Tuesday, 31 March 2009
The Geithner Plan, his so-called Public-Private Partnership Investment Program or PPPIP, as we have noted previously ( Obama's Rettungsplan für die Banken: keine Lösung, sondern legaler Diebstahl ), is designed not to restore a healthy lending system which would funnel credit to business and consumers. Rather it is yet another intricate scheme to pour even more hundreds of billions directly to the leading banks and Wall Street firms responsible for the current mess in world credit markets without demanding they change their business model. Yet, one might say, won't this eventually help the problem by getting the banks back to health?
Not the way the Obama Administration is proceeding. In defending his plan on US TV recently, Geithner, a protégé of Henry Kissinger who previously was President of the New York Federal Reserve Bank, argued that his intent was ‘not to sustain weak banks at the expense of strong.' Yet this is precisely what the PPPIP does. The weak banks are the five largest banks in the system.
The ‘dirty little secret' which Geithner is going to great degrees to obscure from the public is very simple. There are only at most perhaps five US banks which are the source of the toxic poison that is causing such dislocation in the world financial system. What Geithner is desperately trying to protect is that reality. The heart of the present problem and the reason ordinary loan losses as in prior bank crises are not the problem, is a variety of exotic financial derivatives, most especially so-called Credit Default Swaps.
In 2000 the Clinton Administration then-Treasury Secretary was a man named Larry Summers. Summers had just been promoted from No. 2 under Wall Street Goldman Sachs banker Robert Rubin to be No. 1 when Rubin left Washington to take up the post of Vice Chairman of Citigroup. As I describe in detail in my new book, Power of Money: The Rise and Fall of the American Century , to be released this summer, Summers convinced President Bill Clinton to sign several Republican bills into law which opened the floodgates for banks to abuse their powers. The fact that the Wall Street big banks spent some $5 billion in lobbying for these changes after 1998 was likely not lost on Clinton .
One significant law was the repeal of the 1933 Depression-era Glass-Steagall Act that prohibited mergers of commercial banks, insurance companies and brokerage firms like Merrill Lynch or Goldman Sachs. A second law backed by Treasury Secretary Summers in 2000 was an obscure but deadly important Commodity Futures Modernization Act of 2000. That law prevented the responsible US Government regulatory agency, Commodity Futures Trading Corporation (CFTC), from having any oversight over the trading of financial derivatives. The new CFMA law stipulated that so-called Over-the-Counter (OTC) derivatives like Credit Default Swaps, such as those involved in the AIG insurance disaster, (which investor Warren Buffett once called ‘weapons of mass financial destruction'), be free from Government regulation.
At the time Summers was busy opening the floodgates of financial abuse for the Wall Street Money Trust, his assistant was none other than Tim Geithner, the man who today is US Treasury Secretary. Today, Geithner's old boss, Larry Summers, is President Obama's chief economic adviser, as head of the White House Economic Council. To have Geithner and Summers responsible for cleaning up the financial mess is tantamount to putting the proverbial fox in to guard the henhouse.
The ‘Dirty Little Secret'
What Geithner does not want the public to understand, his ‘dirty little secret' is that the repeal of Glass-Steagall and the passage of the Commodity Futures Modernization Act in 2000 allowed the creation of a tiny handful of banks that would virtually monopolize key parts of the global ‘off-balance sheet' or Over-The-Counter derivatives issuance.
Today five US banks according to data in the just-released Federal Office of Comptroller of the Currency's Quarterly Report on Bank Trading and Derivatives Activity, hold 96% of all US bank derivatives positions in terms of nominal values, and an eye-popping 81% of the total net credit risk exposure in event of default.
The five are, in declining order of importance: JPMorgan Chase which holds a staggering $88 trillion in derivatives (€66 trillion!). Morgan Chase is followed by Bank of America with $38 trillion in derivatives, and Citibank with $32 trillion. Number four in the derivatives sweepstakes is Goldman Sachs with a ‘mere' $30 trillion in derivatives. Number five, the merged Wells Fargo-Wachovia Bank, drops dramatically in size to $5 trillion. Number six, Britain 's HSBC Bank USA has $3.7 trillion.
After that the size of US bank exposure to these explosive off-balance-sheet unregulated derivative obligations falls off dramatically. Just to underscore the magnitude, trillion is written 1,000,000,000,000. Continuing to pour taxpayer money into these five banks without changing their operating system, is tantamount to treating an alcoholic with unlimited free booze.
The Government bailouts of AIG to over $180 billion to date has primarily gone to pay off AIG's Credit Default Swap obligations to counterparty gamblers Goldman Sachs, Citibank, JP Morgan Chase, Bank of America, the banks who believe they are ‘too big to fail.' In effect, these five institutions today believe they are so large that they can dictate the policy of the Federal Government. Some have called it a bankers' coup d'etat. It definitely is not healthy.
This is Geithner's and Wall Street's Dirty Little Secret that they desperately try to hide because it would focus voter attention on real solutions. The Federal Government has long had laws in place to deal with insolvent banks. The FDIC places the bank into receivership, its assets and liabilities are sorted out by independent audit. The irresponsible management is purged, stockholders lose and the purged bank is eventually split into smaller units and when healthy, sold to the public. The power of the five mega banks to blackmail the entire nation would thereby be cut down to size. Ooohh. Uh Huh?
This is what Wall Street and Geithner are frantically trying to prevent. The problem is concentrated in these five large banks. The financial cancer must be isolated and contained by Federal agency in order for the host, the real economy, to return to healthy function.
