Wednesday, September 12, 2007

Feeding the Beast

It doesn’t seem so long ago that the evils of CFC's (Chlorofluorocarbons) were being vilified in the press. Today we have a different type of negative connotation to CFC's (Countrywide Financial Corporation). Blamed for much of financial liquidity crisis and turmoil during August 2007 (they were just being greedily like everyone else, but they got a little too greedy) they are once again hungry and need to feed. Such financial behemoths have incredible burn rates (the basic unavoidable running costs of doing business, before any revenue is generated).

Did I mention the housing recession and that only this week several home builders were offering over $100,000 in incentives to get people to clear out some of their massive and costly inventory and provide them with some cash flow and liquidity. Did I also mention the commercial paper that needs to be rolled and isn't finding a home this week, or the off balance sheet debts that are starting to cry for help and also the vastly reduced number of buyers of CMO's (Collateralized Mortgage Obligations) ABS's (Asset Backed Securities), who don't want to share I the risk of loan pools where FICO scores no longer give any indication of who will or won't default due to relaxed underwriting standards, who Countrywide and other originators and banks need to securitize (pass debt onto to) write loans.

It is only 3-4 weeks since Bank of America became a "national hero" and bought $2Bn (shoring up the market and calming everyone's fears) of preferred stock to try and add to the war chest of the largest mortgage originator in the USA. That was on top of $11.5Bn short term credit lines drawn down upon the week earlier. Now Goldman Sachs is trying to put together another round of funding, possibly including J.P Morgan, Merrill Lynch etc.

Are intelligent people throwing good money after bad, surely not shrewd investment banks, it must mean Countrywide will be fine I hear people say. Maybe it is just my cynicism but I believe that whilst Countrywide may well survive in one guise or another, the vultures are lining up for the pickings, as well as protecting their already large investments. How are they doing this I hear you ask, simple, they are buying convertible preferred stock!

What does that mean in reality; it means that if Countrywide defaults or ceases trading they are the first in line to be paid, subjugating all the common shareholders. With assets being sold at cents on the dollar, their $2Bn may well clean up the majority of the real and semi-liquid assets of Countrywide whilst clearing debt, rental agreements, bad credit etc etc.

Okay I am sure I just heard you gasp!

Gasp you should, Countrywide just about managed to pay its staff and dividends due at the end of this month, but without significant loan generation, they will be light on revenue so how will they pay next month! That is why I say these savvy investment bankers are not throwing good money out of bad, they are protecting what will be theirs at the expense of the everyday common shareholders and a board of a company fighting for its very survival is boarding the life raft to leave the sinking ship. Why do I say this, well to build a business you need to be able to borrow and bankers are usually the people doing the lending. So if you scratch their back, they wouldn’t want to you too waste all your skills and talent and energy, so they will invest in you when you coming looking for funds for you new venture in 4-6 months when the smoke has blown away and the bare and empty carcass of CFC is finally laid before the common stock holders!

Did I mention the savvy bankers hedge, should countrywide prove canny enough to survive by a hairs breadth, they can convert their preferred stock into common stock at $18 something a share and have a nice return on their investment!!!

Dare I utter the whisper of the name of another much vaunted company – ENRON!

P.S The car industry will be the next to suffer as dealers give away cars with huge incentives and ultra low financing (even Honda the most frugal of all companies) to clear inventories ready for 2008 models!!!

P.P.S By the way if you haven't realized all this spells the way for a recession of "Great Depression" portions

Copyright Jonathan Rose 2007 - Creative Commons License

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