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No immediate rescue for customers of Countrywide

Customers of Countrywide and Bank of America would see few changes before 2009, when the companies begin to combine some of their operations. Soon after, though, Bank of America says, it will start offering credit cards and other products to Countrywide customers and may put Countrywide loan officers in Bank of America branches.

Last week, Countrywide said that 7% of its borrowers were in default. The company is taking part in a national program to refinance or freeze interest rates for some borrowers with subprime adjustable-rate loans. The merger itself wouldn't immediately affect homeowners who have a mortgage from either lender.

Last summer, Countrywide got out of the business of making new loans to people with tarnished or subprime credit. And Bank of America, traditionally a more conservative company, is expected to eliminate some of Countrywide's other loan products.

"Over time, it's going to mean less choice" for consumers, says Guy Cecala, publisher of Inside Mortgage Finance, a trade publication. "No one is going to want to hear that. Countrywide was really out there in terms of having a breadth of mortgage products."

The deal would accelerate the consolidation of the mortgage industry, which is reducing marketplace competition. The acquisition of Countrywide, a symbol of the excesses in the mortgage market that fueled the real estate bubble, would vault Bank of America from the No. 5 mortgage lender to No. 1. With Countrywide's enormous portfolio of loans and distribution system, Bank of America would soon originate one of every four mortgages in the country.

"When the dust settles on this in two or three years, someone like Bank of America is going to be in great shape," Cecala said. "And I don't think Chase, Wells Fargo (WFC) or Citibank (C) wants to wake up and see they've been left in the dust." The CNBC business news channel reported that JPMorgan Chase (JPM) is in "very early talks" with a half-dozen mortgage lenders, including Washington Mutual.

For Countrywide CEO Angelo Mozilo, the deal signals an inauspicious end to his 38 years at the helm of a company that last year was worth $24 billion but that Bank of America plans to buy for $4 billion.

"I want him to stay until the deal gets done," said Ken Lewis, CEO of Bank of America. "Then I would guess he would want to go have some fun."

Mozilo, 69, will have plenty of money to do that. He's pocketed an estimated $410 million as CEO and stands to receive a severance and retirement package worth additional tens of millions of dollars.

Mozilo declined to comment but in a statement said, "We believe this is the right decision for our shareholders, customers and employees."

Countrywide, based in Calabasas, Calif., laid off 20% of its employees last year as the real estate market sank into the worst downturn since World War II.

It is still the largest mortgage servicing company, with a portfolio of 9 million loans worth $1.5 trillion. Countrywide also has a sales force of 15,000 and some of the industry's best technology.

"Countrywide has product expertise and a sales culture that tops our capabilities," Lewis said.

By combining their operations, Bank of America, based in Charlotte, expects to eliminate overlapping costs to save 11%, or $670 million, by 2011. The company didn't say how many jobs would be cut. There will be "near-term challenges," Lewis cautioned.

"We expect continued weakness in housing throughout 2008 … and rising delinquencies and defaults continue to increase," Lewis said.

He tried to assuage concerns that Bank of America is exposing itself to an unknown number of bad loans by Countrywide, as well as lawsuits from investors and authorities. Cleveland, which has been crippled by foreclosures, has named Countrywide, Bank of America and 19 other lenders in a lawsuit, alleging that their practices have hurt property values and tax revenue.

And the SEC, which is investigating Mozilo's stock sales, is now also looking at Countrywide's accounting to determine whether it put aside enough reserves to cover potential losses, The Wall Street Journal reported.

"Hopefully," said Martin Eakes, CEO of the Center for Responsible Lending, "Bank of America will not be surprised by the extent of the problems with Countrywide's home loans."

The Economy
Recession 101
Tom Van Riper, 01.23.08, 11:30 AM ET

Americans woke up Tuesday morning to word that the Federal Reserve had issued its biggest rate cut in 23 years to help stave off a rough open to the stock market on the heels of overseas losses Monday. The Fed cut rates three-quarters of a point, to 3.5%, on a day it wasn't supposed to meet. Another cut is expected at next week's regularly scheduled meeting.

Meanwhile, the White House and Congress are staging a dizzying series of negotiations to offer up a stimulus package to rescue the American economy from the doldrums in an election year. On the campaign trail, candidates of every stripe are trotting out big-dollar ideas, and tearing up opponents for not going far enough. Housing prices have fallen. Oil prices have jumped. Stocks have swooned, as people opening up their 401(k) statements are learning.

Scary stuff. It all has the feel of an emergency. But just as likely it's a gauge of how conditioned we've become to a strong economy. Downturns are nothing new, yet the era of instant news and analysis beats the drums louder then ever. Yes, the just completed holiday retail season was the "worst in five years," but sales still grew 3.5% from the year before. Is it any wonder the markets have become so much more volatile in recent years?

"Overall, the economy is relatively healthy," says UBS economist Jim O'Sullivan. He figures that we're in for a decline in gross domestic product for the first two quarters of the year, which would mean we've already begun a recession, but that growth will resume by the summer after the economy is done shaking out its mortgage excesses. Quick and relatively painless, just like the 1990-91 downturn.

A bit of historical perspective: There have been 20 recessions in the U.S. since 1907, according to the National Bureau of Economic Research, each lasting an average of 14 months. Each was followed by a lengthy recovery, with particularly formidable booms coming in the mid-'40s through the mid-'50s, the '60s, '80s and '90s. It's been almost seven years since the last recession, the longest upward stretch since the bull run from the fourth quarter of 1982 through the third quarter of 1990.

So we're probably due. Recessions are predictable and necessary phenomena that keep the free market honest, a sober reminder that merger mania ('80s), Internet bubbles ('90s) and housing hot streaks ('00s) can't last forever.

