Gold Rebounds as Dollar Tumbles After Fed's Interest-Rate Cut

(Bloomberg) -- Gold rose after an emergency cut in U.S. borrowing costs reduced the value of the dollar, boosting the appeal of the precious metal as an alternative investment.

The Federal Reserve slashed its benchmark interest rate 0.75 percentage point to 3.5 percent after global equity markets tumbled on concern the slumping U.S. economy will drag down the growth rates of other nations. Gold rallied 31 percent in 2007 after the Fed cut rates by 1 percentage point, sending the dollar down 9.5 percent against the euro.

``This is a pure dollar play if ever there was one,'' said Jon Nadler, an analyst at Kitco Minerals & Metals Inc. in Montreal.

Gold futures for February delivery climbed $8, or 0.9 percent, to $889.70 an ounce at 11:57 a.m. on the Comex division of the New York Mercantile Exchange. The price earlier fell as low as $849.50.

Gold for immediate delivery rose $24.22, or 2.8 percent, to $889.22. The price fell 2.1 percent yesterday, when the Comex was closed for Martin Luther King Jr. Day.

The rate cut was the biggest single reduction since the Fed began using the benchmark as the principal tool to control monetary policy in 1990. The dollar dropped as much as 1.3 percent against the euro.

``Lower interest rates are very good for gold because the dollar will weaken against other currencies,'' said Marty McNeill, a trader at R.F. Lafferty Inc. in New York.

Policy makers are scheduled to meet on Jan. 30. Interest- rate futures show a 70 percent chance the Fed will cut the benchmark rate 0.25 percentage point to 3.25 percent at that session, compared with no chance a week ago.

`Total Meltdown'

``At this point, the Fed looks like they're asset- senstive,'' said Frank McGhee, head metals trader at Integrated Brokerage Services LLC in Chicago. ``They're going to put liquidity in the market to keep stock prices higher and a total meltdown from happening.''

U.S. stocks tumbled for the fifth session with the Dow Jones Industrial Index plunging as much as 3.8 percent before paring losses. European stocks rose for the first time in six session after the Fed's surprise cut.

``Market participants see weakening economic conditions as the cause of the emergency rate cuts and stronger inflationary pressures as a result,'' said Stuart Flerlage, who helps manage more than $600 million at NuWave Investment Corp. in New York ``This will continue to provide a strong bid for gold.''

 

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Ambac, MBIA's Lust for CDO Returns Undermined AAA Profitability

(Bloomberg) -- Municipal bond insurers such as MBIA Inc. and Ambac Financial Group Inc. had a good thing going.

For years, they earned some of the highest profit margins in any industry -- by writing coverage for securities sold by states and cities to build roads, schools and firehouses. During the past five years, MBIA's average profit margin was 39 percent, more than four times the average of the Standard & Poor's 500 Index, according to data compiled by Bloomberg. Ambac's average profit margin was 48 percent.

The good times are over, and the culprit isn't municipal bonds; it's subprime debt, a market the insurers waded into in pursuit of even greater profits. Some of the biggest bond insurers are facing potential claims that may deplete their capital. Their share prices have plunged, and credit rating companies are scrutinizing their AAA status. Ambac became the first insurer to lose its triple-A rating, when Fitch Ratings downgraded the company to AA on Jan. 18.

With the main players distracted by subprime woes, billionaire investor Warren Buffett's Berkshire Hathaway Inc. is expanding into their core business of insuring bonds in the $2.6 trillion municipal market.

``The good, solid, old-fashioned but profitable business may gravitate over to Berkshire Hathaway,'' says Mark Adelson of Adelson & Jacob Consulting LLC, a New York firm that advises on the structured finance market. ``That was the bond insurers' anchor; that's what saw them through.''

The crisis has been brewing for about six years, ever since the insurers discovered collateralized debt obligations. These securities, part of an area known as structured finance, were created by Wall Street by repackaging assets such as mortgage bonds and buyout loans into new obligations for sale to institutional investors.