This is what must be put into bankruptcy receivership, or nationalization. Every hour the Obama Administration delays that, and refuses to demand full independent government audit of the true solvency or insolvency of these five or so banks, inevitably costs to the US and to the world economy will snowball as derivatives losses explode. That is pre-programmed as worsening economic recession mean corporate bankruptcies are rising, home mortgage defaults are exploding, unemployment is shooting up. This is a situation that is deliberately being allowed to run out of (responsible Government) control by Treasury Secretary Geithner, Summers and ultimately the President, whether or not he has taken the time to grasp what is at stake.
Once the five problem banks have been put into isolation by the FDIC and the Treasury, the Administration must introduce legislation to immediately repeal the Larry Summers bank deregulation including restore Glass-Steagall and repeal the Commodity Futures Modernization Act of 2000 that allowed the present criminal abuse of the banking trust. Then serious financial reform can begin to be discussed, starting with steps to ‘federalize' the Federal Reserve and take the power of money out of the hands of private bankers such as JP Morgan Chase, Citibank or Goldman Sachs.
Source: William Engdahl
Standard & Poor's has announced that it is removing Ireland's coveted AAA rating and replacing it with a AA+ rating, capping a day of misery in global markets.
The decision will raise suspicions that the UK may soon find its own debt downgraded. The ratings agency said it had taken the decision after examining the prospects for the country's public finances. The country's finance ministry insisted that it was determined to keep its debts under control in the coming years, saying: "The government is committed to restoring order to the public finances by bringing the deficit below the three percent limit by 2013."
Read Full Article
Monday, 30 March 2009
Source: Rolling Stone
Sunday, 29 March 2009
Jim Faulds, chairman of the Dunfermline Building Society, said the institution's imminent takeover was both unnecessary and a "scandal".
Mr Faulds insisted the Dunfermline had a viable long-term future, claimed its problems were not as bad as portrayed, and accused Chancellor Alistair Darling of being badly briefed.
These two predictions seem to be in opposition to each other. A fall of 30% in commercial real estate would surely place downward price pressure on the American economy. Local banks are more heavily invested in commercial real estate than residential. Fannie Mae and Freddie Mac created the housing boom. The government and the Federal Reserve System are trying to bring the boom back to life by buying the debt of these two agencies, using FED fiat money. Mortgage rates are now under 5%. Still, the residential real estate market continues to fall.
COMMERCIAL REAL ESTATE
Commercial real estate's future value is ultimately a function of the net revenues it can generate. The economy continues to remain in recession. The expectation of national unemployment in the 9% range is now conventional. As consumers shift spending from discretionary to non-discretionary goods and services, existing businesses that cater to discretionary spending will come under intense pressure. Some are going to go out of business. They will cancel their leases.
I had a taste of this recently. My wife and I went to lunch downtown in our little community. It is the county seat. The county has recently opened a large, modern facility several miles from the town square. The old buildings are still occupied by the county, but not with the same high concentration of employees.
We headed for a great little Mexican restaurant. It was gone. Next door, a 2,700 square foot facility was empty. Another empty office was three doors down. There used to be a sandwich shop down the street. Gone.
This has happened in less than two months. Businesses that were doing fine are gone forever. The owners should have seen this coming, but owners are optimistic. They think, "It won't happen to me." But it does.
Every owner should have gone shopping for a new location as soon as the county announced the new building. I assume that was at least five years ago. Maybe it was more. Those store fronts should be occupied today by businesses that are not dependent on walk-in traffic from county employees. The rent should have fallen as soon as the leases ran out in the year that the new facility was approved. But this is never how it works. The existing renters did not perceive that their business plans were doomed. They pretended that the flow of customers would not change, despite the fact that the customers would no longer be within walking distance.
On the door of the sandwich shop was a forlorn note announcing the closing and thanking the customers for their loyalty. Loyalty? When? For how long? What percentage of customers? Most of the ex-customers will never read that sign. They won't go downtown again. If they do, they will not stay long enough to buy a sandwich.
Now the owners of all that space are facing a disaster. We are in a recession. Banks will not lend to small start-up businesses. The landlords had bet their future on rental income from small businesses that catered to the county's employees. Now they must find completely different types of renters. The rental space is no longer prime. They should have canceled leases, year by year, on every business that was county employee–dependent. The recession would have hit, but they would now have a cushion. They have no cushion.
People see things coming. They ought to understand that new market conditions will force major plan revisions. Bankruptcy is one of those plan revisions. But people assume that whatever trends are good will continue, while trends that are negative will evaporate. Their optimism leads them into business. Then it leads them out.
It takes a systematic act of will to follow the implications of an irreversible trend. The trend of traffic was obvious, given the new county building, but existing renters refused to extrapolate the trend. They did not devote time and effort to overcoming this trend by starting over elsewhere, while they still had working capital. Instead, they just sat.
What is true of a business owner is also true for most employees and most investors.
THE REAL ESTATE FALL-OUT
How many investors had heard of subprime mortgages in 2005? Of those who did, how many of them knew of the packaging of these mortgages? How many knew that the credit-rating services were rating as AAA packages that are today being sold at 30 cents on the dollar? How many knew that these packages were being bought by hedge finds with borrowed money at leverage of 30-to-1? On and on it went.
The fall-out was not perceived by regulatory agencies, the entire investment banking industry, commercial banks, Federal Reserve economists, and European bankers who decided that 30-to-1 was too conservative.
We are now in a recession the likes of which nobody has ever seen. The fall-out continues to fall out. Investors think that the problem is solved. Then two more appear.
Soros' words ought to be accurate: "It is inevitable, it is written, everybody knows it, there are already some transactions which reflect and anticipate it, so we know. . . ." They are not accurate. The phrase, "so we know," is wrong. "We" do not know.
