Knock knock – retail bankruptcy here

Eight retail chains, including Levitz and Sharper Image, have declared bankruptcy. And, they’re not all.

Rumor says Linens ‘n Things is next, possibly later this week. (Disclosure for local readers; there’s a Linens store here in Cedar Hill, suburban Dallas.) But that’s not all.

Over the next year, Foot Locker said it would close 140 stores, Ann Taylor will start to shutter 117, and the jeweler Zales will close 100, the Times story says.

Part of the problem is the credit crunch. Banks are getting tighter on their lending to retailers, not just would-be homeowners.

Here’s why the credit crunch is a problem for many of these retailers:

The bankruptcies are putting a spotlight on a little-discussed facet of retailing: heavy debt.

Stores may appear to mint money by paying $2 for a T-shirt and charging $10 for it. But because shopping is based on weather patterns and fashion trends, retailers must pay for merchandise that may sit, unsold, on shelves for long periods.

So chains regularly borrow large sums to cover routine expenses, like wages and electricity bills. When sales are strong, as they typically are during the holiday season, the debts are repaid.

But, of course, this year’s holiday sales were relatively light.

And, the news for many of these companies isn’t good for either today or tomorrow:

Most of the ailing companies have filed for reorganization, not liquidation, under the bankruptcy laws, including the furniture chain Wickes, the housewares seller Fortunoff, Harvey Electronics and the catalog retailer Lillian Vernon. But, in a contrast with previous recessions, many are unlikely to emerge from bankruptcy, lawyers and industry experts said.

And, while bigger, older retailers aren’t in danger of bankruptcy, many, like J.C. Penney, are scaling back on expansion plans.

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Credit default swaps to follow subprime loans, CDOs, to bubbleland stage?

It does indeed seem possible that more and more economic talk will focus on the “arcane” CDSs.

Like other recently crafted financial tools, such as their somewhat kin collateralized debt obligations, or CDOs, CDSs have a few problems. First, what are CDSs?

Credit default swaps were invented by major banks in the mid-1990s as a way to offset risk in their lending or bond portfolios. At the outset, each contract was different, volume in the market was small and participants knew whom they were dealing with.

No. 1 and above all, especially in the eyes of more critical economists, is that CDSs, just like CDOs, are not “marked to market.” In other words, nobody knows if their paper value is at, or even anywhere close to, their real-world value. The reason is the same as with CDOs — they’ve never really been tested on the open market.

Major insurer AIG has already admitted some of its CDSs were mispriced.

Third, one-sixth of CDSs were created as backstops for holders of CDOs, and we know the CDO market ain’t so healthy.

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A new acronym means recession could be worse than many claim

You’ve learned about CDOs and SIVs; now, it may be time to bone up on CDSs.

John Markman claims credit default swaps by banks and other financial institutions will add extra pain to the current recession:

Nearly seven decades ago, the eight months between Germany’s invasion of Poland in 1939 and its invasion of France in 1940 was known as the “phony war” — a period of escalating anxiety, denial, appeasement, danger and death, but nothing like the murderous global train wreck soon to follow.

Likewise, we may come to look at the period between July 2007 and January 2008 as a sort of phony war in the worldwide credit crisis, because although the market has fallen 15 percent since summer, there have been no defaults of key bonds or asset-backed securities. The curious lack of real blowups has led even seasoned observers to believe that fears were exaggerated and that chaos will be averted.

In reality, however, the skirmishes we’ve seen so far might be little more than a prelude to a deeper, harsher, longer decline than most yet perceive possible. And in a very postmodern twist, it is beginning to look like unexpected consequences of an investment instrument designed to mitigate risk could turn out to be the nuclear option that bombs the globe into the financial equivalent of World War III.

Here’s why CDSs could be a problem, according to Markman:

Because we are coming out of a long period in which debt defaults have been unusually low, hundreds of little-known hedge funds, pension funds and insurers worldwide were lulled by a false sense of complacency into the practice of selling CDSs — and their ability to pay up in the event of widespread defaults amid a long, hard recession is not just in doubt but completely unlikely.

Markman lists various ways these issuers are likely to try to get off the hook. They include contract loopholes, imprecise language not crafted to a specific bond insurance need, whether or not a bond issue’s “restructure” equals a default, available collateral and hedging of CDSs, and more.

Oh, for a good summary list of financial acronyms, visit this Economist story.

[More econ news below the fold]


Housing slump worst since Depression?

For the first time since comprehensive records going back to 1968, housing prices declined for an entire year in 2007. How bad is it? Even the financial guru for the National Association of Realtors was glum:

Lawrence Yun, the Realtors’ chief economist, said it was likely that the country has not experienced a decline in housing prices for an entire year since the Great Depression of the 1930s.

In other words, neither a Fed rate cut nor a one-off stimulus package is going to make a lot of difference. The housing market is going to have to suffer through this; I hope part of the price of that suffering is a variety of new regulatory legislation, not only on the marketing of subprime loans, but the use of things such as CDOs and SIVs by financial institutions, AND…

Regulation to address the currently incestuous relationship between these institutions and ratings agencies such as Moody’s.

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What happens if all those CDOs are uninsured?

It’s quite possible. Today, bond insurer MBIA announced it has more exposure to collateralized debt obligations than its entire net worth.

MBIA said it has exposure to $30.6 billion in complex mortgage securities that it insures, an amount that eclipses its entire net worth, … (including) exposure to $8.1 billion of collateralized debt obligations, or CDOs, including mostly risky debt known as CDO squared, or CDOs backed by other CDOs, it reported on its Web site late on Wednesday. The company's net worth as of September 30 was $6.5 billion.

Meanwhile, Morgan Stanley’s mix of real indignation over the under-insuring, mixed with faux indignation about another company besides Morgan Stanley cutting corners on investments, sounds like it comes straight from a reel of “Casablanca”:

“We are shocked that management withheld this information for as long as it did,” Morgan Stanley said in a report, referring to the CDO-squared exposure.

Shocked that there’s gambling in this loan-based securities establishment!

Meawhile, Bear Stearns posted its first quarterly loss in history.

I’m sure the bulls on the Street are trying to do their latest spinmeistering as we speak.

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Now China wants a piece of the U.S. financial action

Just weeks after Singapore and the Abu Dhabi Investment Authority became major investors in cash-strapped financial institutions, China is getting in on the action.

Morgan Stanley, the No. 2 U.S. investment bank, reported a $9.4 billion writedown on Wednesday from bad bets on mortgage-related debt, leading it to take a $5 billion infusion from an arm of the Chinese government.

China Investment Corp. (made the) investment in Morgan Stanley. China's government-controlled investment vehicle will hold no more than 9.9 percent of the investment bank once its investment converts to common shares in 2010.

Several points to note. One, the writedown is three times what MS had previously warned of just a month ago.

Two, if the writedown problems are continually that bad, as every financial institution weighing in on the matter of their books in the past 30 days have said, just how shaky is the system?

Three, as I’ve talked about before, just how much will foreigners try to invest in U.S. financial institutions? Will the Securities and Exchange Commission weigh in, or drop some hints? Or the Fed? Or Congress?

Paul Kennedy spoke about issues like this in his magisterial book, “The Rise and Fall of the Great Powers,” too.

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