Subprime Home Loans

Attracted by top ratings from Standard & Poor's, Moody's Investors Service and Fitch and by lucrative premiums, the insurers agreed to pay CDO holders -- many of them banks that created the securities -- in the event of a default. Insurers backed $127 billion of CDOs that relied at least partly on repayments on subprime home loans, according to a Dec. 19 report by S&P, the No. 1 credit rating company.

``It looked so profitable and so easy that they let the portfolio shift too far toward structured finance,'' says Robert Fuller, who runs Capital Markets Management LLC, a Hopewell, New Jersey-based firm that advises municipalities and nonprofits. ``It morphed into this monster that is devouring them.''

CDO Rating Cuts

The tipping point came last year when the three major rating companies downgraded thousands of CDOs. Ratings on more than 2,000 CDOs were cut in November alone, with Fitch lowering CDOs backed by subprime mortgages 9.6 levels on average, according to a Dec. 13 UBS AG research report.

Rating cuts on CDOs and other securities backed by subprime mortgages and home equity loans led S&P to conclude bond insurers faced potential losses of $19 billion, the rating company said in its December report. That sent insurers scrambling for additional capital to protect their own credit ratings from being cut -- by the same companies whose judgments they had relied on in backing the CDOs.

Fitch Ratings said at the end of December that MBIA, Ambac and FGIC Corp., the fourth largest, had four to six weeks to raise $1 billion each to keep their AAA ratings.

MBIA Raises Capital

Seeking to avert a crippling reduction of its triple-A rating, MBIA, the largest of the companies, said in December that it would raise as much as $1 billion by selling a stake to private equity firm Warburg Pincus LLC. It said Jan. 9 that it will slash its dividend to 13 cents a share from 34 cents, and two days later it paid a yield of 14 percent to sell $1 billion of surplus notes, bonds issued by insurance companies that state regulators consider equity.

Shares of the Armonk, New York-based company fell 86 percent on the New York Stock Exchange to $8.55 on Jan. 18 from $60 on Aug. 31.

Ambac, the second largest, replaced Chief Executive Officer Robert Genader, 60, on Jan. 16, cut its dividend 67 percent and said it would raise more than $1 billion in capital. Two days later, it scrapped the plan to raise capital. The New York-based insurer's shares dropped 90 percent to $6.20 on Jan. 18 from $62.82 on Aug. 31.

Blackstone Group LP, the New York buyout firm run by Stephen Schwarzman, said Jan. 10 that it may write down its stake in FGIC, which it bought from Fairfield, Connecticut-based General Electric Co. in 2003 along with PMI Group Inc. and Cypress Group LLC.

First to Fall

The first to fall was ACA Capital Holdings Inc., whose ACA Financial Guaranty Corp. unit guaranteed $26.6 billion of CDOs backed by subprime mortgages, according to S&P. The New York- based firm was founded in 1997 by H. Russell Fraser, a one-time chairman of Fitch, to insure municipal bonds that triple-A rated insurers wouldn't cover.

S&P slashed ACA Financial's rating to CCC, a low junk level, from A in December and earlier this month suspended ratings on almost 2,150 bonds it insured. ACA Capital shares plunged 93 percent to 48 cents on Jan. 18 in OTC Bulletin Board trading from $6.70 on Aug. 31; the stock was suspended from trading on the New York Stock Exchange before the opening on Dec. 18.

``I knew that if they played with fire long enough, they were going to get burned,'' says Fraser, 66.

He left the company in 2001 over a dispute with the board about insuring CDOs, he says. Back then, it was debt of Enron Corp. and WorldCom Inc. -- companies that later filed the two largest bankruptcies in U.S. history -- that was being shoveled into CDOs.

Old West Museum

``Companies that were having problems or were growing very fast began to turn up in all the deals ACA was offered,'' says Fraser, who moved to Wyoming to run a 12,000-acre (4,856-hectare) ranch and turn a ghost town into a museum of the Old West.

