By Katie Benner

The death of the investment banks. The ban on short selling. The unrelenting pain for anyone who needs to borrow money. Chaos has descended on Wall Street, and at least one hedge fund manager isn’t going to take it anymore.

Cliff Asness, managing partner of AQR, a $30 billion hedge fund firm, produced a searing, angry, and hilarious piece for Joe Nocera at the New York Times that rails against the Securities and Exchange Commissions “temporary” ban on short-selling. God only knows how Asness fared when the ban, which prohibits investors from betting against a company’s stock, went into effect. But it forced funds to cover short positions (Wall Street speak for scrambling to buy shares of companies they hate and had therefore shorted). And quantitative funds that use computer models, like Asness’ AQR, undoubtedly did not have a “what if the government bans shorting” contingency built into their algorithms.

Unsurprisingly, Asness is hopping mad. He hits all the expected notes: The government greenlighted Wall Street greed and the residential real estate bacchanalia. The Federal Reserve under Alan Greenspan led the way by refusing to let the country go into a recession when it should have, creating a massive real estate bubble.

But he also includes zingers like, “So, what goes through the minds of the politicians and bureaucrats and what do they say to themselves? Perhaps it’s the following: ‘What this crisis absolutely requires is that a really futile and stupid gesture be done on somebody’s part and we’re just the guys to do it.’ It was funny when Bluto said it in Animal House. Appropriately if you stayed for the end of the movie you discovered he went on to become a senator. It’s not funny in real life.”

But you know Asness is a man at the end of his rope if you bother to click on the disclosure that accompanies the story. His views and opinions, of course, do not necessarily reflect the views of AQR Capital Management, LLC its affiliates, or its employees. But they are, he concedes, the work of a man who is “criminally insane.”

“Anyone trading on my advice, or a client, consultant, employee or Iraqi insurgent thinking he has been wronged by my attitudes or opinions can have a $250 out-of-court settlement right now if they’ll sign a waiver, otherwise we’ll break you. Oh, and we lied about the $250, but seriously, we will break you.

“Furthermore, if you read one guy’s opinion on a blog and do anything based solely on that, you are an idiot.”

As Nocera wrote at the top of the story, we too hope to hear from Asness as often as possible as this crisis plays out.

Fannie Mae (FNM) chief Dan Mudd got a vote of confidence Wednesday as the mortgage giant shook up its management suite. Mudd promoted three top financial executives and said three others - including finance chief Stephen Swad - will depart.

“The Board of Directors is firmly committed to Dan Mudd, the management restructuring, and the strategic objectives around capital and credit he set forth on Aug. 8,” said Chairman Stephen B. Ashley. “The Board will continue to work closely with Dan and his management team to guide the company and support the housing finance system through a very challenging period.”

The departure of a chief financial officer at a company under market scrutiny is always noteworthy, though Swad seems like an unlikely candidate for any intrigue. Before he came to Fannie he held jobs including deputy chief accountant at the Securities and Exchange Commission. Another notable departure is Fannie’s risk chief, Enrico Dallavecchia, who is going to “pursue other opportunities in finance and risk management,” Fannie said.

Fannie said the shakeup is necessary for the company to implement a plan announced earlier this month to better manage its capital and reduce credit losses, which are hitting all-time highs as the housing bubble deflates.

Fannie named Peter Niculescu chief business officer, David C. Hisey chief financial officer and Michael Shaw chief risk officer. All three already held executive positions at the Washington-based mortgage finance company. Departing along with Swad, who came aboard just last spring, and Dallavecchia will be Rob Levin, who will leave after 27 years with the company, most recently as chief business officer.

The shakeup comes as Fannie and its government-sponsored sibling Freddie Mac (FRE) enjoy a respite from the government-takeover talk that has swirled for much of the past two months. Shares of the companies have plunged to lows last seen in the 1990 banking crisis amid chatter that their capital won’t be sufficient to shield them from losses on their big mortgage holdings and guarantee portfolios.

But in recent days more and more Wall Streeters have been acknowledging that Treasury chief Henry Paulson doesn’t want to take the companies over, and the companies have continued to say they plan to weather the housing storm as independent entities, the stock market’s low opinion of their prospects notwithstanding. Mudd pointed out last week that revenue on Fannie’s current book of business is running at record levels - a point taken up in a report earlier Wednesday on Bloomberg.