"Recession can be a good thing, as long as you can limit the downside," says Mark Vitner, an economist at Wachovia Securities, who points out that both monetary and fiscal policy (i.e., tax cuts and Fed actions) have largely done that over the past two decades. But is the U.S. economy teetering enough to compel foreign investors to pull out their money, thereby making things worse?

"I don't see any conceivable possibility that would happen," Vitner says, adding that the size of the U.S. economy makes it vitally important globally, despite talk in some circles that its effect on the rest of the world has diminished.

How much worse have things been? In the gas line years of the late '70s and early '80s, inflation averaged double digits for three straight years, peaking at 13.5% in 1980. Even the core rate--net of the volatile food and energy sectors--grew at a double-digit clip in both 1980 and 1981. Unemployment peaked at 10.8% in 1982, while averaging 7.6% from 1975 to 1985.

Today, unemployment is 5%, while median household income is double its 1975 level even in inflation-adjusted dollars, according to Census Bureau figures. The Dow, meanwhile, stood at 990.25 on Dec. 16, 1982, which would equate to 2,120 today. We're more than five times above that, even after the shaky start to 2008.

So buckle up for some turbulence. But keep in mind you'll be free to move about the cabin soon enough. That's always been the case.

The Economy
Confidence Game
Brian Wingfield, 01.22.08, 1:06 PM ET

It was supposed to be a confidence builder, but the Federal Reserve's emergency rate cut Tuesday sends just one message: The Fed is reacting, not leading. This could spell big problems for the economy.

"This smacks of closing the barn door after the horse is out," says Philip Orlando, a market strategist for Federated Investors, of the Fed's action.

Two things are all but certain when the Fed cuts interest rates: Inflationary pressures increase and investors flee dollar-denominated assets. Tuesday's emergency rate cut indicates that at least for now, the Fed is more focused on helping stocks than fighting inflation. Meanwhile, the drastic interest-rate cuts--coupled with a stimulus package that would add $150 billion to the federal deficit--will batter the already weak dollar.

Following two days of sell-offs in stock markets across the globe--and a week ahead of its Federal Open Market Committee meeting (when the rate cut was expected)-- the Fed slashed short-term interest rates by three-quarters of a percentage point, its single most dramatic rate reduction since 1984.

And they may not be done. According to a research note published by Deutsche Bank Tuesday, expect another rate cut when the FOMC meets next week. "Since 1998, every inter-meeting rate cut has been matched by a similarly sized rate cut at the ensuing meeting," the note says. Deutsche Bank expects the next rate cut to be at least 50 basis points.

The aim behind all things government right now is (or should be) to inject confidence--not fear--into the system. But just the opposite is happening. Haphazard responses, emergency rate cuts, presidential speeches, election season bluster and Washington politics have scared consumers and unnerved investors.

Sen. Max Baucus, D-Mont., chairman of the Senate Finance Committee, says "there are reasons to believe" action by the Fed might not be enough to rescue the economy. The glut of houses could undermine the effectiveness of interest-rate cuts. Skittish lenders might not make loans, no matter how low interest rates go, he says.

Since September, the Fed has reduced short-term interest rates by 1.75%. The effects of this monetary maneuver are just starting to seep into the economy at large, Orlando says. Economic growth for the fourth quarter of 2007 is still projected to be positive, but only barely so.

We'll know more next week: Fourth-quarter growth data is expected, the FOMC meets, OPEC will decide whether to boost oil supplies (which would ease some pressure on the U.S. economy) and President Bush will hold his final State of the Union address.

Investors won't need a crystal ball to see them through the end of January. They'll just need a seatbelt.

Don't count on a 'normal' recession

Wall Street expects financial innovations and global growth to keep any US slowdown in 2008 short and shallow. But the stock market is likely to be seriously disappointed.

By Jim Jubak

The stock market doesn't much care whether a 2008 slowdown in the economy is an official recession or not. As far as Wall Street is concerned, there's just not much difference between economic growth falling to 1% or to minus-0.5%.

As long as the slowdown, recession, whatever, is short. No more than two quarters. Over and done with by mid-2008. Then the economy and the stock market, Wall Street believes, can look forward to another long boom.

Recent history supports that view. Over the past two decades, recessions have been remarkably short and remarkably mild. If any 2008 recession is a "normal" one, investors are absolutely right to look past it to an economic recovery in the second half of 2008. And that would explain why the sea of troubles that has washed over the economy in the last few months of 2007 has had relatively little effect on stock prices. The Dow Jones Industrial Average ($INDU), for example, as of Dec. 20, was down just 7% from its Oct. 9 all-time high.

Disappointing odds

But what if a 2008 slowdown or recession isn't normal? What if it drags on for 12 months and not just six or eight? Then the stock market has set itself up for serious disappointment, with multiple dips in the major averages as investors gradually realize that 2008's economic slowdown will be lengthier than expected.

The odds of that kind of disappointment in 2008 are, unfortunately, high. This sure doesn't look like the "normal" recession. Because so many consumers got used to drawing against their rising home equities to fund their spending, the bursting of the housing bubble and the crisis in the subprime-mortgage market have resulted in far more damage than usual to consumer cash flows. The drop in consumer demand is well beyond what you'd expect in an economy that's still producing jobs at a decent rate.

Even with personal income rising at a 6% annual nominal rate -- that's before subtracting inflation -- consumer spending has started to slow. If employment growth drops, as the Federal Reserve projects in 2008, then the drop in consumer spending could well accelerate. And at the current rate of progress in the housing market, it's going to take way more than a couple of quarters to repair consumer balance sheets damaged when the bubble burst in 2007.

The bad old days

A 2008 economic slowdown or recession wouldn't need to be one for the record books in order to disappoint Wall Street. It could simply mark a return to the bad old days, from 1959 through 1983, when recessions lasted 50% longer, were nearly twice as severe and took place about twice as often.