Fraser, who first rated MBIA and Ambac in the 1970s as an analyst at S&P and later helped turn Fitch into one of the three major rating companies, says that while ACA's original mission had been to help finance projects such as nursing homes and rural hospitals, the board didn't want to allocate the capital needed to insure riskier municipal bonds.

Backing CDOs with credit-default-swap contracts was more alluring, Fraser says. Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a borrower's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should the borrower fail to adhere to its debt agreements.

Scooping Up Premiums

By using swaps, ACA wasn't limited to guaranteeing only securities with a lower credit rating than its own. It could compete with AAA-rated insurers to back top-rated CDOs while having to maintain less capital than the triple-A companies. The top-rated insurers collected annual premiums for insuring CDOs with swaps that were 50 percent of the capital the rating companies required them to maintain, S&P said in a July 2007 overview of the bond insurance industry. ACA was scooping up premiums that were 130 percent of its required capital.

``ACA has had good success assuming exposure to very low risk supersenior CDO tranches, where the goal of the counterparty is risk transfer and the associated mark-to-market relief,'' S&P said.

By December, after S&P completed a ``stress test,'' it projected more than $3 billion of losses on those low-risk securities. Alan Roseman, ACA's CEO, didn't return a voice mail message seeking comment.

Ridgeway Court Funding

The deals could be complex, sometimes involving layers of potential risk related to the same troubled assets while appearing to offer diversification. As recently as June, Ambac insured $1.9 billion of a CDO called Ridgeway Court Funding II Ltd. whose holdings include other CDOs, some of which contain still more CDOs, according to documents prepared for investment managers that were reviewed by Bloomberg News.

In one case, Ridgeway Court has a direct interest in Carina CDO Ltd., whose assets are being liquidated, according to a statement issued Jan. 7 by its trustee, Bank of New York Mellon Corp. Ridgeway also has an indirect interest through another CDO holding called 888 Tactical Fund Ltd. that has a stake in Carina. And it has still more indirect interest in Carina through two CDOs, Pinnacle Peak CDO Ltd. and Octonion CDO Ltd., that hold interests in 888 Tactical Fund, according to the documents.

Ridgeway Court Funding II experienced a so-called event of default after declines in the creditworthiness of its holdings indicated some senior investors may not be fully repaid, S&P said in a statement on Jan. 18.

Credit-Default Swaps

While the bond insurers made big bets on CDOs using credit- default swaps, others in the market used similar contracts to bet against MBIA and Ambac. Credit-default swaps tied to MBIA's bonds rose to 26 percent upfront and 5 percent a year on Jan. 18, according to CMA Datavision in New York. That meant it would cost $2.6 million initially and $500,000 a year to protect $10 million in MBIA bonds from default for five years. The price implied traders were putting the chance MBIA would default in the next five years at 71 percent, according to a JPMorgan Chase & Co. valuation model. Credit-default swaps on Ambac rose to 26.5 percent upfront and 5 percent a year, implying a 72 percent risk of default within five years.

Two of the seven top-rated municipal bond insurers have so far escaped the deepest pitfalls in the structured finance market: New York-based Financial Security Assurance Holdings Ltd., the third largest, and Bermuda-based Assured Guaranty Ltd. FSA is a unit of Brussels-based Dexia SA, the world's largest lender to local governments. FSA and Assured Guaranty are the only two bond insurers that deserve top credit ratings, says Janet Tavakoli, president of Chicago-based Tavakoli Structured Finance, who has written two books on CDOs.

`Faux Ratings'

``All the AAA ratings are faux ratings at this point, with the exception of FSA and Assured Guaranty,'' she says.

The three major credit rating companies have affirmed FSA's AAA rating with a stable outlook. Assured Guaranty, which earned a Moody's top Aaa rating in July, opened a new office in Sydney and plans to expand into Asia. Dexia shares declined 25 percent to 15.14 euros ($22.14) on Jan. 18 from 20.21 euros on Aug. 31, while Assured Guaranty shares fell 33 percent to $17.46 from $26.07.

