deduction on their federal income tax returns. With the bill, you can now take an additional federal tax deduction of $500, or $1,000 if you are married and filing your tax returns jointly. The deduction is limited to the amount of the property tax you paid.
The other major piece of the bill is the redefinition of a jumbo loan. Under the new legislation, Fannie and Freddie have permanent authority to buy bigger loans in areas with high housing costs. (Temporary measures allow them to buy bigger loans, but those expire on Dec. 31.) They can buy loans up to 115% of the local median home price, though they cannot buy any loans larger than $625,500. Any larger loan will generally be a jumbo loan, which will cost more in interest.
Oh well—the whole thing is ridiculous, but you really should take advantage of the perks that exist. Just make lemons out of lemonade, if you will.
Let’s start with the best aspect of the miserable housing bill. At a time when people are preoccupied with their money, there is a refreshing reminder that we are at war and that there are soldiers who are risking their lives so that we can worry about our money. The housing bill requires lenders to wait 9 months, instead of the usual 90 days, before beginning foreclosure proceedings on homes owned by someone returning from the military. Lenders must also wait a year before raising interest rates on a mortgage held by someone returning from military service. That’s about the least we can do!
Let’s say you completely blew it on real estate—you bought near the top and assumed a variable rate mortgage. Well, Congress is rewarding your stupidity by creating a program that may allow you to cancel your old mortgage and replace it with a new fixed-rate loan lasting at least 30 years. Don’t get too excited—there are some hurdles for eligibility on this one. The new loan amount must be no more than 90% of what your property is actually worth now, so the upside-downers may not be able to do it. Also, you need to have originated your troubled loan on or before Jan. 1, 2008 and the loan must be on your primary residence. That means that the slew of people who bought vacation condos in Naples can’t refi and those who thought that they were going to become real estate barons with investment properties are out of luck. Unlike the first time around, you will actually have to verify your income and your monthly housing payment (including the principal on all your various mortgage payments, interest, taxes and insurance) has to have been at least 31% of your monthly household income.
If you do manage to obtain a new loan, you cannot establish a home equity loan for at least 5 years after you obtain the new mortgage, you will have to pay a 1.5% fee each year on the remaining balance and you have to hand over no less than 50% of any appreciation on the home to the government once you sell. Sell the house in less than 5 years, and you will have to turn over as much as all of the gain. This program ends on Sept. 30, 2011 and although it does not officially take effect until Oct. 1, lenders may be willing to start their negotiations with borrowers now.
If you are buying a primary residence for the first time, you are eligible for a federal tax credit of $7,500 or 10%, whichever is smaller. With a tax credit, you subtract the credit amount from the total you would otherwise pay the IRS. If you earn a modified adjusted gross income of more than $75,000, or $150,000 for those who are married filing jointly, the credit phases out. You have to pay back the credit over the next 15 years, in equal amounts each year when you pay your federal taxes. That makes this more like an interest-free loan than a true credit.
The absolute gimmee in the bill is for those homeowners who take the standard deduction on their federal income tax returns. With the bill, you can now take an additional federal tax deduction of $500, or $1,000 if you are married and filing your tax returns jointly. The deduction is limited to the amount of the property tax you paid.
The other major piece of the bill is the redefinition of a jumbo loan. Under the new legislation, Fannie and Freddie have permanent authority to buy bigger loans in areas with high housing costs. (Temporary measures allow them to buy bigger loans, but those expire on Dec. 31.) They can buy loans up to 115% of the local median home price, though they cannot buy any loans larger than $625,500. Any larger loan will generally be a jumbo loan, which will cost more in interest.
Oh well—the whole thing is ridiculous, but you really should take advantage of the perks that exist. Just make lemons out of lemonade, if you will.
Monday, July 28, 2008
The Best Defense
It has been said that the best defense is a good offense, but that usually applies to sports, not investing. I thought about that after hearing about a broker’s pitch to her client. The saleswoman recommended that one way to claw back from the depths of losses is to buy more of the stuff that has dropped the most, which in this case was the financial sector. There was only one problem: the broker had suggested the same strategy starting last summer and every quarter since then.