The typical bankers who lent 60% of their depositors' money to commercial real estate projects are in the same situation as the landlords of the now-empty space in my town square were two years ago. They did nothing to protect themselves when they might have been able to. They sat, just as their lease-holders sat. They all knew that the courthouse was going to be run at quarter staff. But they did not perceive that the departure of the employees would bankrupt business after business.
Local bankers are sitting there, hoping for the best. They are not in emergency mode, preparing for the departure of their tenants. Their tenants will be forced by market conditions to close their doors.
The market is relentless. It will have its way. The reality of falling traffic and lower purchases will make itself felt, as surely as it made itself felt last Christmas. The discounting began as soon as the shopping season did. Yet hope remained. The press kept saying that things were slow, but that business owners hoped for a buying spree in the final days. It never materialized. It was wishful thinking.
Consider this fall-out. Banks will find that borrowers cease paying. Developers are going under now. Abandoned, 70% completed strip malls testify to the spreading crisis. Empty large anchor stores no longer provide the overflow foot traffic for the shops that once profited from the anchor business, which now has departed. Properties like this line every main drag in the country. Has the local Circuit City building been rented to a new customer in your town? It hasn't in mine.
This is truly a case of falling dominoes. At this point, there is nothing that the borrowers can do, other than to hope, pray, and delay. The banks that lent to them must cut back on new loans, either now or when the defaults force the change.
Companies with good credit and years of reliable repayment now face the prospect of their banks calling the loans. The banks will refuse to roll over these loans. They will have no choice. Their capital will be gone. It is gone now, but they have not yet written down the losses. They will not be able to delay much longer unless the Financial Accounting Standards Board revises FAS 157 in the next week (which it may do).
Because the initial phase of this recession has been related closely to residential real estate, which was marketed nationally by Freddie and Fannie, most local businessmen have not faced the problem of collapsed bank capital. Their lenders have continued to roll over their lines of credit. This is about to end.
I remember the situation in Texas in 1985, when oil fell and the real estate bubble collapsed. Good businesses that had long worked with a local bank found that the local bank had been absorbed by a distant national bank. The local staff had either departed or had handcuffs put on them by a national committee that knew nothing of local conditions. Businesses that had depended on a long tradition of borrowing and repaying found that they were facing bankruptcy.
A line of credit today is considered a permanent operating condition. Businesses no more plan to pay off these loans than the U.S. Treasury expects to pay off its lines of credit. The name of the game in both markets is rollover. The Treasury can play this game because it has China and the Federal Reserve to keep the money flowing. A local business does not.
Soros makes a public statement about 30% losses in commercial real estate, and it does not get top billing. It is just more noise. Soros is very rich. He made his money in leveraged currency futures markets, the toughest market there is. If he says there will be a 30% decline, plan for this.
But how can you? If you run a business, you can pay your bank to sign an agreement to supply credit. That is worth the money, I think. It will give you a source of capital, if your accounts receivable really do become accounts paid. Your customers are using you as their line of credit. You will find it difficult to speed up collections. You will find it impossible to get them to pay cash up front.
Your employer may need a different client base, but it cannot get it in a recessionary economy. The competition for such clients is fierce.
Soros also predicted explosive price inflation. He has looked at the monetary base of the Federal Reserve. What else could he conclude? When banks pull their excess reserves out of Federal Reserve accounts that pay 0% to .25%, and they start lending – to anyone, on any terms – the fractional reserve process will begin.
Soros knows currencies better than any other public figure. He has become rich from his ability to predict and even trigger major currency devaluations. Central bankers insist that everything is fine; Soros takes a position on the other side of the trade; and the central bank capitulates. It hands him a billion or more dollars' worth of profits. He goes on to bigger fish to fry.
He could have said this: "It is inevitable, it is written, everybody knows it, there are already some transactions which reflect and anticipate it, so we know, that prices in dollars will rise at east [xx] percent." He didn't.
The public does not perceive any of this. It has no idea what the monetary base is, or what this has to do with M1. People just struggle to stay ahead of the recession's fall-out. They have so little money to spend that is not committed to paying monthly bills that changes in their plans are marginal. They cannot fund major changes.
We do not see panic yet. We see hope that the Obama Administration's weekly new policies will work. If the earlier ones had any chance of working, why are new ones announced each week?
Investors want to believe that the Federal Reserve and the Treasury can extricate the economy from the broad disaster that Federal Reserve policy and Treasury policy created under Greenspan. They expect the Treasury's revolving door of experts from the Council on Foreign Relations to get it right this time. They take the official assurances at face value. There is no FAS 157 governing official pronouncements from Geithner or Summers or Bernanke. There is nothing that compels pundits to write down their statements at face value to something markedly less. There is no mark-to-market accounting for political pronouncements.
Soros says we will experience falling commercial property prices and rising general prices. If he believes this, then he has to be making an assumption: the present bailout plans of both the Treasury and the Federal Reserve will not reach the local banks and the local real estate markets. He is saying that Wall Street and Main Street are not in synch. Main street is where consumers meet sellers and work out deals. He is saying that Main Street's businesses will not be able to avoid consumers that refuse to buy.
Main Street today is where businesses that boomed under Greenspan now operate. That world is gone. Consumers will still spend money, but they will not spend it on the same products as before. Main Street's businesses that rely on discretionary spending to keep their doors open will not be able to survive.
Soros is saying what Ludwig von Mises and Austrian School economists have been saying for over nine decades. The issue is relative prices. The general price level can rise, but specific consumers, businesses, and sectors will not benefit. In short, the economy is not like the ebb and flow of the tides. All ships don't rise and fall together.
Donald Trump did fine when the Federal Reserve's real estate bubble was expanding. Investors thought he would make all those Atlantic City casinos keep them rich. They were wrong. Three of the casinos filed for Chapter 11 protection in February. The problems? Leverage. Recession. A change in taste by gamblers who were discretionary gamblers. They stopped gambling.