A September 2007 report from the Federal Reserve Bank of Dallas summarizes the difference between a recession in the bad old days and now:

"On average, the five recessions from 1959 to 1983 were 47 months apart, lingered 12 months and were associated with a 2.17 percent peak-to-trough decline in real gross domestic product. By contrast, the 1990 downturn came after 92 months of expansion, lasted eight months and involved a 1.26 percent decline in GDP. The 2001 slump ended a record 120 months of uninterrupted growth, lasted eight months and entailed a GDP decline of only 0.35 percent."

Video on MSN Money

Is more bad economic news ahead?
The year is ending with weaker-than-expected reports on retail sales, employment, housing and durable goods. But the ability of big banks to raise capital should prevent a downturn from turning into a panic, MSN Money's Jim Jubak says.

Economists first picked up this shift to shorter, less severe and less frequent recessions in the late 1990s. Since then, they've been working hard to explain why the economy is behaving this way. Explanations for what has been dubbed the Great Moderation include:

• Structural changes in the economy, such as "just in time" production systems that prevent a big buildup of investories that can result in a slump in new orders as companies work off old stock.

• Financial innovations, such as home-equity loans that smooth the swings in consumer buying that can result from dips in personal income and employment.

• The creation of global markets for raw materials, including labor, goods and services, that smooth out shifts in the growth rate of any individual economy.

It's the second and third of those three possible causes for the Great Moderation that form the crux of Wall Street's hopes for a quick and shallow downturn. Yes, it's absolutely true that the surge in mortgage refinancing and home-equity lending fueled the boom in U.S. consumer spending that drove not only the U.S. economy but also the world economy.

Continued: Global insurance policy

The cash coming out of U.S. home equity turned into massive purchases of goods and services from China, India, Japan, the oil economies of the Middle East and Russia, and the European Union. And that purchasing produced double-digit growth or near-double-digit growth in those economies.

Those economies pumped a good percentage of their cash back into the U.S. through purchases of Treasury bills and mortgage-backed securities. Those purchases lowered U.S. interest rates and made it possible for another round of home-equity refinancing at lower interest rates and another round of home-equity cash-outs.

Global insurance policy

It was great while it lasted, but now it's time to pay the piper. The fountain of U.S. home-equity cash has dried up. U.S. consumer spending is slowing, and so is the nation's economy. A weak dollar is enabling U.S. companies to increase exports, which cuts into sales by overseas companies. At some point, all this adds up to recession or near recession in the U.S. and a slowdown in global economic growth.

Not so fast, Wall Street says. In your emphasis on cause No. 2, financial innovation, you've forgotten about cause No. 3.

In a global market, consumers in the fast-growing economies of China, India and Russia have become rich enough that they increasingly demand goods and services. These emerging-economy consumers can take the baton from U.S. consumers and keep the race going. Not only will that be enough to keep the global economy as a whole from slumping, but growth in these countries will moderate the depth and duration of any decline in the U.S.

Think of this increase in demand as a kind of insurance policy for U.S. and global economic growth. If an economic storm strikes the U.S., this policy will work to minimize the damage.

But any insurance policy has its limitations. For example, a storm can be so intense that it inflicts damage beyond the coverage of the policy.

And that's the danger we face in 2008. As long as the downturn in the U.S. economy is modest, then, yes, demand from overseas consumers with newly increased incomes can pick up the slack. But if the downturn in the nation's economy is serious, there simply aren't enough consumers in China and India and elsewhere to pick up the slack.

According to the U.S. Bureau of Labor Standards, consumer spending accounts for about 60% of the country's $13.2 trillion economy. That's about $8 trillion. A 1% drop in U.S. consumer spending equals $80 billion.

The Chinese, Russian and Indian economies are significantly smaller than the U.S. economy, ending 2006 at $2.7 trillion, $1 trillion and $900 billion, respectively (at the exchange rates then). And consumer spending makes up a significantly smaller percentage of overall economic activity in these countries. Consumer spending in China, for example, makes up less than 30% of the total economy.

White-swan pricing

Using that 30% figure as an average to get a ballpark number, each 1% drop in U.S. consumer spending would require a 7% increase in consumer spending from China, Russia and India. That seems doable for these economies. At that level of decline in the U.S. economy, the global insurance policy could work, I'd say.

But increase the severity of the U.S. decline to 2%, and China, Russia and India would have to grow consumer spending by 14%. That would be tough. China is going full-tilt, with inflation racing ahead, and its GDP is growing at just 11% a year.

So investors are facing another version of the problem that sank the mortgage-backed debt market. Within some definition of "normal," the insurance policy works. In the mortgage-backed debt markets, AAA-rated securities are indeed safe. And in the economic realm, the U.S. economic slowdown is short and shallow.

Video on MSN Money

Is more bad economic news ahead?
The year is ending with weaker-than-expected reports on retail sales, employment, housing and durable goods. But the ability of big banks to raise capital should prevent a downturn from turning into a panic, MSN Money's Jim Jubak says.

But if we get an abnormal event -- what's called a black swan -- then "safe" mortgage-backed securities fail, and the U.S. economy experiences a downturn that lasts longer than Wall Street expects.

Right now, the stock market is priced only for white swans. Given Wall Street's recent record on valuing debt securities while underestimating the ramifications of a black-swan event, that makes me nervous.

A game of wait-and-see

So put me in the "show me" camp. I'll believe the downturn in 2008 will be "normal" when I see housing prices stabilize, when I hear Wall Street CEOs saying they know the size of their eventual write-offs and when I see banks willing to lend to each other again.

Until then, I'm going to follow the strategy I outlined in my Dec. 21 column of building cash and taking small test positions in stocks that I'd love to own at the right price (and when I see less risk in stock prices in general).