The net result of the strategy was a decimated portfolio---a drop from $3,000,000 at the top to $1,000,000 as of June 30th. The client was distraught and needed to understand how the broker could have made advocated such a terrible strategy. (Note to all of the brokers out there: if the strategy had worked, the client would not have known just how bad the strategy really was---proving once again that it stinks to be wrong!)
I hate these stories—they are oddly reminiscent of the dot-com flame-out, when throughout 2000 and 2001, some brokers advocated “doubling down,” “taking advantage of sale prices,” or my least favorite, “just hanging in there.” These comments and the subsequent action or inaction taken simply compounded the original sin of advocating portfolios that were highly concentrated in risky assets or asset classes.
Yet after doing this for some time, I have come to believe that most of the brokers then or now are not actively trying to harm their clients. Sure, they may be trying to scratch out a living by selling a loaded mutual fund, but I think that they really do believe the strategies that they advocate. It’s just that they are a tad bit hopeful and succumb to the age-old problem of many in the retail investment business: they are overly optimistic because they really want to believe that all will be better. If conditions improve, clients stop calling and complaining and it’s easier to sell more stuff.
So what is a good defense when markets start to turn? The same exact core strategy that is created for a good offense when markets are rising: a diversified portfolio that is structured to be shifted as conditions change in the economy and the marketplace. By its very definition, this type of portfolio is better suited to a fee based on assets under management, rather than on commission. The reason is that as you shift the asset allocation here and there, you do not want to pay a commission.
Beyond the actual fees that you pay, there is a more important message here: nobody wants a salesperson to be a cheerleader for the market—we have CNBC and Jim Cramer for that. Retail investors are not asking their brokers to tell them what they want to hear, rather they are hoping for unbiased guidance that will allow them to earn money when the market rises and mitigate losses when it falls. When the industry wakes up to this fact, it just might stop getting caught up in market cycles. Interestingly enough, this might actually smooth out earnings for the big firms and make for happier clients over the long term. Imagine that? A win-win in an industry plagued by “heads we win, tails you lose.”
The net result of the strategy was a decimated portfolio---a drop from $3,000,000 at the top to $1,000,000 as of June 30th. The client was distraught and needed to understand how the broker could have made advocated such a terrible strategy. (Note to all of the brokers out there: if the strategy had worked, the client would not have known just how bad the strategy really was---proving once again that it stinks to be wrong!)
I hate these stories—they are oddly reminiscent of the dot-com flame-out, when throughout 2000 and 2001, some brokers advocated “doubling down,” “taking advantage of sale prices,” or my least favorite, “just hanging in there.” These comments and the subsequent action or inaction taken simply compounded the original sin of advocating portfolios that were highly concentrated in risky assets or asset classes.
Yet after doing this for some time, I have come to believe that most of the brokers then or now are not actively trying to harm their clients. Sure, they may be trying to scratch out a living by selling a loaded mutual fund, but I think that they really do believe the strategies that they advocate. It’s just that they are a tad bit hopeful and succumb to the age-old problem of many in the retail investment business: they are overly optimistic because they really want to believe that all will be better. If conditions improve, clients stop calling and complaining and it’s easier to sell more stuff.
So what is a good defense when markets start to turn? The same exact core strategy that is created for a good offense when markets are rising: a diversified portfolio that is structured to be shifted as conditions change in the economy and the marketplace. By its very definition, this type of portfolio is better suited to a fee based on assets under management, rather than on commission. The reason is that as you shift the asset allocation here and there, you do not want to pay a commission.
Beyond the actual fees that you pay, there is a more important message here: nobody wants a salesperson to be a cheerleader for the market—we have CNBC and Jim Cramer for that. Retail investors are not asking their brokers to tell them what they want to hear, rather they are hoping for unbiased guidance that will allow them to earn money when the market rises and mitigate losses when it falls. When the industry wakes up to this fact, it just might stop getting caught up in market cycles. Interestingly enough, this might actually smooth out earnings for the big firms and make for happier clients over the long term. Imagine that? A win-win in an industry plagued by “heads we win, tails you lose.”
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