Wells Fargo & Casualties of Constipated Collateral Damage

In the last five months, Merrill, Citigroup and UBS CEO's have all stepped down.

Those companies accounted for about 60% of the $45 billion of writedowns reported by the world's biggest banks and securities firms so far this year.

To date, the industry has cut 10,000 jobs, and stock losses at the five largest securities firms total $84 billion of market value.

The Nattering One muses... Banks, Brokers and Financial Houses deemed solvent at the moment, are facing a financial tidal wave...

that will claim many casualties or collateral damage. The irony is, the constipation is being caused by damaged collateral.

Banks including Citigroup, JPMorgan Chase and Credit Suisse are stuck with an estimated...

$300 billion of bonds and loans they committed for the record number of LBOs announced this year.

The Nattering One previously estimated the debt back up, between off book LBO and short term ABCP based on MBS...

that has been rolled at the Fed window since August, to be no less than $1 Trillion.

$1 Trillion is a very large obstruction in the bowels of the financial and banking system. In addition to accepting ANY collateral, even boat loans...

the Fed has lowered Fed Funds and the emergency window discount rate by 75 bps.

The media advertised a Q3 "kitchen sink" write down, to lure unwary investors back to sinking financial stocks.

The financial houses have engaged in book cooking chicanery, shifting loans to "held for investment" assets...

rather than taking the write downs as required when "held for sale".

In addition, liquidations of plunging MBS to stay solvent and keep their off book SIV conduits afloat...

have been masked with purchase of additional "off book" securities.

The bulk of MSR mortgage servicing rights and MHFS mortgage held for sale are classified Level 2 or 3.

Subject to the holding companies valuation, rather than actual Level 1 market valuation.

Take "solvent" Well Fargo's Q10 filed on Nov 6th as a prime example.

Page 17: $10 Billion less mortgages for sale: Mortgages held for sale decreased to $29.7 billion at September 30, 2007, from $39.9 billion a year ago.

This could be because, originations and the unclosed pipeline were both down $10 Billion vs last year. I don't think so.

The disclaimer: "From time to time, we hold originated ARMs in our loan portfolio as an investment for our growing base of core deposits.

We determine whether the loans will be held for investment or held for sale at the time of origination
." Isn' that special?

Consumer Real Estate 1-4 Family 1st Mortgage Loans held as assets increased from $60 Billion to $73 Billion since last year.

How did assets increase if both originations and the unclosed pipeline were down $10 Billion?

The magic of creative accounting. The $10.2 Billion got shifted to mortgages (assets) held for investment...

as such those loans did not have to be valuated at current market value or written down at a market valuated loss.

"At September 30, 2007, we held $54.9 billion of debt securities available for sale, compared with $41.8 billion at December 31, 2006.

76% of this portfolio was mortgage-backed securities."

Private collateralized mortgage backed securities for sale +300%: $12.086 Billion vs Dec 31st $4.046 Billion.

Short term borrowings +300% $41.729 Billion vs $13.8 Billion a year ago. Both increasing exponentially.

Why? No buyers for the MBS and ABCP securities, which forces them to borrow more short term money to stay solvent.

Page 58: $26.714 Billion MHFS mortgages held for sale, NONE are Level 1 assets. $18.233 Billion MSR Mortgage Servicing Rights , NONE are Level 1 assets.

In other words, NONE of the $45 Billion in mortgages is valued at actual market value,

only what Wells tell us, they think its worth. Worse yet 70% of Well's trading assets, securities & mortgages are Level 2 or 3.

Notional value related to written options was $45.6 billion at September 30, 2007.

This is Wells hedge against the mortgages "valued" at $45 Billion going down in value.

"During the quarter, we sold $27 billion of our lowest yielding mortgage backed securities that were largely hedging the MSR assets against a decline in interest rates.

The securities were replaced with "off-balance sheet" economic hedges to more efficiently manage the market risk in the MSRs portfolio
."

In other words, so far we've been forced to liquidate $27 Billion of MBS at a discount, to stay solvent during this ABCP debt market crisis,

and replaced those securities with "off balance sheet" assets, which we don't have to valuated objectively or write down.

$45 Billion in subjectively valued mortgage assets, $45 Billion in notional value options to hedge the assets.

A $27 Billion MBS liquidation, a tripling to $41 Billion in short term borrowings, to stay solvent.

A $10 Billion shift in mortgages held for sale to mortgages held for investment and

replacement of the $27 Billion liquidated MBS with $17 Billion in additional "off book" securities.

What else is UP at Wells: Total non performing or non accruing loans UP 50%: $3.183 Billion vs $2.1 Billion a year ago.

Total loans 90 days delinquent and still accruing UP 52%: $5.526 Billion vs $3.664 Billion a year ago.

The number of REO listings in California alone, for Wells Fargo as of Sept 5th, roughly 3800.

Wanna know what the number is NOW? 5380; UP 41% in just 2 months. I expect by January this number will be over 7000 easily.

Much like the Etrade story earlier today, devaluation by debt quality downgrading, or actual marking to market,

and the liquidity strain of subsequent increases in reserve requirements, along with deposit attrition,

John Q. withdrawing his already borrowed refi money from plunging stock and money market accounts,

could lead to a forced liquidation of the subjectively valuated assets that are supported by the already overleveraged deposits. Its a vicious circle.

We are not there yet, but where would this leave the bank, the depositors, the insurers of the debt & deposits, and the taxpayer?.

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