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From Times staff writer Walter Hamilton:
Who would have expected Citigroup Inc. to ride to the rescue of the financial sector?
The banking giant reported a smaller-than-expected second-quarter loss this morning, relieving some of the pressure on financial issues that was expected the day after Merrill Lynch & Co. uncorked terrible results.
Citigroup Inc. lost $2.5 billion in the quarter (54 cents a share), wrote off $7.2 billion in mortgage-related debt and recorded an additional $7.2 billion in credit costs -- mostly also tied to the housing meltdown, as consumer loan losses mount.
But analysts had expected the New York-based company to lose about $3.7 billion, according to Bloomberg data, and to suffer a larger asset write-down.
 Given that anything less than a catastrophe passes for good news these days in the financial industry, Citigroup's shares are getting a bounce, for a third straight session. The stock was up $1.59, or almost 9%, to $19.56 about 10:30 a.m. PDT. After reaching a nearly 10-year low of $14.56 on Tuesday, the shares rebounded 13.1% on Wednesday and 9.1% on Thursday.
Short sellers -- traders who had borrowed Citi stock and sold it, betting the price would keep falling -- probably are helping to push it higher today as some of them close out their bets. The total of shorted shares of Citigroup reached 152 million as of June 30, up from 108 million just since mid-May.
The financial stock sector index of the Standard & Poor’s 500 initially fell early today after Merrill’s larger-than-expected quarterly loss, reported after the closing bell Thursday. But the index was up about 0.6% at 10:30 a.m. PDT after surging 19.6% in the two previous sessions.
"All things considered, it was a decent quarter for Citigroup," William Tanona, an analyst at Goldman Sachs Group, wrote in a note to clients.
Still, Citigroup's report underscored the heavy exposure that the mastodons of American finance continue to have to the subprime mortgage market. The company’s subprime assets were reduced from $29.1 billion in the first quarter but still totaled $22.5 billion as of June 30.
Citigroup was able to sell or otherwise dispose of $3.2 billion in subprime assets but got rid of the biggest chunk -- $3.5 billion -- by simply writing it off.
Analysts expect that to continue for the foreseeable future.
"We still believe the company will face additional write-downs on these assets in coming quarters," Tanona wrote.
Photo: Citigroup's headquarters in New York. Credit: Justin Lane / EPA
From Times staff writer Walter Hamilton:
Merrill Lynch & Co. just threw cold water on the idea that the housing crisis was letting up on Wall Street.
Better-than-expected second-quarter earnings from Wells Fargo & Co. on Wednesday and JPMorgan Chase & Co. this morning had boosted hopes that major banks and brokerages could sidestep more worst-case profit hits from the housing collapse.
Earnings dropped at both Wells and JPMorgan, but far less than analysts had feared. Wells even raised the dividend on its stock.
But Merrill late today reminded investors that the end isn't close for companies that played in the deep end of the pool during the housing boom.
 The New York-based brokerage giant reported after the end of regular trading that it lost $4.7 billion in the latest quarter, or $4.97 a share, including almost $10 billion in write-offs tied largely to the faltering mortgage-securities market. The numbers were significantly worse than even the most pessimistic analysts had expected.
The news drove Merrill's shares down $1.97 to $28.76 in after-hours trading. The stock had jumped $2.73 to $30.73 in the regular session amid another big rally in financial shares.
The upshot, it seems, is that "the companies that have been steady sources of bad news will continue to be sources of bad news," said John Bollinger, head of Bollinger Capital Management in Manhattan Beach.
Merrill's latest write-offs included $3.5 billion for those exotic -- and toxic -- mortgage securities known as collateralized debt obligations, and $1.3 billion for residential-mortgage "exposures."
On the company's earnings conference call today, one analyst asked Merrill CEO John Thain a technical question about the CDOs "you guys" created.
Thain shot back: "First of all, I take exception to the 'you guys' comment. I did not create any of these CDOs."
Thain, 53, took the brokerage's helm in December after Stanley O'Neal got the boot.
Like others, Merrill has been scrambling to get bad assets off its books. It slashed its U.S. asset-backed CDO exposure to $4.5 billion as of June 30 from $6.7 billion at the end of the first quarter. It whittled its U.S. subprime exposure 29% to $1 billion, primarily because of $544 million in write-offs.
But Merrill and other investment banks are on the proverbial treadmill. As quickly as they're taking mortgage write-offs, the value of the underlying assets is deteriorating further.
The result is that the firms still have significant exposure to the most troubled areas of the mortgage-securities arena. And it's doubtful that Merrill and others can stop the bleeding -- or even accurately calculate how much bleeding they have left to do -- until the housing market stabilizes.