People who make money under one set of conditions lose money when these conditions change. Soros is predicting two seemingly rival sets of conditions: falling commercial real estate and rising prices. Those who are heavily invested in commercial real estate will take a hit before mass inflation arrives.
The recovery phase will bring monetary inflation: the multiplication of the monetary base. That will do the renters of busted businesses no good. It may bail out owners of these properties if they can keep the banks from foreclosing. It's a race against time.
The world needs capital, not more digits. The Treasury and the Federal Reserve can rearrange digits and interest rates. Investors and borrowers will follow the money. The planners can lure investors and consumers into one or another market by means of the flow of borrowed and newly created digits. But by undermining the information sent by prices, the digit-masters lure investors and buyers into debt traps. As surely as Donald Trump and his investors failed to adopt an exit strategy to deal with Bernanke's tight money policies, 2006–2007, so will investors and borrowers fail to adopt a survival strategy for the next wave of price inflation.
The destruction of capital through bad investing is the legacy of tax policies, monetary policies, and subsidy policies of government and its ally, the central bank. All over the world, this unholy alliance has destroyed capital. There is no good reason, in theory or practice, that indicates that these digit masters will get it right this time.
Donald Trump is smart. His bondholders are smart. Central bankers are smart. But they are not smarter that the assembled knowledge of a free market that is not being distorted by bureaucratic monetary policy. If the government would pay the salaries of every Federal Reserve employee, sending them all home and freezing current assets forever, the economy would become productive after a sharp, fearsome depression. That is not going to happen. The digital deception will go on.
Don't be deceived. The system is rigged against you.
Source: Market Oracle
Saturday, 28 March 2009
Convenient that they decided to dump this information on Friday afternoon, and at the close of a very good week.
J.P. Morgan Chase Chief Executive James Dimon said…that March was a little
tougher than the first two months of the year….Bank of America…CEO Kenneth Lewis also said that March had been a tougher month for his bank.
Readers may recall that a few weeks ago, those two CEOs—along with Citi’s Vikram
Pandit—said the first two months of the year had been very good:
Pandit, March 10th: “We are profitable through the first two months of 2009 and are having our best quarter-to-date performance since the third quarter of 2007.”
Dimon, March 11th: “Jamie Dimon, the chief executive of JPMorgan Chase,
said Wednesday that the bank was profitable in January and February…”
Lewis, March 12th: “We have been profitable for the first two months of
the year,” Lewis told reporters after a speech in Boston today
This was possibly the most nakedly self-serving bullshit the big bank CEOs have offered to date. (”bullshit” being a technical term of course, see Harry Frankfurt)
By February, it was understood that the big banks are all insolvent, certainly Citi and BofA. To deal with them, consensus among the cognoscenti was finally tending to a proper recapitalization: wiping out shareholders and forcing losses onto creditors via debt-for-equity swaps. Call it nationalization, call it preprivatization, call it FDIC receivership, it was clear that losses had to be recognized and by those to whom they properly belong: investors across the banks’ capital structure.
But no one really wanted to do this, not in Congress and certainly not in the Obama administration, where Timmy Geithner has made clear that his priority isn’t a cleansed banking sector, it’s a privately-owned one. For obvious reasons the banks don’t like this solution either. So they offered up their self-serving b.s. regarding January and February, buying just enough time for Congress/Bernanke to badger FASB into changing mark-to-market rules and for Geithner to roll out his private-public partnership plan.
Now whatever losses the banks can’t hide with revised accounting treatments, they can simply fob off on taxpayers via the partnerships. They got what they always wanted: A bad bank! An entity that will actually absorb losses from the asset side of the balance sheet! Shareholders and creditors don’t have to worry about further writedowns, not the ones that can’t be hidden anyway. Taxpayers will pick up the check!
Even better, the Geithner plan is so ridiculously complex—and public disclosure is likely to be so minimal—that toxic asset transfers are likely to happen largely out of view. Maybe Treasury will have to increase its borrowing substantially in order to fund the losses, but by that point everyone will be celebrating that banks have started lending again. Hooray!
By the way, are there ANY substantial protections to prevent banks from gaming this plan? What’s to stop them from acting as the equity investors in the partnerships, ponying up a sliver of equity to effect a transfer of toxic assets from their own balance sheets to the public’s? The FDIC’s FAQ for the legacy loans program doesn’t even address this particular Q. Is it not being frequently asked?*
This is all of a piece. The longer CEO/policy-maker collusion can delay loss recognition, the more time they have to invent ridiculous leverage schemes (more money printing! more government borrowing to fund “stimulus”! more FDIC “guarantees”!) to inflate those losses away…and to continue looting the public’s wealth.
But losses aren’t going away. Trading smaller private liabilities for larger public liabilities in order to artificially inflate asset prices does nothing to repair the economy’s aggregate balance sheet. At the end of the day, we’re still just lending more and more against a dwindling pool of real equity. The unwind is coming. Adding more leverage to delay it will only increase the pain.
Source: Rolfe Winkler
Friday, 27 March 2009
Today, it's a report by Cambridge Energy Research Associates (via NYT), that said the drop in oil investment and production will cause a “powerful and long-lasting aftershock following the oil price collapse.”
When demand picks up again, there won't be oil in place to support the expansion of the economy and we'll probably see another spike in oil prices.
It's just another alarm bell ringing on oil. The IEA warned in February that a lack of oil exploration would lead to a big spike in price once the economy gets going again. We said it again in March. Then Barclay's using a technical trend analysis said oil would definitely hit $57 soon, and would probably go to $60. And, of course, T. Boone Pickens clangs the bell every opportunity he gets.
