Common Sense Financials = Disclosure

I came across an interesting podcast from Bill Parish, a financial adviser for Parish & Company, an investment management and research services firm, website Parish & Company. The topic, hedge funds, private equity and disclosure, a well deserved docket. I've discussed Hedge Fund Regulation Proposals before, but Robert takes it further and does an excellent job explaining it:



He boldly claims back in January that Citigroup is bankrupt. Since then C has been able to raise significant amounts of capital and today Citigroup sells $4.5 billion in shares:

"Meredith A. Whitney, an analyst at Oppenheimer who correctly predicted that the company would cut its dividend last October, said Citigroup needs to raise an additional $15 billion to $18 billion. That effort might include reducing the dividend further.

While many banks have rushed to raise capital lately, the effort at Citigroup, which has lost nearly $40 billion from the credit crisis, stands out in its scale and diversity. It has raised money from public shareholders, foreign governments and big institutions, as well as from its former chairman, Sanford I. Weill. Citigroup is also shedding billions of dollars of assets.

The stock sale is linked to an offering of $6 billion of preferred equity that Citigroup undertook last week. The latter meant the bank might brush up against certain regulatory capital limits. Issuing public shares would put that issue to rest."

Who are these fools? Why would you possibly think Citigroup is a well run, efficient company? More write downs are coming when commercial real estate reaches headlines and Citi will once again race to raise capital and the sheep will (sadly) flock to its Shepard. Dilution, losses, and shattered pride for all the investors who got sucked into the black hole that is Citigroup.

Stay Seated, Credit Crunch Seventh Inning Stretch Is Not Close

Morgan Stanley See Big Bank Woes Just Beginning:

"Morgan Stanley (MS.N) analysts on Monday told clients to "sell the rally" in financial stocks, slashing forecasts for big bank earnings and warning that the current credit crunch is only just beginning.

In aggregate, Morgan Stanley reduced its estimates for 2008 large bank earnings by $17 billion, or 26 percent, and reduced 2009 forecasts by $13 billion, or 15 percent. The analysts expect higher loan losses and expenses, offset by higher net interest income, though profits could fall further still if the Federal Reserve stops lowering interest rates."

Fed rate cuts are irrelevant at this point. More cuts will do little to lower mortgage rates further or offset risk premiums in the ABS markets. There is also the consequence of more price inflation in commodities and agriculture as rate cuts continue to send the dollar plummeting.

Beware of comments like "analysts expects higher loan losses and expenses, offset by higher net interest income". True, losses and expenses will increase and may be offset by interest, but at what cost? There is no doubt that interest is earning at low rates and the higher income earned from interest will only be as a result from large cash and treasury stockpiles. The actual cost of holding these in terms of residual income or income earned above the cost of financing and operations, will be higher than the rate earned, destroying value in equity and earnings.

The cost of raising capital is increasing as well, with banks and investment banks issuing debt and convertible debt with interest around 8%. This is a double whammy, not only are they obligated to high payments for a long time on debt issued, but shareholders will be diluted from hybrid offerings as they convert to equity.

"More capital hikes and dividend cuts (are) coming as our credit deteriorates and forward earnings decline," analysts led by Betsy Graseck wrote in a report. "We think we are only in the third inning of the credit cycle and expect this credit cycle will be worse than (the slump in) 1990-91."

Overall good advice, you do not want to be the shareholder who buys in at "bargain" prices, only to have large capital infusions severely dilute your holdings, while at the same time have losses reduce your market value. Or worse yet, be a shareholder in of a financial institution that fails to raise more capital and end up like the shareholders of Bear Stearns.

Betsy Graseck believes we are in the third inning of the credit cycle, a long way from nine and a big deviation from the opinions of the traditional cheerleaders who say we're 2/3 of the way through. Consumers have just begun to change their attitudes and lower confidence is the consensus, with consumer sentiment 28% lower than a year ago. Also we know that as The Real Estate Epic Turns Another Page banks will have a whole new demon within their midsts.

Risks & Regulatory Tricks

Stellar article in the NY Times from Saturday, Wall Street, Run Amok, which is surprising because it was written by Ben Stein, which all of you Big Picture readers know, Ritholtz blasts on a weekly basis on his weekend linkfest....but anyway more Ben Steinery, on with the article!

As the title of the article suggests, Stein takes a crack at the outlandish regulatory structure and risk taking on Wall Street:

"Under an interesting set of rules promulgated by the Securities and Exchange Commission in 2004, called “Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities,” the amount of capital that had to underlie assets was reduced substantially. (Mr. Einhorn rightly says that this set of rules should have been called the “Bear Stearns Future Insolvency Act of 2004.”)

Through the act, the S.E.C. — acting as one of Wall Street’s chief regulators, mind you — also allowed such things as “hybrid capital instruments” (much riskier than cash or Treasuries), subordinated debt (ditto) and even deferred return of taxes, to be counted as capital. The S.E.C. even allowed the banks to hold securities “for which there is no ready market” as capital.

“These adjustments reduced the amount of required capital to engage in increasingly risky activities,” Mr. Einhorn says.

In response to Mr. Einhorn’s critique, an S.E.C. spokesman told me that these changes could theoretically lower capital, but that the agency has seen no evidence that that has, in fact, occurred.

But Mr. Einhorn has even more troubling observations. He says the S.E.C. also allowed broker-dealers to set their own valuations on assets and liabilities that were hard to value. And broker-dealers could assign their own creditworthiness ratings to counterparties in complex derivatives transactions when those counterparties were otherwise unrated.

In a word, Mr. Einhorn says, the S.E.C. told Wall Street to police itself to save on regulatory costs, while not bothering to “discuss the cost to society of increasing the probability that a large broker-dealer could go bust.”

A result of all this, he says, was as follows:

“The owners, employees and creditors of these institutions are rewarded when they succeed, but it is all of us, the taxpayers, who are left on the hook if they fail. This is called private profits and socialized risk. Heads, I win. Tails you lose. It is a reverse-Robin Hood system.”"

Ben bravely tackles deregulation:

"It looks to me as if the inmates are running the asylum. One truth, that deregulation is sometimes a good thing, has been followed down so long and winding a road that it has led to an immense lie: that deregulation carried to an extreme will not lead to calamity."

The man has a point, but to what extent should regulation be implemented to?

The problem is the system where companies like Carlyle Capital can leverage itself 32:1, which breeds failure, especially where trading is contingent on some overly complicated strategy relying on hedges that follow a mathematical model, but not common sense. If regulation is to be beefed up, then it should be in the amount of capital reserves required on books and full disclosure of level three and off balance sheet items.

The Street is nervous about excessive leverage now as Banks Cut Hedge Fund Lending.