In my previous column, I gave you a list of five stocks that I'd like to buy when the time is right. Here are five more:

• Burlington Northern Santa Fe (BNI, news, msgs).
• Monsanto (MON, news, msgs).
• Novartis (NVS, news, msgs).
• Potash of Saskatchewan (POT, news, msgs).
• Schlumberger (SLB, news, msgs).

In my next column, the first of the new year, I'll tackle how to invest if we get the worst of possible worlds in 2008 -- no growth and high inflation, also known as stagflation.

Continued: Developments on a past column

Developments on a past column

"Make money off China's nightmare": Here's more news from Western Australia iron ore upstart Fortescue Metals Group (FSUMF, news, msgs), a new target price and a bit of buyer beware.

On Dec. 19, Fortescue announced that its Solomon holding contained 70% more iron ore than previously estimated. The company increased its estimate for the area to 1.7 billion metric tons from 1 billion and said it might upgrade estimates for the eastern part of the Solomon project by an additional 25%, or 175 million metric tons, during the first half of 2008. The company also said it was still on schedule to produce its first ore in May.

• Video: Is bad news ahead?

You can see why this news, the continuing upward trend in iron ore prices and speculation that a Chinese steel maker or an Australian iron ore giant such as BHP Billiton (BHP, news, msgs) would lead me to raise my target price, as of today, to $8.50 a share by July 2008 from the prior $6.30.

One caveat, though: On Thursday, the Australian Securities Exchange asked the company to explain -- in Australia it's called a "please explain" -- why its shares had soared on higher volume the day before it announced the jump in its Solomon reserve estimates. The company has said it knows of no reason for the increase in stock price and trading volume. (Full disclosure: I own shares of Fortescue in my personal portfolio.)

How Those With Underwater Mortgages Can Stay Afloat

By Aleksandra Todorova
January 10, 2008

THERE'S HARDLY A homeowner out there who doesn't cringe at the thought of how far their home's value has sunk over the past year. But for those who find that they owe their mortgage lender more than their home is actually worth, things can get especially painful.

Folks with these "underwater" mortgages who are already having trouble making their payments may feel as if they have nowhere to turn. Pending mortgage rate resets, mounting debt and eventual foreclosure seems inevitable.

That's largely because despite well-publicized efforts on both the federal¹ and, in some cases, state² level to help homeowners facing mortgage rate resets, no aid is being extended to those whose homes have negative equity.

But while conventional "exit" options — selling the home or refinancing into an affordable mortgage — seem difficult or downright impossible when you're "underwater" on your mortgage, many banks are now offering solutions that help homeowners do just that.

The exact number of folks with negative equity is hard to determine, but the figure could easily exceed one million. A study by FirstAmerican CoreLogic, a real estate data analysis firm, estimates that 11% of homes purchased between 2004 and 2006 (not only the peak of the housing market, but also the period during which most no-money-down loans were issued) are currently underwater. Needless to say, that percentage will only grow larger should housing values continue to fall.

The good news is that lenders are becoming increasingly willing to help these homeowners avoid foreclosure. That should continue to be the case, as long as the high number of foreclosures continues to leave banks with a glut of repossessed homes, which is an expensive proposition: Not only do the lenders suffer losses on the loans for these homes, but they have to maintain and market them to potential buyers, as well.

"You'll see more and more lenders helping people stay in their homes over the long run," says Todd Mark, a vice president of education at Consumer Credit Counseling Service of Greater Dallas, a HUD-approved housing counseling organization.

One caveat: Don't expect help if you're current on your mortgage and can afford the payments in the foreseeable future. "[Lenders] want to know the hardship is there," says Brian Tracz, a New York-based real estate attorney who specializes in foreclosures. "They view this almost as a partnership in misery."

For homeowners caught in this predicament, here are two solutions worth considering.

Loan modification

Until recently, housing advocates gave lenders poor marks when it came to doing loan modifications, or changing the terms of loans by lowering the interest rate, switching adjustable-rate loans to fixed, or both. According to a Moody's report published last year, lenders modified less than 1% of the loans that reset during the months of January, April and July 2007.

But as the Bush administration's "teaser freezer" plan brought rate reset troubles into the spotlight, lenders' efforts to help homeowners have increased. "Lately, I've been doing a lot more loan modifications because of all the hype," says Dania Perez, a foreclosure prevention specialist with the Tampa Bay Community Development Corporation, a HUD-approved housing counseling organization. Since the plan's announcement, the organization's successful completion of loan modifications has doubled.

So who is a good candidate for this solution? To start with, you have to want, and be able, to continue living in your home, says Patrick Carey, executive vice president for default and loss mitigation at Wells Fargo. Lenders typically request a letter explaining your financial hardship (the reasons why you fell behind on your loan), along with detailed financial information, including bank statements and a budget, proving that should the bank modify your loan, you'll be able to afford the mortgage payments.

While many lenders still refuse to work with homeowners unless they're already delinquent, some — including Wells Fargo — encourage their customers to contact them as soon as they see trouble coming.

Short sales

What if you can't afford your home — even at a lower mortgage rate — or have to move? Then a short sale may be your best bet. A short sale is when your mortgage lender agrees to let you sell your home at a loss with the understanding that it will have to take the financial hit.

Short sales were practically unheard of in the real-estate boom years, when housing values went up so quickly that homeowners were almost certain to sell for a profit — even if they bought the home with little or no money down. Now that home prices are falling, short sales are becoming increasingly common, at least in neighborhoods or regions that have been overwhelmed with foreclosures.

In an odd way, short sales are somewhat of a win-win situation for the bank and the borrower, since both parties stand to lose a lot more if the home goes into foreclosure, explains Joel Broyles, a real estate broker in the Dallas-Forth Worth area. But that doesn't mean these transactions are easy to accomplish.