And we all know that hasn't happened yet.
Photo: Merrill CEO John Thain. Associated Press
The "shorts" are on the run again today, particularly in stocks of some small California banks.
Financial issues that had been brutalized for the last six weeks are up sharply for a second day, in a rally that has all the earmarks of a short-covering panic.
The day’s winners include many California community banks that have been heavily shorted in recent months by bearish traders. In a short sale, a trader borrows stock and sells it, hoping the price will drop so he can replace the borrowed shares later with stock bought at a lower price.
That strategy has worked well for much of this year with financial stocks as the companies’ earnings have withered amid rising loan losses.
 The problem for short sellers is that, once a heavily shorted stock begins to rebound, the turn can trigger a rush to close out those bearish bets. As shorts jump in to buy, they become each other’s worst enemies, driving prices higher.
Panicked buying? Look at Pasadena-based East West Bancorp, which was up $1.05, or 12.1%, to $9.72 at about 10 a.m. PDT, after soaring as high as $13 early in the session. The stock rose 16% on Wednesday.
Struggling mortgage lender Downey Financial, based in Newport Beach, has gained 86 cents, or 39%, to $3.08 after rocketing 66% on Wednesday. Downey shares, which closed at $1.28 on Monday, spiked as high as $3.80 early today.
Other big gainers among California community banks include L.A.-based Cathay General, up 14% so far today, and San Francisco-based UCBH Holdings, parent of United Commercial Bank, which is up nearly 10%.
Threats by the Securities and Exchange Commission this week to crack down on what it labels abusive short selling may be giving some short sellers another reason to close out their bets.
Was today just manic enough on Wall Street to mark a short-term bottom in the stock market?
The Dow industrials slumped 227 points early in the day on Federal Reserve Chairman Ben S. Bernanke’s depressing assessment of the economy, rallied 295 points from the low (to a net gain of 68 points) as oil fell more than $6 a barrel and stayed there, then sank again in the final hour with financial stocks, as usual, leading the way down.
The Dow ended off 92.65 points, or 0.8%, to 10,962.54 -- the first close below 11,000 since July 2006. That extended the index’s decline from its October peak to 22.6%. Trading volume today was massive on the New York Stock Exchange.
 The market is "alternating between euphoria and depression. Sometimes in the same hour," said Steve Todd, editor of the Todd Market Forecast in Crestline, Calif.
But it’s often when the market looks the nuttiest that it’s on the verge of wringing itself out.
The bulls got one sign they’ve been waiting for: The so-called VIX index, which measures Wall Street’s fear level by tracking activity in put and call option contracts on the Standard & Poor’s 500 index, jumped above the 30 level for the first time since mid-March.
The last four times the index has been above that threshold -- in August, November, January and March -- it foreshadowed that the market sell-off of that moment was cresting, and that a rally (however fleeting) was imminent. Go here for more on the VIX’s recent history, including a chart.
The VIX surged as high as 30.81 early today before falling back to close at 28.54, up from 28.48 on Monday.
Something else that could push the bears back, for better or worse: The Securities and Exchange Commission’s new plan to curb short selling of major financial stocks, as reported here.
Still, financial-stock sellers -- short and otherwise -- continued to drive many big-name issues to new multiyear lows today, indicating no let-up in fears about the state of the banking system. They have TVs on Wall Street; they can see those lines outside IndyMac Bank branches.
Investors are betting "there are going to be a lot more shoes to drop" in the financial sector, said Art Hogan, veteran trader at Jefferies & Co.
Fannie Mae fell $2.66, or 27%, to close at $7.07, Freddie Mac tumbled $1.85, or 26%, to $5.26, Bank of America slid $1.63, or 8.1%, to $18.52 and Citigroup was off 66 cents, or 4.3%, to $14.56. For Citi, that was the lowest closing price since the company was created by the October 1998 merger of Citigroup and Travelers Group.
Photo: Edvard Munch's Expressionist masterpiece "The Scream." Solum, Stian Lysberg/AFP/Getty Images
The government’s rescue plan for mortgage giants Fannie Mae and Freddie Mac, announced by Treasury Secretary Henry M. Paulson Jr. on Sunday, sparked a brief rally in the stocks early today. Very brief.
The shares bounced up at the opening of trading but couldn’t hold their gains. Both ended down for the session, at new 17-year lows. Fannie Mae rose as high as $13.50, then closed off 52 cents, or 5.1%, at $9.73. Freddie Mac rose to $9.80, then ended down 64 cents, or 8.3%, at $7.11.
