Subprime Still Dominates Markets, Banking

Here are my thoughts this Monday morning:

1) Citigroup's earnings were about in line with their own drastically reduced guidance they gave a couple weeks ago. Fixed income was poor as expected, and consumer delinquency rates continue to uptick. International posted strong revenue growth (up 30%) Conference call at 8:30 am.

2) Diversified manufacturer Eaton beat but lowered their guidance, citing the weakness in housing. Down 6% pre open.

3) We'll have a much better view of the U.S. economy in the next two weeks. Stocks like UPS, CSX and Office Depot are good proxies for the U.S. economy, while financials like Bank of America, JP Morgan and Wells Fargo will provide additional color on the subprime issue. Tech stocks like Intel and Google will have to provide some kind of color to back up their recent strong showings.


For the moment, much of the reason behind the recent rise in prices remain in place. First, corporate share repurchases continue at a near-record pace, with $2.9 billion in estimates repurchases daily. Also, cash takeovers, despite the slump in LBO deals, remains strong, with strategic acquisitions like Oracle's attempted takeoverof BEA Systems still strong.

4) Speaking of subprime: M-LEC to the rescue? Wall Street has been chuckling all weekend about the plan to address the subprime mess. Dubbed Master-Liquid Enhancement Conduit (M-LEC), it involves several big banks, including Citigroup, that are expected to create a pool to back up to $100 billion in mortgage securities. These discussions were supposedly instigated by the Treasury Department. The worry is that banks will have to sell billions of dollars in mortgage-backed securities at a steep discount, which would of course means big write-offs and a lot of people unable to refinance their mortgages.

Citigroup has been at the forefront of these discussions, and for good reason: it is a leader in these funds that have been set up to own mortgages, called structured investment vehicles (SIVs), which are theoretically independent of the banks that set them up. They issue their own short-term debt and use the money to buy longer-term, higher yielding assets, but recently many of the SIVs could not roll over their debt due to concern about the quality of the underlying assets.

This M-LEC would essentially be a superconduit: that is, it would be a fund set up by several banks that would itself issue short-term debt and buy some of the assets from the SIVs. But what's the difference, you might ask? Aren't we just taking a lot of junk from one bucket, and throwing it into another bucket? What's the secret sauce here? Perhaps some kind of implicit guarantee from the banks, or the government itself? And of course the big problem is how to price the underlying assets.

This is a reminder that the subprime mess has not left the minds of bankers, or Treasury Secretaries.

Questions? Comments?