The siren call of CDOs was too strong for most insurers to resist. Virtually all of the securities were rated triple A and backing them required very little capital.

``This type of risk is thought to be one of the most profitable for the bond insurers,'' S&P said in a 2007 industry report.

Risk-Adjusted Ratio

Annual premiums on CDOs averaged 50 percent of the capital that the rating companies required the insurers to set aside, according to S&P. That compared with an average risk-adjusted profit ratio of 8 percent for insuring other types of structured- finance securities.

What the insurers hadn't bargained on was that the rating companies themselves, including S&P, had grossly underestimated the risk of CDOs.

``Insurers got into trouble because they charged too little for the risk they took on,'' says Joshua Rosner, managing director of New York-based research firm Graham Fisher & Co. While they shielded banks from taking writedowns on their CDOs, they undermined their own credibility, Rosner says. ``They lost their way out of greed.''

The lack of data on the securities that backed CDOs should have been a red flag. CDO prospectuses warned that reliable default rates for some types of securities backing the CDOs didn't exist, Tavakoli says.

`They Got It Wrong'

Structured-finance adviser Adelson says analysts failed to see that the mortgage market was becoming riskier. They relied instead on models to predict the performance of CDOs based on historical defaults, recovery rates and correlation risks for various credit ratings. They didn't consider how piggyback loans, which are loans used to borrow a down payment, would perform when extended to people with a history of not paying their bills, Adelson says.

``They treated it like a math problem, and they got it wrong.''

That became obvious in October, when New York-based Merrill Lynch & Co., the biggest U.S. brokerage firm, announced $8.4 billion of writedowns on subprime mortgages, asset-backed bonds and bad loans. Analysts used the numbers to shine a light on CDO prices. They began to estimate losses in the billions when the guarantees on securities were marked to reflect the market's view of the CDOs.

 

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Stock Tumble Drives 43 Benchmarks Into Bear Market

(Bloomberg) -- More than half of the world's biggest stock indexes fell into a bear market as mounting concern about a U.S. recession dragged down banking and retail shares across Asia, Europe and Latin America.

The MSCI World Index's 3 percent decline yesterday, the steepest since 2002, left benchmarks in France, Mexico, Italy and 35 other countries at least 20 percent below their recent highs. Declines today turned Greece, India, Indonesia, the Philippines, Saudi Arabia, Slovenia, South Korea, Taiwan and Thailand into bear markets as well.

U.S. stocks tumbled for a fifth day, the longest stretch of declines in 11 months, after the Federal Reserve's emergency interest-rate cut failed to persuade investors the economy will avert a recession.

UBS AG and Bank of China Ltd. led financial companies lower since October after banks lost more than $100 billion on credit investments. Bang & Olufsen A/S and Wal-Mart de Mexico SAB were among consumer stocks that tumbled amid signs the world's biggest economy is shrinking. Even with MSCI World valuations at the cheapest since at least 1995, some of the biggest investors say stocks may fall further.

``I'm struggling to find a catalyst that will turn this market around,'' Bob Parker, who helps oversee more than $600 billion at Credit Suisse Asset Management in London, said in a Bloomberg Television interview. ``What we need is evidence that the write-offs in the financial-services sector are behind us, and we are probably only going to get that in the second quarter. Clearly the market situation is fairly ugly at the moment.''

Sept. 11

Europe's Dow Jones Stoxx 600 Index slumped the most since the Sept. 11 terrorist attacks yesterday, sending it into a bear market, commonly defined as a drop of more than 20 percent in a 12-month period. Japan's Nikkei 225 Stock Average tumbled 5.7 percent today, completing its worst two-day drop in 17 years.

The MSCI World Index of 23 developed markets is down 18 percent from its Oct. 31 record. The MSCI gauge of developing nations also reached a bear market yesterday. Declines in Lima- based Cia. Minera Milpo SA and Tainan, Taiwan-based Catcher Technology Co. led this year's 16 percent retreat.