"The most leveraged funds are now borrowing no more than five times their asset base, compared with 10 times their asset base just six months ago, according to fund of hedge fund managers. The move comes as banks withdraw from risk-taking to repair tattered balance sheets, and places strains on formally lucrative hedge fund relationships."

"The uncertainty has prompted many top hedge funds to demand “lock-ups” on their margin agreements to try to protect themselves from a further clampdown from prime brokers, which could force sales of assets into falling markets and potentially put funds into a death spiral. Such “lock-ups” are contractual periods during which the prime broker cannot change terms even if the market environment worsens.

One prime broker said recently that the top 10-15 per cent of hedge funds wanted lock-ups as long as 120 days, against just 1 or 2 per cent last July."

This is good, but after all is said and done and the recession has played out (not for quite some time) risk will return, and obscene amounts of leverage will return with it and large rewards for those who employ it. Finally Welcome to the next inning; Lawmakers and their Priceless Insight introduced us to why new regulatory proposals will only bandage the wounds, but not cure them.

Fiscal Stimulus - FAIL

President Bush can be seen with a certain glean in his eyes in some of his more recent interviews as his stimulus plan is coming of age soon, a fool's twinkle if you may. I trust Bush's instinct and reasoning like I trust a 5 year old with a gas welder on Ritalin. I know this topic has been debated more times than Steve-O from Jack-Ass has been arrested on Cocaine charges (which says a lot), but let's review anyway:

• Consumer sentiment is the lowest its been in 26 years
• Food and energy costs are raping consumer wallets, fueled by our weak dollar, peak oil and good ol' fashioned speculation
  
• A deleveraging phenomenon is taking way as credit deteriorates and everybody hoards cash
• Homeowners are experiencing negative equity on their home and foreclosures are rising, likely into 2010 as ARM's reset
• Finally, the number one reason why the stimulus package will not bolster the economy and create jobs is because most recipients are expected to spend their checks on credit cards and other debts.
  

The Higher Education Dilemna

An article from the Washington Post caught my eye Study Up on College Loans Before Learning About Debt the Hard Way, as it is very relevant to my own situation.

The author poses the question of whether higher education costs are worth the investment for prospective college students. I agree with her inquiry as I myself incurred a ridiculous amount of debt in my college endeavor. $75k after Capitalizing interest into principle later, I found myself the proud new owner of a bottom of the totem desk job making barely enough to scrap by, in fact my monthly payment on my loan I estimate is around 40-45% of my monthly net wages (yikes!). So is it worth it?

According to the article:

"The College Board likes to highlight in its annual survey of college costs that over a working lifetime, a college-educated person can earn considerably more than someone with just a high school diploma.

But many of those college grads are now using an increasingly higher percentage of their incomes to pay down student loan debts -- for at least a decade after they've left school. Add at least another decade if the student attends a pricey, private college."

According to one student interviewed in the article:

"Going into a lot of debt for my education seems crazy to me now," she said. "Even though some financial counselors say education debt is good debt, it's not good to me."

I feel your pain. There is definitely changing attitudes towards higher education and especially taking on debt considering the massive deleveraging going on in our economy, consumers are fed up.

Peter Schiff of Euro Pacific Capital recognizes the problem, and to borrow a thought from his article The Collapse of America's Service Economy:

"The same mathematics will come into play for our ridiculously expensive higher education system, which can not exist without a well lubricated loan infrastructure. Limit the ability of students to take on heavy loans, and college education becomes untouchable for anyone but the wealthiest Americans. If loans dry up, universities will be forced to slash their bureaucracies and substantially reduce tuitions. Ironically the silver lining here is that with low tuitions students will no longer need the loans that kept tuitions so high in the first place."

Schiff is referring to the spillover effect from the ABS market into the student loan backed securities market, or lack there of. Recently, Bank of America (BAC) announced it will no longer provide private student loans to borrowers, ending its contract with already troubled First Marblhead Corp (FMD). Student loan asset backed securities don't carry the same risk that other ABS's do thanks to bankruptcy laws that don't allow student loans to be written off from your record, but investors are freaked out anyway; contagion. TERI, the not for profit student loan guarantor recently filed for bankruptcy, but in my opinion its mostly for protection as defaults are fairly certain to rise in the short term. Check out the long term recovery rates and delinquency rates though on TERI's balance sheets for FMD's trusts, obtained from FMD ABS Investor Info:


Initially, recovery is low, but eventually students catch on that they can't escape this debt and they will be totally f%^&d if they keep defaulting. Alright, now check out the default rates for their 2004 and 2005 trusts:

Not too shabby, delinquencies in the 180 day range are incredibly low and 0% for the oldest 2004 trust. However, in this instance the short term poses significant challenges for FMD, especially since they revoked their credit line with Goldman Sachs. They need to raise capital and whether the storm, or change the structure in which they provide services, possibly carrying the loans on their balance sheets instead of securitizing for underwriters. One thing is certain, the lack of disclosure is not helping their situation out. Earnings are scheduled to be released May 8th, hopefully new plans will be laid out.

My prediction: College costs have soared, private lending is drying up (in the short term) and consumers are debt burdened and are finally beginning to realize the impact. I laid out the details in Contagion Spreads to the Education Industry for why technical schools will reap the benefit of all of these problems. They are a lower cost solution that provides results comparable to more traditional universities in terms of wages and value received. Devry, Inc. (DV) one of the colleges mentioned in my previous posts, boasts in Alumni Success Forms Foundation for Devry University Brand Campaign:

"System-wide, 93 percent of DeVry’s October ’06 and February and June ’07 graduates in the active job market were employed in their fields within six months of graduation at an average salary of $43,000. Furthermore, since 1975, 227,605 undergraduate students system-wide have graduated from DeVry and 90 percent of those in the active job market were employed in career-related positions within six months of graduation."

Not too shabby. DeVry also claims in their most recent 10-K that approximately 70% of their DeVry University enrollments pay tuition, fees, and book expenses with federal grants. Again, refer back to my previous post and learn how little dependence some of these institutions have on private loans for revenue. Focused colleges like these are proving more valuable and much more prudent in gaining access to.

The days of high cost traditional four year universities could be slowing down, Americans' attitudes are changing and the resources are drying up in the short term and education and the nature of our service economy is transitioning with it.

Ambac "Suprises" with Huge Loss, Bond Insurers Revisited

Ambac Shares Dive After Steep Loss, the Washington Post reports:

"The company's shares fell 19 percent pre-market as Ambac reiterated that it is writing "very little new business," and that the weak quarter wiped out 40 percent of the company's net worth."