To start with, borrowers must be delinquent on payments in order to even be considered for a short sale. Then, there's a heap of documentation to be filed, including a home appraisal and bank statements showing the owner's assets aren't enough to make up the difference between the amount owed and the home's market value. And there's the small matter of finding a buyer — a feat that's next to impossible in places that have been infiltrated by "For Sale" signs. Since the short sale process can take months to complete, buyers often lose patience or find more attractive offers and withdraw from the process, says Christian Folland, a Miami Beach-based real estate attorney. In these situations it's best to recruit experienced help, including a real estate broker and an attorney who specialize in short sales. (Ask a trusted lawyer or realtor for recommendations.)

The good news: You won't suffer a tax bite. Thanks to the Mortgage Forgiveness Debt Relief Act of 2007, the difference between the original mortgage and the amount for which a home sells at a short sale (i.e., the amount of debt forgiven by the bank) is no longer considered taxable income by the IRS.

The bad news: Your credit score³ will be trashed. In fact, it will suffer just as much as it would if your home was foreclosed, explains John Ulzheimer, author of "You're Nothing but a Number," a book on credit scores. "The credit scoring model doesn't evaluate that you tried to do things better with a short sale," he says. The severity of the hit depends on your payment history; if your score is already damaged from late payments, it will drop less than if you had a good payment history.

But time heals all wounds. The impact of a short sale lessens over time (just like it does for those who have been through foreclosure). Also, when reviewing your credit report, future creditors will be able to distinguish between a short sale and a foreclosure, which should help you catch a break.

Links in this article:
¹http://www.smartmoney.com/consumer/index.cfm?story=20071206
²http://www.smartmoney.com/consumer/index.cfm?story=20071213
³http://www.smartmoney.com/nowwhat/index.cfm?story=20020826

Fed's call for stimulus may be too little, too late

Commentary: Credit losses appear to have bankrupted system

Friday, January 18, 2008

By Lou Barnes
Inman News

Markets have entered a panicky freefall, the common precursor to at least a temporary rebound. Mortgages reached 5.75 percent, approaching the 5.25 percent all-time lows of '02-'04 from which rates vee'd up every time. Of course rates could go lower, even set a new record, but this is a bird-in-hand moment for refinancing.

This adventure began in August with the onset of The Crunch. Through September the markets were aware of a modest crisis, one of those odd, transient, Fed-bank-plumbing things. Only credit market insiders were worried, staggered by the magnitude of potential loss. By October even the Fed had relaxed. Concern renewed and spread on news of defaults and losses in November and consumer weakness in December, but financial market opinion, especially in stocks, was still cool about the whole thing.

In the last three weeks, painted plainly on stock market charts, everyone has waked to danger, and the hazard itself has grown. Once confined to mortgages and very strange "structured" IOUs, an economic pullback threatens defaults in a wide range of credits, the typical victims of an economic slowdown, hitting a badly impaired system.

After this week's massive write-downs at Citi and Merrill and elsewhere (about $30 billion), the Wall Street Journal totes the aggregate write-down since August at $107 billion. Some say we are past halfway in the adventure, but credit people laugh bitterly at the suggestion.

New economic data are not as bad as the fear of what will come: December retail sales fell 0.4 percent; inflation numbers were OK, just above the 2 percent "core" bound; new-home construction indicators in December were awful; the Philly Fed's index went to recession level (a big Thursday mover); and indices of the global economy are sinking. Then a pair of positive surprises: New claims for unemployment insurance are way down, and January consumer confidence rose from the December pit.

I wrote last November that this situation was so serious that it had become a pre-bailout political matter, no longer a matter solvable by the markets. This week's political theater failed to reassure anybody.

Federal Reserve Chair Ben Bernanke testified to the House on Thursday; stocks sank from the moment he began, after he left, and until the end of the day. He was true to form: bland, passive and void of insightful conclusion. He may know exactly what he is doing, and it may be correct, but he drains confidence from a room like an open window in an igloo.

The House was at its anti-inspirational best when one dim representative, hectoring the Chairman for profits made in his prior career, was advised that Princeton didn't pay very well and that she had the Chairman confused with the Goldman-veteran Treasury Secretary. She blinked in pure Gilda Radner: "Oh. The other one." Look for replays.

The whole show was surreal, with Bernanke present to ask for fiscal stimulus "quickly." The only thing that Congress does quickly is to give money away, but the markets are not impressed. This morning, the instant that President Bush announced that he is on board with stimulus, the stock market rolled over. Again.

Stimulus makes some sense, as it would take effect more quickly than Fed monetary policy. However, neither measure has anything to do with the fundamental problem: Unrecognized credit losses appear to have bankrupted the system.

Congress might have asked … Mr. Chairman, you have succeeded in liquefying your banks, and in preventing fire sales. However, the real economic problem, far worse than housing, is some $4 trillion in bad assets that you and your predecessor allowed to be created. You've had six months to figure out how deep these losses really are and where they are. How bad is it? What is your plan? Just leave these dead assets where they are, rotting and choking off new credit?

You are here to ask us to move quickly, yet you have cut the cost of money only 1 percent in six months? Your new transparency policy has brought us quick release of Fed forecasts, since August each one replaced by a new and weaker one. Why should we have faith in the one you brought today, growth and no recession?

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.

Credit Crunch
You Should Worry About Ambac
Liz Moyer, 01.17.08, 4:47 PM ET

A growing crisis at Ambac Financial, one of the biggest bond insurers, is raising questions about Wall Street's exposure as counterparties to the bond-insurance industry coming off a period in which the big banks are reeling from more than $100 billion in write-downs of mortgage-related securities.