Japan became the first of the world's 10 biggest stock markets in November to enter a bear market since the summer's U.S. subprime-mortgage collapse. China followed later that month before the benchmark CSI 300 Index recovered and rose 162 percent for the year.

Bear Markets

Among 80 equity national equity benchmarks tracked by Bloomberg, indexes in Argentina, Australia, Austria, Belgium, Bulgaria, Chile, Colombia, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Greece, Hong Kong, Hungary, Iceland, India, Indonesia, Ireland, Italy, Latvia, Lithuania, Luxembourg, Mexico, Namibia, the Netherlands, Norway, Peru, the Philippines, Poland, Portugal, Romania, Saudi Arabia, Singapore, Slovenia, Spain, South Korea, Sweden, Switzerland, Sri Lanka, Taiwan, Thailand, Turkey, Venezuela and Vietnam have also dropped at least 20 percent from recent highs.

The S&P 500 has fallen 11.2 percent so far this year, while declines in the U.K. and Germany yesterday left those countries' benchmark indexes down 12 percent and 16 percent respectively.

``We've seen panic selling,'' said Matthias Jasper, head of equities at WGZ Bank in Dusseldorf, Germany. ``Particularly small investors lost their nerve. These people are selling with conviction.''

The slump has made stocks cheap by historical standards. The 1,953-member MSCI World is now valued at 14 times its companies' profits, the lowest since at least 1995, according to data compiled by Bloomberg. Europe's Stoxx 600 has a price-to-earnings ratio of 10.9, the smallest since at least 2002.

 

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Fed Cuts Rate 0.75 Percentage Point in Emergency Move

(Bloomberg) -- The Federal Reserve cut the benchmark interest rate by three quarters of a percentage point, its first emergency reduction since 2001, after stock markets tumbled from Hong Kong to London amid increasing signs of a U.S. recession.

The central bank cut the target overnight lending rate to 3.5 percent from 4.25 percent, the Federal Open Market Committee said in a statement in Washington. Policy makers weren't scheduled to gather until next week. It's the biggest single reduction since the Fed began using the rate as the principal tool of monetary policy around 1990.

``Broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households,'' the Fed said in a statement in Washington. The FOMC took the action ``in view of a weakening of the economic outlook and increasing downside risks to growth.''

Policy makers set aside concerns about inflation to lower borrowing costs for the fourth time since September after the unemployment rate rose, retail sales fell and stocks slumped. Chairman Ben S. Bernanke shifted the Fed's stance to a more aggressive approach in remarks this month citing a need for ``decisive and timely'' action.

The dollar slid and Treasury securities rallied after the announcement. Stocks slumped as some investors questioned whether the Fed would be able to avert a recession, and then recouped more than half the losses. The Standard & Poor's 500 Index fell 0.5 percent to 1,318.28 at 11:15 a.m. in New York, after dropping as much as 3.8 percent earlier.

Bear Market

Yesterday, almost half of the world's biggest stock indexes fell into a bear market as mounting concern about a U.S. recession dragged down banking and retail shares across Asia, Europe and Latin America.

``The bottom line was that financial conditions were tightening sharply'' and affecting the economic outlook, said former Fed economist Brian Sack, who is now with Macroeconomic Advisers LLC in Washington. ``The view so far has been that they're somewhat behind the curve and needed to adopt a somewhat more aggressive approach.''

The Bank of Canada, in a scheduled meeting, lowered its main interest rate by a quarter point today to 4 percent and signaled it will act again to shield Canada from the U.S. slowdown. The Bank of England said it has no plans to change the date of its next rate decision. The bank's policy makers are due to begin a two-day meeting in London on Feb. 7.

Paulson Reaction

Treasury Secretary Henry Paulson called the Fed's move ``very constructive'' and a ``confidence builder,'' when asked about the Fed decision after a speech in Washington. He also said it was a sign to the rest of the world that the U.S. central bank is ``nimble.''