"The quarterly loss was $1.66 billion, or $11.69 a share, compared with year-earlier net income of $213.3 million, or $2.02 a share. Excluding items, Ambac's loss was $6.93 per share, far more than analysts' average forecast for a loss of $1.82 a share and a sharp reversal from year-earlier earnings of $2 a share."

"The company said it marked down the value of derivatives on repackaged mortgage bonds, known as collateralized debt obligations, by $940.4 million, because it expects to make payouts on those securities. Total mark-to-market losses on credit derivatives were $1.7 billion."

"Net premiums written sagged 38 percent to $135.7 million."

"The results were weak enough to erase $980 million, or 40 percent, of Ambac's shareholders' equity. The company struggled to sell $1.5 billion of shares and convertible securities in March as New York State Insurance Superintendent Eric Dinallo worked with banks and others to help the insurer raise capital."

Was this really such a surprise for the market? Why does Moody's and S&P still support their credit rating?

"Many investors can only hold bonds with "triple-A" ratings from both Moody's and S&P. Fitch stripped Ambac Assurance of its top ratings in January. Callen said on Wednesday that the company exceeds S&P's target capital level by a comfortable margin, and expects to exceed Moody's target level in the second quarter."

The above statement about investors being restricted to only holding triple-A rated bonds addresses why Moody's and S&P have been reluctant to downgrade this wounded duck. If they do, then it will completely wipe out Ambac's creditability, and therefore its ability to generate new business, spark a wave of selling, lowering prices and will fuel more inevitable write-downs in our financial institutions. These predictions of exceeding capital requirements by years end just do not seem fathomable to me. If you're looking for a brief introduction to how bond insurers got themselves in this mess the consult The Legend of Subprime. Back in November of 2007, Pershing released a paper How to Save the Bond Insurers which addresses how bond insurers business operates, their problems, and possible solutions. For now, I will skip over the basic operations and economics of bond insurers and analyze exposures and risks:

"Bond Insurers will likely soon need to fund significant claims. In our view, their capital resources are grossly insufficient to meet these demands

Applying Merrill Lynch and Citigroup valuations to guarantors’ Super Senior CDO exposure would eliminate 45%-107% of their statutory capital"

Specifically for Ambac, Fitch in the Pershing paper estimates they are under capitalized by $459 million, while MBIA will have excess cushion of over $3 billion. These are only 4Q projections and Pershing warns of more expected losses from sub-prime exposure well into 2008.

"Bond Insurer CDO of ABS MTM losses are less than 1/10th the ~20% write- downs taken by banks"

Since the majority of CDO problems are the consequences of sub-prime and alt-A loans that should have never been approved by underwriters in a bubble housing market, foreclosures will continue to rise, possibly well into 2010 as ARM resets occur, check out the estimates in the chart on the left provided by Deutsche Bank. The model assumes 30% default rates based on ARM resets, predicting home foreclosures will persist into 2010. This is only the start of the problem for the bond insurers, now enter home equity lines of credit HELOC) and closed end second mortgates (CES).

"Home Equity Lines of Credit (HELOC) and Closed-end Second Mortgages (CES) securitizations are junior to even the most subordinated tranches of a typical Mezzanine CDO"

"Bond Insurers typically insure HELOCs and CES to the underlying BBB level. HELOCs and CES are in a first-loss position and are leveraged to a decline in housing values"

"In a flat to declining home price environment, we believe HELOCs and CES are likely to suffer 100% loss severity upon default"

Applying Mortgage Insurers’ own loss estimates to MBIA and Ambac’s exposure implies large losses which have not been reserved for

In essence, MBIA and Ambac are uncapitalized or only mildly capitalized for losses in the ABS market, but have no reserves for HELOC's and CES's in which defaults will prove more severe because they are junior to other higher tranche mortgages. Combined, the two bond insurers have a total estimate in losses for HELOC's and CES's of approximately $13.5 billion. Thought you were now out of the woods...think again! The above was in reference to Reisidential Mortgage Backed Securities (RMBS), but take a look back into The Real Estate Epic Turns Another Page and learn that commercial real estate and Commercial Real Estate Backed Securities (CMBS) will be in just as much trouble as the residential side.

"CMBX spread movement suggests potentially significant impairment in the underlying CMBS securities insured by MBIA"

This is not the end of the line here for exposure risks, also included is the reinsurance exposure and below investment grade exposure. Adding those into the formula estimate losses now total to $8,791 for MBIA and $8,020 for Ambac:
The list continues, as even the bond insurers investment portfolios are questioned as overvalued, but there is no estimate of losses. Liquidity risks are now apparent, and with downgrades come higher capital requirements. Considerably more leverage is being carried, with MBIA's debt to equity at almost 5.

"Approximately $5.5 billion of MBIA’s on-balance-sheet debt will come due before year-end 2008, $8.5 billion before year-end 2009"

Uncovered here, there are still many more considerations in the suspect business of the bond insurers. The bond insurers are doomed. Rating agencies will eventually be forced to downgrade them, capital will be difficult, if possible at all to raise any more, and undesirable worthless securities will liquidate at bargain prices....finally bankruptcy.

Innovative Ignorance

The above title refers to the consequences of productive and reproductive creation of something new, specifically here financial innovation. The depths of which are brilliantly crafted, misunderstood and willingly accepted, but ultimately unsustainable. Review your market history pages and discover the sophisticated failure of financial innovation.

Leading to the market crash of 87' was portfolio insurance. Forged from graphite and quants, this innovation is responsible for the largest single day crash in history; the catalyst was futures arbitrage, the rising action, panic and predictability. Irony you'll have it, that the same instrument that was intended to protect losses and the very same outcome from occurring, was in fact the very instrument in place that exacerbated the problem to an irrevocable level. At the core of portfolio insurance is a strategy that implements itself automatically based on self reinforcing price levels and mathematical equations.

Even our regulation is corrupted with regulation innovation, allowing companies to report in a fantasy world where profits are plentiful and earnings never miss....until they miss when they run out of room under the rug. The culprit, GAAP! This misguided set of principles allows companies to fudge numbers for short term results. Some of these rules include:

• Boosting profits by retiring debt where the market value has fallen, and reporting a gain
• Recording large one time profits without disclosing them as non recurring, or commingling non operating activities into operating income
  
• Failing to write off worthless assets (this one sounds familiar)
• Acquiring assets and recording them at undervalued books and selling them for largely appreciated gains (something we may start to see more often here, as financial institutions are capital impaired and may start selling real estate recorded at book)
• Recording revenue when services are still due and when uncertainties exist

This is only the tip of the iceberg, but certainly food for thought. Give less attention to quarterly reports and more weight to annuals since they are audited.