The stocks are down more than 75% year to date, but today's action suggested the bottom still may not be in sight.
 Yet investors had no fear of buying three- and six-month debt securities from Freddie Mac today. The company sold $3 billion of the bills, and the offering attracted a larger-than-usual number of bids.
In an otherwise frazzled market, investors’ split views of the companies’ stocks and their debt instruments actually make sense. Wall Street has no real doubt that Uncle Sam will back the debt, if that’s what it comes to. We’re talking trillions of dollars' worth of the company’s bonds in the hands of investors worldwide, including foreign central banks.
If anything is "too big to fail," it’s the debt side of Fannie and Freddie. That's good news for popular bond mutual funds like Pimco Total Return, which owns heaps of Fannie and Freddie bonds. Pimco Total Return's shares edged up 4 cents to $10.68 today.
As for the companies’ equity investors, however: After an initial burst of optimism today, "I think they realized that there is a distinction between saving Fannie and Freddie and bailing out the shareholders," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago.
If the Treasury ends up buying equity stakes in the companies to bolster their capital, current shareholders will be left with little or nothing.
It wasn’t just the common shares of the companies that fell further today. So did many of their preferred issues -- stocks that pay high dividends and are ahead of the common shares in any claim on the companies’ assets. Presumably they fell on the assumption that any government stake in the companies also would be senior to existing preferred shares.
It’s the least the Treasury could do for taxpayers if an equity bailout becomes inevitable.
Photo: Treasury Secretary Henry M. Paulson Jr.
The sight of depositors lined up outside IndyMac Bank branches today to pull their money can’t be giving comfort to bank regulators.
It gave none to bank stock investors: Wall Street hammered bank shares across the board. The BKX index of 24 major and regional bank issues plunged 8.5%, deepening its year-to-date loss to 43%.
Check out the day’s percentage declines in National City Corp., Washington Mutual, Zions Bancorp and Downey Financial, to name just four.
Investors who are dumping bank stocks, even at these severely depressed levels, are voting with their feet. The question is, how many bank depositors around the nation today are doing the same?
 There’s the potential for a vicious circle here: Investors fear bank failures, so they pound the stocks. Depositors, seeing Wall Street’s reaction, begin to pull their funds, worrying (probably needlessly) that their money is in another IndyMac. A deposit run then can turn a reasonably healthy bank into a problem bank in a hurry.
Sheila Bair, head of the Federal Deposit Insurance Corp., is trying her best to induce calm, saying over the weekend that "the overwhelming majority of banks in this country are safe and sound."
But we’re in an environment where there has been no payoff for taking chances in the financial system.
By the FDIC’s count, about 10,000 IndyMac customers held a total of $1 billion in uninsured deposits in the bank. If those customers believed that the deposit insurance limit didn’t matter -- and that the government would back all of their savings if IndyMac failed -- they have just now come to realize how wrong they were.
Too late.
If you’re over the FDIC’s insurance limit at IndyMac, the agency will let you pull out half of whatever you have on deposit above the limit. Then you’ll wait to find out what the FDIC can get as it sells off IndyMac’s assets.
The FDIC can’t predict what portion of the remaining uninsured deposits, if any, will be repaid.
That is a horrible situation for those depositors. They should have known better, but they either ignored the insurance limits or put off doing something about their funds.
So we can imagine what’s going on around the nation today. How many bank customers, now realizing that it is possible to lose money if your deposits exceed the federal insurance limits, are trying to make sure that they don’t repeat IndyMac customers’ grave mistake?
The banks aren’t going to tell us if they’re facing a wave of customers either withdrawing money to get below the FDIC’s limits or restructuring their accounts to stay within those limits. It isn’t in any bank’s interest to be that upfront.
The FDIC may be right when it says the risk of your bank failing is extremely low. But the fate of uninsured depositors at IndyMac is a bell-ringer. It says you can lose.
For many Americans, that now may be all they need to know.
Photo: Customers wait outside of IndyMac's headquarters office in Pasadena today. Al Seib / Los Angeles Times
The Bush administration acknowledged today that it couldn't afford to leave mortgage giants Fannie Mae and Freddie Mac on their own to face another ravaging by Wall Street.
The government announced plans to provide financial backup to the battered companies amid fears that they could face failure as home loan defaults keep rising.
Treasury Secretary Henry M. Paulson Jr. said the Bush administration’s proposal, which will need Congress' approval, would boost the companies’ ability to borrow from the Treasury if needed, and would allow the Treasury to buy stock in the companies to bolster their capital.
Separately, the Federal Reserve today said it would permit the companies to borrow directly from the central bank if they needed short-term cash.