Paulson, charged by President George W. Bush last week with negotiating a fiscal stimulus plan with lawmakers, said a package ``must be enacted quickly.'' White House spokeswoman Dana Perino told reporters that the administration hasn't ruled out a proposal exceeding $150 billion.

The Fed Board of Governors, in a related move, lowered the so-called discount rate on direct loans to commercial banks by a 0.75 percentage point to 4 percent. The Chicago and Minneapolis district banks had requested the reduction, the Fed said.

``Appreciable downside risks to growth remain,'' the Fed statement said. ``The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.''

Futures Contracts

Traders had anticipated 75 basis points of rate cuts this month, according to futures prices on the Chicago Board of Trade.

The FOMC vote was 8-1, with St. Louis Fed President William Poole preferring to wait until the regularly scheduled meeting. Fed Governor Frederic Mishkin was absent and not voting.

Fed officials met by video conference at about 6 p.m. yesterday, spokeswoman Michelle Smith said. Mishkin was traveling and unable to participate, she said. The voting members were the same as in 2007 because the presidents don't rotate in until the first regular meeting, Smith said.

Today's so-called inter-meeting rate cut is the first since Sept. 17, 2001, when the Fed lowered borrowing costs in the aftermath of the terrorist attacks six days before. That was the third emergency reduction in a year which saw the last U.S. recession.

 

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SA losing faith in govt

(Fin24) - If the power deadlock within the ANC is perpetuated, a feeding frenzy of opportunistic corruption, near corruption or inertia could follow, according to a researcher from the Institute for Justice and Reconciliation (IJR), Susan Brown, who calls this "the worst case".

Brown was speaking during a breakfast briefing to launch the IJR's transformation audit, which she edited, and which showed there has been an alarming slump in public confidence in SA leaders and its representative institutions, including parliament.

The report was conducted between April 2006 and April 2007 among 3 500 respondents.

The Presidency has already received a copy of the report, and according to the IJR it was "receptive", questioned whether a trend was being seen and engaged more openly in dialogue than they would have perhaps a year ago.

IJR researcher Jan Hofmeyr explains that all 23 government performance areas showed significant declines, with seven showing declines of 20% or more.

"This is quite significant," he noted, adding that there was a decline in the trust being placed in national leaders. Added to this were concerns around softer issues, like the integrity of leadership.

Incoming executive director of the IJR (replacing Charles Villa-Vicencio, who remains on the board) Fanie du Toit said: "There are some serious findings here. It speaks of a more systematic failure to take the public into confidence."

He added that there was a "startling gap" between economic growth and the public perception as displayed in the audit.
SA has been enjoying the highest growth in its business cycle since the Second World War, but yet the public was clearly not happy. Some blame must lie somewhere, and as the audit showed, there appeared to be something of a leadership crisis within government institutions and lack of delivery to a wider base.

Brown highlighted inefficiencies in the education system, which she explained fed into unemployment. She said the linkages with tertiary institutions had hardly expanded since 1994.

Du Toit pointed out that SA compared badly with its peers on the education front, and said that the pool of people from which tertiary students were derived was still the same size as it was in 1995.

"It affects the nature of the macroeconomic system we have, and it affects public confidence and the ability to develop a unified society," said Brown.
 

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Lekgotla to solve energy crisis

(Fin24) - Eskom CEO Jacob Maroga will face some tough questions from the South African government which will use its two-day Lekgotla, starting January 23, to help solve the country's energy supply shortfall.

Maroga joins the Lekgotla which brings together all ministers and their deputies, premiers, director-generals and representatives of the South African Local Government Association.

Rolling blackouts throughout South Africa have ground business to a halt and severely disrupted roads and other infrastructure, as well as weakened confidence in the country's ability to attract and support future investment.

After the Lekgotla all eyes will be on February 8, when President Thabo Mbeki's state of the nation address in parliament is expected to detail some of the Lekgotla's findings.

A statement released by the cabinet today apologised for the electricity predicament and the impact it has had on the country's citizens, economy and image.
 

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