The most recent "innovation" of which the history was outlined in The Legend of Sub-Prime, describes how derivative contracts and counter party risk had its coming of age, where even the insurers who's early policies were logical engaged in these instruments, whose sole backings were based on overvalued home prices.

The only question left to ask is when the dust settles, what will be the new craze in which investors can proclaim risk has been averted, performance boosted and complementary crash at the top of the blowing bubble guaranteed. And wouldn't you know, the Fed has already upholstered your red carpet with bargain basement interest rates.

Rosy Predictions Are Misguided

NAR existing home sales was released today, but before analysis let's get a clear definition and Comparing New & Existing Home Sales the NAR and census bureau

"The Census Bureau collects new home sales based upon the following definition: "A sale of the new house occurs with the signing of a sales contract or the acceptance of a deposit." The house can be in any stage of construction: not yet started, under construction, or already completed. Typically about 25% of the houses are sold at the time of completion. The remaining 75% are evenly split between those not yet started and those under construction.

Existing home sales data are provided by the National Association of Realtors^®. According to them, "the majority of transactions are reported when the sales contract is closed." Most transactions usually involve a mortgage which takes 30-60 days to close. Therefore an existing home sale (closing) most likely involves a sales contract that was signed a month or two prior.

Given the difference in definition, new home sales usually lead existing home sales regarding changes in the residential sales market by a month or two. For example, an existing home sale in January, was probably signed 30 to 45 days earlier which would have been in November or December. This is based on the usual time it takes to obtain and close a mortgage."

Considering that, Census bureau estimates are subject to more revisions and therefore less reliable. The chart below shows existing home sales since January of last year, courtesy of March Existing Home Sales: A Critical Look:

They give a their own comparison and explain further why their estimate is better:

"Existing-home sales, which include single-family, townhomes, condominiums and co-ops, are based on transaction closings. This differs from the U.S. Census Bureau’s series on new single-family home sales, which are based on contracts or the acceptance of a deposit. Because of these differences, it is not uncommon for each series to move in different directions in the same month. In addition, existing-home sales, which generally account for 85 percent of total home sales, are based on a much larger sample – nearly 40 percent of multiple listing service data each month – and typically are not subject to large prior-month revisions."

The NAR Chief Economist offered a warning to the Fed Chief:

"With elevated inflation, the Federal Reserve should be extra careful about further rate cuts,” he said. “Mortgage interest rates, which do not move directly with Fed funds rates, may rise measurably and hurt the housing recovery if inflation gets out of hand. Monetary stimulus is plentiful – what is needed more at this point is a home buyer tax credit to get buyers off the sidelines and prevent the market from overshooting on the downside.”

However Yun's rosy predicts Pending Home Sales to Stabilize Before Upturn in Second Half of 2008. This is not in line with my Housing Pain prediction, where I pointed out that "A credit burdened consumer in a slowing economy should be reluctant to enter new housing contracts, so predicting an increase in home sales is a bit stretched." For reasons why consumers will be reluctant to enter new housing contracts, revisit The Leverage Factor and How Indebted Are we? where I considered how increases in household debt, a declining jobs market, rising food and energy costs and overstated compensation give proof of a continuing slide in new home sales and housing starts. Consumers are psychologically losing confidence, especially in the housing market where prices are declining and have a long way to decline still, Yun is wrong, housing sales will take longer to recoup than by the second half of 2008, especially as The Real Estate Epic Turns Another Page and banks are forced to incur more "unexpected" write downs when their commercial real estate starts losing value, making them even more cautious in lending.

Shoulda Got a Hybrid!

Wish you could return that SUV you just got? You will be, since oil just hit approximately $117 per barrel this week according to Reuters Drivers Paying Record Pump Prices:

"U.S. average retail gasoline prices hit a record $3.4737 per gallon on April 18, up 15.66 cents from the April 4 average, according to the nationwide Lundberg survey of about 7,000 gas stations."

The worst part is the new crude highs haven't been reflected at the pump yet. If crude doesn't come down, there could be an additional 10 to 20 cents in gasoline prices.

"So far this year, the price of gasoline has climbed 53.47 cents per gallon, Lundberg said."

Mish does a good job of outlining Why Do Oil Prices Keep Rising?:

• 
  

The dollar is falling

Global demand is still rising

Peak Oil

Speculation

• 
  

Speculation can account for a good deal of that as we are experiencing a commodity bubble now as investors run from financials and other weak industries like retailers and builders. So save that road trip, to further elaborate on Mish's outline:

• The dollar is not going to rise any time soon thanks to a leveraged American economy (private and public), low interest rates and a trade deficit as consumers feed their every desire with lower cost imports (this should be corrected as consumers finally start to feel the strain of tighter lending, higher food and energy and job losses continue to rise)
• The prevailing sentiment is that commodities are a safe place other than treasuries, which will further fuel the commodity bubble
• Developing nations like China and India continue to support high demand for energy, creating a supply and demand issue
  

A Sea of Funds

The NY Times covered a book "The Investors Dilemma: How Mutual Funds Are Betraying Your Trust and What to do About it" by Louis Lowenstein this week in Some Mutual Fund Numbers Look great, But For Whom?

Interesting fact:

"$10 trillion in life savings that 90 million individual investors in the United States have entrusted to mutual funds."

Needless to say, Lowenstein is concerned with the results from our investments:

“There is a profound conflict of interest built into the industry’s structure, one that grows out of the fact that the management companies are independently owned, separate from the funds themselves, and managers profit by maximizing the funds under management because their fees are based on assets, not performance.”

So how is the performance of mutual funds? T. Rowe Price, one of the top mutual funds in the country is used as an example:

"From 2001 to 2005, T. Rowe’s mutual fund assets under management soared 70 percent to $270 billion; the profit of the management company that owned the funds more than doubled. But most of the investors in T. Rowe’s five leading large-cap growth funds were treading water. During the five-year period ended Dec. 31, 2005, two of the funds gained 1.26 percent and 1.38 percent, barely outperforming the 0.54 percent return of the Standard & Poor’s 500-stock index. The other three T. Rowe funds posted negative returns, ranging from minus 0.26 percent to minus 2.06 percent."

If I were a T. Rowe Price fund owner, I'd be pissed! Standards are set low for the performance of mutual funds:

"Their goal, he says, is not to beat the S.& P. 500 average or the average of a particular industry sector, but simply to “track,” or approximate, those averages so that their managers “don’t look bad.”"

There's a reassurance for retirement savings! Lowenstein sites an interesting point, where fund managers have a very little stakes in their own mutual funds. Just like any good management team for a publicly traded company where large interests of insider ownership is a vote of confidence in the company, is just as applicable for mutual fund managers.