Shares of Fannie Mae and Freddie Mac, which combined own or guarantee about $5 trillion in home loans -- roughly half the entire U.S. market -- both lost more than 45% of their value last week amid furious selling tied to rising concerns about the companies’ solvency.
 Paulson last week insisted that the companies’ finances were sound. But the deepening pessimism about the firms on Wall Street, and the spillover into financial markets in general, left the government little choice but to step up with a potential rescue plan -- even though it is sure to be perceived as yet another government bailout of private interests.
Because of the companies’ size and their importance in providing funding to the mortgage market, "we must take steps to address the current situation," Paulson said in a statement this afternoon.
Key elements of the proposal the White House will send to Congress:
--Bigger credit lines with the Treasury: As a "liquidity backstop," the Treasury would temporarily increase the lines of credit Fannie Mae and Freddie Mac have with the agency. The companies currently can borrow up to $2.25 billion each from the Treasury, although they’ve never tapped those lines. The current lines long have been minuscule compared with the growth of the companies' assets (now $843 billion for Fannie, $803 billion for Freddie).
The Treasury didn't spell out the size of the new credit lines.
--Possible stock purchases by the Treasury: To ensure that the companies have "access to sufficient capital to continue to serve their mission," the Treasury would get temporary authority to buy stock in either of the companies "if needed."
"Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer," Paulson said.
The idea of an equity infusion may be the most contentious issue in the Treasury's plan because it will be seen as a bailout of the companies' current shareholders, which include some of the nation's biggest investment firms. But any equity stakes the Treasury would take almost certainly would result in severe dilution to current investors, if not wiping out their stakes entirely.
Some experts, including former Federal Reserve Bank of St. Louis President William Poole, have said that nationalizing the companies -- turning them back into government agencies -- is the only practical solution to the challenges they face from surging losses on defaulted home loans.
--New oversight by the Federal Reserve: To protect the financial system from "systemic risk" going forward, the Federal Reserve would be given a "consultative role" in setting capital requirements and other "prudential standards" for Fannie Mae and Freddie Mac. This looks like an admission of a lack of faith in the companies' current regulator, the Office of Federal Housing Enterprise Oversight.
In its separate announcement today, the Fed said it granted its New York branch the authority to lend to Fannie Mae and Freddie Mac "should such lending prove necessary." The Fed normally lends to commercial banks, and, since March, has opened its borrowing window to brokerages as well, in an attempt to ease the credit crisis stemming from the bursting of the housing bubble.
Daniel Mudd, chief executive of Fannie Mae in Washington, said in a statement that the company "appreciates today’s announcements and the expressions of support."
Freddie Mac's CEO, Richard Syron, said the McLean, Va.-based company was "heartened" by the Treasury and Federal Reserve announcements.
Whether Wall Street is comforted will be evident in the action in the companies' stocks Monday and the reaction of the credit markets to Freddie Mac's plan to issue $3 billion in short-term debt, part of its routine financing program.
Photo: Henry M. Paulson Jr. by Karim Jaafar/AFP Photo
Sen. Chuck Schumer today went on another counterattack against federal banking regulators who’ve blamed him for helping cause the failure of IndyMac Bank.
At a news conference, the New York Democrat repeated his contention that the bank’s regulator had been "asleep at the switch." He said his public questioning of IndyMac’s financial health in late June merely stated the obvious.
"The administration is doing what they always do, blaming the fire on the person who called 911," Schumer said, according to the Associated Press’ story from the news conference in New York.
 Pasadena-based IndyMac, with $32 billion in assets, was seized by the government Friday. The loss-ridden mortgage lender had faced an outflow of deposits since Schumer on June 26 made public a letter he sent to the Office of Thrift Supervision and the Federal Deposit Insurance Corp., saying he was "concerned that IndyMac's financial deterioration poses significant risks to both taxpayers and borrowers."
Schumer’s decision to go public with those comments ignited a firestorm in Washington. Regulators on July 2 said he was contributing to "rumors and innuendo" about the bank that could hasten its demise.
On Friday, regulators specifically fingered Schumer for IndyMac’s failure. The Office of Thrift Supervision said in its statement announcing the seizure that "the immediate cause of the closing was a deposit run that began and continued" after Schumer went public with his concerns.
"This institution failed due to a liquidity crisis," OTS Director John Reich said Friday. "Although this institution was already in distress, I am troubled by any interference in the regulatory process," a reference to Schumer.
The FDIC estimates that IndyMac’s failure will cost the agency between $4 billion and $8 billion as it unloads bad loans and makes insured depositors whole.