“As we move through the bottom of this cycle,” Mudd said, “maintaining capital, managing credit and driving revenues are the priorities - and we have to organize and staff accordingly.” Fannie Mae shares were halted after hours Wednesday following a 15% rise in regular trading.

Motorola (MOT) shares surged in premarket trading Thursday after the struggling tech titan posted a minuscule second-quarter profit in spite of the latest sales decline at its handset unit. The Schaumburg, Ill.-based company made $4 million, or less than a penny a share, for the quarter, reversing the year-ago continuing operations loss of $38 million, or 2 cents a share. Excluding certain costs, the latest-quarter profit at Motorola was 2 cents a share - a nickel better than the Thomson Financial analyst estimate.

CEO Greg Brown, installed after a bruising battle with activist investor Carl Icahn led to the departure of former chief Ed Zander, cited solid results at the company’s networking and enterprise mobility segments. But the handset unit continued to struggle, with sales down 22% from a year ago to $3.3 billion and the segment operating loss widening to $346 million from $332 million a year ago. Motorola, the world’s No. 3 mobile phone maker, will have to start making phones that people want to buy in order to rescue that sinking ship. In the meantime, investors are happy enough to see Motorola making a bit of money - the company expects to earn 6 to 8 cents a share for the year, beating the penny-a-share Thomson target. Shares rose 11%.

by Katie Benner

Fannie Mae (FNM) and Freddie Mac (FRE) have long been considered bulletproof by the big three credit ratings agencies, but now Moody’s has dared to throw the first stones at the mortgage giants. The companies still have a top-notch AAA rating on their corporate bonds, but the preferred stock and bank financial strength ratings for Fannie and Freddie were cut one notch Wednesday, and the companies are on review for further downgrades.

The preferred stock ratings were cut to A1 from Aab because of adverse market conditions and the potential for greater-than-expected credit losses. “In Moody’s view, these risks outweigh the benefits of Fannie Mae’s recent capital raise,” the agency said in the Fannie Mae ratings note. Moody’s said that both companies may have to suspend dividends on its preferred stock if certain capital levels are not maintained.

“Adverse market conditions have reduced Fannie Mae’s ability to raise additional equity capital,” said Moody’s senior vice president Brian Harris. “This limits the company’s ability to build further cushion to offset unanticipated stresses in its asset quality.”

The bank financial strength ratings, which measures the likelihood that an institution will require extraordinary financial assistance, were cut to B- from B. Moody’s isn’t exactly ahead of the curve here given that the Treasury and Federal Reserve provided some extraordinary financial assistance Sunday, three days before the ratings agency thought some sort of aid might happen.

However, Moody’s did acknowledge that the firms are troubled, particularly Freddie Mac, and that both could face higher than anticipated credit losses. Regarding both firms, Moody’s said that adverse market conditions have reduced their ability to raise additional equity capital, “thus limiting the [companies] ability to build further cushion to offset unanticipated stresses in its asset quality.”

By Katie Benner

Should Fannie Mae (FNM) and Freddie Mac (FRE) run into serious problems, a rescue plan would likely shaft shareholders, the Wall Street Journal reports. Citing people familiar with the matter, the Journal says Treasury Secretary Henry Paulson is adamant that no government bailout plan benefit shareholders. The Bush administration says it thinks the firms will not fail and that its plan is to support Fannie and Freddie in their current forms.

Talk of a rescue heated up this week after a Lehman report Monday said that the companies may need to raise a combined total of $75 billion due to a possible Financial Accounting Standards Board (FASB) rule change that would force the mortgage giants to move securities they now hold onto their balance sheets. Fannie shares plunged 16% and Freddie shares 18% Monday, even though the analyst note said that the companies were both solvent and would probably not be affected by a change in accounting rules.

Even so, investors continued to flee the stocks all week, worried that the firms would need some sort of government intervention to prevent insolvency. Panic grabbed a hold of the market after former Federal Reserve governor William Poole said that Freddie Mac is already “insolvent”; and the Journal reported Wednesday that the government was reviewing possible bailout scenarios. Even though both Fannie and Freddie were quick to say that they have plenty of capital, a sentiment echoed by Treasury Secretary Paulson, the stocks still ended the week down just over 45% for the week and about 75% for so far this year.

