ebruary 14, 2009

Peanut Corporation of America to Liquidate

By ANDREW MARTIN

The peanut company at the center of a salmonella scandal filed for bankruptcy protection on Friday, saying the extensive recalls of its products left it no choice but to close.

The Peanut Corporation of America filed for liquidation under Chapter 7 of the bankruptcy law in Virginia, where it is headquartered.

“This bankruptcy filing, while regrettable, will allow for an orderly liquidation of the company,” said Andrew S. Goldstein, a lawyer representing the peanut firm.

The company is the subject of a federal criminal investigation for allegedly sending out batches of peanut products that it knew to be contaminated with salmonella. Company officials could not be located for comment and have not spoken publicly since the outbreak began.

To date, the Centers for Disease Control and Prevention has tied 637 illnesses to the salmonella outbreak, and it is believed to have caused nine deaths. More than 2,000 products have been recalled that contain peanuts, peanut butter or peanut paste from the company.

The outbreak has also refocused attention on the nation’s frayed food safety net, with members of Congress and of the Obama administration calling for major reforms.

The outbreak originally focused on the company’s Blakely, Ga., plant, where investigators from the Food and Drug Administration found a leaky roof, mold and roaches. But the company closed a subsidiary in Plainview, Tex., this week, after salmonella was found there, too.

Texas state officials have ordered a recall of all products ever shipped from the Plainview plant, which began operations in March 2005, after inspectors found rodents, rodent excrement and bird feathers in a crawl space above the production area.

In a related matter, Texas officials said Friday they had fired an inspector who certified the Plainview plant for organic production. The Texas Department of Agriculture said the inspector had indicated that the company had provided proper documentation. The plant was initially certified as organic in November 2005.

But after the salmonella outbreak unfolded, starting in mid-January, state officials learned that the plant did not have a state health certificate, as required, and “found that the inspector accepted incomplete information,” according to a statement.

The state agriculture department issued a notice to revoke the plant’s organic certification once it learned of the problems at the plant. A spokeswoman for the Texas agency declined to identify the inspector or to elaborate on the state’s organic certification of the plant.

Truth and Lies about the Financial Crisis

Much as been said about the 2008 Financial Crisis we are still going through; unfortunately, populism has come into force to point the wrong people and the wrong pratices: here is a list of errors commonly spread in the press.

1) Hedge Funds are in part responsible for the crisis due to massive speculation: FALSE

Because Hedge Funds' management are opaque, because they are located in Tax Havens, because the bonuses of their top managers are way above that of Goldman Sach's heads, they are regularly criticized by politicians, who perceived them as a threat to the financial stabilization [1]; in 1998, one of the biggest Hedge Fund that ever existed, LTCM ("Long Term Capital Management"), was about to collapse because of the Russian Crisis. It was saved thanks to William McDonough, president of the New-York Federal Reserve back at the time, who convinced American and European major banks to contribute to a 3,625 billion dollars bailout; in fact, with over 4,5 billion dollars equity and 124 billion dollars debt, its collapse would have been a disaster for the Global Financial System. It happened that the management of the Fund was a failure, so the Hedge Fund Industry in general brought many suspicion with the current crisis; however, things are quite different now. Let's recall why:

• Were Hedge Funds responsible for the Oil Soar in 2008? NO
  

 
When oil soared till mid-2008, many said hedge funds were speculating on a continuous rise with a 200 $ target for the barrel. But the rise of oil was led by simple supply & demand criteria, and the Hedge Funds had nothing to do with it.
The Graph below shows the part of non-commercial positions in long-term forward contracts in percentage of total contracts, ie speculative positions; as one can see, those speculative parts didn't play a key role..

Non-Commercial Forward Contracts - Source: Bloomberg

• Did Hedge Funds managed ot make profits with the Subprime Crisis? NO

The graph below shows the evolution of Hedge Fund indices recently, for each strategy used (Equity Market Neutral, Convertible Arbitrage, Event Driven, Macro & Equity Hedge); it proves that Hedge Funds suffered the crisis (because of spreads widenings and liquidity contraction).

2) The Financial Crisis was a consequence of Excessive Traders' Bonuses: FALSE

One common argument you may heard is that traders' desire to get big bonuses led them to take too many risks which ended up in the crisis; this is completely false. Actually, a good trader is an efficient risk-manager, and not a speculator. 
A trader who exceeds his risk-budget will always be fired, since banks are fully aware of the risk a massive position can turn out to be a losing one; to those who would object by speaking of Jérôme Kerviel, I would suggest to wait for the end of his trial...
Up to 2008, many traders got bonuses without jeopardizing their banks or the financial system....

3) Too much Risk led to the Subprime Crisis: FALSE

• First, what happened to subprime mortgages?..

This is a touchy part that deserves a clear explanation; when American banks started to lend money to individuals who didn't meet underwriting guidelines, they didn't keep these loans in their balance sheet, using a sophisticated financial technique called securitization: described simply, a bank create a pool of the mortgages embedded in its balance sheet and produce a financial security (called ABS, "asset-backed security")  which is in turn sold to investors, and freely negotiated on capital markets. The graph below illustrates the way securitization works:

• How could those mortgages impact the entire World?