Schumer today said his June 26 letter contained "no new revelations" about IndyMac. He repeated much of his previous defense of his decision to go public about the bank’s ills, including his assertion that the OTS was "a weak regulator" and that "my job was to try and toughen them up, and that's what I tried to do."
Photo: Sen. Charles E. Schumer by Mark Wilson/Getty Images
The federal government is doing a lot of jawboning this weekend to try to keep the crisis surrounding mortgage giants Fannie Mae and Freddie Mac from worsening. Still unclear is whether the feds will take specific action to bolster the companies’ finances.
The clock is ticking: Asian financial markets will open later this afternoon, U.S. time, and a massive sell-off in Asian stocks, or in the dollar, could set the scene for another harrowing day in Europe on Monday and then on Wall Street.
Here’s what’s going on so far:
--U.S. cash infusion for Fannie and Freddie? The Times of London reported that the Treasury is working on a plan to inject up to $15 billion of capital into Fannie Mae and Freddie Mac. The government would make the infusion in return for a new class of shares in the companies, the newspaper said.
But the Times is alone on this report, at least among major news organizations. The Wall Street Journal, in a short dispatch on its website, says the Treasury today is expected to make a statement "supportive" of the companies, but that it is merely expected to be "a statement of facts designed to reassure markets."
The problem is that "facts" about the companies, including their regulators’ assertion that they are adequately capitalized, did nothing to halt the collapse of their stocks last week.
--Please buy this debt: Treasury officials on Saturday were calling major financial institutions to try to assure there would be plenty of buyers for Freddie Mac’s offering of $3 billion of short-term debt Monday, the Washington Post reported.
The debt sale is a routine offering by Freddie Mac, but given the heightened fears about the company’s solvency the sale looms as a crucial test of the markets' faith in the company.
Sen. Jon Kyl (R-Ariz.) told CNN today that the government had "a lot of different options" to ensure that the companies could meet their obligations. Many on Wall Street expect the Federal Reserve to invoke emergency powers to allow Fannie and Freddie to borrow directly from the central bank if investors balk at providing the short-term funding the companies need in their day-to-day operations.
--Rumor-mongers put on notice: The Securities and Exchange Commission today signaled a fresh crackdown on the spreading of "false information" aimed at driving down stock prices. The clear target: "short" sellers, traders who borrow stock and sell it, hoping the price plunges.
Shares of financial firms, including Fannie and Freddie, have become favorite targets of short sellers this year.
The SEC, in a rare weekend announcement, said it and other regulators would "immediately conduct examinations aimed at the prevention of the intentional spread of false information intended to manipulate securities prices."
The timing of the SEC’s announcement also seemed to be aimed at bolstering confidence in U.S. markets ahead of Asian markets’ opening today.
William Poole has long warned that mortgage titans Fannie Mae and Freddie Mac had grown so large that they posed a serious threat to the U.S. financial system.
It looks like the former Federal Reserve policymaker had it right. Stocks of both companies are in meltdown mode this week, sending ripples through U.S. markets, on fears that they don’t have the capital they’ll need to survive rising mortgage defaults.
So let’s admit the obvious, Poole suggests: Fannie and Freddie should be nationalized.
In America, nationalization is among the dirtiest of words. It conjures the image of the government grabbing control of private-sector assets.
But Fannie and Freddie, which buy or guarantee mortgages to support the housing market, are strange animals. They are owned by shareholders, but they were chartered by the government, and they’ve grown to their gargantuan sizes ($843 billion in assets at Fannie, $803 billion at Freddie) because investors worldwide believe their debts have the implicit backing of the U.S. Treasury.
 If Fannie and Freddie face a wipeout of their capital because of loan losses, then, Uncle Sam couldn’t possibly allow the companies to collapse. So why not just nationalize them now, turning them into full-fledged government agencies and thereby taking away the uncertainty on Wall Street about their ability to continue buying home loans?
Poole, who was president of the Fed’s St. Louis branch until he retired in March, said in an interview with Bloomberg News this week that nationalization was "the only practical course" for Fannie and Freddie.
Though he’s often labeled a curmudgeon, the 71-year-old Poole isn’t alone in his view of what to do with Fannie and Freddie, which combined either own or guarantee a total of $5 trillion of U.S. home loans, nearly half the entire market.
"We have to stop pretending these are private companies," said Christopher Whalen, a managing director at research firm Institutional Risk Analytics.
There has always been an inherent conflict in the structure of Fannie and Freddie, Whalen notes: Their shareholders would reap the benefits if the companies took big risks and won, while it was presumed Uncle Sam would have to pick up the pieces if the companies blundered.