Earlier this week McKinsey released 150 page PDF detailing why oil would run right back to $150 unless we changed a few things. Mckinsey suggested that we implement government policies so we can reduce the demand for oil, as it will be more difficult to control supply than demand.
Some of their suggestions:
In light vehicles we can apply more stringent efficiency standards which would cut oil demand by 2 million barrels a day.
Increase building and industrial efficiency could save 6 million barrels a day.
Remove trade barriers to sugar-cane ethanol, could abate oil-demand. Along with that require all autos to be fuel-flexible so they can take advantage of biofuels.
Reverse the shift to diesel passenger vehicles will save .5 million barrels per day of diesel.
Substituting boiler fuels, could abate 8 million barrels a day.
We are skeptical of any plan that calls for an increased reliance on biofuels. Maybe the government should consider subsidising oil production? We'd like to see the public reaction to that idea. As of right now, crude oil for May delivery is at $53.33 a barrel on the NYMEX.
Source: Business Insider
Investing in China and Dow 10,000
Thursday, 26 March 2009
However, almost all packages are based on the following assumptions:
1. The present crisis is a recession to disappear within one year or at the maximum two years, as it is only a short term phenomenon.
2. It is basically a problem of credit crunch.
3. The market is flooded with unsold industrial and consumer products.
4. Speedy recovery could be made by injecting more funds either by debt or deficit financing.
5. By ensuring easy credit and supporting banks and also one or two major industries, the crisis could be averted and recovery could be made soon.
The present Global Economic Crisis has been over simplified or presented as a mere financial meltdown or recession and it could be dealt by making available more funds to the consumers so as to create new demand for all the unsold items and thereby revive the market and ultimately bring back the boom. The required fund could be raised by either deficit financing or public debt, besides borrowing from other sources that could form the basis of further credit. All the assumptions are wrong with out any basis.
But the very assumptions of all these recovery packages are conceived without the backing of any sound theory and strategy or even history. Both the experts and rulers ignore the truth that the basic problem is not of the credit but of income and earning of the people to create a sustained demand and ensure reasonable saving and investment. If the newly created funds are flooded to the market, of course, most of the unsold items will be sold out and after that people may not have any more money or credit with them to make further purchases. That leads to another great catastrophe to appear more rigorously than ever.
Boom: Real or Illusion?
It is high time to re-examine the very truth and foundation of the so called boom that the global economy had undergone with the unbelievable availability of free credit for all. Almost all banks had offered unlimited credit, ten or twenty times over their liquidity or reasonable limit, that too without bothering the repayment capacities of the borrowers. For amassing very huge amounts as bonus, the bank men and CEOs had prepared inflated or fabricated statements about their assets, liquidity and profit without any basis by cleverly manipulating accounts, e-banking, e-credit and e-commerce. On the strength of the easily available credit cards and e-money, consumers had rushed to the market to buy even unwanted items, without bothering much about their real income and repayment capacity. That had made an illusionary boom, without the backing of real earning and actual purchasing power. In other words, the boom was not a real one.
Simple Economic Truth
No economy can survive long with mere credit based purchases without the backing of the real income and earning besides adequate saving and investments. Income and earning are very much related to resource allocation efficiency, over all productivity and competitiveness. Profitability depends upon demand and cost of production as savings depend upon thrift, earning, cost of living and taxation. Without a reasonable savings, no investment and innovation could be made.
It is equally important for a healthy economy to keep its cost of production and cost of living at the bottom. Further, there must be inter-sector balance with regard to growth and earning between various sectors, as all the sectors are equally important for the healthy survival of the global economy. The greatest blunder that we committed was giving dominance of Service Sector over Agricultural and Industrial Sectors that lead to the collapse of agriculture and then industries. The very reason for the present global crisis that has grown to the extent of the Great Depression II is the deliberate denial or rejection of the basic economic truth committed by all the economic and business players, including governments and international agencies.
The rate of consumption is not a true index of the soundness of an economy. Some times it shows the intensity of illness of a weak economy. If there is no hope or future, people or nations may spend every thing at the height of desperation's, including for defense expenditure and terrorism . It can be seen that in the entire history of mankind, the west and the newly rich regions spend trillions just for consumption for the last five years on the wrong belief that spending or consumption's lead to economic boom. This is the basis of Consumerism and Modern Marketing.
The unlimited spending on consumption drains away the entire saving and even dwindles the wealth of nations and individuals and turned everybody debtors. If governments thrive on deficit financing and individuals and families live lavishly and spend on credit, an economic collapse or a Great Depression is inevitable, as nobody can prevent it. In short, Consumerism has emerged as the greatest threat of humanity in the twenty-first century, as it begets Materialism and Terrorism besides Greed, Corruptions and Frauds.
The Hidden Threats
The stimulus packages so far announced are based on wrong or improper assumptions without taking into account the simple economic truth. Credit and banking have no existence or future if the whole economy is weak and sick. No stimulus package is effective or successful if it rejects the basic economic truth. The package must be aimed at improving the very foundation and health of the economy. Other wise, the packages with shorter objectives of selling out the unsold items in the market that too based on credit, will be self-defeating and bring out further crisis more rigorously, making the entire world suffer more and making future generations more debtors.
There is no short cut to solve the crisis other than putting the economy on a sound basis by improving the income and earning of the people besides their productivity and efficiency. In other words, the actual purchasing power of the people, even without the backing of credit, must be improved tremendously along with cutting the cost of production and cost of living, so as to ensure sustainable saving and investment. In other words, consumerism must be buried down at any cost for the very survival of humanity. Inter-sector and inter-regional imbalances must be rectified. It is a blunder to give too much faith or emphasis on Information Technology, Modern Management Techniques and the Service Sector. Since the problems are global in nature, their solutions too must be global. No country or people should be left in the efforts from a speedy recovery of the illness of the global economy.