Once those mortgages were packaged in MBS (for "Mortgage-Backed Securities"), they were traded on capital markets, either directly or through tranches of CDO (for "collateralized-debt obligations"); those products were supposed to offer a very interesting risk-reward profile, so many investors and banks buy those products throughout the World, and consequently regional banks in Germany, Scandinavia turned out to have subprime mortgages in their balance sheets; they were exposed to the US Real Estate market.

Source: Credit Suisse

• As a conclusion, what can be infered about Risk?

The conclusion is that banks' balance sheets and assets are so much intertwined that flaws in securities built on American Mortgages impacted banks in the entire World; an interesting thing to underline is that bankers faced fierce criticism for creating sophisticated derivatives products, but no one ever thought of asking to treasurers in smaller banks and financial institutions why they bought those complicated products.
As a matter of fact, the issue with the subprime crisis was that no one was fully aware of where lied the risks, no that there was too much risk.... the difference is important.

4) Complex derivatives products led to the Financial Crisis: PARTLY FALSE

Glorious speculator Warren Buffet once expressed a curious opinion on derivatives products that he called. "weapons of mass destruction"[2] 
In fact, derivative products were first created 30 years ago; here is a summary of the financial crises that occured since 1980, excluding the October 1987 Krach that wasn't followed by an economic crisis:

Year	Description	Causes
1980	Latin American Crisis	Foreign Debt of Latin American Crisis exceeded their earning powers
1989-1991	US Savings & Loans Crisis	Tax regulation and imprudent real estate lending
1990	Japanese Crisis	Inflation of Real Estate and stock prices
1997-1998	Asian Crisis	Asian Government decisions to let their currencies float
1998	Russian Crisis	Russia inability to reimburse its debt
2001-2002	Argentine Crisis	Foreign Investors withdrew their investments from Argentina

And as one can see, every financial crisis that occured during the past thirty years had nothing to do with structured products and/or derivatives; the subprime crisis of 2007-2008 had one simple reason: the end of the rise of the Real Estate Market in the US, that is shown on the graph below:

Since the mortgages lent to American borrowers were based on the value of their houses, and not on their own wealth, things started deteriorating when the Real Estate market stopped rising. Obviously, US bankers that recommanded those mortgages were not absolutely honest...

However, concerning the crisis we are going through as well as for those above, the very first reason for their appearance was each time a macroeconomic reason and not for some dangerous behaviors on trading floors..

The mortgages-derivatives products described above obviously played a role in the spreading of the crisis since every bank was exposed to them; that why those derivatives were part of what brought the crisis.

But to be completely precise, it must be said:
- that the trigger of the crisis was a macroeconomic event and nothing else
- that mis-management of the risks linked to mortgage-derivative products is to be underlined, not all the derivatives themselves...

5) Rating Agencies Are to Blamed for the Subprime Crisis: TRUE

Some pointed at the Rating Agencies (Moody's, S&P, Fitch) for they role in the crisis; but not enough, to my mind... and even if more regulation is being discussed at the time, one could wander if strong decisions will be taken in the end.
A Rating Agency assesses the credit worthiness of a firm which issues bonds; this credit worthiness is symbolized by letters, from AAA (the company has very little chance of defaulting) to C or D (the company has defaulted or is close to default); surprisingly, and though many banks fiercly compete with each others to get customers, rating agencies almost form a monopoly: only three major rating agencies exist, two of them acting as leaders on the market (Fitch is a little less active).

• Conflicts of Interest

The way they work carries some conflict of interest; the firm who want to have its debt ranked has to pay the agency, which in turn must be as objective as possible when assessing the firm...

• Serious Mistakes

• When Rating Structured Products
  

The Rating Agencies not only rated debts issued by companies, but also the famous Asset Backed Securities, Mortgage Backed Securtities and CDOs discussed above; many of those products got a very good grade, mostly AAA, though it appeared that the risks embedded in those products were largely undervalued.

• A Striking Example: CDPOs
  

[3]

6) Appendix

Source: Bloomberg

Source: Bloomberg

Source: Bloomberg

Source: Bloomberg

The downturn in facts and figures

The downturn in facts and figures

The US sub-prime mortgage crisis has led to plunging property prices, a slowdown in the US economy, and billions in losses by banks. It stems from a fundamental change in the way mortgages are funded.

THE NEW MODEL OF MORTGAGE LENDING

How it went wrong

Traditionally, banks have financed their mortgage lending through the deposits they receive from their customers. This has limited the amount of mortgage lending they could do.

In recent years, banks have moved to a new model where they sell on the mortgages to the bond markets. This has made it much easier to fund additional borrowing,

But it has also led to abuses as banks no longer have the incentive to check carefully the mortgages they issue.

THE RISE OF THE MORTGAGE BOND MARKET

In the past five years, the private sector has dramatically expanded its role in the mortgage bond market, which had previously been dominated by government-sponsored agencies like Freddie Mac.