An Economist article Money For Old Hope goes even further into the article:

"IMAGINE a business in which other people hand you their money to look after and pay you handsomely for doing so. Even better, your fees go up every year, even if you are hopeless at the job. It sounds perfect.

That business exists. It is called fund management. Charley Ellis, a veteran observer, explains that fees in the industry tend to grow at around 15% a year because markets rise by an average of 8% and savings grow by 5-6%. This growth is being maintained despite the industry's vast size. According to a report by Watson Wyatt, a consultancy, the value of all professionally managed assets at the end of 2006 was $64 trillion."

The author sites a figure compiled from Vanguard's founder John Bogle:

"Over the 25 years from 1980 to 2005, the S&P 500 index returned an average of 12.3% a year. Over the same period, the average equity mutual fund returned 10% and the average mutual-fund investor (thanks to his regrettable tendency to buy the hottest funds at the top of the market) earned just 7.3%, five percentage points below the index."

Yet fund managers profit margins are approximately 42% according to the Boston Group Consulting survey referred to in the article, hardly justified for the above lackluster performance for the mutual fund owners. And yet investors still flock to mutual funds, availing funds to unsustainable dollar amounts of assets under management, which can increase the chance of dismal performance:

"size is not necessarily an advantage. True, it can bring an improvement in margins; managing $2 billion does not cost twice as much as managing $1 billion. It also gives managers the marketing clout to build a brand name. Yet size can also be the enemy of investment performance. If a fund becomes too large, trading moves prices against the manager, or the fund starts to resemble the overall market. And star managers may be driven away by bureaucracy or lack of freedom."

As if the high fees from fund managers and the corresponding sub par performance paid for it, investors also face high fees from third party administrators for their 401k's and financial adviser fees. A 2006 article from the Los Angeles Times reports in Fees Eat Away At Employees' 401k Nest Eggs, gives an account of a particular employee who learned about these outside administrative fees:

"Because the administrative fee is a percentage of his balance, he will pay more and more as his savings grow. Fuchs figures that by the time he retires, it will have cost him more than $316,000 in direct charges and lost investment returns."

"Workers who save conscientiously suffer a disproportionate hit because fees are typically taken as a percentage of their account balances. Someone with $100,000 pays 10 times as much as a co-worker with $10,000, even though it costs about the same to administer the two accounts."

I think the chart eye candy above illustrates beautifully the difference fees can make in savings in the long run, where in this case a gap of approximately $405,000 results in a difference of only 0.9% in annual fees.

Hedge funds, while I outlined disclosure flaws in Hedge Fund Regulation Proposals among many other flaws in their structure, at least are modeled in theory with the client in mind with regards to fees. Hedge funds usually use performance fees based on a benchmark or high watermark that must be met and exceeded in order for managers to earn from their performance. When the benchmark isn't met, the manager may have to make up the lost performance and earn above the benchmark in the future to receive performance fees. Until the past lost performance is made up, no new performance fees may be collected, a fair proposition. In addition to this a management fee is usually enforced as well, so beware of hedge funds that set high management fees in addition to their performance fees as we've seen the effect it can have on the growth in your assets.

Hedge Fund Regulation Proposals

Joanna Jung of the Financial Times writes US Hedge Funds Issues Set of Guidelines:

"One recommendation asks hedge funds to provide investors with annual and quarterly reports, and independently audited financial statements based on disclosure models used by public companies. Managers should also assess the creditworthiness of counterparties and understand the complex legal relationships they may have with these counterparties, the report said."

One positive consequence in times of market turmoil is that common sense occasionally emerges and receives an audience. Investors use financial statements, preferably audited statements, to determine the financial soundness of a company, gauge managements actions, honesty and comments, and to forecast growth and valuations. Investment companies are required by law in the Investment Company Act of 1940 to provide quarterly reports to clients, it's called disclosure and it is the means by which investors make reasoned decisions. Personally, I don't believe hedge funds should be regulated with regards to the risk they take on in their investments, but it should at least be disclosed in statements to their clients so they can understand the risks inherent in their investment and decide accordingly. Hedge Fund managers are joined in lobbying against the proposals, a predictable reaction. Let's hope this recommendation doesn't fall on deaf ears.

Poised For Growth

The above title, "Poised for Growth" is an infamous phrase from management that let's investors and shareholders know that they've seriously f^&d up and it can't possibly get any worse. Only this time around it's analysts that are optimistic, not the CEO's. Analysts are Investing on Hope that write-downs are nearing an end, but CEO of Merrill Lynch John A. Thain on his conference call today painted a surprisingly realistic picture, courtesy of the NY Time At Merrill, write-downs and More Lay Offs:

“So far the slowdown has been finance-driven,” Mr. Thain said. “What we haven’t seen yet is the impact on the consumer of falling house prices, rising energy prices, higher food prices and higher unemployment.”

This is right in line with what I broke down in Why is Market Cheer Leading So Prevalent?, so let's review:

• A housing market that could decline an additional 20%
• Estimates of up to a trillion dollars in write-downs for financial institutions
• Increasing unemployment, especially as Wall Street firms anticipate up to 25,000 in job cuts
• Deteriorating consumer confidence, with consumer spending possibly heading to minus two percent year of year. This is of course led by high debt burdens on consumers no longer able to tap into MEW's (mortgage equity withdrawls) because of declining home prices.
• Commercial real estate has already started to follow the housing market's lead; The Real Estate Epic Turns Another Page
• Major brokerage firms still cannot estimate how to value their "mark to market" assets
• Fed emergency lending programs Term Securities Lending Facility (TSLF), Term Auction Facility (TAF), Primary Credit Dealer Credit Facility (PDCF) have all failed to restore liquidity (solvency?) to markets

You can add on to that list credit card burdens on consumers, and rising food and energy costs are eating up more available income to pay that off. So far Merrill has taken roughly $30 billion in write-downs, with no logical time frame for an end, included in that was $3.1 billion of off balance sheet write-downs, which of course analysts believe they will be able to write back up. But what those off balance sheet items make up is suspect, almost like imaginary assets. Those Wall Street job loss estimates are becoming a reality,

When asked about additional layoffs, Mr. Thain said, “I think 4,000 is enough for the environment we’re in today.”

We're still in the beginning and the Fed is running out of options, especially since inflation is becoming a serious problem throughout the global economy, limiting the easing ability of interest rates of foreign central banks. This will keep our peso-dollar low relative to other currencies, making the goods in our import addicted economy more expensive.