In Washington, Treasury Secretary Henry M. Paulson Jr. and others want Fannie and Freddie to get back on their feet on their own. But if the companies try to raise massive sums of new capital by issuing stock, they will severely dilute the ownership of their current shareholders (that’s a big reason the stocks have nosedived).
And what if, six months from now, the loan losses turn out to be so massive that any additional capital the companies raised in the interim is burned up?
Politically difficult as it may be, Whalen says, if you make Fannie and Freddie government agencies now, "you take a major source of instability out of the market. You don’t have to worry about it anymore." That would be one less issue for the housing market, which obviously has plenty.
Given the dilution risks they already face, shareholders of Fannie and Freddie ought to welcome a buyout even at these depressed prices, Whalen says.
In terms of stock market value, all that’s left of Fannie and Freddie now is about $18.2 billion, combined. Wall Street wouldn’t even notice that amount disappearing from the public market.
Citigroup Inc.’s shareholders have nothing but losses to show for Chuck Prince’s four-year tenure as CEO of the financial giant.
Now he gets a chance to give advice to Xerox Corp.’s CEO, Anne Mulcahy: Xerox’s directors today elected Prince to join them on the copier company’s board.
 It just goes to show that even when CEOs fail massively, they rarely get kicked out of the club.
Prince was ousted from Citi in November as the bank began to reel from losses on high-risk bonds. Citi had loaded up on subprime-mortgage-related debt on Prince’s watch, and it’s still sinking under the weight of its bad bets: Analysts expect the company in the second quarter to record its third straight quarterly loss.
Citi’s shares today closed at $16.28, their lowest in nearly 10 years. The price has been cut in half since Prince was booted.
Xerox, in announcing Prince’s board seat today, noted that he “was appointed CEO of Citigroup in 2003 and remained in this position until his retirement in 2007.” Ah, yes, retirement -- at the ripe old age of 57.
Mulcahy, in a statement, hailed Prince as a “visionary leader” with “unique talent and exceptional business experience.”
You can read that any way you want.
Xerox's shares fell 2 cents to $13.16 today before the announcement. They're down almost 19% this year.
Photo: Chuck Prince. Daniel Acker/Bloomberg News
Can it get any worse for financial stocks? Oh yes it can. Here’s the rundown on today’s crises:
--FANNIE MAE and FREDDIE MAC: Shares of the mortgage giants plummeted again on fears that they won’t survive without a government bailout that could wipe out their shareholders’ stakes. Fannie fell as low as $11.70 early today, from $15.31 at Wednesday’s close; Freddie fell as low as $6.75, from $10.26.
The stocks have since rebounded somewhat as Treasury Secretary Henry M. Paulson Jr. and a host of politicos have tried to assure investors. Paulson, testifying on Capitol Hill at a previously scheduled hearing on financial regulation, said Fannie and Freddie were "adequately capitalized."
But that was contradicted by Federal Reserve Chairman Ben S. Bernanke, who said at the same hearing that he believed the companies needed to raise more capital.
On Wednesday, former Federal Reserve Bank of St. Louis President William Poole labeled Freddie as "insolvent" in an interview with Bloomberg News and said Fannie was on the verge of insolvency.
The market is voting with Poole: At about 11:45 a.m. PDT Fannie still was off $1.81 to $13.50; Freddie was down $2.10 to $8.16.
--LEHMAN BROS.: The brokerage’s shares plunged as low as $15.40 early today, in part on rumors that Newport Beach-based bond fund titan Pimco had stopped trading with the firm because of concerns it could fail. Deja vu? In mid-March, Bear Stearns Cos. collapsed when its trading partners pulled away.
But Bill Gross, Pimco’s chief investment officer, went on CNBC today to say Pimco hadn’t backed off from Lehman. He said Pimco had "no question" about Lehman’s solvency.
Lehman shares were off their lows at about 11:45 a.m. PDT but still were down $3.22 to $16.52.
--WACHOVIA CORP.: The market is giving no rousing welcome to Robert Steel, the former Treasury undersecretary who was named CEO of struggling Wachovia on Wednesday by the bank’s board. The shares are off 81 cents, or 5.7%, to $13.48, a 17-year low, after Steel declined to answer questions about the bank’s capital situation or its dividend, saying investors would have to wait for the company’s second-quarter earnings report on July 22.
Here it is again, on the record: Bank of America Corp. CEO Ken Lewis doesn’t expect the bank to need to raise more capital or to cut the dividend on its stock, two moves many of its struggling rivals have been forced to make.
But in an interview in L.A. on Wednesday, Lewis acknowledged that his views on BofA’s ability to weather this economic storm depended on how many Americans are able to hold on to their jobs.