Investors were quick to bail in part because questions have long lingered about whether the two companies had taken on too much risk, are too leveraged, and are short on capital. But Fannie and Freddie have become so vital to the mortgage market that regulators and officials have been loathe to force change at the government-sponsored, publicly-traded companies.

By Katie Benner

Federal prosecutors are investigating whether two former Credit Suisse (CS) brokers lied to investors about how they placed their money into auction rate securities, a type of bond investment that has hurt investors, reports the Wall Street Journal. The $330 billion market for auction rate securities allows issuers such as municipalities and student loan companies, closed-end mutual funds or financial institutions to borrow money in the form of long-term bonds. The market has treated these bonds like safe, short-term investments because investors can sell them at weekly auctions. But the auction market for these bonds dried up when the credit crisis hit, and investors were trapped in these long-dated securities because there were no buyers.

The investigation is being conducted by the U.S. attorney’s office for New York’s Eastern District, according to the Journal. Many individual investors have already filed lawsuits in an attempt to get their money out of these bonds. Some of these claims say brokers misleadingly described auction-rate securities as “money market” funds, or other cash equivalents. Massachusett’s regulators last week filed a civil fraud suit against UBS (UBS) executives, alleging that UBS brokers told investors the securities “were safe, liquid ‘cash alternatives’ when UBS knew they were not.” UBS has denied wrongdoing.

In the Credit Suisse case, New York-based brokers Eric Butler and Julian Tzolov resigned from the firm on Sept. 7, 2007, amid accusations by clients that they were misled about the nature of the auction-rate securities they bought, according to the report. Clients said they were told the securities they purchased were backed by student loans, but they were really backed by risky collateralized debt obligations, or pools of bonds tied in part to subprime mortgages, said the Journal. Credit Suisse has said that it is working with regulators to get to the bottom of the matter, and the report says it is not a target of the investigation.

A spokesman for the U.S. attorney’s office and Paul Weinstein, a lawyer for Mr. Butler, declined to speak with the Journal. But Kenneth Breen, a lawyer for Tzolov, said his client is a well-respected broker who shouldn’t be blamed for an unforeseeable market failure. “Julian Tzolov deceived no one,” he told the newspaper. “He had his clients’ interests at heart at all times. We are confident that the U.S. attorney’s office will make the correct decision and choose not to bring charges.”

Both brokers joined Morgan Stanley a few days after leaving Credit Suisse; but a Morgan Stanley spokeswoman told the Journal that they were fired on Monday and declined to elaborate.

It’s getting more expensive for Fannie Mae (FNM) to borrow money, according to a Bloomberg report. Investors are demanding a higher interest rate to buy Fannie’s bonds to compensate for perceived risk that the mortgage company could run into serious problems. This week the company auctioned off $3 billion worth of two-year notes and they yielded 3.27%, 74 basis points more than comparable U.S. Treasuries. According to Bloomberg, that’s the biggest spread since Fannie Mae first sold two-year benchmark notes in 2000.

Government Treasuries are considered the very safest investments, so its yields are relatively low. If the spread between a bond’s yield and its comparable Treasury yield widens, that shows the market believes the bond itself is becoming a riskier investment.

As the spread between Fannie debt and Treasury debt grows, investors and traders are apparently overlooking the government’s implied guarantee of Fannie Mae, says Bloomberg. The companies have raised more than $20 billion since December as their combined losses grew to more than $11 billion; and credit-default swaps tied to their $1.45 trillion of AAA rated debt are trading at levels that imply the bonds should be rated a lower A2 by Moody’s.

Jason Lobo, a Fannie Mae spokesman, would not discuss the bond sale with Bloomberg. In June, Fannie Mae last sold $4 billion of two-year notes at 3.036%, or 65 basis points over Treasuries. A basis point is 0.01 percentage point.

By Katie Benner

The Federal Reserve will hold off on an interest rate hike until central bankers first stop providing loans to Wall Street banks, according to a Bloomberg report. For as long as the Fed has to maintain (or even extend) its emergency lending program, the report says, it’s unlikely that the market will be stable enough to handle higher borrowing costs.

“We think they’ll wait until 2009,” Brian Sack, who used to head the Fed’s monetary and financial market analysis group before he joined Macroeconomic Advisers, tells Bloomberg. Successfully dealing with an end to the Primary Dealer Credit Facility is “a hurdle for credit markets to get past before the Fed will likely start tightening,” he said.