The Leverage Factor

A while back I inquired into How Indebted Are We? At the end I posed the question of whether disposable income has kept up, specifically disposable personal income. Personal income lumps to many sources of "revenue", such as inventory valuation adjustments, that is unrealistic in determining real income available for spending for the average consumer. I find compensation of employees to be a more suitable measure, since it is income from production, according to the Bureau of Economic Analysis:

"Compensation of employees, paid (1–1) shows the income accruing to employees as remuneration for their work for domestic production; it includes compensation paid to the rest of the world and excludes compensation received from the rest of the world. It is the sum of wage and salary accruals and of supplements to wages and salaries."

A better measure no doubt, in considering if our incomes have grown proportionally to our household debt, but supplemental wages distort this:

"Supplements to wages and salaries (1–5) consists of employer contributions for employee pension and insurance funds (3–15) and of employer contributions for government social insurance (3–16)."

Surely this increases our wealth, but counting supplements as a wage is distorting since it is deferred and not readily available for spending. Also included are wage and salary accruals, which severely skews compensation of employees since we all know bonuses are handed out like fliers, especially on Wall Street. Compensation is reported gross, so a large chunk of this will find its way to Uncle Sam. The bottom line is that compensation to employees is logically overstated in terms of the average consumer. Compensation since 1980 has increased 375%, a chart for you to drool over:

If you remember from How Indebted Are We? consumer credit outstanding increased by 877% since 1980.

So overstated compensation in terms of the average consumer accounts for only 57% of the debt outstanding. Now that doesn't sound so bad at first, but a crucial point to remember is that consumer debt outstanding is only a portion of how leveraged consumers are, case in point is the massive increases over the past decade in food and energy costs. To borrow some info from Energy Affecting Food Prices at Mish's site:

"Nearly every food staple has seen a double-digit percentage increase over the past year, including a 38% hike for a dozen eggs, to $2.16, and a 19% jump, to $1.78, for a loaf of white bread, according to American Farm Bureau data. With Americans spending 15% of their household income on food and drinks, rising prices in the grocery aisles have spurred consumers to hunt savings."

Rising prices in the economy makes that debt outstanding more significant and now with home equity in free fall and in some cases negative equity compared with mortgages, look for a long deleveraging period.

Blog Alert

Market Process is a useful and informative new blog created from a close associate of mine. The blog gives links to and quick excerpts from other blog posts in a "Daily Top Five", very cool. Some of the blogs referenced may look familiar (check out blogroll).

(click the title to automatically link to Market Process)

Housing Pain

Today's headlines, among other things brought us housing starts and what others may perceive as bad news, I find good in:

March privately owned housing starts came in at 11.9% lower levels than February's numbers and 36.5% below March 2007 levels.

Considering the abundance of inventory levels of homes for sale, this is good news, home builders are finally starting to recognize the need for downscaling their operations. The oversupply of this inventory is only acting to exacerbate the problem of declining home prices. Builders created too many homes for too long as teaser rates flooded the markets with Greenspan cheer leading at their side. So to have a visual on where inventory stands I compiled two charts from census bureau data; housing starts and houses for sale.

I encourage you to investigate into Inventory, Inventory, Inventory, an article from Calculated Risk as they did an excellent job in describing what all this data means, but I will highlight some important concepts for you to note:

"the Census Bureau ignores cancellations (here is the Census Bureau description of how they handle cancellations), so during periods of rising cancellation rates, the Census Bureau overstates New Home sales and understates the increase in inventory. Conversely, during periods of declining cancellation rates, the Census Bureau understates sales. Second, new home inventory excludes many condominiums, and in certain communities (like Miami and San Diego) there are anecdotal stories of a glut of condos."

(1) According to the Census Bureau there are 35.12 million rental units in the U.S. If the rental vacancy rate declined from 9.6% to 8%, there would be 1.6% X 35.12 million units or about 560,000 units absorbed.
(2) Based on the homeowner vacancy rate declining from 2.8% to 1.7% on 75 million units.
(3) Based on a return to 5 months of hard inventory (completed or in process). 100,000 additional units are included based on rising cancellation rates."

Currently, the Census bureau is predicting there is 9.8 months supply of inventory at the current sales rate. But factoring in an additional 100k additional units based on high cancellation rates assuming constant sales would bump that number up close to 12 months. As noted in the Calculated Risk article, 5 months inventory is close to the historic level. The Calculated Risk article also looks into alternative housing measures such as rents and total existing inventory, but for our purposes here I found homes for sale a suitable metric.

A credit burdened consumer in a slowing economy should be reluctant to enter new housing contracts, so predicting an increase in home sales is a bit stretched. It seems logical to predict housing starts will have to keep plummeting further to get untangled from this mess. Please see How Indebted Are we? to get a better idea of how consumer credit stands.

Peter Schiff on Markets

Peter Schiff of Europacific Capital Management is simply the man and he's been right about the direction of our economy for years. Since I'm on a bit of a video kick, here's some more mind candy:



Peter Schiff on Current Market Conditions Jan 2008

Essential Video - The Money Masters

As my title suggests, this video is of crucial importance in understanding our truly flawed banking system and The Fed. My apologies however as this is a 3 1/2 hour video (YIKES!). So whip up some popcorn, find your favorite easy chair, relax, and most certainly enjoy!



The Money Masters - How International Bankers Gained Control of America

Bush Has A Point!

The Real Speech of George W. Bush

Bernanke: The Man, The Magician

Big Ben has managed quite a feat in the past month; he has successfully issued $130 billion dollars in US Treasuries from their balance sheet and yet the MZM has still managed to increase...enjoy:

What's puzzling is the massive issuance of US Treasuries from the Fed's balance sheet, which normally contracts the money supply. The answer may come from this article from the Von Mises Institute Inflation Is A Policy That Cannot Be Last.

"There are basically three strategies the government can pursue to prevent a contraction of the credit and money supply caused by a breakdown of the banking sector.

The first strategy is to inject peoples' tax money into banks, thereby socializing (part of) the domestic banking industry. Under the second strategy, the government would simply buy banks' risky assets, thereby making available (what is left of) banks' equity capital for new lending.

However, it does not take much to see that both strategies might be highly unpopular. In particular, to finance capital injections and/or purchases of banks' risky assets, the government would have to take recourse to tax financing — using either current taxpayer money or, in the case in which the government issues bonds, future taxpayer money.

However, there is the third strategy available to the government, a much more subtle and very powerful way of redistributing peoples' resources through the hands of the state: increasing inflation by making the central bank buy banks' risky assets. In fact, such a strategy amounts to creating inflation via monetizing banks' risky assets.