And he didn’t offer any near-term encouragement about the home-foreclosure situation, or about rising losses on the bank’s credit-card and home-equity-loan portfolios.
Lewis, 61, was in L.A. to give a speech ("Mending Our Mortgage Markets") to Town Hall Los Angeles and to visit the Countrywide Financial operations in Calabasas, nine days after Charlotte, N.C.-based BofA acquired the troubled mortgage giant. He also met with Times reporters and editors.
 Some excerpts from the interview:
--On the bank’s capital situation and its dividend payment (now $2.56 a share at an annual rate): "I’ll restate what I said two or three weeks ago. Given our view of things, we do not expect to cut the dividend nor do we expect to have to raise capital.
"We get investors and analysts calling us saying, ‘You’ve got to cut your dividend because the market is saying you should cut your dividend.’ We’ve reminded them that the market over the short-term is not always right."
At Wednesday’s closing stock price of $22.06, BofA’s annualized dividend yield was 11.6% -- far above the yields on most other big bank stocks.
--On the outlook for home foreclosures and repossessions: "We make projections but I can’t tell you that we feel like we’ve got our hands around it at this point."
Like other lenders, he figures much will depend on where, and when, home prices bottom. "We think nationwide that we’ve got another 15% housing decline, and we think it will probably go into at least the first quarter of next year."
In California, Florida and other previously red-hot markets, BofA expects a 20% additional price decline, on average, Lewis said.
--On growing losses on credit cards and home-equity loans: Credit card delinquencies have risen but "those still are within our ability to predict. We’ve done a good job of saying, 'Here’s about what we think they’ll be next month,' and they’ve been right in that area.
"That is not so with home equity. Home equity [loan] deterioration has been much more rapid than we predicted. Our portfolio has a lower loss rate than most but the rate of increase has been pretty substantial. And the severity of loss is much higher than in any other period because of the dramatic house price declines. You’re going from a secured product to an unsecured product."
Note here, Lewis is talking about BofA’s home-equity loan portfolio, not Countrywide’s.
--On the outlook for U.S. consumer spending: "I do think there’s going to have to be a retrenchment. The financial system is going to force that. Because you’re not going to get the same loans or the same terms you did before.
"To the extent that that retrenchment then causes a kind of a domino effect and therefore unemployment starts to rise higher than we think, then you’ve created a situation that is really ugly.
"If you can see unemployment levels peaking at 6% [compared with the current 5.5%] then I think we’re OK" in expecting the economy to begin reviving in mid-2009, he said.
If unemployment rises "substantially" above 6%, Lewis said, then "all bets are off."
Photo: BofA CEO Ken Lewis. Lawrence K. Ho/Los Angeles Times
For the stock market, it was one day out of the frying pan -- the next day into the fire. Again.
Share prices followed Tuesday’s rebound with a steep plunge today, as fears about the financial system again gripped Wall Street. Iran’s latest missile test didn’t help the mood.
The sell-off pulled the Standard & Poor’s 500 index into bear-market territory for the first time since the 2000-02 dive. It joins many other indexes that have been dragged into the bear cave in recent weeks.
The S&P 500 tumbled 29.01 points, or 2.3%, to 1,244.69, leaving it down 20.5% from its record closing high of 1,565.15 reached in October. A drop of at least 20% is Wall Street’s usual threshold for a bear market.
 "It’s a pretty ugly picture," said Brian Gendreau, investment strategist at ING Investment Management in New York. "It’s very hard to point to a catalyst for getting back into" stocks.
Unless losing nearly 24% of your capital in a day is your idea of fun. That’s what happened to investors in mortgage giant Freddie Mac today.
Despite attempts by federal officials to dispel concerns about the financial health of Freddie and its sister company, Fannie Mae, the market clearly isn’t buying it: Freddie plummeted $3.20, or 23.8%, to $10.26. Fannie slid $2.31, or 13.1%, to $15.31.
Wall Street was unnerved by another sign that investors are becoming less willing to extend credit to Freddie and Fannie, despite the implied government guarantee of their debt: Fannie Mae issued $3 billion in two-year notes today at an annualized yield of 3.27%, far above the 2.37% that the U.S. Treasury pays on two-year notes.
In theory, Fannie shouldn’t be paying this much on its debt -- if investors believed it was truly a solid credit.
And if there are doubts about Fannie and Freddie, that doesn’t bode well for financial giants that aren’t technically backed by the Treasury. Merrill Lynch sank $3.03, or 9.2%, to $29.74, its lowest since 2002.
