The new research says that:

“While U.S. home prices have stabilized considerably since the recession officially ended in mid-2009, recent housing data suggests that the winter season will likely chill recently improving home prices, according to a new report published by Standard & Poor’s Ratings Services In line with this expectation, Standard & Poor’s Ratings Services believes home prices will decline an additional 7%-10% through 2011.”

The news is shattering. The S&P Cash-Shiller Index has shown some improvement, albeit modest, over the last few months. But, foreclosure rates have increased according to RealtyTrac. The number of mortgages underwater still stands at over 11 million, about 21% of all home loans in the US. Fed governor Rifkin recently commented that foreclosure rates would get no better in 2011 and would barely improve in 2012.

The report indicated that the reasons for the forecast were few but powerful. “An elevated, but declining level of short sales and distressed asset sales; a large backlog of distressed properties that have yet to be re-marketed for sale; and a high national unemployment rate”

And, joblessness is probably at the very core of the matter. Nearly 17% of Americans are either unemployed, barely employed, or no longer seeking work. They are essentially not only out of the home buying market, but are foreclosure risks.

The other reason for the nation’s “buyers strike” is the April expiration of federal home buyer tax credits. That, combined with a fear that home prices have further to drop, makes the concerns a self fulfilling prophecy.

Douglas A. McIntyre

Perhaps as a punishment for these misdeeds, Moody’s competitor S&P has put the company on CreditWatch.

“Standard & Poor’s Ratings Services today placed its ‘A-1′ short-term rating for Moody’s Corp. on CreditWatch with  negative implications.”

Perhaps it is time for Moody’s to downgrade S&P’s parent McGraw-Hill (NYSE: MHP) for the same reason.

Douglas A. McIntyre

"The CreditWatch listing reflects our view that an increased level of business
risk is likely following the announcement that the Financial Reform Conference
Committee has reconciled bills from the U.S. Senate and House, and that the
agreed upon legislation could result in a change in the applicable pleading
standards for certain litigation brought against rating agencies," said
Standard & Poor's credit analyst Emile Courtney.

According to our ratings criteria, we place ratings on CreditWatch when, in
our view, there is a 50% chance or more of a rating change, and CreditWatch
reviews can be the result of regulatory changes' impact on an issuer's
business.

Douglas A. McIntyre

Blanchflower’s name can be added to the long list of economists and traders who believe that the nearly $1 trillion aid package put in place to support sovereigns in the region and the euro is entirely inadequate given the massive national debt levels of  Greece, Spain, and Portugal.

S&P said today that it lowered and removed from CreditWatch negative its credit ratings on all  Greek securitization notes rated above ‘A’ to ‘A’ on account of its view of  how increased country risk may affect Greek structured finance transactions.

The ratings agency also indicated that unrest and strikes were likely to be a major cause of the long-term problems of Greece.

The current negative outlook on the  ratings on Greece reflects the possibility of a further downgrade if, in our  view, the Greek government’s ability to implement its fiscal and structural  reform program is undermined by domestic political opposition or materially weakens for other reasons, including even weaker economic conditions than we currently assume.

These troubles have caused S&P to take the extremely pessimistic position that Greece’s GDP will not return to 2008 levels until 2017. That in turn will greatly increase the risk that Greece will not be able to refinance its debt without ongoing support from the IMF and Eurozone nations. The current $140 billion package Greek aid package will only last for the next three years.

S&P’s outlook on Greece is a partial confirmation of Blanchflower’s view–  the bailout of Europe is only at the start of what will be a long and expensive process.

Douglas A. McIntyre

Moody’s and S&P have begun to do a great deal of damage to the prospects that the sovereign debt crisis will be contained in Greece. This may be in a reaction to how badly they were burned by MBS ratings which were part of the cause of the credit crisis.

Moody’s and S&P are under pressure from investigations by the federal government and several state attorneys general. Almost all of these inquiries could end in fines and more regulation.

One reasonable reaction by the agencies would be excessive caution which, as the pendulum swings, may lead investors astray again. But, in this case it is only another way to cause investors to go astray.

Douglas A. McIntyre

His beliefs have nothing to do with the outcome of investigations of the two firms.