It is high time to adopt a mature and balanced approach towards consumerism, marketing, credit, e-banking and e-commerce besides minimizing oil or energy consumption, development based on tour and travel and automobile. The world has more cars than it actually needs; we are burning more oil than our environment could afford and people are traveling more than what is needed for the wrong or mistaken logistics of their stay and work. Because of aggressive consumerism and marketing, just 8 % of the world population spend and consume as much as the rest of the world.
The wage and salary structure, including bonuses must be restructured so as to ensure some reasonable balance between agricultural, industrial and service sectors and between industries and services. Unreasonably high salary, bonuses and profits in some sectors or firms lead to greed, extravagance and the associated crimes that would affect their own very efficiency and survival.
UN and other intergovernmental and non-governmental agencies must come together to chalk out global strategies and policies to deal with the Great Depression II. The major religions of the world must play a pro-active role in minimizing the sufferings of the world population rather than spreading hate and revenge leading to terrorism.
What is commercial real estate? It's a $6.5 trillion market financed with $3.1 trillion of debt (Real Estate Roundtable, as quoted in WSJ).
Deutsche Bank estimates that commercial real estate prices will fall 35%-45%. That will make commercial real estate a $4 trillion market financed with $3.1 trillion of debt.
The main problem with commercial real estate debt, meanwhile, is not default risk but refinancing risk. Over the next few years, hundreds of billions of loans will come due, and banks won't be quick to refinance them again. As in residential real estate, lending standards have tightened and collateral prices--the real estate--have dropped.
Citigroup has already dumped $20 billion of its commercial real estate risk onto the taxpayer in one of its many bailouts. But it still has $38 billion left. The company has been rapidly increasing loan-loss reserves, but we'd guess not nearly fast enough.
Knowing what you know about Citigroup, what do you think the odds are that Citi has adequately reserved against its commercial mortgage portfolio?
By the way, Bank of America (BAC) and JP Morgan (JPM) are both carrying their commercial mortgages at 100%, too. Wonder what their reserves look like.
Here's more background on the Commercial Real Estate implosion from Richard Parkus at Deutsche Bank:
Deutsche Bank Commercial RE Q1 2009
Red Adair put out oil well fires by setting off gigantic explosions at the wellhead. "My belief is that the Fred Adair solution is to blow up or burn the OTC market in credit default swaps," Scholes said this morning. What that means, he elaborated, is that regulators should "try to close all contracts at mid-market prices" and then start up the market anew with clearer rules and shorter-duration contracts.
This was at a conference at New York University occasioned by a new collection of papers on how to fix the financial system, authored by a bunch of NYU Stern School faculty. Scholes kept saying Fred Adair. Sometimes he'd notice and correct himself, sometimes he wouldn't. The FT's John Gapper, who was on a panel with Scholes, finally speculated that this was because the government response to the financial crisis has been such an unwieldy mix of Fred Astaire (dancing around the problems) and Red Adair (doing something to fix them). Scholes did not disagree.
The blow-up-the-CDSes option is intriguing, and I'm going to check in with Scholes later to see if he wishes to elaborate. But for now, a few more notes from the panel, which was moderated by Paul Volcker and also featured NYU finance professor Matt Richardson:
Some would say Scholes is partly to blame for this whole mess, and Volcker dropped a couple of hints in that direction. Scholes didn't exactly accept responsibility, but neither did he give a blindered, Chicago-style defense. For one thing, he cited John Maynard Keynes—still a nonperson to many of Scholes's fellow Chicago Ph.Ds—arguing that we're currently stuck in a situation where the financial system needs to deleverage, but its current deleveraging is causing asset values to plummet, meaning that it's not succeeding in deleveraging at all (that is, debt is down, but so is the value of everybody's capital, so leverage ratios aren't declining). For another, he seemed to agree with one of the main criticisms of the Wall Street risk models that evolved in part from Black-Scholes—that they have some ability to capture the risks faced by one investor operating in a financial market that the investor is too small to influence, but aren't much good at capturing the risks faced by the entire market. "Risk aggregation is not linear," he said. "It's nonlinear." (This is what Chapter 13 of The Myth of the Rational Market is about. Doesn't that sound exciting?)
As the moderator, Volcker didn't say all that much. He did talk for a bit, though, about how "maybe we ought to have a two-tier financial system," with a heavily regulated "core part that I will for purposes of simplicity call commercial banking" and a less-regulated outer realm of hedge funds, proprietary trading desks, and such. Hmmm, said Gapper, that "reminds me of something I once heard of called the Glass-Steagall Act." This Glass-Steagall revivalism is happening all over. I'm even beginning to feel the spirit. But Gapper had an interesting question: "If you wanted to set up a new Glass-Steagall, where would you draw the line?"
Scholes finally got his free-market Chicago dander up over the possibility of synchronized global financial regulation—something that Volcker has been advocating as chairman of the Group of Thirty project on financial reform—sparking this entertaining exchange:
Scholes: If we internationalize everything, we end up with rules that stifle freedom and innovation. Mr. Sarkozy and others say our system has failed and we should adopt theirs. Do we want to become French?
Volcker: I'm not an acolyte of Mr. Sarkozy.
Gapper: Actually, the French banks are big derivatives users.
Volcker: The U.S. is no longer in a position to dictate to the rest of the world.
Both Citi and BofA each have received $45 billion in federal rescue cash meant to help prop up the economy and jumpstart the housing market.
But the banks' purchase of so-called AAA-rated mortgage-backed securities, including some that use alt-A and option ARM as collateral, is raising eyebrows among even the most seasoned traders. Alt-A and option ARM loans have widely been seen as the next mortgage type to see increases in defaults.