What was bad for financials was bad for the rest of the market, as usual. Among the 10 major industry sectors in the S&P 500, only utilities were up for the day. In the tech sector, Cisco Systems crumbled $1.30, or 5.7%, to $21.58 after CEO John Chambers suggested his customers don't expect an economic recovery until 2009.
With forecasts like that, "You have to keep asking, 'Why would you want to buy stocks right now?' " said Dan McMahon, veteran trader at Raymond James & Associates.
Among major market indexes, the Dow industrials and the Nasdaq composite fell further into bear-market territory. The Dow slid 236.77 points, or 2.1%, to 11,147.44, the lowest close since August 2006; the Nasdaq gave up 59.55 points, or 2.6%, to 2,234.89.
The Dow now is down 21.3% from its record high in October.
Crude oil prices pulled back today after an initial jump, and finished up just 1 cent at $136.05 a barrel, following two days of heavy losses. But nobody seemed to be paying much attention to oil after financial-company jitters revived. If the financial system unravels, the cost of gas at the pump may be among the least of our problems.
Photo: On the floor of the New York Stock Exchange today. Andrew Harrer/Bloomberg News
From Times staff writer Walter Hamilton:
Long after Internet stocks crashed eight years ago, investors learned that some of the stock analysts who had heavily touted tech companies had privately badmouthed them, including in e-mails.
A version of that unsavory behavior appears to have taken place behind the scenes of the subprime mortgage boom, according to a report Tuesday by the Securities and Exchange Commission.
The report indicates that as the subprime bubble inflated in recent years, some analysts at the three major credit-rating firms -- Standard & Poor's, Moody's Investors Service and Fitch Ratings -- questioned the accuracy of the buoyant ratings their firms were assigning to mortgage-backed bonds.
The analysts seemed to suggest that they couldn’t do thorough assessments because they were snowed under by the avalanche of increasingly complex securities that they had to review as their firms tried to cash in on the housing boom.
 In an April 2007 e-mail, an analyst wrote that her firm’s evaluation methodology did not capture even half of the risk of a certain deal, but added that “it could be structured by cows and we would rate it,” the SEC report says.
In a December 2006 e-mail, another analyst at the same firm wrote that the market for arcane securities known as collateralized-debt obligations had become a “monster.”
“Let’s hope we are all wealthy and retired by the time this house of cards falters,” the analyst wrote. The SEC didn’t disclose which firm employed those analysts.
SEC Chairman Christopher Cox said at a press conference in Washington that the study uncovered "serious shortcomings" at the three firms. "When there were not enough staff to do the job right, the firms sometimes cut corners."
The credit-rating firms gauged the credit-worthiness of the thousands of bonds and other securities that Wall Street investment banks were creating from pools of subprime mortgages. Banks wanted top ratings so that pension funds and other institutional investors would buy the bonds from them.
The positive ratings helped super-charge the housing bubble in the boom years. Since the bubble burst and the true risks of the bonds have become evident, furious downgrades by the rating firms over the last year have aggravated the housing and credit-market busts.
Overall, the SEC report found that the firms mishandled conflicts of interest and didn’t always follow internal procedures in assigning ratings.
Unrealistically lofty ratings from the credit graders have long been cited as one of the causes of the subprime catastrophe. The SEC report just underscores that -- although it's of little help now to homeowners stuck with bad mortgages or to the U.S. economy as it grapples with the fallout.
Photo: SEC Chairman Christopher Cox. Brendan Smialowski/Bloomberg News
From Times staff writer Walter Hamilton:
For financial stocks, the third quarter is starting out in much the same way the second quarter ended -- with share prices in the sector sinking on worries about a lack of capital.
Today’s descent was led by mortgage giants Fannie Mae and Freddie Mac, which tumbled after a Lehman Bros. analyst predicted the pair might have to raise a combined $75 billion to comply with a potential accounting change.
Shares of Freddie Mac plunged 17%, while Fannie Mae sank 15%. The KBW bank stock index, meanwhile, slid 3.8%. Citigroup Inc. and Merrill Lynch & Co. fell to fresh multiyear lows.
If the accounting change -- which relates to the handling of home loans that are turned into mortgage-backed bonds -- takes effect, Fannie and Freddie “would both swing from having a large surplus capital cushion to having an even larger capital deficit,” Lehman analyst Bruce Harting wrote in a report to clients.
Fannie Mae may need to boost capital by $46 billion and Freddie Mac by $29 billion, Harting predicted. Those would be huge sums any time, but are especially eye-popping given that financial institutions worldwide already have been forced to raise $320 billion in the last year, according to Bloomberg data.
Much of that capital has come from big investors whose positions are now underwater because of t | |
