The Smart Money

# Warren Buffet says "there's going to be more pain" and that the Bear Stearns bailout "doesn't mean the losses are over by a long shot."
# After taking $45 billion in write-downs and losses over the past nine months, Citigroup announces plans to sell $400 billion in assets in an attempt to keep itself afloat.
# American International Group announced another round of record quarterly losses, detailed plans to raise $12.5 billion in capital, and said that there can be "no assurance" that the losses are over.
# The Financial Times reported that "Bankruptcies and Defaults Gather Pace"

Shrinking Citi

The banking giant said Friday it will sell at least $400 billion of the $500 billion in legaccy assets it identified as "not central" to its mission, including $170 billion worth of marked-to-market assets in its investment banking division. The planned sale, which will take place over the next three years, is more than double what analysts expected.

For example, of the $500 billion in "legacy assets," $30 billion is in highly leveraged loan commitments, another $25 billion is toxic subprime collateralized-debt obligations, and $55 billion is in off-balance-sheet entities that are highly illiquid. The rest are in real estate ($175 billion) and auto loans ($20 billion).

The New York Times on Friday said Pandit is preparing to sell Citigroup's Primerica Financial life insurance and mutual fund complex, the business on which Sandy Weill built his financial empire. Other divisions likely for sale are a back-office outsourcing unit in India, retail brokerage operations in Australia, and possibly bank branches in Germany, according to the paper. Citigroup, according to sources, also may be trying to sell its defined-benefit business operations in Latin America.

Citi needs to cut at least 45,000 jobs and eliminate the dividend today and sell non-core assets over the balance of this year not 3 years!

SEC Christopher Cox Speech

In the immediate aftermath of the Bear Stearns meltdown — and by immediate, I mean within days — the SEC has focused on the need to change the standards for measuring the adequacy of liquidity in light of the "run on the bank" that Bear experienced. Three days after the Bear transaction, I wrote to the Basel Committee to offer strong support for extending the existing capital adequacy standards to deal explicitly with liquidity risk. And in the ensuing weeks, the SEC has arranged to join with the Basel Committee in this important work. At the same time, without waiting for new internationally accepted standards, the Division of Trading and Markets has strengthened the liquidity requirements for CSE firms relative to their unsecured funding needs. They are closely scrutinizing the secured funding activities of each CSE firm, with a view to lengthening the average term of secured and unsecured funding arrangements. And they are currently obtaining funding and liquidity information for all CSEs on a daily basis, and discussing with CSEs the amount of excess secured funding capacity for less-liquid positions. There will also be more disclosure of actual capital and liquidity positions of the CSE firms in terms that the market can readily understand and digest. The CSEs will institute public disclosure of their capital ratios computed under the Basel Standard later this year, and then phase in additional disclosure related to concentration of exposures.

S&P forward P/E = 20.5 (vs. 15-16X trailing earnings)

Despite P/E contraction since July 2007, market is not cheap. Historical average P/E b/w 15-16 is based on 1-year trailing reported earnings, not on forward operating earnings. S&P 500's current P/E of 20.5 as of Apr 10 is at top of historical range based on forward earnings

The Fed is getting Desperate ...

In mid-March – at the peak of the crisis - the Fed did not just partially bail out the Bear Stearns shareholders who would have been totally wiped out in the case of a disorderly collapse of Bear Stearns; more importantly the Fed effectively bailed out JP Morgan that had – like Bear – and still has a massive exposure to the CDS market; it bailed out the creditors of Bear Stearns who would have suffered massive losses if the Fed had not outright bought $29 billion of toxic securities held by Bear; and it effectively bailed out Lehman, Merrill and a good chunk of the shadow financial system as the Bear Stearns bailout – together more importantly with the new TSLF and the PDCF facilities – ensured – for the first time since the Great Depression - that systemically important broker dealers would have access to the lender of last resort support of the Fed. Without these new facilities and the Bear bailout a generalized run on many institutions of the shadow banking system would have occurred.

While the extreme tail risk of a systemic financial meltdown – and we were in mid-March one epsilon away from such a generalized run on most of the shadow banking system – was avoided by the trifecta of the Bear Stearns bailout, and the creation of the TSLF and the PDCF facilities the stresses in the financial markets – liquidity and credit crunch - remain severe as even the FOMC had to admit in its latest statement.

The severity and persistence of the liquidity crunch is evident from the fact that in the interbank markets spreads (Libor/OIS + TED) remain extremely high and still close to their peaks since this crisis started last summer in spite of 325bps Fed Fund ease by the Fed, in spite of the creation and vast expansion of the TAF auctions (now up to $150 billion over a month), in spite of the creation and extension of the TSLF, in spite of the creation of the PDCF.

Why? Banks and non bank primary dealers having access to the Fed liquidity are hoarding such liquidity and not relending it to the other members of the shadow banking system for two reasons. First, they need that liquidity for themselves as the roll-off of SIV and conduits and concerns about future liquidity needs have led to a massive need for liquidity insurance; second, given the counterparty risk – who is holding the toxic waste and how much of it – that an opaque and non-transparent financial system has created no one trust its counterparties and is willing to lend them money on a term basis.

Thus, monetary policy can address illiquidity problems but cannot resolve credit and insolvency problems. And this US economy now suffers of a virulent strain of illiquidity and insolvency problems. So the liquidity crunch remains severe in spite of all of the extreme policy actions by the Fed and other central banks.

Eye of the Hurricane

From Reuters: JPMorgan says no near end to financial crisis: report

"We can only speculate how deep and how long the recession in the United States will really be and how that in turn will impact banks," [JPMorgan Chase & Co CEO] James Dimon told "Welt am Sonntag".

"But we are not done with the crisis for a long time," Dimon said ...

And from Goldman Sachs: Eye of the Storm (research report no link). Goldman argues there is a "gaping hole in the side of the U.S. economy" from falling house prices (significantly more price declines to come in their view) and too much supply.

[Fiancial market] relaxation is unlikely to mark the start of a sustainable recovery.

... the evidence for spillover effects from housing via the credit crunch, wealth effects, and multiplier effects in the broader economy is mounting, particularly as far as consumption is concerned. ... In an absolute sense, the data this week were clearly quite poor.

And from the WSJ: Downgrades Show Storm Isn't Over

ResCap's credit rating was cut deep into "junk" territory after it unveiled plans to restructure $14 billion of debt and possibly borrow billions more from its parent, GMAC LLC.

Countrywide's debt rating was slashed to junk from investment grade by Standard & Poor's after Bank of America Corp. said it isn't sure it will stand behind roughly $38 billion of Countrywide debt.

Credit markets have become substantially calmer since the Federal Reserve helped avert a complete collapse by Bear Stearns Cos. in March. Friday's downgrades were a reminder that other big financial institutions are still struggling under the weight of problem mortgages.

Calculated Risk: "Being in the eye of the hurricane can lead some people into thinking the storm has passed. Maybe. But probably not.

With falling house prices, less mortgage equity extraction, less consumption, and falling business investment (especially for non-residential structures), there is more storm damage to come."

Financial Market Liquidity