Late Wednesday, Moody's Investors Service said it might downgrade Ambac's (nyse: ABK - news - people ) all-important triple-A financial-strength credit rating after the company forecast significantly higher-than-expected losses from insuring credit derivatives, many of them tied to subprime mortgages.

Raising the level of alarm a notch, Moody's and Standard & Poor's said they will be evaluating their ratings of other bond insurers.

Bond insurers use their top credit ratings to insure bonds issued by municipalities and others against default. That makes it easier for the issuers to sell the bonds at an attractive rate to institutional investors, like pension funds.

In recent years, Ambac, MBIA (nyse: MBE - news - people ) and others have ventured into insuring credit derivatives and other relatively newfangled fixed-income products invented by and peddled by Wall Street. Ambac guaranteed $38 billion of debt linked to subprime mortgages and has exposure to $45 billion of other mortgage investments.

The banks, as counterparties, are on the hook for billions in insurance they bought to hedge credit-derivatives positions. The insurance policies, called credit default swaps, have exploded in popularity in the last few years, with some $45 trillion outstanding.

Closely watched bond guru Bill Gross of Pacific Investment Management calls banks' participation in the CDS market a ponzi scheme that may trigger losses of $250 billion.

Bank disclosure is sketchy, and the market is hard to evaluate for lack of information. Credit default swaps are sold over the counter, are not traded on an exchange and are outside the close scrutiny of regulators.

"The ultimate systemic risk caused by the weakened positions of the monoline insurers is overwhelming and scary," said CIBC World Markets analyst Meredith Whitney in a late-December research note. "The impact will be sizable and very negative for the banks."

On Wednesday, Merrill Lynch (nyse: MER - news - people ) said it wrote down $3 billion of hedges with a counterparty that had slipped to junk grade during the fourth quarter, $2.6 billion of that write-down for hedges to asset-backed collateralized-debt obligations.

The counterparty was the troubled bond insurer ACA Financial Guaranty, which Moody's cut dramatically from A to triple-C one day in December. Canada's CIBC is also on the hook for $2 billion in insurance it bought from ACA to hedge its CDO positions.

On Monday, the Canadian bank said it has bought insurance for U.S. real estate exposure from other financial guarantors. "In the event that the credit ratings for one or more of these financial guarantors were downgraded, or if CIBC's own assessment of the credit status of any of the financial guarantors deteriorated significantly, it is possible that CIBC would make additional fair-value adjustments," the bank said. In other words, more write-downs are possible.

According to Fitch Ratings, Morgan Stanley (nyse: MS - news - people ), Deutsche Bank (nyse: DB - news - people ), Goldman Sachs (nyse: GS - news - people ) and JPMorgan Chase (nyse: JPM - news - people ) were the biggest counterparties in terms of notional value outstanding at the end of 2006, and the market expanded substantially in 2007. Merrill Lynch, Citigroup (nyse: C - news - people ) and UBS (nyse: UBS - news - people ) were the top three underwriters of structured finance CDOs last year.

"There is systemic risk," says Eileen Fahey, managing director at Fitch Ratings and head bank credit analyst. "This could really damage the overall derivatives market."

Shares of Ambac swooned 60% in trading Thursday, and rival MBIA fell 40%. Fitch Ratings, which affirmed MBIA's triple-A rating on Wednesday, is still reviewing Ambac.

The company is struggling to hold on to the top financial-strength rating, as its capital position is severely strained by exposure to subprime mortgage securities that have deteriorated in value, triggering the possibility that Ambac and other bond insurers will have to pay out on the policies they wrote.

That business is unraveling. Earlier this week, Ambac ousted Chief Executive Robert Genader and said it expected a $5.4 billion mark-to-market loss in the fourth quarter, which, coupled with a $143 million loss provision, will bring the quarter's net loss to $32 a share. Ambac announced plans to raise $1 billion by selling equity and equity-linked securities.

Those plans seem seriously in jeopardy now that the stock has been pounded. "Ambac's ability to raise sufficient capital to avoid a downgrade is now in significant doubt," said CreditSights analyst Rob Haines in a research note Thursday.

"In view of the uncertainty generated by Moody's' surprising announcement, Ambac is assessing the impact of this action on the company's previously announced capital plan," the company said in a statement.

The New York State insurance regulator, who said Thursday he continues to monitor the Ambac situation closely, invited other companies to open up for business to ensure that there would be bond insurers to go around in case any of the big ones fell apart. Berkshire Hathaway (nyse: BRKA - news - people ) jumped in last month with a newly formed bond-insurance company. Others are in the works.

Stock market 'winter' is moving in

Daily FX
Traders Are Pricing in a 50 bps Rate Cut in January by the Federal Reserve
Thursday January 10, 12:31 pm ET
By Antonio Sousa, David Rodríguez, and John Kicklighter Currency Analysts for DailyFX.com strategist@dailyfx.com

Bernanke signals bold Fed action to lift growth

Market Scan
The Housing Horror Show
Andrew Farrell, 01.08.08, 2:30 PM ET

The bar has been set very low for the troubled housing industry but it still continues to disappoint. On Tuesday, KB Home announced a much bigger-than-expected loss and an industry trade group released data that showed falling homes sales.

Shares of KB Home fell $1.27, or 6.9%, to $17.21, after the company reported its fourth-quarter loss ballooned to $772.7 million, or $9.99 per share, from $49.6 million, or 64 cents per share, a year ago.

The loss was driven by big write-downs on the value of unsold homes. The company wrote them down by $403.4 million during the quarter ending November 30.

On the continuing operations basis used by analysts the company lost $399 million. Analysts polled by Thomson Financial expected a loss of $96.6 million, or $1.08 per share. KB Home did not provide losses from continuing operations on a per share basis.

Also Tuesday, the National Association of Realtors announced that its index of pending sales of existing homes fell 2.6% to 87.6 in November from 89.9 in October. Economists had expecting only a 0.8% decrease.