Gross makes the obvious point that his firm is large enough to do its own research, making the ratings firms’ work  irrelevant to him, but he believes that they offer “second grade” intelligence to their clients.

Gross’ examination of the two ratings agencies goes well beyond the debacle of the mortgage-backed securities mess. Both companies gave derivatives that turned out to be junk “AAA” ratings. Congressional investigations and suits by state attorneys general claim that rich fees and shoddy research helped cause the credit crisis.

As Gross looks at Moody’s and S & P, his current concern is their ratings of sovereign debt. Spain, he reasons, does not deserve a high rating largely because of its 20% unemployment rate. There were rumors this week that the IMF was working with Spain on a 280 billion euro bailout which would be twice the size of the one prepared by the Eurozone for Greece.

The effectiveness of the rating system as they release their opinions on the weakest European nations will only face a real test when the deep trouble in the region is largely past or when it has erupted into one of the great financial disasters of recent years. If the road leads to disaster, Moody’s and S&P will be accused of being too optimistic about their ratings of Spain, Portugal, and Italy. The two firms will almost certainly say that they could not reasonably see the risk of  “contagion.” That is likely true, and lower ratings could  actually be the cause of a liquidity crisis in the region.

S&P and Moody’s are not in business to prevent contagion, no matter how convenient it is to take that point of view.  Nonetheless, their credit ratings of the weak European nations are almost certainly much too high.

Douglas A. McIntyre

S&P became much more aggressive than Fitch as it told Greece that its status with the credit agency could change. According to Reuters, “Greece is at risk of a rating downgrade if high borrowing costs persist and the government does not manage to address the consequent deviation from its deficit-cutting programme.”

Greece is now may move into technical default on some of its notes with the next few weeks, if the expected aid is not forthcoming. The nation could choose to leave the eurozone alliance in the hope that it can devalue its currency. Or, the large, rich nations like German may elect to pressure Greece out of the group so that it is not forced to put German assets into a risk ridden situation.

Either way, Greece is in a death spiral.

Douglas A. McIntyre

The latest is that S&P said that its outlook on the UK’s “AAA” rating remains negative. According to MarketWatch S&P voiced ‘concerns the general government debt burden could reach a level incompatible with the (AAA) rating unless a “strong fiscal consolidation plan” is implemented.’

Ratings agencies have been loudly whispering similar doubts about US debt, deficits, and the apparent refusal of Congress and the Administration to address the federal spending problem.

One large problem with the S&P reveiew of the largest developed nations is that the debt of two of three could be downgraded nearly simultaneously which would leave large bond investors like Pimco and even the Chinese government to wonder where they will put their money. It almost goes without saying that sovereign interest rates would then have to rise to create demand for their paper. It is scenario that is played out over and over again in the media and probably among the “quants” at fixed income funds.

The S&P statement about the UK is not new, but the pace of the drum beat is quickening.

Douglas A. McIntyre

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The reason for the change is because Sierra Health Services Inc. (NYSE: SIE) was removed from the S&P SmallCap 600 after today’s close of trading due to its completed acquisition by UnitedHealth Group Inc. (NYSE: UNH).

We at 247WallSt.com prefer index additions such as this one.  The reason we prefer "new member adds" like this is because fund managers and investment managers that track the S&P 500, the S&P MidCap 400, and the S&P SmallCap 600 Index do not yet own shares of the stock.  When these get upgraded from one index to another it often creates close to a net-zero effect or at least a more muted effect. 

West Pharma shares closed down 0.3% at $41.70 today, but shares are up 1.7% at $42.40 for its limited after-hours trading and the "bid/ask indications" are both higher than that now.  Its 52-week trading range is $35.20 to $54.83.  Shares are up over 10% since it released earnings last week. 

Jon C. Ogg
February 26, 2008

What is obvious as a nose wart is that by now everyone in the world realizes that the ratings agencies are artificially keeping the rating elevated.  That will allow for a bailout resolution to 1) have time to come about and 2) allow the banks to not fear they come up with a multi-billion bailout plan that ultimately leads to more downgrades anyway.

We have hinted at government wink-winks for over a month right now where there will probably be all sorts of "incentives" handed out to avoid an economic meltdown.  These writedowns will come through time anyhow, but as long as they don’t all hit at once and as long as the bubble that will lead to de-leveraging lets the air out slowly then a meltdown might just be a fairly mild sector recession rather than it looking like doomsday.