One Wall Street trader told The Post that what's been most puzzling about the purchases is how aggressive both banks have been in their buying, sometimes paying higher prices than competing bidders are willing to pay.
Recently, securities rated AAA have changed hands for roughly 30 cents on the dollar, and most of the buyers have been hedge funds acting opportunistically on a bet that prices will rise over time. However, sources said Citi and BofA have trumped those bids.
The secondary market represents a key cog in the mortgage market, and serves as a platform where mortgage originators can offload mortgages in bulk that have been converted into bonds.
Yields on such securities can be as high as 22 percent, one trader noted.
BofA said its purchases of secondary-mortgage paper are part of its plans to breathe life back into the moribund securitization market.
"Our purchases in [mortgage-backed securities] increase liquidity in the mortgage market allowing people to buy a home," said BofA spokesman Scott Silvestri.
A Citi spokesman declined to comment, though people familiar with the bank say it argues the same point.
Citi's and BofA's purchases highlight the challenges both banks face while operating under intense public scrutiny.
While some observers concur that the buying helps revive a frozen market, others argue the banks are gambling away taxpayer funds instead of lending.
Moreover, the MBS market has been so volatile during the economic crisis that a number of investors who already bet a bottom had been reached have gotten whacked as things continued to slide.
Around this same time last year some of the same distressed mortgage paper that Citi and BofA are currently snapping up was trading around 50 cents on the dollar, only to plummet to their current levels.
One source said that the banks' purchases have helped to keep prices of these troubled securities higher than they would be otherwise.
Both banks have launched numerous measures to help stem mortgage foreclosures, and months ago outlined to the government their intention to invest in the secondary market to expand the flow of credit.
Geithner’s plan, unveiled three days ago, is aimed at financing as much as $1 trillion in purchases of illiquid real- estate assets, using $75 billion to $100 billion of the Treasury’s remaining bank-rescue funds.
Roubini echoed criticism from Nobel laureate Paul Krugman that the proposal will not be enough for those banks that are insolvent and predicted that ultimately the government will have to take over more of them. He didn’t name which companies he thought would need to be rescued.
“Some banks are going to have to be nationalized and for them the plan doesn’t apply,” Roubini said in an interview with Bloomberg Television in London today.
While the Standard & Poor’s 500 Index is recording its best monthly rally in 17 years, Roubini predicted it will not be sustained as the U.S. economy will continue to contract through this year and investors will start “discriminating” between solvent and insolvent financial companies.
“People are going to be surprised to the downside,” Roubini said.
The government is conducting stress tests of banks to determine how much more capital each will need. Roubini said once those were completed it will be evident that some banks will need to be taken over and have their good and bad assets separated before being returned to the private sector.
Critics of Geithner’s plan including Krugman, a professor at Princeton University, say the government should take over banks loaded with devalued assets, remove their top management, and dispose of the toxic securities. Sweden adopted the temporary nationalization approach in the 1990s.
Roubini, who also runs his own economics consultancy, estimates a total of $3.6 trillion of loan and securities losses in the U.S., including writedowns on $10.84 trillion of securities and losses on a total of $12.37 trillion of unsecuritized loans.
With “deflationary forces” lingering for as long as three years, Roubini said U.S. government bond yields were going to remain relatively low and that American house prices would fall as much as 20 percent more in the next 18 months. While the dollar will benefit as investors seek safe havens, it will ultimately decline as the U.S. trade deficit has to shrink, he said.
The need for governments to issue more public debt to fund stimulus and bank-rescue packages risked more downgrades to sovereign debt and the failure of more government auctions as happened in the U.K. yesterday, Roubini said.
Wednesday, 25 March 2009
Hannan tells Gordon Brown the truth which he will not accept but we all know to be true.
However, RPI at zero and CPI at 3.2pc reveal as much about flawed statistical measures as any change in how the economy is behaving. The inflation figures were strong only in the same way that a fish thrashing in the bottom of a boat can be surprisingly energetic, but not something that lasts.
Tuesday, 24 March 2009
(At the bottom, there’s an extra credit question. And there’s a prize for being first to get it right!)
Having taxpayer’s absorb the banks’ bad assets means equity holders are no longer in line to eat those losses. Take Citigroup stock for example. At $1 a share, C’s shareholders were essentially buying a call option on the possibility that the government would rescue them from their bank’s terrible mistakes. It’s a small bet with potentially huge upside.
On a stand-alone basis, the bank is insolvent. It’s equity is worthless and much of its debt would be in line for a huge haircut. But if the government is going to absorb the bank’s toxic assets, then suddenly the balance sheet looks a heck of a lot better.
A busted bank balance sheet is very similar to an upside down mortgage. Understanding the mechanics of the rescue is to understand why equity is miraculously increased…
OA’s erstwhile example uses an imaginary condo buyer, who in 2006 plunked down $1 million for a phat pad that in 2009 is only worth $500k. His original equity investment was his $50k downpayment; the other $950k was financed with a mortgage. The condo buyer’s before and after balance sheet looks like this (recall assets = liabilities + equity):
Condo Buyer, 2006—$1m condo = $950k mortgage + $50k downpayment.
Condo Buyer, 2009—$500k condo = $950k mortgage - $450k equity
This is what it means to have “negative equity.” The value of the asset isn’t high enough to pay off the liability, so equity is negative. Someone has to eat the loss. It should be the bank. After foreclosing on the buyer (assuming he stops paying his mortgage), the bank has to sell the house at the $500k market value and write off the $450k portion of the mortgage it’s never going to collect.
So here is the bank’s balance sheet:
Bank, 2006—$950k mortgage loan = $400k consumer deposits + $400k debt + $150k shareholder equity.