The Fed opened its window to investment banks in March after the near-bankruptcy of Bear Stearns, which sold for cheap to JPMorgan Chase (JPM), in an effort to keep markets calm. The decision to make Fed loans available to a group of institutions that include Lehman Bros. (LEH), Merrill Lynch (MER), Morgan Stanley (MS), and Goldman Sachs (GS), was highly unusual. The Fed had traditionally provided loans to commercial banks but not investment banks. New York Fed President Timothy Geithner said in early June that as long as markets were distressed, the emergency measure would remain in place. However, part of the Fed’s plan to keep the economy on track has meant maintaining low interest rates. With energy and food prices rising fast, inflation has become a serious concern and some economists think it’s time to raise interest rates.

The market has priced in 74% odds or a rate hike by the end of 2008, but those odds might be overly optimistic given that people are still hesitant to lend and Wall Street is still perceived as weak, Bloomberg says. The next rate hike, whenever it comes, will be the first increase since 2006.

By Katie Benner

If you’re Lehman Bros. (LEH), the market has doubts about your balance sheet, your stock is down, and rumors say you’re going out of business or bound for the auction block. So forming a hedge fund that looks like nothing more than a place to dump unknown assets might not be the smartest idea.

But, reports Bloomberg, this seems to be exactly what Lehman has done. The firm has sold $4.5 billion worth of assets to a newly-formed hedge fund that counts Lehman as a significant investor; is run by seven recently-departed Lehman executives; and operates out of Lehman office space, three floors down from the office of Lehman’s corporate secretary, the report says. What’s more, Lehman is keeping its dealings with the fund, R3 Capital Partners quiet, and it isn’t mentioned in the firm’s Securities and Exchange Commission filings.

You don’t need to know much more about R3 to see that this could be cause for alarm.

Lehman investors will want to know how any transactions with the fund have affected the bank’s financial statements. R3 told Bloomberg that it is “an independently managed fund in which Lehman Brothers is a limited partner and holds a passive, minority stake in the general partner.”

Not good enough for a firm that wants to restore investor confidence, says Bloomberg. “That [statement] won’t keep investors from forming their own conclusions. If Lehman doesn’t like what they decide, it will have only itself to blame.”

The credit crisis has caused Wachovia (WB) no end of grief. As Warren Buffett would say, this commercial banking stalwart was one of the many companies left swimming naked when the tide went out. It had expanded beyond its expertise into businesses like financing private equity deals and issuing bad mortgages; and the stock has been duly punished, dropping from $53 to $15 in the last year. One analyst has a suggestion for the bank, its board and its interim management, which he says “have no idea of how to run this company.” Richard Bove, at Ladenburg Thalmann, says Wachovia should hire Phil Purcell as CEO.

In a research note to clients issued Wednesday, Bove’s case for a Purcell hire includes points like:
* Wachovia has a big problem with its acquired thrift, Golden West, and its mortgage business. Purcell has operated thrifts and mortgage operations.
* Wachovia operates one of the largest retail sales forces in the country. Purcell took a retail sales business, Dean Witter, and made it strong enough to buy Morgan Stanley.
* Wachovia’s investment bank is so weak that Goldman Sachs (GS) was hired to handle its distressed mortgage portfolio. When Purcell was forced out of Morgan Stanley, investment banking was its best-performing business.

Is Bove working for Purcell’s headhunter? Remember, too, that Purcell clashed with employees at Morgan Stanley after the merger with Dean Witter, and that he was ousted by John Mack and a group of eight former Morgan executives. His detractors said that he never really understood institutional securities.

While the idea of a Purcell hire seems a bit far-fetched, there is one thing about the former Morgan head that Wachovia desperately needs. When Purcell was tossed from Morgan Stanley and John Mack took the reigns, one issue was Purcell’s cautious approach to risky business. He preferred to build profit margins rather than expand revenue, which was considered a hindrance.

Now we can see that banks like Wachovia and even Morgan Stanley could have used a healthy dose of Purcell’s prudence. Whether his caution was based on ignorance or prescience is a moot point. Banks need leaders that have a sense of proportion and respect for risk so they can put these businesses back on a profitable track.