The index is used as a leading indicator of home sales. The index measures sales contracts for existing homes which usually predate the closing of the transaction by one or two months.

The weak November reading shows demand for homes continues to slip into 2008. Housing demand has dropped as mortgage lending tightens and slipping home values and negative headlines keep worried buyers on the sidelines. At the same time, huge supplies of unsold homes have pooled.

The situation does not look like it will improve anytime soon. Treasury Secretary Henry Paulson said there is no evidence that the housing market has bottomed.

"It will take additional time for markets to regain confidence," Paulson said Monday. "The overhang of unsold homes will contribute to a prolonged adjustment and poses by far the biggest downside risk."

The double whammy of Tuesday's negative housing news sunk homebuilders. An index of the sector compiled by Revere Data fell 3.1%.

The Associated Press contributed to this article.

The Croesus Chronicles
How The Mighty Have Fallen
Robert Lenzner, 01.04.08, 6:00 AM ET

It was a bloodletting on Wall Street last year. The loss of share value in just five major financial giants--Citigroup, ($135 billion); Morgan Stanley, ($40 billion); UBS, ($40 billion); Merrill Lynch, ($34 billion); and Bear Stearns, ($10 billion)--gave investors a $258 billion bloodying in 2007.

They are Wall Street's finest--employing some of the highest-paid individuals in the world, the products, in many cases, of the most prestigious institutions of higher learning.

They blithely kept pushing and shoving to sell more mortgage-backed bonds to unsuspecting buyers across the globe, who believed their imprimatur meant these investments were safe. They pledged tens of billions of dollars' worth of loans for mega-deals arranged by the private equity firms that have become household names with the allure of Rothschild or Rockefeller. They set up off-balance-sheet vehicles secured by little or no capital to borrow short and lend long--a still-evolving disaster no one wants to bail out.

In this folly, they were given license and little or no oversight by the guardians of the financial system, the Federal Reserve Board and the U.S. Treasury. In fact, Rep. Barney Frank, D.-Mass., chairman of the House Committee on Financial Services, told me late last summer that both the Fed and the Treasury were shocked--almost totally unsuspecting the ramifications of the subprime debacle becoming a full-fledged credit crisis. This foolishness was facilitated by the credit-rating agencies, which are neither checks nor balances to the profit-maximization drive of Wall Street.

So, some powerful lessons to be learned:

First, the act of selling investment vehicles that were solely subprime mortgages lacks common sense, especially as the borrowers had little or no credit standing. Can it be that we witnessed the spectacle of Wall Street not comprehending what they were doing?

Second, the whole process showed a lack of risk controls at major institutions with immense responsibility for how the markets function. Risking capital without any idea of the risks being taken seems absurd.

Third, how is that well-informed investment firms like BlackRock and T. Rowe Price saw the dangers early and liquidated most or all of the radioactive paper in order to avoid losses for their clients? So it could be done.

It's easy to wail that there is pathetic oversight and regulation of Wall Street. The free markets are always allowed to run to excess until some crime or conspiracy is unearthed, like the inside information--junk-bond mischief of the 1980s--that seems like peanuts today.

What's hard to divine are the ramifications of disasters like this, which have played out in cycles throughout U.S. financial history. If there is a recession, can we blame Wall Street for creating the housing bubble? Can we admonish the merger and acquisitions cult who unthinkingly engineered one massive takeover after another--a powerful force for the upward push in stock prices? Is there some Loch Ness Monster lurking out there that's going to cause more pain?

Another theme for our times is the contrast between super-colossus Citigroup , which ain't so super, and its rival JPMorgan Chase. Croesus has no inside track, but would bet good money that Citi will take more massive write-offs from writing down its assets and will cut its cash dividend in part or all--and still have to find another massive injection of capital besides the Abu Dhabi Investment Authority.

What an unbelievable comedown from the empire-building era of Sandy Weill. Even under $29 a share, I'd say it's a good short, prior to the loss of the dividend. The rags-to-riches-to-rags tale of Citi will go down in financial history as one of the more pathetic performances by the powerful oligopoly of American banks/investment banks.

By comparison, Croesus was sent some time ago a rabble-rousing private memo sent 'round to the JPMorgan troops by Weill's former protégé, the tough and capable Jamie Dimon, whom I know personally and highly respect. Dimon asserted that Morgan had "a fortress balance sheet," which was "a critical differentiating point for us." He claims, "We have the capital, liquidity, reserves and overall strength to be there for our clients and to get through tough times, while also increasing reserves and investing in our businesses. ... Our capital and liquidity are in excellent shape, and I believe this will set us apart in future years."

Get this: Dimon even disclosed a typically brilliant investment technique in taking advantage of others' weaknesses to build the franchise. "Even in this environment," he asserts, "we're still investing in our mortgage businesses in the investment bank and home lending." So, take that, Sandy.

Backseat Driver
Fifty Million Experts Can Be Wrong
Jerry Flint 01.03.08, 6:00 PM ET

Auto industry seers are dressed in sackcloth and ashes. If you believe most analysts, the industry is in for a bad year. Perhaps a very bad year. For reference, U.S. annual sales of 17 million passenger cars and light trucks makes a "good" year; 16.5 million sales a "fair" year; 16 million, "poor"--and any sales number that starts with 15 is "very bad." Last year's sales score poor, at 16.1 million units.

For 2008, many analysts are predicting sales in the neighborhood of 15.7 million. I have an analyst acquaintance, Nathan Spunt of Fitch Ratings, who predicts 15.6 million sales, with a caveat: "That's without a recession."

I recently went on record that 2008 auto sales will either match their 2007 number or even come in as much as 10% higher than last year. Why do I differ so much from everyone else?