If the central bank buys banks' bond holdings in the amount of US$1,440, banks' base-money holdings rise to US$1,500, with excess reserves rising to US$1,469.90 (Fig. 4).[9] Banks' equity capital ratio rises to 11.3%, allowing banks to increase credit and money supply by US$1,440. If banks start lending, the loan supply would increase to US$4,875, with the stock of payments rising to US$1,445 (Fig. 5).

With remaining excess reserves of US$1,441.10, banks could decide to buy government bonds (for which banks do not have set-aside equity capital), thereby increasing the money supply.[10] However, the societal damage of an accelerating inflation would not stop here if the system of fractional-reserve banking under the auspices of the government remains in place."

The Fed has effectively pursued this policy with its TSLF, so the decrease in the money supply that normally occurs wasn't the case. In fact, because Treasuries fairly liquid, it most likely acted to increase bank cash and lending. Consider the Total Loans and Leases of US Commercial Banks:

Commercial bank lending is still increasing despite the credit crunch in the residential mortgage backed securities market. So in honor of Bernanke's talent in the dark arts, please enjoy the following:

The Legend of Sub-Prime

I found an excellent working paper for the whole sub prime debacle explaining how the mess unfolded from the start of the early 90's, at a moderated and risk adjusted pace, to the careless risk ignorant system that flooded the market in 2004. Here are the most important parts of the paper:

"Until 1997, the vast majority of home equity ABS had used bond insurance for credit enhancement. Thus, the bond insurers were the main group of market participants pricing the credit risk on deals backed by sub-prime mortgages. A bond insurer would set its premium (fee) for a given deal based on its analysis of the underlying loans and on the seller/servicer's track record. Moreover, a bond insurer would not accept unreasonably risky loans for inclusion in deals that insured. The bond insurers' willingness to say "no" was a key constraint on the riskiness of loans that originators could make.
Around the middle of 1997, issuers of sub-prime mortgage ABS started using subordination as the method of credit enhancement in a growing proportion of their deals. The investors who purchased the subordinate tranches of those deals were generally ones that had significant mortgage expertise and extensive experience investing in the subordinate tranches of deals backed by mainstream mortgage loans. Like the bond insurers, the traditional subordinate investors were methodical in their pricing of risk and were willing to say "no" to loans that carried too much risk.
The subordinate investors became a source of competition for the bond insurers in the subprime mortgage area. Rather quickly, the market established an equilibrium, where bond insurance provided credit enhancement on about half (40%-55%) of the new deals and subordination provided credit enhancement on the remainder. That balance persisted from 1997 through 2002.
The bond insurers and the subordinate investors provided a critical benefit to the whole system. As the key players who accepted and priced credit risk on sub-prime mortgage loans, they provided a market-based limitation on the riskiness of loans that sub-prime lenders could securitize. Moreover, because both the bond insurers and the subordinate investors had substantial experience and deep expertise in the area of mortgage risk, their pricing decisions and their risk tolerances were sensible.
Things started to change in important ways in 2004. Structured finance assets particularly home equity ABS became the main asset class backing collateralized debt obligations. For the full year, structured finance assets accounted for half of the assets backing arbitrage CDOs. In fact, the market started creating "synthetic ABS" (i.e., credit default swaps on ABS) to meet the strong demand from the CDO sector. The surging demand from the CDO sector helped spreads on triple-B-rated home equity ABS to tighten notably during the second half of 2004. By the end of that year, spreads on triple-B-rated home equity ABS had reached their tightest levels since
1998.
The trend continued into 2005. CDOs had a growing and seemingly insatiable appetite for home equity ABS. ISDA's introduction of standardized forms for creating CDS on ABS accelerated the trend. Spreads on triple-B-rated home equity ABS became so tight that the bond insurers and the traditional investors stepped to the sidelines, leaving the CDOs as the sole investors for subordinate credit risk in sub-prime mortgage ABS. This was the key event that changed everything.
The CDOs were less selective and discriminating than the bond insurers and the traditional investors had been. In particular, the CDOs were willing to accept loans in securitizations that the bond insurers and the traditional investors would have rejected. Thus, when the bond insurers and the traditional investors left the market, the benefit that they had provided a limit on the riskiness of loans that originators could securitize disappeared. In effect, there was no constraint on the riskiness of sub-prime loans that could be included in securitizations. With no constraints, lenders began originating riskier loans. In fact, there is a clearly discernable trend of
deteriorating sub-prime loan quality that starts in late 2005 and runs into 2007.1
Why were CDOs willing to accept ABS backed by unreasonably risky mortgage loans? Perhaps it was because the managers of the CDOs lacked the knowledge and experience of the bond insurers and the traditional investors. More likely, however, it was because the CDO managers did not care. The CDO managers did not bear the primary risk of their investment
decisions. Rather, the investors in the CDOs were the ones who bore the risk. The CDO investors generally were not mortgage experts, but rather relied on modeling assumptions and Monte Carlo simulations as the main basis for judging the credit risk of their investments. Some CDO investors may not have fully understood the math and the assumptions behind the analysis. Some may have pretended to understand it in order to avoid appearing ignorant or unskilled in math. Some probably understood it and (naïvely) accepted it. In doing so, they ascribed mathematical properties to the underlying sub-prime mortgage ABS default probabilities, recovery rates, and correlations when they should have been focusing on the actual loans and on the lending process.
Somewhat ironically, the several of the bond insurers ended up with significant exposure to the sub-prime problem through their CDO departments. They took exposure to the senior or "super senior" tranches of CDOs that invested in the ill-fated ABS deals of 2005 and 2006. The CDO departments within the bond insurers seem not to have bothered calling on the expertise of their colleagues in the mortgage departments of those companies. However, in fairness to the bond insurers, many other firms (including some of the largest investment banks) fell victim to the sub-prime problem through their CDO departments."

The actions of the bond insurers and investment bank CDO departments reminds me of a story Warren Buffett has shared in some of his annual reports (recounted to the best of my ability) where a speculator finds himself at the gates of Heaven and is informed there is no room left. The speculator asks if he can speak to the crowd, and once allowed he yells "Oil struck in Hell!" Everyone from Heaven's gates rushes to Hell to find their share. The speculator is then told there is room in Heaven now, but instead of entering he says "I think I'll head south, their might be some truth in that rumor after all".

The Sub-Prime Problem: The Causes and Losses

Bank Write-Downs: where we are and where we're going

Check out this bank write down chart courtesy of An Investment Banker's Take on Life:

If there is truth to the expected $1 trillion dollars in write-downs, then we're not even 1/4 way through in terms of more write-downs to come globally, expect more pain. From Naked Capitalism Goldman: Wall Street faces $460 billion in write-downs.

"Goldman Sachs forecasts global credit losses stemming from the current market turmoil will reach $1.2 trillion, with Wall Street accounting for nearly 40 percent of the losses."