MBIA shares are now up more than 12% today and Ambac shares are up 7% on the day.  Both initially spiked higher on the headlines.

Jon C. Ogg
February 25, 2008

Barron’s was very negative on this one even last summer about the exposure to mortgages being overlooked.  Back then MBIA shares traded hands at $65-ish.  But now Barron’s is saying "the market has gotten too bearish on the bond insurer."   Barron’s now summarizes the situation at MBIA as: "MBIA was due for a setback. But at its current price, it’s being punished too severely for bond-industry problems." The entire article is online and you can see the other points there.

This more or less denotes that much more of the woes at MBIA is more in sympathy with Ambac Financial (NYSE: ABK) than to the exact exposure that MBIA has in reality.  This article does not at all indicate that Ambac will escape the storm like MBIA can. It also notes what we observed last week with MBIA’s new $1 billion in capital surplus notes with a 14% yield have fallen down to 75 cents on the dollar.  Its credit protection costs also jumped to previously unheard of levels.

Barron’s also points out that even though large value investors such as M.J. Whitman’s Third Avenue Fund, Davis Select Advisors, and Warburg Pincus are down significantly, they are now key investors in MBIA.  Another Barron’s attribute of this being cheap is that it notes "MBIA remains a profitable entity, but its shares are off nearly 90% from their highs." 

One key issue that Barron’s is hinging much of the contra-mortality of MBIA is that any future claims losses from principal and interest will be dribbled out a the 20-year (or in some cases 50-year) time period; hence "the present value of claims cost dwindles dramatically in relative significance."  This also notes that when Warburg Pincus ran its worst case stress test under "Armageddon-like housing and other economic assumptions" that its annual loss expenses came to no more than around $250 million per year under the most harsh conditions.  This even points to some claims of liquidation value being $30 to $40 per share, although we would caution that others are arguing that the death sentence for all of these has already been determined and the formal verdict just hasn’t been announced.

There are other things at work that could topple all of these companies, even if the original blame lies elsewhere.  The new issue for 2008 is "counterparty risk" and the implications of systematic counterparty failure are disastrous.  This is the new term that bears will use (and are already using) to put pressure on financial and other sector stocks, even if it is not a new term nor a new issue at all.  The reality is that the blowup at ACA would end up looking like a cartoon in comparison.

Frankly, an intervention via a government stimulus package may or may not help, and you can find the criticisms and support all over the place on that issue.  An intervention with a financial stimulus plan for the public may not be enough if there is actual counterparty failure and outright systematic default.  If a stimulus package is presented whereby the government acts as a backstop to prevent the counterparty defaults from being 100%, then this entire issue may be minimized drastically and the fears of a 1929 crash or 1987 crash would effectively be put to rest.  If some of the figures really do pan out the way some of the calculations we have seen, then the expected meltdown of these insurers could literally have dire consequences in the financial markets.  We have even noted the possibility of a 1,000 point drop in the DJIA.

Perhaps the single best tool to use outside of personal opinions derived from all the facts that can be gathered is to look at the trading volume.  The trading volume measured by inflows and outflows of dollars in stocks and sectors will tell you immediately what Wall Street is thinking.  So far that verdict IS that a death sentence is most likely.  The reality is that some firms have yet to implode.  If we start seeing counterparty defaults then we will see more waves of writedowns from major financial institutions.  To make matters worse, many of those institutions may not survive counterparty implosions that leave them on their own. 

We recently pondered a scenario where Warren Buffett and Berkshire Hathaway (NYSE: BRK-A) could save the day.  The reality there is that he would save the day if it ends up looking like a layup, but he won’t come to the rescue just because these need rescuing. This is also just one more piece of the puzzle in what we have deemed as financial mergers becoming mandated rather than preferred.

Right now the situation is deemed as almost entirely up to the ratings agencies like Moody’s and S&P after "negative credit watch" turned this further into another house of cards.  The worst case scenario very well may end up being another Enron situation, with the difference being that the widespread impact of the bond insurers failing having a much broader economic impact on the entire financial system.  It goes without saying that this holiday-shortened week will be more crucial for all the bond insurers.

Jon C. Ogg
January 21, 2008