I have been following this industry for a long time, and I remember some awful times. The economy and population were smaller in 1958, but sales fell to fewer than 5 million vehicles. That was a nightmare. Another terrible year was 1991, when sales dropped to 12.3 million vehicles versus 13.9 million the year before and 14.5 million in 1989. Maybe I am wrong, but what is going on now does not have the smell of those times.

In recent months, the sales totals have been close to last year's results. November, for example, came in at 1.2 million sales, down only 19,000 vehicles, or 1.6%, from the year before. Friends in the business, however, tell me that retail sales--to individual buyers--were down 8% that month; fleet sales had propped up the monthly total.

I do not see any real signs of recession, despite all the news headlines, which I believe many journalists are overplaying in order to attract attention. The Cold War is over. Global warming is becoming a bore--at least to this jaded writer. Journalism, which thrives on bad news, needs a new scare. Why not economic collapse?

The Detroit three, General Motors, Ford Motor and Chrysler, are cutting production sharply for the first quarter so they wont be overloaded. That is a good idea, whatever happens to demand in the coming months. It is easier to boost production than to cut it. Detroit's inventories have been too large for years, triggering give-away deals that wipe out profits.

On the positive side, U.S. employment levels and exports are strong. Another big plus is that the auto industry has introduced or is about to introduce a number of exciting vehicles. That is always good for the business.

What is the bad news? We all know about housing, construction, credit and energy prices. The credit problems are real, since banks traditionally tighten up by making it tough for even those with good credit to get loans. This hurts construction, and that takes a toll on truck sales. Since Detroit makes most of the pickups, a slowdown in this business does hurt.

As for the real estate and mortgage mess, I suspect that speculators are behind a sizable percentage of the foreclosed or troubled properties. Such people bought homes, with the intention to flip them at a much higher price after a short period. When prices dropped, these people just walked away from their investments. That is a business decision, not necessarily a personal calamity.

Overall, I do not think the big decline in housing prices is a disaster, because prices had climbed too high, too fast. A correction was due. People still need homes, and this market could soon return to a saner equilibrium between buyers and sellers.

I do not feel sorry for the financial service firms caught up in this mess. It looks like there are plenty of foreign buyers to feed money to these banks. Nor am I worried about foreigners buying up the country. Remember a few years ago, when we worried about the Japanese making big investments in U.S. assets?

Watch the stock market. It has been volatile lately, but the Dow Jones Industrials ended last year above 13,500. If some people are losing money on their houses, others are still making money in equities. The market is usually a calendar quarter or two ahead of the overall economy. If stocks start an upward trend it, could mean auto sales will rebound in a few months. Even a stock market correction, a downturn of 10%, is not the end of the world. This ties into my belief that auto sales may well be weak in the first half of this year, but will pick up sharply in the second half.

My take on individual car companies is that Toyota Motor, which is planning on a 1% sales increase in 2008, and Honda Motor, should show gains in 2008. General Motors has a good lineup, but will have to work hard to sell its trucks. The sales decline at Ford Motor could level off this year. Brands like BMW and Nissan also seem strong enough to hold their own.

Chrysler is another story. It is difficult to understand if the new team knows what it is doing, as it seems to be planning a deliberate sales decline. Losing an excellent vice president of public relations and putting PR under the personnel department seems foolish, too.

I have looked at the doomsday predictions, and while I may be wrong, I will stick with my forecast: that 2008 will be better than 2007, maybe even a much as 10% better.

US Reserve proposes new mortgage rules
By Patrick Rucker And John Poirier

Lenders will have to confirm that a borrower can afford a mortgage before making a loan under protections proposed by the US Federal Reserve, following defaults and losses on US subprime mortgages this year.

The proposals are intended to replace loose lending standards that have put many Americans at risk of losing their homes because they took out mortgages they could not afford and may not have fully understood.

The new rules will not assist today's struggling homeowners but would give consumers the right to sue mortgage lenders who act unfairly and deceptively in preparing loans in future.

Millions of Americans who bought homes in recent years face the risk of foreclosure as mortgages with initial "starter" interest rates are reset with sharply higher rates in coming months.

The Fed's board of governors unanimously approved the standards recommended by its consumer rights staff and said they strike a balance by protecting consumers while preserving their access to credit.

"These new rules, once adopted, would apply to all mortgage lenders," Fed Chairman Ben Bernanke said as the board met to consider the proposals.

He said the rules would be "consistently applied and vigorously enforced" by state and federal regulators.

The new rules would put the nation's 50,000 mortgage brokers under some federal supervision, according to Fed staff.

The plan also states that lenders who are found to be "engaging in a pattern or practice" of offering unaffordable loans would run afoul of the rules.

The proposal was criticised by several leading lawmakers and praised by an industry group.

The Fed has been faulted for failing to use all its consumer protection authority during the housing boom that ended in 2005, and lawmakers are threatening to take back some of those powers.

The proposed regulations would require that lenders confirm a borrower can afford a home loan by verifying his income and assets with tax records, payroll receipts, and other documentation.

The new rules are aimed at ending the recent practice of so-called "stated income" loans in which borrowers state their income without any evidence.

The proposals would also limit the penalties imposed when a borrower pays off a home loan early. No "prepayment penalty" would apply, for instance, if a loan is refinanced less than 60 days before its interest rate resets higher.

The proposed rules also require that borrowers receive details of their brokers' compensation and be billed monthly for annual charges, such as property tax and insurance, that are placed in escrow.

The Fed plan also contains sweeping new standards for home appraisers and targets abusive practices by loan servicers.

The proposed regulations protect borrowers with interest rates of more than three percentage points above US Treasury securities of similar maturity. For example, a 30-year Treasury bond yields around 4.55 per cent, and so a "high-cost" 30-year mortgage loan today would have an interest rate of 7.55 per cent or highe