Bank, 2009—$500k mortgage loan = $400k consumer deposits + $400k debt - $300k shareholder equity.
The bank’s stock is just a single share of its total equity. If equity is negative, then the stock is $0. In the example, there’s still $300k of losses to absorb after equity is wiped out. This puts the bank into bankruptcy, where creditors have to fight it out to determine how they’ll share the losses.
But the bank hasn’t been forced to write down the value of the mortgage just yet. It hasn’t foreclosed on the home just yet, so its day of reckoning is delayed. The market knows the writedown is coming, so the stock trades at a paltry sum, probably $1 or less. Why does it have any positive value? Because it’s possible the government will still rescue the bank.
To do so, the government has to do something about the toxic asset on the left side of the equation. This is how the Geithner plan miraculously repairs the bank’s equity. Using government money, he creates a brand new balance sheet to buy the $950k mortgage from the bank at close to that price.
The Fed prints money to buy Treasury bonds–>the Treasury uses proceeds of the bond sales to finance its public-private partnership vehicle–>the vehicle buys the toxic asset, the mortgage, for $850k let’s say.
Here is the vehicle’s balance sheet:
Vehicle, 2009—$850k mortgage = $720k FDIC debt + $65k Treasury equity + $65k private equity.
Having paid $850k cash for the bank’s mortgage, suddenly the bank’s balance sheet is rescued:
Bank, post Geithner plan—$850k cash = $400k deposits + $400k debt +$50k equity.
Suddenly the bank again has positive equity value. Shareholders are saved! The stock market skyrockets!
Ah, but like a good economist, you note that there’s no free lunch. The condo is still only worth $500k. Who eats the additional $350k loss? Well, you do.
Vehicle 2010—$500k mortgage = $720k FDIC debt - $220k Treasury equity + $0 private equity.
The money loaned to the vehicle is non-recourse, so the private partner stands to lose no more than his initial investment. It’s Treasury and FDIC, i.e. you and me, that ends up eating the loss.
And that’s how you use taxpayers’ money to rescue a bank.
Source: Rolfe Winkler
“The practical implications of this is bankruptcy for the United States,” Gregg said of the Obama’s administration’s recently released budget blueprint. “There’s no other way around it. If we maintain the proposals that are in this budget over the ten-year period that this budget covers, this country will go bankrupt. People will not buy our debt, our dollar will become devalued. It is a very severe situation."
Monday, 23 March 2009
In short, because the plan is yet another massive, ineffective gift to banks and Wall Street. Taxpayers, of course, will take the hit.
Why does Tim Geithner keep repackaging the same trash-asset-removal plan that he has been trying to get approved since last fall?
In our opinion, because Tim Geithner formed his view of this crisis last fall, while sitting across the table from his constituents at the New York Fed: The CEOs of the big Wall Street firms. He views the crisis the same way Wall Street does--as a temporary liquidity problem--and his plans to fix it are designed with the best interests of Wall Street in mind.
If Geithner's plan to fix the banks would also fix the economy, this would be tolerable. But no smart economist we know of thinks that it will.
We think Geithner is suffering from five fundamental misconceptions about what is wrong with the economy. Here they are:
The trouble with the economy is that the banks aren't lending. The reality: The economy is in trouble because American consumers and businesses took on way too much debt and are now collapsing under the weight of it. As consumers retrench, companies that sell to them are retrenching, thus exacerbating the problem. The banks, meanwhile, are lending. They just aren't lending as much as they used to. Also the shadow banking system (securitization markets), which actually provided more funding to the economy than the banks, has collapsed.
The banks aren't lending because their balance sheets are loaded with "bad assets" that the market has temporarily mispriced. The reality: The banks aren't lending (much) because they have decided to stop making loans to people and companies who can't pay them back. And because the banks are scared that future writedowns on their old loans will lead to future losses that will wipe out their equity.
Bad assets are "bad" because the market doesn't understand how much they are really worth. The reality: The bad assets are bad because they are worth less than the banks say they are. House prices have dropped by nearly 30% nationwide. That has created something in the neighborhood of $5+ trillion of losses in residential real estate alone (off a peak market value of housing about $20+ trillion). The banks don't want to take their share of those losses because doing so will wipe them out. So they, and Geithner, are doing everything they can to pawn the losses off on the taxpayer.
Once we get the "bad assets" off bank balance sheets, the banks will start lending again. The reality: The banks will remain cautious about lending, because the housing market and economy are still deteriorating. So they'll sit there and say they are lending while waiting for the economy to bottom.
Once the banks start lending, the economy will recover. The reality: American consumers still have debt coming out of their ears, and they'll be working it off for years. House prices are still falling. Retirement savings have been crushed. Americans need to increase their savings rate from today's 5% (a vast improvement from the 0% rate of two years ago) to the 10% long-term average. Consumers don't have room to take on more debt, even if the banks are willing to give it to them.
In Geithner's plan, this debt won't disappear. It will just be passed from banks to taxpayers, where it will sit until the government finally admits that a major portion of it will never be paid back.
After all, we’ve just been through the firestorm over the A.I.G. bonuses, during which administration officials claimed that they knew nothing, couldn’t do anything, and anyway it was someone else’s fault. Meanwhile, the administration has failed to quell the public’s doubts about what banks are doing with taxpayer money.
It’s as if the president were determined to confirm the growing perception that he and his economic team are out of touch, that their economic vision is clouded by excessively close ties to Wall Street. And by the time Mr. Obama realizes that he needs to change course, his political capital may be gone.
Even more important, however, is the way Mr. Obama is squandering his credibility. If this plan fails — as it almost surely will — it’s unlikely that he’ll be able to persuade Congress to come up with more funds to do what he should have done in the first place.