Contagion Spreads to the Education Industry

Consider the 6 month performance of the education services industry relative to the S&P courtesy of Google Finance:

• Schools -24.07%
• S&P -11.66%

The industry slump comes from concern over private student lenders, who securitize the student loans and sell them to investors. This is the very same process as with the MBS that have wreaked havoc on the market since the latter half of 2007 when the large write downs began. This creates a contagion effect and there has been a huge slowdown in the student loan ABS market; according to Securitization.net,

"Overall, issuers completed $58.8 billion of student-loan securitizations last year, according to Asset-Backed Alert's ABS Database. Some $18.4 billion of those deals priced by the first week of March, placing the year-to-date slowdown at 67%."

With such a large slowdown in student lending the concern then switches over to the education institutions themselves with worries over enrollments and the industry is down approximately twice as much as the S&P to reflect that. However, Uncharted Waters writers and readers know better and can smell a possible bargain like poo on a baby! The cards don't lie child (lord o mercy!):

• Apollo Group, Inc. (APOL) -39.21%
• DeVry, Inc. (DV) -21.01%
• Strayer Education, Inc. (STRA) -11.31%

All three of these stocks are down big YTD as you can see. However, the contagion effect from the ABS worries is unjustified. Each of these three institutions have 5% or less exposure to private loan revenues. Why is this significant? Well because government issued student loans are federally guaranteed up to 97% in the case of default. This is even true for securitizations where government issued student loans are included.

"For the issuers' part, many industry players describe the crisis as a question of liquidity, rather than credit quality. Since most of the loans backing auction-rate student-loan paper carry 97% guarantees from the federal government, investors would likely be made whole even in the event of widespread collateral defaults. That has some calling the exodus from auction-rate notes the result of panic."

Because of the lack of exposure to student private loans though, these three institutions haven't been affected in finding sources of capital for their enrollments:

• DeVry, Inc. saw total undergraduate enrollment increase by 10.3% from fall 2006 to fall 2007.
• Apollo Group, Inc. saw an 11% increase in average degreed enrollment for the 6 months ended February 2008 relative to February 2007.
• STRA had a 16% increase from the previous year in average enrollment

It appears the bombardment of all of the educational service industry isn't 100% warranted and has been exposed to contagion from fears in this credit crisis.

A Second Look at Educational Services and Student Lending Problems

Key Education - Lending Source Obliterated

Education Lenders Transferring to Floaters

DV 2007 10K

APOL Q2 10Q 2008

STRA 2007 10K

Investing on Hope

There is a sentiment out in Wall Street land today, lead of course by the UBS write-down, that hope is in the air. The news is all over the major publishers today;

"Stocks started off the second quarter with a rally on Tuesday as investors weighed a fresh round of mortgage-related write-offs at UBS and Deutsche Bank, two of the world’s largest financial institutions.

But despite the discouraging numbers — $19 billion in write-downs at UBS and nearly $4 billion at Deutsche in the first quarter alone — investors hoped that the bad news could signal the last of Wall Street’s subprime woes.

As reported in the NY Times article Shares Surge on Bank Write-Downs

“It’s psychological,” said Richard Sparks, a senior analyst at Schaeffer’s Investment Research. “When a company comes out and writes down more, it leads people to believe that they’re being forthright.”

“We’re hoping that we are closer to the end than the beginning,” he added."

The market in turn saw a flight from treasuries into the financials today as a result of the write-downs. The Relatively Good News in the article:

"A closely watched manufacturing report, prepared by the private Institute for Supply Management, ticked up last month, though business is still shrinking within the industry. The gauge of manufacturing activity edged up slightly to a reading of 48.6 in March from 48.3 in February, slightly better than expected. Any reading below 50 is seen as a sign of contraction.

Elevated export orders continue to offset flagging domestic demand, but manufacturers are feeling the effects of inflation: a gauge of prices paid for production materials reached its highest level in nearly 6 years.

Spending on construction projects also improved, as overall spending fell 0.3 percent in February after declining 1 percent in January, the Commerce Department said on Tuesday. Government-financed building is increasing even as private residential construction remains in a slump.

Investors were also buoyed by a drop in commodity prices, which have reached record levels in recent weeks. The declines in prices for oil, gold and wheat could translate to cheaper prices for consumers.

Crude oil has fallen for three consecutive days; it dropped by $0.41 on Tuesday to just under $102 a barrel. Gasoline prices were also trading lower. Gold, which becomes more expensive in times of crisis, declined to $888 a troy ounce after reaching $1000 just two weeks ago."

Better than expected does not imply strong fundamentals. Hope is a hell of a thing to invest on; better save it for the tracks. I already outlined why we are not going to see an upturn any time soon in Why is Market Cheerleading so Prevalent? Besides, investors and traders have already hoped before that the write-downs were all but over back in Q4 2007. David Gaffen of Marketbeat explains this conundrum Behind the Write-down Rally:

"With Tuesday’s 300-point increase in the Dow Jones Industrial Average, investors are engaging in a familiar game — buying shares of equities, particularly financial stocks, on the hope that the worst news has been accounted for in current share valuations....

...Several earnings-related releases produced rallies in the financial-services sector. On Oct. 1, 2007, Citigroup Inc. shares gained 2.2% after the company announced a $5.9 billion write-down on its subprime-mortgage exposure. A few days later, on Oct. 5, Merrill Lynch & Co. Inc. admitted to a $5.5 billion write-down — sparking a 2.5% rally in Merrill stock. And about a month later, on Nov. 8, Morgan Stanley shares gained 4.9% after the company announced a $3.7 billion loss on sub-prime exposure.

“Everybody said, ‘this is the kitchen sink quarter,’ and it turned out not to be,” says David Joy, chief market strategist at RiverSource Investments, a unit of AmeriPrise Financial. “Now we’re getting the same sort of sentiment here, and it remains to be seen whether this is truly the kitchen-sink quarter. There’s some optimism that it will be.”

Until housing prices return to normal price levels vs. housing rents and inventory in the housing market has decreased significantly I wouldn't get your hopes up too much because those are the sources of our economic burdens now and the they must be unwound before a market bottom can be realized. Furthermore, analysts and traders better also hope corporate profits improve, because the BEA Q4 GDP & Corporate Profits news release was fugly!

"Domestic profits of financial corporations decreased $74.4 billion in the
fourth quarter,compared with a decrease of $32.5 billion in the third.
Domestic profits of nonfinancial corporations decreased $34.3 billion in the
fourth quarter, compared with a decrease of $14.4 billion in the third."
That is simply astounding, non-financial profits are declining faster than
financial profits!