About Patrice Sarath

In The New Yorker recently, an article discussed antibiotic-resistant bacteria, strains that are so resistant they make an MRSA infection look like a walk in the park. So what does this have to do with quarterly earning reports? Well, drug companies have, by and large, pulled out of antibiotic research because it’s not where the money is. When you have shareholders to mollify, you direct your research platform toward blockbuster drugs. No matter how much we are going to need new antibiotics, they will never be profitable for drug companies (especially since overuse is what got us into this mess in the first place).

Richard Syron, the CEO of Freddie Mac, recently allowed that even if he had acted on 2004 warnings that the company was underwriting very high risk loans, there was little he could have done about it.

“This company has to answer to shareholders, to our regulator and to Congress, and those groups often demand completely contradictory things,” Mr. Syron said in an interview. But if Freddie and its sister, Fannie, had kept their underwriting standards tight, fewer bad loans would have been made and the subprime crisis could have been partially averted.

Never really healthy, the auto industry has been bleeding cash over the years, interspersed with short periods of remission. Now the cure — trucks and SUVs — has become the disease. Automakers grew too comfortable building for the “cheap gas” economy, even when interest was rising in hybrids and electric cars, and they marginalized their research in these new technologies. And that was before gas prices soared. Now they are playing catch up, but don’t expect changes any time soon. Gas prices have dropped a little, and the short-term mentality (i.e., quarterly earning reports) will come back into play.

The oil companies have been reaping record (some say windfall) profits. Each quarter as gas prices rise, so have their profits. Nice, huh? A port in the storm? But their business model is built on a non-renewable resource. Oil sands, offshore drilling, Arctic drilling … it doesn’t matter. The oil is going to run out. Instead of quarterly earnings, shouldn’t we be asking ExxonMobil and its ilk what their long-term plans are?

As Syron points out,  companies answer to shareholders. At what point do we require companies to answer to the rest of us? As long as a company’s success is measured in quarters, can our industries build the products and provide the economic stability that the we need for the long term?

The auto industry suffered another setback recently when several finance companies, some tied to automakers, others among the biggest names in lending, said they would get out of the lease financing business.

It turns out that lenders were having trouble selling previously leased vehicles when their leases were up. High gas prices and a generally weak economy were fingered as the culprits. So what had once been a fairly lucrative business was hit by the malaise Americans are feeling due to higher gas prices, higher grocery bills, and other pains in the wallet.

Chrysler started the run of bad news when it said that its financial unit would get out of the leasing business entirely. In response, JPMorgan Chase subsidiary Chase Auto Finance basically said, “Hey, don’t look at us.” The company announced it would not take on any new leasing business from Chrysler dealers.

Wells Fargo Auto Finance also exited the business, citing low volume in its quarterly earning press release. Ford Motor Credit tried a different approach — it raised the prices on its leases, presumably to discourage prospective customers and encourage them to buy instead.

The bad news kept on coming, as GMAC Financial Services attributed a nearly $2.5 billion loss for the second quarter in large part to its auto leasing operations.

Leasing won’t go away forever, but customers who love the idea of driving a new car every few years might have to wait til the market comes back. Either that, or get some of that spray stuff.

Banks are desperate to move CDOs, those dangerous collateralized debt obligations that are backed  by subprime mortgages, off their books. The problem is, who is brave, or stupid, enough to buy them?

In Merrill Lynch ’s case, that would be Lone Star Funds. But Lone Star was far from stupid — they agreed to the deal because Merrill Lynch funded most of the transaction. Lone Star Funds is buying the CDOs for $6.7 billion, and Merrill is financing the purchase up to $5 billion. It’s better than being on the hook for the estimated $11 billion that Merrill Lynch says the investments are still worth — a dubious estimate at best, since for all intents and purposes, the CDOs are worthless. Merrill Lynch is basically paying Lone Star to take them off its hands and its books. It originally valued the package at $30 billion (it’s hard to tell if that’s what it paid for the investments, since none of these figures are crystal clear).