They specialised in new types of mortgages, such as sub-prime lending to borrowers with poor credit histories and weak documentation of income, who were shunned by the "prime" lenders like Freddie Mac.

They also included "jumbo" mortgages for properties over Freddie Mac's $417,000 (£202,000) mortgage limit.

The business proved extremely profitable for the banks, which earned a fee for each mortgage they sold on. They urged mortgage brokers to sell more and more of these mortgages.

Now the mortgage bond market is worth $6 trillion, and is the largest single part of the whole $27 trillion US bond market, bigger even than Treasury bonds.

HOW SUB-PRIME LENDING AFFECTED ONE CITY

THE SUB-PRIME CRISIS IN CLEVELAND

	Sub-prime lending		Black areas
	Foreclosures (repossessions)		Deutsche Bank properties

For many years, Cleveland was the sub-prime capital of America.

It was a poor, working class city, hit hard by the decline of manufacturing and sharply divided along racial lines.

Mortgage brokers focused their efforts by selling sub-prime mortgages in working class black areas where many people had achieved home ownership.

They told them that they could get cash by refinancing their homes, but often neglected to properly explain that the new sub-prime mortgages would "reset" after 2 years at double the interest rate.

The result was a wave of repossessions that blighted neighbourhoods across the city and the inner suburbs.

By late 2007, one in ten homes in Cleveland had been repossessed and Deutsche Bank Trust, acting on behalf of bondholders, was the largest property owner in the city.

THE CRISIS GOES NATIONWIDE

Sub-prime lending had spread from inner-city areas right across America by 2005.

By then, one in five mortgages were sub-prime, and they were particularly popular among recent immigrants trying to buy a home for the first time in the "hot" housing markets of Southern California, Arizona, Nevada, and the suburbs of Washington, DC and New York City.

House prices were high, and it was difficult to become an owner-occupier without moving to the very edge of the metropolitan area.

But these mortgages had a much higher rate of repossession than conventional mortgages because they were adjustable rate mortgages (ARMs).

The payments were fixed for two years, and then became both higher and dependent on the level of Fed intereset rates, which also rose substantially.

Consequently, a wave of repossessions is sweeping America as many of these mortgages reset to higher rates in the next two years.

And it is likely that as many as two million families will be evicted from their homes as their cases make their way through the courts.

The Bush administration is pushing the industry to renegotiate rather than repossess where possible, but mortgage companies are being overwhelmed by a tidal wave of cases.

THE HOUSING PRICE CRASH

The wave of repossessions is having a dramatic effect on house prices, reversing the housing boom of the last few years and causing the first national decline in house prices since the 1930s.

There is a glut of four million unsold homes that is depressing prices, as builders have also been forced to lower prices to get rid of unsold properties.

And house prices, which are currently declining at an annual rate of 4.5%, are expected to fall by at least 10% by next year - and more in areas like California and Florida which had the biggest boom.

HOUSING AND THE ECONOMY

The property crash is also affecting the broader economy, with the building industry expected to cut its output by half, with the loss of between one and two million jobs.

Many smaller builders will go out of business, and the larger firms are all suffering huge losses.

The building industry makes up 15% of the US economy, but a slowdown in the property market also hits many other industries, for instance makers of durable goods, such as washing machines, and DIY stores, such as Home Depot.

Economists expect the US economy to slow in the last three months of 2007 to an annual rate of 1% to 1.5%, compared with growth of 3.9% now.

But no one is sure how long the slowdown will last. Many US consumers have spent beyond their current income by borrowing on credit, and the fall in the value of their homes may make them reluctant to continue this pattern in the future.

CREDIT CRUNCH

One reason the economic slowdown could get worse is that banks and other lenders are cutting back on how much credit they will make available.

They are rejecting more people who apply for credit cards, insisting on bigger deposits for house purchase, and looking more closely at applications for personal loans.

The mortgage market has been particularly badly affected, with individuals finding it very difficult to get non-traditional mortgages, both sub-prime and "jumbo" (over the limit guaranteed by government-sponsored agencies).

The banks have been forced to do this by the drying up of the wholesale bond markets and by the effect of the crisis on their own balance sheets.

BANK LOSSES

The banking industry is facing huge losses as a result of the sub-prime crisis.

Already banks have announced $60bn worth of losses as many of the mortgage bonds backed by sub-prime mortgages have fallen in value.

The losses could be much greater, as many banks have concealed their holdings of sub-prime mortgages in exotic, off-balance sheet instruments such as "structured investment vehicles" or SIVs.

Although the banks say they do not own these SIVs, and therefore are not liable for their losses, they may be forced to cover any bad debts that they accrue.

BOND MARKET COLLAPSE

Also suffering huge losses are the bondholders, such as pension funds, who bought sub-prime mortgage bonds.

These have fallen sharply in value in the last few months, and are now worth between 20% and 40% of their original value for most asset classes, even those considered safe by the ratings agencies.

If the banks are forced to reveal their losses based on current prices, they will be even bigger.

It is estimated that ultimately losses suffered by financial institutions could be between $220bn and $450bn, as the $1 trillion in sub-prime mortgage bonds is revalued.