What is Lone Star going to do with this hot potato? The company is no stranger to distressed assets. Those are its bread and butter. Maybe it’s hoping that the government’s bailout of Freddie and Fannie and the homeowner relief plan will stabilize the underlying mortgages and it won’t be left holding the bag. Most likely they will be collecting on the underlying debt. (Hey, it might just be a few pennies on the dollar, but after a while, it adds up.)

In the meantime Merrill Lynch still hasn’t extricated itself from these investments, it’s just moved them from one column to another. It’s a good move and a necessary one, but as the company is finding out, that’s one sticky hot potato.

We have this idea that the US economy is based on the free market system. The SEC’s new rule against naked short selling for certain companies and entities sure puts paid to that belief.

In short sales, an investor borrows shares of a company, sells them, and hopes the stock price later drops before he has to pay back the shares.  It’s a classic instance of selling high, buying low.

In naked short selling, the investor doesn’t borrow the stock first. Less risk, so more reward — if the stock does fall as expected.

The rule has already raised a chorus of complaints from financial services firms that aren’t on the safe list. It also is probably not the right way to restore stability to the market. Granted, the horse is already out of that barn, but the best way the SEC and the Fed could have stabilized the market was to have put the brakes on the bubble in the first place. But oh no — we have a free market, right? No market interference here.

Gretchen Morgenson of The New York Times has a trenchant article on just this topic. She writes:

HERE is a question: Might not the routs, which inevitably follow the manias, be less painful if things were not allowed to get wild and crazy on the upside? Might not the American people be better off with regulators who curb market enthusiasm — whether in the form of errant lending or voracious, ill-considered deal making — when it reaches manic levels, to protect against the free fall, and the bailouts, that ensue?

Since the Fed has no problem with regulating some of the markets some of the time with rules that only apply to certain companies and certain investors, why not drop the pretense of the free market completely and create different regulations that are designed to do exactly what Morgenson suggests — regulate on the upside too?

If that is unpalatable, then when a Bear Stearns, a Lehman, or a Freddie and a Fannie look like they are failing, let the free market take its course.

Banks and mortgage holders are bracing themselves for the next wave of foreclosures as ARMs reset. What some other industry veterans are also bracing for is a wave of fires.

Bloomberg quotes James Quiggle, a spokesman for the Coalition Against Insurance Fraud, who states, “Home arsons follow foreclosure trends, with a lag. We’re facing a potential spike in arson like we’ve never seen before.”

According to housingwire.com, many homeowners whose homes have been foreclosed on damage the property before they leave. Punching holes in the drywall is often the least of it. Arson could be the worst, and if Quiggle is right, we’ll see a lot more of it.

So what does this mean? Neighborhoods are already suffering as more and more houses are left vacant. Vagrants move in, causing damage; untended lawns and properties lead to deterioration, which in turn affects the entire block.

An Atlantic Monthly article discusses what happens when suburban neighborhoods empty out, and it’s not pretty. Across the country, property and other crime rises in unlikely suburbs, leading to an unexpected irony; homeowners who fled cities because of crime and poor schools are now leaving the same conditions in their wake.

So what happens now? Will suburban communities recover? As neighborhoods deteriorate and gas prices continue to rise, will people make the return journey and head back to the cities? What will happen to the schools, the tax base, and infrastructure (roads, sewer, fire, and police)?

Here’s one solution. Mortgage holders don’t want to foreclose on homes. When there are just a few foreclosures it’s a costly headache, so the current deluge is unmanageable, whether banks admit it or not. So what if, instead of removing the homeowner, the mortgage can be rewritten as a rental contract? Obviously the bank will take less money in rent than a house payment, but it will keep the house occupied and kept up, the property stabilized, and the neighborhood a little bit safer.

Better to keep a fire from starting than to have to put it out.